Choice of Entity

1. Background
a. Why do people need lawyers if they can incorporate their business for $10-$20 (ads)
i. Customized Service- Forming the corporation is the beginning, not the end of
the story. Once these co’s incorporate they don’t tell you what to do.
ii. They are just order takers- maybe a corporation form isn’t the best choice for
you
b. Different Entities
i. Sole proprietorship (SP)
ii. General Partnership (GP)
iii. Limited Partnership (LP)
iv. Limited Liability Partnership (LLP)
v. Limited Liability Corporation (LLC)
vi. Corporation (C or S corp- tax designation)
c. Which form is best for your client- 6 factors that we need to think about
i. Who is liable for the debts of the business if the business cannot pay?
ii. Who controls or manages the business?
iii. How easily can ownership interests be transferred?
iv. What is the businesses continuity of existence? (i.e. how long can it last?)
v. How is the entity taxed?
1. Entity level
2. Flow thru taxes
vi. How easily can this business form raise additional capital (money) later on?
2. Sole Proprietorship (SP)
a. Most common type of business entity
b. Need only 2 things to form SP:
i. A person
ii. A business
c. SOLE MEANS SOLE- cannot have more than 1 owner- if more than 1 owner it will
be a partnership, BUT can have employees.
d. If not stated otherwise, the name of the SP is your own personal name
e. DBA’s- (doing business as)- fictitious business name- file at the county level-
generally no other filings for SP’s
f. Six Factors
i. Who is liable for the debts of the SP if the SP cannot pay?
1. The owner is responsible if the business can’t pay its debts b/c there is
NO distinction between the business and the sole proprietor.
2. Owner has unlimited personal liability (UPL)
a. To help limit liability the owner can buy insurance
b. Can also limit debt recourse solely to the assets that have been
purchased from the proceeds.
c. Personals creditors can go after all business assets and
business creditors can go after all personal assets
d. NO distinction between personal or business assets- ALL assets
are exposed!
ii. Who controls or manages the SP?
1. The sole proprietor (owner) controls and manages the business
iii. How easily can the SP ownership interest be transferred?

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 1. sole proprietor can sell or transfer her business to someone else by
selling all the assets that she used in the business including IP rights
and also might have the buyer assume some liabilities (Asset deal).
2. No stock certificate that you could sell to someone
iv. What is the SP’s continuity of existence?
1. SP dies when the owner dies
2. SP can also terminate at the discretion of the owner, or owner can sell
the business or file for personal bankruptcy
v. How is the SP taxed?
1. NO separation between business and owner so personal tax return will
reflect how the SP does
a. Owner must file Schedule C- tax form- indicates whether there
was net income or loss- transfer directly to Form 1040.
i. Income shows up above adjusted gross income- doesn’t
get watered down so every dollar of profit gets taxed
and every loss gets deducted!
ii. More money you make the less you get to deduct.
vi. How easily can the SP raise additional capital later on?
1. If the sole proprietor wants to remain an SP he can’t bring in other
investors, because then it becomes a partnership, so only way that an
SP can expand is by getting loans.
2. SP ability to expand is limited!
3. General Partnerships (GP)
a. Usually governed by partnership agreement, but if don’t have a partnership agreement
or if an issue isn’t governed by the agreement then fall back to statutory law.
b. Depending on what jurisdiction you are in there are 2 potential statutory provisions:
i. Uniform Partnership Act (UPA)
ii. Revised Uniform Partnership Act (RUPA)
c. UPA and RUPA are default or supplemental regimes in the absence or anything
otherwise you would look to these provisions to fill in the gaps. If no partnership
agreement you will look solely at UPA or RUPA to govern your GP. Otherwise what
you have in your partnership agreement trumps UPA or RUPA.
d. There are some provisions in UPA and RUPA that CANNOT be trumped (WAIVED)
by your partnership agreements
i. RUPA § 103b2, b10 - Nonwaivable Provisions
1. The partnership agreement CANNOT limit a partners liability
e. A partnership is an association of 2 or more persons to carry on as co-owners a
business or property (UPA 6(1) definition).
i. Association denotes the consensual nature of a partnership- people have to
want to do something together HOWEVER
ii. The fact that the people did not intend to become partners does NOT control-
the key factor is not the parties subjective intent of whether they intended to
form a partnership
1. MUST look at surrounding circumstances, objective
2. Hilco Property Services, Inc. v. United States (29)- Whether or not
you are operating a partnership is a question of fact.
a. “It is immaterial that the parties do not call their relationship,
or believe it to be, a partnership, especially where the rights of
third parties are concerned.”
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3. Martin v. Peyton (31)- Martin isn’t owed any money by Peyton or
Other D’s but by the KNK partnership. Partnership has no money so
Martin claims that Peyton and other D’s created a partnership when
loaning money to KNK, so they are liable. Martin is trying to create
deep pocketed D’s.
a. Issue- Were in fact the D’s partners of KNK- if so then they
owe money (liable), if not then they don’t.
b. D’s became involved in the partnership:
i. Hall (partner) asked to borrow money from friend the
D’s b/c GP needed more money
ii. Hall borrowed ½ million of liberty bonds from Peyton.
Bonds are a safer type of loan for Peyton because could
be used as collateral and Hall can borrow against them
iii. KNK needs more money so it asks the D’s to become
partners but the D’s refuse, probably because they don’t
want to be held jointly and severally liable.
iv. D’s loaned Hall 2 million in liquid securities (ease of
saleability b/c can be easily & quickly converted into $.
In return for loans D’s received 40% of profits until the
loans were repaid (profit couldn’t exceed 500,000 and
be less than 100,000) and partnership option
c. D’s didn’t intend to become partners when they entered into
this agreement- signed statement that no partnership was
formed- NOT conclusive, some evidence but not dispositive
d. What people put in the agreement is not controlling. Even if
there is a K with another party that states specifically that this
relationship is not a partnership, it is not dispositive! (Not
controlling)
e. “Statements that no partnership is intended are not
conclusive. If as a whole a K contract contemplates an
association of 2 or more persons to carry on as co-owners a
business for profit a partnership there is.”
i. Court says that in deciding whether partnership was
formed we must look at the statutory definition of
partnership and look at facts and see if they meet this
definition. must look at everything (parties
agreements, relationship, interactions, relations with 3rd
parties).
f. Fact finder will decide.
g. Under RUPA sharing of profits is important evidence but not
conclusive that a partnership exists
h. Under UPA, receipt by a person of profits is prima facie
evidence of a partnership, but not when its made in repayment
of a loan. Will presume that you are a partner unless you can
prove otherwise.
i. Many other detailed agreements are contained in the papers…
are they here to protect the lenders or to make them co-owners?
Answer depends on an analysis of the various provisions (33)

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 i. Peyton and Freemen were trustees so were kept
informed of what was happened to the loaned securities
and the income generated by these securities Court
says that this doesn’t make them partners, says its
typical for lenders to have control over collateral and
for lenders to receive income generated by the
securities.
ii. Provision that required Hall to run the partnership
alone- doesn’t mean that they are interfering with
running the business because provision is not unusual to
see in a credit or loan agreement. This doesn’t make
them partners. They believe in Hall and what he can do
so its important that he run the business and not
someone they don’t know.
iii. Requirement that the trustees be given veto power over
any partnership action that they believe would be highly
speculative and injurious These types of provisions
are very typical in lending agreements b/c the lender
wants you to operate in a certain manner, so can’t do
certain things without approval.
j. Taken as a whole the court finds that the D’s are NOT partners,
so not liable.
f. Joint venture- partnership from a legal perspective, but the business purpose differs.
Business purpose that is either of very short duration or for a very specific purpose.
Unique- getting together solely for the purpose of X.
g. Don’t need a formal partnership agreement to form a partnership, but it is advisable
i. There are a number of very large partnerships that do not have partnership
agreements, but b/c they make so much money there is nothing to fight about
ii. Partnership agreement can be oral, written, or implied.
h. Six Factors
i. Who is liable for the debts of the GP if the GP can’t pay?
1. The partners are liable if the GP can’t pay b/c there is joint and
several liability for all GP debts, even if debt was incurred by another
partner.
a. UPA §17., RUPA 306b Liability of Incoming Partner (104)-
A person admitted as a partner into an existing partnership is
liable for all the obligations of the partnership arising before
his admission as though he had been a partner when such
obligations were incurred, except that this liability shall be
satisfied only out of partnership property (Only to the extent of
the new partners investment)
b. Can buy insurance to limit liability
c. Can limit creditors recourse to specific assets
d. Partnership agreement itself can limit the authority of certain
partners to certain kinds of debt (certain partners don’t have the
authority to bind the partnership to certain K’s)
e. A personal creditor CANNOT go after the assets of the
partnership, but they can go after your partnership stake in the
partnership because that is a share that you own.
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 2. Get legal malpractice is example of limit liability of partnership.
a. Under 303 RUPA- can be filed with state and limit partnership
to third parti’s in particular RE.
3. Martin v. Peyton (31)- Issue- Were in fact the D’s partners of KNK- if
so then they owe money (liable), if not then they don’t. Since taken as
a whole the court finds that the D’s are NOT partners, so not
liable.
4. the receipt of the share of the profits of the business is not enough to
prove partnership.
ii. Who controls or manages the GP?
1. UPA § 18e (default provision)(105)- All partners have equal rights in
the management and conduct of the partnership business, unless the
partnership agreement specifies otherwise.
2. partnership agreement may create classes of partners with different
voting and financial rights.
3. many law firms utilize classes of partners in this fashion to ensure that
the senior partners have power to govern the affairs of the partnership.
4. Lupien v. Malsbenden (35)- P wants to buy a Bradley car and goes
to Cragin, DBA as York motor mart. P never received his Bradley and
Cragin flees the country. P sues Malsbenden under the theory that D
is a partner of York motor Mart.
a. P thinks that Malsbenden is a partner because:
i. P dealt with Malsbenden not Cragin
ii. Malsbenden says that P has to turn in his car as part of
the deal, so gives him a loaner car, but the loaner car
turned out to belong to someone else and was at York
for sale. Malsbenden bought the car from the 3rd party
and gives it to P.
b. Malbenden doesn’t agree that he is a partner, he says that he is
a banker, b/c loaned Cragin $5,000 and wanted to be paid back
proceeds from the car. If he is a banker than York is a SP,
which makes Cragin the only one liable.
c. Malsbenden opened up the business daily, made deals for the
business, paid salaries of the employees with a personal check,
bought supplies (NEVER pay with a personal check, b/c then
creditors will start to look to you as the obligor to pay debts).
d. Malsbenden had complete physical control of the business once
Cragin left the country.
e. Court finds that Malsbenden was a partner b/c he had a lot of
control. There is no difference if there was a partnership agrmt.
5. How does control merge with the notion of co-ownership?
a. Don’t have to have joint-title in all assets to be co-owners
b. Co-ownership could mean joint title, but doesn’t have to be
c. The right to participate and control the business is the essence
of co-ownership
d. Most important feature in Lupien was that Malsbenden had a
lot of control.
6. Factual distinction between Martin v. Peyton and Lupien v.
Malsbenden
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 a. In Martin, Hall was always in charge and the D’s only had
control akin to the kind that lenders usually demand.
b. In Lupien, Malsbenden had complete control so his argument
that he is only a banker fails
7. Summers v. Dooley (41)- Trash business partnership. Summer
suggests to Dooley that an additional worker be hired to help operate
the business, Dooley refuses, but Summer hires a new employee on his
own and pays for him out of own pocket. Dooley refuses to pay for ½
so Summer sues for ½.
a. Summer argues that although Dooley didn’t agree to hire this
employee, he still benefited through increased profits and less
workload, so he should be estopped from denying the need for
the employee (unjust enrichment argument).
b. Issue- Can 1 partner make a decision against the will of another
partner and then attempt to get paid for ½ (notion of control
and making managerial decisions)
i. Idaho statute- Any difference may (MUST) be decided
by a majority of the partners, provided that no other
agreement exists. So in a 2 person partnership, both
partners must make the decision (unanimous)- each
partner has a complete veto power.
8. Problem- 43- A, B, and C form a partnership. A contributes 90% of
the capital, and by agreement is entitled to 90% of any profits and is
responsible for 90% of any losses. B and C each contribute 5% of the
capital and by agreement each is entitled to 5% of any profits, and
responsible for 5% of any losses. Nothing is said in the agreement
concerning how decisions will be made. If A votes one way on an
ordinary matter connected with the partnership, and B and C vote
another way, who prevails?
a. Under UPA § 18h (105)- Any difference arising as to ordinary
matters, connected with the partnership may be decided by a
majority of the partners, but no act in contravention of any
agreement between partners may be done rightfully without the
consent of all the partners.
b. So B & C get to dictate what the partnership does
c. If A wanted more power, need to put in partnership agreement
that A gets 90% of the vote.
9. Hypo- James and Susan are equal partners and lacks partnership
agreement. Both partners must provide financial statement to bank in
order to get loan. Susan says no since invasion of privacy and james
sues Susan for breach of fiduciary duty. What result? Sanchez v.
Saylor, if partnership doesn’t get loan it could go under but its Susan’s
right and her essentially voting No get bank loan and thus no fiduciary
duty is owed when comes to managing the business.
a. James can sue to dissolve partnership- remedy….thus always
important to have management provision and have a process
when partners don’t agree
10. Relationship between partners- Meinhard v. Salmon (65) – involved
2 partners and 1 partner was presented with a business opportunity
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 which could have been pursued by the partnership, but instead usurps
the opportunity for himself
a. CJ Cardozo says that while the partnership continues partners
owe the duty of finest loyalty- rule of undivided loyalty is
relentless and supreme! MUST put partnership ahead of your
own personal financial needs.
11. Dissolution can carry consequences
a. Among the partners
i. If a partner, W, wrongfully causes dissolution, under
UPA §38 (2)(b) provides that although the partnership
is dissolved, the remaining partners can continue the
partnership business. To do so the remaining partners
must either, 1 pay W the value of her partnership
interest, minus any damages caused by the dissolution,
or 2 put up a bond to secure such a payment, and
indemnify W against present and future partnership
liabilities.
b. Between the partners as a group and third persons, such as
individuals or firms with whom the partnership has contracted
i. Ex. title insurance co has policy with A,B,C,D. A,B,C
transferred their partnership interest to E. E and D
apparently continue the business. However the court
nevertheless held that title insurance co. was not bound
under its policy because the partnership to which it had
issued the policy had been legally dissolved.
c. For tax purposes
i. Internal Revenue CCode §708 provides that a
partnership existence does not terminate for tax
purposes until either no part of any business, financial
operation, or venture of the partnership continues to be
carried on by any of the partners in a partnership, or
within 12 month period there is a sale or exchange of
50 percent or more of the total interest in partnership
capital and profits.
d. UPA and RUPA require that a partner hold in trust anything
that is for the benefit of the partnership and then remit it to the
partnership
i. UPA § 20 (106)- Duty to Render information-
Partners shall render on demand true and full info of all
things affecting the partnership to any partner or the
legal representative of any deceased partner or partner
under legal disability.
ii. UPA § 21 (106)- Partner accountable as a fiduciary
1. Every partner must account to the partnership
for any benefit, and hold as trustee for it any
profits derived by him without consent of the
other partners from any transaction connected
with the formation, conduct or liquidation of the

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 partnership or from any use by him of its
property
2. This section applies also to the reps of a
deceased partner engaged in the liquidation of
affairs of the partnership as the personal rep of
the last surviving partner.
iii. RUPA § 103(b)(3) (125)- the partnership agreement
may not eliminate the duty of loyalty
iv. RUPA § 403 (153)- Partner’s rights and duties with
respect to info
1. Must keep books and records at chief executive
office. Info must be made available to all
partners.
v. RUPA § 404(b)(1) (154)- General standards of
partners conduct- A partner’s duty of loyalty to the
partnership and the other partners is limited to account
to the partnership and hold as trustee for it any property,
profit, or benefit derived by the partner in the conduct
and winding up of the partnership business or derived
from a use by the partner of partnership property,
including the appropriation of a partnership
opportunity.
1. Under RUPA, a partnership agreement can
define what fiduciary duty means, but can’t
eliminate the duty
iii. How easily can GP ownership interests be transferred?
1. in the absence of an agreement about how profits are to be shared, the
default provision of the UPA is that partners share profits equally.
2. Since a GP is consensual in nature the partnership agreement can say
what ever it wants about transferability of partnership interest, but if it
doesn’t or if there is no agreement then must look to statutes
3. UPA § 27(1) (107) & RUPA § 503(a)(b) (160)- A partner can transfer
his or her interest, but the transfer itself only entitles the transferee to
the financial aspects of that partnership interest (under RUPA,
financial aspects are viewed as personal property). It is only if ALL
the partners consent then the transferee will be considered a partner
and allowed to take part in managerial aspects
a. Transferor = Financial Aspect + Management and Control
aspect
b. Transferee= ONLY financial aspect NOT management and
control
i. When the transferee receives the financial aspects the
M & C remain with the transferor until the new party is
admitted as a full-fledged partner. If the transferor is
dead then M & C dissolves and is spread throughout the
other members. Transferee might requires that the
transferor vote the way he would (proxy)
ii. Joint and Several liability remains with the M &C
element (transferor) b/c can control debts etc. Very
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 often what the transferor will do to get out of that
problem is withdraw or disassociate as a partner
immediately after the transfer so no more voting power
and no more liability.
c. Under UPA §18(g) (105) can change voting threshold from
unanimous to another requirement for admitting a new partner.
iv. What is the GP’s continuity of existence?
1. GP lasts until 1 of certain specified events listed in the partnership
agreement occurs:
a. Death of a partner
b. Completion of a business project (joint venture)
c. End of a specified date (expiration date)- partners can always
amend the agreement to extend that date.
2. If there is no partnership agreement then UPA and RUPA specify the
events
a. Dissolution v. Termination
i. Dissolution happens automatically on the happening of
a certain event. It is not the end of the partnership, just
a change in the relationship of the partners.
ii. Partnership agreement typically provides that the
remaining partners can vote to continue on the
happening of that event or choose not to continue and
head to winding up and then termination,
b. Step 1- Dissolution (vote to continue or not to) if no then move
to Step 2- Winding up (pay off all creditors, liquidate assets,
distribute remaining profits), then move to Step 3- Termination
c. ex. partner would die and there is 4 partners, 3 are left, and
partnership are consensual and thus the 3 must decide if they
want to continue on without the fourth, partnership Agreement
may have provisions that says move ahead or upon event of
dissolution there is termination (call quits, and liquidate assets,
pay off creditors, and whatever left allocate).
v. How is the GP taxed?
1. GP’s are flow thru tax entities (desirable), so no firm or entity level
income tax, instead individual partners are taxed based on their
allocated share of profit or loss. Entity itself doesn’t pay tax on any
profit it makes. (not subject to double taxation like corps)
2. Partners must file Form 1065 (informational only)- tells the govt what
to look for on the individual partners personal tax return. K-1- your
personal share
3. Problem with investing in partnerships/LLC’s/S-corp is that you have
to pay tax on your allocated share, but you might not get any cash that
year b/c the partnership is preserving the money to finance the
partnership. To avoid this problem can try to put in the agreement that
the partnership will distribute enough money to partners so can at least
pay tax bill.
vi. How easily can the GP raise additional capital?

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 1. Can take in additional partners by selling additional equity (ownership
stakes)- will result in dilution of the ownership interests of the original
partners
a. Process is governed by the partnership agreement (typical
provision delineated in PA), but if no provision fall back to
UPA or RUPA (allow new partners with approval)
2. Can borrow money, loans
i. Biggest drawback of GP is joint and several liability, so other similar entities were
formed to deal with this
GENERAL RULE- Corps, LPs,, LLPs, LLCs can be organized only if certain formalities are
complied with and a filing is made with the state vs. GPs can be organized with no formalities
and no filing

4. Limited Partnership (LP)

a. Way to bring investors ($) into business without exposing them to joint and several
liability
b. Must have 2 types of partners (at least 1 of each)
i. Limited Partners
ii. General Partners
c. Governed by Old ULPA- Revised Uniform Limited Partnership act (RULPA) or New
ULPA- Uniform Limited Partnership Act (ULPA).
d. Under RULPA § 201 (233)- in order to form a LP must file a certificate of LP with the
sec of state
i. File in LP and not GP, b/c want to put creditors on notice that certain
individuals DO NOT have joint and several liability (limited partners)
e. Must specify LP at the end of co name to put people on notice (i.e. XYZ Limited
Partnership (LP))
f. Main distinction between GP and LP is in liability and management and control
g. Continues today even though the LLC is the logical candidate to replace it.
h. Six Factors
i. Who is liable for the debts of the LP if the LP can’t pay?
1. General Partner has joint and several liability
2. Limited partner is only liable to the extent of the amount invested in
LP
a. Will only lose amount invested, not responsible for unpaid
debts of LP
ii. Who controls or manages the LP?
1. GP has management and control over the LP in exchange for accepting
liability.
2. LP is essentially a silent partner, in return for having only their
investment at risk they have limited control.
3. In return for limited liability, LP gives up management and control, but
in all states, if the LP engages in too much M & C, then LP will
become a de facto GP.
a. Control rule- if you want to be an LP, then act like one, b/c
otherwise you will lose limited liability.
b. Under New ULPA- ULPA §303 (281) (not yet adopted by any
state)- the control rule is eliminated in its entirety- No liability
as limited partner for limited partnership obligations
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 i. An obligation of a limited partnership, whether arising
in contract, tort, or otherwise, is not the obligation of a
limited partner. A limited partner is not personally
liable, directly or indirectly, by way of contribution or
otherwise, for an obligation of the LP solely by reason
of being a limited partner, even if the limited partner
participates in the management and control of the
limited partnership.
1. Why would this provision when traditionally it
was otherwise?
a. If GP not managed well, the LP’s can
step in
b. LLC is becoming the entity of choice
and it is an attempt to change the rules of
LP to make it competitive with the LLC
form
4. Difficulty of determining when LP’s become de facto GPs- Gateway
Potato Sales v. GB Investment Co. (482)-Gateway, a creditor of
Sunworth Packing LP brought suit to recover payment for goods it had
supplied to the LP. General Partner is Sunworth Corp and Limited
partner is GB investment Co (GBIC). Gateway doesn’t sue the GP b/c
has no money.
a. Normally the extent of LP liability is the amount invested.
b. Gateway’s theory is that GBIC’s conduct makes it a de facto
general partner and therefore has joint and several liability.
GBIC managed/controlled in a manner antithetical to LP status.
(See footnote 1 p. 483) (Suspicious actions!)
i. All trends and important business decisions had to be
approved by GBIC
ii. Employees of GBIC were at the office daily and
directed changes of business operations
iii. Accounting involvement
iv. Equipment selection; Packaging modification;
controlled advertising
v. Obtained loans
vi. Signed checks <sometimes> (certain checks paid
directly by GBIC)
c. Arizona Statute § 29-319 (a)- A limited partner is not liable for
the obligations of an LP unless he is also a GP or in addition to
the exercise of his rights and powers as a LP he takes part in
the control of the business (Sentence one same as RULPA 303
(a) (p. 237)).
i. GP can also make an investment in a LP as a limited
partner- ultimately his liability doesn’t change b/c can
lose all his LP investment and be liable for the whole co
(just an easy accounting method).
ii. An LP doesn’t have to be totally silent. Clearly has
rights under RULPA 303(b) (238):

