Bus Orgs Outline (2nd)Agency+Corp

CORPORATIONS OUTLINE What is a Corporation?

o An artificial person or legal entity created by or under the authority of a state. Corporations can own property, sell property, enter/breach contracts,

sued/be sued, etc. Can only act through agents (directors, officers, employees, etc.) Has no expiration date.

o Divided into 3 groups – 1) Shareholders

Individuals; own shares 2) Directors

Elected to oversee operations 3) Officers

Appointed to run the corporation

AGENCY – R3dA 1.01-04 Restatement 3rd 1.01: Fiduciary relationship which results when one person, a

principal, manifests assent to another person, an agent, that the agent shall act on the principal’s behalf and subject to principal’s control and the agent manifests or otherwise so consents to act.

o No contract required, can be formed verbally, by deed, simple writing, or mere employment

o Creation of agency has both inward-looking and outward looking elements Inward – legal ?’s about alleged principal and alleged agent Outward – focus more on interactions between agent and 3rd party

§ 1.02 : Whether relationship is characterized as agency in an agreement between parties or in the context of industry or popular usage isn’t controlling.

o 2 types of authorization – 1) Express; 2) Implied Express – specifically said agent could do activity Implied – agent has act to achieve, so can do what is implied to complete

that act. Principal is liable for things he didn’t authorize.o U.S. v. Cyberheat (Cyberheat’s affiliates sent unconsented to emails, violating

statute. Gov’t contends that Cyberheat should be held liable based on actions of affiliates)

3 Factors: 1) the principal’s right to control the alleged agent;

o Control is the right to give interim instructions/directions 2) alleged agent’s duty to act primarily for the benefit of the

principal; 3) alleged agent’s power to alter the legal relations of the

principal It is the substances of the relationship, not the label the parties give it. A principal will be held liable for agents wrongdoing upon matters

which they might reasonably expect would be the subject of representations, even if unauthorized, as long as 3rd party doesn’t know they are unauthorized.

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Up to a jury to look at whether Cyberheat exerted or could/should have any control/supervision over affiliates based on materials provided. Also look at knowledge of Cyberheat regarding violations, and if actions taken were reasonable under circumstances

RULE: control is key, what is important is if you control the agent, then there is agency, if not controlling then no agency relationship

AGENT’S FIDUCIARY DUTIES TO PRINCIPAL R3dA 8.01-05 Loyalty § 8.01: Agent must act loyally for principal’s benefit in all matters connected with

the agency relationship o Includes obligations to: (8.05)1) not use or communicate confidential info of

principal for agent’s own purposes or those of a 3rd party; (8.04) 2) don’t compete w/ principal in any matter w/in scope of relationship; (8.03) 3) don’t act as adverse party to principal in transaction connected w/ agency relationship

o Food Lion v. Capital/ABC – (ABC employees went undercover and worked at Food Lion, and exposed bad practices. Is this a violation of duty of loyalty?)

Tort of Breach of Duty of Loyalty when: 1) Compete directly w/ employer; or 2) Misappropriates employer’s profits or property; or 3) breach employer’s confidences

Default duty of loyalty: don’t do activities against interests of employer. Act solely for benefit of principal in all related matters.

Rule in place if no contract or agreements otherwise Economic logic under default rules b/c individualized

contracts would take forever. Lowers cost of transactions and catch loose ends.

Mandatory Rules: ex. criminal laws. Always wrong to kill someone, so can’t agree otherwise.

Reach of agency law stops when employment ends Reason for Non-Competes:

o Must be reasonable in 1) Geography, 2) Scope of Work, 3) Time; b/c otherwise biz would be crippled b/c nobody could work.

RULE: Found breach of duty b/c requisite intent to act against interests of employer.

ATTRIBUTION UNDER AGENCY LAW o Rules of Attribution: Outward Looking Consequences – Bind Principals & 3rd

partieso Principals can be held liable for tortious actions of their agents, and can be

required to fulfill contracts into which their agents have entered.o Restatement 3 rd 1.01 comment: the chief justification for principal’s

accountability for the agent’s acts are the principal’s ability to select and control

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the agent and to terminate the agency relationship, together w/ the fact that the agent has agreed expressly or implicitly to act on principal’s behalf

Control, Benefit, Consent important concepts Those who gain from the actions of another should sometimes be

held to answer for costs inflicted by those actions Consent is central to finding when agency relationship exists, and

thus when it’s fair to impose liability on the principal for actions of the agent.

Vicarious liability – respondeat superioro Actual Authority: Principal has actually said to the agent go and do something

on my behalf. Principal consents to the agent taking actions on principal’s behalf.

Express Actual Authority: all the details of Authority is specified in the communication between Principal and Agent. Must be conveyed orally or in writing.

Express Implied Authority: When you give someone ACTUAL AUTHORITY (ex. run my business) there is many things that are implied w/ this authority to fulfill the agency

Castillo v. Case Farms of Ohio, Inc (Under oral contract ATC was recruiting for Case Farms, but employees promised so much and whem they got to the job they got nothing/treated badly. Plaintiff’s sought to recover from Case farms believing they were the Principal to ATC)

Must evaluate the communications from the principal to the agent.

There was agency here. Express authority to recruit and hired people, and Implied authority to do all things proper, usual, and necessary to exercise that authority.

o Also no distinction between employees; and paychecks came from Case Farms.

Common law: Where express authority, also implied authority RULE: Principal is liable for actions of agency only if those

actions are taken in scope of agent’s employment.o Case Farms responsible for ATC’s actions

Very fact specific inquiries to determine type of authority.o Apparent Authority and Estoppel – R3dA 2.03-04, 3.03

One person may bind another in a transaction with a 3rd party, even in the absence of actual authority, when the 3rd person reasonably believes based on “manifestations” by the purported principal that the actor is authorized to act on behalf of the purported principal.

Apparent Authority is basis for Liability in 2 situations: Where person appear to be agents, even though they don’t qualify

under the definition Where agents act beyond the scope of their actual authority

Difficulties revolve around notion of Manifestation – person manifests consent or intention through written or spoken words or other conduct.

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Ex. Prior Dealings; “My agent will contact you..” Communications from the principal need not be directed to 3rd

person before apparent authority is created and need not use word “authority”

2 key points to finding apparent authority 1) manifestation (however defined) must emanate from the

principal (or purported principal) and must be received (either directly or indirectly) by the 3rd person

2) Scope of the agent’s apparent authority depends on the 3rd person’s reasonable interpretation of that manifestation.

o Subjective and objective components: Cts consider prior dealings btwn parties, customs that apply in particular setting, and nature of the proposed transaction.

o Reliance is not req’d to establish, but rather is an element of estoppel.

Implied Apparent Authority – you know someone is doing things not authorized to do as your Agent but you don’t stop them - MINORITY

Implicates issues of control, benefit, consento Estoppel – non-agency doctrine that’s similar to apparent authority in that

both are created when the principal leads a 3rd party to believe that an agent is authorized to act on the principal’s behalf, even though no such authority has been granted.

Distinguished from apparent authority by: 1) Estoppel requires 3rd party to change position in reliance on the

principal, whereas a principal may be bound under apparent authority even in the absence of such detrimental reliance.

2) Estoppel allows the 3rd party to hold the principal liable when reliance and harm are so great that remedy would be created, but does not give the principal any rights against the 3rd party.

o Both Apparent Authority and Estoppel require communications between principal and the 3rd party

In attempt to base liability in consent of principal, above docrines lost notion that principals could sometimes be held liable merely b/c of status.

In cases of customary authority, courts hold principals liable to extent that custom would justify reliance by 3rd party

o Apparent Authority NOT present when 3rd party believes that an interaction is with an actor who is a principal. AA can’t exist in cases involving an undisclosed principal

o Inherent Agency Power – Principal hasn’t authorized agent at all, but principal is bound by agent’s action for reasons of fairness. ABANDONED!!

Bethany Pharmacal v. QVC – (Company was going to sell their product on QVC believed they were chosen b/c they thought Janice was an agent of QVC b/c of certain manifestation of assent

IL law agency exists if:

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o 1) the principal consents to or knowingly acquiesces in the agent’s conduct

o 2) the 3rd party has a reasonable belief that the agent possesses authority to act on the principal’s behalf

o 3) 3rd party relied to his detriment on the agent’s apparent authority.

o MINORITY LAW- agency can be created through silence

Court found that Bethany didn’t prove that QVC took steps that would make a reasonable person believe that Janis had authority to contract on it’s behalf. QVC consistently maintained Bethany was alternate, and upon hearing of Janis’ error, kept stating that a valid contract could only be created by a purchase order from QVC

Janis initiated contact with vendors, her conduct did not constitute a manifestation by QVC to 3rd party that Janis had authority to contract on their behalf. At no point did QVC represent Janis as their agent.

RULE: Determine AA by evaluating principal’s conduct towards 3rd party.

Respondeat Superior – R3dA 2.04o Only covers employeeso §2.04 - Employer is liable for torts committed by an employee within the scope

of employment. Don’t have to prove principal did anything wrong. Restatement 2nd distinguished btwn independent contractors and

employees 10 Factors to be used in determining whether one acting for

another is an employee or an independent contractor, including such: where work is done, whose tools are used, who directs specifics of the work, how person is paid, etc

3rd restatement eliminated that and just defined R3dA§ 7.07(3)(a) employee: agent whose principal controls or has right to control the manner and means of the agent’s performance of work. Labeled “employee” and “non-employee” now.

o Many people use respondeat superior to go after deep pockets of employer.o Limited Liability – shareholders aren’t responsible for paying judgments

against a corporation if the corporation doesn’t have the resources to pay such judgment, despite the idea of the shareholder being the principal and corporation, its agent.

o Ware v. Timmons –( Timmons underwent surgery and died from post surgery anesthesia complications. Mother is suing Dr. Ware under resp. superiof for Nurse Hayes actions)

Must establish master-servant relationship between employer/employee Alabama law – master must have the right to select the person claimed

to be a servant. Must be consensual relationship

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Dissent : felt control over picking agent isn’t as important as control over her actions at the time.

To prevail just prove: Negligence at time she was agent of Dr. and 2) negligence occurred within scope of employment by Dr.

Policy : as patients would want Dr. to be responsible for agent, whether he picked them or not.

o ISSUES: 1) Control

The Principal will to some extent control the agent The principal to some extent control the 3rd party’s reliance on

the agnet 2) Benefit

Principals benefit from their Agents doing work for them SO only right that they be responsible if something goes wrong

as well 3) Consent

Principal must manifest some type of consent to the Agent to act in his behalf, otherwise there is no Agency relationship

o Krispy Kreme Case A contract in the Franchise agreement specified that there is NOT an

agent/principal relationship. This helps for internal purposes. But if there is a tort, franchisor is going to be found responsible for franchisee’s actions

Principal owes agent – good conduct, noninterference Law doesn’t provide remedy really for principal’s hurting agents

Reasons for barring suit by agents against principals: Franchise agreement is meant to shift risk from OR to EE.

