Jeffrey Haas

New York Law School

Corporations
Spring 2013

I. Choice of Entity
A. Sole Proprietorships (SP)
1. Generally
a) a business individually owned by a single person
b) very little distinction between the personal and business affairs of the
owner
2. Legal - Unlimited Liability
3. Control – the sole proprietor controls completely, but is free to hire employees –
employees will have no liability
4. Tax
a) The proprietorship is not a separate taxable entity, no separate federal
income tax return is filed, but the proprietor must file a schedule C with his
individual return showing revenues and expenses of the business.
5. Transferability
a) through sale of transfer of assets to 3rd party buyer – no stock certificate
to sell
b) the sole proprietor can transfer ownership through an asset deal – the
proprietor sells the assets of the business to the new owner. The new owner
generally assumes the debts of the sole proprietor
6. Continuity – when does the business end
a) Whenever SP dies, or when subsequent owners decide to terminate the
business bankruptcy, decision to stop being in business, or sale of the business
B. GENERAL PARTNERSHIPS
1. Generally
a) An extension of a proprietorship when there is more than one owner
b) Lenders are not partners (may safeguard their interests without being
partners in business)
c) No need for a written agreement
2. Determining Formation of Partnership
a) Whether parties:
(1) have shared profits or losses
(2) have had the right to participate in control of the enterprise, or
commonly held real property
(3) Communit of interest in the venture
b) Rule: It is of no importance that the parties did not expressly negotiate
or agree to form a partnership.
c) Footnote 4 says that the right to participate in the control of the
business is the essence of co-ownership.
d) Subjective intent to form a partnership is not the test!!!! It is the
subjective intent to do things that just so happen to constitute activities of a

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 partnership
e) Even if a written agreement expressly disclaims that the parties are
forming a partnership, if the other terms of the agreement include profit and loss
sharing, and joint participation, the agreement might be construed as having
formed a partnership – in other words, if it looks like a duck, it’s a duck
(1) Default Provisions – govern aspects of the partnership where
the partnership agreement is silent – most applicable when the agreement
is not written
(2) Mandatory Provisions – mandatory provisions govern the
relationship among the partners and cannot be altered by the partnership
agreement. These include:
(a) Fiduciary duty
(b) power of every partner to dissolve partnership at any
time
(c) Unlimited liability of every partner for partnership
obligations
3. Liability:
a) If the partnership cannot pay
b) Each partner is jointly and severally liable for the debts of the
partnership, even if the debts were incurred by another partner on behalf of the
partnership – this is independent from any loss sharing agreement – the partner
can then sue the other partners for contribution
c) A personal creditor of a partner cannot attach or seize partnership assets
d) Partnership creditors can go after partnership assets and the personal
assets of any partner
4. Control and Management
a) All partners have equal say in the management of the business and voting
is done per capita – one man, one vote, unless there is a partnership agreement
stating otherwise.
b) If partners make unequal financial contributions, it is still equal say,
unless the partners agree to have their votes weighted according to the
contribution
c) Partners may agree to vest mngnt rights in a mnging partner, committee,
Sr. partners, or some group made up of less than all partners
5. Financial Provisions
a) Partners may share profits and losses in any way they agree
b) They may agree to share in losses differently than in how they share
profits
c) Types of sharing:
(1) Flat percentage
(2) Relative to financial contributions
(3) Sliding scale based on a partner’s efforts
d) Salary agreements:
(1) Fixed salary and salary is expense of the business
(2) Guaranteed payment - Salary charged against the partner’s
distributive share and no refund given if the salary exceeds the partner’s
share for the year
(3) UPC default – partners share profits and losses equally
e) Accounts:

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 (1) Drawing Account – advances are authorized so that a partner
may withdraw a specified amount either weekly or monthly against the
ultimate annual distribution
(2) Capital Account – reflects amounts invested by each partner
(3) Income Account – income is credited to the account as it is
ascertained and allocated among the partners
6. Transferability
a) When a partner sells his partnership interest, the partner is still entitled to
manage the partnership, until he gives up managerial control and the rest of the
partners agree to allow let him go and to give managerial control to the assignee
b) The selling partner is still joint and severally liable for the debts of the
partnership until he no longer has managerial control.
7. Duration: Dissolution, Winding Up, and Continuation of the Business
a) Partnership at will – UPC default: a partner has the power to compel
dissolution of the partnership at any time
b) Partnership for a term
(1) the partnership agreement expressly states that the partnership is
to continue until a specified date or event.
(2) If a partner breaks up the partnership beforehand he can be held
liable for breach of contract.
(3) Dissolution occurs immediately upon the happening of the
specified date or the event.
(4) Dissolution is not the end of the partnership, it is a change in the
relationship of the partners.
(5) Upon dissolution, the partners can vote to continue the
partnership or windup the partnership affairs and terminate the
partnership.
c) Death of a partner
(1) does not necessarily break up the partnership.
(2) The estate might be entitled to the deceased partner’s share of
the partnership and then the partnership continues, or an agreement
might state that death of any one of the partners dissolves the partnership
8. Fiduciary Duties
a) Cardozo: Joint adventurers, like co-partners, owe to one another the
duty of the finest loyalty
b) May require voluntary disclosure of all relevant information
c) Fiduciary duty continues even if the partners are in the process of
dissolving the partnership
9. The Partnership as an Entity
a) Modern View – more likely to treat the partnership as a separate legal
entity
b) Taxes
(1) Partnerships are flow-through tax entities – this means that there
is no income tax at the partnership or entity itself – the partners are taxed
personally based on their allocated share of the partnership profit or loss.
(2) the partnership is not a separate taxable entity for federal income
tax, but state tax laws might vary.
c) IRS Form 1065
(1) All partnerships must file a 1065- informational form

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 (2) allocation of profit does not necessarily mean that the partner
was paid that profit. The allocation might have been reinvested into the
partnership. To alleviate this, the partnership agreement can state that
each partner must receive distributions of at least enough to pay the tax
bill.
10. Raising Additional Capital
a) Loans
b) Invite new partners – the process of bringing in new partners will
typically be governed by the partnership agreement, if no agreement then
governed by UPA or RUPA.
C. Partnership Breakup Under the UPA
1. Three Phases of the Termination Process
a) Dissolution - an Event, usually decision of partner or court that sets
termination in motion. Dissolution does not end the partnership, it merely ends
the carrying on of business. It is a change in the legal status of the partners and
the partnership
b) Winding Up - Process of Termination, paying off debts, settle
employee/customer contracts, find purchaser for factory/bldg/assets/etc.
Winding up is an economic event of liquidation that follows dissolution
c) Termination – Completes the winding up and ends the partnership
2. Effect of One Partner leaving the Partnership
a) The UPA definition of dissolution says that the partnership is dissolved
when any partner leaves the partnership. UPA says that if one partner leaves and
the partnership is dissolved, the remaining partners can agree to carry on the
business under a continuation agreement. This essentially creates a new
partnership. The leaving partner is entitled to compensation for his share in the
partnership
3. Effect of Dissolution (one Partner leaving) on Third Parties
a) If the third party is leasing a bldg from the partnership, the lease is
xferred to the new partnership. Assets, licenses, franchises are also xferred to the
partnership.
4. Tax Consequences of Dissolution (one Partner Leaving)
a) The Internal Revenue Code says that fro tax purposes the partnership is
not dissolved unless the remaining partners do not continue to carry on business,
or there is a sale of at least 50% of partnership assets within 12 months
D. Joint Ventures
1. A joint venture is just like a partnership but is usually limited to short-term
purpose or to a particular business transaction.
E. Limited Partnership/Limited Liability Company/Limited Liability Partnership
1. Limited Partnerships – just like a GP except there are one or more general
partners, and one or more limited partners.
a) General Partner of Limited Partner?
(1) Control Test - Old statutes apply the control test
(2) Safe Harbor Statute - Some modern statutes contain a list of
activities that LPs may engage in without losing their shield of liability.
(3) Other statutes provide that a limited partner that crosses over into
general partner activities is only liable as to those specific transactions
b) Formation
(1) Old ULPA 201 – Certificate of Limited Partnership must be

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 executed and filed with the Sec. Of State in the state in which the P is
formed. The certificate must include the financial and other info about
the business and the general and limited partners.
(2) New ULPA
c) Liability
(1) GP: unlimited liability for debt of business
(2) LP: not personally liable for the debts of the partnership
and who are not expected to participate in the day-to-day affairs of
the partnership. They stand to lose their investment and nothing
more.
Management and Control
(3) General Partners - In return for taking on the liability, general
partners have the right to control the partnership
(4) Limited Partners
(a) not involved in the day to day affairs
(b) Not entitled to manage or control the business
(c) Control Rule
(i) LPs cannot engage in significant control or
managerial activities.
(ii) If they do so the start to look like GPs and they
lose their limited liability and be held joint and severally
liable.
(iii) If it looks like a duck, it’s a duck.
(d) Old ULPA Clandestine Problem – the LP can act as a
GP so long as no one finds out about it he won’t be liable
(e) Indirect Knowledge Problem – the creditor’s
reasonable belief that the LP crossed the line, the conduct must
have come from the limited partner himself –
(f) New ULPA § 303
(i) A limited partner is never liable for an
obligation of a LP, even if the limited partner
participates in the mgmt and control of LP.
(ii) This section eliminates entirely the Control Rule
and brings limited partners into parity w/LLC members,
LLP partners and corporate shareholders. Many states
have not adopted this section.
d) Taxation
(1) Firm Taxation or Flow-Through
(2) Traditionally – firm taxation applied to corporations and flow
through applied to partnerships.
A general partner can minimize his joint and several liability by interposing a corporation or LLC b/t him
and the LP (e.g. Gateway). If the LP cannot pay, limited partners lose their money and the creditor can go
after the assets of the corporation, which will have minimal investments.