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 1. Can be a contractor or even an employee of the
LP, even president.
2. Can consult and advise the GP with respect to
the business of the LP
3. Can request or attend meetings of partners.
4. BUT, can’t go too far!!! If you go too far in
exercising your power you can lose your limited
liability. Can be held J & S liable if act like GP.
iii. Sentence 2 of RULPA differs significantly: RULPA
303(a) (237)- If the limited partner participates in the
control of the business, he [or she] is liable only to
persons who transact business with the LP reasonably
believing, based on the limited partners conduct, that
the limited partner is a general partner
1. Lessens the impact of 1st sentence that says you
can go too far.
2. Gateway court sees 2 dangers with 2nd sentence
RULPA 303 (a) (237)
a. Indirect knowledge problem- Must have
direct contact with the limited partner or
else you are out of luck, so cant learn of
conduct via 3rd party.
b. Incentive for lack of transparency
(clandestine problem)- a limited partner
can completely control a LP and not fear
the loss of limited liability so long as she
does everything in hiding. If a creditor
never sees the LP doing this, then the
creditor is out of luck.
3. Arizona Statute 2nd sentence- However if the
limited partners participation in the control of
the business is not substantially the same as the
exercise of the powers of a GP, he is only liable
to persons who transact business with the LP
with actual knowledge of his participation and
control.
a. Doesn’t solve the direct knowledge
problem b/c still need actual knowledge
b. Solves the transparency problem b/c you
will be held J & S liable even if someone
doesn’t see you, so long as LP
participation is same as GP. If not
substantially the same need actual
knowledge!
4. So these statutes show a relaxation of strict no
management and control as LP- modifying LP’s
chances of losing limited liability. (ex. LP as
key employee, like president, making key

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 decisions, but still not have liability). GP might
want to do this for monetary reasons.
iii. Next 4 factors are same as in GP (see pg. 5-6 of outline)
iv. Biggest drawback of LP form is Joint and several liability so GP can limit
liability by interposing another corp entity or LLC between the limited
partnership and themselves and make that limited liability entity the GP.
1. You will be the shareholder, director and officer of the corporation
(GP) and a limited partner in the LP.
2. Since corp is the GP, creditors will go after the corporation and if you
don’t put a lot of money into the corp then creditors will hold the bag,
will have to get assets of corp.
3. IF you are the shareholder, then you will more often then not qualify
for S-corp status and get flow-thru taxation
4. tort victims are involuntary creditors
5. Employee wages- same outcome as creditor liability
6. LP and GP owe each other the duty of finest loyalty, so what if the LP
wants to sue the corporate GP for breach of loyalty? Does the corp
form protect these people who were in essence disloyal? Is this an
added benefit of having a corp GP?
a. In re USACafes, L.P, Litigation - “Not me- it’s the
corporation argument!
i. You are the one being disloyal, if the corp you are in
charge of is being disloyal.
ii. SO, you can be sued for any disloyalty because you
have a duty!
iii. Interposed corporation regarding creditors = safety,
BUT interposed corporation regarding disloyal
conduct= open to suit from other partners.
iv. IF a limited partnership has a corporate general partner,
its officers (including directors) owe fiduciary duties to
the limited partners.
5. Limited Liability Partnership (LLP)
a. GP’s that have limited to some degree the joint and several liability of some of the
partners <via statute>
b. LLP, professional corp, used almost exclusively by professionals- lawyers, doctors,
accountants- to limit malpractice liability. (any vocation that can be sued for
malpractice).
c. Under most LLP statutes each partner is liable for general obligations (i.e. lease of
office space, if can’t pay, landlord can go after entire firm), BUT each partner is liable
for THEIR OWN acts of malpractice, and not on the hook for acts of malpractice of
other partners in the partnership.
d. Statute specifies the minimum amount of malpractice insurance to be in play at all
times, so will collect under insurance and then from partner as necessary.
e. Must file a certificate to put people on notice that an LLP has been formed.
f. Governed by RUPA § 1001 (196)- Partnership must end with LLP or equivalent to
create notice.
g. In the absence of a provision in the partnership agreement, all partners are entitled to
participate in the management of the business itself.
6. Limited Liability Company (LLC)
1
a. Wyoming- first to form LLC statutes.
b. Designed to take advantage of the best of what the partnership has to offer and the
best of the corporate form
c. Formed by filing articles of organization in a designed state. The articles must include
the name of the LLC, the address of its principal place of business or registered office
in the state, and the name and address of its agent for service of process.
d. Noncorporate entities,but entities created by statute, can hold property and be sued.
e. Started off slowly because of tax problem because wasn’t clear whether it would get
flow thru taxation due to corporate attributes, but now taxed like partnership.
However, can choose double taxation- useful when the LLC will grow quickly and
soon convert to corp form.
f. In deciding which entity to choose, most people are concerned with taxes and
existence of developed case law interpreting statutes for certainty.
i. LLC concerns about taxes abolished
ii. People understand LLC’s better than before.
g. Six Factors
i. Who is liable for the debts of the LLC if the LLC can’t pay?
1. provides investors with limited liability like corporation each
investor can lose ONLY their investment. Creditors can NOT go after
owners if/when they cannot pay.
a. Owners are called members, formation of LLC is statutory in
nature; Must file articles of organization similar to certificate of
LP.
b. However, members may become liable if the conditions for
piercing an LLC veil are satisfied.
ii. Who controls or manages the LLC?
1. Provides tremendous flexibility- like a GP all members can participate
in the management of the LLC, unless the operating agreement says
something to the contrary.
a. Members who engage in management are called managers and
other members are just members. Operating agreement will
specify the difference
b. LLC’s can be member managed or manager managed
i. Member managed- no select people- everyone
manages and can bind the LLC
ii. Manager managed- select few manage (typical)
1. Agency relationships/Laws important when
members act on behalf of LLC especially when
not a manager.
2. Members can bind the LLC only if member
managed (apparent authority) , otherwise
managers must act
3. like shareholders have no apparent authority to
bind corp., members of manager managed LLC
cant bind.
iii. How easily can LLC ownership interests be transferred?
1. LLC interest can be transferred UNLESS operating agreement
specifies otherwise (which it often does)
a. Can limit transfers to people you know, understand, etc.
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 2. Transferees do NOT become members without approval, until then
will only get the financial aspects of ownership, but since always have
limited liability, no issue, but still no Management & Control)
iv. What is the LLC’s continuity of existence?
1. Events of DisAssociation, Similar to GP- Operating agreement will list
certain events that if occur will give choice to continue LLC or wind
up and terminate. (similar to event of dissolution in LP )
v. How is the LLC taxed?
1. Flow-thru taxation (like GP)- members are taxed at their personal tax
rates based on share of profit/loss and LLC itself not taxed.
2. Must fill out an informational return
a. Members of LLC will get a schedule K-1, which will then have
to report on 1040.
vi. How easily can the LLC raise additional capital?
1. Additional members can be brought in to the extent allowed by the
operating agreement if not prohibited by statute (like GP).
a. Ex. can have class A-complete voting rights and class B where
get no voting rights.
2. Capital Structure is flexible (can make your own rules)
a. Tiered
b. Voting rights or non-voting interest
c. Pro Rata etc
i. Flexibility is important because preferred choice
even over an S-corp (b/c in S-corp can only issue 1
class of share)
ii. Everyone has limited liability, regardless of what class
of ownership, but not possible with S-corp.
3. Since corp is the only entity that can sell ownership stakes to public to
raise capital, a lot of LLCs as they grow and want access to public
funds convert to corp form before going public.
h. LLP’s, LLC’s and LP’s are statutory entities so can sue and be sued
7. Corporation
a. Basic features
i. Export of England- needed charter from the crown (explicit approval from the
King or Queen)
1. Document filed to create is charter- certificate/articles of incorporation
ii. After U.S. independence businesses needed a way to incorporate so turned to
state legislatures for authority to operate corporate entities
1. Typically, charter was valid for only specified type of business and
getting the charter took political influence (bribery)
2. Needed better ways to incorporate business so general incorporation
laws were developed
a. 1811- NY first state, but only designed for manufacturing
entities. Certain businesses needed additional approval from
other state organizations
iii. Corporations are separate legal entities- artificial persons- separate and
distinct from the legal personalities that own/control them
1. Ownership claimants of the corporation are called
shareholders/stockholders (depending on jurisdiction
1
 a. New York- shareholder
b. DE- uses both shareholder and stockholder interchangeably
2. Board of directors, chosen by the shareholders, are overseers of the
corporation
3. Officers and managers operate business daily and carry out the board’s
decisions.ex. hire employees.
a. Officers:
i. CEO- Chief executive officer
ii. CFO- Chief financial officer- invest, raise capital,
dividends- big picture person
iii. COO- Chief Operating Officer
iv. Comptroller- Chief Accounting Officer- lesser officer
v. President
vi. Vice-President- can have many
vii. Corporate Secretary- Very important role- keeps track
of board of directors meetings, notices, and statutory
compliance
viii. General Counsel
b. Some officers can hold more than one office (i.e. CEO &
President; General Counsel & Corporate Secretary)
c. Officers can also be directors (i.e. Chairman of the board and
CEO)
i. But pressure via investors, media, SEC for companies
to split Chairman and CEO titles (Ex. Walt Disney CEO
and Chairman- Michael Eisner pressured to yield
chairman title)
ii. Amount of power that Chairman has on the board
depends on the person and CEO.
d. Board of directors hires CEO and officers of corp, not
shareholders (1 of the most important thing the Board does).
Only board can fire CEO!
iv. 6 factors
1. Who is liable for the debts of the corp if the corp can’t pay?
a. Owners have limited liability, so generally shareholders are not
personally liable for the debts of the corporation, BUT can lose
initial investment
b. Corporations are separate legal entities
i. Power to contract, sue and be sued
ii. Can commit crimes
iii. Subject to income and other taxes
iv. Corps have constitutional rights (i.e. due process and
equal protection rights)
v. Attorney-client privilege can be invoked
vi. Corporation cannot take 5th amendment, BUT 4th
amendment protections against unreasonable search and
seizures
vii. Corps can sue for defamation (Famous British case-
McDonalds sues couple)
viii. Corporations do not have a right to privacy
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 ix. Generally corps have very expansive 1st amendment
rights, but corporation speech is regulated regarding
defrauding consumers.
2. Who controls or manages the corporation?
a. Separation between ownership AND control
i. Direct management removed from shareholders
b. Under DGCL 141 (a) (550)- Corporations shall be managed by
or under the direction of a board of directors
i. Shareholders can also be on the board (gives
shareholder some control)
c. Closely held corps- common to have shareholders that are also
directors and officers- often no separation. Ex. guy who owns
subway franchise store.
3. How easily can corporation ownership interests be transferred?
a. General rule is that you are free to transfer your shares to
whomever you please. However, when dealing with a privately
held corp shareholders are few in number and not public so
transferability is often limited by contractual shareholder
agreement. Alternatively, also have to be concerned about who
is going to buy your shares, especially if you invest in a very
small local business, b/c there might not be a liquid secondary
market!
b. Privately held co’s v. Publicly traded corp
i. Publicly traded co- all shares of stock are sold to the
public through IPO; whenever shares are offered to the
public must register shares through the SEC and
comply with the Securities Act of 1933.
1. Ease of transferability b/c shares are listed on
the stock exchange and individuals can sell
them freely with mkt generated price.
2. Transparency- Securities Exchange Act of 1934
requires after IPO that the co become a
reporting co. Required to make periodic
disclosures about business, employees and
financial condition to the SEC (public docs-
competitors can look, so might not be great
thing for all co’s)
3. has lower cost of capital, liquidity, but can be
subject to hostile takeover and info is public
“glass house.”
c. Private co’s- Shares are sold only to a select few, privately (no
IPO)
i. Transferability- no liquid secondary mkt; top 2
candidates to buy shares are existing shareholders or the
company.
ii. Transparency- co info is proprietary so only co. insiders
will have this info.
4. What is the corporation’s continuity of existence?

1
 a. Termination date to be specified in charter, if none then can
have perpetual existence. Termination date can always be
amended.
5. How is the corporation taxed?
a. Double taxation (firm tax and flow through taxation) (unless S-
corp) – C Corp- Co gets taxed and shareholders get taxed on
dividends
b. Subject to both local and fed tax
c. Co might qualify as an S-Corp; if elects to do so then the co
will be treated as a flow-thru tax entity. Must make election in
timely manner. (not all co qualify)- S-corp requirements:
i. 75 (100??) shareholders or fewer
ii. Shareholder must either be individual (US resident or
alien) or qualified estate or trust, or another S-corp
iii. If a C corp or foreigner buys stock in an S corp than the
S corp designation immediately become C and then
have double taxation.
iv. Capital structure- co can only issue 1 class of stock if it
wants to be an S corp
v. S corp can own shares in a subsidiary co and it doesn’t
matter if that subsidiary is an S or C corp.
1. Policy behind S corp is to encourage small
business growth and development but b/c the
LLC does everything all at once the S- corp is
becoming more obsolete.
d. If s-corp then profits and losses are allocated to shareholders,
see 1120S-only info tax return then K1- receive in mail which
allocates your profit or lose and then report this on first page of
140 of line 17 (above the line and thus above to offset day
income)
6. How easily can a corporation raise additional capital?
a. Co’s have tremendous flexibility to raise additional capital b/c
just sell securities
i. Caveat- S-corp has limited flexibility b/c can only issue
1 class of stock
b. 3 types of securities a co will issue: (can have diff categories
within each of 3 classes)
i. Debt securities
ii. Preferred stock
iii. Common stock
v. Chain of payments: (1) Creditors (secured, senior, subordinated (higher yield
to be last in line of creditors- junk bonds)); (2) Preferred stock holders; (3)
Common stock holders
vi. par value- is the legally allowable, minimum amount of consideration that a
corporation can accept from an investor for a share of its common or preferred
stock. Number is decided by board. Smaller number is smaller creditor
cushion and thus proshareholder.

1
vii. legal capital and par value is designed to protect the creditors of the co. This
cant sell stock for less then par value since defrauding the creditors since they
are not getting cushion.
1. ex. if the par value of a share of a company’s common stock is 1.00,
then a potential investor must pay at least 1.00 per share for the stock
he buys
2. 2. companies try to sell their shares of stock at prices significantly
higher than par value
3. any consideration that the investors pay in excess of par value is
included in the “additional paid-in-capital account” (APIC) on the
company balance sheet
4. lower par value hurts creditors because they minimize the size of the
capital cushion designed to protect creditors
viii. can issue “no par” stock
1. this means no predetermined amount and board decides how much of
the consideration received should be allocated towards common stock
acct. and how much should be toward APIC.
ix. Debt securities- Co IOU’s issued to investors. Co will pay interest and
principle upon maturity. (ex. Bonds (generally secured by assets of the co.
and if co cant repay then the lender will seize the property), debentures, notes
(shorter term obligations that may be secured or unsecured).
1. Contract claimants on co – contractual right to interest (can sue if they
don’t pay)
2. Upside potential is capped at the interest rate- less risk but less
opportunity for upside.
3. bonds and the indenture need to be conceptually distinguished
a. bonds set out a promise to pay that runs to the holders of the
bonds
b. indenture is a bundle of additional promises (including a
backup promise to pay) that run to the trustee
x. Preferred stock- Hybrid securities (mix of stock and debt)
1. Most common form of equity ownership in a co., but K claimants, not
equity
2. S corp cannot issue preferred stock because need at least 1 class of
common stock at all time (need 1 owner) and can only have 1 class of
stock. If an S corp issues preferred stock, then loses status.
3. Contractual obligations voted on by board
4. Certificate of designation is filed with the state and becomes part of
co’s charter (no actual K) (DGCL 102(a)(4) (537), NYBCL 402(a)(6)
1124
a. Terms of preferred stock are rarely put into the charter, b/c
can’t determine mkt conditions in advance, instead blank
check authority given to directors-statutory ability to issue 1
or more series of preferred stock at boards discretion, with
terms figured out then. Board will negotiate terms for series
and when adopted those resolutions will become part of
charter.

1
5. Traditionally issued by co’s in 1 or more series (1st series A, then b
etc)- terms will vary btw series b/c like debt need to yield different
interest rates based on interest rates at the time.
6. Dividend preference- must receive/pay all their dividends of preferred
stock prior to the time that the company can pay any dividends to
common stock holders. CS holders will receive nothing if PS holders
are in arrears. (DE statutorily based- DGCL 151(c) (559); NY- K
based, need for demand of PS)
a. Legal Capital rules must still be met before paying dividends
i. DGCL 170(a) (569)- surplus (net assets-
capital<CS+PS>) or from net profits this year or last
year
ii. NYBCL § 510 (1133)- equity insolvency test & net
assets test (net assets remaining after paying dividend =
stated capital)
b. PS more risky than debt b/c dividends only paid at discretion of
the board and then ONLY if legal cap rules satisfied, Debt must
always be paid, or can lead to bankruptcy
7. Liquidation preference- PS holders will get a stated dollar amount at
liquidation before CS holders get anything (typically the amount of
money the PS holders paid for the stock in first place- par value (debt
like feature))
8. Dividend = Annual Dividend Yield (%) * Par Value
a. May be paid in cash, property, or in shares of corp’s capital
stock. And payable at board’s discretion.
9. Annual Dividend Yield (%) = Dividend / Par Value
10. Preferred stock has a higher interest rate then the markets interest rate
11. Dividend payments of preferred stock are payable at the discretion of
the board
a. Can only pay it out of funds that are legally available
12. Cumulative v. non-cumulative
a. Cumulative PS (contractual right)- if board declines to pay
dividend in a quarter, it accumulates, and can’t pay CS
dividend until they pay all dividends past and present. Even if
dividend is prevented b/c of legal capital rules it accrues
b. Non-cumulative- if the co decides not to pay dividend it is lost
forever and it would be illegal for the co to pay a past missed
dividend b/c like a undeserved gift. This type often used by
venture capitalists in the form of non-cumulative convertible
stock b/c get the chance to convert into CS, but if the co fails
get paid right after debt.
13. 2 types of voting rights
a. Voting rights (entitled by law)
i. Vote w/cs holders, but since usually more cs, they rule
ii. If the amendment of charter would adversely affect the
preferred shareholders than the preferred shareholders
must also approve the amendment as a separate class
(DGCL 242(a) (598) NYBCL 501(a) (1126))
b. Contractual Voting Rights
1
 i. Cumulative Preferred Stock- If the co has missed 6
quarterly dividend payments then the preferred
stockholders can elect 1 or more directors to the board
who will stay on board until the arrearage is paid off,
but then get kicked off! Those who get elected have a
fiduciary duty to ALL shareholders. K provision can
provide that missed dividends need not be consecutive
14. Conversion rights- can negotiate for option to convert PS to CS
(residual claimants) so can capture upside if co is doing well. Usually
must accept lower dividend yield for this right.
15. Participation Rights- negotiate to receive both PS and CS dividend.
Only works well when a co wants to pay CS dividends (cash cow)
16. Redemption Rights- DGCL 151b, the co buys back the PS b/c rates
change (useful b/c when interests rate decline, can buy back and
reissue at a lower dividend yield, shareholders will demand a premium
for selling their above market dividend yield stock) There will
typically be a period of time when the co is prohibited from redeeming
the stock (call protection), but the co will buy at a premium price, b/c
if not will have to wait maybe 5-10 years until can buy w/out prem
xi. Common Stock- ownership equity claim or interest in co
1. Ownership claimants not contract claimants (Residual claimants) – get
everything left over so upside is NOT capped. (get paid last at
liquidation)
2. Board decides how much CS will cost, but cannot sell for less than par
value b/c would be watered stock. Questions used to decide:
a. How much money are we looking to raise
b. What % of ownership are we willing to give up for that amount
of money (very early on owners are willing to give larger
pieces for less $, until get closer to going public)
c. What is the entire co worth? Based on comparable valuations
and discounted cash flow from investment banks….
d. How much of the co are you willing to give up to go public? (a
very strong family might not want to give up control!)
i. Ex. Assume want to sell 49% of co that is worth $100
m ($49 m)
1. Want good float and liquidity (lots of shares)
and don’t want share price looking cheap try
getting at least $10.
3. Voting
a. Typically common stock receives 1 vote per shares, but can
issue stock with NO voting rights (DGCL 151(a) (558),
NYBCL 501(a) (1126)), but MUST have voting class so will
have 2 classes. (if S-corp and want voting and non-voting
shares will lose designation).
i. Non-voting CS- Still need to get shareholder approval
over certain things, but means that won’t get to vote for
directors. A lot of investors don’t care about voting but
want the financial benefits of being an investor.