ORGANIZING AND STRUCTURE OF A CORPORATION MBCA . 2.01 – 03, 2.05-06o Corporation: legal fiction with qualities:

o 1) Centralized Managemento 2) Continuity of Lifeo 3) Transferability of ownershipo 4) Limited Liability

For shareholderso Participants

o Shareholders (equity) Have limited Rights:

Right to Vote on fundamental transactions, and elect directors Sell their stock Right to Sue

“owners” of the corp. Limited liability Control in public corps: through annual elections of directors, and voting

on specific proposals when allowed

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Control in close Corps: mechanisms of control exercised by SH, often govern by prior agreement in contracts among selves, very dominant.

o Directors Elected by shareholders, to manage Corporation, supervise

officers. No authority to act as individuals. They are the agents, they can be sued by shareholders if they

don’t do what they promise to doo If they promise to do X but do Y and the value of the

Stock goes down directors will get sued by Stockholders Hire and Fire officers

o Officers (CEO, President, CFO) Do the day to day management of the corporation. Make many of the

decisions that define a corp’s activities. Little law about officers.o Employees (non-officers)o Creditors (Debt)

Invest money into the Corporation, they have no right to vote but they have a lot of interest in the Corp b/c they are affected by what the corp does.

Get paid first if the Corp liquidates or gives out dividendso 2 kinds of corporations

o Publicly Traded Corporation Separation of control, Directors, Shareholders, Officers Disparate constituencies Federal Securities Law disclosure

Disclosure obligations – quarterly and annuallyo Federal fees are huge when people do not follow

securities law Control mechanism of Accountability

o Shapes both kinds of decisions managers make and investment and voting decisions of SH

Hostile Takeovers Public corp are subject to them since no single person control the

corpo Close Corporation

Usually all the control is held by the Shareholders, through shareholder agreements

Private (for profit) Corporations Small amount of shareholders No public market for shares

Private (not for profit) Corporations Do not issue stock at all

Professional Service Corporations Shareholders have to be members of the profession. Think of a

lawyers that are Partners of a Firm Only prohibited against fraud, no disclosure minimums

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Motivated more by initial costs of corporation and annual maintaining costs, rather than a highly sophisticated corp law system.

o Sources of Corporation Lawo State - Each state has its own corporations lawo Internal Affairs Doctrine – corporation located in one state, can legally

reincorporate in another state and its state of affairs are subject to law of the new state.

o Federal Law – only important with publicly traded companieso Model Act

o Starting a Corporation – Incorporationo Most statutes only require one person to form a corp. Comes into existence when

AOI filed with state.o Charter (DGCL §102; MBCA §2.02(a))

General Term that describes the Certificate of Incorporation or The Articles of Incorporation.

This is the document that creates the corporation and sets forth a variety of rules that set forth the rules between the shareholders and the Corp as well as the Shareholder and the Directors

It states what directors and shareholders can and cannot do Must Include:

Name of corporation Number of authorized shares of stock Name and address of registered agent in the state of incorporation DGCL requires: include the purpose of the Corp, which usually

is general “to engage in any lawful purpose for which a Corp may be organized”

May Include: Anything can be put into the charter and it will be legally enforceable

Initial Directors: may provide names and addresses of initial directors

Corporate Purpose: DGCL requires it but under Model Act (2.02(b)(2)(i)) it is optional

o Limitation on charger can be enforce by SH suit, Suit by corp against directors/officers, or judicial dissolution

Management Provisions: Provision for manage the business and regulating the affairs of the Corp, this insulates them from change by Shareholders

o Example: Need “cause” to remove a director from board at any time other than annual meeting

Bylaw provisions Director Liability: called an exculpatory provision. Need this

provision to be exempt from certain liability. Some states have self-executing which allows directors to be automatically excused from liability

DO NOT REQUIRE: Duration and Initial Capital Must file with the Secretary of State

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As long as Articles of Incorporation meet § 2.02 secretary shall file them.

o Organizational Meeting (DGCL §108; MBCA §2.05) The purpose of this meeting is to document asset contribution to the

Corp, Issue Stock, Appoint Directors, Form the By-Laws Many times when it is a small Corp, this meeting does not take place.

o Bylaws (DGCL §109; MBCA 2.06) Contains provisions for managing the Corp, but can’t be inconsistent

with the articles of incorporationo Grant v. Mitchell (3 people started a company and then turned it into a Corp.

Grant was the money guy along with Mitchell and Melzer who were the ones doing the hard work. Incorporated but never named a board)

Named Mitchell to the board in the Foreign Corporation Certificate. Law firm says Grant never held official board meeting, and thus, Grant

had a meeting with himself as sole incorporator and named himself sole director.

RULE: Can’t incorporate by accident, documents filed under penalty of perjury that named directors at incorporation

Fine point of Corporation Lawo Meeting Minuteso Making/using bylawso Encourage clients to take care of details

o Charters are usually thin Most complicated things are contained in the bylaws

Approved by shareholders Requires majority vote of only shareholders or board of directors

to change bylaws If you don’t trust board, put something in the charter b/c then it’s

almost impossible to change.o Capital Structure –

o Combination of claims sold by the Cropo 2 groups of claims

1) Equity – power to control (stock and right to receive fruits of the business through dividends, distribution, liquidation)

2) Debt – fixed obligation of repayment independent of the success or failure of the business

o Equity Articles of Inc./Charter must set forth total number of shares corp is

authorized to issue Distinctions between holders done by separate SERIES within class Issued – when they are sold

Oustanding – SH holding them Treasure Shares – repurchased, issues but not outstanding.

Eliminated by MBCA Articles of Inc. typically designate shares as common shares or

preferred shares

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Common Stock – simplest kind of shareo Residual ownership interests – get what is left after

everything else paid offo Dividends not guaranteedo They do receive voting rights (voice) and liquidity rights

(exit) o Right to enforce fiduciary duties (loyalty)o Unlimited voting rights (including right to vote for

directors)o Can be issued in multiple classes of common stock

Different voting power for different types of common stock

Preferred Stock – hybrid of debt and common stock. laid out in MBCA 6.01, DGCL 151

o Might earn fixed dividends and is entitled to fixed liquidation rights; has face value

o Created through quasi contracto Senior to common shares, but junior to claims of

debtholders and creditorso Cumulative dividends – if not paid one year, corp still has

to pay them before future dividendso Participation rights – right to participate w/ common

stock in any dividends declared on the commono Generally does NOT have voting rightso Conversion rights – option to convert into other stock of

the corpo Antidilution Rights – take into account changes that have

occurred in amount of common stock outstanding since preferred issued

o Redemption – can be at option of corporation or shareholder

Par Value o Artificial dollar amount specified in AOI, amount that

must be paid so shares are considered “fully paid”o Diminishing importance, no relationship to market value

companies set it at 1 cent now, so can sell at whatever price they want.

most comps don’t’ even have par value DE need to set PV or else taxes will be assessed

on other money =malpracticeo DEBT – not described in AOI

Registered Securities – holders name in registry Bearer Securities – paid to whoever presents coupons Sold by the company Usually takes form of bonds (usually secured by corporate assets)

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Debentures (unsecured debts) Board has discretion to issue debt securities Contract to pay interest on a schedule, and then repay principal on

specified date, sometimes at discretion of Corp Indentures – define payment priority of the debt to other debts No fiduciary duty Not risky Some are convertible and can be turned into common stock Can contract for certain covenants that corp refrain from, or order in

which to be paid. Ratings – rated by private organizations as highly or poorly secured.

Debt issued b/c (1) interest payments on debt are deductible to comp, dividuends to SH are not; (2) repayment of principal is nontaxable return of capital to investor, dividends are ordinary income to investor; (3) if company fails, bad debt may be ordinary loss, but loss of stock is capital loss to investor.

Leverage – borrowers may use borrowed money to generate returns greater than cost of borrowing

o LIQUIDATION PREFERENCE If company fails:

Employees get salary Assets attached to loans Bond holders get paid Preferred shareholders Common shareholders (if anything left)

o Grimes v. Alteon (oral promise by CEO to sell investor add’l stock at certain price if more was issued, before it went to market, is it valid?)

Promise was not approved by the board and was not in writing – NOT VALID

DGCL §152 – reserves for the board the right to determine the amount to be received for shares

DGCL §157 – pre-emptive right must be approved by board Court defines rights: something that is due to a person by just

claim that is legally enforceable. Court says §157 applies to rights, not just options, and that this is a right

under 157 if it grants the oblige the ability to require the obligor to issue stock offering even though obligation is conditioned upon duty of oblige to buy offering

Reasoning behind Rules To consolidate in its BOD the exclusive authority to govern and

regulation a corp’s capital structureo The ability to issue/limit new stock is essential powero Don’t want to tie company’s hands in the future

To ensure certainty in the instruments upon which the corp’s capital structure is based.

DIRECTORS AND SHAREHOLDERS – Corporate Governance

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Directorso Role: Manage Corporation (8.01(b)

o Every public corp must have a board, closely helds don’t – MBCA 8.01(a) , 7.32o Do not manage the Corp on a day to day basis, those duties are delegated to the

employer, but the important decisions are discretionaryo Charter may prescribe director qualifications – MBCA 8.02o Allowed to have one director, exact # specified in charter/bylaws MBCA 8.03o Manage or supervise the management of the corp. In public corp, this role

includes hiring, advising, supervising, and firing the chief executive officer of the corp. Most board of public corporations play a limited role in the management of the corp except in crises

o Type: Inside v. Independent Inside Directors:

Have something significant staked in the Corp (many times they are also employees such as the CEO)

They have different concerns then Outside directors have Outside/Independent Directors

Theory that Corp governance is better if you have Outside Directors managing the Corp

Don’t work for corp There are other ideas that they can bring outside ideas Strong desire to have outside directors; less conflict of interest

situations; greater independent decision making Little companies don’t have to have Outside Directors usually

o Term and Termination Term: generally directors serve for a year then they have to be re-

elected. All directors are elected by shareholders at an annual SH meeting, unless their terms are staggered

Classified/Staggered Board (MBCA 8.03(c) and 8.06) Certain directors are designated by a particular class of

stockholders (Classified) Staggered Board – directors are elected for certain terms, so that

all the directors terms are staggered, so directors 1-3 elected for 1 yr terms, directors 4-6; 2 yr terms, etc.

o Important mechanism for helping existing directors maintain control, avoid hostile takeovers

Early Termination (MBCA 8.08) Shareholders under certain conditions can fire directors If you have staggered or Classified board then you can’t just fire

them but have to fire them for cause May be removed with or without cause unless charter provides

that can only be for cause. Vacancies

Directors may resign at any time, usually by delivering a written notice of resignation. MBCA 8.07(a). Vacancies may be filled yb remaining directors or by SH. MBCA 8.10(a)

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Meetings/Actions on consent Director considered present if participate in meeting by phone or

similar device that allows directors to hear each other MBCA 8.20(b)

Can act without holding meeting. Action by written consent if unanimous director consent, as long as charter/bylaws don’t say otherwise. MBCA 8.21

Special Or Regular Meeting require notice of date, time, and place of meeting, not necessarily purpose unless required by charter/bylaws MBCA 8.22.