2. Corporate General Partner

a) Generally
(1) This is a way to get around the liability concerns of a general
partner.
(2) The corporation is the general partner and makes a small

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 investment in exchange for the general partnership interest.
(3) A third party can sue the corporation as general partner and can
go after the assets of the corporation.
(4) The owner of the corporation is insulated by interposing a
limited liability corporation as the general partner – his personal assets
cannot be touched.
b) Corp. General Partners owe Duty of Loyalty to LP
F. Limited Liability Partnership
1. Generally
a) Essentially a general partnership, but
b) The joint and several liability of the partners limited to their own
personal malpractice and not the malpractice of other partners
c) Each partner is still personally liable for the general obligations of the
LLP if the LLP cannot pay.
d) For malpractice, each partner is only liable for acts of malpractice and
not the malpractice of any other partners in the LLP
e) To protect the public, LLPs require some type of filing, and that the LLP
has some minimum amount of malpractice insurance in place
2. RUPA 101(5) – LLP means a partnership that has filed a statement of
qualification under section 1001 and does not have a similar statement in effect in any
other jurisdiction
3. RUPA 1001 – Statement of Qualification
a) A partnership may become LLP pursuant to this section
b) The terms and conditions of the partnership becoming an LLP must be
approved by the vote necessary to amend the agreement except where the
agreement expressly considers contribution of obligations, the vote necessary to
amend those provisions
c) After approval required by (b) the partnership must file a statement of
qualification that must contain:
(1) Name of partnership
(2) Street address of the chief exec. Office and street address of an
office in this state if different from chief office
(3) If no office in the state then the name and address of the
partnership’s agent that can receive service of process
(4) A statement that the partnership elects to be limited liability
(5) A deferred effective date if any
4. Management & Control, Transferability, Continuity of Existence, Taxation
and Capital Raising Capability- See GP
G. Limited Liability Company
1. ULLCA 103 – Operating Agreement – Nonwaivable Provisions
a) The operating agreement may not:
(1) Unreasonably restrict a right to info or access to records
(2) Eliminate duty of loyalty, but agreement may
(a) Specify types or categories of activities that do not
violate duty of loyalty, if not manifestly unreasonable
(b) Specify # or % of members or disinterested managers
that may authorize or ratify after full disclosure of material facts,
a specific act or transaction that otherwise would violate the duty
(3) Unreasonably reduce duty of care

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 (4) Eliminate obligation of good faith and fair dealing
(5) Vary the right to expel a member under 601(6)
(6) Vary the requirement to wind up
(7) Restrict the rights of a person, other than a manager, member,
and transferee of a member’s distributional interest
2. ULLCA 105(a) – The name must contain limited liability company, limited
company, L.L.C., LLC, LC, L.C. Abbreviations allowed: Ltd. & Co.
3. ULLCA 112
a) An LLC has the same powers as an individual.
4. ULLCA 202 – Organization
a) One or more persons may organize an LLC by filing articles of
organization with the Secretary of State
b) The effective date is the date of filing or the date specified in articles
c) The filing with Sec of State is conclusive proof that the organizers
satisfied all conditions
5. ULLCA 203 – Articles of Organization must include
a) Name of company
b) Address of initial designated office
c) Name and address for initial agent for service of process
d) Name and address of each organizer
e) Whether the co. is to be a term co., & if so the term specified
f) Whether the co. is to be member managed or manager managed and the
name and address of each manager
g) Whether one or more of the members is to be liable for the co. debts
h) Articles cannot vary the nonwaivable provisions of 103
6. ULLCA 301 – Agency of Members and Managers
a) Subject to (b) & (c)
(1) Each member is an agent and has power to bind the co. for co.
business unless he had no authority and the 3rd party knew so
(2) An act of member that is not for co. business has no power to
bind unless authorized by other members
b) In a manager managed co.:
(1) A member is not an agent for co. business. Only managers can
act and have power to bind for co. business unless he had no authority
and the 3rd party knew so
(2) An act of manager not for co. business only binds the co. if he
was authorized under 404
c) Unless limited by the articles of organization any member or manager of
a member managed or manager managed co can transfer real property and the
instrument is binding upon a purchaser who gives value w/o knowledge of the
lack of authority
7. ULLCA 303 – Liability of Members and Managers
a) The debts and liabilities of LLC are solely the debts and liabilities of the
co. Members and managers are not personally liable
b) The lack of LLC to observe co. formalities or requirements is not a
ground for imposing personal liability on members/managers
8. ULLCA 404 – Management
a) Member managed company

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 (1) Each member has equal rights in the management and conduct of
business
(2) Except as provided by (c), majority vote prevails
b) Manager Managed Company
(1) Each manager has equal rights
(2) Except as provided by (c), majority vote prevails
(3) A manager
(a) Must be designated, appointed, elected, removed, or
replaced by a vote, approval, or consent of majority of the
members
(b) Holds office until a successor has been elected and
qualified, unless the manager resigns or is removed
c) The only matters or a member or manager managed co requiring consent
of ALL members are:
(1) The amendment of operating agreement
(2) Authorization of acts that would violate duty of loyalty
(3) Amendment to articles of organization
(4) The compromise of obligation to make contribution
(5) Admission of new member
(6) The compromise of obligation of a member to make contribution
(7) Consent to dissolve company
(8) Waiver of a right to have company business wound up and the
company terminated
(9) The consent to merge with another entity
(10) Sale, lease, disposal of company property with or without
goodwill
9. Formation
a) Article of Organization must be filed with the Secretary of State.
Requires the same type of basic information as is required for a partnership filing
10. Liability
a) All members of the LLC have limited liability as with corporations – as
an investor you can lose your investment but you can’t lose more than that.
11. Management and Control
a) For management and control, the LLC is more like a partnership than a
corporation
b) All members may participate in the management of the LLC unless the
main operative document designates otherwise
c) Operating agreement can and often does place management and control
in the hands of a select few persons.
(1) Member Managed LLCs – Each member has the power to bind
the LLC
(2) Manager Managed LLCs - Only the managers have authority to
bind the firm
12. Transferability
a) Financial interest in the LLC is freely transferable
b) The transferee only receives the financial aspects of the LLC until the
other members decide to let the transferee engage in management and control
aspects

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 13. Duration
a) Lasts for a specified amount of type as set out in the operating agreement
b) Events are not called events of dissolution as with partnerships, they are
called events of disassociation
c) If a specified event occurs, the LLC can decide to continue, or wind up
and terminate
14. Taxation
a) Flow-through
15. Raising Additional Capital
a) Additional Members could be brought it, like partnerships
b) Can have different class of securities- unlike S corp where you can only
have 1 type.
16. Operating Agreement
a) Contains the same types of issues that are covered in a partnership
agreement – management, allocation of losses, etc.
H. The Corporation
1. Generally
a) Must file a document with the Secretary of State
b) Separate and distinct legal entities from those who manage them
2. Public Held Enterprises – ownership interests are held by members of the
public, as opposed to owner-managers
a) Limited Liability
(1) Shareholders –limited liability; can only lose their amount of
their investment and no more
(2) Corporate Managers (Board of Directors) – elected by
shareholders; not personally liable, so long as they act on the
corporation’s behalf within their authority. .
(3) Officers – Members of the Board select Officers who manage on
a day to day basis;
(a) President/Vice President
(b) CEO – Chief Executive Officer
(c) CFO – Chief Financial Officer
(d) COO – Chief Operating Officer
(e) CAO – Chief Accounting Officer – Controller
(f) CIO – Chief Information Officer
(g) GC – General Counsel
b) Transferability of Ownership Interest
(1) Ownership interests in corporations (equity) – represented by
shares of stock – are freely transferable
(2) However, with closely held businesses, contractual agreements
between shareholders often exist and may contractually restrict a
shareholder’s ability to sell shares to a third party, or federal or state
securities laws might restrict who stock can be sold to
c) Continuity of Existence – the legal existence is perpetual, unless a
shorter term is stated in the certificate of incorporation (charter), or bankruptcy
d) Management and Control
(1) Direct management is removed from the hands of the owners
(shareholders) and given to directors