1
 1. Stock exchanges WILL NOT LIST NON-
VOTING SHARES- didn’t want these stocks
b/c didn’t think it was fair, so instead co’s
decided to issue super voting stock (i.e. family
members will get 10 votes per share, public
shareholders will get 1 vote per share)
b. CS holders can vote on charter amendments (including how
many shares the co is allowed to issue, so if limit reached and
want to issue more need shareholder approval), mergers, sale
of all or substantially all of the co’s assets, election of directors
(if not non-voting stock which can exist in non-public co’s),
termination of the co.
4. Dividends- CS holders are not automatically entitled to dividends b/c
directors discretion, but in rare circumstances a court could compel a
co that has so much money in bank to pay a dividend (Microsoft).
Dividends do NOT have to be in cash. Dividend can be shares of co
stock, shares of another co the co owns, excess inventory, IOU’s.
a. Spin off- Parent co w/2 shareholders owns all the shares of its
subsidiary and parent co takes the shares of the subsidiary and
give it to the 2 shareholders. 2 shareholders will now directly
own the shares of the subsidiary. Important b/c now
shareholders can sell stock of subsidiary, but couldn’t before
b/c protected by parent co.
5. Redemption rights- Under DGCL 160(a) (565), a corporation is
empowered to repurchase its securities, including common stock.
However, via contract (more common with closely-held corporations)
you can force common shareholders to sell their shares back to the
corp.
6. Preemptive Rights- (Private Co’s only)- Contractual in nature and
guarantee a shareholder the ability, but not the obligation to maintain
his ownership % if gets watered down. Traditionally, all shareholders
had these rights (statutorily), but now must be specified in charter.
(DGCL § 102(b)(3) (538), NYBCL § 622(b)(3) (1151). Need
shareholder approval to amend the charter to add a preemptive rights
provision, accordingly, the prospective shareholder would have to have
a lot of clout (or be offering to invest a large sum of money) for that to
happen.
a. Preemptive rights wouldn’t make sense in a case where co A
acquired co B, and “used existing stock to do that”- When you
use authorized but unissued shares of common stock to buy
another co, those shares are issued to the selling shareholders
of that other co (Company B). If some of the stock being issued
in connection with the acquisition had to be offered up first to
company A’s stockholders due to a preemptive rights provision,
it could endanger the whole acquisition. (could lead to
chicken/egg problem). For example, if co A offered a 35%
aggregate interest it Company A to Company B’s shareholders
in exchange for B’s stock, and then A’s shareholders sought to
enforce their preemptive rights, a 35% stake could never be
1
 issued to B’s shareholders. Thus, virtually all preemptive
rights provisions in charters carve out issuances of shares in
certain cases (e.g. in connection with acquisitions and in
connection with the exercise of employee stock options).
b. Public co’s won’t have this right, if it’s in the charter existing
shareholders will take out before going public. A company that
has a preemptive rights provision isn’t a good candidate for
going public. It would make the raising of capital in the future
(even in the IPO itself) too complicated and uncertain.
Therefore, the investment bankers who are going to underwrite
the IPO tell existing shareholders that they will not take them
public unless they remove the preemptive rights provision.
Since going public is a way for existing shareholders to make a
lot of money, they acquiesce.
7. Stock can have no par value- stock that allows the board to specify the
amount allocated to the common stock account at the time stock is
issued. (Par value stock has a predetermined amount that will be
allocated to the common stock account). In the case of “no par” stock,
the amount allocated to the CSA can be different (or the same) each
time common stock is issued.
b. Legal capital rules
i. Designed to protect shareholders- CANNOT pay a dividend if it will reduce
the capital cushion, but even in the leanest of times there is tremendous
pressure on the board to pay a dividend to shareholders.
ii. DE Legal Capital Rules – DGCL § 170(a)- Directors may declare and pay
dividends on common stock either:
1. Out of surplus
a. Surplus is the excess of any of the corporations net assets over
the amount determined to be capital. Surplus = (Total Assets-
Total Liabilities)-capital (DGCL § 154)
i. Surplus= Additional paid in capital, Retained Earnings
and other comprehensive income
b. Capital- the amount that is sitting in the common stock account
and preferred stock account
c. Net assets- the amount by which total assets exceed total
liabilities of the corporation
2. OR, if there is no surplus then out of net profits for the current fiscal
year and/or the preceding fiscal year
a. A prime example of DE being a management friendly state-
tells us even though there is no capital cushion to protect
creditors, can still pay common stock holders if the co was
lucky enough to make money this year or last year- to the
detriment of shareholders b/c less left for them.
i. Management gets to keep their job by keeping
shareholders happy by paying them dividends, but at
the expense of creditors.
Surplus = (TA-TL) – Capital (CSA + PSA)

HYPO
1
 - assume corp has 100,000shares of common stock outstanding (in hands of shareholders),
par value is $2 per share and thus CSA= 200,000
- assume total assets = 3 million dollars and TL = 2.6mill and Net Loss= (400,000k) but
last yr. had net profit of 100,000k
- can we pay dividend legally based on these facts? If yes how much?

1. do we have surplus?
a. Surplus= TA-TL-Capital
i. 3mill-2.6-(200,000)=200,000 so yes have surplus…if have any surplus
never go to second prong or next step****and thus can pay max. of
200,000k in dividends
1. s 200,000/100,000 which equals a max of $2 per share…
HYPO 2
- assume corp has TL= 2.9 mill instead of 2.6

1. surplus= TA-TL-Cap
a. 3mill-2.9-200,000= (100,000) and thus no surplus but in Delaware still can pay
dividend if made profit this yr. or last current fiscal yr.
i. This yr no (lost 100,00)
ii. Last yr made 100,000
1. thus can ignore Net liability of (400,000k)
2. can pay 100,000/100,000= $1 dividend per share
3. and thus reduces capital cushion (since comes out of CSA)

so if had 200,000 NL….AND/OR******

iii. Under DGCL § 174(a)- Those who vote in favor of a dividend that would not
be legal are jointly and severally liable to the corporation or creditors in the
amount of overpayment. Directors will be held liable if they did so willfully
1. Knowing shareholder exception- Directors who are held liable for an
illegal dividend can sue any shareholder who took the dividend with
knowledge that it was illegal,
2. Under DGCL 172(a) (569)- Directors are entitled to rely reasonably
on outside advisors. Due Care Exception.
iv. NY Legal Capital rules- NYBCL § 510 - 2 parts to NY’s legal capital test-
BOTH must be met: More pro creditor.
1. Equity insolvency test (510(a))- a corporation cannot legally pay a
dividend if the co is insolvent or would be rendered insolvent as a
result of a payment of dividends AND
a. Insolvent- unable to pay its debts as they become due in the
ordinary course of business.
i. Can tell this by looking at the statement of cash flows
or looking at the balance sheet and comparing total
assets to total liabilities (if far exceed most likely wont
be able to pay.) Also, current assets v. current
liabilities
ii. Wouldn’t want to just ask a creditor if they have been
paid in time b/c co might be paying late as part of its
cash flow management, or there could be a dispute over

1
 the bill etc, many other reasons not to pay besides not
having cash.
2. 2nd Prong- Net assets test (510(b))- (balance sheet surplus test)
a. The board can only declare and pay dividends out of surplus so
long as the assets remaining after paying at least equal the
amount of stated capital.
i. Stated capital = common stock account + preferred
stock account
1. shares outstanding * par value.
ii. Maximum dividends payable = net assets (which is TA-
TL) – stated capital (same as DE’s surplus formula)
HYPO-
NY Corp- current on paying its bills and has 500,000 common stock outstanding and par value is
$1 per share and thus amount in CSA $500,000…assume TA is 5.1mill. and TL is 3.2mill.

- can NY corp pay dividend and if so what amount?

o Good evidence that it is solvent since current on bills or could look at TA-TL and
if positive then good indicator solvent since can pay of liabilities or can look at
CASh v. Current Liabilities (if cash greater then good indictor)
 So assume we are solvent
- first formula
o TA-TL has to be > stated capital
 5.1mill- 3.2 mill is greater than 500,000
 1.9mill > then 500,000 so yes can pay dividend
· So what is the max dividend payable?
o 1.9-500,000=1.4 mill if want to figure out on per share
basis then 1.4mill/500,000 which equals $2.8 per a share

HYPO 2
- assume TA is 3.6 mill. as opposed to 5.1 mill. and assume the co. earned net profits
(NP)equal to $250,000 and last yr. had net loss of ($150,000)
- assume other facts above and so can we pay dividend and if so what is max?
- still solvent see facts above but what about second prong
o TA-TL> stated capital
 3.6-3.2 must be greater or equal to 500,000K
· 400,000 is LESS than 500,000k and thus cant pay any dividend so
next question is can we pay dividend up to 250k since made money
of 250,000 this yr? NY does not have second prong of Delaware
test-----******NY only cares if solvent AND TA-TL is greater
then stated capital

In theory the 250,000 is still in the account available to creditors but who cares since co is still
paying credits on time…..

v. NYBCL § 719(a)(1) (1169)- Those who vote in favor of a dividend that

would not be legal are jointly and severally liable to the corporation or
creditors in the amount of overpayment. Directors will be held liable if they
did so willfully
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 1. Exception- Relying on faulty info and knowing shareholder exception
(See § 719(d)(1))
c. Where to Incorporate? Delaware’s Preeminence
i. Governance of a co is controlled by the co law in the state in which the co is
incorporated, no matter where the business is actually located- so where to
incorporate is an important decision
ii. elements of the doing business and franchise taxes may overlap, so that if a
corporation is doing business mainly on one state, its total tax bill usually will
be lower if it is incorporated in that state.
iii. More than 50% of publicly traded co’s are incorporated in DE and many co’s
reincorporate in DE to take advantage of DE law (form a fully owned DE
incorporated subsidiary and then merge the 2 co’s into 1 DE co)
iv. 3 reasons for why DE
1. Statutorily liberal- Management friendly- places minimal restrictions
on corporate manager when running their business. Managers can
treat the business as their own instead of being ruled by shareholders
a. DE allows the adoption of certain takeover defenses
i. Ex. Poison Pill defense- makes it expensive for one co.
to take over another co.
b. Allow manager to keep their jobs- don’t want shareholders
willy nilly throwing them out of office
c. Minimizes the need for shareholder approval on a number of
things
2. Large established body of case law in the DE Chancery court (a lot of
high profile corporate disputes) so has expertise that can’t find in other
courts around the country.
a. Stability b/c people can always rely on DE case law
3. DE chancery is very efficient when it comes to large co disputes (often
gets a case heard in a matter of weeks and sometimes even quicker).
v. Can Reincorporate
1. make subsidiary and then merge into subsidiary and change the name
to the old corp. Thus all assets flow into the corp by operation of law.
SEE SUPPLEMENT HYPO PG 2
d. Corporate Governing Documents and the Interplay with Corporate Finance
i. 3 main documents that govern the internal corporate governance of the co:
1. Certificate or articles of incorporation….some times called charter and
most supreme
2. By-laws (contain more detailed day to day corporate governance
provisions)
3. Board of Directors resolutions (often taken at board of directors
meetings)
ii. Charter or certificate of incorporation
1. DGCL § 102 (536) and NYBCL § 402 (1124)- Specify what needs to
be in the corp charter at a minimum
a. Name
i. NYBCL §402(a)(1) – Cannot mislead people with the
corp name and certain terms can only be used in the
name if you get pre-approval from a particular NY state
Dept – certain words are off limits
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 1. ex. savings or loan can if approved.
ii. NYCBL § 301(a)(5)(a) (Stat II- 20)- list of words that
cannot be used in name
1. ex. police
iii. NYCBL § 301(a)(1) (Stat II- 19)- Name must include
corporation, limited, incorporated or any abbreviation
of those.
iv. If someone else has the same name as you have to find
a new name, file and pay again.
v. Under both DCGL § 102 (536) and NYBCL § 303
(Stat- II- 22)- Can reserve a name for up to 60 days
with 2 extensions allowed.
b. Business purpose- must be included in charter. Can state a
specific or generic purpose or both (Generic- any lawful
activity allowed under law). Most co’s just put in a generic
purpose, but some risk either way.
c. # of authorized shares- 403a4, Must include the class or classes
of stock that the co can issue and also the par value for each
class. To change that # (amend the carter) need shareholder
approval. Shareholders will only allow change if it is
reasonable.
i. Under DGCL 102(a)(4) (537) and NYBCL 402(a)(5)
(1125) if the co decides to issue separate stocks into
different classes they must describe how they differ
(typically differ only in voting rights)
1. NYBCL § 502 (1127)- blank check
EXCEPTION for preferred stock- can
designate board the right to later decide rights,
preferences and privileges of different series at
the time of issuing, w/no shareholder approval
b/c pre-approved.
d. Duration of the corporation- can specify a termination date, but
if you don’t then life of the corporation is perpetual.
e. DGCL § 102(b)(7) (539) and NYBCL 402(b) (1125) allows co
to assert in charter a provision that limits a directors personal
liability for breaches related to fiduciary duty other than those
taken in bad faith or involved in petulant conduct. Most
charters include this provision. (DE case law Smith v. Van
Gorkan said that directors can be liable for breaches of
fiduciary duty, but DE law changed this)
f. Can put anything else in your charter as long as it’s not illegal!
g. If want to change charter
i. Ex. increase number of shares Del 241, 242 or NY 803-
majority of stock holders and the board have to approve
amendment, if it adversely effects a specific group, that
group can vote and veto it.
h. If charter proves to be problematic and you need to amend the
charter NYBCL § 803(a) (Stat II 105)- tell us that (1) if there
are no shares outstanding, so no shareholders, the sole
1
 incorporator can make any amendments he wants; (2) if there
are shares outstanding, need approval from a majority of
shareholders to make amendment.
i. EXCEPTIONS to rule of needing shareholder approval:
1. NYBCL § 803(a) (Stat II 105)- No shareholders
2. NYBCL § 105 (Stat II – 9) – correcting all
typos EXCEPT typos in the name
a. DE doesn’t provide typo exception so
need shareholder approval
iii. By-laws
1. Nuts and bolts of co- Mechanics behind calling and holding meetings,
meetings of shareholders, typically will specify the number of
directors that will sit on the board, discuss how to fill vacancies on the
board if director dies or resigns
2. Amending the Bylaws (depends)- DGCL § 109 (a) (544) and NYBCL
§ 601 (1139)- Shareholders through a vote can always amend the
bylaws. However, if they choose they can put in their charter a
provision that shares the power to amend the bylaws with the directors
(w/out shareholder approval). If directors change the bylaws so they
are adverse to shareholders the shareholders can change it back b/c
shareholders are the owners of the co, while the directors are agents of
the owners; shareholders have preemptive power over the bylaws and
their amendments take precedent.
iv. Board of Directors resolutions
1. Co’s are entities (artificial people) and they themselves can take
actions in their own right.
2. Since co can only act through its officers and directors it makes sense
that when they resolve to do something to memorialize resolution in
writing.
3. There is no bright line test over what an officer can do without the
board’s approval- when it’s a material decision the officer needs to get
board approval.
e. Ultra Vires Doctrine
i. Beyond the corporations power and thus enforceable since lack of mutuality.
ii. Asbury Railway v. Riche (126) held that any K of a co found to be ultra vires
is void even if there is shareholder approval of the K after the fact, so the co
can’t enforce it against the party and the other party cannot enforce it against
the co.
iii. Theory behind this doctrine is that shareholders should be able to rely on the
charter and we want to prohibit unsanctioned corporate activity. Protect Public
iv. In the US we have the competing policy of certainty in commercial dealings
b/c we want to promote economic growth and development, thus in state
where the co lacked the explicit power to do xyz the courts often found
implied power.
1. Ex. Charter is silent over whether the co can become a limited partner
in a partnership.
a. In the UK this would be ultra vires
b. In the US under common law this would be ultra vires as well

1
 c. However under DGCL 122(11) (547) and NYBCL 202(a)(15)
(1123) Specifically authorizes a co to participate in
partnerships of any kind (Statute gives you implicit (implied)
power that you will have even if it isn’t stated in your corporate
charter)
v. Ultra Vires v. illegal or unauthorized acts- Just because something is in the
corporate charter doesn’t mean that it’s legal and just because something is
ultra vires doesn’t mean it’s illegal. Also, something can not be ultra vires,
but can be unauthorized because not previously approved by the directors, but
a co will be bound to 3rd parties based on officer’s actions, b/c didn’t know
that directors didn’t approve
vi. Goodman v. Ladd Estate Co. (129)- Wheatley (Director of Westover Co)
wants to get a loan from Citizens bank and needs an endorsement from
another entity so asks Ladd Estate Co. Ladd wont do it without guarantee
from Westover. So if Wheatley can’t pay back loan Ladd Estate must pay and
if Ladd doesn’t pay then Westover will have to pay. Wheatley defaults on the
note, so Ladd estate is required to pay the bank loan, and Ladd looks to
Westover for reimbursement, but Westover wont pay, so Ladd sues Westover.
P’s in this case are the Goodmans (purchased all common shares of Westover)
seeking to enjoin Ladd from enforcing the guarantee from Westover.
1. P’s knew about the guarantee when they purchased the shares (thought
it was unenforceable), but think they deserve an enjoinment b/c it was
ultra vires b/c co cant guarantee a debt. Ultra Vires b/c the guarantee
wasn’t made to benefit Westover, but for Wheatley personal purposes
2. Everyone concedes that the guarantee was in fact ultra vires, so would
think that the court will enjoin the enforcement of the guarantee, but
court will only enjoin an ultra vires act if doing so is equitable.
3. Court instead decides that despite the fact that it was ultra vires, b/c the
stock owner approved the guarantee at the time, and could have
approved a charter amendment that would have allowed this type of
guarantee to exist (which would have made this act not ultra vires) and
the Goodman’s knew all this, they step into his shoes and must
guarantee.
vii. US courts have an aversion to throwing out corporate actions based on ultra
vires doctrine.
viii. If the primary shareholder in a corp, participates in an ultra vires
agreement, he or his successors cannot later attach the agreement as ultra
vires.
ix. DGCL § 124 says that ultra vires can be asserted in 3 situations
1. Proceedings brought by a shareholder to enjoin the doing of any act or
acts or the transfer of real or personal property by or to the
corporation.
2. In a proceeding brought by a co or the representative against an
incumbent or former officer or director due to damage caused by an
authorized act (not really ultra vires because something within the
power of the co, but this person didn’t have the authority to do so)
3. Proceedings brought by the Attorney General to dissolve a corporation
or to enjoin it from doing any act deemed to be ultra vires.
f. Objective and Conduct of the Corporation
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i. Financial credo of corporations is generally the maximization of shareholder
wealth. Problem with this is that sometimes it diminishes the benefits to
others (ex. Employees, creditors or local community)
ii. Role that co should have in society Shareholders probably want the co to be
also thinking about employees, local communities and charities.
iii. Dodge v. Ford Motor Co. (139)- At formation, Ford Motor was privately
held w/ Henry Ford owning 58% and 10% owned by Dodge bros. Ford was so
profitable that it had a very rich history of paying dividends and also declared
special dividends (happens when co is so profitable and has no other use for
$). Ford decided that he will no longer give out special dividends and instead
redistribute that $ to the employees. Also plows back $ into the community by
employing more men and reduces price of cars to make it more affordable.
$52.5 million lying around the co at the time of this decision.
1. Purpose of the co. in this decision tends to be a little old school
2. P’s contend that Ford’s plan is focused on other people and not the
shareholders of the co – running Ford as a charitable institution, not a
business institution. Dodge bro’s want to compel the payment of a
dividend, despite the general rule that shareholders are not entitled to a
dividend.
3. Ford defends his actions by saying that the charity is incidental to the
primary business purpose of the co, which is designed to provide a
profit for shareholders.
4. Trial court forces the co to pay a dividend and Michigan Sct doesn’t
buy Henry Fords argument. Sct agrees that co’s can engage in
incidental charity, but CANNOT make charity your primary purpose
and business purpose incidental.
5. Although this case suggests that a court can force a co to pay a
dividend under the most extreme circumstance, most courts won’t do
so! Very very difficult thing to get court to do.
iv. A.P, Smith Mfg. Co. v. Barlow (141)- Co made valves, fire hydrants and
other special equipment and throughout the years made charitable
contributions to the community and to the local colleges. One year it wanted
to make a large gift of $1,500 to Princeton University and some of the
stockholders challenged this gift. Co in turn seeks a declaratory judgment
about the validity of a contribution like this.
1. Lower court finds that this contribution is valid and the D’s appeal the
decision to the NJ Supreme crt
a. Testimony of variety of co executive shows that the greater co
purpose is promoting wealth in the industry through higher
education. Giving to education is essential for the communities
and the co itself b/c ensures a supply of educated employees in
future.
2. D’s aren’t debating the benefits of co charitable giving, but the charter
doesn’t expressly authorize this type of contribution, therefore ultra
vires act. Also, the statute that authorizes these types of gifts was
created after the co’s creation so shouldn’t apply retroactively to the
co’s formed before.
3. Court held that the common law rule on co giving if private profit is
the goal of the co is that charitable giving must be incidental, so
1
 CANNOT give a corp gift that doesn’t benefit your co in any form.
Also, gift is subject to reasonable limits.
4. Court based its decision on the NJ statue- Can give reasonable
amounts to charity so long as
a. the recipient doesn’t own more than 10% of the stock of the
donor corporation and
b. any contribution cannot exceed 1 percent of the capital and
surplus of the co unless the excess is authorized by
stockholders. (don’t want gifts so large that they endanger
capital cushion of co)
5. The common law rule that a co cannot give charity unless this would
benefit the co has been watered down so now the benefit can be
indirect, but court believes that the case would come out same way
under common law and under the statute. Court states that the statutory
provisions simply constitute helpful and confirmatory declarations of
the power of the co to make charitable contributions under common
law. Since co charters are a gift from the legislatures, court has no
problem finding that the statutes applied retroactively to the co’s
formed earlier.
6. Court believes that the biggest danger of charitable contributions by
co’s is that the CEO often gives $ to his/her pet charity in order to
benefit themselves,
v. DE and NY give statutory authority for co’s to make charitable gifts
1. DGCL § 122(9) (547)- Power to “make donations for the public
welfare or for charitable, scientific or educational purposes, and in
time of war or other national emergency in aid thereof”
a. Doesn’t mention anything about how contribution must be in
furtherance of its corporate welfare, so must look at DE case
law to see how DE courts decided this issue.
2. NYBCL § 202(a)(12) (1123)- Power to in furtherance of its corporate
purposes: “make donations, irrespective of corporate benefit, for the
public welfare or for community fund, hospital, charitable,
educational, scientific, civic or similar purposes, and in time of war or
other national emergency in aid thereof.
a. Most charters are silent as to specific purpose
vi. Alternative to corporate charitable giving is to give $ to shareholders and let
them choose their own charities, BUT some people wouldn’t give and
wouldn’t get the corp benefit of giving the gift. So corporate giving might be
better for shareholders b/c of the repercussions of the gift. Gift will be large
than individual gift, so more impact on the community which may help profit
the co (can be considered an investment. Also, tax benefits for co to give
charity.
vii. What if a corporation that you own shares in donates to a charity in which you
do not believe in - such as for abortion right?
1. sell your stock - not worth the money to fight it
2. proxy fight - try to replace existing board members with new nominees
who shares the same beliefs as you
viii. Extent to which NY or DE law allow directors to consider constituencies
other than shareholders when making business decisions:
1
 1. NYBCL § 717 (b) (1169)- When board makes decisions it can
consider many different things: Shareholders, employees, retired
employees, creditors, consumers, community,
a. Most of these statutes are a relatively recent phenomenon
adopted by legislatures to deal with hostile takeovers where
many people were fired etc. So passed this statute in an attempt
to protect local co’s.
b. Typically, the hostile co will pay a premium price for the stock
so when a board adopts a takeover defense it does so to
preserve the enterprise, but at the same time prevents the
shareholders from getting a premium price.
2. DE does NOT have a statute on point, but generally puts the priority of
constituents in this order: (1) Management (2) Shareholders.
According to case law relating to hostile takeovers, Board can consider
other constituents provided that they have a reasonable relationship
with shareholders. (employees, retired employees, creditors,
consumers, community)
a. In some states the constituency statute only applies to decisions
by boards relating to mergers and acquisition transactions. In
other states their statutes don’t have this limitation. Thus,
technically a board could consider a company’s creditors when
it decides whether or not to manufacture a new product. (Now,
it wouldn’t make sense to do this, but the statute would allow
for this). In practice, constituency statutes usually are
implicated only in the takeover context.
g. Pre-Incorporation Transactions by Promoters - #8
i. Promoters are individuals who (without incorporating) come up with a
business idea, do a feasibility report, and come up with the necessary funding
to create the business and get it up and running. Once the co is formed they
hope to receive cash or stock for putting the co together (expect compensation
for services).
ii. Issue whether the services of a promoter constitute consideration for stock
(must give consideration to receive stock) b/c services done before the co is
even born. Statutory law says that it constitutes consideration.
1. DGCL § 152 (562) – Services rendered to the co constitute valid
consideration for stock- case law holds that promoter services before
the co is born constitutes valid consideration
2. NYBCL § 504(a) (1129)- Services in connection with the formation of
the co constitute consideration for stock
iii. Liability of the promoter- Goodman v. DDS Associates (115)- Goodman
negotiated to renovate apts for DDS and notified them that he would be
forming a co to limit his personal liability. The renovation work didn’t pan
out like it was supposed to and Goodman defaulted on the K prior to the time
he formed the co. Thus, DDS seeks to hold Goodman personally liable on the
K. Goodman defends himself by saying that he personally wasn’t a party to
the K b/c Goodman signed the check as President of Building Design Inc. On
the periodic payment checks he received which said BD co and Goodman,
Goodman crossed out his name and made sure it said Building Design-

