AGENCY

Defining Agency
- A fiduciary relationship that arises when on person (principal) manifests assent to another person (agent) that agent shall
act on his behalf & subject to Ps control, A also manifests assent/const (1.01 3rd)
- Asking when one party responsible for the actions of another and what rights & obligations do those parties have to one
another
- Agency created with the manifestation of consent by principal that agent would act on their behalf, agents assent
o Gorton v Doty: relationship doesnt have to involve matters of business, just that where one undertakes to transact
some business or manage some affair for another by authority or on account of the later
Principal is responsible for the acts of his/her agent
EAKELEY: isnt good law / result oriented case that permitted to get insurance
o Look at what was said, to whom it was said and their response/conduct following it
- Even without expressed language, relationship can be created thru the exercise of control and influence &
principal is liable for the transactions agent enters into
o A. Gay Jenson Farms Co. v Cargill Inc: creditor who assumes control of his debts business may become liable as a
principal for the acts of the debtor in connection with the business
Existence of agency may be proved thru circumstantial evidence; P must be shown to have consented to
the agency
Securities holder doesnt become a principal if he merely takes managerial position but when he
assumes de facto control over the conduct of his debtor can be made into principal
Court distinguishes btwn 14o and 14k
14o creditor becomes principal when he assumes de facto control over his debtors conduct
14k only if its agrees that he is to act primarily for the benefit of the other and not for himself
o Factors used to indicate a relationship must be considered together and not in isolation
Principal Characteristics
- Agent has to consent and be subject to roles
- Not dependent on what they think the relationship thus you can create one & call it something else, but a court will
consider it one
- Relationship based on trust & imposes obligations good faith, duty of care and loyalty (specifics dictated by context
of K)
- Cant disclaim an agency relationship if one exists
- 3 principal forms of agency
o Relation of principal agent
o Relation of master servant
o Relation of employer or proprietor and independent contractor
Authority Created
- Doesnt have to be in writing, can be verbal or even by conduct; however writing & verbal instructions reasonably
reviewed causes agent believes that are authorized to act
- Scope of authority may be changed replace original manifestation but must create a new one

Liability of principal to third parties in contract

o

Agents Authority
Actual Implied authority is the actual authority, circumstantially proven, which the principal actually
intended the agent to possess and includes power necessary to carry out duties [P & A]
Mill Street Church of Christ v Hogan: specific conduct/course of dealing establishes authority
(carrying duties & nature of the task)
o Factors used to consider whether implied authority exists
Focus upon the agents understanding of his authority
Whether the agent reasonably believe bc of principals past or present conduct, that
the principal wishes him to act in a certain way or to have certain authority

Person alleging agency has the burden of proof to show its existence; can be proven thru
circumstantial evidence including acts and conduct
Implied authority may be necessary in order to implement express authority
impossible that the principal knows exactly everything that he needs agent to do; agent takes other
necessary steps within duties; principal liable
o Policy implication: important in creating relationship that principal draft good instructions
for the agent otherwise the agent is free to do & undertake any means
Actual Express Authority principal tells agent to do X, agent does X, principal now bound
2.01 (3rd) an agent has actual authority to take action designated or implied in the principals
manifestations to the agent and acts necessary or incidental to achieving the principals objectives as
the agent reasonably understands the principals manifestations and objectives when the agent
determines how to act
2.02
3rd party can enforce K against principal
Apparent authority is not actual but its the authority the agent is held out by the principal as
possessing; its the matter of appearance [communication btwn P & 3rd Party[
Conditions in an agreement will limit apparent authority
Only exists when a 3rd party reasonably believe the actor has authority to act on behalf of the
principal and that belief is traceable to the principals manifestations (2.03 3rd)
o Principle still liable
o Only when theres a connection btwn the principal and third party
o How did third party know about the relationship?
o Not enough that the agent makes assertion of the relationship -- verbal & conduct needed
Look at the manifestations btwn the principal and the third party
Communicates to the third party or their observations from the principle that give an appearance
that agency exists
Liability of undisclosed principal
Undisclosed principal when an agent and a third party interact, the third party has no notice that the agent
is acting for a principal (1.04 (2)(b) 3rd)
Cant have apparent authority with undisclosed principal
Will usually arise in situations in which the agent acts in a manner consistently with the authority that a third
party reasonably believe the agent to have under the same circumstances if the principal had been disclosed
Once undisclosed principal established, ordinary doctrine applies making principal liable that are
within the authority of that agent of that character
Watteau v Fenwick: upon discovering undisclosed principal, can sue only where the act done by
the agent was within the scope of his agency not where there has been an excess of authority
Show that principal acted in a way that enabled their agent to hold himself out to the world as their
proprietor of their business
Liability 2.06 (3rd)
(1) Subject to liability who is justifiably induced to make a detrimental change in position by an
agent acting on principals behalf and without actual authority, if the principal having notice of the
agents conduct & that it might induce others to change their positions, didnt take reasonable steps
to notify them
(2) Undisclosed may not rely on instruction given an agent that qualify or reduce the agents
authority to less than the authority a 3rd party would reasonably believe the agent to have under the
same circumstances if principal had been disclosed
Ratification
My agent didnt have the right to enter into this K, but Im glad she did so ill affirm the transaction and
agree to be bound
2nd Restatement 82 the affirmance by a person of a prior act which didnt bind hum but which was done
or professedly done on his account, whereby the act as to some or all persons, is given the effect as if
originally authorized by him
Requires an acceptance of the results of the act with an intent to ratify, and with full knowledge of all
material circumstances
Involves 2 questions

What types of acts constitute an affirmation by the principal; did the P, thru word or deed, manifest
his assent to the agreement
What effect should we give to that affirmation
Ratifying: 4.01(2)
Express affirmation
Implied acceptance
Implied affirmation thru silence or inaction
Bringing lawsuit to enforce K
Must ratify all or refute it entirely 4.07 (3rd)
Valid ratification principal must know material elements 4.06 (3rd)
If the original transaction was not purported to be done on account of the principal, the fact that the
principal received its proceeds doesnt make him a party to it
Botticello v Steanovicz: need an intent to ratify or new material facts on the deal
o Standard of proof: preponderance of evidence with having the burden
Estoppel
The appearancy and appearance of authority must be shown to have been created by the
manifestations of the alleged principal and not alone & solely by proof of the supposed agent
Hoddeson v Koos Brothers: when a proprietor enables an imposter to transact his business, the
law will not permit him to avail himself to the imposters lack of authority and escape liability
Duty of proprietor includes the duty of reasonable care and vigilance to protect customers
To prove liability:
o (1) Express or real authority which has been definitely granted
o (2) Implied authority, that is, to do all that is proper customarily incidental and reasonably
appropriate to the exercise of the authority granted
o (3) Apparent authority such as where the principal by words conduct or other indicative
manifestations has held out the person to be his agent

Fiduciary Obligations of Agents (or duty of loyalty owed to principals)

o

Duties during Agency

Duty of loyalty owed
3 common situations that constitute breach of loyalty
o agent receives from 3rd party in connection to a transaction, a benefit (388 (2nd) or 802 (3rd))
o Secret profits obtained by agent in acting adverse to principal
o Agent uses his position for a benefit [387(2nd) or 8.02(3rd)]
Is there an inherent conflict of interest?
If servant takes advantage of his service and violates his duty of honesty and good faith to make a profit, in
which he utilizes the assets he has control over, facilities or position he occupies and thru this he makes his
profit then he is accountable to his master
Reading v Regem: if servant unjustly enriched himself by virtue of his service without masters sanction
then law says he cant keep money
o Utilizes the facilities provided by employer
o Sole cause of benefit is derived from the position itself
However this is distinguishable from when his position merely affords him the opportunity to
profit (this is okay)
Ask what/how is the sole reason/cause servant is getting his money
When agency relationship real cause or predominant part in generating the profits then theres a breach
Doesnt matter if principal didnt lose any benefit
R. 92nd) 376: general Rule of duties [depends upon the agreement btwn the 2]
380: good conduct
387: basic duty of loyaly unless otherwise agreed, act soley for the benefit for P
394: Acting with conflicting interest
404: liabilities imposed on using Principles assets
Employee has a duty to deal openly with his employer and to fully disclose to him info about matters affecting
the companys business

Rash v JV Intermediate LD: had a general duty of full disclosure on business matters affecting principals
interest and a general prohibition against fiduciarys using the relationship to benefit his personal interest,
except with full knowledge and consent of principal
Fiduciary Duties -- 8.01, .02,.04,.05
8.01 General Fiduciary Principle: agent has a fiduciary duty to act loyally for the principals benefit in all
matters connected with the relationship
8.02 Material Benefit Arising out of Position duty not to acquire a material benefit from a third party in
connection with a transaction
8.04 Competition throughout the duration of relationship, agent has a duty to refrain from competing
with the principal & from taking action on behalf of or otherwise assisting the principals competitors;
during this time can take action not otherwise wrongful to prepare for competition following the end of the
relationship
8.05 Use of Principals Property; Use of Confidential Info duty (1) not to use property for agents own
purpose or those of a third party; and (2) not to use or communicate confidential info for their own purpose
or of 3rd party
8.06 Duty to Disclose

Duties during & after termination of Agency Gravving and Leaving

o Employee may not solicit owners customers who arent openly engaged in business in advertised locations or whose
availability as patrons cant readily be ascertained but whose trade and patronage have been secured by years of
business effort and advertising, time, and money spent constituting a part f the good will of the business
Town & Country Home & Home Service, Inc v Newbery: general clients solicited publically may be acquired since
ads were around however cant solicit those client lists that were created thru hard work
Policy Argument: to protect the investment of former employer in running their business but still want to
promote competition and innovation

PARTNERSHIPS
Defining Partnerships & Partners
- Uniform Partnership Act: an association of two or more persons to carry on as co-owners a business for profit
o Sharing of profits is prima facie evidence of partnership but no such interference shall be drawn if such profits
were received in payment as wages of an employee
- Rule of partnership: make each partner potentially liable for all the debts of the partnership
- UPA 103 Effect of Partnership Agreement; governs the partnership but if theres no agreement than UPA
default act controls
- Partnership distinct from its entity
- Characterization of partnership & having an agreement doesnt necessarily establish it
- Mutual Agency every partner is an agent for all the other partners & an agent for the partnership itself
- 401 (UPA 1997) Partners Rights and Duties
o 401(a): each partner is deemed to have an account that is:
(1) credited with an amount equal to the money plus the value of any other propert, net of the
amount of any liability, the partner contributes to the partnership and the partners shares of the
partnership profits
(2) charged with an amount equal to the money + value of any other property, net of the amount
of any liabilities, distributed by the partnership to the partner & partners shares of the
partnership losses
o 401(f) each has equal rights in the management and conduct of the partnership business
- 801(1) UPA 1997 Events Causing Winding Down & Dissolution
- Partners Compared with Employees
o Fenwick v Unemployment Compensation Committee
Elements in determining the existence of partnership; deal points; basic aspects to the association
& relationship to those participating
Intention of parties
Right to share in profits
Obligation to share in losses
Ownership and control of the partnership property and business
Community of power in administration
Language in agreement
Conduct of the parties toward third parties
Rights of the parties on dissolution
Distinguish btwn employment & self-employment
- Partners Compared with Lenders
o Martin v Peyton: an agreement that offers a degree of control to protect lender assets not considered a
partnership since the original party maintains control of it
Measures taken were precautions to safeguard the loan
The General Partnership
- Advantages:
o More than 1 owner & want an active role in business (i.e. management)
o Receive flow thru tax treatment avoiding double taxation
o Loss bore on individual investors
o Tax planning: flexibility in allocating income loss deductions or credits
Doesnt have to file entity taxes just their own
o Partners basis determines amount of income tax they will pay
o Structure more flexible
- Disadvantages

Mutual agency arrangement: each has the power to bind the partnership when acting within the scope of
business
o Unlimited liability for the debts and obligations
o Payment of taxes on his distributive share of partnership income
o Dissolution death, bankruptcy or withdrawal
o Restrictions on alienability shares arent transferable
- Considerations
o Limited Liability:
Investors want protection; can shield themselves of personal liability by having one partner being the
entity, buy insurance, draft agreement lessening personal liability
o Transferability
Better to have buy-sell agreements or repurchase agreement
In agreement of by laws or shareholders agreement, if one wishes to withdraw or shareholder want
to get out certain rules apply
o Obligation of association to buy out or close company to do it or remaining partners
obligated to buy his shares
o Life of an Entity
Partnership by agreement that business will continue without dissolution after death or even after
partner dies/retires
Flexibility: dont need a filing anywhere

Fiduciary Obligations of Partners

- Joint adventurers, like co-partners, owe to one another while the enterprise continues, the duty of the finest
loyalty
o Meinhard v Salmon: as managing co-adventurer, had a duty to disclose the opportunity so that the other may
have the opportunity to compete
May even had the obligation to offer him the job/share it with him bc of the nature of the duty of loyalty
Managing partner owes a duty to keep partner updated
- When a partner is offered an opportunity he has a duty to entrust it to the partnership & has to disclose it so
partnership gets the opportunity

Partnership Property
-

UPA partnership property consists of:

o Rights in specific partnership property partnership tenancy possessory right of equal use or possession by
partners for partnership purposes
Right incident to the partnership & possessory right doesnt exist absent the partnership
Possessory right is not the partners interest in the assets of the partnership
o Interest in the partnership
o Right to participate in management
Partners real interest is his share of the profits and surplus and the same is personal property
o Putnam v Shoaf: partnership owns the property or asset
Partners interest is the pro rata share of the net value or deficit of the partnership
o A conveyance of property held in the name of the partnership is made in the name of the partnership and
not as a conveyance of the individual interest of the partners

Rights of Partnerships
-

Default Rule: if you have a partnership agreement that is silent in granting authority to the parties, then equal right
applied (default rule)
o 18(e) UPA: in the absence of an agreement all partners have equal rights in the management and conduct of the
partnership business
18(h) any difference arising as to ordinary matters connected with the partnership business may be decided by the
majority of partners
a partnership has the power to bind the partnership in any manner legitimate to the business; what either party
does with a 3rd party is binding on the partnership

National Biscuit Company v Stoud: a general partner with no restrictions in the partnership agreement on his
authority to act within the scope of the business has equal rights with other partners
Therefore partner cant restrict his authority to perform when its an ordinary matter connected with the
partnership business, for the purpose of its business and within its scop
With only 2 partners; opposing partner is not & couldnt be majority
o Majority can restrict acts
Pav-Saver Corp v. Vasso Corporation
o 38 UPA Dissolution Provision affords partners that didnt cause the dissolution certain rights
if dissolution caused is a violation of partnership agreement, he is liable for any damages sustained by
the innocent partner
innocent partner also has the option to continue the business in the firm name provided they pay the
partner causing the dissolution the value of his interest in the partnership
o non-offending party may retain the partnership property & all that goes with it if he wishes to continue the
business
Sharing of Losses
o General rule: in the absence of an agreement, partners agree to share equally in profits and losses regardless of
how much each capital contribution was (under the notion that each partner actually made a contribution)
o Kovacik v Reed: anomaly to general rule one partner contributes the money capital against the others skill and
labor, neither party is liable to the other for contribution for any loss sustained
One who contributed money cant seek loss from the other who only gave services
o UPA 1914 18(a) rights and duties of partners : each is to be repaid his contribution (thru capital or advances to
the property), share in profits & surplus remaining after all liabilities; & must contribution towards the losses
whether of capital or otherwise sustained by the partnership
o UPA 1914 40(b): liabilities are to be paid: creditors, partners other than for capital and profits, owing to
partners in respect of capital, owing to partners in respect of profits
o UPA 1914 40(d) partners are to contribute te amount necessary to satisfy the liabilities
o UPA 1997 401(b) readopts the loss sharing rule that each partner is entitled to an equal share and is chargeable
with a share of partnership losses in proportion to the partners share in profits
Buy Out Agreements: an agreement that allows a partner to end their relationship with other partners and receive a cash
payment or series of payments or some assets of the firm in return for the interest in the firm
o Default rule: right to withdraw even if partnership agreement prevents you to
o Ready exit strategy without dissolving the firm but grants the ability to take with you your negotiated share of
the firm or anything you have negotiated
o Critical elements
Price: usually want to sell interest/stock at their market value but partnership usually dont have readily
ascertainable market value
Can hire an appraisal, agree on a formula in determining the price, book value
How must will one get post exit?
50% market value at the time of departure
define a process
o other considerations: consequences of refusal to buy, method of payment, protection against debts & procedure
for offering either to buy or sell

Limited Partnerships
- Liability on general partners rests on how much control of the business they took
o Holzman v De Escamilla: if exercising duties as a limited partner & if you take control you wont be treated as a
general partner except to persons who transact with LP and reasonably believe the parties are general partners
UPA 1997 303(a)
o Simply consulting doesnt constitute control Section 303b

CORPORATIONS
Introduction
- Basics/Characteristics
Corporations have an independent perpetual existence & owns the business assets & is liable for any
business debts; able to enter into K, purchase property; indefinite life which enhances the stability of
corporate form
Board of directors manages the corporation and are subject to fiduciary duties
Shareholders have a limited governance roles: can vote to elect directors, approve fundamental corporate
changes but cant act on behalf of the corporation
Return of the investment:
Creditors shareholders (last in line & receive dividends as declared at the discretion of the board)
If corporation dissolves, creditors claims have priority & shareholders are residual claimants
(receive their share from the remaining assets after all has been paid post liquidation)
Corporate Constituents
Shareholders provide money capital invest for their beneficiaries
Board of Director/managers oversee the business and its employees; elect its officers
Offers deal with the day-to-day business
Lenders supply additional capital as secured bank loans, unsecured bonds, short-term notes, and
suppliers trade credit
The Corporate Form
Legal personality with indefinite life; limited liability for investors, free transferability of share
interest, centralized management
2 distinctions
o Publicly held corporation Tend to adopt all the basic characteristics of the corporate form;
incorporate to raise capital
Generally have a class of equity securities held by 500 shareholders & assets of
1mill; always C Corporation
o Closely held corporation: few shareholders, incorporate for tax or liability purposes rather
than capital-raising purposes
Shareholders likely to be officers and directors
Usually drop corporate features of corporate formalities that conflict with their
status as incorporated partnership
Either C or if they qualify shareholder may elect Subchapter S status and flowthru tax treatment
- Forming/ Incorporation reflected in 2.01-2.04 of Revised Model Business Corporation Act
Filing of articles in state (doesnt have to be in the same state it will do business in)
Formation involves 3 steps
Preparing articles of incorporation (aka charter or certification of incorporation) according to the
requirements of that state
Signing of articles by one or more incorporator
Submitting the signed articles to the states secretary of state for filing
2.02 Articles of incorporation (must include)
Name must be stated & include a reference to its corporate status; name must be distinguishable
List registered office and agents: must state corp address for service of process and for sending
official notices; a registered agent may be named

Capital Structure specify the number of shares its authorized to issue; the various class of stock, # of
shares to each class
Other provisions not inconsistent with law may be added but not required:
Purpose and powers for organizing
Managing the business and regulating affairs
Defining, limiting the powers of the corporation, stockholders, directors
A par value of the shares
Imposition of personal liability on shareholders for the debts of the corporation
Corporate existence begins when the articles are filed
After Incorporation
If initial directors are named, they will hold an organizational meeting to complete the organization
of the corporation by appointing officers adopting bylaws and carrying on with other matters
If initial directors arent named, the incorporator will hold this meeting to elect directors and
complete organization or elect directors who will complete the organization
Organizational meeting working structure is created, enumerated in the bylaws
Corporate Capital structure (assets and future earnings) issued pursuant to a formal K called securities
Securities can be stocks, debt instruments (notes, debentures), bank loans are not
May be short term to long term notes
Equity Securities (share of stocks) represent the units into which propriety interests are divided
o If you own shares of the stock you own units of the company (a piece of that company)
shareholders = owners
o Note shareholders dont own fiduciary duties to each other; but directors owe a duty to them
Duties of loyalty and good faith
But directors dont owe duty to debt securities
Preferred Stock: contains things that preferred stockholders prefer that residual claimants dont
o Distinguishable from common stock: right of preferred to have their dividends paid first
over common stock shareholders
o Accumulated right to dividends
o Liquidation preference: they have a call of assets
Convertible Securities: convertible to other securities
Class of Securities: companies can issue each of which are different rights
Incorporations II
Corporate securities are traded in markets
Primary market: corporation sells shares to investors; IPOs (initial public offerings)
Secondary market: trading market in which investor buy/sell securities thru the market
o Original corporator doesnt get involved in trading their securities; only involvement is thru
regulations
Rules of Boards and Shareholders
Board of directors: managing & supervising the business
Shareholders: extremely limited governance of corporation
o Have right to vote directors thru proxy contest, right to vote to change certain affairs,
initiate limited reforms
Articles of Incorporation: charter, foundational document that states the purpose and power, describes
special features in which only a few are mandatory
Publicly filed document
Must pro-profit have a broad purpose
Non-profit have limited charters; limited purpose
Internal Affairs Doctrine where you form is the law that governs
Deciding state to incorporate in
o Corporate law of state and home state advantage
o Incorporating in DE & do business in NJ can get foreign corporate standing
Double Taxation
Ways to Protect Shareholders
Cumulative voting: each vote determined by multiplying # shares owned by them, # of director position up
for vote so a shareholder can vote all their shares towards 1 director