Directors may waive notice of meeting, in writing or by participating in the meeting. MBCA 8.23

Majority of directors being present satisfies quorum req’ts, but charter/bylaws of corp may alter req’ts to specify more or less of majority. MBCA 8.24 (a) and (b)

o Committees Can act through committees primarily/exclusively of outside directors.

MBCA 8.25 Rules governing BOD also govern committee meetings Committee actions may carry same weight as board actions Corp statutes limit matters handled by committee 8.25

Actions needed to be put to SH vote, not to committeeo Shareholder Voting

o Each share of common stock carries one vote (MBCA §7.21)o Shareholders vote on election of directors, and fundamental transactions 8.03, 08

Things they can vote on: amending charter; bylaws; merger; sale of assets not in OCB; dissolution of comp; conflict of interest transactions

o Vote at SH meeting or by proxy. MBCA 7.22o Majority vote wins except in director elections when plurality required. MBCA

7.28 Most of these rules can be altered within limits by provisions in

charter/bylawso Proxy Voting

Authorization given by a SH to another person to vote the SH’s shares. DGCL 212(b); MBCA 7.22(a)

o Voting Rules Straight Voting

Each SH votes all of his shares with respect to each open seat on the board.

o Ex. 100 shares. 9 Seats. 100 shares gets voted 9 times. Cumulative Voting

SH concentrate voting power bot voting all shares in a block for a limited number of nominees.

o 100 shares, 9 seats. Could vote all 900 for a single candidate.

o Protects minority SH

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o Shareholder Meeting Annual SH meeting required. SH can act without meeting, by written

consent, unless power prohibited in charter. MBCA 7.01 Special meetings to vote on particular issues that may arise MBCA 7.02 BOD or 10% SH can call special meeting. MBCA 7.02 SH can act without meeting, by written consent, unless charter takes

away that power. DGCL 228, 275. MBCA 7.04(a) Process for calling special meeting in charter/bylaws. Must give notice of

purpose of special meeting MBCA 7.05 Unless charter/bylaws say otherwise, SH holding majority fo shares must

be present (person or proxy) to constitute quorum. MBCA 7.25(a), DGCL 216

o Adlerstein v. Wertheimer (Adlerstein owned the voting rights of the Corporation. He is also the founder. Took company public so there is public shareholders and him. The problem occurred at the meeting of the BOD, planned to fire him and issue new stock to Reich, which would trump A’s stock. Was meeting legit?)

He was not given notice of agenda of items to be discussed at meeting Undisputed that Adler was told of the meeting, but not the purpse Courts invalidated action of meeting on 2 grounds:

Notice: o have to give notice to directors of meeting; He didn’t

know purposeo DE Law: don’t have to tell director meeting purpose

unless req’d by bylaws Bylaws didn’t require it here, but Justices

thought result was so unfair that notice not given

Fairnesso Unfair to do, even though he wasn’t good with

companyo 2 problems:

He is director Has control as shareholder

Action was to strip him of both, and unfair to do secretly It’s the notion to protect core rights of shareholders. Law

requires that if it is your corp and you control it, you are entitled to know when other ppl on BOD will fire you

Key: BREACH OF FAIRNESS CAN OVERRIDE A DUTY TO FOLLOW RULES THAT ARE LAID OUT.

PIERCING THE VEIL Limited Liability

o LL encourages shareholders to diversify b/c they aren’t exposed to risk; finance business; monitor managers and reduces costs of monitoring other SH

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Trading would be severely impaired if investors exposed themselves to liability every time they purchased shares – reduces need for investors to monitor.

Not going to stick with just safe shareso LL also allows clients to set up corporations to protect from personal liability,

and shield their assets. Disadvantages

Loans have higher rates b/c bank knows they can’t go after personal assets

Recklessness- founders may engage in risky behavior b/c of protection

Not usually for very small biz b/c owner will personally guarantee loan.

Veil Piercing – happens when one disregards corporate personalityo Nobody is liable to pay the debts of a corp unless they agree to do so or ignore

the legal personality of the Corpo Internal Tests: Corporate Record Keeping

Corp record keeping, how accurately, effectively did the Corp keep books

Accounting Courts: look at this when deciding if to pierce veil

o External Tests: Notice to the world; reasonable reliance; fairness Did shareholders treat the Corp as if it were a third person, or did use

Corp’s funds as own How it appears to outside world, if person uses Corp to do biz but

doesn’t tell you that they’re using Corp. Undercapitalization – comp doesn’t’ have enough assets to actually run

business Reasonable Reliance: Did you reasonably rely on Corp or a human when

you dealt with “Corp” Fairness: Is it fair to pierce Corp Veil

o Pre-conditions: no publicly traded comp has been pierced Pierce hasn’t happened when more than 10 SH

Usually when 4-5 or less SH Or subsidiary comp where parent comp owns all shares

o Soerries v. Dancause (dram shop case, 18 yr drunk in nightclub, owner kept books poorly. Often paid corp expenses out of own pocket. He owns building and land, club owns nothing. Corp always declaring losses. Proper to pierce veil?)

To pierce, must be abuse of Crop form. P must show that D disregarded separateness of legal entities by comingling on interchangeable basis or confusing otherwise separate properties, records, or control

Rule: if individual who is the principal SH/owner of the Corp conducts his private and corp business on an interchangeable or joint basis as if they were one, then he is w/out standing to complain when an injured party does the same. Court may disregard Corp entity.

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Piercing is typically an issue for the jury unless there is no evidence to justify it

o Minno v. Pro-Fab (Minno hired by See-Ann, sister company of Pro-Fab, he was injured at job site and is trying to go after the assets of Pro-Fab. Is there enterprise liability here?)

Enterprise liability – likely when managers who run “sister”/asset corp also run the “risk”/principal corp

Belvedere Test: 1) control over corp by those to be held liable was so complete that corp has no separate mind, will, existence of its own; 2) control of crop by those to be held liable was in manner as to commit fraud or an illegal act against person seeking to disregard corp entity; 3) injury or unjust loss resulted to P from such control and wrong

Here there was no fraud, but See-Ann was undercapitalized, Ct overreached and held issues of fact for jury to decide if separate or not for veil piercing

Equity: disallow parent corp, as alter ego of subsidiary, to avoid liability for subsidiaries misdeeds

o In Re Phillips (Reverse Piercing. Corporation in limited circumstances may be liable for debts of controlling SH or other corp insider where SH or insider treated corp as his alter ego to perpetuate a fraud or defeat a rightful claim and an equitable result is achieved by piercing.)

8 Factors: 1) corp is operated as distinct biz entity; 2) funds/assets comingled; 3) adequate corp records are maintained; 4) nature/form of entity’s ownership and control facilitate misuse by insider; 5) business is thinly capitalized; 6) corp is used as mere shell; 7) SH disregard legal formalities; 8) corp funds/assets used for non-corp purposes

Inside Reverse Piercing: involve controlling insider who attempts to have corp entity disregarded to avail the insider of corp claims against 3rd

parties or protect assets from 3rd party claims on assets owned by insider Outside Reverse Piercing: corp outsider pressing action against insider

seeks to disregard corp entity and subject corp assets to claim OR when outsider w/ claim against insider seeks to assert that claim against corp in an action between claimant and corp

Not all jurisdictions allow reverse piercing

CLOSELY HELD CORPORATIONS

Few shareholders – at least 2o Active participation by SHo Most of their net worth is in this corpo No ready market to sell shares of close corp

CONTROL STRUCTURES Shareholder Agreements

o Usually protect minority shareholders Minority SH seek board representation by vote pooling agreement,

obligate SH to vote together as single block. MBCA 7.31

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More controversial SH agreements are those that attempt to control actions of directors. Minority SH frequently bargain for rights, sometimes affirmative rights, sometimes negative covenants.

Right to name certain corp officers; right to employment; right to certain salaries/dividends; negative – right to veto certain corp transactions.

o MBCA § 7.32 – validates SH agreements even when they limit board powers in enumerated ways – can’t have agreement against public policy – saying directors have no duty of care/loyalty

(b)(1) – requires agreements be unanimous and that they must be included in charter or bylaws, or in a written, signed agreement

(b)(3) – limits duration of shareholders agreement to 10 yrs, unless otherwise agreed

(c) – requires a legend on the share certificate or on the information statement to notify transferees of the agreement

(d) – limits availability of the section to close corps (f) – SH will not have personal liability even if the effect of the

agreement is to create a partnership Ronnen v. Ajax (Dad started Corp, gave to the kids, but he left a contract about the

management of the Corp. Brother holds SH meeting to vote for directors. Sister demands she can vote. Question was whether SH agreement gave brother or sister the right to hold the directors)

o Court found agreement conferred power to vote for directors to brother. Case of contract interpretation.

o Court had to pick between 2 ppl both of whom looked in the wrongo Contract expressed what she can vote for, so that means she had to have been

excluded from other functiono SH agreement would NOT pass under § 7.32 b/c agreement only valid for 10

years unless otherwise specified, and this was 13 yrs later. Transfer Restrictions

o Some restraints of Corp stock b/c close corporations and you want to be able to have say on who you have to run company with.

o Provide certainty in estate planning, ensures corp complies with statutes and regulations. Imposed in charter/bylaws, in sep SH agreement, or between SH and Corp. MBCA 6.27(a)

o MBCA §6.27(d): Restrictions on stockholder to resell the stock. Such as Rights of First Refusal or Rights of First Offer. There must be some time of notice to the transferee, usually on stock certificate.