1
 Goodman “president” and instructed DDS to make out the future checks to
the co,
1. General rule for promoter liability is that where a co is contemplated,
but has not yet been organized, the promoter is personally liable on the
K, even though the K will benefit the co once it is formed.
EXCEPTION- if the contracting party knew that the co was not yet in
existence at the time of contracting, but nevertheless agreed to look
only at the co once formed the promoter is off the hook.
2. Goodman has the burden of showing that DDS knew that it was
dealing with a not yet formed co and agreed to look only at the co.
3. Goodman is held liable, b/c court thinks that DDS intended to make
him a party (based on their checks) and only at his request did they
agree to take his name off.
iv. 3 related concepts as to whether the co itself once formed can be bound by
pre-incorporation K’s made by the promoter
1. Ratification- NO relevance here, involves agency law. One of the
types of authority that can be given to officers or directors. Board will
adopt as their own a K made by agent, after the fact. Since no co
existed, promoter not an agent for co, so this principle cant be used
w/pre-incorporation K.
a. R(S)A -326
2. Adoption- Board will adopt a K once its formed, but a co does NOT
have to adopt a pre-incorporation K. However, to adopt the K the
board does not need to take formal actions, it can merely adopt by their
own actions- accepting the benefits of the K. BUT once adopted
formally or informally, the promoter is NOT off the hook. BOTH the
promoter and the co are jointly and severally liable for the K. (Illinois
Controls, Inc. v. Langham (116)) To get the promoter off the hook
need a formal Novation
3. Novation- 3rd party lets the promoter off the hook. Separate agreement
that mirrors the original K is made but this one only has the co’s name
on it and not the promoters. Most 3rd parties won’t want the promoter
off the hook, so might make him pay for this.
v. To avoid all these issues it’s better to form the corp first and then enter into
K’s
h. Consequences of Defective Incorporation
i. People who never incorporate or who do so defectively can still nevertheless
get the benefit of co (limited liability)
ii. De Jure Corp (this is what u want)
1. is a corp. organized in compliance with the requirements of the state of
incorporation
2. cannot be attacked by either private parties or the state
3. need substantial compliance
iii. De Facto Corp – provides limited liability to promoter
1. insufficient compliance to constitute a de jure corp. vis a visa a
challenge by the state, but the steps taken toward formation of a corp.
are sufficient to treat the enterprise as a corp with respect to third
parties. In such a case, the corp state can be invalidated by the state

1
 through quo warranto proceedings, but not by creditors or other
persons who have had dealings with the enterprise.
3 requirements:
i. Execute certificate of incorporation
ii. Bonafide effort to file certificate
iii. Actual exercise corporate power
iv. Cantor v. Sunshine Greenery, Inc. (117)- Cantor drew up a lease for
Sunshine as tenant. Brunetti (President of Sunshine) signed the lease on
behalf of sunshine. Despite the fact that Sunshine was a newly formed co,
Cantor did not request a personal guaranty from Brunetti, nor did he make
inquiry as to his financial status background. Cantor relied solely on the
ability of the Co to pay the rent. At the lease signing (Dec 16) Cantor insisted
on receiving a check covering the 1st months rent and a security deposit, but
Brunetti claimed he had none with him. So Cantor furnished a blank check
which was filled out for requisite amount, with the name of Brunetti’s bank,
and signed by Brunetti as President of Sunshine. The lease was repudiated by
legal counsel for Sunshine, and Cantor responded that he would hold Brunetti
responsible for all losses. The check was not honored b/c Brunetti stopped
payment and b/c Sunshine didn’t have an account in the bank.
1. The certificate of incorporation for Sunshine was signed by Brunetti
and Sharyn as incorporators on Dec 3rd and mailed with the
appropriate fee to the Secretary of State, but deemed to be filed on Dec
18th. The lease was entered into between Dec 3rd and 18. So the lease
was signed before there was a legally formed (“de jure”) corporation.
2. Being a de facto corporation will provide limited liability (presupposes
a corp statute)
3. 3 requirements for being a de facto corporation
a. Execution of a certificate of corporation (signing)
b. Bonafide attempt to file the certificate of incorporation with the
secretary of states office
i. NOT enough to draw up the certificate of incorporation,
MUST sign and send it in
ii. It is a bonafide attempt if it is sent in with the fee, but
gets lost in the system b/c no follow up requirement for
a de facto corporation.
iii. Not an attempt if don’t send in fee.
c. Exercise of corporate power
4. If 3 requirements are met, the corp will be treated as a corp. with
respect to third parties and there would be limited liability to the
promoter.
5. The lower court didn’t find a de facto corp and held Brunetti liable b/c
didn’t think they exercised corp power b/c no board meeting, issuing
of stock etc.
6. Higher court found a de facto corp, so Brunetti not liable under the
lease. Held that there was no need for formal meetings, board
resolutions or issuance of stock. Acting in the name of the co is
enough to form a de facto co.

1
 7. This result is different than a pre-incorporation K followed by
adoption of the K, where the promoter is still on the hook, b/c actual
actions were taken to form this co.
v. Doctrine of Estoppel (123)
1. While concept of de facto co depends entirely on what the incorporator
does, estoppel is based on 3rd parties actions- 3rd party never expected
to look beyond the co for payment, so why should it be allowed to do
so now.
2. Does not shield you from 3rd parties who have not dealt with you as a
business
3. Under estoppel doctrine, the 3rd party has to have dealt with a business
as though it were a co….does not matter if attempt to file certificate.
4. De facto defense is a better defense than estoppel. One thing that the
estoppel defense won’t protect you against, where de facto might, is
when dealing with tort victims. If someone slips in front of your store,
and it turns out you didn’t really incorporate, estoppel won’t work
because never dealt with you as a corp, but de facto corp defense will
work.
a. In Cantor, the P did in fact deal with Sunshine as it was a co,
but Brunetti attempted to use co powers.
8. Courts are split on holding shareholders personally liable for debts incurred in the corp’s
name when the corp is neither de jure nor de facto nor a corp by estoppel.
a. Piercing the Corporate Veil
i. A shareholder has no liability for corporate obligation and shareholders risk is
limited to her investment (amount paid for her shares) See DGCL § 102(b)(6)
(538).
ii. Managers are not liable for the corporation based on agency principles
1. in the case of a K that is made by an agent within his authority, the
agent is not liable as long as she purported to act in that capacity and
the identity of her principle was disclosed
2. In the case of a tort by a corporate employee, the manager would
normally not be vicariously liable.
iii. HOWEVER, there are times when people for a de jure corporation will be
denied limited liability. Piercing of the corporate veil will occur if there is
abuse of the corporate form. – lose your limited liability as a stockholder(can
lose your personal assets)
iv. Corporate veil refers to shielding from personal liability a corporation’s
officers, directors, or shareholders for unlawful conduct engaged in by the
corporation.
v. Kaycee Land and Livestock v. Flahive
1. when determing whether LLC pierced the corporate veil, look at
commingling of funds, treatment of corporate assets as its own, the
failure to issue stock, the holding out by individual as being
responsible for corp. debts, and the use of the corp. as a shell to evade
creditors.
2. Wyoming said it is possible to pierce LLC veil. Same factors.
vi. Fletcher v. Atex, Inc, (220)- Atex (D) was a wholly owned subsidiary of
Kodak (D) until 1992, when Atex sold substantially all of its assets to another
party. Atex then changed its name to 805 Middlesex Corp. Kodak continued
1
as the sole shareholder of Middlesex. Fletcher (P) and other claimants
brought suit against Atex and Kodak to recover for stress injuries they
incurred from utilizing keyboards produced by Atex.
1. Fletcher argued that Kodak exercised undue control over Atex by
using a cash management system, exerting control over Atex’s major
expenditures, and by dominating Atex’s board of directors.
2. Under applicable state law (DE), the court may pierce the corporate
veil of a company and hold shareholders personally liable only in
cases involving fraud, or where the company is a mere instrumentality
or alter ego of its parent company.
3. NY state law looks to the law of the state of incorporation to determine
whether a court will disregard the corporate form and hold
shareholders individually liable for the actions of the corporation. B/c
Atex is a DE co, the law of DE applies.
4. Under DE law, an alter ego is demonstrated by showing that
a. The parent and subsidiary acted as a single economic entity and
b. It would be unjust or inequitable to treat them as distinct from
one another.
i. A showing of fraud or wrongdoing is not necessary
under an alter ego theory, but the plaintiff must
demonstrate an overall statement of injustice or
unfairness.
5. Factors that a court may consider in its determination of alter ego:
a. Adequacy of capitalization
i. Did Kodak put enough money into Atex when it was
formed
ii. Does subsidiary have enough money to run its business
or pay off creditors
b. The corporate solvency- can it pay its debts in usual course of
bus.
c. Payment of dividends
d. Observation of corporate formalities
i. Does the subsidiary have director meetings, shareholder
meetings (corporate housekeeping) vs. LLC don’t need.
e. Intermingling/ Siphoning of funds
i. Did the subsidiary treat the corporation like its personal
atm.
6. Evidence of alter ego in this case
a. Inclusion of the Kodak log on Apex’s products
b. Apex described as a division of Kodak
c. Interlocking directorate (shared directors)
d. Apex had to get approval for major decisions from Kodak
e. Centralized cash management system- single economic theory-
Kodak can take money from Atex’s pockets.
7. Argument that Atex is a mere façade for Kodak is that Atex needed
approval from Kodak for its decisions, but its common for parent
companies to control decisions of their subsidiaries. Hard to prove as
an evidentiary matter. Atex was referred to as a division

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 (instrumentality) in a brochure. Court holds that is not sufficient to
pierce the corp veil, b/c unreliable source
8. Court held that an implementation of a cash management system,
standing alone, does not rise to the level of intermingling contemplated
by the statute, neither does the overlap of the board of directors. The
fact that a parent and subsidiary have common officers and directors
does not necessarily demonstrate that a parent dominates the activities
of a subsidiary.
vii. Walkovsky v. Carlton (226)- Walkovsky (P) was run down by a taxicab
owned by Seon Cab Corp (D). In his complaint, P alleged that Seon was one
of the 10 cab co’s of which Carlton was a shareholder, and that each
corporation had only 2 cabs registered to its name. He implied that each cab
corp carried only the minimum automobile insurance required by law,
$10,000. It was further alleged that these corps were operated as a single
entity with regards to financing, supplies, repairs, employees, and garaging.
Each corp and its shareholders were named as defendants because the
multiple corporate structure, according to P, constituted an unlawful attempt
to defraud members of the general public. He wanted to get at the personal
assets of Carlton, including his stock in other cab co’s.
1. P argues that Carlton operated the 10 corporations as a single
economic entity. He does this so to compartmentalize the limited
liability each co took out the minimum insurance required by law.
2. Whenever anyone uses control of a corporation to further his own
rather than the corporation’s business, he will be personally liable for
the corporation’s acts. Under respondeat superior the liability
extends to negligent acts as well as commercial dealings. However,
where a corporation is a fragment of a larger corporate combine which
actually conducts the business, a court will not pierce the corporate
veil to hold individual shareholders liable.
3. In NY, courts will disregard the corporate form (pierce the corporate
veil) to prevent fraud or achieve equity. It MUST be shown that the
stockholder was conducting the corporations business in his individual
capacity (alter ego notion).Must plead that the co was inequitable,
dummy corporation. When look to see if a corp is treated as a dummy
we look at a few things:
a. Whether the shareholder treats the co as her personal agent and
not a separate entity
b. Whether there is any co-mingling of personal and corp assets
4. Majority held that can’t pierce the corp veil just b/c the co didn’t carry
enough insurance or have enough assets to pay the P’s claim.
5. Dissent felt that the attempt to do corporate business without providing
any sufficient basis of financial responsibility to creditors, here
through under capitalization and minimum insurance liabilities, is an
abuse of the corporate entity.
viii. To avoid getting veil pierced NEED to maintain corporate formalities
1. Do your corporate housekeeping
a. Maintain minutes of meetings
b. Be prepared with board resolutions and document
c. Treat corp. as a separate and distinct equity
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 2. Co mingling problems
a. Have to keep personal funds away from co funds EVEN if you
are 100% shareholder.
b. Always let the co write the check
c. Keep a separate bank account
d. DON’T write personal checks
3. When taking money out of the co must be appropriately documented
as a dividend, salary or bonus and keep records of everything.
4. Have to give the co the minimal amount of capital customary to run
that type of business, so if the business fails then you personally feel
it- “When nothing is invested in the co, the co provides no protection
to its owners!”
a. Adhering to the relatively simple formalities, creating and
b. for maintaining corp liability (249).
ix. Repercussions of veil piercing are a little different when dealing with parent
co’s and individual shareholders b/c courts are more sympathetic to individual
shareholder, so slightly more reluctant.
x. Berle, The Theory of Enterprise Entity (231)- Large scale businesses today
(conglomerate- conducts multiple businesses typically through multiple
subsidiaries. These subsidiaries are all owned, directly or indirectly, by an
ultimate parent company) are usually conducted not by a single co, but a
constellation of different co’s.
1. Formed less for business reasons then they are for tax and liability
reasons
2. Could simply operate the business as mere divisions of the corporation
itself rather than as subsidiaries
3. Argues therefore that if a particular subsidiary incurs a liability the
assets of the entire conglomerate should be liable if the subsidiary in
question cannot pay.
xi. According to Professor Eisenberg, a corp that puts some of its business into
co form is likely to treat the same exact way as they treat unincorporated
businesses, the only difference is that a lawyer will spend time each year
writing fictitious minutes, notes, etc of fictitious boards (meant to defraud
creditors)
xii. Minton v. Cavaney (238) – In 1954, P’s daughter drowned in a public
swimming pool owned by Seminole Corporation. P’s sued Seminole and got a
judgment but weren’t able to collect from Seminole. So P’s went after the
assets of one of the directors Cavaney (who died, so now wife is dealing
w/case). Seminole had no assets, only thing they had was a swimming pool
lease. Never issued shares of stock and had NO capital (owners never put $
into the co).
1. Essentially, all we have here is the paper shield (certificate of
incorporation)
2. Cavaney gets sued b/c he is a director, secretary and treasurer.
Cavaney claims that he is merely a lawyer who was acting as those
things merely as an accommodation to his clients until they figured out
who will hold these positions. He also allowed Seminole to use his
office to hold records and receive mail (put address of his office when
filing as co (typical for lawyers), so mail came to him) P sues Caveney
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 b/c he has the deepest pockets and is the only person that can be
identified. P’s argue that Caveney is the alter-ego of Seminole, so
should be personally liable.
3. According to the CA Supreme Court there are several facts that
support veil piercing:
a. Inadequate Capitalization (saw this in Atex case-DE)
b. Adding or withdrawing capital from the co at will (Haas says
that’s ok as long as documented)
c. Treating the co’s assets as the owners
d. Using personal checks
e. Officer and director of the co have to be actively participating
in the conduct of the co (important thing to remember when
you are in the gray area)
i. Gray area- from the time you incorporate until the time
you issue stock- who is responsible?
f. No capitalization here “ Capital is inadequate when it is
trifling compared to the business to be done and the loss”
i. `In CA state law inadequate capitalization alone is not
enough to pierce the veil (Arnold v. Browne (240)),
but 9th circuit Federal Court has held that under
capitalization is enough under its interpretation of CA
law
ii. In NY, under capitalization is NOT enough, but an
important fact.
g. Piercing the co veil gets to the assets of shareholders, but here
we have NO shareholders b/c in gray area, so Court looks for a
nexus between individuals and the corp. Who was actively
involved in the co during this gray area? Notion of an equitable
owner, not a true stockowner b/c no stock issued, but someone
who has a strong nexus to the co. Cavaney is a deep pocket,
held director position etc (mere accommodation to clients).
h. Court holds that it doesn’t matter what Cavaney’s intent was
b/c CANNOT separate real directors and real officers from
accommodation directors and accommodation officers. Also,
accommodation has lasted for 8 months, long time to merely
help clients.
i. Lawyer should try to say no to clients and if not
indemnification.
i. P’s don’t end up winning the case b/c seeking to enforce a
judgment against Cavaney, but he wasn’t a party in the original
lawsuit, and so he couldn’t adequately defend himself.
xiii. Limited liability is not the same thing as risk free investing, b/c your
investment is exposed, but if the co goes under all you will lose is that initial
investment.
xiv.Shareholders do not have a legal responsibility to invest more money in the co
after it runs smoothly for a few years and then starts to experience problems.
1. No need to put money into a failing business
2. The capitalization requirement incurs at the inception of the co, BUT
not later
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 3. This is a business decision, so NO duty.
Equitable Subordination
1. deep rock doctrine
2. the claims of creditors/stockholders should be treated as equity or stock investments
3. Benjamin v. Diamond Case
a. 3 conditions for ES
1. claimant (owner/shareholder/creditor) must engage in some type of inequitable
conduct. He has the burden of proof
2. misconduct in question must result in injury to creditors of corp. or result in
unfair benefit to the claimant
3. ES must not be inconsistent with the provisions of the Bankruptcy Code.
4. Costello v. Fazio
a. 3 partners converted partnership to corp.
b. court held that the IOUs were dressed up as a creditor claim and the court looks at two
test of ES
1. Deep Rock Doctrine- whether within bonds of reason of fairness, was there a
plan where stockholder get x and creditor get Z
2. Pepper v. Linten Test- when claim is against fiduciary (in this case yes,
stockholders), could a third party ask for the same deal? Here NO
****fraud is not essential.
c. partners F and A were guilty of ES and trying to cut in line in the food chain…

Corporate Structure
1. Corporate Governance- Directors are agents of the stockholders and are charged with
representing their interests. Directors, in turn, often delegate the day to day managerial
responsibilities to the corporation’s senior officers. This is especially true when the corporation
in question is publicly traded
2. part of the power of stockholders lies in their ability to elect directors. Stockholders typically
elect directors at the annual meeting of stockholders. Each stockholder’s voting power is directly
tied to the amount of her capital contribution, as votes are allocated on a per share basis.
3. Distribution of Corporate Powers (Between shareholders, directors and officers)
a. Power is statutorily based:
i. DGCL § 141(a) (550)- The business and affairs of every organization shall be
managed by or under supervision by the board of directors (unless otherwise
directed by this section)
ii. NYBCL § 701 (1160)- Subject to any provision in the certificate of
incorporation, the business of a corporation shall be managed under the
direction of its board of directors, each of whom shall be at least eighteen
years old. The certificate of incorporation or the by-laws may prescribe other
qualifications for directors. (Also must be at least 18 years old to be a sole
incorporator).
b. ALI Principles of Corporate Governance
i. § 3.01 (1308)- The management of a business of a publicly held corporation
should be conducted by or under the supervision of the senior executives.
1. Alters the formulation of DE and NY b/c it is trying to reflect the
reality of the situation. Members of the board are not there every day
to run the business, so have more of a supervisory role (Board could
manage if it wanted to)
ii. § 3.02 (1308)- Board has the power to manage, but its not expected to.
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 1. In instances where there are scandals the board will often step in and
manage.
c. Case law is more in tune with the ALI principles of corporate governance and not the
statutes. So, in some ways undermine the statutory provisions at least when it comes
to publicly traded co’s.
d. Executives who do in fact manage the business are the CEO, CFO, President, Vice-
President etc.
e. Powers that are left to the shareholders (What they can typically vote on)
i. Election and removal of directors, BUT they DON’T vote on vacated seat.
ii. Amending the by laws (power can be shared with directors if charter provides
so)
iii. Fundamental corporate transactions
1. Mergers
2. Consolidation (merger involving 3+ companies)
iv. Sale of all or substantially all of co. assets
1. DE looks at the % of income that the assets produce and the % of
assets being sold
2. Cases with certain %
v. Corporate dissolution (since they are owners they should vote on termination)
vi. Amendments to the certificate of incorporation
1. Once shares have been issued need to get shareholder approval to
increase the number of shares that can be listed
2. Once additional shares have been authorized it is up to the board to
decide to list or not.
f. Removal of existing directors from the board- Comes into play whenever doing M &
A work, particularly hostile takeovers. Hostile co will try to oust the board of
directors b/c don’t want to deal. How to get rid of directors in the middle of things:
i. In NY, shareholders can remove directors for cause (but what constitutes
cause? Conviction of a felony is usually a cause). See NYBCL § 706 (1162)-
Removal of Directors
1. Directors can also be removed for NO cause, if a provision that allows
shareholders to do so exists in the certificate of incorporation or
bylaws. NYBCL § 706(b).
a. Makes co. harder takeover target.
ii. In DE, any director or the entire board of directors may be removed with or
with out cause, by the holders of a majority of the shares then entitled to vote
at an election of directors UNLESS charter provides otherwise. See DGCL §
141(k) (553)-
1. If co has cumulative voting (shareholders can put all votes on 1
person) if less than the entire board is to be removed, no director may
be removed w/out cause, if the votes cast against removal would be
sufficient to elect him to the board. DGCL § 141(k)(ii)
g. Charlestown Boot and Shoe Co v. Dunsmore (1880)
i. Shareholders allege Dunsmore, director’s negligence, lost co several
thousands of dollars in bad debt by not insuring the property but court found
the director not to be negligent.
ii. Shareholder have no power over the management of the corp. and cannot
order directors to take particular actions in managing the business of the corp.,
They may remove the directors though.
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h. Schnell v. Chris-Craft Industries, Inc. (169)- P sought to enjoin management from
moving up the date of the shareholder meeting. Management wanted to move up the
meeting date so shareholders wouldn’t have enough time to wage a hostile proxy fight
so they could elect their own choices for board of directors. Earlier meeting would
give shareholders less time to get their act together and make it more likely that
management won’t lose their jobs. Management amended the by laws to move the
meeting up by 1 month
i. Amending the bylaws was proper under DGCL § 109 (so long as power is in
charter), so what directors did was statutorily legal!
ii. However, this action is forbidden by equity! (Just because something is legal,
DOESN’T make it equitable).
iii. This wasn’t a legally permissible reason to bump up the meeting date b/c
directors owe a fiduciary duty to the shareholders and have to look out
for the needs of the shareholders and put their needs in front of their own.
i. Blasius Industries, Inc. v. Atlas Corp. (171) (created the Blasius standard of
conduct for directors)- Blasius was Atlas’ biggest shareholder and was very unhappy
with the current management. Blasius starts to accumulate shares of Atlas and once
it acquired more than 5% of Atlas shares it was required under Securities Law to file
a schedule 13-D with the SEC and state its intentions. Stated that it wants to
encourage Atlas management to have a restructuring or other type of strategic
transaction to enhance shareholder value.
i. Purpose of the disclosure schedule that must be filed according to S & E Act
of 1934 is to alert the mkt place of what your intentions are (trying to take
over co or investment purposes?) Traditionally in a takeover the person
buying the co pays a premium price for the shares b/c control of co is valuable
(control premium). By alerting the mkt place it tells the shareholders to keep
their shares b/c maybe they will get a premium price for shares.
1. 10 day grace period to file the 13D gives 10 more days to keep buying
shares w/out the control premium
ii. Restructuring can enhance value to the shareholder by selling of businesses
that are dragging down performance. Involves a realignment of the right side
of the co’s balance sheet (liabilities and owners equity) that allow rejuggling
of debt to equity mix in a way that enhances shareholder value.
iii. Blasius proposes a leveraged recapitalization (restructuring- realigning
different assets on the balance sheet)- Suggesting that Atlas borrow
significantly against its assets. Huge amount of debt on the right side of the
balance sheet would increase cash and Blasius wants Atlas to pay out the
increased cash in the form of special dividends. BUT a leveraged recap
makes the financial viability of the co more precarious b/c it is a huge amount
of additional debt that must be paid back. Not the best thing for a co to be so
highly leveraged b/c the best case scenario has to happen at all times for the
co to survive.
iv. Blasius Proposal
1. Special cash dividend in the amount of 35 million plus proceeds from
the exercise of stock options, plus proceeds from sale of certain
businesses.
2. Sell off all the assets that don’t relate to mining operations because
they are under performing.