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 (2) Shareholders have no right to participate in management
(3) Management is by the Board of Directors or under the direction
of the BoD through officers
e) Entity Status
(1) A corporation is a legal person
(2) A corporation can exercise power and have rights in its own
name; has the power to enter into contracts, to sue and be sued, to
commit a crime, to be subjected to income and other taxes
(3) Constitutional Rights: Due process, 1st amendment rights. No
right to privacy, no right to remain silent.
f) Taxation
(1) Subchapter C – Double Taxation Entity –
(2) Subchapter S – Flow Through Taxation
(a) In order to be taxed as an S-Corp, the corp must actively
elect to be taxed as such.
(3) S-Corp Election Requirements
(a) Number of shareholders – you can only have up to 100
shareholders
(b) Identity of shareholders – Must be US citizens or legal
alien, or estate or trust, or another S-Corp –CANNOT BE C
CORP
(c) Capital Structure – an S-Corp can only issue shares of
one class of stock with equal voting rights and equal
management rights
(d) Subsidiaries
(i) An S-Corp can own shares of another S-Corp
and can also own shares of a C-Corp.
(4) S-Corp must file 1120S to the IRS – this is informational only so
that the IRS knows what
3. Differences Between Privately Held Corps and Publicly Held Corps
a) Capital Raising
(1) Public Corp: IPO, disclosures, public filings
(2) Private corp: shares are sold privately – a private placement and
is an exception to the securities laws.
b) Management
(1) Public – Separation
(2) Private – Unity
c) Transferability
(1) Public – Can sell on secondary market
(2) Private – There is no liquid secondary market; getting out is
much more difficult because not as much information about the business
d) Transparency
(1) Public – Must be transparent
(2) Private –Information is kept in house.
4. Raising Additional Capital
a) Primary Market – when a corporation first issues shares
b) Secondary Market – the purchase and sale of shares in the stock
exchange

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 c) Aside from borrowing money from a bank can raise capital by
issuing three types of securities:
(1) Common stock
(2) Debt Securities
(i) Bonds
(a) Long term debt securities – typical
maturity of 30 years
(b) Secured – such as a mortgage bond
which is collateralized by real estate. If they
don’t pay the bond
(ii) Debentures
(a) Medium term – typical 10-20 year
maturity
(b) May be secured or unsecured – if
unsecured then if the company goes bankrupt
you are fucked
(iii) Notes
(a) Short term – 5-10 years
(b) May be secured/collateralized
(3) Preferred Stock
(a) A hybrid security - cross between a debt security and
common stock
(i) Liquidation and dividend preference.

Statutes

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 d) DGCL §141(a)
(1) Business affairs of the corp are run by the BoD
(2) The # of directors is to be fixed by the by-laws
(3) Directors hold office until successor is elected or resignation or
removal
(4) Directors need not, but may be shareholders
(5) Majority vote of directors prevails
e) NYBCL §701
(1) Business affairs of the corp are run by the BoD
(2) Directors must be at least 18 years old
(3) The certificate of incorporation or by-laws may prescribe other
qualifications
f) NYBCL §630 – Liability of Shareholders for Wages Due to
Laborers, Servants, Employees
(1) The 10 largest shareholders – are jointly and severally
personally liable for all debts, wages, salaries due to any laborers,
servants, employees, other than independent contractors for services
performed for the corporation.
5. Where to Incorporate – Delaware’s Preeminence
a) In the context of a publicly traded corporation, Delaware permits the
corporation to take a poison pill to guard against hostile takeovers
b) Management friendly
II. Capital Structure and Legal Capital
A. Generally

●
●

B. Shareholders’ Equity
1. the owner’s equity portion of any business’s balance sheet will break down into 3
subparts
a) Capital contribution – this is what an equity owner invests in the
business. This is listed on the right side of the balance sheet under shareholder’s
equity. In current assets, that investment would appear as cash.
b) Retained Earnings/ Deficit – this is the portion of the owner’s equity
that reflects the accumulated profits that have not and are not being paid to the
owners.
c) Other Comprehensive Income/Loss – this is designed to reflect either
gains or losses that do not result from our continuing business operations, but
currency rates.

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C. Corporation’s Balance Sheet
1. The shareholders are the ownership claimants. 4 subcategories that fall within a
corporations owner’s equity
a) Common Stock Account –# of shares CS x par value. This dollar
amount forms for the legal capital rules, what is referred to as “capital” under
Del. law, and “stated capital” in NY
b) Preferred Stock Account – # of outstanding shares of preferred stock
multiplied by the par value of preferred shares of stock. Called “capital” in Del.
and “stated capital” in NY
c) APIC Account – this is referred to as the additional paid in capital
account. Also referred to as capital surplus. Generally only relates to common
stock and reflects the excess if any of the consideration paid to the corporation
that goes above and beyond the par value per share.
d) Common Stock plus Preferred Stock Plus any amount in the APIC
account equals the total value that stockholders have invested in the corp.
e) Common Stock Plus Preferred Stock equals Capital
D. Retained Earnings or Loss – the accumulative amount of earnings the co has made less the
accumulative amount of earnings distributed to shareholders in the form of dividends. Moneys that are in
this account – the corresponding account is cash – are used to finance business growth
E. Hypos:
1. Corp sells 50 shares of common stock, par value $5/share and sell to shareholders
at $100/share. Then corp sells 10 shares Series A preferred stock, par value $20, sold for
$20
Assets Liabilities
Cash: $5,200
Owner’s Equity
Preferred Stock Account: $200 (10 X $20)
Common Stock: $ 250
APIC: $ 4,750 (50 X $95)
Total Assets: $ 5,200 Total Liability +
Owner’s Equity: $ 5,200

F. Par Value
a) Protects creditors – minimal capital cushion within the company from
which distributions to shareholders cannot be paid.
b) Stockholders protected – ensure that some minimal equitable
contribution are always being paid for shares of stock.
G. Watered Stock
1. Stock offered for less than the par value – you do not want watered stock in a
company- this is illegal
H. Who Decides what the Par Value is
1. Board of Directors arbitrarily determines par value.
2. Where can you find par value of a corp: this goes in the certificate of
incorporation which is filed with the Sec. Of State. Or you can look at a stock certificate.
Or you can look at the balance sheet under stockholder’s equity.
I. Legal Capital
1. It is illegal for a corp to pay dividends to shareholders out of the capital cushion.

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J. DGCL § 154, NYBLL § 504 (d) - BoD can, on an ad hoc basis, candetermine par value.
K. Preferred Stock
1. Characteristics
a) Preference rights
(1) Dividend Preference – until preferred stockholders have
received there entire dividend, common stockholders cannot be paid
dividends
(a) Cumulative Preferred Stock – dividends for periods
that dividends were not declare accrue, PS holders must be paid
(b) Noncumulative – missed dividend quarters do not
accrue and the board cannot pay dividends for missed quarters
even if it wanted to. When the board finally declares dividends
it can only pay for that quarter.
(i) Venture Capitals prefer noncumulative
preferred stock over common stock – they ask for
convertible preferred stock – convertible preferred stock
gives the shareholder the option to convert the preferred
stock into common stock
(ii) Venture Capitals prefer noncumulative
preferred stock over cumulative preferred stock –
banks are reluctant to lend to young companies that have
arrearage dividends building up.
b) General Terms of a Preferred Stock Contract
(1) Voting Rights – emerge one of two ways
(a) By Law: Preferred stockholders vote as a group
separate from a general stockholder vote have to approve the
amendment or it won’t pass if the amdendment affects just them.
(b) Contract: Preferred stockholders generally do not elect
directors, vote on mergers, etc. But in the context of cumulate
preferred stock if the corp. misses a specified number of
dividends it might have the contractual right to elect members to
the board until the board pays the missed dividends
(2) Conversion Rights: the right to convert shares of preferred
stock into common stock at a specified conversion price.
(3) Participation Rights – entitle the preferred stockholder to
receive preferred stock dividends but also receive common stock
dividends as if the preferred stock was common stock.
(a) For example if the dividend on preferred stock is
$1/share and wants to pay .25/share to common stockholders. If
you have 20 shares of preferred stock that has participation
rights. You would receive $1 x 20shares AND .25 x 20shares –
you would end up with 20 as a straight preferred stockholder but
$25 if preferred stock with participation rights
(4) Redemption Rights – Company pays preferred higher dividend
yields for the right to redeem share at predetermined price. This is
beneificial if the dividend yield is 6%, but the current market interest rate
is 4%, the company would want to buy the outstanding shares and
reissue at the lower rate.