Must pass 2 part test: 1) Restrictions must comply with formal requirements relating to

adoption of the restrictions and must conspicuously noted on share certificates

2) Restrictions must be for proper purpose. MBCA 6.27 (a) (b)o General test is REASONABLENESS

Types of Transfer Restrictions

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Option: SH must offer corp or other SH option to purchase shares either at price specified by prior agreement or at price offered by prospective 3rd party

Buy-Sell Agreement: the corp or other SH are obligated to purchase shares

o Provide liquidity for SH who wish to withdrawo Determine price of share at time when none of parties to

the agreement knows which of them will be sellers and which buyers

o Allow principals of corp to plan w/ some certaintyo Price in B-S agreement

Fixed Price: must be updated constantly to reflect current value

Book Value: most popular measure b/c easy to determine

Appraisal Formula – extremely complicated

Prior Approval or Consent Requiremento Corp or other SH must approve transfer of shares

First Refusal: first offer shares to corp or other SH at price and terms offered by otusider

Flat prohibition of any transfer – usually found unreasonable and struck down.

o Capital Group v. Armour (Husband and wife get divorced. She wants half of shares. Whether stock transfer restrictions may reasonably operate to prevent the transfer to the wife of any legal or beneficial interest in the stock?)

Wife argues that transfer restrictions are unreasonable, and thus unenforceable.

Burden of proving restriction unreasonable is on contesting party. Deciding scope of reasonableness, look at:

1) is the actual restriction reasonable to achieve a legit corp purpose?

NOT going to look at if restriction reasonable as it applies to a particular individual

Strong deference to fact individual agreed to terms beforehand Legit corp interest to restrict # of SH to avoid being a public company.

Voting Trusts o Created to overcome rules against irrevocable proxies. In a voting trust, legal

title to shares is transferred from the SH to the voting trustees. Long frowned upon; Usually enforceable unless contrary to public policy Typically Limited in duration

o Purpose: Ensure continuity of management; place control in hands of trustee, so

consistent voting. Usually part of reorganization plan or to prevent dissesntion among various factions of SH

o MBCA §7.30

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Must be written trust agreement SH transfer some or all of shares to trustee

SH agreement can’t be de facto voting trusts Initially created to overcome rules against irrevocable proxies. Agreement specifies term not to exceed 10 yrs. Can extend by later

agreement Trustee prepares list of trust beneficiaries (may be different from SH who

transferred shares), description of shares. Delivers copy of list and trust agreement to Corp’s principal office.

o Warehime v. Warehime (John is CEO of Corp and Trustee of voting trust. A bunch of amendments to further the company, Michael wants injunction to prohibit voting of shares in favor of amendments, b/c it would extend John’s control beyond termination of voting trusts)

Apply lower standard of good faith, but not higher duty of absolute loyalty.

Trustee must act in good faith and use best judgment when voting the stock.

Must follow fiduciary duties contained in trust agreement As long as act to benefit corp and SH beneficiaries, then doesn’t

matter if it just happens to be in trustees self-interest as well Want to maximize the ultimate, net benefit to minority SH

CLASSIFIED SHARES: allocate voting power disproportionately to financial interests and various classes of SH

o You can have more than one type of stock. Corps can issue Stock A, B, C, etc.o Common Stock is defaulto Classified Stock can have whatever right the parties want to give them but must

be noted in the Articles of Incorporation. MBCA §6.01; DGCL 151 Special Rights Which Can be Given:

Priority of payment; special voting rights; holders of stock can veto certain action; holders get paid out first; special dividends

Only has to exist in AOIo Ex. Class A elects 2 directors, Class B elects 3 directors

Or ex. nonvoting common has financial rights equal to voting common, but doesn’t change control balance

Can be used to limit board discretion: Pres and VP must be class B holders.

o Can invite conflicto Benchmark Capital v. Vague (Benchmark invested in company and owned

Series A and B stock – Juniper needed more capital, and CIBC was willing – Juniper planned to issue CIBC another senior preferred stock, but Benchmark wouldn’t allow this, wince it would reduce jr. preferred stockholder position from 29% to 7%. Juniper and CIBC then merged and amended/restated charter, changing rights of jr. preferred SH. Benchmark argues this can’t be done w/out their vote b/c merger adversely affects their rights)

Protective provisions drafted to provide a class of preferred stock w/ a class vote before those shares’ rights, preferences, and privileges may be

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altered or modified, do not fulfill their apparent purpose of assuring a class vote if adverse consequences flow from a merger and the protective provisions don’t expressly afford protection against a merger.

Line of cases saying must expressly use the word “merger” Other factors:

o Benchmark has sophisticated lawyers – if they wanted these protections, they would have provided for them

o This was a bank which required the cash and without it, bank wouldn’t last

CUMULATIVE VOTING o Method of counting SH votes in director elections in which each SH is entitled to

cast a number of votes equal to the product of the number of such shareholder’s shares times the number of directors to be elected.

They may cast all of his or her votes in favor of a single director rather than allocating them among the candidates.

Policy; to increase minority participation on the board of directors Either opt in or opt out depending on the state

o Can be defeated by staggering the boardo MBCA 7.28: don’t have the right to cumulate votes for directors unless AOI

provides otherwise. SUPER MAJORITY REQUIREMENTS – Minority Control Rights

o Purpose:Give minority participants a veto power. Power can cover specified matters, or all matters (but that risks deadlock). Can be used Safeguard minority rights. Protect the status quo. Protect against change in other negotiated allocations of control

o Creation: Must be specified in charter, either when originally drafted or amended. Usually new supermajority provisions or to repeal must be approved by supermajority, for shareholder actions. SM req’ts for director voting can be put in Articles or bylaws, or if unanimous then in SH agreement for closely helds. MBCA 7.27

o Validity: States generally permit SJ req’ts. Can be with voting or quorum (can absent yourself to cast veto. If present then counted in quorum #)

DE has no provision governing amendment or repeal of SM req’ts

o Mason Capital v. Kaman (Mason wants to prevent Kaman from implementing recapitalization proposal b/c it needs to be approved by 2/3 of disinterested SH as required under a CT statute b/c it’s a “business combo”)

The plain text and the structure of the controlling act as well as the practical outcome can be indicative of whether a supermajority vote was expressly required.

Here, the recap proposal was held not to be a business combo under Statute.

When looking at proposals, use rules of grammar, look where commas are as to what should be included when look at proposals and statutes

Recap proposal NOT a biz combo, so doesn’t’ need to comply w/ supermajority voting req’t

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PREEMPTIVE RIGHTS o Allows SH to acquire shares when corp issues new shares to protect existing

proportional interest. o Now generally a matter of statutory rights. Some states one must “opt out” others

you must “opt in”. o Not inherent, must be granted or denied by Articles of Incorporation. MBCA

“Opt in”; complicates issuance of shares. MBCA default rule: againsto Makes issuing new shares cumbersome. Don’t exist when shares issues for

management services or noncash property. Usually not found w/ Public companies.

o Kimberlin v. Ciena Corp (Kimberlin financed Ciena, and there was agreement that Ciena would use Spencer Trask (Kimberlin’s firm) first for offering any series of stock. But continually breached used other venture capitalists. Agreement terminated. Settlement gave shares of Series B. Kimberlin claims he has right to prorate share of future C stock, but that could be nullified by 67% of A/B holders agreed to waive that rate. 92% waived right of first refusal.)

Must look at language in purchase agreement to determine if preemptive rights are waivable. The Ct won’t look at evidence of trade usage and course of dealing in regard to provisions of each company.

Duty of good faith can’t be relied upon to alter terms of contract itself. Can’t be used to rewrite terms of purchase agreement

DEADLOCK o Occur when SH vote is evenly divided. Sometimes intentionally planned b/c

some business relationships shouldn’t go on unless unanimous assent.o Deadlock usually leads to dissolution of a corporation. o May be judicially dissolved if deadlock can’t be solved.o Conklin v. Perdue (Started business together. Conklin provided capital for the

business. Biz failed, disagreed about shutting down of business. She went and stole records. Case came to court after Conklin tried to start new biz on his own.)

Court decided to invoke equitable powers. When deadlock by directors and SH can’t break the deadlock.

Courts can retroactively dissolve corporation if necessary. They did here to avoid any “corporate opportunity” claims that

Perdue might try to bring to make case go on. To avoid deadlock: draft detailed SH agreement

Also could have more than 2 SH and 2 directors. Or not split 50/50 since only one was putting in capital.

MBCA 14.30: mandates corporate repurchase at a fair price as a remedy for deadlock and dissension. Close Corps only.

o Red Hat Case Study (Created Red Hat software comp. Company went public. Offered multiple offerings of preferred stock for venture capital financing. 4 main investors with similar stock packages. Owned 55% of company)

Here terms of Preferred stock were: can be converted 2 to 1 into common stock. If comp flops they get money back, if does well they get return on investment.

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Voting rights: general – vote as single class. Same voting power as common. Targeted – power as far as merging and consolidation. Negative covenants- veto power over extraordinary transactions.

Venture Capitalists can demand company buyout shares, essentially sinks Corp.

Comp has to promise to register securities so will become public at some point.

Right to first refusal : investors can continue ownership if doing well, or if originals don’t want in, incentive for company to keep growing to keep them happy.

VC’s want to make sure provisions to protect investment and not allow them to lose their investment b/c of someone else.

OPPRESSION OF MINORITY SHAREHOLDERS Freezout – isolate minority SH from Corp participation, forcing them to sell/buy from

Corp under unfavorable terms. Majority will withhold things to coerce action. Forceout – Majority can manipulate the fundamental structure of the corp and forcibly

eliminate minority interests. Not a big problem with public Corps b/c can just sell, problem in Close held Corps.

o Wilkes –(setout 2 prong test – Mass Law) Merely being shutout from a benefit is not oppression When majority takes some sort of action that minority questions:

1)Court will demand that majority come up w/ legit business reason for action

2) If majority proffers this, up to minority to respond to show there is a less harmful alternative

DE Law - Up to investor to barter for protections when entering Corp Minority oppressed SH can ask court to dissolve a Corp so they could get

money after liquidation. Can be used when Board deadlock, SH deadlock, or Misconduct (illegal, fraud, oppressive, waste, protection of SH). Can use this option to force Corp/other SH to make offer to buy shares so won’t have to be dissolved.

When determining this, decide if close corp (# of SH, who is involved in day to day, etc)

o MBCA Remedies: Dissolution : 14.30 – a corp may be dissolved if the directors or those in

contorl of the Corp have acted, are acting, will act in a manner that is illegal oppressive or fraudulent.

Receiver – 14.32 – judicial proceeding brought to dissolve corp, ct may appoint 1 or more receivers to wind up and liquidate, or 1 or more custodians to manage affairs of Corp

Forced Buyback – 14.34 corp or SH can purchase shares at fair value. Not to be used strategically by oppressed SH.