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 3. Special non-cash dividend (shareholder IOU)- turns the shareholders
into creditors as well (highly specialized type of IOU)
a. This may be beneficial to shareholders b/c some of their
investment is taken out and if the co doesn’t do well it doesn’t
matter to them and if it does do well it is better for them.
v. Atlas Management doesn’t react well to the proposal and weren’t happy that
the shareholders were telling them what to do b/c directors manage the
business. So Blasius decides to try to get rid of the directors who don’t like the
idea. The problem is that under the co charter doesn’t allow for getting rid of
directors mid stream, so instead try to take action through written consent of
shareholders. (2 ways to take shareholder action (1) shareholder meeting, or
(2) in between meetings in action by written consent)
1. DGCL § 228 (592)- Action can be taken without meeting by the
written consent of that action by the shareholders by the same # of
votes that would be required to approve this action at a meeting.
Quorum (critical mass of shares) requirement don’t come into play).
Have 60 days to get enough other votes in writing for that to be
effective.
2. See NYBCL § 615 (1146)
vi. Blasius’ written consent demands the adoption of a precatory (prayer like,
wish or desire, not a demand) recommendation that the board engage in a
leveraged recap. The shareholders don’t have the authority to demand that the
board engage in a leveraged recap b/c statutes give the directors the authority
to manage the business. So if the board won’t act the way you want them to
your only option is to get rid of the board of directors.
1. Also demanding an increase of # of board members from 7 to 15 (max
# allowed by charter).
2. Also request to appoint 8 new specific people to those additional seats.
vii. To defeat Blasius’ consent solicitation the board amends the bylaws to
increase the size of the board from 7 to 9 and to appoint two people who are
favorable to them making it impossible for Blasius to control the board
through the consent solicitation.
viii. Blasius alleges that the Atlas board actions constituted a breach of their
fiduciary duty and care and the directors actions were designed to entrench the
directors in their positions. (3 Rules)
1. The directors defend themselves by saying their actions were taken in
good faith. Also the 1. business judgment rule “mere rationality”
(legal presumption in favor of directions that so long as they act
without a conflict of interest they are presumed to have acted in good
faith, due care, and in the shareholders best interest) so presumed to
have satisfied their fiduciary duties and up to shareholder to prove
otherwise.
a. Mere rationality rule- shareholder can challenge BJR by
showing that there was no rational bus. Purpose for the board
to do what they did.
2. Directors believed that the Blasius proposal if fulfilled would be a
huge detriment to the co so they were taking action against a hostile
threat (Unocal defense).

1
 a. 2. Unocal standard (defensive measure standard)- the
board can take defensive action even against shareholders
if there is a real threat or perceived threat so long as the
defense is reasonable or proportionate to the threat posed.
b. While the board is normally afforded the presumptive BJR, it is
not the case when the decision involves the implementation of
takeover defenses. The board must first satisfy 2 burdens
before apply BJR
i. Demonstrate reasonable grounds for believing that a
danger to corporate policy and
ii. Board must demonstrate that the defensive response
was responsible in relation (proportionality test)
ix. Court throws out the Unocal standard, b/c not a defensive strategy case, and
instead says that this case is whether the board can act for the principle
purpose of preventing the election of a new majority of directors. This issue
deserves even closer scrutiny than Unocal (requires strict scrutiny). Also, the
business judgment rule doesn’t apply b/c this DOESN’T deal with the power
of the board over the co’s assets and what they want to. This is a case dealing
with the allocation between the directors and the shareholders of corporate
power (power struggle).
x. In order to protect the shareholders right to vote the court adopts the 3.
compelling justification standard/ blasius rule.- Board CANNOT take
unilateral action the primary purpose of which is to interfere or to
impede the shareholders voting franchise unless they have a compelling
reason to do so (no case in which the board has satisfied this burden).
1. When the board takes action w/out a compelling justification there are
breaches of two fiduciary duties of the board – (1) duty of care and (2)
duty of loyalty (put the needs of shareholders above yours).
xi. Blasius standard is a pro shareholder test, but the tricky part is getting the DE
court to use it, very often when Blasius appears to be implicated, the DE
Court will go for the Unocal test, Revlon test, or business judgment rule.
j. MM Companies v. Liquid Audio
i. MM owns 7% of liquid Audio and sought to gain control by purchasing it for
$3 per share. Audio rejected and thus MM intended to propose amendment to
bylaws at annual meeting to expand board to 9 from 5 (staggered or classified
board) Tough for hostile takeovers in single meeting.. P filed a proxy
statement with SEC at its intention to expand board. D first expanded board
from 5 to 7 and thus after P established that primary purpose for board action
was to impede or interfere with the effectiveness of shareholders’ vote, the
burden shifts to the board to prove a compelling justification for the board
action.
ii. D, board failed to meet the threshold burden of the Unocal and Blasius
Standard. Rule of thumb- if have burden prob. Will lose.
1. Board must first demonstrate compelling justification. If one of the
primary purpose is to interfere with shareholder purpose to vote, must
satisfy Blasius standard and then Unocal Standard. If cant come up
with compelling interest don’t go to Unocal, game over (which was
this case)> If motive is not to prevent shareholders from getting seats
then do it to protect co then go to second tier, Unocal standard.
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k. Stroud v. Grace (181) – (case that people point to say that DE Sct has embraced the
Blasius standard given by Chancery Court). Privately held co. (Milliken family). After
a member of the family dies 17% of stock passes to the Stroud family. Since its such a
large amount of stock, they could potentially nominate someone members to the
board and the Milliken family didn’t want this. So wanted to amend the by laws so
that there are certain criteria that must be met to become a director (co’s often do
this). Problem here is that these director qualifications are being inserted at the same
time that the stock was transferred to Stroud family, so looks like it is designed to
prevent Stroud family from nominating their own candidate. Amendments contained a
provision that said that a candidate can be disqualified at any time for not meeting
qualifications.
i. Court is concerned less here than in Blasius mainly b/c this isn’t a unilateral
action taken by the board, yes the board approved the action, but then they
sought shareholder approval to ratify these amendments and 78% of
shareholders approved it.
ii. Shareholder ratification after FULL DISCLOSURE sterilizes even
voidable actions by the board, burden is shifted to Stroud family to prove
that these actions were unfair. (Often will see arguments about the quality of
disclosure).
iii. If the people who are adversely affected by amendment approve it and they
are given full and fair disclosure, then court will keep it approved.
l. Williams v. Geier (SCM 84) (DE Sct 1996)- Dispute occurred during 1985, during
the height of a hostile takeover boom. One of the D’s is a publicly head co Milicron,
controlling shareholder is the Geier family. Milicron had 10 board of directors (3
insiders own 12.6%, 7 outsiders own 1%). Milcron developed a recapitalization plan
that greatly offended the P Tenure voting plan similar to Smuckers co. plan.
i. Under the tender voting plan, Milcron’s certificate of incorporation would be
amended so that all stocks will be deemed to have 10 votes per share rather
than just one. If sold your shares of common stock the transferee will only be
deemed to have 1 vote per share and only after that transferee has held on to
the shares for 3 consecutive years will the shares revert back to 10 votes per
share. If Milicron issued new shares, new buyers of shares would have to wait
3 years to get 10 votes.
ii. Recap plan has a number of different objectives.
1. Takeover defense- if a corporate raider purchased the share he couldn’t
get control b/c would have to acquire many more shares than 50% so
long as other shares retained their 10 vote per share power. Raiders
will have to stick around for 3 years to get super voting power and
raiders are usually short term profit artists who have no interest in
sticking around for 3 years.
2. Creates incentive for people to be long term stock holders and turns
attention to the long term.
3. Increase power of majority power, Geier family is less likely to trade
4. deter hostile party to tender offers
a. tender offers are always made at a price higher at what stock is
trading at and thus incentive to buy co always above what the
stock is trading at.
iii. Tender Offers must comply with Securities Exchange Act and Williams Act-
need full and adequate disclosure.
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iv. Geier family owns over 50% of the co pre-voting plan, so for raider it means
that the family MUST sell, for him to gain control. Raider must negotiate
with family. So hostile successful could NOT be successful already, what is
the purpose of the tenure voting plan?
1. Stealth Objective- Geier family wants to sell some stock, BUT retain
control over the co that has been in their family for years. (also
common when family bus. Goes public)
a. P. 88 Footnote 10- if 30% of shares in the minority shares, then
the Geier family could sell 30% of their shares and still retain
over 50% voting power.
b. So, objective is to protect the Geier family, NOT to protect the
company, encourage people to be long term shareholders, or
discourage hostile takeovers.
v. Basic principles of equity tells us that the majority should be able to ACT like
the majority
vi. To implant a tenure voting plan need to amend the certificate of incorporation
1. DGCL § 242(b)(1) (598)- Board must consider the issues, vote to
approve it and advise shareholders that it is in their best interest.
Shareholders must vote to approve. Once approved by shareholders
the amendment has to be filed with the sec of state.
vii. Milicron follows steps perfectly (Issues- shareholder vote)
1. Information is given to shareholders regarding the upcoming vote via
the mail.
a. Publicly traded co’s must adhere to Federal Proxy Rules.
i. Don’t have to be at the meeting to vote, you can let
someone vote for you, but must get a proxy statement
that complies with federal rules of disclosure.
2. Milicron gives 2 pieces of info to shareholders dealing with recap plan
approval
a. It was going to pass NO matter what b/c the Geier family owns
majority
b. If don’t get 66 2/3% approval, then will be delisted from
NYSE. Since Geier family doesn’t have that much, the other
shareholders need to approve.
viii. Information given to shareholders is coercive b/c people don’t want to be
delisted from NYSE, b/c would lose liquidity, so will vote yes.
ix. Lower court applied the Unocal standard, but Sct doesn’t agree with the
application of this standard b/c that only applies to unilateral board action,
here we have an action that REQUIRES shareholder approval.(b/c
amendment). P’s argue that Blasius requirement of compelling justification
applies, but the court rejects this argument. So P’s focus on full and fair
disclosure, claiming that the board did not give enough info. P’s attack the
vote itself, if successful then essentially there is no vote, and then we can get
back to Unocal or Blasius.
x. DE Sct applies the business judgment rule (bad for P’s b/c 9/10 times that it is
applied and shareholders challenge, they will lose).
xi. Business judgment rule is a rebuttable presumption that directors fulfilled
their fiduciary duties when they took a particular action- directors acted on an

1
 informed basis, in good faith and in the honest belief that the action was taken
in the best interest of the co.
1. To rebut presumption can sow that there was a conflict of interest, so
maybe can show lack of due care.
2. No evidence here to overcome presumption via due care failure- Board
hired 3 legal advisors to explain and compare the plan, and met 3 times
to discuss, voted in favor at 3 meetings.
3. When bjr applies can’t attack decision based on it being bad w/20/20
hindsight-so long as there is a rational business purpose, even if there
were better ways to achieve it, you cannot question
xii. Court held that the board acted in good faith, tipped its hat to outside
directors.
xiii. Controlling shareholders also have fiduciary duties running to minority
shareholders, they CANNOT use their power or dominance over co to garner
a benefit that is NOT available to anyone else. (ex. Cant give dividend just for
themselves). Geier and tenure voting plan didn’t breach their fiduciary duty to
minority shareholders because the minority gets the same benefit they did- 10
votes per share.
xiv.It is irrelevant that less than 50% of minority voted to approve the plan b/c no
requirement under DGCL that you need a majority of the minority to approve
the plan.
xv. Del is promanagement over stockholder and pro stockholder over creditor.
m. Inside v. Outside directors
i. Inside directors are employees or officers of the co
ii. Outside advisors (lawyers or accountants) insiders or outsiders? Question is
whether they are independent or aligned with the co. Can make the argument
that these people are inside directors b/c would like to keep that account or
business so they are not likely to rock the boat and most likely wouldn’t rock
the boat. May want to look at the size of the relationship (major client or
not?), Typically considered inside. Important because DE courts give high
deference to what independent directors do b/c feel they have no reason not to
trust independent directors who thoroughly thought of problem.
iii. Outside directors have no financial nexus to the co other than sitting on the
board.
n. Tender offers- offer that a party makes to all the public shareholders of a certain
company at a stated price (price usually higher than mkt price b/c of control
premium).
i. Need to comply with federal securities law (Williams Act- SE act of 1934)
Purpose behind fed regulation started in the 60’s because people were coming
out with offers called Saturday night specials that gave co’s 3 days to accept
offers, making co’s feel coerced into agreeing. So Fed gov gave framework-
every offer has to be open for 20 days, mandatory disclosure, so people know
whether to tender or not.
ii. Tender offer is a reverse IPO b/c takes shares from public and makes them
private again.
iii. Hostile tender offer- Tender offer made to all shareholders without the
blessing of the target co’s management. Management not consulted at all and
usually fired after the deal is done.
4. Authority in General
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a. Directors and Officers as agents
b. 3 parties in an agency law issue:
i. Agent
1. General agents- authorized to engage in a series of actions over a wide
spectrum that involves a continuity of service (ex. Corporate officer
who works daily for the company in actions over a wide spectrum for
benefit of company).
2. Special Agent- authorized typically to conduct a single transaction or a
series of related transactions that do NOT involve a continuity of
service.
ii. Principal (3 types)
1. Disclosed principle- 3rd party transacting business with agent is
AWARE that there IS a principal and know the identity of that
principal.
2. Partially disclosed principle- 3rd party knows that the agent is acting on
behalf of principal BUT does not know the identity of the principle.
(ex. World Disney and Disney World Story)
3. Undisclosed Principal- 3rd party does NOT know that the agent is
acting on behalf of a principal, 3rd party believes that agent is acting
for him/herself.
iii. 3rd Party
c. 5 types of Authority (agent can only act for a principle within the authority that was
given to her)- Principle should be bound by agents actions if she gave authority
i. Actual authority
1. Focus is on the agent- what would a person in the agent shoes believe
that the principal has told him to do.
2. Can be either express or implied
3. Incidental authority (ex. Tell someone to sell your car, give them
authority to advertise b/c need to advertise to achieve the goal)
4. If an agent has actual authority, the principal is bound even if the third
person did not know that the agent had actual authority.
ii. Apparent Authority
1. Focus is on the 3rd party- entails if someone in the shoes of the 3rd party
would think that the agent had the authority from principal to do
certain act.
2. Example- Power of position (reasonable for 3rd party to assume that
the co treasurer has the power to sign a check on behalf of the co).
3. Often goes hand in hand with actual authority, BUT sometimes don’t
(ex. Maybe CEO says he is the only one who can sign checks-
divergence from what 3rd party might think) VS. a treasurer who signs
and reasonable for 3rd party to think so thus has apparent authority.
4. HYPO: P owns a granary and employs A to manage it. A’s employment
agreement with P states that A’s authority to purchase grain is limited
too transactions that do not exceed 5000; larger purchases require P’s
express approval. This limit is unusual in the granary business. P
directs A to tell T, a seller of grain, that A’s unilaterial authority to
purchase is unlimited because P believes this will induce T to give
priority to orders placed by A. A represents to T that A’s authority to
purchase is unlimited and enters into a k on P’s behalf with T to buy
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 10,000 of grain. P is bound by the contract with T. A has actual
authority to make the representation to T. A has apparent authority to
enter into the contract with T because T reasonably believes A has
authority to bind P to a contract to buy the grain.
iii. Agency by estoppel (a little like promissory estoppel)
1. Focus is on the 3rd party and principal
2. 3rd party deals with someone who isn’t an agent (purported agent) and
the principal has done some conduct to lead the 3rd party to reasonably
believe that this person is the agent and the 3rd party changes his
position relying on the purported agent and the principal hasn’t taken
any action to remedy this belief.
iv. Inherent authority
1. Focus in on the principle- would a person in the principles shoes in
fact think that the agent would take these actions despite the fact that
it’s in violation of instruction and the principle was in fact aware of
this possibility, so reasonable chance this might happen.
2. Principle must bear the risk of the agent harms the 3rd party. (ex.
Negligent or overzealous agent- Dominoes Pizza- less than 30 minutes
promise- foreseeable that drivers would drive crazy, even if not told to
do so). Ex. when bind the principal when agent had no actual or
apparent authority.
v. Ratification
1. After the fact approval of what the agent has done- principle affirms
the agents conduct or engaging in conduct that is justifiable only if he
had such intention (can be implicit or explicit)
2. Remember in promoter context can’t say that the co has ratified what
the promoter has done b/c no co at the time, so have to say that the co
adopted what the promoter has done.
d. Liability
i. Principle to a 3rd party- If an agent engages in action with a 3rd party and had
any of the 5 types of authority, the principle is bound to the third party.
ii. 3rd party to principle (after agent forms some k with him)- If the principle is
bound to the 3rd party under 1 of 5 types of authority then the 3rd party is
bound to principle, BUT 1 EXCEPTION
1. Exception- undisclosed principle- 3rd party doesn’t have to complete
the transaction with the principle if the agent or principle knew that the
3rd party wouldn’t complete the transaction if he knew who the
principle actually was. (makes sense b/c reflects the consensual nature
of K- shouldn’t be forced to deal with people you don’ t want to deal
with).
2. 3rd party is able to get out when its an undisclosed principle, but not a
partially disclosed principle b/c in partially disclosed principle case the
3rd party is put on notice and could have taken the time o find out who
the principle was and if agent refuses to disclose can refuse to go
through with the transaction.
iii. Agent to a 3rd party- IF the agent has one of 5 types of authority then she is not
bound to a 3rd party unless the principle was undisclosed or partially disclosed.
When the agent DOESN”T have 1 of the 5 types of authority then the agent
has just entered into a transaction on their own account.
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 iv. Agent to Principle (agent gets the principle into trouble when dealing with 3rd
party)
1. If the agent has actual authority then she is not liable to the principle at
all.
2. If the agent has apparent authority then she is liable to the principle for
resulting damage (if based on principles actions, why should agent
pay? Maybe b/c the agent should have known)
3. Agents liability stemming from inherent authority is unsettled.
4. If a co ratifies after the fact, the agent should no longer be responsible
to the co because the co has ratified as its own something that the
agent has done.
5. Restatement 2nd Agency- if the agent has breached a duty to the
principle he is liable.
6. If the agent acted within her actual authority, the principle has to
indemnify for any damages the agent pays (ex. Expenses incurred by
agent for any costs incurred in defending against 3rd parties).
e. Restatement 2nd of Agency § 387 - § 390 (30-33)- Focus on the duty of the agent to
act solely for the benefit of the agent. Issue is one of trust. (ex. Director must put the
needs of shareholders above himself)

5. Action by Directors (Agents of shareholders, should be working on shareholders behalf)

a. Formal notice is not required for a regular board meeting.
b. Two models of corporate governance
i. Traditional- the board of directors manages the business and affairs of the co
ii. Modern- Directors don’t manage, but just act as watchdogs and overlook.
1. Modern world has led to the modern model- constraints on the modern
directors time, info,
a. Most boards of publicly traded co’s meet 6-12 times for about
2 hours, so approx 60 hours a year. Senior officers who work
at the co are there every day of the work week so have more
time to manage.
b. Generally the board will approve things based on info the
officer send them, which they often don’t get in timely manner,
so also constraints on info and ability to look at it. Directors
don’t ask for the info in timely manner b/c:
i. some directors don’t want to be bogged down by extra
work
ii. May be subject to more liability the more they know
iii. Bad manners- certain etiquette that comes along with
being a director
iv. Board of directors usually consists of insiders,
luminaries, friends of CEO’s, close investment bankers
etc, so unless there is a major shareholder, no one is
likely to rock the boat. Most looking to appease the
CEO. CEO doesn’t want all outsiders, b/c often feels
like this is own co. Also another problem is that
independent directors will change to be insiders over
time.