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 2. Preferred Stock Contract: The rights, privileges, preferences of PS are in the
certificate of incorporation in one of two ways:
a) In cert of incorp, amendment, or with Sec. of state
b) Blank Check Preferred Stock Provision –BoD has authority to
determine on an ad hoc basis to issue preferred stock at some later date. Then
they file a Certificate of Designation (Del.) with the Sec. Of State, in NY it is
called a Certificate of Amendment..
L. DGCL
1. DGCL § 170(a) – LEGAL CAPITAL RULE
a) Surplus = Total Assets Minus Total Liabilities Minus Capital. With a
low par value you can minimize capital and increase surplus. This is a technique
used to maximize the ability to pay dividends.
b) Net Profits – If there is nothing in the surplus account (or if the surplus
account is at a loss) can pay out of net profits for current year or from past year.
c) Hypo:
(1) Let’s assume that our common stock account has in it $200K
(2) This is b/c we have issued 100K shares of common stock with a
par value of $2 per share = $200K
(3) Balance sheet says we have total assets of $3MM
(4) Total liabilities of $2.6MM
(5) Net earnings of the FY are at ($400K)
(6) But last FY we made $100K
(7) Can we pay a dividend?
(8) First question – Do we have a surplus? Total Assets $3MM-
Total Liabilities $2.6MM – Capital $200K = Surplus $200K
d) Dividends; Payment; Wasting Asset Corporations: The directors may
declare and pay dividends upon the shares of its capital stock either:
(1) Out of its surplus
(2) If no surplus, out of its net profits for the fiscal year or last FY
2. NYBCL § 510 – LEGAL CAPITAL RULE IN NY - Dividends or Other
Distributions in Cash or Property
a) Equity and Solvency Test: A NY cannot pay a dividend if it is
currently insolvent or become insolvent by paying a dividend.
(1) Under §102 (8), insolvency is defined as unable to pay debts as
they become due in the usual course of the debtors business. If you look
at the total assets and total liabilities and if you were to liquidate all
assets and still not have enough to pay back creditors, this is an
indication the corp. is insolvent.
b) Net Assets or Balance Sheet Test: Dividends may be paid out of the
surplus so long as the net assets of corp remaining after the payments are at least
equal to the amount of its stated capital
(1) What are net assets in NY? – Total assets minus total liabilities
(same as Delaware). Thus, a NY corp could pay dividends if it isn’t
insolvent, if it wouldn’t be insolvent as a result of paying the dividend,
and if after paying the dividend the net assets are at least equal to the
amount of stated capital (the amount in the CS account plus the amount
in the PS account).

15
 (2) The effect of this rule is that a NY corporation can only pay in
dividends what it has in surplus. In NY you cannot go to net earnings of
this or last fiscal year. NY then is pro-creditor
c) Class Note: For a NY corp to pay dividend, it must past both tests
In NY - Can a
Corporation Pay
Dividends in
Accordance with section
510?
Common Stock 500,000 $ 500,000.00
shares - par value
$1/share
Assets $ 5,100,000.00
Liabilities $ 3,200,000.00

Net Assets $ 1,900,000.00 Net assets equals total assets minus total
liabilities.
Since in this example, net assets is MORE than
capital, dividends can be paid.
Surplus $ 1,400,000.00 Surplus equals net assets minus capital, which
equals the Maximum Dividend we can pay
Dividend per share $ 2.80
Common Stock 500,000 $ 500,000.00
shares - par value
$1/share
Assets $ 3,600,000.00
Liabilities $ 3,200,000.00
Net Profits This Year $ 250,000.00
Net Profits Last Year $ (250,000.00)

Net Assets $ 400,000.00 Net assets equals total assets minus total
liabilities.
In NY, since in this example net assets is less
than capital, they cannot pay dividends
Surplus $ (100,000.00) Maximum Dividend we can pay
Dividend per share $ (0.20)

3. DGCL § 174 – Liability of Directors for Unlawful Payment of Dividend, or

Unlawful Stock Purchase or Redemption; Exoneration from Liability; Contribution
Among Directors; Subrogation
a) Directors are jointly and severally liable for the full amount of the
unlawful dividend, stock purchase or stock redemption, if made willfully or
negligently (this means that if directors did not violate their duty of care they are
not liable. If they reasonably relied on the info provided them by accountants,
they are not negligent and not liable).
b) Knowing Shareholder Exception: If the stockholders were aware that
the dividend was unlawful, a director may collect contribution from those
stockholders in proportion to the amounts received by them
4. NYBCL § 506 – Determination of Stated Capital

16
 a) The state capital may be increased by the BoD by xfering all or part
of the surplus to stated capital
5. NYBCL § 630 – Liability of Shareholders for Wages – See Above
M. Common Stock
1. Generally
a) The BoD decides the price at which shares will be sold.
2. Common Stock and Voting:
a) Each share of common stock entitles the owner to one vote. If you own
one share, you are entitled to one vote.
b) Nonvoting Stock: There can be nonvoting stock, as long as there is a
class of voting stock.
c) Supervoting stock emerged. This means that the Class B stock gets 10
votes per share, and the Class A public stock gets one vote per share. This
enables the family to retain control over the company.
d) What do common stockholder vote on?
(1) Members of the Board
(2) Mergers
(3) Sale of all or substantially all of assets
(4) Amending the charter – NYBCL §803
(a) probably the most important voting right.
(b) Once a corp has issued shares, it may not amend the
charter w/o shareholder approval. Then the amendment must be
filed with the Sec. Of State.
(c) Exceptions:
(i) If you haven’t issued stock yet, the incorporator
may amend the charter w/o approval.
(ii) NYBCL § 105 - Typos may be corrected
without shareholder approval, but you cannot fix a typo
in the name of the company without sharedholder
approval
(d) If you have 50,000,000 shares authorized and they are all
sold, but you need to raise more capital, you might want to issue
50,000,000 more shares. The corp would need to get common
stockholder approval.
(e) To reduce preferred stock dividend rates – and then the
preferred stockholders would have to vote as a separate class
(5) Dissolution – the common stockholders would get to vote on
whether they want to the company to continue or not
3. Preemptive Rights
a) Can use these rights to prevent your control from being diluted – this is
like a right of first refusal so you holdings may not be diluted.
b) When do you have preemptive rights? Del. §102b3, NY §622 say that
you get no preemptive rights unless it is specifically stated in your charter.
III. Corporate Governing Documents and the Interplay with Corporate Finance
A. DGCL
1. DGCL §101 – Incorporators; How Formed; Purposes
a) Any person, partnership, association, or corp, no matter where they live
may incorporate in Del. by filing a cert or incorp w/ Sec. Of State
b) Can incorp. For any lawful purpose

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 2. NYBCL § 201 – Purposes
a) Any lawful purpose; but may not operated child day care unless
commission of social services so approved
3. DGCL §102 – Certificate of Incorporation
a) The certificate must set forth:
(1) The address of the registered office in Del. and the name of its
registered agent at that address
(2) The nature of business and its activities
(3) Stock classes and # of shares
(4) The name and mailing address of incorporators
(5) The names and mailing addresses of directors
4. NY §402 – Certificate of Incorporation
a) Name of Corporation Requirements
(1) Can’t mislead the public
(2) Can’t use the word “police” in your name
b) Shares – the aggregate # of shares the corp is authorized to issue must be
set out - if only one class of shares, the par value must be stated, or a statement
that the shares will not be sold at par value, and if the shares are to be divided
into classes, the # of shares in each class, and the par value of shares having a par
value, and a statement as to which shares are without par value
c) Liability of directors – you can eliminate or limit the personal liability
of directors for breach of duty, except that you can’t exclude liability for bad
faith, intentional misconduct, or knowing violation of law
B. Three Main Documents
1. Hierarchy:
a) The Cert
b) By Laws
c) Resolutions
C. Certificate of Incorporation
1. NY §301
a) You can’t use the word Bank unless you are a bank or NY banking
unless you get NY banking dept approval
b) You can reserve a name so long as you file a certificate within 60 days
2. NY §402
a) must include the business purpose in the cert. of incorp.; can choose a
generic business purpose “to engage in any lawful activity under NY law.” If
you do business beyond the stated purpose you run into “ultra vires.”
b) The terms of each class or series of stock must be set out in the cert.
c) Duration of Corp: you can specify a termination date – if you don’t the
assumed date is perpetual
d) You can put in a provision that eliminates your director’s breaches for
duty of care, but not for malfeasance
e) You can put anything else you want in the cert so long as it is not illegal
A. Milton Friedman – Corporate executive responsibility is to make as much money
as possible while conforming to the basic rules of the society, both those
embodied in law and those embodied in ethical custom.
B. NY has constituency statue-not Delaware.