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o Elmaleh v. Barlow (SH filed action alleging breach of fiduciary duty to the Corp and its SH, interference with advantageous business relationship. D’s argue not a close Corp and so no heightened fiduciary duty of utmost good faith and loyalty)

Heightened duty between SH only arises in close corps. Elements of close Corp:

1) small # of SHo Look at both # of SH and ownership of stocko Never held close corp when more than 21 SH

2) no ready market for the Corp stocko Opportunity for majority to oppress since can’t sell

3) substantial majority SH participation in the management, direction, and ops of the corp.

o When many outside investors, and here only 10% participating. Usually close is very involved.

o Must prove by preponderance of the evidence Here it was held not to be close corp, so no heightened duty of good faith

and loyalty.o Leslie v. Boston Software (Leslie was voted off board, terminated, and removed

as trustee. He was in charge of administration, so didn’t bill work hours. Disagreed with other SH in the workplace.)

2 majority SH stopped paying distributions and instead gave themselves raises. Offered him severance package.

He was entitled to utmost good faith and fair dealing. Court ensures: 1) fair compensation for loss of employment, 2) fair

compensation in nature of dividend; 3) as long as he is SH, be able to monitor management and participate in returns of SH

Did all this in lieu of reinstatement, b/c reinstatement was not in best interest.

Don’t order buyout, maybe to help other SH from going underMeaning of Oppression Oppression: 1) burdensome, harsh wrongful conduct that is visible departure from

standards of fair dealing (focuses on action of majority SH); 2) breach of duty of fair dealing, ehnhanced in close corp stting; 3) frustration of reasonable expectations of Minority SH (views problem thru minority SH eyes)

Kiriakides v. Atlas Foods (Claim fraudulent, oppressive, and unfairly prejudicial. Want buyout of shares. Louise and John against Alex who is majority SH.)

o Oppressive and Unfairly Prejudicial – 1) visible departure from the standards of fair dealing and a violation of

fair play on which every SH who entrusts his money to a company is entitled to rely

2) breach of duty of good faith and fair dealing 3) whether reasonable expectations of minority SH have been frustrated

by actions of majority 4) lack of probity and fair dealing in affairs of company to the prejudice

of some of tis members

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5) deprivation by majority SH of participation in management by Minority SH

o Does not focus on rights or interests of complaining SH but rather specifically places focus upon actions of the majority, what they did as far as corp or to SH. Not a reasonable expectation standard.

o Case by case analysis of whether oppressive and unfairly prejudicial under the factual circumstances.

Remedies for Minority Oppression Most common remedy is the buyout, which is available in half of the states. Courts more

willing to use buyouts as relief, even if not statutorily mandated. MBCA 14.30 Naito v. Naito (Sam’s family vs. Bill’s Family. Bill’s largely shutout of employment b/c

didn’t receive shares, steps taken to close them out from future participation.)o Court held not minority oppression, but given the buy-sell agreement, lack of

dividend payments seemed somewhat unjustified.  Ordering payment of dividends – court doesn’t like to do this – feels like determining amount to be paid is best left to the management and directors.  Does not want to dissolve, though, as corporation is running well.

o They want trial court to maintain oversight on dividend agreement for next 5 years.

o Courts in extreme cases will order buyouts or other specific remedies. But still unwillingness to get involved in corporate decisions

CONTROL OF PUBLICLY HELD CORPORATIONS Separation of ownership and control: centralized power is necessary if anything is to be

accomplished on a daily basis.o Shareholder: have limited rights

Right to vote; sell their stock; right to sueo Directors

Elected by SH, to manage the corp They are the agents, they can be sued by SH if they don’t do what they

promise to do. If value of Stock goes down, directors will get sued by stockholders if

they promised to do X but do Y Hire and fire officers

o Officers Day to day management of the Corporation. Many labels for these

members. Congress required companies to provide more info to investors so they could make

informed investment and voting decisions.o This is part of intersection between SH and Managemento How to make sure they carry out task. Use legal and non-legal mechanisms.

Give manager comp packages that align their interests with SH. i.e. stockso Financial Journalists – CEO’s don’t want bad press

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Kmart Case Study (DGCL 141 – every corp organized under this chapter will be managed by or under direction of BOD. MBCA 8.01 – all corp powers shall be exercised by or under authority of BOD.)

o Activist investors can increase the value of the companies they invest in by making smart decisions regarding plans.

Shareholder Voting

Vote at annual meetings. Rarely direct contact between SH and Corp. o Can’t choose officers, day to day activities, or easily overturn decision about

direction of company Vote on directors; extraordinary transactions; charter change; SH

proposals For proposals – majority vote required Directors usually elected by plurality

o But still directors are agents of SH. But not agency law.o Also Special meeting:

Held by board or by SH in extraordinary situations DE says only board can call meeting unless charter says otherwise MBCA gives more power

Proxy – authorization given by SH to another person to vote SH’s shares. Successfully sought by incumbent management, which means that management has the right to cast most SH votes. Must tell SH how their votes will be cast on every item.

Poison Pills – rights extended to existing SH to buy shares at a discount if a hostile acquirer tries to take over the company. Existence of a pill makes companies much more expensive and difficult to take over in a hostile acquisition.

o Board can buyback each right for a penny per right.o If friendly takeover, board redeems rights and then let’s takeover happen.

Unisuper v. News Corp (Newscorp inc in Australia. Wanted to reincorporate in DE. DE law doesn’t’ require permission for poison pill, Aussie does. SH don’t want DE law. BOD extended pill without SH vote, so filed suit)

o Trying to see if New Corp retained Aussie rule, and if they could adopt poison pill without SH vote under DE law

o BOD agreed that if did put in unvoted poison pill, it would sunset after a year. It didn’t.

BOD argues this is attempt to take away power from board to manage Corp.

o Board policies are typically revocable by the board at willo So no violation here, unless breach of contract. But on P’s to prove contract

Blasius v. Atlas (Blasius was buying up the stock of Atlas and was planning some changes as majority stockholder. In order to implement the changes they determined that they would need to increase the amount of directors to get the majority vote. However the changes they were planning would hurt the company. So the company themselves increased the amount of directors from 7 to 9 in a way entrenching themselves. Blasius wanted to do was bad, and BOD got advice from pros saying it was bad, but they acted before they got the advice)

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o Rule:BOD may take certain steps such as the purchase by corp of it’s own stock that have the effect of defeating a threatened change in Corp control when those steps are taken advisedly in good faith pursuit of a corp interest. And are reasonable in relation to a threat to legit corp interest posed by the proposed changed in control.

o Court: BOD can’t take away the power of the SH right to vote on something by entrenching themselves. It is true that the Directors have to act in the best interest of the Corp, however they must get pro advice first and then act on it. If directors don’t like proposal they can’t take away the power of the vote, they have to go out explain why this proposal was bad such as get a compny like Goldman & Sachs to review the proposal. However, taking an action PREEMPTIVELY w/out pro advice is where court was bothered.

o Business Judgment Rule: does not apply between actions of SH and directors. Just between Directors and Corp

BJR doesn’t protect board decision w/ primary purpose of interfering with effectiveness of SH vote

SH always have right to vote on proposal, no matter how bad it isFederal Proxy Regulation Securities Act of 33 – regulates sales of stocks or bonds to public, usually happens w/

underwriter, which initially buys from Comp and then sells to public.o Sets out liability provisions if there are misstatements or material omissions of

fact. Strict liability for issuers Securities Exchange Act of 34 – regulates secondary transactions

o Regulates actions of brokers and dealers in trading venues w/ respect to trading practices.

o ID’s info public reporting companies are required to disclose to market on a regular basis.

Mandatory Disclosure: SEC staff members review disclosure docs, and look to see if the risks of an investment are adequately disclosed. Substantial uncertainties are to be described in prospectus

Must disclose who managers/directors are and what they are paid, and any conflicts of interest that they may have.

o Proxy Statement: must be comprehensive and accurate. Each agenda item must be fully and accurately described in proxy statement.

Proxy Solicitation – requires proxy statement with specified info to be sent out to SH being solicited..

o Occurs in prep for annual meetingo Rules that SH proposal can be excluded from proxy statement on certain grounds

Rule 14a-8 – Reasons that companies can exclude SH proposals from proxy statement.

14a-9 – COA for false or misleading statements in proxy statements 14a-10 – prohibits certain solicities

o Solicit, Solicitation: any request for proxy whether or not accompanied by or included in form of proxy

Request to execute/not execute or revoke a proxy

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Furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in procurement, w/holding or revocation of proxy

o Amendments to proxy rules about communications re: corp gov or agenda proposals: allow large institutional SH to communicate more freely among themselves about corp performance and qualify of management. Part of growing SH movement.

LILCO v. Barbrash (LILCO is big electric co. Defs want to replace with publicly owned utility. Matthews wants to get elected for county exec and is party of Corp that owns LILCO shares, and shares of his own, launched proxy context. Committee attacked LILCO in newspaper ads, but they don’t mention proxy)

o LILCO says Matthews solicitation and newspaper ads linked, so solicitation affected.

o Majority ruled that solicitation doesn’t have to be direct. Need not be targeted directly at SH.

1st amendment issue: extent to which the activities of the Defs amount to solicitation of proxies of SH may determine whether or not their actions are protected by 1st amend

o SEC has broad definition of proxy solicition (mentioned above) Proxy rule 14a-9 – private cause of action when you make a statement that is false

or misleading in regards of a material fact. Fact specific inquiry as if material fact to decision being made.

Shareholder Proposals One of few proactive SH powers, to propose SH resolutions to be put in proxy statement Rule 14a-8 – Company must include SH proposal in proxy statement. SH must

meet eligibility requirements, and follow proper procedure of presenting proposal. May not exceed 500 words. Must be received no less than 120 days before proxy statement released. Company can exclude if they notify you and you fail to correct it. If still want to exclude the comp must go through SEC.

Social Activist Proposals(25%) – asking BOD to study whether Corp uses sweatshop labor or on things related to environmentally sustainable policies. Evaluates company on fiancial, social, and enviro grounds.

Corporate governance proposals (75%) – seeks changes in company’s bylaws to do away with poison pills or to separate jobs of CEO from chairman of BOD, or other ways company is governed. Promote management policies that maximize firms value and

Corp can choose to exclude for # of reasons: 1) improper under state law; 2) De minimus (must relate to at least 5% of company’s dealings, unless social policy); 3) ordinary business/management; 4) relating to elections; 5) personal grievances

o To get put in proxy SH must: send it to company. If comp doesn’t’ want it in, must get No Action letter from SEC. Not a judicial ruling, just means SEC won’t punish you.

o If denied but still want to get it out w/out court, invoke 14a-7 and get access to SH list and send out on your own $.

Reasons for excluding:

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Proposal improper under state law; not relevant; relates to ordinary business/management functions; relates to elections.

No action letters are not technically precedents that parties can rely on.o The leverage of withdrawing a potentially embarrassing proposal has been

used in amny cases to get companies to agree to various changes at the company or to produce info to activists.