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 1. DGCL § 141(e) (552) and NYBCL § 717 (a)-
tells us that directors can rely on reports
prepared by officers and also opinions and
reports by outside advisors.
a. UK has professional directors (outsiders)
who are independent with an office in
the co and is there daily
b. Must rely in good faith to those who are
competent in giving the advice.
c. Staggered or Classified Board- rolling election process- ability to take your board of
directors and break them down into different classes (typically 3). Each class comes
up for re-election in different successive years, SO typically only 1 class of directors
comes up for re-election in a given year.
i. Ex. Assume have 9 directors in 3 classes, year 1- directors 1,2,3, next year
directors 4,5,6 and so on
ii. Politically correct reason for this is continuity of knowledge and info b/c
won’t have 9 new directors in one year, maybe 3 new directors, but 6 old in
any given year. BUT real reason is that it hinders hostile takeovers b/c
prevents the hostile part from replacing a majority of shareholders in 1 year,
will have to wait for the next annual meeting to try to replace the next 3 and
so on if more, if achieve this will be successful.
1. Necessary for hostile party to replace the board in order to get rid of
poison pill (adopted and redeemed unilaterally by the board). Can
either replace the board or raise your offer price to a point they can’t
refuse to get rid of the poison pill.
iii. Poison pill and staggered board makes the co impervious to take over
d. Directors can generally take action in 1 of 2 ways
i. Action by unanimous written consent (series of board resolutions prepared in
advance by a law firm)- DGCL § 141(f) (553) and NYBCL § 708(b) (1163)-
allows directors to take action out of meeting of directors through unanimous
written consent. Saves time and expense of a meeting, BUT MUST be
unanimous. If there are vacancies on the board, can still take action by written
consent, but all existing directors must sign.
ii. Action at a board meeting- can either have a regular meeting or can call a
special meeting.
1. To take action at a board meeting need 2 things:
a. Quorum of directors- before the board can take binding
action on the co needs to have a critical mass of directors
showing up at the meeting.
i. Typical quorum is a majority of the entire authorized
board, not merely those then in the office. (Ex. 9
directors, need 5 for quorum, even if 2 vacancies)
ii. DGCL 141 (b) (550) & NYBCL § 707- Certificate of
incorporation can change the quorum requirement to be
greater (super majority) or less than the majority, but
can’t have less than 1/3.
b. Appropriate vote to get the matter passed- typical vote
needed is majority vote of directors present at the meeting.
(DGCL § 141(b) (553) and NYBCL § 708(d) (1164)
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 i. Ex. 9 directors and 5 people show up (quorum), 3 out of
5 need to vote yes to pass something
ii. Generally speaking you can raise the vote
iii. Both NY and DE don’t let you lower it to less than a
majority.
1. Can have a situation where 2 people take action
that binds the whole board. Ex. If your quorum
is 1/3 of the board, w/9 people on the board, and
3 people show up to meeting that is a quorum
and so 2 is a majority.
6. Leveraged Recapitalization
a. Goal is to put substantial amount of cash into the hands of a co. common stockholders
by leveraging the co assets. To achieve this goal, the co. will borrow large amounts of
debt and then distribute the proceeds to its stockholders in the form of an
extraordinary dividend. A stockholder vote is not required to effect a leveraged recap.
b. Stockholders receive a large amount of cash, but their shares of stock become less
valuable. They now own shares in a co. weighted down with debt
7. Action by Shareholders
a. Election of board of directors (plurality vote needed to elect)
i. Ex.10 nominees and 5 open spots, assume that every nominee gets a few
votes, the top5 vote getters will get the job.
1. DGCL § 216(iii) (583)- unless the certificate of incorporation or
bylaws state otherwise the board will be nominated by a plurality of
shares made by shareholders by proxy or at meeting.
a. If charter says can be less than majority then ok
b. A person who doesn’t vote but there for quorum is considered a
No for the vote.
2. NYBCL § 614(a) (1146)- unless the certificate of incorporation states
otherwise the board will be nominated by a plurality of shares made by
shareholders by proxy or at meeting.
a. An absent vote don’t count as a vote at all.
Hypo: 500 shares rep. at meeting and assume satisfies quorum, Assume 200 vote yes, 175 vote
no and the other 125 are abstentions
- In Del the matter is not approved since 175+ 125 (count abstentions as no)= 300 which is
more than 200yes.
- In NY- it would pass since 200 vs. 175 and therefore yes wins.
o Need majority of yes + no notes
o Ex. have 200 of 375 which is thus a majority

b. Manner in shareholders vote for directors

i. Traditional or straight method (applies virtually to all co’s)
1. Assume 5 open spots and 7 candidates (top 5 vote-getters will be
elected), assume we have 300 shares- get to cast 300 votes for up to 5
people, don’t split up 300 among 5!!! If you only like 3 candidates,
then you can give 300 to only 3 and abstain for other 2.
2. if own more than 50% then have power to elect all directors.
ii. Cumulative voting (uncommon) (ONLY APPLIES FOR ELECTION OF
DIRECTORS)

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1. allows a shareholder to cast a number of votes equal to the following
formula Shareholder cumulative votes = # of
shares a shareholder holds * # of votes per share* # of open slots.
a. Can cast these votes all in favor of just 1 nominee or spread
them out evenly or unevenly for other nominees.
b. Ex. You have 100 shares and 2 nominees running for board. #
of cumulative votes= 100*1(# of votes per share)* 10(number
of slots open) = 1000 votes. If you feel very strongly that 1
person will be elected you can put all 1000 of your votes on
that one person (contrast that with 100 that you could
ordinarily put on that person if you had straight voting).
2. Purpose behind cumulative voting is that it is designed to help ensure
that minority shareholders will have at least 1 representative on the
board of directors. Minority shareholders by cumulating their votes
and putting it all on 1 person can help defeat a majority nominee.
3. DGCL § 214 (583) & NYBCL § 618 (STAT II-68)- Both say that
shareholders can accumulate their shares only IF the certificate of
incorporation says, SO better get it in before there is a controlling
shareholder b/c after the fact no majority shareholder will vote to
amend the charter to have this. Majority shareholder cant change
provision alone!
4. As a shareholder of a co that has cumulative voting you might want to
find out if you own enough shares to choose a director of your
choosing:
a. N= (X * (D + 1)/S
i. X= # of shares you own
ii. D= number of directors to be elected (seats open)
iii. S= total number of outstanding shares that can be
elected (not the cumulative votes)
b. Formula assumes 1 vote per share. Have to assume worst case
scenario that everyone votes, but some people don’t vote so it
makes votes more important.
c. Must round down whatever number you get. IF don’t have
enough votes can get together with 1 or 2 minority
shareholders and pool your votes.
d. Hypo- 5 person board and all up for reelection, you own 100
out of 1000 stocks outstanding
i. N= .6 which means elect zero people.
5. If we were to buy shares in this co that has X shares outstanding
(assume 1000), what would be the fewest shares we could buy and still
elect the director of our choosing? Formula must equal 1.0. Stick with
the old formula but work it in reverse.(D=5, S=1000, N=1)
a. N = X (D +1)/S
b. 1= X (5+1)/1000
c. X=166.67  have to round up – Need 167 votes to elect
exactly 1 director
6. Without cumulative voting majority shareholder gets to elect ALL
board members. Majority shareholder of a co being formed wont want
to put cumulative voting in charter b/c doesn’t work in his favor.
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 Typically see cumulative voting when a group of people get together
and form a co, but wouldn’t even raise the point with 1 person forming
the co.
c. Shareholder Meeting
i. Need a quorum to take legally binding action, if not vote will be ineffective
1. DGCL § 216 (1) (583)- Certificate of incorporation or bylaws can
specify a quorum, but it can’t be less than 1/3, default provision-
majority of shares entitled to vote at that meeting.
2. NYBCL § 608 (1143)- Certificate of incorporation or bylaws may
provide for a lesser quorum (than majority of shares), but not less than
1/3 of votes and ONLY the certificate of incorporation can provide for
a greater quorum.
a. In NY, once a quorum is reached, it is not broken by
subsequent withdrawal. This motivates people not to leave, b/c
if they do it will be up to others decisions. For vote will need a
majority of people present, not majority of the quorum. Proxy
card filled out in the beginning won’t be valid if you leave.
ii. Proxy card- nominate someone to be your proxy (vote the way you want them
to). Proxy’s legitimately filled out and sent in counts as a quorum. (most
shareholders vote by proxy)
iii. Quorum is measured at the start of the meeting.
iv. Vote needed to approve an action (ex. merger or charter amendment)
1. DGCL § 216 (2) (583)- Unless the DGCL species a contrary threshold
or the bylaws or certificate of incorporation states otherwise a majority
of shares present at the meeting or by proxy is needed. (NOT plurality
of shares, that is only for election of directors!!!)
a. Minimum number of shares needed to approve something in
worst case scenario- 26% of shares voting in favor of
something can bind the whole co if 51% of shares are
represented and of those 51% say yes.
b. Abstentions count as NO votes
2. NYBCL § 614 (b) (1146)- NYBCL, certificate of incorporation or
bylaws can provide for a different votes, but if it doesn’t then the
default requirement is a majority of votes cast in action.
a. Abstentions DO NOT count as votes in NY- huge distinction
between NY and DE. Count for quorum purposes but don’t
count in determining whether a specific action is approved. So
measure majority approval by comparing majority yes votes
with no votes- so long as 1 more yes vote there is shareholder
approval. In DE NEED a majority vote in favor of action, (ex.
out of 500 need 251 yes). If have 200 yes votes and 175 no
votes, essentially have 300 no votes, but in NY action would be
passed b/c abstentions don’t count.
v. Proxy Voting – ability to vote shares even though cant attend meeting in
person
1. NYBCL § 609 (a) (1144)- Shareholders can authorize another person
to vote their shares
a. Typically the designated person to appoint is one of the officers
of the co (preprinted appointee). Appointee gets to vote as you
1
 see fit, but there are circumstances where you essentially give
someone carte blanche to vote how they see fit.
b. When you give someone your proxy it generally lasts for that
meeting.
2. NYBCL § 609(b) (1144)- proxy lasts as long as the proxy specifies,
but in any event no more than 11 months (basically will last for this
meeting, but not the next).
3. If you give your proxy to someone, but end up coming to vote, your
vote controls, not the proxy (proxy will be discarded, even if you don’t
let them know)
4. NYBCL § 609 (f-h) (1144)- Proxy’s are normally revocable at the
pleasure of the shareholders executing them. Can also change your
vote at your pleasure. However, can also make a proxy irrevocable, so
you can’t change your mind if the following things occur:
a. On its face, the proxy says its irrevocable
b. Has to be given to one of the following entities
i. Pledgee- ex. if you pledge your shares to a bank and the
bank will require you to give it an irrevocable proxy, so
it can vote as it sees fit for the duration of the
irrevocable proxy.
ii. Someone who has purchased or has yet to purchase
your shares- designed to get at the record date problem
(co’s have to choose a date and time where everyone
who owns shares after this time will only be able to
vote at next meeting, not this 1).
iii. Someone designated under a valid shareholders
agreement- essentially an agreement amongst
shareholders that may decide a number of thing about
their relationship with one another. (other shareholders
may agree to vote as this other person, so give
irrevocable proxy to that person to ensure that it
happens)
5. DGCL § 212(B) (580)- The duration of the proxy last as long as 3
years unless a longer time period is specified in the proxy (shows DE’s
management friendliness, not seen in NY)
a. DGCL 212(e) (581)- Irrevocable proxy exception- Proxy can
be irrevocable if it says its irrevocable on its face, but it also
has to be coupled with an interest. So people who receive the
irrevocable proxy must have some interest in either the shares
or the co.
6. Vast majority of all shares at public co’s are voted by proxy. This may
lead to a problem b/c may be tough to get people’s attention. So many
shareholders all around the country w/out large stakes, so don’t really
care. Still need quorum, so have trouble taking action.
7. Oral expressions of a proxy do not constitute a proxy, MUST be in
writing.

Corporate Fiduciary Duties: The Duty of Care

1. Basic Standard
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a. Fiduciary duties are essential the same for officers and directors
i. Duty of care
ii. Duty of good faith
iii. Duty of loyalty
b. Concerned about harm coming to the co itself through actions of directors which
hurts shareholders and even creditors. (Caused by sloppy decision making by
directors, or even inaction)
c. Need a duty of care when it comes to common shareholders b/c they may be ignorant
about the co (negligence), while creditors and preferred stockholders go in on a
transaction basis so have a K. No K protection for common shareholders, most
transactions aren’t even documented, so can’t say you did x and this K says you cant
do this, so we are suing you.
d. Francis v. United Jersey Bank (520)- Pritchard & Beard Intermediaries Co was a
reinsurance broker (reinsurance is process by which an insurance co will share risk
with other insurance co to limit own exposure- through reinsurance brokers find
reinsurer who will take risk from a few co’s for premium). P & B was heavily
involved with the flow of money, $ that didn’t belong to itself. Family owned co 3/5
directors were Charles Pritchard Senior, Lillian Pritchard, and Charles Jr.
Eventually 2 Pritchard bros and Lillian were the only directors left- Charles as
president and William as Vice President. When the bros took over they began to
engage in unscrupulous conduct. Took money out of the co for personal use under
guise of shareholder loans, but never paid loans back. Also, co-mingled $ held on
behalf of insurance co’s with P& B’s $, so taking loans from $ that didn’t belong to
them.
i. Both re-insurance co’s and insurance co’s were severely hurt b/c bro’s took
money. Co went into bankruptcy.
ii. Trustees of P&B (try to find people that owe co money so can pay back
creditors) find the mother as a defendant
iii. Directors actions at meetings- Very perfunctory actions- election of officers,
adoption of banking resolutions (almost comical), adoption of a retirement
plan. Minutes do not reflect anything about the loans or the financial
condition of P& B. Upon instruction of Charles Jr. financial statement were
not to be given to anyone but himself.
iv. Court condemns Lillian Pritchard as a director- Not active in the business and
knew virtually nothing of its corporate affairs; visited the office only on one
occasion; unfamiliar with the rudiments of insurance; made no effort to ensure
that the co complied with industry standards.
v. Ms. Pritchard’s defenses: Senile defense; after her husband died she became
incapacitated, grief stricken, too much alcohol, psychologically overborne by
her sons.
1. Court rejects this defense and finds her competent. She didn’t know
what her sons were doing only because she made no effort to know
what they were doing.
vi. NJ Supreme Court- “Directors are NOT ornaments, they are essential to
corporate governance!”
vii. NJ Business Incorporation Act (14(a)(6-14)- Directors must discharge their
duties in good faith and with that due care and diligence that…
e. NYBCL § 717(a) (1168)- Duty of Directors- A director shall perform his duties as a
director in good faith and with that degree of care that a ordinary prudent person in a
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 like position would use under similar circumstances. (notions of diligence and skill
are subsumed within the word care)
f. Revised Model Business Corporation Act- RMBCA § 8.30 – Each member of the
board of directors, when discharging the duties of a director, shall act: (1) in good
faith, and (2) in a manner the director reasonably believes to be in the best interests of
the corporation.
g. DGCL- statutory standard doest exist, duty of care in DE is common law based.
h. Under NY, NJ and RMBCA, the test for whether a director has fulfilled duty is both
objective and subjective
i. Objective component- compare what the director has done with that of an
ordinary prudent person.
ii. Subjective components- Look at an ordinarily prudent person in a like
position- so must look at the same skill set as director at hand. Also, under
similar circumstances- practical import of this is that hindsight has no place in
the analysis- the fact that the action proved to be incorrect is irrelevant.
i. Directors have a duty to:
i. Have at least a rudimentary understanding of the business
ii. Keep informed of developments of the co.
iii. General monitoring function (don’t have to be there daily to operate
business)
iv. Directors don’t need to go in and do an audit of financial records, but
have to have familiarity with the financial status of the co which comes
from periodically reviewing the financial statements. (If Ms. Pritchard had
looked at the financial statements should be tipped off about son’s shareholder
loans)
j. If directors finds something fishy, have duty to investigate, and if directors uncovers
some misfeasance must:
i. Object to the conduct (say you MUST stop now)
ii. If conduct doesn’t stop, need to seek out legal counsel (in house or outside)
and discuss with them what the appropriate action should be (ex. can sue)
iii. Another alternative- Noisy exit- director resigns under protest and sends a
detailed letter stating why he or she is resigning, detailing the misfeasance. If
the co is publicly traded co it has a disclosure obligation on form 8-K and the
co must disclose that a director has resigned due to a disagreement with
management and if the director sent in a letter stating why he/she resigned.
k. Even if the directors have been negligent or engaged in misfeasance, they will
NOT be held responsible UNLESS THEY CAUSED THE LOSS. (Proximate
cause)
i. NJ Court in Francis adopts the substantial factor test- misfeasance or non-
feasance must have a substantial link to the loss. Court has to think about
what caused the loss. In Francis, court had to ask whether Ms. Pritchard’s
inaction caused the harm. Court points to 3 problems that led to the loss: (1)
commingling of funds, (2) Brother’s stealing, (3) Mrs. Pritchard’s dereliction
of duty (substantial factor b/c the sons spawned their fraud from the backwater
of her neglect)- her failure to supervise allowed them to continue their
malfeasance.
ii. There has to be a nexus between the injury caused and the directors actions,
must be substantial factor

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 l. NOT a defense for directors to say that they were induced to become a director by
being told they wouldn’t have to do anything, b/c this analogous to ignorance of the
law and doesn’t help!
m. In Re Emergency Communications Case
i. Director of co. relied on outside advisor in good faith in which the advisor
gave opinions based on his own expertise. However director Mudo had the
expertise and thus held to a higher standard then compared to other directors
who didn’t know.
ii. Directors must review financial statements, have fundamental standings about
the business
n. In re Caremark International Inc. Derivative Litigation (569) (gets to heart of
directors duty to monitor)- Healthcare Co. committed multiple violations of the law,
essentially bribing doctors and had to pay a lot of fines for its conduct. Shareholders
sued the directors to recover losses as a result of the litigation. P’s claim, that the
directors neglect in their duty to monitor led to the co’s losses, b/c didn’t realize what
the co was doing. Weren’t being careful!
i. Court states that the breach of the director in not exercising appropriate
attention can be attributed to 2 different sets of facts
1. Typical claim- made ill advised decision that turned out to be
disastrous
2. Unconsidered inaction- the board failed to take action to prevent a loss
b/c the board was never aware that there was a loss in the first place.
a. Directors generally talk about the big picture items while the
underlings operating the co are the ones that can take actions
that cause big losses with no concern for upper level directors,
SO directors MUST have in place an info system to ensure
that they have a reasonable ability to find out what the
underlings are doing. Info at the grassroots level must flow
upstream.
b. Board MUST make a good faith judgment that its info
reporting system in both concept and design is adequate to
upstream info. (standard used by court)
c. To show lack of good faith on the part of the board P’s must
look at the system and see how it operates and essentially show
a “sustained and systematic” failure to show that an info
system was in place
ii. Court says that the directors would have no problem showing that they had a
good faith belief that their info system was adequate, yet still approved the
settlement b/c the settlement called for them to tweak the info system to make
it more effective.
2. Business Judgment Rule
a. Normally courts, especially DE courts, give great deference to board room decisions
b. 2 judicial developments that watered down the duty of care for directors (Aronson v.
Lewis (532))
i. Gross negligence is the standard used for director liability in duty of care
ii. Business judgment rule is a presumption that in making a business
decision the board acted on an informed basis, in good faith and in the
honest belief that the action was in the best interests of the co. Up to the

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 P’s to overcome this presumption- can rebut by showing conflict of interest or
gross negligence, waste of assets or disloyal conduct
c. Elements of the business judgment rule (545)
i. Need a business decision, includes a decision not to act and a decision to take
action (decision to expand the board is NOT a business decision (Blasius))
ii. Decision needs to be made on an informed basis (duty of care concept)- focus
is on the decision making process- did the board hold meetings, read
documents, hear people’s opinions?
iii. Decision was made in good faith (carries with it a notions of loyalty)
iv. Decision has to honestly be made in the best interests of the co.
d. Smith v. Van Gorkom (549)- Transunion Co had valuable investment tax credits,
but couldn’t use them b/c didn’t have taxable income, so rather than waste these
credits it wanted to find a way to help a 3rd party to use these credits. Decided to find
a 3rd party that had a lot of taxable income so it could acquire transunion and use
these tax credits (concept of synergy) To buy all the outstanding shares of TU on the
open mkt would cost a lot of money so any co would need to borrow money
(leveraged buy out). Co never figured out how much the shares of the co are worth,
only figured out how much debt would be required to buy all the shares. Considered
management buy out but vetoed idea b/c it would cause a tremendous conflict of
interest and didn’t want to deal with it (Putting their own needs ahead of
shareholders, b/c making an offer with inside info- obviously want a good deal for
themselves at the expense but might be at expense of principle). Van Gorkom
expressed his willingness to sell his 75,000 shares at the right price ($55). Came up
with number basically out of no where (Roman’s, CFO, just using # in leveraged buy
out hypos; represented a 45% premium over current mkt price, so sounded good) VG
decided it was time to sell the co. VG meets with Pritzker, takeover specialist, and
makes a detailed proposal about buying Transunion for $55 per share and
demonstrates that the LBO debt can be paid off w/transunions cash flow within first 5
years. Pritzker agrees to $55 dollars per share. VG says that they should make sure
that $55 is the best price for the co, so until the deal is closed should be allowed to
accept other offers. Pritzker isn’t happy about that b/c he doesn’t want his co to serve
as the stalking horse for an auction (doesn’t want to put up time and effort into the
deal and then lose). So as a compromise they agree that Transunion will give him an
option to buy 1 million shares of stock at the current price b/c if he loses the auction
he can take the shares and sell them to the highest bidder. Pritzker also demands that
transunion act on his merger proposal over the weekend (3 days to decide). VG calls
a special meeting (Sept 20) 1 day in advance, but doesn’t tell the board what the
meeting was about and doesn’t invite their investment banker, also no proposals were
given, b/c not yet drawn up. Senior management reacts negatively to this whole
proposal. Romans says that $55 is too low a price, VG rejects this counsel. VG
doesn’t tell the board how he arrived at $55 per share, but does tell them there is 90
day period where someone can come in and make another offer if felt that it was
under priced, but couldn’t solicit bids. Attorney at meeting stated that a fairness
opinion was not required by law before the transaction went through. Traditionally,
investment bank will give opinion about price. Attorney also tells them that they
might get sued by shareholders if they reject the offer. Romans tells the board that
while $55 is not an unfair price, it is at the lower end of a fair price, board agrees.
Merger agreement is executed at a social event, VG doesn’t read it just signs it. No
director actually reads the agreement. Big release comes out trumpeting the deal.
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Senior management of TU revolted, particularly didn’t like restraints on soliciting
other offers. Pritzker agrees to amend the merger agreement to keep management
happy b/c doesn’t want to lose them (Oct). Amendments approved sight unseen based
on VG’s representations, but when read there are variations. Pritzker obtains
financing for deal, so satisfies contingency of the deal, also purchases million shares
at mkt price. As part of the amendment, transunion can actively seek other offers,
but must be done with deal before Feb. 1. Investment bank generates interest from
other firms.
i. KKR expresses interest and sends a formal offer to purchase all the assets and
assume liabilities for $60 a share. VG reacts poorly to this offer and was
especially upset that it contained a financing contingency. No press release
was put out about this offer b/c VG thought it might chill other bidders.
Ultimately KKR withdraws its bid when a key supporter withdraws his
support when VG talks to him privately.
ii. GE capital also expressed an interest but it needed more time to make an offer
(60-90 days) but VG refuses, ultimately puts in an offer but somehow fades
away.
iii. Action is commenced by shareholders claiming that the board failed to reach
an informed decision in accepting Pritzkers offer.
iv. In DE, breaches of duty of care are predicated on concepts of gross negligence
b/c the business judgment rule is the presumption. Have the directors
informed themselves prior to making a business decision of all the material
info that is reasonably available to them?
v. Lower court says that the TU directors fulfilled their duty of care b/c acted on
an informed basis- discussed transaction on 3 diff occasions, so falls within
the BJR; P’s have to come up with particularized evidence to show that there
is gross negligence.
vi. Directors argues that the court should look at what they knew on and after
Sept 20, and reapproved it after learning more, met 3 separate times. Also, cut
a great deal b/c getting $55 per share (mkt price $38), 48% gain. Also, mkt
test period, so if price was too low, others would make a deal. Court should
defer to them, b/c have so much experience. Finally they relied on legal
counsel, and could have been sued if didn’t accept this deal. (Suggests a
breach of duty of loyalty, b/c shouldn’t be concerned about being sued
personally, putting their own interests ahead of shareholders; also have
liability insurance, so not paying out of pocket anyway).
1. Key to all breach of fiduciary duty cases is getting beyond motion to
dismiss and into land of discovery. Often, D’s will settle b/c not worth
time and effort past the motion to dismiss. This is why the P’s need to
offer particularized facts suggesting breach of fiduciary duty- so high
standard to get passed motion to dismiss.
vii. The standard of care- mere negligence is not enough to hold directors liable
they need to be grossly negligent and stockholders must show particularized
facts to overcome the presumption
viii. DE Supreme Court says there are 2 issues: (1) whether the board made an
informed judgment on Sept 20 (2) Assuming that they didn’t make an
informed decision on Sept 20, were the actions taken after adequate to cure
the infirmity on Sept 20?