If shareholder doesnt have control super majority provision 102 DE Corp Law
Cant amend without 80% affirmative vote
Part Value Stock: stock with a stated face value rarely used tho

Role and Purpose

- In the advancement of the public interest the reserved power may be invoked to sustain later charter alterations
even tho they affect contractual rights btwn the corporation and its stockholders
o Ap Smith Mfg. Co. v Barlow:
Common law rule: those who managed the corporation couldnt disburse any corporate funds for
philanthropic or other worthy public cause unless the expenditure would benefit the corporation
NJ Statute 14:3-13: any corporation could cooperate with other corporations and natural persons in the
creation and maintenance of community funds and charitable, philanthropic or benevolent
instrumentalities conducive to public welfare and could for such purposes expend such corporate sums
as the protection of the corporate interests
Reserve power: permits alteration in the public interest of the contact btwn the state and the corporation
Court goes around Zabriskie case prior court didnt consider the public interest in applying reserve
power so we will approve the amendment to the corporations charter to include the NJ statute
o Limitations on charitable contributions
Cant be pet charity & no furtherance of personal interest but instead corporate best interest
Must be for a corporate purpose
- Other States Law
o DE Gen Corp Law 122: every corporation created under this chapter shall have power to
(9) make donation for the public welfare or for charitable, scientific or educational purposes and in time
of war or other national emergency in aid thereof
authorizes charitable contributions that serve the basic purpose of business corporations which is to
maximize profits
BJR accepted when determining whether a charitable donation will be good for the corporation
o CA Corp Code 207(e): gives corp the power to make donations regardless of specific corporate benefit, for the
public welfare or for community fund
o NY Bus Corp Law 202(a)(12): general powers of corporation includes the power to make donations,
irrespective of corporate benefit
o Federal Income Tax law 170(b)(2): deduction for charitable contributions by corporations is limited to 10% of
taxable income; deduction not dependent on business purpose
- It is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the
merely incidental benefit of shareholders and for the primary purpose of benefiting others business
corporations are organized & carried on primarily for the profit of shareholders
o Dodge v. Ford Motor Co: powers of the directors are to be employed for that end (profit for shareholders)
General rule that its only the directors of a corporation that have the power to declare a dividend of the
earnings and the amount
Court of equity wont interfere in the management of directors unless it is clearly made to appear that
they are guilty of fraud or misappropriation of corporate funds or refuse to declare a dividend when
corporation has a surplus of net profits which it can, w/o detriment to its business divide among its
stockholders and when a refusal to do so would amount to such an abuse of discretion as would
constitute fraud or breach of that good faith which they are bound to exercise towards the stockholders
There must be fraud or a breach of good faith which directors are bound to exercise in order to justify
the courts entering into the internal affairs of corporation
- Corporate Finance
o Typical problem in determining how much to declare of special dividend
State have imposed rules to serve as accrued protections
141(a) DE Code: business and affairs organized under this chapter must be controlled by board
holding out on special dividends means that you wont have to pay taxes on it
o dividends may be paid in shares, cash, property
o 170(a) in charge of whether to declare dividends
may be paid out of the net profits of fiscal year or surplus
- The judgment of the directors enjoys the benefit of a presumption that it was formed in good faith and designed
to promote the best interest of the corporation they serve BJR

10

o
o

Court may not substitute its judgment for that of the directors
Shlensky v Wrigley: unless the conduct of the at least borders on one of the elements, the courts may not
interfere
Directors elected for their business capabilities and judgment and the courts cant require them to forego
their judgment bc of the decisions of director of other companies
o Courts cant actively supervise corporations to protect shareholders
Beyond ability of the court
If they do then centralization of the corp would be lost
Reserve power to intervene
Heightened judicial review would take away some autonomy away from the board
Business Judgment Rule: presumption that the board decision was made in good faith, so a court wont substitute
their judgment for the judgment of the board however court will interfere on 3 grounds
o Fraud, illegality or breah of the conflict of interest (self dealing); rubberstamps
o If can establish one of these then BJR cant be evoked
If you have a board that is conscientious in rendering business decision you have BJR
o Moreover, these directors were elected to represent the shareholders
o Without the presumption anything may be challenged in court

Limited Liability/Piercing the Veil

-

Corporate Entity
o Shareholders generally not responsible for the debts/liability of corporation
o Exceptions:
6.22 Model: unless in the articles of incorporation, shareholders not personally liable but may become
responsible thru his acts/conduct
Voluntarily assume
Involuntarily liable thru conduct that evoked the equitable remedy of piercing the corporate veil
o Either the shareholder is conducting the business in his individual capacity or isnt/ if he is, he will be
liable if not then doesnt matter -- in so far as his personal liability is concerned that the enterprise is
actually being carried on by a larger enterprise entity
Walkovsky v Carlton: taxi cab runs over , he sues & attempts to pierce the veil claiming that owns
10 corporations that appear independent but are actually operating as a single entity thus constituting a
multiple structure in an attempt to defraud
Court reasons that theres a distinction btwn a corporation thats a fragment of a larger corp and
one where the corporation is a dummy for its individual stockholder
o Note that either would justify treating the corporation as an agent and piercing the veil
to reach the principal
o But this would have different results
Piercing the veil on the double corporation would result in holding the larger
enterprise liable
Whereas piercing the veil in the latter results in shareholder liability
Corporate form must not be disregarded
3 ways to determine when the corporate liability should extend to shareholders
o Conducting business in individual capacity
o Further personal interest
o Distinguish btwn fragmented corporate entity
Shareholder may be personally liable on a principle-agent theory if he uses his control to further
his own interest
o Corporation is treated as an agent
Piercing the Corporate Veil veil a mere instrumentality to hide their actions (shareholder)
o must establish:
control of the corp by that is so complete as to amount to total domination of finances, policy and
business practices so much so that they arent separate but rather one mind
Such control is used to commit a fraud wrong or other violation of rights
The control or breach of duty owed was a proximate cause of the injury

11

May be pierced if shareholder acts in a way that disregards the corporate formalities or works in a fraudulent
way on public
o Standards vary by states
Common law hasnt been codified
No bright line test
o Determination in whether or not to pierce is intensely fact specific
o A veil will be pierced if there is a unity of interest and ownership that the separate personalities of the
corporation and individual no longer exist (2) not doing so would sanction a fraud or promote injustice
Sea-Land Services, Inc v Pepper Source: Jamaican corporation that never paid for the spices;
Promoting injustice some kind of wrong ; unfairness, deception
o Other injustice includes
Judgment uncollectable unless veil pierced
Unjust enrichment, adverse possession, liabilities would be escaped
Some element of unfairness or other compelling public interest or some wrong for creditors inability to
collect
Limited Liability
o When shareholders, who are also corporations officers/directors, conscientiously keep the corporate
affairs separate from their personal affairs, and no fraud or manifest injustice is inflicted upon third
party corporate entity is to be respected
Frigiaire Sales Corporation v Union Properties, Inc: respondents did constol the limited partnership
but in their capactities as agents for their principal
Corporate entity could only act thru its board
Cant ignore the corporate entity
Form over substance
Each have different formal roles they can act

Derivative Litigation
-

Derivative Suit: claim or right derives from corporation, board of directors have not sought to pursue that claim;
shareholder disagreeing with the director takes it upon their right to do so
o Only way shareholders could intervene in the governance of the company & hold board accountable
o Loss derives from a loss to the corporation
Direct Suit: loss to the shareholder
NJ Statute: a stockholder who brings a derivative suit takes on a fiduciary character; representative of a class similarly
situated
o Cohen v Beneficial Industrial Loan Corp: concern with strike suits (shareholders bring nuisance suits) the
amount of owned financial interest is a plausible interest in shareholders good faith capacity
If the injury is one to the as a stockholder, and to him individually and not corporation, suit is individual in nature &
may take the form of a representative action
o Eisenberg v Flying Tiger Line, Inc: 2 prong standard who suffered harm & who recovers the remedy
If derivative action settled before judgment -- corp can pay legal fees of both parties BUT if money damages imposed
on , except to the extent covered by insurance -- will be required to pay those damages & bear the cost of their
defense
Distinction btwn direct & derivative nature of the wrong & relief would could result
Demand Requirement on Directors
o If its a derivative suit, its the corporation that has the decision to assert claim or not
o Derivative action impinges on the managerial freedom of the directors
o Demand requirement is a recognition of the fundamental precept that directors manage the business & affairs
o Demand refused doesnt mean its been excused with respect to other legal theories
o Stockholder filing a derivative suit must allege either that the board rejected his pre-suit demand to have
the board assert the claim or allege an exception to the demand rule
Grimes v Donald: exception to demand rule (demand futile)
Demand is futile when theres reasonable doubt that board can make an independent decision
Basis for claiming excusal
o Majority of the board has a material financial or familial interest

12

Majority of board incapable to acting independently for some other reasons (domination of
control)
o Underlying transaction is not the product of a valid exercise of BJR simply rubber
stamped
Demand works like an alternate dispute method can avoid litigation bc board can change their
dealings
o Grants the corporation control over the procedure
o Purpose for demand:
Relieve courts from deciding matters of internal corporate governance by giving the board time to correct
alleged abuses
Provide the board with reasonable protection from harassment by litigation matters within their discretion
Discourage strike suits commenced by shareholder for personal gain rather than benefit of corporation
o Marx v Akers
DE Approach: whether board validly exercised BJR determined whether they took procedural and
substantive due care
Note: in DE state court if you make an initial demand, you have essentially waived your right to
say that the board is incapable of acting on suit
NY Approach: would be futile if:
Majority of board interested in transaction
Directors failed to inform themselves to a degree reasonably necessary
Directors failed to exercise BJR in approving transaction
Demand/Futile Standard
Excused bc of futility when complaint that the board is interested
o Interest can be self interest or a loss of independence bc controlled by one with self interest
Excused when shown board didnt fully inform themselves of the transaction
o No investigation/due diligence
Excused when challenged transaction so egregious on its face that it couldnt have been product
of sound BJ
Self Interest get a direct financial benefit that is a different benefit to shareholders
Note to file a derivative suit:
o must have been a shareholder
o complaint must be verified to ensure that conducted an investigation that claim has substance
o complaint alleged not a collusion one
o must adequately represent interest of shareholders

Role of Special Committees

o
o

Directors can only delegate their duties to committees

When shareholder demand made or futile committee can be appoint to determine what they should do )sue on behalf of
corp, step aside & let shareholder do it or reject the demand & dismiss suit)

Committee Structure:
Set up to avoid interested-director justification for a demand excusal
Corporation delegates to such a committee the responsibility of examining the suit to determine whether or not it should
go forward (proper delegation not an abdication of their responsibilities)

Terms of Delegation
Committee comprised of non-board or disinterested members; independence must be proved
Given tools to obtain necessary info to evaluate claim
Determinations are final/not reviewable by the board
Answers all the possible objections to having board make decision itself

Potential Problems:
Even if impartial, how likely itll actually decide to go forward with suit?
Would it challenge corporate culture & support suit?
Therefore court may have to examine their decisions

13

o
o

Courts Evaluation of Committee decisions: assessing actions of committee not liability

Is committee independent?
o Are they carrying out its obligations w/o conflict of interest?
o When were they established to make them independent? What is their actual role
What methods and procedures did they use?
o Did they make the decision in the right way (not the merits but the procedure used)
o Nature and characteristic of their procedure
NY Approach more corporate friendly; reserves BJR to corporation
DE Approach looks more into details of decision making process & gives ct discretion
Aurbach v Bennett : company conducts its own investigation after hearing rumors that other companies had been making
questionable payments; turned out GTE had been so a shareholder files a derivative suit, board then creates a special
committee to determine what position the company should take in the suit (committee = 3 disinterested directors that joined
adter the filing)
Issue on the proper application of BJR to the decisions of Special Committees
Here, committee decision accepted/valid

Some only look at the procedures taken to make decision not the actual decision

Further judicial inquiry only if their independence is questionable; if they are independent then they dont stand in a dual
relation that prevents an unprejudicial exercise of judgment
Court looks to see if the committee met its fiduciary duties
o Were the procedures selected appropriate
o Substantive decision predicated on the procedures used
Court looks at the adequacy of the procedures followed (nature and characteristics)

Zapata Corp v Maldonaldo: filed suit where demand would clearly be excused bc all directors implicated, firm appointed
2 outside directors to the committee, then in turn dismissed the suit
Issue on whether a committee has the power to cause the present action to be dismissed
If demand rejected, shareholder can still sue must show
In DE: rejection was wrongful
NJ: disinterested
And futile
141(c) allows a board to delegate its powers to a committee
therefore committee can dismiss an action
Self interested board can create committee under same section
Court creates a procedural rule to be used by committee to dismiss suits
Concern that allowing BJR to committees may cause abuse or subconscious abuse
o Board is suspect & even tho committee appointed
Rule: After objective and thorough investigation, committee can file a pretrial motion to dismiss (in the best
interest of corporation)
o Court has 2 step analysis to motion
1. Burden of proof corporation must show independence, good faith & reasonable
investigation [if they succeed still not home free bc court applies its own BJR]
2. Court applies its own independent business judgment whether the motion should be granted
or not applies diligence on best interest bc the board suspect & even tho they appoint the
committee the court will still do more even if you had a demand requirement

NOTE: in a demand excuse suit

- files a suit and shows interested directors can go forward
- OR
- The company can create a committee to try to dismiss the suit (committee can make two decisions)
o 1. Dismissal bc not in best interest of the corporation
no you have court saying its no independent or procedures adequate so well overturn & have suit continue
OR

14

Yes independent committee, reasonable basis etc but in independent judgment should continue (usually
rarely implant their decision
OR
Continue onward with the suit

In re Oracle Corp Derivative Litigation [stanford litigation]

o Alleges insider trading, breached their duty of loyalty by misappropriate insider info & using it as a basis
for trading decisions; special committee formed that included members joined over 6months after Oracle closed
o Special Committee
Paid & agree to give up their compensation if not found independent; retained advisors
After intensive investigation declared corp shouldnt pursue the suit
o Court determined the committee wasnt independent
Reports failed to disclose facts that showed significant ties to Oracle//Stanford
Boskin professor there, Lucas made certain donations after Grundfest delivered speech there
(Boskin was actually his teacher) (lucas loyal Stanford alumnus & contributor)
Evaluation: can committee may an objective decision; focus on impartiality & objectivity
o On grounds that the ties are so substantial that they cause a reasonable doubt about committee ability to
impartially consider whether the should face suit [standard]
May be empathy btwn the committee and board, given the fact that Lucas is a huge contributor and
implausible that they wouldnt be concern how the action would effect them
o NOTE: this is not the standard used in determining independence in DE or anywhere
o Assuming committee went thru movements -- will have to show in order to proceed that
Demand futile board suspect bc they are interested plead facts with particularity that creates a reasonable
doubt that the board is independent/disinterested
o EAKELEY:
Committee:
Had to first investigate then make determination whteher to proceed or not
o Authorixed to make final decisions by board & take final action on behalf of corp
Chosen: outward appearance of unbiased nature
Produced 1000+ report by interviewing; even asked to identify witnesses they should interview
Conclusion: Oracles revenues came in at the end, hard to predct the first 2 months of the quarter and
thus the deviation from actual and guidance wasnt something that suggested it wouldnt have been
made
Relevance to the lack of connection of special counsel to the company show independence
Independence of counsel have they done any material work for the company or any directors
NO BJR (precluded) bc no independence

Independence a condition precedent in finding availability of BJR defense, but independence arises outside of derivative action
- Standard of review in related party transaction
- Take over transaction
- Precondition of the application of BJR
- Publically traded must have audit committee with entirely independent directors and their directors
Each stock exchange has a list of requirements in order to be listed
p. 125 of the Supplement excerpt of NY listing model
No material relationship but then prescribes what cant be: an employee, receive or have a family receive more than
1200 compensation
Not independent if current partner or employee of the internal or external auditor
Not independent if youre executive officer of another company (this company has boards on the other company)
Current employee or immediate family memb to a company that has made payments or received from the list

Duty of Care (duties of officers, directors and other insiders)

-

2 Principles of Duty: CARE & LOYALTY

o Consider these two & BJR

15

o
o
o

BJR grants broad immunity to their mistakes but only applied if there is no fraud/negligence
Conflict of interest relates to duty of loyalty
Negligence duty of care
Both duties cause harm to corporation no economic distinction
Violation of loyalty conscious and intentional (care is not)
Director liability for damages have been written out of certificate of incorporation in majority of states

Obligations of Control: Duty of Care

o Kamin v American Express Company: directors decide to distribute stock that had loss value in kind instead of
selling it, foregoing tax benefits but making their net earning look better. challenged decision
Ct: No breach of duty of care, BJR protects even bad decisions if made in good faith
Complaint didnt state a claim of fraud, or self dealing, no bad faith mere mistake insufficient for equity
interference
Court will examine business matters if premised on bad faith
702(a)(1)(A) Bus Corp Law permits an action against directors for the neglect of or failure to
perform or other violations of his duties in management & disposition of corporate assets committed
in his charge
Claim of Negligence must show director acted fraudulently, dishonest, or nonfeasance
all directors have an obligation to maximize income for the benefit of all persons having a stake in the
welfare of the corporate entity & are entitled to exercise their honest business judgment on info before them
& to act within corporate powers
o

Smith v Van Gorkom: Van Gorkom negotiated sale of Trans Union to Pritzker without really informing the board
about his decision or making or following protocol himself: just 20 minute presentation of planned sale at board
meeting, copies of agreement were delivered too late for study, no presentation of any details, no seeking of any
alternative offers.
Directors duty 8 Del. C. 251(b): to act in an informed and deliberate manner before submitting the
proposal to stockholders (in specific contect of proposed merger)
Cant abdicate this duty by leaving it to the shareholders
Decision violated duty of care decision to approve merger wasnt product of informed BJ & board
failed to disclose all material facts to shareholders before securing their vote
Board didnt adequately inform themselves of role in forcing the sale
At the minimum they were grossly negligent in approving sale upon 2 hours of consideration
without prior notice and not under crisis
Under 8 Del. C. 141(e) directors are fully protected in relying in good faith on reports made by
officers
Reports -- informal personal investigation; must be pertinent to the subject matter upon which a
board is called to act
Here, no reports, just oral representations,
TAKEAWAY: breach of duty to stockholders for failing to inform themselves of all info reasonably
available & relevant to make their decision; (2) failure to disclose material info such as reasonable
stockholder would consider important in approving merger

Cinerama Inc v Technicolor Inc: stockholder who opposed merger & filed an action for rescission
Board violated duty of care even tho they did a thorough investigation bc they didnt disclose info
RULE:Director must disclose material facts
Factors to consider in determining fairness of transaction: timing, initiation, negotiation, structure of
transaction, disclosure & approval by directors and the disclosure/approval by shareholders
Legislative Response
Del Gen Corp Law 102(b)(7) allows in certificate of incorporation a provision eliminating or limited
personal liability of a director for monetary damages for breach of fiduciary duty provided that such
provision doesnt eliminate/limit liability for any breach of duty of loyalty, for acts/omissions not in good
faith

Monitoring principle of the board to monitor the management of company

Fail to do so BJR wont protect you

16

Most oversight cases arise bc board failed to monitor or failed to act when presented with red flag

Francis v United Jersey Bank: wife inherits 48% of company from her husband (makes her the largest shareholder
& director) her sons served as directors, over time they were taking out loans from the trusts of their clients;
company goes bankrupt & loans are discover; claims against wife to recover that money (Husband forewarned her
about son but she didnt do anything about it )
Issue: had to owe clients duty in order to be found liable; Ct: held liable given the nature of the company
in holding trusts for their clients (duty depends on company)
Board members dont escape liability from being passive; although they can avoid it by objecting to a
proposal captured in minutes or resigning
General Rule: Directors are under continuing obligation to keep informed about the activities of the
corporation
Should at least acquire a rudimentary understanding of the business
Directors Duties EAKELEY BEST TAKE AWAY
Acquire an understanding of the business
Familiarity with the fundamentals of the business its engaged in
Lack of knowledge isnt a defense should have done an inquiry or not acted
Continuing obligation to keep informed about activities of the corp
Cant shut eyes to misconduct
o Upon discovery of an illegal course of action, director has a duty to object & make it aware
Management doesnt require day-to-day supervision but a general monitoring is okay
Maintain familiarity with the financial stats of the corp by a regular review of financial statements
Duty of care applies to closely held corporation just like in publicly traded corp
Duty is for the benefit of the corporation, only indirectly the shareholders
Requirements to manage carefully apply to whoever is actually running the corp
Generally directors owe fiduciary duty to shareholders, not creditors unless it falls under an
exception