18
 C. Time did not hold that corporate culture, standing alone, is worthy of protection
as an end in itself. Promoting, protecting, or pursuing non-stockholder
considerations must lead at some point to value for stockholders.
D. Giving away services to attract business is a sales tactic, not a corporate culture.
E. NY Law- “stated capital”
F. Delaware- “capital”

D. Ultra Vires Doctrine

a) Modern Day US - Where a corp lacks the explicit power to engage in
activity, the court often finds implicit powers to keep the k alive.
2. Distinction between Ultra Vires Act and Illegal Act – illegal acts are illegal
acts for everyone, but ultra vires acts could be legal acts, but just go beyond the corp
charter
3. Distinction between Ultra Vires Acts and Unauthorized Acts – if an officer
enters into a k that is within the purpose of the corp charter, but did not get Board
approval, the act is unauthorized
4. Unauthorized Acts By Corporate Officers – acts that the corporation had the
authority to engage in, but the particular person lacked the authority to engage in the
transaction
5. DGCL § 124 – Lack of Corporate Capacity or Power; Ultra Vires – No act or
a corp or xfer of real property to or by a corp shall be invalid by virtue of the fact the corp
was without capacity or power to do such act, but such lack of capacity may be asserted:
a) In a proceeding by a stockholder against the corp to enjoin the corp from
going through with xfer of real or personal property of the corp. The court will
balance the equities in making a determination as to whether the contract is void
– the court will consider the respective damages to the parties
6. NYBCL § 203 – Defense of Ultra Vires - No act of corp or xfer of property to
or by a corp is shall be invalid by virtue of the fact the corp was without capacity or
power to do such act, but such lack of capacity may be asserted:
a) In a proceeding by a stockholder against the corp to enjoin the corp from
going through with xfer of real or personal property of the corp. The court will
balance the equities in making a determination
IV. OBJECTIVE AND CONDUCT OF THE CORPORATION
A. Corporate Social Responsibility
(1) Corp can make donations, but they may not be too great.
B. NY more constituency friendly than DE.
(1) The short and long term interest of the shareholders and its
impact on
(2) Corps current employees
(3) Retired employees
(4) The corps customers and creditors
(5) The employment opportunities and impact on he community
b) Del – there is no constituency statute. All rules dealing with
constituencies are from case law.
2. ABA Rules of Prof. Conduct § 2.01 – Objective and Conduct of Corp
a) Objective of business activities should be to enhance corp profit and
shareholder gain
C. Pre-Incorporation Transactions by Promoters – USUALLY ON BAR

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 1. Promoter – A person who transforms an idea into a business by bringing
together the needed persons and assets, and superintending the steps required to bring the
new business into existence. (recruiting employees, looking into getting capital)
Promoters usually get some type of interest in the company that they set up – they
become one of the initial stockholders.
2. Promoter Liability
a) General Rule – A promoter is personally liable on a contract he makes
for the benefit of a contemplated corporation even after the corporation comes
into existence. He is essentially a party to the contract
b) Exception – A promoter is not a party to the contract, and not personally
liable, if at the time the contract was entered into the other party
(1) knew that the corporation was not in existence; and
(2) agreed to look solely to the corporation for performance. This
can be express or implied from the conduct of the parties – if the
promoter receives payments made out to his name, there is evidence that
there was not an agreement that the promoter was not a party to the
contract
(a) Mere knowledge that the corporation was not in
existence is insufficient – the party must agree not to hold the
promoter liable

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 A. Consequences of Defective Incorporation

3. Revised Model Business Corp Act

a) § 2.03 Incorporation – unless a delayed effective date is specified, the
corp comes into existence when the articles of incorp are filed. The sec of state’s
filing of the articles is conclusive proof that the incorporators satisfied all
conditions precedent to forming the corp
b) § 2.04 – Liability for Preincorporation Transactions – All persons
purporting to act as or on behalf of a corporation knowing that there was no
incorporation are jointly and severally liable
4. NYBCL § 109(a)(2) – En Quo Laurento (the state can kick your ass) The AG
may maintain an action or special proceeding to annul the corporate existence or dissolve
any corporation that has not been duly formed
5. DGCL § 329(b) - ……..
6. Doctrine of Estoppel:
a) Third parties are dealing with you as if you are in fact an agent of a
corporation. The doctrine of estoppel is if third parties treat you as a corporation
and they don’t expect to get paid beyond what the corporation can pay, they
cannot after the fact sue the alleged shareholders personally, because they are
estopped from doing so. This does not work for tort victims – like a slip and fall
outside the store – b/.c the victim did not deal with you.
7. De Jure – means the corp did everything required by law to form a corp. then
you would get limited liability and can get your veil pierced
8. A de facto corporation is said to exist when the steps taken to incorporate
the enterprise were insufficient to result in a de jure corporation with respect to a
challenge by the state in a quo warranto proceeding, but were sufficient to treat
the enterprise as a corporation with respect to third parties. Corporate status can
be invalidated by the state through quo warranto proceedings, but cannot be
invalidated by third parties.
9. Estoppel theory v. De Facto theory
a) Estoppel is based on what the third party thinks about the business –
people that choose to deal with a corporation. But de facto is based on what the
“corporation” has done – this would apply to tort claims – the victim doesn’t
know that it is a corporation that is responsible for shoveling the sidewalk if he
slips in the snow.
b) The effect is generally the same – a corp can’t argue that they were not a
corp – but estoppel is usually applied to only one transaction, because the other
party relied on the representation of the corp that they were a corp.
c) The difference is in precedential effect – b/c de facto requires a showing
of the conduct of the parties, a decision that a corp is de facto in one case might
not necessarily mean de facto in a case involving another plaintiff because the
conduct of the corp in that transaction might be different and not as conclusive
10. Cantor v. Sunshine Greenery, Inc., 1979
a) DE FACTO CORP RULE - Even though a promotor hadn’t formed a de
jure corp he satisfied the elements of forming a de facto corporation and thus he
is not liable under the contract. Three requirements:
(1) Execution of a certificate of incorporation
(2) Bona fide effort to file the certificate – even if it hadn’t been
filed

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 (3) Actual exercise of corporate power
D. Piercing the Corporate Veil
1. How to Avoid A Piercing of Your Corporate Veil
a) Keep separate personal and corporate bank accounts
b) Keep corporate formalities – have board meetings, keep minutes of those
meetings
c) Document money paid to you or other people in the corporation need to
be documented, like employee salaries; interest on loans
d) Provide the minimum amount of capital customary for the type of
business involved
2. If a majority representing ¾ of the value of creditors or stockholders agree to any
compromise and to any reorganization of the corp, the said compromise if sanctioned by
the court shall be binding on all the creditors and all the stockholders and on the
corporation.
a) Piercing the Corporate Veil in DE
(1) Fraud OR
(2) Alter Ego
b) Alter Ego Rule: Plaintiff must show that the parent and the subsidiary
(1) operated as a single economic entity; and
(2) an overall element of injustice or unfairness
Factors for Consideration:
(a) Whether the corp was solvent
(b) Whether the corporation was adequately capitalized –
did the parent give enough funds the subsidiary to make it
successful
(c) Whether dividends were paid
(d) Corporate records kept
(e) Officers or directors functioned properly
(f) Corporate formalities observed – does the Board of the
subsidiary meet, does the parent recognize shareholder approval
before subsidiary action, does the subsidiary file its own taxes,
etc….
(g) Whether dominant shareholder siphoned corporate funds
(h) Whether the corp functioned as a façade for the
dominant shareholder
c) NY Rule for Piercing the Corporate Veil - Respondeat superior:
whenever anyone uses control of the corporation to further his own business he
will be liable for the corporation’s acts. Such liability extends to corporate
commercial dealings and negligent acts
d) 2 possible situations of respondeat:
(1) that the corporation is a fragment of a larger corporate combine
which actually conducts the business – if this is the case then only the
larger corporate entity would be liable and the shareholder would not be
personally liable
(2) the corporation is a “dummy” for individual stockholders who
are carrying on the business in their personal capacities for personal
rather than corporate ends – in this case the stockholder will be
personally liable
3. Minton Case

22
 a) The court said that the equitable owners of the corp may find themselves
liable for the debts of the company if: if the officer treats the corp assets as his
own, they add capital to the corp at will, they hold themselves personally liable
for the corp liabilities, they provide inadequate capitalization, and the equitable
owner actively participates in the business of the corp.
b) Inadequate Capitalization – capital is inadequate when the capital is
trifling as compared to the work to be done and the possible liability. When the
co. is not funded enough to cover the liability and self-finance from one dry spot
to the next.
c) Accommodation – just because he was acting as officer out of courtesy,
if he put himself in that post, then he will be liable if equitable. He cannot escape
equitable liability just because he took on the position as an accommodation.
E. Equitable Subordination of Shareholder Claims
1. Deep-Rock Doctrine - Punishing shareholders who cut in the repayment food-
chain line. Potentially applies to the debt claims of stockholders.
2. Three requirements for inequitable subordination/Deep Rock
a) The creditor has to engage in some type of inequitable conduct – but
does not need to rise to the level of fraud. Inequitable conduct includes:
(1) breach of fiduciary duties
(2) undercapitalization
(3) transferring capital investment interest to debt claim for purpose
of moving up food chain
(4)
b) Must have resulted in inequity to other creditors to the corp
c) Equitable subordination of the claim must not be inconsistent with the
bankruptcy code
V. CORPORATE STRUCTURE
A. Distribution of Corporate Powers
1. Generally
a) Corporate powers are governed by statute according to the corporate
code of the state
b) A corporation’s by-laws and charter will further define the allocation of
power among stockholders, directors and officers.
2. Shareholders can vote on – 1) Board of Directors, 2) Fundamental
corporate transactions- merger, consolidation (merger with more than 2
companies), sale of all or substantially all the assets of the company, 3)
charter amendments – if it adversely affects another class of stock – they
have veto power, 4) bylaws, 5) dissolution.
a) Shareholders have power to vote on removal of electors
(1) How can you remove a director in NY?
(a) § 706(a) -You can remove directors for cause by vote of
the shareholders
(b) § 706(b) – Directors can be removed without cause by a
vote of the shareholders so long as the bylaws or cert of incorp
so provide.
(2) How can you remove a director in Del.?
(a) §141(k) – You can remove directors with or without
cause by a majority vote of the shareholders