Apache v. Nycers (SH proposal regarding employment discrim on basis of sexual orientation. Doesn’t want comp to discrim, and implement such policies. Apache refused to put it in)

o SEC said this falls under ordinary business and so issued No Action Lettero Court agreed and said this was micromanaging.o Ordinary Business Operations – certain matters which have significant policy,

economic, or other implications inherent in them. 1) Certain tasks are so fundamental to management’s ability to run a company on day to day basis that they could be subject to direct SH oversight as a practical matter. 2) degree to which proposal seeks to micro manage the comp by probing to deeply into matters of a complex nature upon which SH as a group would not be in position to make an informed judgment about.

o Ok to exclude if not significant policy, but implicates ordinary business operations

Shareholder Proposals: Bylaw Resolutions o SH can change the bylaws and the charter can also give concurrent power to the

board, but it can’t that power away from the SH. MBCA 10.20(b)(2) takes it a step further and says that SH can amend a bylaw and expressly state that the directors cannot then amend, repeal or reinstate that bylaw.

o Only the board can initiate changes to the charter, but the SHs have the opportunity to vote on them. MBCA 10.03(a). Charter is unchangeable unless SH group gains control over the board.

o SH initiated changes to the bylaws cannot take away power from the directors, nor may the SHs require the directors to do anything MBCA 8.01(b)

o Directors can undermine SH actions attempting to exert control through a bylaw amendment by fixing dates of either annual or special meeting

Shareholder Proposals: Nominations of Directors o Registrant can exclude a SH proposal if the proposal relates to a nomination or

an election for membership on the company’s BOD or analogous governing body or a procedure for such nomination or election.

o Principal purpose of 14a-8 is to make clear that it’s not proper means for conducting campaigns or effecting reforms in elections of that nature, since other proxy rules, 14a-11, are applicable thereto.

o AFSCME v. American International Group (Whether SH proposal requiring company to include certain SH nominated candidates for BOD on corp ballot can be excluded from the proxy statement b/c it relates to election listed uner 14a-8.)

SH proposal that seeks to amend corp bylaws to establish procedure by which SH nominated candidates may be included on corp ballot does not relate to election within meaning of Rule 14a-8 and therefore cannot be excluded from corp proxy materials under that regulation.

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Agency interpretations of the rules warrant deference from court when they interpret ambiguous regulations.

Narrows scope of rule to not touch things that are a “means” of relating to election, but only directly affects election.

MINORITY LAWo Principal purpose of 14a-8 is to make clear that it is not the proper means

for conducting campaigns or effecting reforms in elections of that nature. SH proposals that result in contested election, including those establishing procedure, fall within election exclusion.

CA v. AFSME (Proposal for bylaws that stockholders would be reimbursed for reasonable expenses incurred in connection with nominating one or more candidates in a contested election. SEC did not provide no action letter, certified the question to the court, which handled de novo)

o Issues: Are shareholders allowed to adopt bylaws like this? (it commands an expenditure. tell the board to do one thing vs. numerous bylaws telling the directors to do stuff)

Next issue, common law backstop, which says the board of director cannot sign away fiduciary duties

o Held: Proposal CANNOT be adopted because does not contain language that would reserve to CA's directors their full power to exercise their fiduciary duty to decide whether or not it would be appropriate in a specific case to award reimbursement at all.

Enron Case Study o Had 3 main businesses, started out as oil and natural gas company, also traded

certain commodities like broadband/auction house like ebayo In order to do business, often created special purpose entities (e.g. allow 2

companies to enter into joint venture), do not have to put debt of SPE on books But the whole point of SPE is that the company who sets up one cannot

own the SPE Enron created SPE's partnered with other companies (posing as

independent investor) but really financed by Enrono Improper accounting treatment, more debt then disclosing o Braveheart deal--delivering movies on demand through broadband. Problems -

tech did not exist + blockbuster did not own rights to stream broadband Enron created a new company, sold a sliver, overstated value No one blew the whistle, institutional investors, law firms, employees,

stock analysts, accountants Arthur Anderson, financial journalists Sarbanes-Oxley – Result of Enron and other big company actions (although most Corp

law is state law, the federal government stepped in and set up regulations)o PCAOB, public company accounting oversight board (sets standards for audits) o Internal controls 404 - requires annual assessment on whether controls are

working o In 1st yr, $4 million per company to set up checkso CEO, CFO Certification - must certify the accuracy of financial statements)

Misstatement of financial statements result in 10 yr prison term

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o Auditor independence, audit committee directly responsible for supervising auditors, independent directors - no job in company, no sign. Sharehold, add. Oversight

o Lawyers responsibilities - lawyers report up evidence of securities laws violations, all the way up to audit committee

o Fed gov steps up in the domain what has trad been state law

DUTY OF CAREDirectors Duty of Care and the BJR Directors duties developed as matter of common law. MBCA 8.30 – Directors must be informed, acted in good faith, honestly believed

their decision was in the best interest of the company. Duty of care owed to the Corp. Similar to duty of care in Tort law. But liability is near zero b/c of BJR.

o b/c want to encourage people to serve as directors. Risk taking can be good. Gagliardi v. Trifoods International (Used to own trifoods, sold it, he was kicked out by

the new owners, and he sued b/c their decisions didn’t pan out, and he thought they were unwise.)

o BJR provides that where a director is independent and disinterested, there can be no liability for corporate loss even if decision is foolish, unwise, or doesn’t pan out, unless the facts are such that no person could possibly authorize such a transaction if he or she were attempting in good faith to meet their duty.

Negligent decision is not enough for COAo It’s in SH best interest to allow directors to operate without liability – don’t want

them to be risk averse. Could just buy insurance. But no matter what happens, the SHs bears cost of the directors.

o Gagliardi could try to buy back company if he would like to protect investment. Or sell his interest and buy bonds.

o Rule: cts will not second guess the decisions of directors unless the process that generated those decisions is unsound.

Decision Making Context o Circumstances where courts get suspicious of decisions:

1) When directors are subject to a conflict of interest with respect to the challenged decision, courts review the decision under the standards developed under the duty of loyalty

2) when directors fail to gather the requisite information to make the challenged decision, will be reviewed under gross negligence standard.

o Smith v. Van Gorkom (duty of care and BJR in decision making of fundamental transaction. Transunion trying to maximize tax benefits, and turn them into $$. First they bought companies, then decided to sell Transunion to a larger company w/ more taxable income.)

CEO/chairman solicited merger offer from outside investor, arbitrarily arrived at $55/share – offer proposed 2 subsequent times before its formal acceptance.

No written summary of the terms presented. Directors had no, and requested no, substantiating data regarding feasibility of $55 per share.

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They just took his representations. No consideration was given to allowing time to study proposal or to gain more info. As a result, decision was grossly negligent and not protected by BJR

Finalized in a week or so, didn’t look to any other companies. BOD can’t be pressured by single individual

No experts brought in to provide fairness opinion. Since board was not informed, neither were shareholders.

Lawyers unfamiliar with firm were brought in Intrinsic value found to be $60. GET REPORTS AND OUTSIDE VALUATION.

BJR DOESN’T APPLY IF YOU ARE JUST GUESSING Before VG – good enough if no self interest/self dealing; good faith; and

honest belief in best interests of company NOW: Directors obligated to act in an uninformed and

deliberate manner. Be careful and diligent. Can be held responsible if GROSSLY NEGLIGENT – failing

to inform yourself and failing to follow proper procedures. After Van Gorkom, key is to attack decision making process, not decision itself.

o This is how you win duty of care claims. Look to see if procedures not followed.o DGCL 102(b)(7) – Corporation can put into charter a provision stating that

directors aren’t liable for monetary damages for breach of fiduciary duty. Can’t eliminate liability for breach of duty of loyalty, or for acts or omissions no in good faith.

This is Opt-In

The Oversight Context Duty of care is primarily procedural – part of this duty is a duty to be informed about

what is happening within the Corp – OVERSIGHT Oversight function merits a unique standard of liability under MBCA 8.31 – establish

that challenged conduct consisted or was the result of a sustained failure of the director to be informed about the business and affairs of the corp, or other material failure of the director to discharge the oversight function.

o Oversight cases often arise where employees of a Corp have engaged in illegal activities. Occur when managers are asleep at the wheel while Corp crashes.

o Oversight duties seem to be ensuring that financial information gets to the board on a timely basis so that directors can determine if the company is “on target” financially – ensuring that there is reason to believe the company’s financial reporting is accurate, and ensuring that the company has a functioning law compliance structure.

B/c directors are bound to exercise ordinary care, they can’t set up as a defense lack of the knowledge needed to exercise the requisite degree of care.

In Re Caremark (indicted for violating a federal law making it a felony to pay kickbacks to persons for referring Medicare or Medicaid patient to it. Caremark pled guilty to mail fraud and paid criminal fines and civil reimbursement – SH brought suit seeking to recover these losses from directors.)

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o In order to show that the directors here breached their duty of care by failing to adequately control caremark’s employees, P’s need to demonstrate that directors knew or should have known that violations of the law were occurring and they took no steps in a good faith effort to prevent or remedy that situation, resulting in the losses complained of.

o Most decisions that corporations make are not the subject of director attention. Board was informed about efforts to assure compliance with the law

Previous Graham holding: directors don’t have duty unless cause for suspicion. If no suspicion, can’t be held liable for assuming integrity of employees and honesty of their dealings on the company’s behalf

o Good idea to have reporting system, but even without, unless utter/sustained failure, no liability will attach. Only a sustained or systemative failure of the board to exercise oversight – such as an utter failure to attempt to assure a reasonable information and reporting system exists will establish lakc of good faith necessary for liability.

The Waste Standard A board of directors enjoys a presumption of sound business judgment, and its decisions

will not be disturbed if they can be attributed to any rational business purpose. Often brought up regarding executive compensation

o To safeguard: 1) cap on tax deductions for salary, 2)publicize what top 5 are paid/benefits; 3) These actually didn’t help at all.

Must show that no reasonable person would have made decision that a board reached.

o No emphasis in DE b/c other approaches for proving breaches of duty of careo Ex. Firesale prices on assets; 2) Hot Dog vendor as CEO

Neither good faith nor waste are protected by the BJR

Role of Good Faith Allegation of lack of good faith serve to overcome exculpation clauses Good faith as duty of loyalty:

Directors don’t initially have benefit of BJR for duty of loyalty claims; so cannot be exculpated for duty of loytlayt claims, or insured or indemnified for them.

In Re Walt Disney Derivative Litigation (Eisner was preparing to find successor. Choose Michael Ovitz of CAA. Compensation agreement is center of suit. Termination agreement was worth $140 million. P’s claiming waste and product of breach of fiduciary duty by Ovitz and Disney)

o Bad Faith – intentional dereliction of duty, a conscious disregard of one’s responsibilities. More than gross negligence

o Does BJR protect the conduct here? Always evaluate this for breach of duty of care. Shouldn’t look to see

that you acted in good faith. Have to show malfeasance on part of directors to not be covered.

o Next look to exculpatory provisions (102(b)(7)) indemnity unless bad faith

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Without provision in charter establishing compensation committee, full board evaluation is presumed. Here committee solely responsible for determining executive comp.