Duty of Loyalty:
-

Modern legislation reverse common law presumption on voiding transactions, instead K are voidable but not facially
void
Self Dealing
Directors and Managers
o Bayer v Beran: creates ad campaign & radio show that has wife working for
NJR yields to the rule of undivided loyalty
Designed to avoid the possibility of fraud and to avoid the temptation of self interest
Dont want directors to be dealing themselves
Dont want to risk having directors put their interest above the companys
Personal transactions of directors with their corporation are subjected to rigorous scrutiny
Evidence of improvidence will shift burden onto director to prove good faith in dealings & inherent
fairness
evidence of improvidence or oppression, any indication of unfairness or undue advantage itll be
voided was it an intended or calculates to subserve some outside purpose (regardless of
consequences to company)
General Rule: directors acting separately & not collectively as a board cant bind corporation bc:
Collective procedure necessary so the action may be deliberately taken after an opportunity for
discussion * interchange of views
That directors are agents of stockholders & are given by law no power to act except as board
If you meet & act as a board record of meeting
However liability not imposed bc they failed to approve the program by resolution at board meeting
Failure to observe formal requirements isnt fatal
Plus meeting to renew broadcasting K is deemed ratification of all prior taken action

17

Creating radio program & ad campaign would have fallen under BJR but bc of wifes involvement had to
examine it
Not improper to appoint relatives of directors/officers to positions but a close relative of CEO &
dominant director takes a position closely associated with a new and expensive activity motive will be
questioned
Has to be questioned or else board could be placed in a position where selfish personal interest
might be in conflict with the duty
Benihana of Tokyo Inc v Benihana Inc: leaves new wife everything
Corporate actions may not be taken into the purpose of entrenchment (more difficult for shareholders to
eliminate directors)
144(a)(1): Safe Harbor -- for interested transaction if material facts as to the directors relationship
or interest and as to the K or transaction are disclosed or are known to the board and the board in
good faith authorizes the K or transaction by the affirmative votes of majority of disinterested
directors

Corporate Opportunities
Doctrine: if a transaction is in line with corporate business & is of practical advantage to the corp, then director must
fairly present the opportunity to the corp first
2 Circumstances C.O Doctrine applies:
o 1. Director uses company info or is acting in capacity where a solicitor would reasonably believe he
is dealing with company
o 2. Director comes across any opportunity in the corps line of business that would be of practical
benefit to corp
Duty of loyalty entails you to present the corporate opportunity (if fits requirements of it) before taking advantage of
it yourself; safe harbor is putting it to the board
Broz v Cellular Information System Inc:
Corporate fiduciary agrees to place interests of the corporation before his own in appropriate circumstances
o If the corp opportunity is one the corp can take/in their business/in their interest by taking it for
himself can lead to self dealing & creates conflict
Conflict btwn the duty to the corporation and self interest
Must examine the opportunity to determine where its one rightfully belonging to the
corporation
If he believes corp not entitled to it then he can take it for himself
Determine whether the company has an interest in it & can even take it on
Presenting it to the board would create safe harbor, but under DE law presentation not necessary
If theres no countervailing duty doesnt have to present corporate opportunity
o Policy consideration: the right of a director to engage in business outside his fiduciary duties would
be illusory if he was required to consider every potential occurrence to see if an opportunity would
implicate his duties
General rule: cant take advantage of opportunity until its been offered to and rejected by corp; must allow
board to exercise independent business judgment
Some courts wont consider whether its been presented in individual capacity
In re eBay Inc Shareholders Litigation: Goldman Sachs retained to underwrite an IPO of common stock, rewarded
individual by allocating to them thousands of IPO shares managed at initial offering price so they got double/triple
return
Ct: corporate opportunity, and even if it werent theres a claim that agent under duty to account for profits
obtain personally in connection with transaction related to company/position

Dominant Shareholders
Normally shareholders & directors have same fiduciary duties
However, shareholders stand in different position than directors look more towards their interest
But duties are imposed on shareholders controlling shareholders can control the board = duties to
minority shareholders
Some corporate trans controlling shareholders, courts may intervene
Transactions btwn controlling shareholders not subject to judicial review but are subject to intrinsic fairness test

18

Shareholders have the burden to show that it was fair to the shareholders
Courts will only use the test when there is a potential for self dealing if not then back to BJR
Sinclair Oil Corp v Levien: Sinclair owned 97% of stock in subsidiary & accused by minority of self-dealing and
unfairness in its distribution of subsidiary dividends bc he decided to drain Sinven of assets by announcing huge
dividends; Ct: no breach, not self dealing bc paid equal dividends to minority shareholders
Rule: Intrinsic Fairness Test used when dealing with parent-subsidiary transactions (have minority
shareholders) high degree of fairness & shifts burden of proof
o Burden to prove that transaction were objectively fair in situations that a parent has received a
benefit to the exclusion and at the expense of the subsidiary
o Used when parent controlling subsidiary
Parent owes fiduciary duty in parent-subsidiary dealings however doesnt evoke standard alone
o Standard only applied when the fiduciary duty is accompanied by self-dealing (parent on both
sides of transaction) by virtue of their domination, parent causes subsidiary to act to parents
benefit
Since there was no self-dealing found applied BJR (note that breach of K held as self dealing)
Zahn v Transamerica Corp: deals with the attributes of the various class of shares
Holder of Class A common stock of Axton sued (on his & stockholder behalf) bc caused Axton to
redeem its Class A stock instead of permitting liquidation (which would have given them double
amount)(dominant knew about the increase in tobacco value)
Majority shareholder has a right to elect and control board but under condition that it has a fiduciary duty to
the minority & corporate
Majority dominated transaction so has to prove fairness
Most states will say that a share is a contractual right and fiduciary duty doesnt go further.- Corp couldnt
call and dissolve (rather than convert) in a way that undermines the contractual rights to converted stock
Remedies available to court include:
o Void transaction
o Impose remedial damages to make transaction fair.
Difference in voting as a shareholder than as a director
o Shareholder: may have a legal right to vote in a view of his own benefits & represent himself only
o Director: represents all shareholders in the capacity of a trustee for them & cant use his office as a
director for his personal benefit at the expense of the stockholder
Zetlin v Hanson Holding Inc:
Rule: those who invest capital necessary to acquire a dominant position in the ownership of a corp, have the
right of controlling that corporation
Absent looting of corporate assets, conversion of a corporate opportunity, fraud or there acts of bad faith, a
controlling stockholder is free to sell & a purchaser is free to buy that controlling interest at premium price
Minority shareholders entitled to protection against abuse of power by controlling shareholder however cant
inhibit the legit interest of other shareholders

Ratification
-

Fiegler v Lawrence (only in dominated corporation)

o Director attempted to sell land to his corp thru a corp he formed claim that shareholder vote ratified their
interested transaction & so they are relieved of the burden of proving fairness; had been approached about an
opportunity in individual capacity, which he presented to corp but they agreed not in their best interest
o Ct: shareholder vote didnt ratify & didnt eliminate need to prove fairness; however proved fairness of
transaction
o Shareholder ratification of an interested transaction shifts the burden of proof to an objecting
shareholder to demonstrate that the terms are so unusual as to amount a gift/waste of corporate assets
o Bc interested shareholders voted, the vote didnt immunize interested directors from total (intrinsic) fairness
examination; Interest shareholder votes dont help
o General Rule: shareholder vote wont really ratify a transaction if is not disinterested shareholder vote
If court going to apply standard based on shareholder approval court will look to shareholders, insist on
disinterested approval
ONLY in dominated corps
In re Wheelabrator Techonologies, Inc Shareholders Litigation (not a dominated corp)

19

o
o
o

o
o
o

Majority vote of disinterested shareholders can ratify a transaction

DE law imposes upon board a fiduciary duty to disclose fully and fairly all material facts within its control that
would have a significant effect upon a shareholders vote
DE ratification decisions involving duty of loyalty claims (2 types)
1. Interested transaction cases btwn a corporation and its directors (or btwn the corp and an entity in which
the corp directors are also directors or have a financial interest
2. Cases involving transaction btwn the corporation and its controlling shareholder
When controlling shareholder involved in a transaction, ratification of a majority of minority doesnt eliminate
the total fairness examination; simply shifts the burden of proof to
BUT without a controlling shareholder, ratification of interested transaction triggers only BJR ( have proof)
Disinterested vote immunizes the directors against both loyalty (interested transaction) and care (waste)
claims
General Rule: independent ratification by majority satisfies the duty of loyalty
Burden of proof issues: now on the person opposing transaction on basis of waste/unfairness to prove that
transaction was outside BJR
If there majority disinterested approval burden on objectors
No majority approval burden on directors

Duty of Good Faith & Duty to Monitor

o

o
o

Obligation of Good Faith

DGCL 154: only directors who act in good faith are entitled to indemnification of legal expenses
DGCL 141(e): only directors who rely in good faith on corporate books or records or reports from corporate officers or
certain advisors are fully protected against shareholder claims
DGCL 144(a)(1)-(2): related party transactions are partially insulated from judicial review only if they are approved by
the disinterred directors or shareholders in good faith
BJR presumes good faith
Good Faith is freestanding fiduciary obligation in having equal dignity with the traditional concepts of care and
loyalty
DGCL 102(b)(7): Contents of Certificate of Incorporation
In addition to the matters required to be set forth in the certification under (a), it can also contain:
(7) provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for
monetary damages for breach of fiduciary duty as a director provided that such provision shall not eliminate or
limit the liability for any breach of duty of loyalty for acts not in good faith or which involve intentional
misconduct or a knowing violation of law of for self dealing
N.J.S.A. 14A:6-14 Liability of Directors; reliance on records and reports (standard is ordinarily prudent person)
[1]. COMPENSATION: In re The Walt Disney Co. Derivative Litigation: dealt with the employment agreement of new
president of Walt Disney (would receive a lot of money if hes terminated); hired by CEO but then he no longer wanted the
new president, so he was trying to find a way to terminate him without having to pay; he argued de facto fiduciary
De facto officer one who actually assumes possession of an office under the claim and color of an election or
appointment and is actually discharging the duties of that office but for some legal reason lacks de jure legal titles
Here: no assumption of duties & anything done before was in preparation of president duties
No duty of loyalty claim so only way to rebut BJR is to show Disney breached duty of care or acted in bad faith
Rule DGLC 141(c): empowers board to appoint committees to delegate braod range of responsibilities (includes
compensation) nothing in here mandates that the entire board make these decisions
Were informed of all info reasonably available
Good Faith Determinations: whether the standard of good faith employed by chancellor was legally correct -- it was but
noted its not the only approach to take
Theres at least 3 different categories of fiduciary behavior that equate to bad faith
o Subjective bad faith: fiduciary conduct motivated by an actual intent to harm (widely accepted standard)
o Lack of due care: fiduciary action taken solely by reason of gross negligence and without any
malevolent intent (note: gross negligence cant constitute bad faith ct reasons)
o Intentional dereliction of duty: a conscious disregard for ones responsibilities
Q is whether such misconduct is properly treated as a non-exculpable violation of duty (2
reasons)

20

1. Universe of fiduciary misconduct is not limited to either disloyalty in classic

sense or gross negligence
2. Intermediate category of fiduciary misconduct
o DGCL 102(b)(7)(ii): denies exculpation for acts/omissions
not in good faith or involve intentional misconduct
Where corporate governing instruments are ambiguous, case law permits a court to determine their meaning by restoring
to well establish legal rules of construction look to extrinsic evidence
Here: evidence supports conclusions that the board & Eisner understood that he had concurrent power to
terminate O
CEO who cant work well with the President has 3 options
Try to work it out; keep employee but in a different role, or terminate the employee
Waste claims: on severance payout
Waste claims premised on rule that -- who fails to rebut BJR isnt entitled to remedy unless transaction
constitutes corporate waste
Proving Corporate Waste: has the burden
o Show that the exchange was so one sided that no business person of ordinary sound judgment
would conclude that the corp has received adequate consideration
o Claim usually only comes up when: in unconscionable case where director irrationally squander
or give away corporate assets
o Standard premised on the presumption that when BJR applicable, boards decision will be upheld unless
it cant be attributed to any rational business purpose
Payment of a contractually obligated amount cant constitute waste unless obligation is itself wasteful
LESSON/TAKEAWAY:
directors could rely on advice bc it was done under good faith right to rely on good faith reports from
counsel, auditors and managers provided that managers have gone thru and evaluated some exercise that
makes report liable
board may delegate its authority to a dully constituted committee comprised of directors DE 141(c)
BJR protects business decision/process wasnt tidy or representative of business practices, but was at least
sufficient to provide a basis of understanding
If fails to rebut BJR only argument left is claiming corporate waste
Gross Negligence must constitute corporate waste
If you can prove judgment was grossly negligent then BJR doesnt apply

Duty to Monitor/ Oversight

Directors dont need to know absolutely everything that is going on throughout a day-to-day basis
At the minimum rudimentary understanding of the firms business and how it works, keep informed about its
activities, engage in general monitoring of corporate affairs, attend board meetings regularly and routinely review of
financial statements
Should the board adopt rules/procedures to ensure corporate officers dont engage in illegal or unlawful conduct
DGCL 102(b)(7)
N.J.S.A. 14A:6-14
Stone v Ritter [controlling law in this area]; Bank kept paying fines bc employees werent filing SARs as required by
the federal BSA
Failure to act in good faith more than and different from conduct giving rise to a violation of duty of care (gross
negligence)
Failure to act in good faith doesnt result in a breach of fiduciary duty but may result in liability bc its a
subsidiary
The failure to act in good faith is a subsidiary element of the fundamental duty of loyalty
o Therefore showing bad faith conduct is essential to establish director oversight liability, the
fiduciary duty violated by that conduct is duty of loyalty
Failure to act in good faith doesnt establish an independent fiduciary duty that stands on same footing as the
duties of loyalty and care imposes liability indirectly
Fiduciary duty of loyalty not limited to cases involving a financial or other cognizable fiduciary conflict of
interest
o Also has cases were it failed to act in good faith

21

Director cant act loyally to the corp unless he acts in the good faith belief that her actions are in the
best interest of corp
Elements to prove Director Oversight Liability
o Directors failed to implement any reporting or info system or control
o Having implemented such a system, consciously failed to monitor/oversee its operation thus disabling
themselves from being informed of risks/problems that needed their attention
o In either case need to show that the directors knew they werent discharging their fiduciary
obligations conscious disregard for responsibilities
Red Flag Concept: if you have this great system, that generates accurate info that shows bad
dealing, & you fail to take action then youre going to be liable (see red flag must act)
Policy Consideration: demanding test of liability in oversight context is beneficial to corporate shareholders as a
class bc it makes board service by qualified persons more likely to continue
o EAKELEY INTERPRETATION: moving directorial oversight out of duty of care now into a conscious
disregard (previously was gross negligence)
An intentional violation is higher standard for directors to show or show that they knowingly
disregarded thus greater shield on oversight liability
Beneficial to shareholders: recruit really good directors & push them to act under good faith
o Important: director duty of governance of compliance
o In the absence of red flags, good faith in oversight context must be measured by the directors
o

22

LIMITED LIABILITY COMPANIES

Applicable Statutes: Uniform Limited Liability Act [ULLCA] 103, 105, 201-203, 301, 303
Hybrid business model combining tax treatment of partnership with limited liability of a corp but allows more flexibility
of management than both
- Members provide capital and manage but their interest arent freely transferable (not personally liable for LLC debt)
- Duration of LLC not limited by statutes
- Become one upon filing a certification with state official
- Almost all are closely-held corporations
Note: Uniform Limited Liability Company Act p. 67 in supplement; consider it as its own business entity
Benefits/Advantages:
- Structure tailored to their particular needs and desires
- Provides it members with past thru tax treatment (no double taxation, enables you to take advantage of earnings/losses
like partnerships)
- Favorable tax treatment & flexible management (ability to engage in management depending on operating agreement
Governing Law: LLC Statutes
- Each state has adopted a LLC statute; cloaking members w/ limited liability
- No LLC statute contains a control rule
- Establish default rules that govern if theres no contrary provision in LLC operating Agreement
- K law usually governs therefore LLC Statutes give maximum effect to freedom of K

DE LLC Act 18-704(a): an assignee of LLC interest may become a member upon:
(1) approval of all members of LLC; or (2) compliance with any procedure provided in LLC agreement
Forming LLC
- 2 Basic Documents: Articles of Organization (filed with state official) & Operating Agreement
o Articles: sets out bare bones of LLC
Must set out office/agent & name must contain terms that identifies it as a LLC
o Agreement: not mandatory but advised to do so, or else default rules of LLC Statute governs
Act like by-laws which spell out more clearly the relationship of various members
- Members of LLC investors/owners of LLC (own distinct legal entity)

23

201 LLC legal entity distinct from members members not liable with several exceptions
303 Liable if:
Agreement says so or member has consented in writing to adopt provision
Management:
o Member managed members have broad authority to bind LLC just like partners
One vote per person, all have right to manage and very egalitarian and democratic
o Manager managed members have no authority to bind
Investors elect to appoint managers and ceded their authority to them for management purposes
Operating Agreement Concerns the relations among the members, managers and LLC
o Can include anything except eliminating duty of loyalty
o 103 Effect of Operating Agreement
Members can enter into an agreement, doesnt have to be in writing, to regulate their companys affairs.
However if something isnt found within their agreement then the Act governs relations default rule
provision
103b cant unreasonably restrict, eliminate duty of loyalty but agreement may state duties
Voting generally in proportion to members capital contribution
Transferability of Ownership interest Most LLC statutes provide that members cant transfer LLC interest without all
members consent
o Standing Consent: some statutes permit articles of organization to provide standing consent for new members
o Transfer of Financial Rights statutes permit transfer of financial rights to creditor, who can obtain charging
orders against the members interest
o

Once Formed LLC has to hold itself out as one if LLC Members fail to disclose existence of their
business organization to third parties then no limited liability for LLC members
- Water Waste& Land, Inc v Lanham: question on whether the members of LLC excused from personal liability on a K
where the other party to the K didnt have notice that members were negotiating on behalf of LLC @ the time [business
card never changed once the LLC was formed]
o Members of LLC that would normally be entitled to limited liability will not get it unless they inform
third parties that they are an LLC (must be informed at the time of K not after the fact)
o Distinguishing btw common law & governing LLC statutes
Statutory notice applies when youre trying to impose liability on LLC but when you are suing under agency
theory, principles of agency apply
Agency liable when negotiating K unless he discloses that hes acting as an agent
o LLC Acts notice provision not intended to alter the partially disclosed principle doctrine
o Articles of organization operate as a constructive notice of LLC form
o Interpretation cant be broadened to do away with agents liability
- LESSON: Partially Disclosed Principle Doctrine: agent is liable on a K entered on behalf of a principle not fully
disclosed
o Statute construed to mean that the name contains in order to put third party on notice + filling = notice if youre
going to take advantage of LLC
Notice gives the third party dealing on constructive notice of the LLCs limited liability statutes and that
managers/members bear no liability bc of their status
Perhaps they may not chose to do work bc of this
- EAKELEY: if you are a member going about dealings without disclosing the LLC on whose behalf youre acting this
could lead to fraud
- MOREOVER

Operating Agreement GOVERNS THE PARTIES THEMSELVES, NOT THE LLC COMPANY BC
COMPANY IS THEIR JOINT BUSINESS VENTURE
- DE LLC Act:
o Flexible statute bc it generally permits members to engage in private ordering with substantial freedom of K to
govern their relationship provided they dont contravene any mandatory provisions

24

Basic approach: provide members with broad discretion in drafting agreement & to furnish default when the
agreement is silent
o 18-1101(b): freedom to contract so as to give it maximum effect
o only when the agreement is inconsistent with mandatory statutory provisions will the members agreement be
invalidated
Elf Atochem North America, Inc v Jaffari: two corporations started a joint venture in DE LLC to produce maskrants.
One was a CA and the other PA corp [case is a paradigm on how relationships are formed/established in LLC]; Q on
whether LL is bound by an operating agreement they didnt self execute
o DE SC reviewed nature of LLC & DE Statute concluded under the policy of giving maximum effect to
freedom of K it would uphold the agreement thus subjecting them to the arbitration provision
Party can contract provisions as they please, however if something missing going to use default rules in
LLC statute
o 18-101(7) defines LLC agreement as any agreement written or oral of the members as to the affairs of LLC
o Members are the real parties in interest, a LLC is simply a joint business vehicle operating agreement
governs the parties themselves not the LLC bc its just a business venture
o contracted his right away to bring suits in DE
o Policy of the DE Act is to give maximum effect to the members freedom to govern their relationship provided
that they do not violate any mandatory provisions of the act
Parties may contract to avoid the applicability of certain provisions including forum selections
Fisk Ventures, LLC v Segal: Operating agreement stated could be liable unless result of gross negligence, fraud of
intentional misconduct; approval of 75% of board. Caused problems bc board couldnt agree on things thus Fisk initiated
suit to dissolve, counterclaims fed claiming breach of agreement, implied covenant of god faith and fair dealing
o Here: essentially built in deadlock in provision, since it permitted the creation of a 5members if benchmark
werent met which happened allowed Johnson 3 out of 5 votes to determine financing
o However you still need a supermajority vote on major decisions which would automatically crate a deadlock
need 75% of board approval
o Court:
LLC Agreement doesnt obligation one class to acquiesce to the others wishes simply vc the other believes
its approach is superior thus to force the court to determine whose BJR was more in keeping with the best
interest would cripple the policy underlying the agreement
So even the recognition of freedom to K, results in mortal deadlock so be it bc you bargained for it
Cant interfere bc its explicitly written in your operating agreement
Implied Covenant of good faith: every k contains one unwritten covenant requires part to refrain from
unreasonable conduct that has the effect of preventing the other from receiving the fruits of bargain
Ct: cant be used to vary or contradict the expressed k
Scope of Implied C: court cant and shouldnt use it to fill gap in K unless its clear from K that the parties
would have agreed to that term
Mere exercised of ones contractual rights without more cant constitute a breach
o Circumstances used to determine reasonable standard for dissolution
Members vote is deadlocked at board level
Operating agreement gives no means of navigating around deadlock
Due to financial condition of company, no effective business to operate
LESSON: 801a or 803 no longer reasonable to continue onward with business