23
 (3) Note: the charter can amend the power to only allow for
removal of directors with cause
b) Shareholders have power to vote on election directors
c) Power to amend bylaws, but the cert of incorp can share that power with
directors
d) Vote on fundamental xactions, like sale of substantial assets, merger,
dissolution
e) Vote on amendments to charter
f) Vote on dissolution of the corporation
g) They could increased the # of authorized shares to be issued to raise
money – but they do not get to dictate when those shares are issued – that is up to
the executives and directors
3. Scnhell v. Chris-Craft
a) Even though the board was legally permitted to change the bylaws, they
acted in bad faith and their action was inequitable to the shareholders. The board
members put their own interests in their jobs ahead of the interests of the
shareholders. This was a breach of the duty of loyalty.
4. Blasius Industries
a) Blasius standard-Board must have a compelling justification in order for
the board to take unilateral action to interfere with the shareholders voting rights.
If you don’t have a compelling justification to do so then you breach the duty of
loyalty.
5. Unocal Decision
a) Unusual – 1) compelling justification (threat to corporate policy),
2) defensive measure is reasonable and proportionate to the threat.
b) Primary purpose of impeding and interfering with the effectiveness
of a shareholder vote in a contested election for directors – requires a
compelling justification by the board.
c) “A defensive measure taken in response to some threat to
corporate policy and effectiveness which touches upon issues of control.”
d) Blasius Rule – For a board to take unilateral action that interferes with
the shareholders voting rights, the board must have a compelling justification.
e) Unocal Test: Reasonable grounds to believe there is a corporate threats,
and the action taken by the board is reasonable in proportion to the threat. This
rule only applies to unilateral board action. If the shareholders voted on
something then this test does not apply.

A. Two discrete corporate events must occur, in precise sequence, to amend the
certificate of incorporation. First, the board of directors must adopt a resolution
declaring the advisability of the amendment and calling for a stockholder vote.
Second, a majority of the outstanding stock entitled to vote must vote in favor.
The stockholders may not act without prior board action.

B. Authority in General
1. Terminology
a) Agent – a person who acts on behalf of and subject to the control of
another

24
 (1) General Agent – authorized to conduct a series of transactions
involving continuity of service. E.g. corporate officer
(2) Special Agent – authorized to conduct only a single transaction,
or hired for a specific limited purpose
b) Principal – a person on whose behalf and subject to whose control an
agent acts
(1) Disclosed – the third person knows that the agent is acting on
behalf of a principal and knows the principal’s identity
(2) Partially Disclosed – the third person knows the agent is acting
on behalf of a principal but does not know the identity
(3) Undisclosed – the agent purports to the third party that he is
acting on his own behalf. The principal is still subject to liability
c) Master – a principal that has control or the right to control the physical
conduct of an agent in the performance of the agent’s services
d) Servant – an agent whose physical conduct in the performance of
services for the principal is subject to the control of the principal
e) Respondeat Superior – a master is liable for the torts of a servant if the
tort is committed while the servant is acting within the scope of employment
2. Liability of Principal to Third Person – Under the law of agency, a principal
becomes liable to a third person as a result of an act or transaction by another on the
principal’s behalf if that person had actual, apparent, or inherent authority, or was an
agent by estoppel.
a) Actual Authority – an agent has actual authority to act on the principal’s
behalf if the principal’s words would lead a reasonable person in the agent’s
position to believe that the principal had authorized him to act
(1) Express – “I authorize you to contract in my name and purchase
100 shares of Western Union stock at today’s market.”
(2) Implied – the instructions are less precise. “I authorize you to
sell my automobile.” Express in this instruction is the authority to
transfer title to the vehicle in exchange for money. But implied is the
authority to extend credit or a payment plan, or to accept something in
partial exchange.
(a) Incidental Authority – an offshoot of implied authority.
The authority to do incidental acts that are reasonably necessary
to accomplish an actually authorized transaction. E.g.: principal
gives authority to sell something at auction. Law requires a
license to sell at an auction. Getting the license is an act
incidentally authorized by giving the authority to sell something
at auction
b) Apparent Authority – an agent has apparent authority to act on the
principal’s behalf in relation to a third person if the words or conduct of the
principal would lead a reasonable person to believe that the principal had
authorized the agent to so act.
(1) E.g.: Principal writes agent directing him to act as his agent for
the sale of Blackacre. Principal sends a copy of the letter to the
prospective purchaser. Agent has actual authority and as to purchaser,
apparent authority.

25
 (2) Variation: on the letter to agent, principal includes a postscript
that is not in the copy of the letter to purchaser, which tells agent not to
sell until he has spoken to principal. Agent has no actual authority, but
to purchaser has apparent authority.
c) Agency by Estoppel – an alleged principal will be liable for the action
of an agent, if the principal knows that the third party believes that an agent is
authorized to conduct business on his behalf, when in fact the agent is not his
agent, and the principal fails to correct a person who is not otherwise liable as a
party to a transaction purported to be done on his account, is nevertheless subject
to liability to persons who have changed their positions because of their belief
that the transaction was entered into by or for him if:
(1) He intentionally or carelessly caused such belief; or
(2) Knowing of such belief and that others might change their
positions because of it, he did not take reasonable steps to notify them of
the facts
d) Inherent Authority – an agent may bind a principal in certain cases
even where the agent had neither actual nor apparent authority. If a person in the
principal’s position should reasonably have foreseen that an agent would take
action that he was not authorized to take, the principal is liable. The doctrine of
inherent authority exists for protection of persons harmed by or dealing with a
servant or other agent
(1) Disclosed or partially disclosed principal is liable for the act of
his agent even if the principal had forbidden the agent to do the act
(a) If the act usually accompanies of is incidental to the
transaction the agent was authorized to conduct; and
(b) The third person reasonably believes the agent is
authorized to do the act
e) Ratification – Even if the agent has neither actual, apparent, nor inherent
authority, the principal will be bound to the third person if the agent purported to
act on the agent’s behalf, and the principal with knowledge of the material facts,
either
(1) Affirms the agent’s conduct by manifesting an intention to treat
the agent’s conduct as authorized (accepts the benefits without
objecting); or
(2) Engages in conduct that is justifiable only if he has such an
intention – also called implied ratification
(a) E.g.: P authorizes A to sell a stove at a specified price
w/o a warranty. A purporting to have the authority to do so,
contracts with T for the stove at a lower price than specified and
with a 2 year warranty. P receives the check given by T
knowing all the facts. The k made between A and T is then
affirmed.
f) Acquiescence – if the agent performs a series of acts similar in nature,
the failure of the principal to object to them is an indication that he consents to
the performance of similar acts in the future under similar circumstances. The
principal’s acquiescence gives rise to actual authority. Is the real difference
between ratification and acquiescence that ratification is one transaction and
acquiescence is a course of conduct?