Committee and not board handling it, is ok Ovitz wasn’t officer at time of dealing, so no duty to contract fairly with

self.o Waste Claim fails b/c what they paid Ovitz was what was required to get him

from CAA – it was his market value. Stock went up when they got him. Board not negligent in appointing him b/c assessed and went through

proper procedures and research. Rational hiring decision. Same with firing, did right research, contacted right people Prove Waste – exchange must be so on sided that no reasonable

business person would have entered into the transaction. Based on rational hiring contract, not waste.

o What is Good faith? – beyond lack of due care, qualitatively more than gross negligence

(something other than reckless disregard is independently actionable) 1) Subjective Bad Faith – You know what the consequences are

but go ahead and act that way anyways. Intentionality. Maliceo Gets around 102(b)(7) and grey legal area.o Different than lack of Good faith

2) Carelessness 3) Deliberate inattention to duties – a conscious disregard for

one’s responsibilities.o MBCA 202(b)(4) : permits limitation or elimination of liability for any

action taken or failure to take any action as director. (more toward reclaiming financial benefits improperly received by directors)

Duty of Loyalty Must show 1) that someone was on both sides of the transaction Stone v. Ritter (Amsouth and Amsouth bank paid 50 mil in fines in suit by SH in

derivative suit. No fines or penalties imposed on directors. Amsouth lacked adequate board and management oversight.)

o Director’s personal liability depends upon whether or not their conduct can be exculpated by 102(b)(7), unless conduct is not in good faith or breach of duty of loyalty.

Assesment of director’s personal liability for failing to act in good faith in discharging his/her oversight responsibilities has evolved beginning with our decision in Graham through Caremark.

o The failure to act in good faith may result in liability b/c the requirement to act in good faith “is a subsidiary element, i.e. a condition of the fundamental duty of loyalty

o the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only the latter 2 duties, where violated, may directly result in liability, whereas a failure to act in good faith may do so, but indirectly.

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o Caremark lays out conditions predicate for director oversight liability: 1) the directors utterly failed to implement any reporting or info system or control; 2) or having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.. Either way, liability requires a showing that directors KNEW they weren’t discharging their fiduciary obligations

Where directors fail to act in face of known duty, and demonstrate conscious disregard for responsibilities, they breach duty of loyalty by failing to discharge that obligation in good faith.

Don’t need malice to get oversight claim. But carelessness is not enough. Must be intentional.

o Stone says Caremark is a duty of loyalty case, and essentially dispenses with good faith as an independent duty, and brings it under Duty of Loyalty.

Now duty of loyalty is no longer excluded by exculpatory clause, and can bring suit.

o In the absence of red flags, good faith in the context of oversight must be measured by the directrs’ action to assure a reasonably information and reporting system exists, and not by second guessing after the occurrence of employee conduct that results in an unintended adverse outcome

Shareholder Primacy Norm Directors must make decisions in the interests of the corporation, and many state

duty is owed to corporation and its shareholders.o SH are primary benficiaries of the duty of care

NOT A LEGAL DOCTRINE – general notion that corporations are intended to benefit SH

Ford v. Dodge (No minority oppression at time of case. Ford decided to discontinue paying a special 10 mil dividend, in order to finance a new plant while paying above market wages and reducing the price of ford cars)

o Minority SH claimed this decision was inconsistent w/ purpose of Corp – to maximize return to SH.

o Court ordered them to start paying dividend again, even though they didn’t stop Ford’s expansion plans at all

o This decision is at odds w/ courts general deference to management Kahn v. Sullivan (Former CEO Armand Hammer case. Occidental’s board of

directors decided to construct and fund an art museum for Hammer’s collection, named Armand Hammer Museum, despite the opposition of some SH. SH filed derivative suit upon board’s approval of this – Sullivan (SH) settled, court approved. Kahn (SH) brought this action to stop the settlement)

o Court looked at whether Occidental made careful, well thought out decision regarding the donation, and if they were informed.

Special Committee was created specifically for this product So no duty of care problem, b/c insulated by hiring indepdent counsel

o BOD alleges goodwill will come from donation.

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o Ct consluded that test of Corp waste is “reasonableness”, so look at Internal Revenue Code for charitable gifts.

Also, Given net worth of Occidental, its annual net income before taxes, and tax benefits to them, gift of Museum was within range of reasonableness. No waste

Also look at what similarly situated companies are giving

DUTY OF LOYALTYSelf Dealing and Controlling Shareholders

Duty of loyalty cases are scrutinized more carefully than duty of care oneso Don’t initially get BJR protection but can try to reinsert that protection through

use of various procedural mechanisms MBCA 8.31 provides that conflict of interest transactions are not void or voidable

if:o 1) the material facts are disclosed to the board of directors or SHo 2) Either the disinterested directors or the disinterested SH authorize,

approve, or ratify the transactions Substantive fairness of a conflict-of-interest transaction is demonstrated by

showing both fair price and fair dealing. Upfront questions:

o Who is on both sides of the transaction? o Once find a director/officer on both sides, eliminates the Business Judgment

Rule o Did the corporation try to cleanse the Duty of loyalty transaction?o Even if Successfully "cleanse", What Standard?

Hollinger International v. Black (Black, controlling SH, faced self dealing accusations. He tried to save himself by coming up with deal, but violated by taking valuable opportunity presented to International. Blocked big opportunity to make $ if deal goes through) – Complicated business structure can give people a lot of opps to violate duty of loyalty

o Black didn’t inform international about deal for paper, and rejected opportunity on own and gave to one of his own companies.

Not allowed under agreement. He was to refrain from transactions. He took personal info that belongs to International to support his deal to

Barclays.o Held: He violated duty of loyalty b/c denied board the right to consider faily the

opportunity he took for himself. He misled fellow directors, improperly used confidential Info, never tried to form an independent committee for this deal. He also urged deal using improper inducements.

Majority or Controlling SH Majority/controlling SH standing on both sides of transaction bears burden of proving

the entire fairness of its actions, that is the fairness of the procedure developed to approve a transaction and the fairness of price of transaction.

Majority SH – owns more than 50% of corp’s outstanding voting rights Williamson v. Cox Communications (2 cable companies owned ISP and sold to 3rd

making it new controlling SH, and so question with Duty of Loyalty is whether they

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were considered a controlling SH, and as such owe a fiduciary duty to the company’s other SH)

o Claim that Cox and Comcast stood on both sides as controlling SH and pushed for unfair agreement to minority SH

o Rule: where an SH stands on both sides of a transaction and is found to be a controlling SH, the transaction will be viewed under the entire fairness standard as opposed to the more deferential business judgment standard.

To be a controlling SH, P must show actual control over Corp and SH

o All Factors put together make it more plausible that D’s are controlling SH (have actual control) and acted without regard for the interests of the other At Home SH. Acted to carve up assets of ISP among themselves. Together they had 1) board membership, 2) veto power, 3) control over income, were the primary customers of ISP service. So SJ dismissed.

Procedural Mechanisms to Limit Judicial Review MBCA 8.31 and DGCL 144: conflict of interest transactions are not void or voidable

if: 1) material facts are disclosed to the board of directors or SH, and (2) either the disinterested directors or the disinterested SH authorize, approve, or ratify the transaction. Alternatively, conflict of interest transactions are not void or voidable if they are fair to the corporation

MBCA 8.61: interested transactions may not be enjoined if (a) the board approves the transaction in accordance w/ 8.62; (b) SH approve the transaction in accordance with 8.63; (c) the transaction is fair to the Corp at the time it’s authorized.

Benihana of Tokyo v. Benihana Inc (Shareholder owning half of corporation's common stock brought breach of fiduciary duty action, alleging that board of directors improperly diluted corporation's common stock by issuing $20 million of preferred stock, and alleging that buyer of stock aided and abetted breach of fiduciary duties) If the material facts as to an interested direct’rs relationship or interest and as to the

contract/transaction are disclosed/known by BOD and BOD in good faith authorizes contract/transaction by the affirmative votes of majority of disineterested directors = safe harbor for deal

disinterested directors possessed all material information on interested director's interest in the transaction, such that business judgment rule applied when transaction was reviewed

interested director did not breach his fiduciary duty of loyalty when he negotiated transaction

evidence was sufficient to establish that directors' approval of the transaction was a valid exercise of the board's business judgment

In Re Wheelabrator Tech (Waste acquired 22% interest in WTI – Waste decided to either acquire a controlling interest or to divest all of its WTI stock.  Reps from both sides agreed that it would be structured as a stock for stock merger conditioned upon the approval of a majority of WTI’s disinterested shareholders – board unanimously approved, and vote went to shareholders – they approved too.  Class action filed by shareholders alleging breach of fiduciary duty to disclose all material information concerning the merger (breach of duties of loyalty and care).

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No evidence for disclosure claim fully informed vote does not extinguish the duty of loyalty claim.  It does, however,

serve to make the BJR the applicable review standard with the burden of proof resting on the plaintiff stockholder.  Fact that the merger was approved by a fully informed majority of WTI shareholders does provide a complete defense to the disclosure claim and the duty of care claim. 

HOLDING:  A FULLY INFORMED SHAREHOLDER RATIFICATION DOES NOT EXTINGUISH A DUTY OF LOYALTY CLAIM, BUT IT SERVES TO MAKE THE BJR THE APPLICABLE REVIEW STANDARD WITH THE BURDEN OF PROOF RESTING ON THE PLAINTIFF STOCKHOLDER

Voidable acts are susceptible to cure by SH approval, void ones are not.