Piercing the LLC Veil RULES OF CORPORATE LAW MAY GOVERN

-

Policy on piercing
o Normative matter on whether it should be pierced in either the case of the corp or LLC
Bc so few formalities with LLC should have to follow them or else
LLC formalities help investors to not be mislead
LLC formality could be to hold oneself out as an LLC
Veil Piercing is good bc externalizes risk
o Court recognize that to pierce the LLC veiled, would have slightly different criteria than for corporate veil
piercing based on formalities

25

o
-

If reasonable expectations of minority owners, creditors or third parties dealing with LLC are based on
misrepresentations, fraud or self dealing then piercing will most likely be allowed

Kaycee Land and Livestock v Flahive [example of not necessarily being automatic in the beginning that the LLC
should be treated like a corporate format]
o RULE: In absence of fraud a claim to pierce the LLC veil will be treated the same as in corporations; no reason
to treat it different (common law shouldnt be overturned)
However given that LLC is more flexible and dont have same organizational formalities court must do
an intensive fact inquiry end exercise its equitable powers to pierce or not
If members/officers or LLC fail to treat it as a separate entity they shouldnt enjoy immunity
o Court reading the WY statute as one thats difficult to read an intent to preclude piercing as suggests
o Equitable Doctrine: paucity of statutory authority for LLC piercings shouldnt be considered a barrier to
application
Lack of explicit statutory language should be considered an indication of legislatures desire to make then
subject to it also presumed that no change in common law was intended unless language shows it
Court imports common law into statute, not withstanding the statute bc its an inequitable doctrine under
common law
o Statutory Interpretation: language in one statute but absent in analogous statute intention to leave it out

Fiduciary Obligation: Limiting Fiduciary Duties by Agreement

- McConnell v Hunt Sports Enterprises: the LLC members essentially were at odds over obtaining a franchise, Hunt did
not think the terms were acceptable so accepted them after stating he would so long as Hunt didnt.
o An operating agreement of LLC may limit or define the scope of fiduciary duties imposed upon its
members
o Participants in CHL agreed to abide by the terms of the operating agreement bc that agreement specifically
allowed competition they were not breaching any duty in competing
o Evidence fails to show that tortuously interfered with prospective business
o held liable for violating the agreement bc they failed to obtain approval from CHL members prior to filing an
answer or counterclaim, since agreement dictated such needs to happen

Additional Capital
-

Racing Investment Fund 2000: unable to continue paying the amount owed to so succeeded to hold them in
contempt; Trial Ct orders LLC to invoke its capital call provision to require members to contribute capital so LLC
could satisfy its judgment, Ct held Trial Ct erred an LLC capital call provision cant be invoked by a court to
obtain funds to satisfy a judgment against the LLC
LLC Statute provides that unless the operating agreement otherwise renders members liable for debts, normal rule is
they arent
o & Provision providing for capital call, at the discretion of the managers, was not a back door way to hold them
liable
LLC members didnt agree to subject themselves to personal liability for the LLCs debts when they signed operating
agreement inless they agree to contrary, the entity form provides the members immunity from personal liability
Clear here that the capital call provision not inteded as a debt-collection mechanism and allowing court to use it
breaches LLCs shielf of limited liability

Dissolution
-

Dissolution upon:
o Expiration of any period of duration stated in articles
o The consent of all members
o The death, retirement resignation bankruptcy incompetency etc of a member unless the remaining members vote
to continue the business
o Judicial decree or administrative order dissolving the LLC for violation of law
Personal Liability following Dissolution
o New Horizons Supply Cooperative v Haack: issued a gas card to Kickapoo LLC which was signed by , but
gave no indication whether her signature was given individually or in a representative capacity on behalf of

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the LLC. contacted , and said payments would be made, but they never were; claims she is not
responsible for the debts of LLC (couldnt produce an operating agreement or articles) but produced articles that
it was taxed as a limited partnership
was held personally liable for the debts not under piercing the veil theory bc there isnt evidence to
support the theory, however still liable bc failed to establish she took appropriate steps to shield herself
from liability for the companys debts following the LLCs dissolution and distribution of assets
o EAKELEY: if your dissolving partnership & LLC you pay creditors first not members
She also gave notice to creditors firstm and if hteres assets to be used to pay off then it will go to them first;
she didnt observe formalities
Relevance of partnership for tax purposes: shouldnt be relevant in determining whether members are personally liable

Article 8 of the Uniform Limited Liability Act Dissolution Rules p. 89

802: LLC continues after dissolution but only for winding up the business
o dissolved but still operating
806: distribution of assets and winding up distrubution assets
o in winidng up assets must be discharged
Section 807 deal with known claims

CLOSELY-HELD CORPORATIONS
Stock is held in a few hands or in a few families and wherein its not at all or rarely dealt in by buying or selling
- Size is not determinative, although most tend to be small, local businesses
- Small number of shareholders & absence of secondary market where stock can be traded
- Most of principle shareholders participate in management
o Usually employees and/or directors better position to monitor the firms performance and the performance of
other employees
o Shareholders will only get a return out of the investment thru salary; salaries are deductible
- No division of shareholders and board
Features
- Earning a return on ones investment provides another reason for active involvement
o Most dont pay significant dividends
bc not deductible by the firm so subjected to double taxation (firm level & shareholder level)
o Instead for tax reasons, shareholders principle return is their salary and bonuses
Differences btwn close & publicly held corporations absence of market is a big one
- Public: if shareholders want out can easily exit via stock market; simply sell out
- Close: no exit strategy; no one likely to buy in
o Absent a buy-sell agreement practically no way for minority to redeem her interest for fair value
EAKELEY: problems of today concern agreements among shareholders & in particular who they vote to be on shareholder
board
- potential for dead lock; and if theres no provision to get rid of it
- Converse problem: one shareholder that has majority can elect their own, so potential for minority to be oppressed
Problems with having no market
- No way to determine the value of shares so usually an estimate of what an interest would be worth if there was an
active trading market
o On an active/public market it has buyer and sellers who are ready willing and able to purchase
- Difficult or impossible to sell an ownership interest
o Potential purchasers will realize that they may have a problem disposing of interest they later want to sell
o Therefore even if you find a buyer, youre likely to sell at a discount
Usually ends up being the other shareholders

27

If more than one owner, possible that someone who owns a minority may be locked into business and yet excluded from
financial participation in benefits of business
o Freeze out of minority shareholders
Stockholder may have the power to compel business to purchase his interest or liquidate business if theres a
stockholder agreement or if oppression can be demonstrated
Inability to exit may be a result of failure to plan

Obtaining/Private Ordering of Control/Governance

- Controlling shareholders have the power
o Having control in management means having control of the board of directors
o 4 main governance problems
Controlling board decisions
Controlling voting by other shareholders
Controlling the transfer of shares and
Abuse of minority shareholders by majority

Control of Voting by Shareholders

-

Shareholders can elect and remove directors thus they form coalitions and create devices or entre into agreements to
control voting
To prevent deadlock/maintain control voting trust agreement or pooling agreement
Voting Trust pursuant to which all shareholders are in a trust
o Agree to transfer shares to a trustee (recorder of shares)
He votes in accordance with the provisions of trust agreement & responsible for distributing any dividends
to beneficial owners of shares
o Eliminates potential for dead lock but you lose control
o In DE: has to be registered by sec of stat & cant be longer than 10yrs in duration
o Doesnt resolve potential for oppression
Vote Pooling
o K among shareholder to vote their shares in the manner written in K
Cumulative Voting #shares owned X # directors elected
o Only applies to the election of directors
o Allows shareholders to accumulate all of their votes and allocate it to one or more candidate
o Increases the chances that minority shareholder will have representation on board
o Must be agreed upon and found in operating agreement
o Protects, or at least gives you one seat on voting board
Proxy: an authorization of somebody else to vote our stock or give them your proxy and discretion to vote
Ringling Bros Barnum & Bailey Combined Shows v Ringling: parties enter into a stock pooling agreement which
they agreed to always vote their shares together, but when Haley refused to agree on a vote, sought to enforce
arbitrators decision
o Voting agreement not void & analogous to a proxy coupled with an interest
o Rule: A group of shareholders may lawfully K with each other to vote in such a way as they determine so long
as its not illegal and doesnt violate public policy
o Has cumulative voting provision
o Vote Pooling Invalid or Enforceable valid
o Both common law and statutes recognize the right of a shareholder to K away his voting rights while still
retaining other rights incident to stock ownerships

Attempts to Control Board Decisions

-

Usual setting: shareholder enters into K with other board members or third party; later one alleges K not enforceable bc
usurps authority granted to board
o Raises the question: should the law allow person to avoid a K bc it was made in a corporate setting, even tho the
K couldnt be avoided if it were made in partnership or LLC setting?
Shareholder agreement entered into by directors as shareholders is illegal & void where the agreement purports
to abrogate the directors independent judgment

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McQuade v Stoneham: controlling shareholder owned NYG baseball team, entered into a K with McGraw;
all alleged to use best efforts to elect each other as directors and as officers at specified salaries; had a falling
out with , caused him to be replaced as a director and officer contrary to K terms
K was invalid
Directors must exercise their BJ on behalf of all shareholders; so if they agree in advance to limit that
judgment, shareholders dont receive the benefit of their independence, and agreement is void
RULE: shareholders could agree to elect each other directors but couldnt in advance agree what they could
do as directors
If stockholders want to make their power felt, they can unite however power to unite is limited to
the election of directors and not extended to K whereby limitations are placed on powers to manage
by selection of agents
Agreement that attempts to divest director power to discharge unfaithful employee is illegal
Just because you can K to elect doesnt mean you can control what they do

Shareholders do not have fiduciary duty BUT if youre a majority you MAY
-

Clark v Dodge: parties jointly owned 2 drug companies; pursuant to shareholders agreement, jointly decided whom to
elect as directors and officers of firm; Falling out used his voting power to oust
o Court uses McQuade to say decision intended to protect minority shareholders not party to an agreement, and
here unnecessary bc theres no minority
o Absent potential harm to bona fide purchasers of stock or to creditors or to minority, theres no justification for
invalidating the K even tho it impinges slightly on principle of director primacy
If enforcement of a K damages no one theres no reason to find it illegal
o If directors sole shareholders no objection to enforce an agreement among them to vote for certain people as
directors -- no divestment of director power
o Where the directors are also the sole stockholders of a corp, a K btwn them to vote for a specified persons to
serve as director is legal and not in contravention of public policy

Note: significant statutory changes

- NY 162 authorizes certificates of incorporation to include provisions such as the selection of officers and their salaries
- DE Corp Law 141: general responsibility for the board in management
-

Galler v Galler: brothers ran Drug Company; their amount of shares included with wives & a key employee owned 5%.
Brothers entered into an agreement, intended to provided financial security for their families if one bro died; agreement
contained several provisions; 2 were objectionable on grounds that they impinged on the directors authority to manage
the corp (pay pension to widow of either contracting shareholder and pay dividend at specified rate)
Death of one bro caused his widow and son to repudiate agreement, other widow sued to enforce
o RULE: an arrangement concerning management should be upheld it it was agreeable to all and if there was no
fraud or injury to creditors or public
o A non-unanimous shareholder agreement could be enforced where
Corporation is closely held
Minority shareholder doesnt object
Terms are reasonable
o Agreements enforceable even if they deviate from state corp law practice close corporations to deviate
from corp norms in order to give business effect to the intentions of the parties
Deviation okay if no fraud/apparent injury to public or credit & no prohibitive statutory language
o General Corporate Rule violated here, directors are managers of the corporation a shareholder agreement in
closed that controls the voting for board and members should nevertheless be enforced so long as it doesnt have
fraud
o EAKELEY: distinction btwn interests of shareholders btwn close & publicly issued
Shareholders arent passive, they want to engage in management & want a return without being shut out
therefore an agreement that goes beyond electing directors is desirable
Legal Principle move away/not strictly enforce corp formalities
Deviation okay if no fraud/apparent injury to public or creditors

29

Voting Agreements binding individual shareholders to vote in concurrence with the majority constitute valid K
o Ramos v Estrada: Shareholder agreement provision required to sell their shares of company stock if they
didnt vote as required per the agreement
Agreement valid, enforceable and supported by consideration that they entered into the agreement for the
purposes of limiting the transferability of stock in the company ensuring that the company doesnt pass into
the control of persons whose interest might be incompatible with the interest of another
Agreement calls for specific performance bc the stock is not readily marketable
The breach constituted an election to sell their shares in accordance with the terms of the buy/sell provisions
not a forfeiture they violated the agreement voluntarily aware of the consequences of their acts and they
are provided
Agreement only called for voting provisions, so her voting as a director was not inconsistent with the
agreement, but having Ventura 41 attorney write the letter was a breach of agreement (repudiation of
agreement)
Not a close corporation but still a valid agreement even if it requires shareholder to vote according to the
will of the majority
Statute interpretation: statutes concern was to provide parties an opportunity to reach an agreement in cases
where, absent an agreement, parties may be damages by an unforeseen event such as a change in majority
voting block
Shareholder agreements regarding the transfer of shares, voting rights, and election of directors are necessary for
investors in close corporations to safeguard their investment given the nature of their departure from the corporate
norm
Note: DE Limited Liability Company Act 18-704(a) an assignee of a LLC interest may become a member upon:
- (1) approval of all the members of the LLC OR
- (20 complaince with any procedure provided for in the LLC agreement

Abuse of Control
-

Oppression of Minority Shareholders is a potential problem

o Freeze Outs of minority in decision making by majority
Majority oppress disadvantage minority
Deprive minority of corporate offices and of employment with corporation
Early success in court bc judges hesitant/disinclined to interfere with corp operations
o Remedies Available
Involuntary dissolution enforce a but out
Violation of Fiduciary Duties
o Alternative Remedies short of Dissolution
Awarding damages to oppressed shareholder
Ordering a buy-out even where state doesnt expressly empower them to do so
Appointing a receiver (liquidate business) or custodian (preserve assets & operate business for an indefinite
period)

In a closely held corporation, the majority have a duty to deal with the minority in accordance with a good faith standard
- Wilkes v Springside Nursing Home Inc: (1 of 4 shareholders) director & salaried officer; his relations with other 3
went sour, he gave notice of intent to sell his shares then stripped of his salary & office (essentially ousted)
o Citing Donahue: shareholders of close corp owe same fiduciary duties & must deal with one another with the
utmost good faith and loyalty Ct tweaks & limits this rule
Doesnt apply this standard bc too strict and may impose limitations on legit action by the controlling group
Majority have certain rights selfish ownership that should be balanced against concept of
fiduciary obligation to minority & minority presumably know that theres going to be a controlling
group given the amount of shares bought
o Denial of employment freeze out of minority
Reason why minority invest in close corp is so they can be employed/have participation
Therefore they rely on salary as principal return of investment

30

SO by terminating his employment essentially frustrating his purpose in entering the venture & denying his
right to a return
Standard to apply when brings breach of strict good faith duty (balancing/burden shift)
1. Whether controlling group can demonstrate legit business purpose for its action
Understand majority need some breathing room
2. However Minority has the option of showing it could have been achieved thru alternative course of action
less harmful to them
ULTIMATELY court must balance test weigh the legit business purpose against the practicability
of a less harmful alternative
Rights of the majority must be balanced against its duty to minority, so when the control can
show legit business purpose no breach will be found
Fiduciary Duty at the minimum owned him duty of utmost good faith and loyalty which demanded that the
majority consider their action

Minority shareholder employment not guaranteed an at will employee doesnt acquire fiduciary rooted protection
against being fired simply bc he is a minority
o

Ingle v Glamore Motore Sales, Inc

asserted that his status as a shareholder requires him to be treated as a co-owner or partner whose employment
rights flow from special duty
REQUIRES US TO SEPARATE THE DUTY OF A CORP OWES TO A MINORITY AS A
SHAREHOLDER FROM ANY DUTY OWED TO HIM AS AN EMPLOYEE
Under common law without reference to shareholders agreement corp had right to discharge at will
No implied obligation of good faith and fair dealing in an employment at will
No duty of loyalty and good faith akin btwn partners precluding termination except for cause, arise among those
operating a business in the corp form who have only the rights, duties and obligations of stockholders and not of
partners
Minority shareholder by that status alone who contractually agee to the repurchase of his shares upon
termination of his employment for any reason acquires no right from the corporation or majority as a
shareholder against an at-will discharge

Smith v Atlantic Properties, Inc: 80% provision had the effect of giving to any one of the shareholders a veto in
corporate decision
He had a veto so became in effect the controlling shareholder but the veto was a bargained for tool, so he can
use it so long as he uses it under good faith
conduct went beyond what was reasonable; he ran recklessly serious and unjustified risks of precisely
the penalty taxes eventually assess risk which were inconsistent with any reasonable interpretation of
duty of utmost good faith and loyalty
Minority shareholders who have at least a veto power over corporate action are subject to the same fiduciary
duties
Minority becomes ad hoc controlling interest

Nixon v Blackwell:
o Stockholder who bargains for stock in a closely held corp can make a business judgment whether to buy into
such a minority position and if so on what terms
o One could bargain for definitive provisions of self ordering pertmitted to a DE corp thur certigivate of
incorporation or thru by-laws by reason of the provisions in 8 Del. C. 102, 109, and 141(a)
o Entering into DE corp: can have shareholders agreement
o Tools of good corporate practice designed to give a purchasing minority stockholder the opportunity to
bargain for protection before parting with consideration
o Would do violence to fashion an ad hoc ruling that would result in a court imposed stockholder buy-out for
which they hadnt contracted
o Inappropriate to have a special judicially created rule for minority investors whenthere arent no negotiated
special provisions in the certificate of incorporation

31

Exit Strategies:
Purchase Options: agreement requiring a shareholder to offer his shares to the corporation or to other shareholders at a
specified price (price is set in agreement)
Right of First Refusal: obligates a shareholder to offer her shares to the corporation (or to other shareholder) at the same price
& terms offered by an outsider for such shares, before selling shares to outsider
- Meaning corporation has first dibs on your shares at whatever price the outsider willing to give you
- Some purchase at book value
- May create a market value price thats lower than actual value
- Doesnt resolve issue of liquidity
Buy-Sell Provisions: parties contractually determine what happens to the corp stock after a triggering event in hopes of avoiding
shareholder disputes & can also solve owners estate planning problem
- Requirement pro rata to purchase the shares in specified situations at a specified time
- Proper Agreement details: (1) what triggers an obligation; (2) what purchase price will be; (3)where money is to come
from
3 Critical Deal Points in Buy-Sell Provisions
1. Trigger what events trigger a buy out or a repurchase?
a. An owner or shareholder becomes disabled
b. Married owners or shareholders divorce
c. Minority owner is fired
d. An owner faces personal bankruptcy
e. An owner is convicted of a crime or involved in a scandal
2. Different forms of buy-out triggered by events
a. Put: shareholder has right to enforce a sale
b. Call: gives corporation the right to mandate a sell
c. Or can have both
3. Evaluation Point:
a. Ideally want to sell at market value: but this is difficult (hard to find other buyer & ascertain actual value)
b. Arrange an appraisal
i. Problematic: different process used to appraise
ii. Practical tip: hire appraiser before & set in agreement so dont run into problems when trying to find
one that wont seem biased
c. Agree in advance in a valuation formula for the buy out (discounted price value, assets)
i. But note hard to estimate future value
ii. i.e. valued at some contractually specified multiple of earnings
d. Book value (costs of assets part of company); but this is a maybe
i. Likely to be far less than fair market value
4. More frequently --- one party doesnt matter remaining or existing shareholder; will pick price and the other has right of
refusal or sell shares at that price

32

SECURITIES LAW
Purpose of Securities Laws
1. Protecting investors engaged in securities transactions
2. Securing public confidence in the integrity of the securities market
Securities -- 2(1) of Securities Act
- Specific instrument lists: stocks, bonds, notes
- List of general catch-all phrases: evidence of indebtedness, investment K, any instrument commonly known as a security
- Context Clause is an escape hatch it can be held as a security however given the transaction Court might deem that its
not
Question becomes is this a security?
- Answering this lead to whether the registration requirements of Securities Act apply to the transaction
o Only have to go thru this process if your client is selling securities
- Antifraud provisions of Act (saying its a security gives you a federal action & advantages)
Most of litigation turns on whether the instrument falls within one of the catch-all phrases in 2 (especially investment
k)
TERMS TO KNOW:
- Issuer: company whose shares being issued
o Must enter into a listing agreement with the exchange; agreement is source of regulation by exchange
themselves
- Underwriter: investment bank, underwrites the risk that there wont be market for IPO; gets commission for issuing
shares
- Lead underwriter: the lead bank
- Syndicator: collects other banks to form this
- Prospectus: needs to be delivered to prospective buyers
- Private Placement: not going to make an IPO but want to issue shares to finite # of people than may do so
o To comply with SEC & prevent shares in violation of safe harbor, there will be restrictions written on actual
stocks saying you cant resale or resale until holding for a year
o Majority of sales done thru private placement
- Proxy Contest: annual meeting shareholder normally elect directors and other business dealings