26
 g) Termination of Agent’s Authority – a principal has the power to
terminate an agent’s authority at any time, even if it means violating a contract
between principal and agent. The agent could sue for damages under the
contract, but the court will not force the principal to allow the agent to conduct
business on his behalf
(1) Exception: Agency coupled with interest
3. Liability of Third Person to Principal – the third person is liable to the
principal if the third person enters into a contract with an agent under which the agent’s
principal would be liable to the third person
a) Exception: if the principal was undisclosed and the agent or principal
knew that the third person would not have entered into the contract had he known
the principal’s identity
4. Liability of Agent to Third Person
a) Where the Principal is Bound – when the agent has actual, apparent, of
inherent authority, so that the principal is bound to the third person, the agent’s
liability to the third person depends on whether the principal was disclosed,
partially disclosed, or undisclosed
(1) Undisclosed Principal – the agent is bound, even though the
principal is also bound. The theory is that the third person must have
expected the agent to be a party to the contract because he did not know
of the existence of principal
(2) Partially Disclosed Principal – the agent is bound, even though
the principal is also bound. The theory is that because the third person
did not know the identity of the principal, he could not have investigated
the principal’s credit of reliability, and probably expected that the agent
would be liable either solely or as surety
(3) Disclosed Principal – if the agent acted with actual, apparent, or
inherent authority, or the principal ratified the act, the agent is not bound
b) Where the Principal is Not Bound – the principal is not bound where
the agent did not have actual, apparent, or inherent authority to act. The agent
would be liable. There are two theories of liability
(1) the contract theory: the agent would be liable for expectation
damages
(2) the warranty theory: the agent would be liable for reliance
damages
5. Liability of Agent to Principal –
a) if the agent had actual authority, he is not liable to the principal;
b) if the agent had apparent authority, she is liable for damages;
c) if the agent’s actions were ratified, the agent is not liable
d) the agent is liable to the principal if he had no actual authority
e) So the sale of Blackacre example. If to the purchaser, the agent has
apparent authority, but the agent had no actual authority because the principal
said call me before you sell, and the agent sold without doing so, the agent is
liable to the principal.
6. Liability of Principal to Agent – if the agent acted with actual authority the
principal must indemnify the agent for any damages the agent pays – like any expenses
the agent pays for defending actions against third parties
7. Agency Costs are the sum of:
a) The monitoring expenditures by the principal

27
 b) The bonding expenditures by the agent
c) The residual loss
C. Action by Directors
1. Role of Directors
a) Modern – the Board is to monitor the corporate executives. This is so
for two reasons: 1) only meet 6-12 times per year; 2) only informed at
meetings
2. Formalities Required for Action by the Board
a) Level I: The Governing Rules – Based on Statutes
(1) Can only take legally binding action in one of two ways:
(a) Unanimous Written Consent – The desired action is
written on a document and each director must sign his name. If
approval is not unanimous, the Board cannot take action.
(b) Meetings – A single director has no power. The
directors can only act as a body. Directors must act at a duly
convened meeting where a quorum is present (teleconferences,
videoconferences will work – and most statutes permit the board
to act by unanimous written consent)
(2) Notice
(a) Regular Meetings - Formal notice not required – the
directors are already on notice of date/time/place.
(b) Special Meetings - notice of date/time/place must be
given to every director
(3) If Taking Action at a Meeting You Need Two Things:
(a) Quorum – a majority of the full board present at the
meeting. Some statutes allow the by-laws to set a higher or
lower number to equal a quorum. Del and NY allow you to
name greater than a majority. Delaware allows as little as a third
to equal a quorum. You cannot name less than 1/3
(i) DGCL 141(b)
(ii) NYBCL 707
(b) Voting – Mostly need majority of quorum, unless
otherwise specified by by-laws.
b) Level II: Consequences of Noncompliance – the board action could be
rendered ineffective
(1) Unanimous Explicit, but Informal Approval – approval
without formalities is ineffective, even if approval was explicit and
unanimous
(2) Explicit majority Approval Coupled with Acquiescence by
Remaining Directors
(3) Majority Approval or Acquiescence
3. Staggered Board of Directors
a) Generally – a board of directors that is broken into multiple classes
(1)
Class 1 - 123 Class 2 - 456 Class 3 - 789
Come up for reelection this Come up for reelection next Come up for reelection the
year year following year

(2) Where is the statutory authority for a staggered board?

28
 (a) DGCL § 141 (d) – a staggered board provision must be
set forth in the cert of incorp or amendment by shareholder
approval. Classes limited to a maximum of three.
(b) NY NYBCL § 704(a) – Allows you to divide directors
into as many as 4 classes. So in NY, it could take as many as 3
years for dissident shareholders to replace directors.
4. Fiduciary Duty
a) Four Basic Tests:
(1) Business Judgment Rule
(a) The presumption is that in making a business decision,
the directors
(i) acted on an informed basis
(ii) in good faith; and
(iii) honest belief that the action taken was in the
best interests of the corp.
(b) The burden therefore is on the party questioning the
board’s action to prove that the action was not in good faith,
informed, etc.
(c) Business judgment is an informed one if the directors
have informed themselves prior to making a business decision of
all material information reasonably available to them. So long as
the BoD had a rational business purpose, even if it makes a
dumb decision, the BoD will almost always win.
(d) The plaintiff would have to present evidence that the
BoD breached their fiduciary duty.
(2) Enhanced Scrutiny Test
(3) Intrinsic Fairness Test
(4) Compelling Justification
5. Stroud v. Grace – Director Qualification Case
a) Class Note:
(1) Director qualification case – directors amend by-laws to set out
characteristics for eligibility to the board. Also involved board action
that impeded shareholder voting rights.
(2) The difference between this case and the Blasius case is that in
Blasius the Board acted unilaterally without shareholder approval. In
Stroud, the shareholders voted and ratified the Board members’ actions,
so the Board did not act unilaterally. The plaintiffs claim here that the
shareholders were not fully informed and claim that the ratification is
void. Because of the business judgment rule, the burden then shifts to
the plaintiffs to show that the disclosure was insufficient.
b) Shareholders sue the board alleging breach of fiduciary duties by
recommending charter amendments to the shareholders. Plaintiffs claim that the
disclosures the board made were inadequate and inaccurate in the notice of
meeting. The amendments would prevent shareholders from nominating
members to the board.
c) Rule

29
 (1) Compelling justification test does not apply in this case because
the board was not acting when its control was being threatened. Where
three directors controlled over 50% of outstanding shares of closely held
corporation, and at least 70% of corporation's shareholders supported
proposed general option agreement, which gave shareholders and
corporation right of first refusal to purchase any shares offered to
unrelated persons.
(2) In the absence of fraud, fully-informed shareholder vote ratifies
board action. The minority shareholders had to show that the
information provided them by the majority shareholders (also directors in
this case) was inadequate or misleading. The burden is on the minority
shareholders to prove that disclosure was inadequate.
6. Williams v. Geier
a) The Board recommended to shareholders that they vote in favor of a
recapitalization amendment, in the form of a tenure voting plan, to give each
share of stock 10 votes, but if the stock were transferred each share would carry
one vote until the transferee owned the shares for at least three years. The Geier
family owns a majority of the stock. Of the remaining stockholders, a majority
of them did not vote in favor of the recapitalization plan.
b) Board’s reason for the plan:
(1) To reward people who own the stock for a long period of time
(2) but the real reason is to reduce the likelihood of a hostile
takeover through a tender offer – an offer made by a third party to buy
shareholders’ shares. This would be published in newspapers. The
tender offer is usually more than the stock price listed in the stock-
exchange. A tender offer must comply with securities laws.
c) Holding: Neither Unocal nor Blasius is the correct test. These tests
apply when the board takes unilateral action impeding shareholders vote or when
the board seeks to secure their positions. That was not the case here. The
shareholders voted. The business judgment rule applies to board in making its
recommendation. There was a fully informed shareholder vote and the vote is
valid
d) What can you do as a Board if after getting shareholder approval for an
amendment; you do not want to file the amendment? DGCL §242(c) governs.
You can as a board choose not to file something that the shareholders voted for –
you have to disclose to shareholders though that the Board retains the right to
ignore the approval. If you didn’t disclose this to the shareholders then you are
powerless as a board to not file it.
SMITH V. VAN GORKUM
Rule: that before making a decision the directors must have informed themselves prior to
making the business decision of all material information reasonably available to them
a) Holding:
(1) The directors did not inform themselves as to Van Gorkom’s role
in the sale price
(2) Were uninformed as to the company’s worth
(3) They were grossly negligent in approving the sale after only 2
hours consideration and without prior notice
7. Class Note

30
 a) Until Van Gorkom came around, the thought among directors was that
no one could ever be grossly negligent to the point that courts would actually
hold them liable. In the aftermath of Van Gorkom, board members were
resigning left and right.
b) In the Van Gorkom era, the state legislatures took almost immediate
action. The passed legislation that limited a director’s personal liability for
director’s breach of the duty of care.
8. DBCL § 242(b)(1) – Amendment of Cert. Of Incorp. After Issue of Stock
a) Resolution from BoD setting forth advisability of proposed amendment
b) Majority of stockholders vote to approve
c) File the amendment with the Sec. Of State of Del. and the amendment is
like a pocket part
D. Action by Corporate Officers
1. Generally
a) Charged by the board with the responsibility of managing the day to day
operations
b) Execs have fiduciary duties to the corp and stockholders
2. DGCL §142 – Officers, Titles, Duties, Selection, Term
a) Officers
(1) Every corp shall have officers with titles and duties as stated in
the by-laws and as necessary to sign instruments and stock certs.
(2) A number of offices can be held by the same person.
(3) Must be a Secretary: At least one officer shall be responsible
for taking the minutes of director and shareholder meetings
b) Terms
(1) The voting method and length of term shall be as stated in the
bylaws.
(2) Each officer is to serve until a successor is elected
3. NYBCL §715 – Officers - board MAY elect or appoint officers (not required as
in Del)
4. NYBCL §716 – Removal of Officers - Officers may be removed by the board
with or without cause
5. President
a) Some Cases: hold that the pres does not have any apparent authority by
virtue of his position, and that he only has the actual authority that the board
confers upon him
b) Modern View: Expansive Interpretation - the pres has apparent
authority to bind the company to contracts in the usual and regular course of
business, but not to contracts of an extraordinary nature
(1) What is extraordinary? Factors considered
(a) Economic magnitude of the transaction in relation to
corp assets and earnings
(b) Extent of risk involved
(c) Timespan of the action’s effect
(d) Cost of reversing the action
(2) Boundaries on Apparent Authority
(a) Only the board can declare dividends