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 1. Court concludes that on Sept 20 the directors didn’t make an informed
business decision. Didn’t have any documents and took the word of
VG. Under DGCL § 141(e)- directors may reasonably rely on the
reports of officers and outside advisors, BUT MUST rely in good faith.
Suspicious circumstances here caused them to have a duty to make
further inquiry (everything happened so quickly). Would have found
w/ a little inquiry that the info provided wasn’t enough to make an
informed business decision.
ix. Under the business judgment rule, there is no protection for directors who
have made an unintelligent or unadvised judgment if their decision making is
grossly negligent.** Based on your process towards decision will be
determinate if acted informed or uninformed.
x. Directors failed to inform themselves about the intrinsic value of their co, a
premium alone is not enough to suggest that it’s a fair price. Need to show
that premium was sufficient. Can get a valuation from internal or external
opinion.
xi. Court finds the mkt test period unduly restrictive b/c didn’t allow for
solicitation of bids and when revised wasn’t amended based on the
representations to the board. It wasn’t a mkt test period designed to provide a
level playing field for other players. Created an auction that continually
favored Pritzker. According to Revlon, need to have an auction. Court says if
u are so wise why did you approve this deal.
xii. Court found that what they did after Sept 20, didn’t correct the infirmities.
Court didn’t believe the amendments did what the directors claimed they did
(didn’t create level playing field). Anyone buying the co would have to pay
off Pritzker b/c he exercised the option to buy the shares. Another deal would
have to be completed by Dec and couldn’t have a financing contingency.
Process that led to the amendments was flawed- directors didn’t ensure that
the right action was taken.
1. Don’t have to read every word of the merger agreement, but have to
have some ability to ensure that the action you authorized was
effective (follow-up required).
2. Directors were grossly negligent
xiii. Remedy-Chancery will determine the fair value of the co and award
damages based on the difference between fair price and $55. If worth same or
less, directors get lucky, but still negligent.
xiv.Ultimately there was a settlement before Chancery gave valuation. P class got
$23 ½ million- 10 million is paid by directors liability insurance and the
remaining amount is paid by Pritzker (indicates that he thought he got a good
deal after taking advantage of them).
xv. Van Gorkam created absolute havoc in the financial world b/c many directors
resigned b/c didn’t want to be held liable for anything, many nominees
declined to be nominated and insurance premiums for directors and officers
skyrocketed. So DE and NY passed legislation that severely dampened the
VG decision b/c didn’t want to deter people from being on boards. Passed
legislation that limited the directors personal liability for breaches of fiduciary
duty, particularly duty of care (Exculpatory Charter Provisions)

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 xvi. DGCL § 102(b)(7) (538)- Certificate of incorporation can contain a
provision eliminating or limiting the personal liability of a director for
breaches of duty to the co or the stockholders.
1. Today, this language is often put in automatically, existing co’s need to
get shareholder approval to put this in.
2. Provision limits directors exposure to monetary damages with respect
to breaches of fiduciary duty (essentially covers directors carelessness
or gross negligence)
3. Provision CANNOT limit:
a. Breaches of duty of loyalty to the co or shareholders
b. Acts or omissions not taken in good faith or involving
intentional misconduct or knowing violation of the law.
c. Cannot get a director off the hook for unlawful payment of
dividends or stock repurchases in violation of legal capital
rules.
d. Will not cover transactions from which directors derived an
improper personal benefit
xvii. NYBCL § 402(b) (1125)- Substantially similar to DE provision- must be
put into the charter and essentially shields you from breach of duty of care.
xviii. Many argue that today the duty of is basically dead, b/c of these statutory
changes, especially since P’s must overcome the business judgment rule.
Nevertheless, often DE courts will go through the whole trial, just to find that
there was no breach of duty and even if there was there is an exculpatory
provision.
xix. RULE: Under the business judgment rule, there is no protection for
directors who have made an unintelligent or unadvised judgment if their
decision-making process is grossly negligent.
e. Malpiede v. Townson
i. Fredrick’s of Hollywood announced it had retained an investment bank to
conduct a search for a suitable buyer and approved a merger with
Knightsbridge. There was a no shop and no talk provisions in the merger
agreement with Knights. Before the merger closed, Fredrick shareholders filed
a class action and moved for preliminary injunction against the merger and
alleged a breach of fiduciary duties and recover damages caused by the
rejection of higher bids.
ii. P adequately alleged a claim of breach of duty of care. However. Corporate
charter exculpates the directors for any breach of duty of care (allows
directors to take risks in good faith). P failed to meet the burden to prove
breach of loyalty (conflict of interest)
iii. The exculpatory provision does not bar duty of care but is an affirmative
defense. .
3. Limits on Liability; Directors’ and Officers’ (“D&O”) Insurance (sometimes E & O
ins.- errors and omissions)
a. These policies are extremely difficult to read and understand, and insurance co’s will
try to do anything not to pay claims.
b. D & O usually kicks in when the co goes into bankruptcy
c. 2 components that relate to indemnification (Very typical to have charter provision
stating that the directors will be indemnified for attorney fees etc.)

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 i. Corporation reimbursement policy- If the co pays the directors, the insurance
co will pay the co for out of pocket expenses
ii. If a claim against the director is not covered by the corporate reimbursement
policy, then the insurance co will pay the director directly for any expenses
incurred. (important that policy requires the insurance co to pay as cost are
incurred, b/c don’t want to wait until the end to get paid).
d. D & O, like malpractice insurance is a claims made policy- Insurance only covers
claims that both arise and are actually brought during the term of the insurance
i. Ex. If something occurs before the insurance kicks in, but file claim when
have insurance, won’t be covered.
ii. Ex. Something happens during the period of insurance, but the claim is not
made until after the insurance expires, won’t be covered.
iii. Result is that directors MUST always think about the statute of limitations- if
a claim arises when is the last possible date it can be brought against you? So
if director retires he can purchase a tail- doesn’t cover future conduct, but
anything that might have occurred during the original insurance period. Can
last for as long as the statutory period and typically cheaper than other types
of insurance.
e. Generally speaking this covers directors for acts of negligence (gross negligence)-
although there are exculpatory provisions at least this will cover the expenses of
going to court when the P wants to prove that you are grossly negligent. BUT,
everything that the exculpatory provision doesn’t cover, D & O WILL NOT cover
also. Will be covered for accidentally violating security laws and defending
unmeritorious claims

Corporate Fiduciary Duties: The Duty of Loyalty

1. Duty of loyalty is typically implicated in 5 recurring factual scenarios
a. Transactions between a director and her corporation
i. Self dealing transactions (implicated b/c in making a deal on their own behalf,
but still need to keep the best interests of the co. in mind)
b. Interlocking Directorships- transactions between 2 entities typically corporations that
have common directors. (implicate duty b/c of the concern of lopsided transactions in
favor of co A over co B- maybe if director has a greater financial stake in co A than
B.)
c. Use of Corporate opportunities (Usurption)- When a director learns of a possible co
opportunity and without offering it to the co takes it for himself (concern is that
director will put personal business interest ahead of those of the co)
d. Entrenchment Actions- actions entrench the directors in their positions (typically
arises in takeover battles)- directors putting their interest of keeping their jobs as
directors and officers ahead of the shareholders’ interests. (May turn away potential
takeover offers just b/c they want to keep their jobs)
e. Favoritism- favoring one class of shareholder over another class of shareholders.
(comes up less frequently)- Directors have a duty to all shareholders regardless of
class.
i. Ex. Co has both common and preferred stock and an outsider says he will pay
this amount of $ for all the shares, and up to directors to divide among the
different classes of shares. An unfair split could lead an allegation that one
class was favored over the other, could be that the directors had a bigger stake
in one class than the other.
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2. Transactions Involving Self- Interested Directors (not always bad but have the ability to be)
a. Historically, in common law (1880), any K between the director and the co was
voidable at the will of the co or will of shareholders whether the transaction was fair
or unfair to the co.
i. Policies underlying this rule is that even the directors who are not involved in
the transaction are unlikely to vote no. (Cumberland Coal Iron v. Parish-
When a K is made with even 1 of the directors, the remaining directors are put
in the embarrassing position of having to check over the transaction). Peer
pressure concern- will simply rubberstamp it because dealing with friends.
ii. Wardwell court made cynical statements about human nature and why the
original common law rule was very much concerned with the directors putting
their own needs ahead of the co In the majority of cases the co will be the
loser and directors financial interest will win b/c of human nature.
b. In 1910, the original common law rule was replaced with a new rule- A K between a
co and director was in fact valid if approved by a disinterested majority of directors
and not found to be unfair or fraudulent when challenged. Rule was changed b/c it
goes to the essence of self dealing transactions- sometimes it might benefit the co to
deal with self interested directors, so in situations when the deal is in fact good why
should the co or shareholders be able to challenge it?
c. In 1960, the rule changed again- Most states created self interested director statutes
which provide a mechanism to cleanse self interested director transactions
i. DGCL § 144 (a) (555)- Provides a mechanism for a transaction that is
otherwise tainted to become cleansed and thus to be able to withstand
shareholder challenge- No contract or transaction between a co and director,
or no contract or transaction between a co and any other co with the same
directors or who have a financial interest, shall be void or voidable even if the
interested director is present at the meeting considering the transaction if:
1. There has been FULL disclosure plus disinterested director approval
OR
a. Transaction will be cleansed of all the material facts as to the
director’s relationship and interests are known to the board and
the board in good faith authorizes the transaction by a majority
of disinterested voters
2. There has been FULL disclosure plus good faith shareholder approval
OR
a. Transaction will be cleansed if there is full disclosure of the
conflict to shareholders and shareholders vote to approve it in
good faith
3. The transaction is objectively fair to the co
a. Must be fair at the time that it is authorized or ratified by the
board or shareholders.
i. The process WILL NOT be tainted if an interested
director votes so long as the truly disinterested directors
vote yes. Sometimes a director doesn’t know that
he/she is interested!
ii. Fleigler v. Lawrence (634)- Allows for judicial
review of transaction, even if it has been cleansed.
So essentially, the only thing that cleansing gets you in
DE is that it puts the burden on the challenger to prove
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 that the transaction is not fair. (essentially 1 and 3 or 2
and 3 to be cleansed!)
ii. DGCL 144b says common or interested directors may be counted for quorum
purposes, they can participate and vote but don’t count for purposes of
cleaning process.
iii. NYBCL § 713 (1165)-(less management friendly, so harder to get things
approved)- Cleansing process is substantially the same as DE- (1)Full
disclosure and disinterested director approval; or (2) Full disclosure and good
faith shareholder approval; or (3) Transaction is objectively fair to the co.
BUT 3 wrinkles:
1. To become an interested director under § 713 the director must be a
interlocking director OR must have a substantial interest in the other
co. (DE doesn’t define it to be substantial, but case law tells us that
the interest must be material).
2. NYBCL § 713(a)(1) requires that disinterested director approval must
comply with the provisions of NYBCL § 708(d) (1164)- Requires
approval by a majority of directors at a meeting when a quorum is
present. IF the number of disinterested directors at the meeting does
not constitute a majority of such directors (708d), then the vote of the
disinterested directors must be unanimous. (NEED majority of
disinterested voters).
a. Ex. Suppose have 15 directors, § 708(d) default rule requires 8
directors (majority) to be present to take action. 13 directors
come to meeting, so have quorum. Under 708(d) need 7
directors (majority of 13) to approve a transaction.
i. Scenario (1)- 4/13 are interested directors, so 9
disinterested. Under § 713(a)(1) a self interested
transaction can only be approved if 7 disinterested
voters vote yes. Won’t matter if other 2 disinterested
vote no!
ii. Scenario (2)- 9 interested directors and 4 disinterested
directors- only choice for approval of self interested
transaction is if ALL (unanimous)4 disinterested
directors vote yes.
1. vs. Deleware need 3 of 4 majority
3. NYBCL § 713(b)- If the procedure of full disclosure is coupled with
shareholder approval or disinterested director approval, then
shareholders CANNOT effectively challenge the transaction- ONCE
IT HAS BEEN CLEANSED, IT IS CLEANSED!!! NOT SUBJECT
TO JUDICIAL REVIEW. But, if this procedure isn’t met then the
burden of proving that the conduct was fair and reasonable to co falls
under to the supporters of the transaction. Great procedural
mechanism in NY, b/c once cleansed can’t be challenged like in DE.
BUT under § 713(b) can challenge that the transaction wasn’t cleansed
properly.
d. Lewis v. S.L. & E., Inc. (602)- 2 companies: (1)LGT- (favored co)- ran a tire
dealership in Rochester and (2)SLE- owned the land and buildings leased to LGT. P
was Donald and D’s were his brothers Allen, Leon Jr. and Richard. Co’s were linked
b/c had interlocking directors- Allen, Leon and Richard were directors of both co’s
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 and also shareholders of both. Donald and sisters were shareholders of SLE, but not
attached or affiliated with LGT. Incentive was created for 3 bros to maximize the
profits of LGT that is shared only between the 3 bros at the expense of SLE b/c the
costs are spread out against multiple shareholders. The 3 bros treated SLE with
disdain and disrespect (largely ignored SLE’s corporate existence)- held no
shareholder meetings and viewed SLE as existing purely for the benefit of LGT and
that viewpoint would have been fine if the identity of the shareholders were identical
for both co’s. SLE leased its land and building to LGT, so LGT can run its business.
Terms of the original lease expired in 1966 (1200/month rent). SLE was responsible
for real estate taxes and all other expenses were borne by LGT. When the lease
expired the lease wasn’t renewed, just continued with LGT paying the same rate, even
though property taxes increased. Donald believed that the rent was severely below
mkt and gross undercharging with respect to the property and building constituted a
waste of SLE’s assets. Donald refuses to go through with shareholder agreement
provision that said that he must sell his shares of SLE at book value to LGT, b/c
owned no shares of LGT. He felt the price was artificially depressed through the
actions of the brothers. Donald sues the D’s for wasting the assets of SLE and they
countersue for specific performance.
i. D’s CANNOT defend on the business judgment rule (even though rent would
fall under it) b/c it is dismantled by their conflict of interest (interlocutory
directors).
ii. District court held that P has the burden of proving that the directors are
wasting co assets, BUT the 2nd Circuit says that interested directors have the
burden of showing that the lease arrangement to SLE b/c NYBCL § 713 tells
us that unless the transaction has been cleansed (which it hasn’t) the
proponents of the transaction have the burden.
iii. IF they went through the cleansing process of 713a, they wouldn’t be able to
obtain disinterested approval since the board is all interest directors
iv. D’s failed in proving that the lease was fair and equitable to the co.
1. D’s defend their action by saying that the real estate value has
dropped, but court rejects this argument b/c real estate taxes have risen
to the point where it eats up the whole rent
2. D also argues that this rent is ALL LGT can afford to pay, but this
argument fails, b/c directors were taking excessive salaries. Also, SLE
could have gotten a different tenant.
v. D’s were held liable for wasting the co assets of SLE. Case was sent back to
figure out what LGT should have been paying so D’s could pay the difference
out of their own pockets. Once that is done the P’s will have to sell their
shares at fair value (which will increase with payment of increased rent)
3. Corporate Opportunity Doctrine and Other Dilemmas
a. Northeast Harbor Gold Club, Inc. v. Harris (673)- Club was fairly isolated.
Harris was the President of club and was presented with 2 opportunities to purchase
land adjacent to the Club. The real estate agent contacted Harris b/c she was
president of the club and it would be in the best interest of the club to purchase the
property. Harris bought the Gilben Property w/out offering it to the club first. She
disclosed to the board after the fact and told them that she didn’t plan on developing
the land so the club will be protected. She then buys the Smallidge property after
learning of its availability from the postmaster during a round of golf. Harris doesn’t
offer this opportunity to the club, but discloses to the board that she is in the process
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of buying the property and then at an official meeting tells them she bought it but has
no interest in developing it. Later she hires people and subdivides the property into
lots and gets ready to develop the lots. The board is not pleased that Harris has
engaged in these actions and asks her to step down as president & brings lawsuit.
i. Actual allegation- breach of fiduciary duty and loyalty seizing the opportunity
that the club thought should be provided to it and then attempting to profit out
of it. Remedy they are seeking is constructive trust remedy- land will be held
in trust for the benefit of the club and as soon as they pay her what she paid
they will get the property.
ii. Trial court found that under existing Main law, Harris has not usurped the club
property because acquisition of real estate wasn’t in the clubs business.
Moreover, the court found that the club lacked the financial ability to buy the
real estate in the first instance.
iii. Sct finds that the current law needs to be revamped: Provides an overview of
the various schools of thought on corporate opportunity doctrine:
1. DE’s Line of Business Test (Guff v. Loft (1939))- Court will try to
figure out if this opportunity is within the line of business of the co. If
a business opportunity is presented to an officer or director of a co and
the co can financially undertake and it is within the line of business
then the officer or director CANNOT seize the opportunity for herself
unless there is disclosure to the corp and the corp does not want to
pursue it.
a. Guff tells us that the opportunity has to be so closely associated
with the existing co activities that if that opportunity was
seized then the officer or director would essentially be in
competition with the co.
i. Problem with this test is that its very difficult in many
instances to decide whether an opportunity is within the
line of the co’s business. (Ex. Golf club was not in the
business of development, but had a policy of trying to
prevent development around the club). Another
problem is that in testing for financial ability the answer
will often be no b/c club won’t know that the
opportunity is available so won’t have the $ lying
around, but great opportunity’s typically open up extra
resources (ex. can get bank loan).
2. MA’s Fairness Test- Look’s at the equity and fairness of the situation
and decides whether it would be fair to the co to allow the officer or
director to pursue this opportunity. The problem with this test is that it
doesn’t five any guidance to any existing directors and officers on
what they can and cannot do.
3. Minnesota Two Step Test-
a. DE Line of Business Test- If the director were to seize this
opportunity would it put her it direct competition with the co?
b. Mass Fairness Test- Once decided that it is within the line of
business, must look at all the circumstances and decide whether
the transaction should be set aside b/c inequitable
i. Problem- combination of DE and MA problems.
4. Principles of Corporate Governance (court embraces this test)
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 a. ALI PCG § 5.05 (1324)- Director or officer cannot take a
corporate opportunity for himself unless certain conditions are
met. (ALL conditions must be met)
i. MUST offer it to the co after full disclosure of the
conflict of interest and the opportunity (if there isn’t
FULL disclosure, then its always improper to seize the
opportunity for yourself) AND
ii. The opportunity MUST be rejected by the corporation
itself AND (1 of 3)
1. Taking of the opportunity MUST be fair to the
co or
2. the opportunity is rejected in advance by
disinterest directors in a matter that meets the
standard of the business judgment rule or
3. ratified after the fact by disinterested
shareholders and the rejection is not a waste of
co assets (cleansing process)
b. Financial ability is a factor under § 5.05 b/c rejection can be
based on the inability to get financing.
c. § 5.05(b) defines a corporate opportunity as 1 of 2 things
i. Any opportunity to engage in a business activity (does
not need to be closely related) of which the director
becomes aware either in connection with the
performance of his job or the person offering it to her
expects her to offer it to the co or she learns of it
through the use of co info and property if the
transaction is one that is reasonably expected to be of
interest to the co.
ii. Corporate opportunity is any opportunity to engage in a
business opportunity of which an officer (not director)
becomes aware of other than on the job and knows that
it is closely related to something the co is engaged or
wants to engage, then has to offer it.
d. If the transaction was not rejected by shareholders or directors,
or ratified by them, then burden falls on officer who seized the
opportunity that it was fair. Otherwise the burden falls on the
challenging shareholders,
5. There was not enough info to decide this case, now the lower court has
to find additional facts to figure out if this is a corp opportunity. On
appeal the court finds that these were corporate opportunities and
Harris breached her fiduciary duties by not offering it to the board,
BUT then the court found that no action could be taken b/c passed the
statute of limitations.
b. Hypo- suppose that O inherits a business that is competitive with that of corporation
X. Here O has not taken a corporate opportunity. However, if O runs the business
without resigning from corporation X, she may be improperly competing with X.
Similarly, suppose O started a business that originally was not competitive with X,
but that later becomes competitive because X itself expands its geographical or