33

o Another way to take over is to run competing slate in proxy & solicit proxies to vote
Tender Offer
Initial Public Offering: raises capital for issuer
o Impose compliance and reporting requirements
o Very expensive as consequence
o Any later issuance of same class secondary market offering
Once IPO launched become traded on more than one market
o One or more investment banks serves as an underwriter
o Initial offeror: issuer

Trading 2 basic types of markets

- Primary Market: issuer of the securities (company that created the security) sells them to investors
o i.e IPO
- Secondary Market: investors trade securities among themselves w/o any significant participation by the original issuer
(i.e. on the floor of NJSE)
o Highly organized and regulated
o No involvement of initial offerer/issuer
o Permit investors to liquidate securities which makes it cheaper for company to make capital on the market
o Reinforces the primary market as company progress
o Markets individual can sell shares registered
Governing Law Federal
- Securities Act of 1933 primary market
o Mandates disclosures of material info to investors did they follow a transactional disclosure model
Transaction issues of stock bonds and others
o Prohibits sale unless and until issuer has registered 5 impositions
Before offered sale, cant sell until registration effective, must deliver prospectus before sale
o Prevents fraud
- Securities Exchange Act secondary market
o Includes a lot of issues --- insider trading & other securities fraud, short swing profits by corporate insiders,
regulation of shareholder voting via proxy solicitations and regulation of tender offers
o Requires periodic disclosures by publicly held corporations
o Created the SEC and Exchange Commission
Primary federal agency charged with administering the various securities law
Serve 3 primary functions
o Provides interpretative guidance to private parties raising questions about application of
securities law to a particular transaction
o Advises the Commission as to new rules or revisions of existing rules
o Investigates and prosecutes violations of securities law
o Requires large publicly held corp to disclose info regularly in form
Form 10 covered corporations must register by filing this initial form
Only needs to be filed once with respect to a particular class of securities first time issuer registers
that class of securities under the Act
Contains exhaustive disclosures similar to those required in a Securities Act registration statement
Form 10-K filed annually containing audited financial statements and management reports of the
previous years activities and usually also incorporates the annual report sent to shareholders
Form 10-Q for each of first three quarters of the year
Contains unaudited financial statements and managements report on material recent developments
Form 8-K within 4 days after certain important events affecting the companys corporations or financial
condition
If a major event happens, the company must report it immediately instead of waiting for the next
quarterly or annual report
Specified event that are considered sufficiently important to require filing (sales or purchases of
significant assets or a change in control of the company
Registration Process

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Securities Act prohibits the sale unless the issuer has registered them with the SEC
Usually Form S-1: an initial form
Register with SEC an IPO then register yourself as an issuer under SEA
5 imposes 3 basic rules
o Security may not be offered for sale thru mails or by use of other means of interstate commerce unless a
registration has been filed
o May not be sold until the registration statement has become effective
o Prospectus (disclosure document) must be delivered to the purchaser before a sale
To register issuer must give Commission extensive info about its finances and business
Reviewing Registration
o Looks at the procedures does it contain required disclosures not whether its a good investment
Cant sell the new securities until approved some companies wait so their value increases
Exceptions to registration requirement
o Exempts some securities entirely and exempts some transactions in securities not otherwise exempt
o An exempt doesnt need to be registered either when initially sold by the issuer or in any subsequent
transaction
o Exempt transactions are one time exemptions
o Example:
A sells a non-exempt to B in an exempt transaction
B not automatically free to resell that security, B must either register to resell or utilize another exempt
transaction
Most appear in 4 of Securities Act
o Include: private placements, transactions by another person other than the issuer, underwriter or dealer (note
cant be these for exemption)
o Private placements are common those relying on it will turn to SEC regulation D (rules 501-06)
Regulation D: regulates what issuers can do
o Regulation D provides a series of safe-harbors that issuers can use to come within the private-placement
exemption an avoid (or reduce) their required disclosure
Rule 504: issuer raises no more than 1mil thru securities, generally may sell them to an unlimited number of
buyers without registering the securities
Rule 505: if it raises no more than 5mil, may sell to 35 buyers but no more
Rule 506: raises more than 5 mill, may sell to no more than 35buyers and each buyer must pass various tests
of financial sophistication

Civil Liability Securities Act

- 10b & SEA 10b-5 basis for all insider trading prosecution
- 11: fraud, material misrepresentation in registration statement
o burden of poor that misconduct didnt cause damages
o No privity requirement
o Strict liability for the issuers
o Standard of negligence applies on directors
o No federal requirement that they have to do due diligence but wont be able to use this as a defense
o Cant be used for exempt offering bc of the misrepresentation or omission must be in the registration statement
- 12(a)(1) if sold w/o registration or prospectus failure
- 129A)(2): imposes civil liability on selling interstate commerce and its misrepresents
o case has 6 elements
1. Sale of a security
2. Thru instruments of interstate commerce or the mails
3. By means of a prospectus or oral communication
4. Containing an untrue statement or omission of a material fact
5. By a who offered or sold the security
6. Which knew of should have known of the untrue statement
Note on Integrated Disclosure and Exchange Act Disclosures
- 2 disclosure systems

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Securities Act disclosure requires disclosures with respect to particular transactions, like new issues of stocks
or bonds to the public
o Exchange Act imposes a system of period disclosures on certain companies; the obligation to file annual and
quarterly reports
- Publicly held corporation: file periodic disclosure reports under EA; must be a substantial amount of overlap and
duplication btwn those reports and duplication btwn SA
Integrated Disclosure System:
- Issuer planning a registered offering first looks to the various registration statement forms to determine which form its
eligible to use
- Forms then direct the drafter to Regulation S-K for the substantive disclosure agreements
- Adopted uniform disclosure standards for both Acts so that virtually all filing are now prepared under identical
instructions
- Requires disclosure of:
o Information about the transaction
o Information about the issuer aka registrant
- Form S-1 basic registration statement form requiring detailed disclosure bout both categories
- But Form S-3 only requires info about the transaction
- Info about the issuer is incorporated by reference from the last 10-K and other EA disclosure docs
- To use Form S-3 an issuer must meet 2 basic requirements
o Must be large and seasoned
o Must have substantial number of shares outstanding and must have been a reporting company for several years
o

SEC v W.J. Howey Co: is a corporation in the business of maintaining orange groves; sold tracts of land to raise money;
those that bought it usually entered into K with him (to service the land); brought an action against for selling an
unregistered security in violation of 5(a) of Securities Act 1933;
- Court starts with broad definition of securities: context could also create other securities depending upon the facts
- Looked to states blue sky law to define investment K they used to import into federal securities law
o placing of capital or laying out money intended to secure profits
- Thats how court gets into passivity of the parties buying into enterprise that does all the work for & they just get a
cut
- offering more than fee simply, offering an opportunity to contribute money and share in the profits of a large
enterprise
Consequence of SEC v W.J.Howey: have to stop offering investment K unless or until they register under 1933 Act with SEC
- Must do regular disclosures, create prospectus and give it to every prospective buyer before selling
- Say this continues, and have more K that make there way into secondary market then have further requirements
Note: had there been a disgruntled investor (although there wasnt) that investor could of sued for rescission, bc securities
supposed to be registered but hadnt been
To get into safe harbor of private placement (whether issuance subject or not) must go thru formalities: declare that they
are private placement, give notice to SEC Rule 10(b)(5)

RULE 10B-5 & MISREPRESENTATION

[use in either insider trading or securities fraud cases]

RULE 10B-5 OF THE SECURITIES EXCHANGE ACT OF 1934

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or
of the mails or of any facility of any national securities exchange, (transactional & jurisdictional nexus)
a) To employ any device, scheme, or artifice to defraud
b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements
made, in the light of the circumstances under which they were made, not misleading; or
c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
In connection with the purchase or sale of any security
Core of modern federal insider prohibition derives from 10b of Exchange Act

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Shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate
commerce or mails of any facility of any national securities exchange, which prohibits:
o (b) manipulative or deceptive devices or contrivances in connection with the purchase or sale of any
security
Courts interpretation: concerned with integrity of the market
State Common Law: rules with respect to fraudulent trading and securities aimed at protecting individual investors
rather than market itself
Not Self Executing congress charges SEC to promulgate rules to make it have meaning
3 types of activities prohibited by the rule note also jurisdictional nexus that needs to be established:
10b-5 adopted to prohibit fraud by anyone in connection with purchase or sale of security
o Fraud may be perpetuated by anyone
o No business transaction is too small to escape the reach (can be publicly traded or closely held)
10b-5: Defining fraud reference for the acts, practices or omissions prohibited under 3 clauses
o Any device, scheme or artifice to defraud
o Any omission or misstatement of a material fact
o Any act or practice that would operate as a fraud or deceit
Securities Fraud: most common application of 10b-5
o Somebody lies, tells half truth, puts out false financial statements, phony press releases, file false documents
with SEC, uses a prospectus or proxy statement containing false or misleading info
Insider Trading: someone buys or sells securities on the basis of undisclosed info available only to the insider
o Non-disclosure when there is a duty to disclose

TYPES OF ACTIONS INVOLVING SEC RULE 10B-5:

1. Private Actions - private right of action for damages;
2. Federal Administrative Actions/SEC Actions (enforcement of securities laws)
3. Criminal Actions - willful violations of the securities laws are potentially criminal. These actions are mandated by the
Securities and Exchange Act of 1934 (U.S. govt is in charge of enforcing provisions of the act).

ELEMENTS FOR A 10b-5 CAUSE OF ACTIONMISREPRESENTATION/ SECURITIES FRAUD CASES

1. Made thru the use of interstate commerce or mails
2. Fraud omission or misstatement [any of the three from the clauses]
a. Prohibits lying; but dont need an evil motive behind it [Basic Inc v Levinson]
b. Omission Cases
i. Liability arises when theres a duty to disclose
ii. Reliance and transaction causation are presumed if duty
c. Need Deception
3. Materiality is there a substantial likelihood that a reasonable investor would consider the info important in deciding
how to act
a. When the event it contingent or speculative apply probability/magnitude test
4. In connection with the purchase or sale of securities
a. Must have bought or sold
b. Proper party didnt have to purchase or sell
5. Causation/Reliance presumed
a. Transaction Causation:
i. Can be proved thru fraud on the market theory
1. When there is an active trading market for a security
2. in an open and developed securities market, the price of a companys stock is determined by
the available info regarding the company and its business misleading statement will therefore
defraud purchasers of stock even if the purchaser dont directly rely on the misstatement
3. The casual connection btwn fraud and purchase of stock
b. Loss Causation: fraud or at least materially contributed to, the pecuniary loss
i. False statement caused the decline in the price of the stock
6. Scienter must show that acted with an intent to deceive, manipulate or defraud
a. Does not require bad faith, evil motive or malice need a false statement
7. Damages

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EAKELEY: 4 elements (scienter, proximate cause (transaction causation and loss causation), materiality and reliance
Jurisdictional Limitations on 10b-5 Actions:
Confer jurisdiction in the federal courts if there is a use of an instrumentality of interstate commerce, the mails, or a national
securities exchange
- Applies to any person who engages in prohibited behavior in connection with a securities transaction, even if they
are not parties to securities transactions so long as their behavior affects the transaction
Basic court adopts a highly fact dependent probability/magnitude balancing approach to materiality in the context of
contingent facts
TEST TIP: in a fact pattern/question where someone is buying or selling securities always consider the possible application of
Rule 10b-5
BASIC INC. v. LEVINSON (US 1988) Despite participating in merger discussions, company publicly and officially
denied those discussions multiple times. shareholder sued asserting that those denials were materially misleading and
actionable under SEC Rule 10b-5; he purchased stocks at a significantly lower price than what they were sold for & purchased
after misleading disclaimer claiming there were no merger discussions
- Issue: Whether the corporate directors are liable for making material misstatement when they made a public statement
indicating the corporation was not involved in merger discussions?
- Materiality: A company statement is material if a reasonable investor would consider it important in deciding how to
invest. This determination requires a case-by-case analysis of the probability of the transaction and the significance of it
to the corporation.
- Would the omitted fact significantly alter the basis for the business decision?
- Highly fact dependent probability/magnitude balancing approach: when the event is contingent or
speculative in nature
o Preliminary merger discussions dont become material until
- Rationale for Materiality filter out useless info that a reasonable investor wouldnt consider significant even as
apart of a larger mix of factors to consider in making his investment decision
- APPLICATION OF STANDARD: balancing of both the indicated probability that the event will occur & the
anticipated magnitude of the event in light of the totality of the company
o When its highly speculative not sure if its going to happen (here there were merger negotiations but
there was the great possibility it wouldnt actually happen)
Reliance: An investor's reliance on material public misrepresentation may be presumed under a fraud-on-the-market
theory. Note: Requiring s in these cases to prove actual reliance places an unrealistic evidentiary burden on them.
- theory: economic theory notwithstanding the technical terms of the disclosures, dont have analysts that read and
understand the technical terms of the disclosures
- Rebuttable presumption: pro
o Relationship on the reliance and market price: no change in market price (an event analysis used in
virtually all securities case, match time of statements and movement
o Common knowledge of the negotiations
o Dealing with stock traded on regional (over the counter) rather than national so traded not on well
developed market, so the market theory couldnt have worked its way into the price; so market doesnt
reflect this
Rule: An omitted fact is material if there is a substantial likelihood that the average, reasonable shareholder would
have considered it important/material knowledge before deciding how to vote.
Fraud on the Market Theory: A companys stock is determined by the available material information regarding the company
and its business. The theory assumes that misleading information or statements will defraud stock purchasers even if they do not
rely on the misstatement.

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Santa Fe Industries, Inc v Green: Morgan Stanley asked going concern value (most simplistic, earning reduced to present
value; how must it would generate income over time) & what does that value reduce to per share; assumed wasnt going to
liquidate so that how they got to 125
- Cant force a liquidation of a company
- Language of 10)b) gives no indication that congress meant to prohibit any conduct not involving manipulation or
deception nor is this supported by legislative history
o Therefore must state such in complaint
- MANIPULATION practices (such as wash sales, matched orders, or rigged prices) that are intended to mislead
investors by artificially affecting market activity in order to mislead investors
- Congress didnt expressly provide a private c/o/a for violation
- Other consideration whether the cause of action is one traditionally relegated to state law
o DE Legislature supplied minority shareholders with a COA in DE court of chancery to recover the fair
value of shares allegedly undervalued in a short form merger
o This extension of federal securities law would overlap and quite possibly interfere with state law
o If they want remedies for breach of fiduciary duties and for appraisals do under state law
- RULE: before a claim of fraud or breach of fiduciary duty may be maintained under 10(b) r SEA of 1934 or
Rule 10(b)(5) there must first be a showing of manipulation or deception
- 10b not an all purpose breach of duty, trains on conduct of manipulation or deception
- all pertinent facts were disclosed here therefore there wasnt deception thru nondisclosure

INSIDER TRADING & THE USE OF INSIDE INFORMATION

INSIDER TRADING: (def: Trading in securities while in the possession of material non-public information).
- Information that will likely cause the price of stock to move up or down
- Before info made public, the insider buys or sells stock and later makes a profit when news is made public
- Or the tippee who buys/sells on the basis of this info makes a profit
- Dealing with complete silence lack of disclosure
- Applies to face to-face transactions but most occur over stock exchange
- Other applicable laws other than 10b-5
o Under State Law
- Officers and directors have duty to disclose insider material info to stockholders whom you are trading with
- Special Circumstance Rule although officers generally owe no duty to shareholder, this give rise to duty
o Concealment of the : stockholder doesnt know hes dealing with corporate director
o Or if the inside info could have a dramatic impact on the price of the stock
o Only apply to personal trades
- GENERAL RULE: trading on impersonal exchange (neither are known or known to each other) no duty to disclose
Who is an insider?
Actual Insiders: Anyone within the company (directors, managers, employees) who has access to material non-public
information.
Constructive Insiders: Outsiders who have been hired by the company to perform a function (financial analysts, lawyers,
accountants, etc.).
person who passes inside info to another person who effects a transaction
indirect tipee
If youre working for a company & part of your representation of the company you learn about info you cant trade on that
info
o Duty extends to fiduciary to attorneys
3 THEORIES OF INSIDER TRADING:
- Classical breach of fiduciary duty
- Tippee is the accessory of an insider who discloses for personal gain & breach of fiduciary duty of tipper, that uses info
for profit
- Misappropriation theory: outsider that trades on info

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THEORIES OF INSIDER TRADING [covers # of legal regimes]

- 10b disclose or abstain rule of SEA and SEC rule 10b-5 (classic insider)
- Misappropriation theory under 10b and Rule 10b-5 (those outside the company)
- SEC Rule 14e-3 under Exchange Act 14e limited to insider trading connected to tender offer
- 16(b) of Exchange Act prohibits corporate directors, officers, and shareholders owning more than 10% of the firms
stock from earning short swing profits by buying and selling stock in 6 month period
- State corporate law targets corporate officers and directors who buy from shareholders in face to face transactions
SECTION 20A: LIABILITY TO CONTEMPORANEOUS TRADERS FOR INSIDER TRADING
(a) Private Rights of Action based on Contemporaneous Trading any person who violates by purchasing or selling a
security while possessing material, nonpublic info shall be liable in an action to any person who contemporaneously
with the purchase or sale of securities that is subject of such violation, has purchased or sold
(b) Limitations on Liability
(1) trading actions limited to profit gained or loss avoided the total amount of damaged imposed cant exceed the
profit gain or loss avoided in the transaction
(2) Total amount of damages imposed against any person under subsection (a) shall be diminished by the amounts if
any that such person may be required to disgorge pursuant to a court order
(3) No personal shall be liable solely by reason of employing another person
(4) SOL no more than 5 yrs later
(c) Joint and Several Liability for Communicating any person who violates any provision of this title by communicating
material, nonpublic info shall be J & S liable
(d) Nothing in Section will be construed to limit or condition the right of any person to bring an action
SECTION 21A: CIVIL PENALTIES FOR INDSIDER TRADING
(a) Authority to impose civil penalties
(1) Amount of penalty for person who committed a violation whenever it appears that any person violated any
provision or rules/regulation by purchasing or selling a security while in possession of material, nonpublic info or
has violated any provision by communicating such info in connection with a transaction on or thru stock exchanges
or thru former dealer, which isnt part of a public offering
a. May brig an action to sek and have courts impose a civil penalty to be paid by the person
(2) Amount of Penalty for Persons who Committed Violations determined by the court in light of the facts and
circumstances but cant exceed 3x the profit grained or lawfulness
(b) Limitations On Liability
a. Liability of Controlling Persons wont be liable unless Commission establishes
i. Such controlling person knew or recklessly disregarded the fact that such controlled person likely to
engage in act constituting the violation and failed to take appropriate steps
b. Additional Restrictions on Liability cant be subjected to a penalty solely by reason of employing another
person who is subject to a penalty
(c) Authority of Commission can order to consider necessary or appropriation the public interest or protection of investors
(d) Authority to Award bounties to Informants
Goodwin v Agassiz: directors purchased shareholder's stock in the corporation through a stock exchange. At the time the s
knew of a theory (but not the actual existence) of mineral deposits on corp's land. sued for rescission of the sale of his stock
claiming the s breached their duty of loyalty when they purchased the stock without disclosing the inside information. Q:
whether directors have a duty to disclose to shareholders who purchase on the market but not during face to face
- Directors of a commercial corp stand in a relation of trust to the corp and are bound to exercise the strictest good faith in
respect to its property and business
- Contention that directors also occupy the position of trustee toward individual stockholders in to is opposite to repeated
decisions
- Director has to have particular knowledge to the condition of a corp & must adhere to the requirements of fiar dealing
hen directly buying or selling stock
- If a director personally seeks a stockholder for the purpose of buying his shares w/o making a disclosure of material
facts known to him & not to shareholder transaction will be closely scrutinized
- EAKELEY: may be a duty if theres a personal dealing so there may be circumstances tha may arise to duty to disclose
- Hard and impossible to have both parties have the same info on a trade

40

o
o

Can argue that: federal securities law designed to provide roughly equal access
Counter to disclose everything would overwhelm the market frequently not in the interest of a company to
disclose its strategies
Holding: no misrep or omission, no basis for inferring fraud or conspiracy; no fact that would give rise to an obligation *
they were trading on market so its impersonal
o EAKELEY: open market stressed bc if youre dealing directly with shareholder you should know youre dealing
with insider