Corporate Opportunities Breach of Duty of Loyalty – diversion of Corp opportunities for the benefit of a

corporate director or manager Courts have Identified 3 tests:

1) the “interest or expectancy” test, which precludes acquisition by corporate officers of the property of a business opportunity in which the corporation has a “beachhead” in the sense of a legal or equitable interest or expectancy growing out of a preexisting right or relationship;

2) the ‘line of business” test, which characterizes an opportunity as corporate whenever a managing officer becomes involved in an activity intimately or closely associated with the existing or prospective activities of the Corp

3) the “fairness” test, which determines the existence of a corporate opportunity by applying the ethical standards of what is fair and equitable under the circumstances

Broz v. Cellular Info Systems (Broz is the President and sole stockholder of RFBC and at the same time a member of the board of directors for CIS.  Broz was approached about purchasing the M-2 license.  CIS had recently emerged from bankruptcy.  Broz approached three board members who each told him CIS was not interested in the license.  PriCellular was in the process of looking into buying CIS.  Broz agreed to buy the M-2 and an agreement went through) Holdings: 1) determination of whether a corp fiduciary has usurped a corp opp is fact

intensive and turns on the ability of the corp to make use of the opp and company’s intent to do so; (2) while presentation of a purported corporate opportunity to the board of directors and the board’s refusal thereof may serve as a shield to liability, there is no per se rule req’ing presentation to the board prior to acceptance of opp, (3) Broz not req’e to consider interests of PriCellular in reaching determination whether or not to buy M2 license

Guth Test: To determine if Corporate Opportunity A corporate officer or director may not take a business opportuniryt for his

own if: no one factor is dispositiveo The corporation is financially able to exploit the opportunityo The opportunity is within the corporation’s line of businesso The corporation has an interest or expectancy in the opportunityo By taking the opportunity for his own, the corp fiduciary will thereby

be placed in a position inimicable to his duties to the corporation

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A director CAN take the opportunity if:o The opportunity is presented to the director/officer in his individual,

and not his corp capacityo Opportunity is not essential to the corporationo Corporation holds no interest or expectancy in the opportunityo the director or officer has not wrongfully employed the resources of

the corp in pursuing or exploiting the opportunity Broz didn’t owe duty to PriCellular, as there was still speculation about

Pri/CSI dealo CIS owed $$ and couldn’t purchase anything until liabilities were

gone DGCL 122(17) – Every corp shall have right to renounce, in its certificate of

inc or by action of its BOD, any interest or expectancy of the corp in, or in being offered an opportunity to participate in, specified business opportunities that are presented to the corp or one or more of its officers, directors, or SH

LITIGATION TO ENFORCE DIRECTORS’ DUTIESThe Demand Requirement

Derivative Action: 2 types of Derivative Actions: (1) suit by SH against corp to compel corp to sue.

Corp is nominal def, directors real Def. (2) action by corp against directors, and the SH are, only the nominal plaintiffs, suing on behalf of corp.

To discourage strike suits; Obstacles set up: 1) P’s must have been SH at time of alleged breach of duty

(contemporaneous ownership rule) 2) P’s must remain SH throughout litigation (standing req’t) 3) SH must “demand” that BOD take action before SH assumed control of

the litigation (demand req’t) 4) once a derivative claim is filed, the ct must approve any settlement.

2 demand cases: Denied: P makes demand and BOD refuses to act, case becomes “wrongful

refusal” case Bypassed: P argues that a demand would be futile, and cts scrutinize case

more carefully; Aronson testo Whether: Under particularized facts alleged, a reasonable doubt is

created that: (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.

It is the care, attention, and sense of individual responsibility to the performance of one’s duties, not the method of election, that generally touches on independence.

MBCA 7.42: universal demand req’t, under which P’s must always first bring demand to the board that it initiate derivative litigation for breach of fiduciary duty. If after 90 days, board hasn’t acted, then P’s can initiate litigation.

This eliminates question of whether demand is req’d or excused. Drafters wanted to save time and money, and streamline litigation.

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Martha Stewart Living Omnimedia v. Stewart (Beam alleged that Stewart breached her fiduciary duties of loyalty and care by illegally selling Imclone stock in Dec. 2001 and by mishandling the media attention that followed. Issue is whether Beam established the requisite reasonable doubt about the directors’ independence in order to excuse a presuit demand)

Lower ct: said failed to show demand futility.o 2 directors weren’t disinterested, still need reasonable doubt about 1

more Martinez – Friend – not enough; Moore – Friend – not

enough; Seligman – backed Stewart before, as well as corp BJR must be overcome in the context of a presuit demand.

o Rebutted if court determines that well pleaded facts create a reasonable doubt that a majority of the board could have acted independently in responding to a demand

Independence is a contextual inquiryo “ Independent from who and for what purpose?”o Must create reasonable doubt that a director is so “beholden” to

an interested director (here Stewart) that his or her discretion would be sterilized

o Allegations of mere personal friendship or outside business relationship, standing alone, are insufficient to raise a reasonable doubt about director’s independence

Friendship must be accompanied by substantially more in nature of serious allegations that would lead to reasonable doubt about independence - ex. financial ties, familial affinity, closed relationship that caused something in past

Interested – would risk reputation more than relationship with interested director

Goal of Ct with demand req’t: (1) deter costly, baseless suits by creating a screening mechanism to eliminate claims where there is only a suspicion expressed solely in conclusory terms. (2) permit suit by SH who is able to articulate particularized facts showing that there’s a reasonable doubt either that (a) a majority of the board is independent for purposes of responding to the demand, or (b) the underlying transaction is protected by the BJR

Direct vs. Derivative Claims Tooley v. Donaldson, Lufkin, Jenrette (SH alleged that members of BOD breached

their fiduciary duties by agreeing to a 22 day delay in closing a proposed merger. P’s contend that the delay harmed them due to the lost time value of the cash paid for their shares.) How to determine if a claim is derivative or direct claim:

1) Who suffered the alleged harm (the corporation or the suing stockholders, individually); and

2) who would receive the benefit of any recovery or other remedy (the corp or the stockholders, individually)?

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Here, delay affects all SH equally, so not a special injury to P, so action is derivative, at most. this standard gets dropped in Tooley

Court must look to nature of wrong and to whom relief should go. SH’s claimed direct injury must be independent of any alleged injury to the

corp. Must demonstrate that duty breached was owed to the Stockhodler and that he can prevail without showing an injury to the Corp.

Special Litigation Committees Where demand is properly excused, company takes control of litigation by appoint

Special Litigation Committee. They determine if in comp’s best interest to pursue litigation BJR does not give BOD power to terminate a derivative lawsuit Heightened Scrutiny – Courts will listen to SLC, but with suspicion

2 part inquiry if SLC recommendation to dismiss should be followed:o Procedural: Must show independence from D’s, good faith,

reasonable investigation, and lega/factual bases for SLC conclusions. If any genuine issue of material face, litigation proceeds.

o Substantive: Even if pass first inquiry, judge can apply own independent judgment as to if suit should be dismissed.

MBCA 7.44: SLC may seek dismissal of litigation after SH has made obligatory pre-suit demand. Independence = whether member can decide on merits of issue rather than on outside considerations/influences. Decision must be made in good faith and after reasonable inquiry

FRIENDLY MERGERS AND ACQUISITIONS 2 types of Takeovers

Friendly Negotiated by respective managers of 2 companies 98% of takeovers are friendly

Hostile Take place notwithstanding the resistance of the target company’s

managementStructuring an Acquisition

3 ways to structure acquisition 1) merger or consolidation

MBCA 11.02 Merger – one company is entirely subsumed by another through operation of

lawo 2 types: o Triangular merger – surviving company establishes wholly owned

subsidiary, and capitalizes the subsidiary w/ the merger consideration, which can include parent’s stock, cash, bonds. 11.02

o Short Form Merger – parent company owns 90%+ stock of target corp. Parent is allowed to merge the subsidiary into itself using simplified procedures, including avoidance of SH vote. MBCA 11.05

SH get appraisal right, even tho no voting rights

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Consolidation – 2 companies use the statutory merger procedure to combine to form a new company

All assets and liability of companies being merged out of existence transfer automatically when a) BOD of both approve merger plan, b) SH approve merger plan, c) surviving company filed merger plan in its state of inc.

If cash is more than 50%, transaction is taxable. MBCA 11.04: SH are given right to vote on transaction, unless “short form

merger”o SH only get voting rights if charter is going to be amended by

merger, or if rights/privileges of shares will be changed, or going to equal 20% or more new stock.

o Policy: SH votes should only be req’d if the transaction fundamentally alters the character of the enterprise or reduces their participation in voting or profit dist.

Many structured as triangular to avoid SH vote in order to protect deal 2) purchase of the assets and liabilities of the selling company;

MBCA 12.02 If selling company is selling substantially all of its assets, then its SH have

the right to approve the sale Neither voting rights, nor appraisal rights are available if the comp will be

left w/ at least 25% of presale assets and either 25% of after tax operating income or 25% of revenues

Look at both quantitative and qualitative importance of what’s sold 3) purchase of stock of selling company

SH decide individual whether to participate, so not like previous 2 where majority of SH acting as group most approve transaction to go forward

If controlling SH doesn’t acquire more than 90% ownership b/c too few SH tender, controlling SH will still be in a controlling position and can then effect regular cash out merger of minority SH by persuading controlled board of subsidiary company to adopt resolution approving agreement to merge w/ parent company.

Fiduciary Duties in Friendly Transactions Directors must fulfill duties of care and loyalty in evaluating and approving transaction,

and generally act in good faith. Must also follow all disclosure rules.The Entire Fairness Standard Weinberger v. UOP (Minority SH of UOP challenged cash out merger, that had been

initiated by parent Signal. Ct said Signal failed to disclose to UOP’s outside directors/SH a feasibility study prepared by UOP’s own management using UOP’s info, who were also execs of Signal. Study concluded a higher share price would have been “good investment” for signal. Signal had initiated and structured merger, no meaningful negotiations. SH not told fairness opinion on stock price. Failed fair dealing test) 2 prong entire fairness test:

Fair Transaction Price:o Valuation must take into account “all relevant factors” including

discounted cash flow (look at anticipated future cash stream, and

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figure how much present cash would produce that future stream) present cash reps business worth.

Fair Dealing:o Relates to when the transaction was timed, how initiated, structured,

negotiated, disclosed to the directors, and how the approvals of the directors and SH were obtained. Strong recommendation to form independent negotiating committee of outsiders to act sa rep of minority SH.

Fiduciary Duties: no dilution of obligation even where one holds dual/multiple directorships. So since on both sides here, had burden of establishing entire fairness of deal.

Kahn v. Lynch Communication Systems (Alcatel acquired 43% of Lynch stock, Lynch amnded AOI to req 80$ affirmative vote of SH for approval of any business combo. Alcatel didn’t want Lynch to acquire Telco, but proposed Selwave instead. Lynch created independent committee regarding negotiations with Selwave. Committee determined deal was not good for Lynch, and unanimously opposed it. After negotiations with Alcatel, it opposed alcatel Merger price) In a parent-subsidiary context, a showing that action taken was as though each of

contending parties had in fact exerted its bargining power against the other at arms length is strong evidence that transaction meets test of fairness.

2 Requirements of Independent Committee Majority SH must not dictate terms of the merger Committee msut have real bargaining power that it can exercise with

majority SH on an arms length basis Based on committee’s actions being well informed and aggressive to simulate an

arms length transaction, the burden of proof as to entire fairness would then shift from Alcatel to contending SH, here Kahn. Must be truly independent and perform their tasks in a proper manner.

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