1
 product line reach, so that it begins going head to head with O’s business. Here too O
has not taken a corporate opportunity, but may be improperly competing with X.
4. Directorial Entrenchment- those activities that the directors engage in that lead them to
make their jobs more secure (comes up most frequently in the context of takeovers
a. Unocal Corp. v. Mesa Petroleum Co. (1140)- Mesa wants to takeover Unocal in a
hostile takeover (Corporate Raider- T.Boone Pickens- CEO of Mesa). Mesa makes a
2 tier front end loaded tender offer for shares of Unocal (2 stages). 1st tier- Mes
offers to pay $54 in cash to obtain 37% of Unocal stock (Mesa already owns 13% of
shares so this would give them controlling rights). 2nd tier (back end)- Mesa will
acquire the remaining public shares through a squeeze out merger- will have enough
voting force to force the merger. Will buy remaining shares with debt securities(junk
bonds) reportedly worth $54. Unocal board finds this offer to be inadequate and
wont recommend to shareholders, after getting 2 outside opinions. Unocal board
approves a defensive strategy- conditional exchange offer- If Mesa acquired enough
Unocal shares to push ownership level above 50% Unocal would then offer to
exchange the remaining 49% for Unocal debt securities worth $72 per share. Mesa
was excluded from participating in this offer. Mesa seeks a preliminary injunction
designed to prohibit Unocal from completing its exchange offer.
i. Court describes this 2 tier front end loaded tender offer as coercive in nature
b/c shareholders won’t want to be stuck at the back end getting junk bonds so
almost forced to tender at front end so they can get cash, regardless of whether
$54 is a fair price.
ii. Mesa will only pay cash to first 37%of outstanding shares, so if too many
shares are tendered at the front end securities law says that everyone will get
some shares purchased for cash and the rest will be returned.
iii. Purpose of the conditional exchange offer is that it would keep Mesa from
getting the other 49% of shares by offering an alternative to the remaining
49%. Once that exchange offer was done and the shares repurchased by
Unocal, the only who will have outstanding shares is Mesa. But now
controlling shareholders of a co that is heavily debt laden (were only planning
on issuing $54 junk bonds not $72).
iv. Mesa makes a number of arguments in support of its request for injunction
1. Discriminatory treatment – Unocal is making an offer to buy
everyone’s shares but Mesa’s, why shouldn’t they get the same
treatment as other shareholders. Potential duty of loyalty problem b/c
directors are shareholders, and they will benefit from this offer. Unocal
responds by saying that Mesa is the one who caused the problem with
an inadequate coercive offer, so don’t owe them any loyalty b/c they
are the one’s trying to hurt the co. Also, BJR.
v. DE court decides that a DE co can selectively buy back some shares from
some shareholders.
1. DGCL § 160(a) (565)- Statutory authority for selective repurchases
2. Meant to defeat practice of greenmail- Corporate raider buys a
significant stake of a co and goes to the board and says they have a
choice- we can launch a hostile takeover and then we will fire you or
you can make us an offer to buy our block of shares at a premium
price (pay us to leave you alone)
a. Court notes that T Boone Pickens and Mesa are notorious
greenmailers.
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 b. Green mail is still legal, BUT the internal revenue code has
taken steps that provides disincentives fro both parties to
engage in a greenmail oriented transaction (can no longer
deduct the spread between mkt price and premium, also
greenmailer must pay substantial tax on the premium price).
c. A lot of different states have taken steps to try to prevent green
mail outright
i. NYBCL § 513(c) (1136)- A co cannot repurchase 10%
or more of stock form a shareholder at a premium price
if the person holding the shares has held it for more
than 2 year, without shareholder approval.
vi. Directors are permitted to take action in response to a perceived threat to the
enterprise
1. Harm reasonably received irrespective of the source- court recognizes
that the threat coild come from one of the shareholders, so it is
legitimate to protect the co even if it means going against one of the
co’s shareholders.
vii. Defensive actions that the board takes fall under the business judgment rule
BUT there is an omnipresent specter that the board may be acting in its own
best interests rather than those of the shareholders.
1. Co’s takeover another usually b/c management isn’t performing well,
so this change may be beneficial
2. By-product of defensive actions is entrenchment of positions.
viii. Court adopts Unocal standard- tells us when defensive measures of
directors preserve the protection of the business judgment rule
1. Directors have demonstrate that there is an actual or perceived
threat to the corporate enterprise
a. Can show this by deliberations (outside directors), looking at
facts, investigating
2. Defensive actions taken must be reasonable in relation to the
threat posed. (Proportionality)
a. A co doesn’t have unbridled discretion to defeat any perceived
threat by any draconian means available. However it was
proper for circumstances.
ix. Holding is still true with private co’s today but With public traded co’s today,
under federal law, under Williams Act (Exchange Act 13e-4 and 14d-10)
1934, prohibit making exclusionary exchange offers like the one made in
Unocal. Must make the offer to every stockholder.
b. Defensive measures that are put in place from time to time:
i. Defensive charter amendments (staggered board or super majority voting
requirement)
ii. Crown jewel strategy- Target co sells or gives someone the option to buy the
most important asset or business of the co at a deeply discounted price if the
hostile party gets a certain % of shares.
iii. White knight strategy- Once it becomes clear that the target will not remain a
stand alone co. the board will sell to someone they like better (odd b/c this is
based on director makeup, not co’s likes or dislikes-so where do shareholder
needs fall into this?)

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 iv. Pac man strategy (not common anymore)- if the hostile co launches a takeover
of your co, you in turn try to takeover their co.
v. Golden parachute strategy- Once co is taken over, very lucrative severance
payments will be triggered for directors who are fired. Makes takeover less
appetizing for potential bidders.
1. WSJ article- Merck adopted golden parachute payment b/c of hostile
takeover threat, providing some director’s w/up to 3 times previous
year salary plus bonus.
c. The Unocal Standard is only used with defensive strategy and only those taken
unilaterally by directors, won’t apply if shareholders approve.
i. Under federal law (Williams Act Rule 14d-10- all holders rule) public co’s can
only make tender offers to ALL the shareholders regardless of who they are.
(So Unocal would have been wrong in not making offer to Mesa, under
federal law). But DE law still stands and Unocal standard is still alive and
well. (Today’s rules)
d. Unitrin Inc. v. American General Corp Case
i. Unitrin had charter with supermajority voting provision.

Corporate Fiduciary Duties: Takeovers

1. Directorial Duties in the context of Corporate Takeovers.
a. Revlon, Inc. v, MacAndrews & Forbes Holdings, Inc. (1160)- Revlon was a
takeover target when Mark Bergerac was CEO. Famous takeover artist Ron
Pearlman, CEO of Panty Pride was the bidder. Initially PP tried making a friendly
offer, but Bergerac hated Pearlman so didn’t want to cooperate. PP board authorized
it to go after Revlon on a hostile basis at a price of $45. Lazard tells Revlon that PP’s
strategy is to acquire Revlon with junk bonds and then break up the co and sell off the
parts at $60-$70 per share. This strategy tells us that the sum of the parts at Revlon
are worth more than the whole (management not doing good job- maybe board
should break up co themselves and get the $ for the shareholders b/c keeping money
all together doesn’t make much sense). Wachtell Lipton, Legal counsel for Revlon
recommends that Revlon repurchase up to 5 million of its own shares (price will
increase by artificial demand, but wont matter to PP b/c will just buy less shares).
Real reason for this is that Revlon can put the shares in an Employee Stock Option
Plan (ESOP) and those shares will be controlled and voted by a trustee nominated by
Revlon, so unlikely that the trustee will tender shares to PP or vote PP nominees to
the board. (makes shares impervious to acquisition by PP). Can also use those
shares to option or sell outright to a white squire (buys a chunk of your stock, unlike
knight who buys all shares) who under a K agreement agrees not to tender those
shares to a hostile co or vote w/out Revlon’s approval (putting shares into friendly
hands). Wachtell also recommends that Revlon adopt a poison pill(shareholder
rights plan) essentially entitles shareholders other than hostile party to purchase
shares at a super cheap price if hostile party were to buy over a certain %, thereby
diluting the mkt place with those shares, making the takeover really expensive.
(Poison pill has never gone through, but good threat). Board adopts the
recommendations.
i. Poison pill adopted and rescinded unilaterally by the board. To get the board
to redeem the poison pill must keep offering a higher price to a point where
the board can’t say no more anymore. Another way is to put together a board

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 that is hostile to the pill (Proxy fight). Shareholders CANNOT redeem a
poison pill. (business decidsion.
1. Flip in- buy cheap stock from your co
2. Flip over- if your co isn’t doing well can buy cheap stock in remaining
co.
ii. PP ultimately launches its hostile bid: $47.50 per common stock and $26.67
per preferred share. Conditioned on PP receiving necessary financing and on
Revlon redeeming the poison pill
iii. Revlon rejects the bid as inadequate and also launches another defective
strategy- exchange offer of new debt securities worth a certain value for up to
10 million shares. By not using cash to buy these shares, Revlon was
preserving cash, but takes 10 m shares out of the mktplace and can add to
ESOP or sell to white squire.
iv. Makeup of Revlon’s board (DE always places high priority on what
independent directors of co does)
1. 14 directors
a. 6 hold senior management positions (inside directors)
b. 2 hold significant blocks of stock (arguably independent
directors b/c most likely to be concerned with shareholders
c. 4 had various business relationships with Revlon at some point
in time (Technically outside directors b/c no current
relationship, but probably looking out for interest of current
directors so can have future relationships.
d. 2- No affiliation (independent)
v. Revlon offers a new price of $42 per share- reflects the exchange program b/c
now Revlon is more highly leveraged.
vi. Sept 24, Revlon board decides not to sell to PP, but up for sale to someone
else. Want to sell to White Knight- Forstmann, so treat him well! Forstmann’s
initial offer was made public and note prices plummeted in value b/c reflected
fact that Forstmann was borrowing to buy Revlon and that debt will be on
Revlon’s books after sale, so less chance of those creditors being paid. Note
holders threatened to sue Revlon for doing deal with Forstmann that undercut
the credit worthiness of the notes and caused the price to fall. Forstmann
comes up with new proposal
1. $57.25 per share (fits valuation of co), but must be granted a lock up
option (allows them to buy 2 important divisions of Revlon, in the
event that another acquirer gets more than 40% of Revlon- Crown
Jewel lock up option). Revlon had to agree to no shop provision-
couldn’t shop around actively for another bidder. Also, cancellation
fee- if a 3rd party bought more than 20% of Revlon stocks, Revlon was
forced to pay Forstmann a check for $25 m. Forstmann in turn agrees
to support the value of Revlon notes in the mkt place, so won’t get
sued. (prop up value- whenever the price of the note starts to drop,
they will step into the open mkt and buy the notes, creating an artificial
demand. Revlon accepts this offer.
2. the cancellation fee is not illegal but must be compensatory (like
liquidated damges it must be reasonable and cant be punitive)
a. between 2 and 4% in DE is considered reasonable.

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vii. PP continues to step up its offer, but demands that Revlon repeal the defensive
strategies. Its last bid was $58, conditioned on nullification of the poison pill,
waiver of debt covenants and repeal of the crown jewel lock up option.
1. The K between Revlon and note holders limits Revlons ability to incur
additional debt and PP was going to borrow most of the $ it needed to
buy Revlon, so with those existing notes outstanding it limited the
ability of Revlon to acquire new debt, ability to sell assets and pay
dividends.
viii. PP seeks injunctive relief
ix. Court grants injunction., Chancery court reasons that Revlon directors
breached their duty of loyalty by making the concessions to Forstmann, by
putting their own need ahead of shareholders b/c were scared of being sued.
x. DE SCT notes that whenever directors take defensive measures there is the
omnipresent specter of the directors own interests.
xi. Court uses Unocal standard to determine whether the defensive strategies are
ok
1. When confronting the hostile takeover, the defense must be reasonably
perceived threat and the response must be proportional (not
dranconina, coercive, preclusive)
2. Poison Pill- the court recognizes the power to adopt it so long as the
reason for it is reasonable. Finds that Revlon acted in good faith and
the poison pill was reasonable in relation to the threat posed.
However, the court says this issue is moot, b/c once the co decided to
sell itself then it had to redeem the poison pill, b/c that prevents the
sale of the co. (redeemed by implication)
3. Exchange offer is proper in connection with hostile threat so long as it
complies with the Unocal standard. DGCL 160a- allows co to acquire
its own seucirites from stockholders.
xii. Boards duty changes once it decides to put the co up from sale- change
from preservation of the co as corporate entity to someone charged with
getting the max value as part of the sale process fro the shareholders
1. Defensive measures become moot- want everyone who can bid to bid
so DON’T want restrictions on shareholders (existence of lock up
arrangement deters other people from bidding). Any defensive
strategies that are inconsistent with director’s role as auctioneer is
a violation of the directors duties.
2. Board members become auctioneers, charged with getting the best
price for shareholders thus give everyone same info and access
3. Board can slightly favor one offer over another higher one, if it is more
solid (Mills Acquisition case, not all bids are alike)
4. Lock Up are not illegal , it would be to institute during active auction
but ok if there is plateu of bids (and make lock up to get a little higher
offer)…anything to slow down auction is illegal.
5. Directors have a duty to explore another offer and if its better to take it
even if they have already committed to sell to another party (usually
provision in K for this)
a. DE courts view cancellation fees under a liquidated damages
scope (should the co who contracted to buy get paid for all
their efforts if someone else swoops in with a better offer and
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 gets to buy?) Usually the court will not allow fee if its more
than 4% of purchase price.
b. Alcoa- Shares selling at $34 on open mkt, but tender offer for 5% of shares was made
to buy shares at $32. This is a legal scam b/c bidder thinks that there are people out
there who will sell b/c ignorant enough not to know that alcoa is trading at a higher
price. Some people tender shares b/c don’t know what they’re doing.
2. Self tender offers, conditional exchange offer and repurchases-(all put more shares in the
hands of the target co b/c essentially the co is buying back its own stock, key difference is the
regulatory regime that must be met when conducting a given transaction.
a. Self tender offer- Repurchase that rises to the level of a “tender- offer” under the
federal securities laws. This triggers a substantial disclosure obligation. Moreover,
since it is a “self”-tender (meaning the company is the one tendering for its own
shares), it triggers even heightened disclosure under the federal securities laws. This
stems from the fact that the agents of the shareholders (i.e. the board) is offering to
buy the shares from their principals (i.e. shareholders) when the board has complete
access to all available info about the co and the shareholders only have limited access.
b. Conditional exchange offer- Form of “self-tender offer. However, b/c the co is
offering to acquire additional shareholders’ shares NOT with cash, but w/ other
securities of the company, it is referred to as an “exchange offer.” The conditional
part relates to specific conditions to the company’s obligations to consummate the
exchange offer. In Unocal, one condition was that Mesa not get to tender its Unocal
shares into the exchange offer.
c. Repurchases- Repurchasing shares is ordinarily governed by state law. See e.g.
DGCL § 160(a) (565). However, if the co is a publicly traded co, the federal
securities laws could come into play depending on the circumstances surrounding the
repurchasing activities, thus triggering certain disclosure requirements. However,
repurchases typically do not rise to the level of a “tender offer,” and thus the
disclosure (if any) mandated by federal law is more minimal.

Corporate Fiduciary Duties: Controlling Stockholders

1. Duties of Controlling Stockholders (with control comes power!)
a. Majority stockholders are all controlling since owe more than 50% of stock and if
don’t have commulative voting then elect entire board.
b. Controlling shareholders are no always majority stockholders. Ex. when there
are millions of shares and you own 12% while everyone else owns less than 1
percent.
c. Controlling shareholder have a fiduciary duty to minority shareholders and to
the corporation
i. Must have a real life board- CANNOT control the co and use if for your own
use.
ii. This is why so many co’s when they acquire another co don’t simply want a
majority stake they want 100% or nothing.
1. Co will make a tender offer at a minimum of the majority of
outstanding shares b/c if not then the co will have a large block of
minority shares outstanding. If 51% is tendered, can do a 2nd step
merger and force out the remaining 49% of shares outstanding. (A
good defense for this is a provision in the charter that requires a super
majority vote).

1
 a. 1st and 3nd step must be the same (i.e.cash and cash, or debt
and debt) if not courts will find it coercive b/c people will
stampede to front so can get cash.
d. Sinclair Oil Corporation v. Levien (707)- Sinclair owns 97% if Sinven and owns
100% of Sinclair International Oil (SIO). Board of Sinvan was made up of everyone
Sinclair elected (virtually all were directors or employees of Sinclair (not
independent of Sinclair))P’s, minority shareholders who own 3% of Sinven alleged 2
breaches of fiduciary duties and sue Sinclair. Sinclair can’t buy remaining 3% of
Sinven b/c Venezuelan govt required that any co’s operating in their country must
retain a certain % of resident shareholders.
i. Sinclair concedes he has fidicuary dity as a controlling stockholder.
ii. Because the Sinven board was dominated by people who were loyal to
Sinclair, Sinclair owed Sinven fiduciary duties (When you don’t have 100%
ownership you can’t treat Sinven as your private play toy, have fiduciary
duties to shareholders and the co.
iii. 1st breach alleged is the excessive payment of dividends (exceeded their
revenue) that drained money from the co, thus stunting its industrial growth.
P’s believe that Sinclair’s motive was that they were short on cash so wanted
to use Sinven as a private piggy bank.
1. The payment of dividends were in compliance with DE legal capital
rules (DGCL § 170(a) (569) a dividend can be paid out of surplus (TA-
TL)-Capital (PV x outstanding shares) or out of this year or last years
net profits), so P’s don’t make an allegation that it violated legal
capital rules.
2. Normally when it comes to paying dividends directors have a very
wide latitude in deciding whether to pay dividends or not, so D’s argue
that the business judgment rule applies.
a. Court says that if the BJR applies than the P’s would have
to show either an improper motive or that it constituted a
waste of corporate assets.
b. If can’t show improper motive or waste of corporate assets,
then have to show that the dividend is not based on any
reasonable objective (mere rationality test)- very tough to
show.
3. Lower court refuses to apply, disables the BJR over the decision to pay
dividends mainly b/c of the domination of Sinclair over Sinven.
Instead the court applies the Intrinsic Fairness Test- the burden of
proof ordinarily on P to overcome the BJR, shifts to D directors to
prove that the dividends and everything else was intrinsically fair to
the co and shareholders.
a. P’s will always try to get this test, and inflict the burden on the
D’s- the best way to get it is to show a conflict of interest.
b. D must show they went through the cleansing process.
4. DE Sct doesn’t believe that the intrinsic fairness test was the right one
to apply b/c to make the intrinsic fairness test apply P’s must allege
breach of fiduciary duty coupled with self dealing
a. Self dealing in parent-subsidiary context- parent is gaining
profit for itself at the expense of the minority shareholders. If

1
 Sinclair used its domination and control to extract a benefit not
also made available to the minority shareholders.
b. DE Sct doesn’t believe that self dealing was involved in this
case b/c the dividends were being paid all the time to BOTH
Sinclair and the minority. Had Sinclair paid a dividend
solely to itself and not to the 3% minority it would have
been intrinsically unfair.
5. P’s argue that they don’t really want the dividend money and Sinclair
doesn’t either, just want it b/c of improper motive (cash flow), and
result is that they are sucking out all the $ out of it so it can’t expand
a. Sct holds that the P has the burden of showing that there were
opportunities that they could have explored and that Sinclair
usurped them from Sinven, but P’s couldn’t do it so these
allegations are just speculation.
6. BJR applies to the dividend payments and the P’s lose on this issue.
iv. 2nd breach of fiduciary duty allegation is claim that Sinclair prevented Sinven
from pursuing its legal rights after SIO breached its K with Sinven. (K called
for Sinven to sell all its crude oil to SIO for min and max prices and SIO
failed to make payments on time and buy the minimum amount of crude oil as
required by the K).
1. Court applies the intrinsic or entire fairness test b/c there was self
dealing here (100% of the benefit of the breach goes to Sinclair, while
only 97% of damage goes to Sinclair).Lopsided transaction, so burden
of proof is switched to D to prove that the failure to allow Sinven to
sue for breach of K was intrinsically unfair to Sinven. (similar to lewis
v. SLE case)
2. D was not entitled to BJR since there was substantial conflict of
interest. However, the BJR is disabled if self dealing.
3. D’s couldn’t come up with a justification so the court finds that it was
intrinsically unfair.
a. Sinclair makes a funny argument about this- SIO was buying
all the oil that Siven produced, so if it turned out that we
needed more than was produced what could we do? Court says
they could have made Sinven produce more oil.
v. Very often minority shareholders, particularly in closely held corporations, do
not have the opportunity to liquidate because no one to sell to, but the
majority of shareholders can because someone will want to buy control. So
minority shareholders will sue the majority for not including them in the deal,
BUT they won’t win b/c controlling shareholder DO NOT have fiduciary
duties over their shares, they can do with them and vote however they
want with them! Fiduciary duties ONLY apply to control and domination.
vi. DGCL 253- Short form merger provision
1. any time own more than 97% can merge subsidiary into parent (cant
merge other way) without asking minority vote
2. however minority has Appraisal Rights, DGCL 262, if merged out of
existence and have no say in matter then allows to dispute the
consideration your receiving.
e. Jones v. H.F. Ahmanson & Co (1969, Cal)

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 i. P, Jones claims D breached fiduciary responsibility in the creation and
operation of UF, DE corp which owned 87% outstanding of Association
(savings, loan bank in which have depositers who conver the deposit stock
into IPOs) stock.
ii. Although directors and officers of a co. are bound by fiduciary duties to act in
best interest of shareholders, the shareholders themselves normally do not
have such duties toward each other. However in Cal, a majority of share
holders of closely held corp. have a duty not to destroy the value of the shares
held by the minority shareholders.
iii. From Pepper v. Litton, a director, or controlling stockholder is a fiducuary and
where any engagements with the corp. are challenged the burden s on the
director or stockholder not only to prove the good fiath of the transaction but
also yto show its inherent fairness from the viewpt. Of the corp. and those
interested therein.
iv. Holding: here no market existed for people to buy Association stock, and thus
the controlling shareholder may not use their power to control the copr. For
the purpose of promoting a marketing scheme that benefits themselves
through the detriment of the minority. P wins.
1. the problem was not that D transferred its shares to UF but rather
offered debentures of Association for security. UF doesn’t own any
assets it’s a holding co and thus the loan to UF was not guaranteed.
This also caused the Assoc. board to stop paying dividends.
2. ex. like Geier Family Case- of the 85% owned sell 49% of the UF co
and still maintain majority with 51% of UF
a. .85 x .51 = 43.3% and yet D’s still in control of Assoc.
v. D could have caused Association to effect a stock split and create a market or
create a holding co. for Association shares and permit all stockholders to
exchange their shares before offering holding co. shares to the public. D never
allowed minority shareholders exchange and be able to optain the forward
stock split of the new UF corp. and thus breached fiduciary duties (like
Sinclair would be considered self dealing).
vi. Court holds that UF must hold an exchange stop split to P for 250 to 1 and
repayment of capital for IPO or allow P to cash out directly.
f. Forward Stock Splits
i. Ex. stockholder of DIM held 50shares worth 100 each (5000 total) before the
split, he will own 150 shares worth 33.33 each (a total of 5000) after the 3 to 1
split.
1. Splits are designed to make its common stock more affordable on a per
share basis to broader range of investors.
2. Tends to be a positive sign. It perceives the split as a sign of
managerial confidence that the co’s stock price will continue rising in
the immediate future. Thus seeking to bring th stock down into a more
affordable trading range.
g. Reverse Stock Split
i. Designed to increase the per share trading price of the co’s common stock and
1. Don’t want to stock to be considered penny stock or delisted for being
to low. NASDAQ below dollar delisted.
2. Market refers stock split as bearish, negative.
ii. can be used to eliminate minority stockholders.
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1. must cash out if only own fraction of a stock