Selling shares to another that doesnt own shares no duty

Face to face transaction need duty
NOTE: SEC NO LONGER GOOD LAW
SEC v Texas Gulf Sulphur Co: corp issued a misleading press release, bc the corp had neither bought nor sold any securities
during the relevant period, it argued it couldnt be held under 10b-5
- Court rejects this argument
- Rule 10b-5 on its face prohibits fraud in connection with the purchase or sale of any security
o as requiring only that the device employed whatever it may be, be of a sort that would cause reasonable
investors to rely there on, and in connection therewith so relying cause them to purchase or sell a corporations
securities
- Anyone in possession of material inside info must either disclose it to the investing public OR if ordered not to disclose
it to protect a corporate confidence, abstain from trading in the securities concerned while such inside info remains
undisclosed
- A company press release is considered to have been issued in connection with the purchase or sale of a security for
purposes of imposing liability under federal securities law and liability will flow if a reasonable investor in the exercise
of due care would have been misled by it
Holding: (1) Insiders cannot trade on material inside information until such information has been disclosed to the
public and has had time to become equally available to all investors. (2) A company press release is considered issued
in connection with the purchase or sale of securities for the purposes of Rule 10b-5, and liability may flow if a
reasonable investor would have been misled by a false press release.
Rule: Insiders may not use business information for their personal trading and press releases, which will
reasonably be relied on by investors, must be issued in good faith
DISCLOSE OR ABSTAIN RULE: The basic test of materiality is whether a reasonable man would attach importance
in determining his choice of action in the transaction in question. This, of course, encompasses any fact that in
reasonable and objective contemplation might affect the value of the corporation's stock or securities.
Elements to Establish a 10b-5 Violation:
- 1. Existence of a relationship affording access to inside info intended to be available only for a corporate purpose
- 2. The unfairness of allowing a corporation insider to take advantage of that info by trading without disclosure
CLASSICAL/ TRADITIONAL THEORY: [of insider trading] 10b & 10b-5 violated when:
- A corporate insider trades in the securities of his corporation on the basis of material, nonpublic information
- Trading qualifies as a deceptive device under 10 b a relationship of trust and confidence exists btwn shareholders of a
corp and those insiders who have obtained confidential info by reason of their position
o This relationship gives rise to a duty to disclose or abstain from trading bc of the necessity of preventing a
corporate insider from taking unfair advantage of uninformed shareholders
- Applies to Officers, directors and other permanent insiders
- Also to counsel, accountants, consultants and others who temporarily become fiduciaries of a corporation
- Corporate insider who trdes his corporations securities
- Applies to anyone in privity of the shareholder who temporary assumes fiduciary duty
- Targets corporate insiders breach of duty to shareholders, ones insider deals with
Dirks v. Securities & Exchange Commission: [tipee liability] -- (the tippee) & an officer of a brokerage firm was told by
Secrist a former officer of Equity Funding that the company was engaging in fraud. was urged to verify the fraud & disclose it
publicly. nor his firm owned Equity Funding but he did investigate & found that they were acting fraudulently. He disclosed

41

this info with clients/investors some who sold their securities, which resulted in value decreasing. SEC sought to censure for
aiding & abetting Rule 10b-5 violations
ISSUE: will a tippee be liable for disclosing nonpublic info received from an insider where the insider will not personally benefit
from the disclosure so its not a breach of the insiders fiduciary duty?
COURT:
- Duty to disclose doesnt arise from the mere possession of nonpublic market info but rather from the existence of a
fiduciary relationship
o Corporate insider own to his shareholders and if they disclose to third party in breach of that relationship &
tippee buys/sells on that info tippee has no fiduciary duty however given the duty already existed
o must also be a manipulation or deception to come within the Rule 10b-5
- RULE: no duty to disclose where the person who has traded on insider info wasnt the agent, was not a fiduciary or
wasnt a person in whom the sellers of the securities had place their trust and confidence
- RULE: tippees obligation arises from his role as a participant after the fact in the insiders breach of a fiduciary duty
o Tipper assumes a fiduciary duty to the shareholders by disclosing info to the tippee and the tippee knows or
should know that there has been a breach
- To determine a tippees obligation must determine whether the insiders tip constituted a breach of the insiders
fiduciary duty ; its a breach depending on the purpose of the disclosure
o Did the insider personally benefit (directly or indirectly)
o Absent personal gain, there is no breach of duty
- TIPEE CAN ONLY BE LIABLE IF THERE IS A DERIVATIVE BREACH [tipper disclosed for their benefit &
tipee had reason to know that tipper satisfied all elements of tipper liability]

Dirks TEST FOR TIPPEE LIABILITY

(1) Did the original tipper breach a duty by disclosing the information (state of mind, conduct of tipper) and (receiving a
personal benefit)?
- How do we tell when there has be a breach of duty that is actionable.
(a) Did the Tipper (Tier 1) receive a personal benefit from the disclosure? ($$, gift, expectation of later gain)
(2) Did the Tippee know or should have known that the info was obtained in breach of duty? (state of mind, conduct of Tippee)
- Must have a sense of the improper use of the gain of information
Dirks TEST FOR TIPPER LIABILITY
(1) Did the breach a duty by disclosing the information & gaining/receiving a personal benefit?
(2) Was it foreseeable that the Tippee in question would trade on the information?
IF THERE IS AN EXAM QUESTION ON INSIDER TRADING:
1. First, decide which theory under 10b-5 or 14e-3 rules applies to the facts;
2. Then, analyze based on that theory

MISAPPROPRIATION THEORY: person commits fraud in connection with a securities transaction and thereby violates 10b
& Rule 10b-5 when he:
- Misappropriates confidential information for securities trading purposes in breach of a duty owed to the source of the
info
- A fiduciarys undisclosed self serving use of a principals info to purchase or sell securities in breach of a duty of loyalty
and confidentiality defrauds the principal of the exclusive use of that info
- Premises liability on a fiduciary turned traders deception of those who entrusted him with access to confidential info
- Not to duty owed to trading party but to the source of the information
o Duty owed to the source ot disclose sources material info & duty to abstain or disclose on trading market
- Designed to protect the integrity of the securities markets against abused by outsiders to a corp who have access to
confidential info that will affect corporations security price when revealed but who own no fiduciary or other duty to the
shareholders
Full disclosures preclude any misappropriation liability even tho itll still affect the market

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United States v. OHagan: law firm retained by Grand Met for a proposed tender offer for the stock of Pillsbury. a partner in
the firm, wasnt assigned to the case, however during the course of representation purchased a total of 2500 Pillsbury call
options & 5000 shares of common stock. Following the announcement of the tender offer, sold his interest; SEC investigated
; Cert granted to determine the propriety of the misappropriation theory
- PERSON WHO TRADES IN SECURITIES FOR PERSONAL PROFIT USING CONFIDENTIAL INFO
MISAPPROPRIATED IN BREACH OF A FIDUCIARY DUTY TO THE SOURCE OF THE INFO IS GUILTY OF
VIOLATING 10(b) and RYLE 10b-5
- 10b requirement met in connection with the purchase or sale bc fiduciarys fraud is consummated (not when they
gain the information but when he uses it without disclosure)
- misappropriator who trades gains an advantage from his market position; he deceives the source of the info and harms
the market
- EAKELEY: source defrauded bc info is constituted as property
Misappropriation is needed or else it hinders a honest market; investors will be hesitant to venture their capital in a marking
based on misappropriated nonpublic info [integrity being affected adversely]
Insiders can trade after the material information has been released and absorbed by the market.
A RULE A THUMB IS 48 HOURS (2 DAYS) AFTER THE INFORMATION IS RELEASED.
If theres a fiduciary relationship to the issuers or if you gain info from independent source 10b comes into play
Exchange Act 14(e): it shall be unlawful for any person to engage in any fraudulent, deceptive or manipulative acts in
connection with any tender offer;
SEC Rule 14e-3(a): if any person has taken substantial step or steps to commence or has commenced a tender offer (offering
person), it constitutes a fraud/manipulation for any other person who has material info relating to such tender offer which info he
knows is nonpublic & knows it has been acquired by
- (1) offering person; (2) issuer of the securities sought or to be sought by tender offer; (3) any officer, director partner or
employee or person acting on behalf of the offering person
to purchase or sell or cause to be purchased or sold of any securities unless within a reasonable time prior to any purchase or sale
and theres a public disclosure by press release
Rule 14e-3 applies whether or not trading breaches fiduciary duty

SHORT SWING PROFITS

SEA 16(A) Disclosure Required:
- Every person who is directly or indirectly the beneficial owner of more than 10% of any class of any equity security
(other than the exempted one) that was registered to Section 12, or who is a director of the issuer, must file the
statements required by this section with the commission (2 days within transaction)
- Requires insider to report their holdings upon registration of securities
SEA 16(b) to prevent unfair use of info that may have been obtained by such beneficial owner by reason of his relationship to
issuer, any profit realized by him from any purchase and sale, of any equity security, they must pay to the corp any profit they
make within 6 months from buying/selling stock unless it was done under good faith in connection with a debt previously
contracted
- 16(b) penalizes insiders for trade unrelated to non-public info & misses many trade basked squarely on such info
- Principal insider trading control
o Any profits on purchases and sales that occur within 6 months of each other must be forfeited
o Captures a lot outside the scope of insider trading
o Doesnt reach a lot of insider trading
o Form Control
EAKELEY:

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applies to only insiders defined as Directors, Officers ..

Smaller group thn 10b-5 reaches
Statutes applies to directors or officers either to purchase and sale but only to shareholders when they have 10% shares
Only applies to firms that must register under 1934 Act (assets with at least 10mil, 5 or more shareholders)
Only applies to equity securities
Applies whether purchases follows sales or vice versa -- so doesnt apply to specific stocks; but does when buying back
10%
Reaches all transaction within 6 month period even if not trading on insider info
Application of Statute:
o Maximize gains company recovers
o Takes lowest price at which shares are purchased at the same price sold

Short Swing is a form of insider trading

Reliance Electirc Co v Emerson: didnt want company to merge with another, so he sold his shares (13.2%) and got that
down to (9.9%) and then sold the rest. Issue was whether he was liable for the second transaction
- Under 16b Corporation may recover for itself the profits realized by an owner of more than 10% of its shares from a
purchase and sale of its stock within 6mon period provided that the owner held more than 10% both at the time of the
purchase and sale
- Congress Goal with Rule: strict liability regardless of the intent of the insider or the existence of actual speculation
wanted to prohibit the possibility of abuse that was intolerably great
- Objective standard: if you sell one day after the period you are out of the woods
- Holder who has more than 10% who first sells enough to bring it below that isnt liable for the profit on the second
transaction even if the two sales were part of a single prearranged plan
Law trying to prevent management from buying/selling shares based on insider trading; dont want you to profit on your
company, flat prohibition on trading stocks of your own company
Foremost McKesson Inc:
- Must be a beneficial owner of more than 10% before the transaction [exempt provision of 16b]
- Looking to legislative intent the requirement omitted from operative language of the section when it was restructured
to cover sale re-purchase
- The purchases that makes a person a 10% shareholder cant be matched against a subsequent sale to create liability
Unconventional Transaction Exception: [doesnt apply to option stocks]
- whether transaction is volitional
- Whether the transaction is one over which the beneficial owner has any influence
- Whether the beneficial owner had access to confidential info about the transaction or the issuer

PROBLEMS OF CONTROL PROXY FIGHTS & RULES

Proxy: (def: 1. One who is authorized to act as a substitute for another; esp., in corporate law, a person who is authorized to vote
anothers stock shares (2) the grant of authority by which a person is so authorized (3) the document granting this authority.)

Corporations hold annual meetings of shareholders for election of directors

Special meetings approval for merger
Few shareholders of public corporations rarely attend these meeting
o some dont have enough shares to make a difference at the meeting
o dont think it necessary to become aware about corporate disputes
usually the election meetings directors get reelected without opposition
Possible Problems:
o Insurgents seeking to take control of the firm elect themselves and their allies to the board

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Issues that require shareholder approval scheduled for determination at the annual meeting or at a special
meeting
Small Firms: shareholders appear at the meeting and help decide business strategy
o They attend bc they have enough shares to make their voice heard
Proxy
o Because few shareholders attend the meetings, outcome generally depends on which group collected the most
proxies
o Under corporate law, shareholders may appoint an agent to attend the meeting and vote on their behalf
proxy holder
o Proxy = document that appoints the agent
o Outcome of the votes depends on who collected the most

Collecting Proxies
o Before meeting managers will write to shareholders of record and ask them to sign and return the enclosed
proxy card
Proxy Fights:
o Results when an insurgent group tries to oust incumbent managers by soliciting proxy cards & electing its own
representatives to the board
Use this in conjunction with tender offers
Subject to 1934 Securities Exchange Act

Statutory Shareholder rights are limited

Corporate affairs managed by directors
Shareholders have not right to initiate corporate actions but do have a right to elect directors @ annual meeting
o All statutes require at least one annual meeting & provide for board to call special meetings for special actions
that need to be taken

Mechanics of proxy voting are federally regulated but the substance may still be regulated by the state
Proxy System: mechanism for entrenchment directors to come onto board
Background on Shareholder Voting:
Shareholders only get to vote on specified topics. The Board generally get to vote on normal matters, and day to day decisions
are made by managers and executives.
3 AREAS SHAREHOLDERS GET TO VOte
1. Get to vote on major specified events in a corporations life after they have been initially proposed by directors
(dissolution and liquidation of the company, mergers, acquisitions, sales of all of substantially all of the assets, sales, etc.)
2. Changes to the articles of Incorporation/Certificates of the Corporation (Constitution of the Corporation)
3. Get to vote for the members of the Board of Directors

FOR AN ELECTION TO OCCUR

1. You must have a quorum (the majority of outstanding shares who are entitled to vote for directors.) It is not the majority of
shareholders, what is relevant is how many shares are outstanding on entitled to vote. Each share gets a vote, not each
shareholder.
However, the certificate of incorporation can reduce it to 1/3 of the shares entitled to vote or 100% and the default
majority of outstanding shares would not apply.
2. Present either in person or by proxy (shareholder appoints someone else to vote on their behalf at the shareholder meeting).
Most of voting is done by proxy because most shareholders dont travel to the meeting. They usually just fill out a proxy
card.
3. Directors are elected by plurality votes, all other decisions are made by majority vote. Plurality means that the individuals
with the largest # of votes are elected directors up to the max # of vacancies on the Board.

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One implication of this is that often very unpopular directors can be elected nonetheless because they dont need a
majority of shareholder votes to get elected. The only names that appear are the names which were proposed by
management.

SECURITIES EXCHANGE ACT 1934 14: PROXIES

- Disclosure Proxy Procedure 14a
o Pursuant to 14a3 the incumbent directors first step must be the distribution to shareholders the annual report
Discussion of management , basic issues confroning the corporation
Send it with proxy or before
Cant solicit unless you arm them with info about the business
o Along with proxy card & annual vote msut include proxy statement as well that includes mandated disclosures
related to matters that will be acted upon & any conflict of interests they may have
o 14a6: proxy statement must be filed
PROXY CONTEST:
- Incumbents communicate with shareholders so they seek shareholders list
- Insurgents bring forth a different slate than those proposed by management
o Shareholders may place forward a competing group trying to get your own slate & get rid of management
- Early serge in proxy contest then switch to hostile tender offer for control
o Switch generated a lot of activity that why it was switched back more efficient to wage proxy contest rather
than a hostile tender offer
Strategic Use of Proxies
Levin v Metro Goldwyn- Mayer, Inc: suit brought by 6 stockholders against 5 directors arising from a conflict control btwn
present management which the two groups have been actively soliciting proxies for this meeting; complained of the manner,
method and means employed in the proxy
- stated were using the company as a platform in their solicitation, and sough to enjoin the solicitation of the proxies
- Issue: whether illegal or unfair means of communication are being employed by present management
- Court cant override or dictate on the matter of this nature to shareholder (decision on the continuance of management);
deference to the right to vote/informed right to vote for shareholder
- RULE IN PROXY CONTEST: THAT THE SHAREHOLDERS BE FULLY & TRUTHFULLY INFORMED AS TO
THE MERITS OF THE CONTENTIONS OF THOSE SOLICITING THEIR PROXY
o Cant use means that are materially misleading
- When the two groups are different importance is that the shareholder be fully informed
- INCUMBENT DIRECTORS MAY USE CORPORATE FUNDS & RESOURCES IN A PROXY SOLICIATION
CONTEST IF THE SUMS ARE NOT EXCESSIVE & SHAREHOLDERS ARE FULLY INFORMED and disclose that
they are using it

Reimbursement of Costs
Rosenfeld v Fairchild Engine & Airplane Corp: stockholders derivative action; seeks to compel a reimbursement to both
sides in a proxy
- insurgents only get reimbursement if they win
- incumbents are allotted the corporation funds to secure their seat given the virtue in voting by informed vote & at
annual meeting with no contest still have to solicit proxies to secure a quorum
o financial burden shouldnt depend upon a proxy contest by an insurgent group
- corporate directors have the right to make reasonable and proper expenditures from corporate treasury for the purpose of
persuading the stockholders of the correctness in their position & soliciting their support for their policies, that they
believe in good faith, are in the best interest of the corporation
- Basic Rule Adopted contest over policy vs personal power interest
o if youre in a contest over policy you can reimburse yourself
o if successful insurgent can reimburse subject to ratification of shareholders
- Need Ratification from shareholders bc insurgents are paying themselves (self interested transaction) without
disinterested shareholders they may be subjected to a derivative suit
- HOWEVER: IF its established that funds have been spent for personal power, individual gain and not in the best
interest of corporation, or where fairness and reasonableness of the amounts are duly challenged, courts wont allow them

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Instances for reimbursement

1. Corporation may not reimburse either party if it doesnt deal with policy
2. Corporation may reimburse if its not wrongfully or rather used for corporate expenditure
3. May reimburse incumberents whether they win or lose
Decision covered by BJR
4. may reimburse insurgent only if they win on the theory that the benefitted the corporation
to make reimbursement protected from attack should obtain shareholder ratification

PRIVATE ACTIONS FOR PROXY RULE VIOLATIONS

14(a)
J.J. Case Co v Borak: Borak shareholder of JJ, company shareholders approved a merger with another, and Borak contended
proxy statement violated federal securities laws
- A federal cause of action available to a shareholder for rescission or damages with respect to a consummated merger that
was authorized pursuant to the use of a proxy statement alleged to contain false and misleading statements in violation
of the federal securities laws
- 14(a) purpose to prevent management or others from obtaining authorization for corporate action thru the use of false or
misleading proxy solicitations
- SEC explicitly provides a private action however none under 14(a)
o Looks to congressional intent to read into a private right action
o Court stated that SEC doesnt have the capacity to police 14a on it own
- Derivative suit even tho its a class action bc it wouldnt meet the requirements of 23?
- Unintended consequential effect that Court is holding onto the derivative right litigation availability
o i.e. if proxy violation claim can be characterized as derivative in nature, and in middle of proxy contest, and
part of incumbent group now you have another weapon to fight the insurgent (shoot them down, another way of
undermining insurgent proxy contesters)
- Legislative jurisdiction for private right found in 27 (catch all provided securities law provides liability and duty)
o 14a doesnt really create this duty and liability tho
o So court takes 27
o Federal court has power
o Policy consideration is the driving force rather than the statute
- Causation is to be determined by the fact finder
Mills v Electric Auto Lite Co: brought a derivative suit and class action against the management of and other companies to
set aside a merger obtained thru allegedly misleading proxy solicitations
- Where a trial court makes a finding that proxy contains materially false or misleading statement under 14a, stockholder
seeking to establish a cause of action under such fining doesnt have to further prove that his reliance on the contents of
the defects in the proxy caused him to vote for proposed transaction that later proved unfair to his interests in
corporation
o Definition of Materiality used: embodies a conclusion th the defect was of such a character that it might have
been considered important by reasonable shareholder who was in the process of deciding how to vote
Has a significant propensity to affect the voting process
- Rejects fairness test
- Proxy materials need to be essential link in the transaction
- Presumption of reliance

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Eakeley: This is a publicly held corporation would assume that this info would be available
o So how can you state that something is misleading when its in the public record [how the court ends with]
o Mills provides economic incentive to sue for lawyers

SHAREHOLDER PROPOSALS
Rule 14(a)(8): If any security holder of an issuer of his intention to present a proposal for action at forthcoming meeting of the
issuers security holders, the issuer sets forth the proposal in its proxy statement & identify it in its form of proxy & provides
means by which the one making proposal
- Without the rule no vehicle to allow shareholders to submit proposals & would have to succumb to proxy contests
- Shareholder submits to secretary a proposal for proxy card to be included in proxy statement of corporation
o Advantage: cheap dont need lawyers
- Company doesnt have to accept it but if you refuse to list the proposal on proxy statement, shareholder can go to SEC
and SEC will referee whether proposal should be included or not
Lovenheim v Iroquois Brands, Ltd
RELEVANCYTEST RULE 14A-8(C)(5)
Facts: /corporation produced pate de foie gras (overstuffed duck liver) as a very small part of its business (i.e., <
5%). /shareholder intended to offer a shareholder proposal for a resolution at the next shareholders meeting
regarding the cruelty to animals in production of foie gras. excluded the proposal as irrelevant under SEC Rule
14a-8(i)(5) since the foie gras sales constituted less than 5% of the company business. However, established his
argument under Rule 14a-8(c)(5). Economic relevance is not the only way, also social significance or ethical
significance could allow it to pass muster because it is otherwise significantly related.
Issue: Whether an issuer can refuse to include in its proxy materials a shareholders information on a proposed resolution if
the issuer decides the materials relate to a subject that is not economically significant to the company?
Holding: A shareholder proposal can be still be considered significantly related to the business of a corporation for noneconomic reasons (including social and ethical reasons) even if it relates to less than 5% of the business of the corporation.
Rule: Under 14(a) of the SEC Act, shareholders may include in the companys proxy statements certain materials that have
limited, if any, economic impact on the company as long as they are otherwise significantly related to the issuers business
Note: The court seemed to recognize the risk of damage to the company's reputation and business related to
important social and ethical issues. Lovenheim prevails and gets an injunction which allows him to go along with his
proposal. If you show that your proposal is ethical, it doesnt matter if it relates to less than 5% of the corporations
earnings or gross sales
- Pursuant to 14(a), a stockholder may notify an issuer of his intention to present a proposal for action at a future meeting
and allow the shareholder to include a statement of not more than 500 words in support of the proposal.
NOTE: Have to be physically present to present proposal, and have to give advance notice to the company the text of the
proposal so they can have time to review it and make a decision to invlude or not
AFSCME v AIG, INC: contended that its shareholder proposal to have the company amend its bylaws to require them to
publish the names of shareholder nominated candidates for director elections could not be excluded from proxy statement
under Rule 14a-9i8

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Rule: believe an agency interpretation of an ambiguous regulation made at the time the regulation implemented or revised should
control unless agency has offered sufficient reasons for its changed interpretation
Holding: shareholder proposal seeking to amend the corporate bylaws to establish a procedure so that nominees may be included
on the ballot doesnt relate to an election within the meaning of the rule & therefore cant be excluded from the proxy
Reasoning
R. 14a-8(i)(8) town meeting rule regulates shareholders proposals (recommendations or requirements that the
company and or board take some action which the submitting shareholder intend to present at a meeting
o If shareholder meets seeking to submit proposal meets eligibility and procedural requirements, the
corporation is required to include proposal unless corporation can prove to the SEC that a given proposal
may be excluded in one of the 13 provisions
o One of those is (i)(8) that provides that a corp may exclude a proposal if it relates to an election for
membership on the companys board of directors or governing body
Ambiguity over relates to an election
o argument over meaning of an intended to relate to proposals that address particular elections instead
of elections generally
ambiguity call to the agency that promulgated the rule
o Agency issued 2 statements that offer informal interpretations
o Will not apply deference to the second statement bc the SEC, division, agency didnt provide an explanation
as to their changed perspective/interpretation and they have a duty to explain its departure from prior
norms
o Therefore defer to the 1976 Statement
Scope of exclusion doesnt cover shareholder proposals dealing with matters such as cumulative
voting and general director requirement
Exclusion limited to proposals used to oppose solicitations dealing with an identified board seat in
an upcoming election
Holding: its not in the purview of a court to determine the policy issue regarding including or not including it, thats for the SEC
to decide

SHAREHOLDER INSPECTION RIGHTS

SEC Rule 14a-7:
Say you are unsatisfied/believe firm is badly managed you may either:
Under federal proxy rules force the incumbent board to include a proposal you draft in its proxy solicitation
materials
But what if you want to elect your own board? the slate wont be included on the proxy, so you need to solicit your own proxy
materials
- You need the list of shareholders but the incumbents wont want to give you these
Battles for the shareholder lists fought under state laws
Crane v Anaconda Co: a stockholder demanded access to shareholder list for the purpose of informing other shareholders
of a pending tender offer was planning to make
- shareholder wishing to inform other shareholders regarding tender offer the shareholder plans to make should be
permitted access to company list for that purposes unless the list is sought for an objective adverse to the company and
its shareholders

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Shareholders have a right to inspect corporate records, and the fact that tender offer is the primary method of corporate
acquisition
o Conceptual basis for the right shareholders beneficial ownership of corporate assets and the concomitant right
to protect their investment
Have to give them some access and some books and records, bc as a shareholders you have some
derivative claim on the assets and right to protect that investment
Business Corporation Law 1315, 624 access must be permitted to qualified shareholders on written demand subject
to denial if the Petitioner refused to furnish an affidavit that the inspection isnt desired for a purpose other than the
business
Whenever a corporation faces a situation having potential substantial effect on its wellbeing or value, the shareholder
qua shareholders are necessarily affects tan the business of the corporation is involved within the purview of 1315
o Statute should be liberally construed in favor of the stockholder whose welfare as stockholder or corporations
welfare is affected
here it will be effects given that he offer is for over 1/5 of the common stock
right adheres as one of property in the shareholder and one for the protection of that interest
didnt meet the burden of proving improper purpose

State ex rel Pillsbury v Honeywell, Inc

DE Statute states that a shareholder must prove a proper purpose to inspect corporate records other than shareholder
lists
o Proper purpose concern with investment return
Inspection is merely he act of concerned owner checking on what is in part of his property
o Power to inspect may be the power to destroy important that only those with a bona fide interest in the
corporation enjoy that power
Limiting purpose to investment returns
seeking record would render impossible not only any attempt to keep their records efficiently, but
the proper carrying on their business
HERE: Petitioner had no interest in the affairs of Honeywell before learning of his production of fragmented bombs
o where it is shown that such stockholding is only colorable, or solely for the purpose of maintaining
proceedings of this kind, we fail to see how the petitioner can be said to be a person interested entitled as of
right o inspect
suit might be appropriate when a shareholder had a bona fide concern about the adverse effects of abstention from
profitable war contracts on his investment
o structure argument that ties back to the investment return; war will end go into another line of work

NOTES:

shareholders with a minimum ownership stake in corporation has a right to inspect certain records
evaluation over the purpose of the shareholder seeking records but also the type of record that is sought
o DE burden of proof will shift depending on the type (improper purpose or proper purpose)
Proper purpose economic benefit to the shareholders of the company
Improper persuade company to adopt their concern
Should have access bc they have a right to know about their investment and be involved with their investment

When a stockholder wants to examine books and records Stockholder must prove the purpose is proper
When a stockholder wants to examine a stockholder list Corporation has burden to prove that the purpose is
improper

It is harder for shareholders to get access to books and records. The shareholder has the burden of proof.
However, they have an easier access to shareholders list because the corporation has the burden of proof.
- Lower threshold for stockholder list; however, a higher threshold for access to books and records.

50

You dont want people rifling through your confidential information so Courts/legislatures are sensitive to the fact that there
can be harmful effects. However, stockholder lists are much easier to monitor and easier for corporations to regulate. That is
why the burden is much lower.
- If Pillsbury said that his primary purpose was the public reputation of the company and his second purpose was noneconomic. The first purpose could be economic and the second purpose has to be either neutral or non-harmful to the
corporation; if it is harmful then it would be an improper purpose.
- A social justice purpose is not affirmatively improper (harmful) but is not proper.

3 forms of list
Issuers shareholders list street names (nominees used by depository)
Depository List of brokerage firms on behalf epository used for nominee is called CEDE
o So when seeking discover
Nobo List non objecting beneficial owners
o Required to be compiled and provided to issuers if they request it
No obligation to provide without request

MERGERS & ACQUISITIONS

N.J.S.A. 14A6-1(2), 3
Gaining Control: of the company
- Buy Stock of Company A from the shareholders of A for cash (cash tender offer)
- Buy Stock of Company A from its shareholders with stock of another company (b) (i.e. stock tender offer)
- Merge one company into another (combine 2 companies)
o Statutory merger state laws governs, A takes title to the assets of B and assumes Bs liabilities, B dissolves
and Bs shareholders receive As stock
o Consolidation new firm C is formed; gets title to the assets of both A and B, they dissolve and A & B
shareholders receive C stock
- Buy assets of one company with cash
- Buy assets of one company with stock of another
- Gain voting control thru a proxy contest

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Non-Merger Form
o Purpose: tax benefits and dissenters rights (aka appraisal rights some state statutes permit shareholder who
dissent may have their shares appraised for their fair value & pay if they dont want the merger)
Merger usually requires an affirmative right from shareholders

ACQUISITION TECHNIQUES
1.
2.
3.
4.

MERGER - friendly
SALE OF ASSETS - friendly
PROXY FIGHT - hostile
TENDER OFFER hostile

TRADITIONAL/CLASSIC MERGER
ALPHA
Merging Corporation

BETA
Surviving Corporation

A plan of merger has to be drafted and specifying the deals, terms, and conditions.
TRADITIONAL/CLASSIC MERGER
1) The most important terms is what the acquired corporations shareholders would be received as consideration
2) The plan of merger must be approved by the board of directors of each of the constituent companies
3) The plan of merger must be approved by the shareholders of each of the constituent companies. This is done by
including a proxy statement and a proxy card asking the shareholders whether they approve the particular merger being
proposed.
- A merger requires an approval by a majority of the outstanding shares. Its not just >50% of the voting shares. But
you need more than 50% of all outstanding shares
4) File the articles of merger with the requisite state organization. These documents are filed with the secretary of state.
This would then have only 1 surviving corporation. The new Beta company by operation of law would succeed to all the
liability, assets, and responsibilities of the Merging corporation.
When 2 companies come together and form a 3rd company that is called a consolidation and not a merger

The De Facto Merger Doctrine

- Statutory Merger: combo accomplished by using a procedure prescribed in state corporation laws
o Terms of merger spelled out in Merger Agreement, drafted by the parties which includes the treatment of the
shareholders of each corporation
Considerable flexibility is available
Company would have disappeared & all property interests, rights and obligations of Company A would
have passed by law to Company B (acquiring company)
o Approval by votes of the boards of directors and shareholders of each of the 2 corporations required
Some states no vote of a corporations shareholders is required if the acquisition doesnt substantially
diminish their control Del Gen Corp. L 251(f)
o Shareholders who vote against merger entitled to demand that they be paid in cash the fair value of their shares
appraisal rights
- Practical Mergers dont use statutory procedure
o Offer Share to Company A, and eventually buy into the company

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Substance over form form more important than substance bc substance is inherently indeterminative

A transaction which in the form of a sale of corporate assets but which is in effect a de facto merger of 2 corporations
must meet statutory merger requirements in order to protect the rights of minority shareholders
- Farris v Glen Alden Corp:
o contend this was a merger while say it was a purchase of corporate assets (which shareholders have no right
of dissent or appraisal)
o to determine properly the nature of the corporate transaction must refer not only to all the provisions of the
agreement but also to the consequences of the transaction and to the purposes of the provisions of the corp law
said to be applicable [practical effect]
o 2 step transaction here (1) stock acquisition; (2) reorganization agreement
de facto bc of the reorganization agreement, it became a new company & would suffer a serious financial
loss
this isnt a straight forward asset acquisition
o PA LAW HERE: shareholder of a corporation which is planning to merge has a right to dissent & to get
appraisal rights, but no rights if his corporation is merely purchasing assets of another
o De facto merger when the agreement will so change the corporate character that to refuse a shareholder
dissent will force him to give up his shares in one corporation and accept shares in an entirely different
corporation
HERE: if agreement performed: will become shareholder in a larger corporation which is engaged in a
different type of business, will have smaller % & market value decreased
o Held: asset acquisitions enjoined, even tho majority supported it, the minority control vetos leads to harming the
majority
- Corporations try to achieve the effect of a merger by alternative methods (sale of assets or sale of shares); formal merger
requirements are consent by shareholders of both corporations and majority approval by directors
- Rationale of appraisal rights shareholder purchased the shares of a specific corporation and to force him to
exchange his stock in a corporation he chose for stock in an entirely different corporation is to deprive him of his
property
Appraisal Rights in dissenting Voters
- process ineffective thats why they have dissenter votes
- courts set the price rather than reviewing fairness
- each shareholder must find their lawyers
- consolidation may be approved class actions?
- DE: have to dissent before vote taken
CURRENT DE LAW: Weinberger
Debate: if appraisal rights should there be standing for shareholder objecting a merger to sue on behalf of dissenting
shareholders or proceed derivative
Comes up with freezing or private action
FREEZE OUT MERGER (CASH-OUT MERGERS)
Usually these are done in 2 step acquisitions
1. Tender offer is presented by the acquiring company to gain +50% of the target company
2. Cash out merger where the remaining shareholders are cashed out in their stake in the merging company.
The Weinberger case is whether or not that second process it fair.

Freeze-Out Mergers:
-

Controlling shareholder buys out minority even if minority objects

Accomplished through triangular merger corporation merges with subsidiary holding company
o Only 1 of the 2 will survive but they will succeed under law of the two constituent corporations
o Converts the shares into whatever consideration specified in merger agreement

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CHALLENGING CASH OUT MERGER MUST ALLEGE SPECIFIC ACTS OF FRAUD,

MISREPRESENTATION OR OTHER ITEM OF MISCONDUCT TO DEMONSTRATE THE UNFAIRNESS
OF THE MERGER TERMS TO THE MINORITY

Weinberger v UOP Inc:

o ENTIRE FAIRNESS STANDARD: when directors of a corp on both sides of transaction must
demonstrate their upmost good faith and most scrupulous of the bargain
o Standard applicable here bc there were interested shareholders; at the time of the transaction one of the Signals
employees was the CEO of UOP
o Germane: info a reasonable shareholder would consider important in deciding whether to sell or remain
o Concept of Fairness: in dealing and in price
Interested board accomplish fair price and dealing if you have independent shareholders of minority
company
Full disclosure of what the minority independent directors know and what the shareholders are told in being
asked to approve the transaction
o Fair Pricing rather than DE Block out Method
proof of value by an technique or methods generally considered acceptable in the financial community and
otherwise admissible in court
o Important Footnote
UPO should have appointed an independent negotiating committee of its outside director to deal with
Signal at arms length
Go about informing as to the evaluation of UPO minority shares
Negotiate at arms length, but negotiation is only effective dependent on the known information
Dont get ratification or approval if ou dont have informed decision

FAIRNESS (UNDER DELAWARE LAW)

1. Fair Dealing: Candor (def: fair, sincere) and negotiation at arm's length (vs. self dealing).
Fair dealing involves evaluating how the transaction was:
i. Initiated
ii. Structured
iii. Negotiated
iv. Disclosed to the directors
v. How the directors and stockholders approvals were obtained
2. Fair Price: All relevant factors.[economic and financial considerations of the proposed merger
Factors include:
i. Corporations assets
ii. Market value
iii. Earnings & future business
iv. & any other elemnt that affects the intrinsic or inherent value of a companys stock
N.J.S.A. 14A:6-1(2)

TAKEOVERS

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If directors dont agree to merger after being approached --- tender offer is an option
Bc theres 2 ways to buy control of another company
o Negotiate the deal with management
o Buy shares from stockholders
By way of a tender offer hostile tender offer even tho shareholders welcome the offer bc its the
management hostile to the tender offer (shareholders getting more buck )
Tender offers fair to shareholders
Acquiring company indifferent -- still have to spend money; if there merger agreement, and incumbent management
receive monetary inducement to go along with the approach
Approach for merger and tender offer acquiring company believes they can do better with the target company
Incumbent management will usually be replaced
Why incumbent managers would negotiate with acquirer that will remanage
o Side payments but in a not obvious ways
o In a merger incumbents granted direct compensation or given long term employment agreements of new
company but with liquidation provisions
Assume acquirer wont pay more for a tender offer
o Payments to incumbents reduces shareholders compensation in acquiring company
o Violation of duty of loyalty of the incumbents
On the other hand, shareholders may be better off with merger
o Management may try to kill the deal in a tender offer
Defensive Measures Overview
1. Having a deal to be locked-up may be a breach of fiduciary duty of the target's directors. Revlon.
2. It is okay to have a poison-pill, but it cannot be coercive or preclusive. It must be reasonable.
Reminder: SEC RULE 14e-3 (SEE APPENDIX)
Transactions in securities on the basis of material, nonpublic information in the context of tender offers. The rule prohibits
trading during the course of a tender-offer by anyone (other than the bidder) who has material, non-public information about the
offer that he knows (or has reason to know) was obtained from either from the bidder or the target. Under Rule 14e-3, and unlike
Rule 10b-5, there is no need to prove that a tipper breached a fiduciary duty for personal benefit.
Reminder: SEC Rule 10b-5
Disclosure in connection with stock trading during a takeover is regulated under Rule 10b-5's broad antifraud provisions. In the
takeover context, Rule 10b-5 has two significant effects.
1. It regulates the issuer's disclosure of merger negotiations, such as when an unsolicited acquirer privately proposes a merger
or during a target's discussions with a white knight of a management leveraged-buy-out group.
2. It also regulates insider trading on the basis of material non-public confidential information about takeover plans, whether or
not relating to a tender-offer.
Reminder: The WILLIAMS ACT'S Effect on Takeovers
By imposing disclosure and timing requirements on bidders, without limiting the defensive measures on the target's part, the Act
seems to tilt the playing field in favor of the target's management. For example, during the mandated waiting period of a tenderoffer, management can mount defenses that are not regulated by the Williams Act.
Control Premium
The extra price a controlling, or near-controlling block of stock commands above the market value of the sum of the individual
shares in the block. A person selling such a block of stock will often have an expectation to receive a control premium.
Decision to Sell the Company
Once the targets management decides that it is willing to sell the company, then the courts give "enhanced scrutiny" to the steps
that the targets board and managers take. Most importantly, management and the board must make every effort to obtain the
highest price for the shareholders. Thus the targets insiders must create a level playing field: all would-be bidders must be
treated equally and the board must act as auctioneers. Revlon. If it's a management buyout, the directors must be especially
careful not to favor management (e.g., it must not give management better access to information). Normally, the targets
independent directors should form a special committee to conduct negotiations on the targets behalf.

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Sale of control
Similarly, "enhanced scrutiny" will now be given to transactions in which the board "sells control" of the company to a single
individual or group. Paramount.
Board Decision not to accept an Offer
In Delaware, if the targets board has not previously decided to put the company up for sale or dramatically restructure it, then
the board basically has a right to reject unwanted takeover offers, even all-cash, high-priced offers that the board has reason to
think most shareholders would welcome. Paramount.
Exclusionary repurchase
If the target repurchases some of its shares at a price higher than the bidder is offering, it may refuse to buy back any of the
bidders shares as part of the arrangement. Unocal.

SPECIFIC ISSUES RAISED BY CHEFF CASE

1. Is there a conflict of interest between the incumbent managers and the shareholders of a company in a takeover
context?
2. How much discretion should courts give managers/Board in deciding whether to resist a takeover?
- Should the Courts apply the business judgment rule to the decision to resist a takeover?
- Should Courts apply the fairness standard applicable to interested directors transactions?
- Should the courts apply a new or hybrid standard to relate to the interests of Board to resist a takeover?
3. What specific types of strategic responses are proper? How far can Boards go in resisting a takeover?
4. Should directors be able to consider the interests of non shareholder constituencies? To what degree and under what
circumstances?
Cheff v Mathes: shareholder of alleged that a repurchase of corporate stock at a premium was effected solely to perpetuate
the directors control of the corporation; claimed that the repurchase was undertaken to protect corporate policy & effectiveness
- Corporate fiduciaries may use corporate funds to fend off what they in good faith and pursuant to reasonable
investigation believe is a threat to corporate policy and effectiveness
- Cant use funds for your control, but can for the goods of the company
- Activities undertaken for the good of the corporation that have an incidental effect of maintaining the directors control
are permissible but acts effected for no other reason are invalid
- Same activity might or might not be appropriate depending upon the motives of the directors
- Burden of Proof:
o Initially presumed that a boards action is in good faith but can be overcome only on an affirmative showing of
bad faith or self dealing
o However a repurchase is a form of self dealing and therefore the burden here is on directors to show a legitimate
business purpose for the transaction
- TO satisfy burden:
o Directors must show reasonable ground to believe that a danger to corporate policy and effectiveness existed by
the presence of the stock
o Must show that they acted in good faith and with reasonable investigation
- Rule: Under 8 Del. C. 160 -- corporation granted statutory power to purchase and sell shares of its own stock
o In NJ (p.119 blackboard) makes explicit; but not all states have provisions like these

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Economic effects of a takeover --- LESSON

o If you prevent current incompetent management will result is everyones job
o If object of takeover is turn around the company may result in some employment loss but ultimately
successful jobs added and saved
Better prices and services given to customers
o No consistent direction at shareholder value added or subtracted
Burden of Proof: directors satisfy their burden by showing good faith and reasonable investigation
o The directors will not be penalized for an honest mistake of judgment if the judgment appeared reasonable
at the time decision made
o But must bare in mind: p. 744 Bennett v Propp
Bare in mind the inherent danger in the purchase of shares with corporate funds to remove a threat
to corporate policy when a threat to control is involved
Directors are of necessity confronted with a conflict of interest and an objective decision is difficult
In our opinion burden should be on directors to justify such a purchase as one primarily in
corporate interest
Finding of Fact purpose to entrench
Only two people interested --- lawyer and Mr. Cheff ; so the rest of dismissed
o Majority of disinterested directors that lets the court make this holding
Shift of Burden: financial expert produced that the price was fair even tho board didnt do anything to obtain an
investment advisor
Ultimately Holland goes out of business

NOTE: NJ rules
13d1 of the 1934 Act
SEC 13(d)
Form 13d
P.330 -346 supplement
o 14e & 14e1 requires that
Unocal Corporation v Messa Petroleum:
Facts: Mesa made a two-tier front end loaded tender offer for Unocal's stock under which the shareholders who
tendered in the first-tier obtained ($$$ cash) a much better value than the ones tendered in the second-tier (junk
bonds). Mesa is offering to buy 51% of the shares at $54 a share. However, the front end is paid in $54 in cash and
the back end is paid in $54 in junk bonds which is actually worth less than cash. In order to counter this coercive
tactic, and following consultations with outside consultants and financial analysts, Unocal board approved a
defensive (and selective) self-tender-offer for its own stock at an amount higher than that was offered by Mesa;
however, Mesa was specifically excluded from the offer.
Issue: Whether a corporations self-tender for its own shares, when excluding from participation a stockholder
making a hostile tender offer for the companys stock, is valid?
Holding: A selective tender offer aimed at thwarting a hostile takeover is not invalid per se.
Rule: Unless shown by a preponderance of the evidence that the directors decisions were primarily based on perpetuating
themselves in office, or a breach of fiduciary duty occurred, a court will not substitute its judgment for that of the board (as a
prescription of the Business Judgment Rule)
Note: 2 Tier Front-End Loaded Tender Offer: (def: The front end of the offer is usually a tender offer which is paid in
cash. The second tier, the back end, is going to be paid with the same amount of consideration, but it will be paid in junk
bonds and not cash.
The front end is definitely a tender offer, however, what will the back end look like?
The back end is actually not a tender offer, but is a cash-out-merger See Weinberger

What was the defensive measure of the Board of Unocal?

They made a self tender offer to buy the remainder of the shares (49%) at $72 a share.
It was clever for the Board to take this action because it only goes into affect in Mesa succeeds in acquiring 51% of the
company. This paralizes activity because no stockholders will sell their shares at $54/share when if they wait they could
possibly sell at $72 a share. This effectively stops the Mesa tender offer by selling shareholders equal to $72. However,

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the Unocal Board never plans on buying the shareholders stock back at $72, because Mesa will never be able to buy
51% of Unocal shares.
The point here is that it is a discriminatory tender offer. Mesa does not get to the benefit from the Unocal board.
A board of directors cannot favor one type of holders of common stock. The Board of Unocal owes a fiduciary duty to both
This goes back to the idea that the offer Mesa made was coercive. It is the Board duty that all the
Even though the board is discriminating against Mesa they are doing so to protect the innocent shareholders from the bad
acting Mesa shareholders. Also, Pickens is a green holder and bad acting.
You can discriminate against shareholders when bad shareholders are attempting to hurt the good shareholders.
The Board can act to protect the interests of long term shareholders against those that are considered to be recent spectators.
Also, the threat is that the structure is coercive and the price is inadequate (the price of $54 is too low) and Pickens was an
unsavory person and had a bad reputation of a green-mailer.
IN ADDITION: Cts have generally construed this very liberally regard provided there are rationally related benefits
accruing to the stockholders. - Revlon
Unocal supports the ability of directors to take into account constituencies. Revlon scales this test back somewhat by saying
that the regard to various constituencies must be rationally related to the benefits of stockholders.
From the case, Pickens had a reputation in the past as a green-mailer and not a liquidator. He wasnt serious about
taking over the company, but was just getting money. The suit is focused on waste and to focus the shares which were
purchased by acquiring shareholder/Pickens. This is called greenmail. Now the IRS taxes 50% of bonuses made by
greenmail.

UNOCAL RULE: - ENHANCED SCRUTINY TEST

1) Did the directors have reasonable grounds for believing a danger to corporate policy existed?
a. Were they motivated by a good faith concern for the welfare of the corporation and its stockholders?
b. Did they conduct a reasonable investigation?
2) Were the defensive measures reasonable in relation to the threat posed? (proportionality)
1) The board must perceive, in good faith, the bidder's action as a threat to corporate policy and effectiveness after a reasonable
investigation. The directors may not use anti-takeover measures merely to entrench themselves in power they must
reasonably believe that they are protecting the stockholders interests, not their own interests. Some dangers that will justify antitakeover measures are: (1) a reasonable belief that the bidder would change the business practices of the corporation in a way
that would be harmful to the companys ongoing business and existence; (2) a reasonable fear that the particular takeover
attempt is unfair and coercive, such as a two-tier front-loaded offer; or (3) a reasonable fear that the offer will leave the target
with unreasonably high levels of debt.
2) The defensive measures taken are proportional to the threat posed (proportionality test). To meet the proportionality
requirement, a defensive measure must not be either "preclusive" or "coercive." A "preclusive" action is one that has the effect of
foreclosing virtually all takeovers (e.g., a poison pill plan whose terms would dissuade any bidder, or the granting of a "crown
jewels option" to a white knight on way-below-market terms). A "coercive" measure is one which "crams down" on the targets
shareholders a management-sponsored alternative (e.g., a lower competing bid by management, if management has enough votes
to veto the hostile bid and makes it clear that it will use this power to block the hostile bid).
Standard of Review: If both prongs of the Unocal Rule are met, then the board's decision will be protected under the BJR.
However, because of the potential conflict of interest of the board, the burden of proof is on the directors to show that those
conditions are met. This burden shifting is a higher level of scrutiny than the BJR, but a lesser scrutiny than an interested
director transaction.
Note: Allowing Mesa to participate in the self-tender would effectively give it a clear benefit of its coercive tactics by allowing
it to realize a huge profit (greenmailing).

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Back end exchange of junk bonds in exchange of those that didnt offer
DE short form cash out merger pursuant to DE Gen Corp 253 provides that a parent corporation may cause a 90% or
more subsidiary to merger into the parent without a vote from the shareholder of subsidiary
251(f) --- one form of merger that doesnt require shareholder approval when merger doesnt amend the inquiring
company certificate, the outstanding shares of sub are unaffected by the merger, the transaction doesnt increase the
amount of shares by more than 20%
Director confronted with a hostile takeover evaluate it , in the interest, see whether to go forward or resist
Standard -- Whether its in the best interest of the corporation and shareholder

Modification in BJR in this context

Initial burden on company good faith and reasonable investigation
Imposing this standard bc of the omnipresent .
Enhanced If you have the majority of outside directors who acted in good faith further serves to insulate the
decision from second guessing and judicial
Revlon cuts back on this standard in the contxt rational relationship that board must consider responses rationally related to
Revlon Inc v MacAndrews & Forbes
DUTY OF MAXIMIZE SHAREHOLDER VALUE IN TAKEOVER SITUATIONS
Facts: In response to a hostile takeover bid from Pantry Pride, Revlon's board granted an asset lock-up option to a
"white-knight"/Forstmann in order to induce it to submit a higher bid. The option, which effectively foreclosed a
bidding contest for Revlon, would have allowed Forstmann to purchase/place bids for 2 of Revlon's most desirable
divisions at a significant discount; if another bidder acquired more than 40% of Revlon's shares. The board defended
its preference for Forstmann because of the bust-up takeover threat Pantry Pride posed. (i.e., busting up the
company b/c its constituent parts are worth more individually than as a whole).
Issue: What is the extent to which a corporation may consider the impact of a takeover threat on constituencies other
than shareholders ?
Holding: The defensive measures adopted by the board were inconsistent with the directors duties to the
stockholders.
Rule: The board has the burden of proving it was motivated by a belief that the takeover posed a threat to the companys
welfare and that its response was proportional to the threat posed.
Revlon Rule (Revlon Auction Duties): Although a board can seek to prevent a bust-up takeover, the board must assume the
role of an auctioneer once such a takeover becomes inevitable.
Note: The board failed this duty because the lockup option ended the bid with very little improvement in the actual final
bidding price. When it is clear that a target is going to be sold, the long-term interests of the corporation are no longer
considered, but instead the board must focus on maximizing the sale value for shareholders, which may include more than
the price. But when the other non-cash items are part of the bid, the quality and market value of those items come into play
as well.
The Revlon Board then gets another financial advisor who suggests that Revlon purchase

1. Notes rights plan: poison pill

2. Self-Tender1/6 of the outstanding shares (actually ends up repurchasing 1/3 of the outstanding shares)
POISON PILL: a corporations defense against an unwanted takeover bid whereby shareholders are granted the right to
acquire equity or debt securities at a favorable price to increase the bidders acquisition costs thus creating a large amount
of debt in the company, making it less desirable for takeover.
- This loads the company with debt and makes it less attractive for Pantry Pride. This also makes it difficult for an
acquiring company to finance the tender offer with junk bonds because they will not have the capital to finance the junk
bonds and take over the large amount of debt with Revlon.
2 DIFFERENT STRATEGIES/DEFENSIVE MEASURES
The Notes Purchase Right Plan on p. 757 is purposed to give shareholders the right to buy stock at $65 if Pantry Pride
acquires 65%.

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This is a Self Tender, where Revlon will tender 10,000,000 shares for notes that are more valuable than the current tender
offer price.
- Leverage Buy-Out (LBO)
- Management Buy-Out (MBO) = Leverage Buyout with the inclusion of management negotiating
- Golden Parachutes
o Golden Parachutes are very extensive compensation packages for management when they are taken-over. This is an
incentive to make managers less hostile and be more neutral. This allows management to have vast sums of money
(millions of dollars) so that they do not resist a takeover which will in essence benefit the shareholders. Golden
parachutes create a way for managers/executives/ Board members to release from control.
- The court enjoins the various defensive measures, after the change from the Unocal test to the Revlon maximize
shareholder value.
At this point you should maximize price, and you should not care who is taking over the company.
- Once the company enters into this Revlon agreement is that they have no duty to the note holders, they only have a duty
to shareholders. At this point you cant really talk about benefits to the shareholder from being loyal to the note holders.
Also, directors do not owe fiduciary duties to creditors, such as the note holders. Here, Board members owe a fiduciary
duty to shareholders, and only owe contractual obligations to creditors/noteholders. Delaware Corporations continue to
have an obligation, once Revlon duties are triggered, to only have a duty to the interests of shareholders.
IN ADDITION: More than 30 states have passed statutes which rejects the holding in Revlon.
Revlon holds that it is inappropriate for Board to account for the interests of stakeholders.
PARAMOUNT v. TIME (DE 1989)
Facts: Time and Warner agreed to a stock-for-stock merger, but two weeks before the shareholder vote, Paramount
announced a $175 (and later increased to $200) cash offer for Time's shares conditioned on the fact that the TimeWarner merger not go forward. This led to a restructuring of the Time-Warner merger into a cash and securities
transaction so that Time would buy 51% of Warner's shares in a lucrative tender offer. Time would take on significant
debt to finance the purchase, and Time's shareholders would be prevented both from voting on the restructured TimeWarner combination and from taking the Paramount offer.
Issue: If a 2nd merger proposal presents a higher per-share price than the transaction being pursued by the companys
board, is the board obligated by its fiduciary duty to pursue the 2nd proposal to maximize benefits to its shareholders?
Holding: (1) When two public companies merge and the control stays in the public shareholders (no single new
controlling shareholder in the combined entity), there is no change of control. Since there is no change of control and no
breakup of the company, the Revlon auction duty to maximize shareholder value are not triggered.
Rule: As a general rule, agreements to undertake a stock for stock merger between 2 public companies pursuant to a
strategic plan does not trigger Revlon duties to maximize duties to shareholders. If a Board is pursuing a merger for strategic
reasons beyond merely the sale or acquisition of another companys assets, it may decline to entertain a competing bid that
may yield a higher short-term gain for its shareholders in favor of a merger that ensures greater long-range gains.
EXCEPTION: If there were a merger where 1 companies SHs held a much smaller % of the combined entity and that
companies management was totally forced out or where the business strategy of the smaller co. was totally abandoned then a
del ct might find that as a situation where it would trigger Revlon duties.
Note also that the exception is more important than the rule is that the exception usually doesnt happen during a friendly
evenly negotiated merger.
- The Chancery Cts focus on the change of control will be highlighted in the Paramount v. QVC case.
Note: The Chancery court says that there are no Revlon duties because there was no change in control, despite the fact that
Warner shareholders have 62%. The relevant standard is that a fluid aggregation of unaffiliated shareholders controlled
these public corporations. The Market is what controls the new Time-Warner and not any individual or entity. The Del.
Chancery says that this is not a sale of the company or the break up of the company, so Revlon duties do not apply.
What is the Del. Sup. Cts. justification for approving the statement?
- Times Board believed that the Paramount offer at the 11th hr was viewed as arguably designed to upset, if not confuse
the Time stockholders vote. The court also held that Time's directors could decide, without violating Unocal's
proportionality standard, to restructure the Time-Warner combination to prevent shareholders from voting on it because
the court accepted the directors' finding that Unocal's offer was inadequate and the shareholders might have been
confused by the timing of Paramount's bid and the strategic value of Time-Warner combination. Those "threats" justified
the "proportional" response of taking the decision away from the shareholders.

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REVLON DUTIES: The courts will impose upon the board of directors a duty to maximize immediate shareholder value
and an obligation to auction the company fairly in the face of a hostile takeover

EAKELEY:
Judicial review of directors decision
BJR (deference to directors absence to bad faith)
o Rebuttable presumption
Entire Fairness entire decision invested with interest and self dealing
o Burden is on directors
Cases weve been reading fall in between the other two standards weve been working with
Enhanced scrutiny test
o Places burden initially on board
o 1. Uniqo standard outside directors that adopt defensive tactics must show good faith and
reasonable investigation & show that their actions constituted reasonable response to the threat
Response proportionate to the threat
o 2. Revlon Standard bidders make option, and dissolution inevitable directors must act
enhanced scrutiny by asking whether the directors acted reasonably in acquiring the
highest and best price for the company

PARAMOUNT v. QVC (DE 1994)

NARROWS THE SCOPE OF REVLON DUTIES
Facts: Paramount and Viacom agreed to a cash and stock merger worth $69 a share. The board of Paramount
amended the company's poison pill to facilitate the Viacom merger and granted Viacom a stock lockup, a large
termination fee, and a no-shop agreement. QVC announced a two-step bid consisting of a first-step cash tender offer
at $80 per share and a second-step of QVC's stock, conditioned on invalidation of the stock lockup which had become
worth $200 million. Viacom upped its price, so did QVC. The Paramount board refused to modify the preferences for
Viacom on the assumption that QVC's offer was illusory. QVC challenged the board's action as breach of fiduciary
duty.
3 DEFENSIVE MEASURES PUT IN PLACE BY PARAMOUNT. QVC sues to enjoin Paramount/Viacom merger
agreement.
1) No Shop Agreement: (Is a per se trigger for Revlon duties)
Paramount would not be able to talk to or negotiate with other parties, unless, (a) if the 3rd party makes an
unsolicited written proposal/offer and (b) the Paramount Board determines that discussions or negotiations with the
3rd party are necessary for the Paramount Board to comply with its fiduciary duties.
The Board could find that its fiduciary duties require it to talk, but the Board wouldnt be able to talk if it entails an
offer.
2) Termination Fee Provision
- The purpose of the termination fee is to serve as a deterrent to go outside of the 2 parties.
- Viacom would receive a $100 million termination fee if:
(a) Paramount terminated the original Merger Agreement because of a competing transaction;
(b) Paramounts stockholders did not approve the merger; or
(c) the Paramount Board recommended a competing transaction
3) Stock Option Agreement
- If any of the termination fee were triggered then:
(a) Viacom was permitted to pay for the shares with a senior subordinated note of questionable marketability
instead of cash, thereby avoiding the need to raise the $1.6 billion purchase price; and
(b) Viacom could elect to require Paramount to pay Viacom in cash a sum equal to the difference between the
purchase price and the market price of Paramounts stock.
Hostile takeover offer by QVC
- $80 cash- first 51%
- $80 QVC stock back end 49%

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This is not a 2 tier front end loaded tender offer, here the cash is equal to the QVC stock. Not cash and unequal junk bonds
in the 2nd tier.
Issue: Whether a board that agrees to the sale of a corporation or the transfer of control obligated to obtain the best price for
the shares? Whether or not there has been a change in control regarding the fluid aggregation of disinterested
shareholders?
Holding: When a "fluid aggregation of unaffiliated shareholders" sell their voting control to a single buyer and give
up their voting leverage, the board has a duty to evaluate the alternatives and seek the best value (Revlon auction
duty) reasonably available to the shareholders. This evaluation is subject to enhanced judicial scrutiny both of the
evaluation process and the reasonableness of the board's actions.
Rule: A board selling its corporation has a duty to obtain the best value for its shareholders and cannot give preference to
one of the competing bidders.
Note: Seeking to clarify Revlon and Time-Warner, the QVC court held that the duty to seek the best value arises not
only when the company initiates a bidding process or when its break-up is inevitable, but also when there will be a
change in control.
What does the Ct say is that standard for the Paramount Directors?
Revlon says you have to maximize shareholder value and get the best price for shareholders. This court says you have to get the
best price reasonably available. The Paramount directors had an obligation to take the maximum advantage of the current
opportunity to realize for the stockholder the best value reasonably available.
The best way to fulfill Revlon duties is to conduct an auction however, this is not necessarily required by the Del. Ct.
Particularly when they feel that they have already found the best bidder and had arms length negotiations on the best price. The
Ct here finds that the Board became paralyzed of their view of the unacceptability of the QVC bid and did not fulfill their
Revlon duties.
ENHANCED SCRUTINY STANDARD: - Basically a softened Unical test:
1) A judicial determination regarding the adequacy of the decision-making process employed by the directors, including the
information on which the directors based their decision; and
2) A judicial examination of the reasonableness of the directors action in light of the circumstances then existing. The directors
have the burden of proving that they were adequately informed and acted reasonably.
What is the role of the Ct in reviewing the action of the directors?
The Ct enjoins the 3 provisions because of . . .
- The process in which they were reached
- The results they had on the bidding
Paramount failed to seize the opportunity to rectify the decisions they had made once QVCs tender offer came into play.
Paramount loses the Ct. case, but ultimately Viacom won the case and were willing to pay $10 billion. As opposed to the $8
billion they offered in the beginning. Having a competing bidder really helped to raise the prices for shareholders, had QVC not
come into play the shareholders would have received much less
CIRCUMSTANCES WHICH REVLON DUTIES TO MAXIMIZE VALUE REASONABLY AVAILABLE TO
SHAREHOLDERS APPLY:
1) Pending change of control; a sale of control;
2) When the directors decide to put the company up for sale; (when the board initiates and active and initiate a bidding
process);
3) When the board adopts a strategy which make a breakup of the corporate entity inevitable.

ANTI-TAKEOVER REGULATIONS (STATE AND FEDERAL REGULATION)

3 VARIETIES OF STATE/ FEDERAL LEGISLATION
Following the Williams Act of 1968, a number of states enacted their own laws regulating tender offers.
- Constitutional Issues around a states power to adopt the statute. (Commerce Clause)
- Williams Act preemption
So long as state legislation does not:

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- Alter the Williams acts basic neutrality between tender offerers and target management
- Impose burdens that would conflict with the Williams act regulations
If these requirements are satisfied, then the states statutes can survive judicial scrutiny.
How would you characterize the S. Ct.s opinion in CTS in terms of the position of the plurality. After CTS, we should see that
States rights decisions are made in favor of the state.
- Alter the Williams acts basic neutrality between tender offerers and target management
- Impose burdens that would conflict with the Williams act regulations
If these requirements are satisfied, then the states statutes can survive judicial scrutiny.
How would you characterize the S. Ct.s opinion in CTS in terms of the position of the plurality. After CTS, we should see
that States rights decisions are made in favor of the state.
CTS v. DYNAMICS CORP. OF AMERICA (U.S. 1987)
Facts: Dynamics announced a tender offer for CTS shares that would bring its ownership to over 20%. Under Indiana law,
such acquisition of interest would be subjected to a shareholder referendum where voting power of those share would
be withheld. Dynamics sued alleging Indiana law violated federal securities laws (Williams Act) and dormant commerce
clause of the constitution.
Issue: Whether a state law imposes restrictions affecting a companys ability to acquire control of another w/out
creating federal issues by restricting the application of federal securities law or the commerce clause?
Holding: A law permitting in-state corporations to require shareholder approval prior to significant shifts in corporate
ownership is constitutional. States have a great interest in their corporations and this justifies the challenged statute.
Rule: State law may impose restrictions affecting a companys ability to acquire control of another w/out running
afoul of federal law or the commerce clause.

Lyondell Chemical Co. v. Ryan: shareholder of brought a class action against the directors claiming that
the sale process by which sold to Basell was tainted by the directors self interest and that the directors
thereby breached their fiduciary duties by failing to maximize sale price
- no legally prescribed steps that directors must follow to satisfy their Revlon duties to max price in sale of
control transaction such that failure to take those steps during the sale of their company demonstrates a
conscious disregard of their duties
-

directors are required to act reasonably not perfect

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