31
 (b) Statutes that enumerate matters that con only be done
upon approval of board and shareholders
6. Chairman of the Board – very little case law on Chairman
7. Vice-Presidents
a) Earlier cases: little or no apparent authority
b) Modern view: modern cases may follow a more expansive approach
8. Secretary
a) Power of Certification - Apparent authority to certify records, including
board resolutions
b) Other powers – close to nil
9. Treasurer – apparent authority close to nil
10. Closely Held Corporations – for closely held corps, some cases hold that if the
pres has been exercising absolute authority over the corp affairs, and the board has never
questioned, altered, or rejected his decisions, the pres will have extremely wide actual
and apparent authority
11. Ratification – Even if an officer has no actual or apparent authority, the corp
may be bound by the officer’s act in entering into a contract or other transaction on its
behalf if the board later ratifies the act. Ratification may occur where a corp, knowing all
the facts, accepts and uses the proceeds of an unauthorized contract executed on its behalf
E. Formalities for Action by Shareholders
1. DGCL § 141(d) - The cert of incorp MAY confer upon stockholders of any class
or series of stock the right to elect one or more directors
2. DGCL §211 – Meetings of Stockholders
a) The cert of incorp may designate where and when meetings will take
place and may confer upon the directors the right to determine the time and place
of meetings
b) The directors may authorize shareholders not present at meetings to vote
remotely
c) Annual meeting for electing directors must be held, unless the
shareholders vote by written consent
d) Special meetings may be called by the board
3. DGCL §212 – Voting Rights, Proxies, Limitations
a) Each shareholder shall be entitled to one vote for each share of stock –
but the cert of incorp may provide for more or less than one vote for any share
b) Each stockholder entitled to vote at a meeting may authorize another
person to act for the stockholder by proxy
c) Delaware proxy will last 3 years unless otherwise provided
d) Irrevocable proxy – a proxy is irrevocable if
(1) it says so on its face; AND
(2) it’s coupled with an interest
4. NYBCL §609
a) (a) – every shareholder entitled to vote at a shareholder meeting may
authorize another person to act for him by proxy. A proxy lasts no more than 11
months from its date. It is only good for one annual meeting. If you’ve given a
proxy, but you then decide to show up at the meeting and vote, the proxy is void.
5. Proxies are revocable at any time at the pleasure of the shareholder executing it.
6. DGCL §216 – The cert of incorp or the bylaws can specify a quorum, but cannot
be less than 1/3 shares entitled to vote at meeting. If the cert or bylaws are silent, then a
majority is the default rule for a quorum

32
 7. NYBCL 608
a) if cert or bylaws are silent then a majority constitutes a quorum
b) In NY can make quorum less than majority but not less than 1/3
c) In NY can make it higher than majority, but must be in cert of incorp –
bylaw is not good enough
8. DGCL §222
9. DGCL §228
10. Meeting and Notice - Special Meeting
a) notice of time, place, and date is required for a special meeting
b) special meeting notice must describe the purpose for which the meeting
is called
11. Quorum –
a) In order for a valid vote, most statutes require a quorum.
b) Under most statutes, a majority of the shares entitled to vote is necessary
for a quorum unless the cert of incorp sets a higher or lower number.
c) Some statutes provide that the cert cannot set less than 1/3 shares entitled
to vote
12. Voting
a) DGCL §216(2)
(1) For matters other than electing directors, a majority vote of the
quorum is required to take action.
(2) So, if 51% of shares make up a quorum, the majority of that 51%
is 26%. A 26% vote can bind the company.
(3) What happens where there are abstentions? Those
abstentions count as a no vote.
b) NYBCL 614(b)
(1) majority vote required for shareholder action
(2) What happens when there are abstentions? The votes are not
counted at all. This is different from Delaware, because abstentions are
counted as no votes.
c) Ordinary Matters
(1) Most statutes require the affirmative vote of a majority of shares
represented at a meeting for shareholder action on ordinary matters
(2) Some statutes require only the affirmative vote of a majority of
those voting
d) Fundamental Changes – includes amendment of the cert, merger,
sale of substantially all assets, dissolution
(1) Requires approval by a majority or two-thirds of the outstanding
voting shares, rather than a majority of those present or voting at the
meeting
e) Election of Directors – only requires a plurality vote – the candidates
that receive the highest number are elected.
(1) If Candidate 1 receives 12% of votes, Candidate 2 receives 47%
of votes, Candidate 3 receives 31% of votes – none has a majority, but 2
has the most votes, so he would be elected
(2) DGCL §216(3) – directors shall be elected by plurality of
shareholders present or by proxy, unless cert of incorp or by-laws states
otherwise

33
 (3) NYBCL §614(a) – same as DGCL 216 except that changes can
only be done by amending the cert of incorp, and not by bylaws
f) Written Consent – statutes typically permit the shareholders to act by
written consent in lieu of meeting. Most of the statutes permit shareholder action
in written consent only if the consent is unanimous
13. Traditional/Straight Voting
a) This is the typical way for voting
b) A shareholder can put a number of votes equal to his number of shares
for each position that is open
c) Under straight voting, a minority shareholder can never elect a director to
the board over the opposition of the majority
14. Cumulative Voting
a) DGCL §214 – shareholders may cumulate their votes only if the cert of
incorp says they can
b) Only arises when the shareholders are electing directors – when voting
on mergers or amendments, cumulative voting is not permitted
c) A shareholder can cast for a single candidate, or for two or more
candidates, the number of votes per shares he holds multiplied by the number of
openings on the board.
d) Do you have enough shares so that you alone can ensure
mathematically that a particular director will be elected to the board?
There is a formula:
(1) N= number of directors that can be elected
(2) X= number of shares controlled
(3) D=total number of directors to be elected
(4) S= total number of shares that will be voted at meeting
(5) N = (X) x (D+1)/S
(6) Example 2
(a) Instead of 100 shares, I own 300 shares
(b) X = 300
(c) D = 6 (5+1)
(d) S= 1000
(e) 300 X 6 = 1800
(f) 1800/1000 = 1.8
(g) I have enough shares to ensure 1 director to the board,
but not quite enough to ensure 2
(7) What’s the minimum number of shares we need to elect one
director to the board
(a) Example
(i) N=1
(ii) D=5+1
(iii) S=1000
(iv) 1 = (x) X (5+1)/1000
(v) x = 166.67
(vi) Must round up to 167
e) This does not guarantee though that the directors will act in favor of the
minority shareholders – the duty of loyalty requires the board to act on behalf of
ALL shareholders

34
VI. CORPORATE FIDUCIARY DUTIES: THE DUTY OF CARE
A. Basic Standard
a) Directors are agents of shareholders and must act carefully/responsibly
when they make business decisions
2. RMBCA § 8.30 – Standards of Conduct for Directors
a) SUBJECTIVE: Each director when acting as director shall act
(1) In good faith; AND
(2) In a manner the director reasonably believes to be in the best
interest of the corporation
b) OBJECTIVE: When directors are becoming informed in connection
with their decision making or devoting attention to their oversight function, they
shall discharge their duties with the care that a person in a like position would
reasonably believe appropriate under similar circumstances
(1) Objective
(a) Ordinarily prudent person
(2) Subjective:
(a) Under similar circumstances
(b) A person with like skills
(c) Hindsight does not play into the analysis – the focus is
on the process not the result.
(3) You must at a minimum have a rudimentary understanding of the
busioness of the corp
(4) You have a continuing duty to keep informed as to the business
of the corp
(5) If you see something that looks funny, you have a duty to
explore further – to look into the matter
(6) If you discover illegal conduct you must report to senior
management and if they do nothing you can resign, bring legal suit
against those engaging in the illegal conduct
(7) Anderson v. Lewis – Directors have a duty to inform
themselves prior to making a business decision of all material
information reasonably available to them
3. Proximate Cause
a) Element of due care
(1) Substantial factor test – so long as the action or inaction was a
substantial factor in bringing about the injury, the directors action will be
held to be the proximate cause
b) here the violation of the duty of care consists of an omission, would the
loss have occurred even if the defendant had not violated his duty – the plaintiff
must show what the director could have done to prevent the breach of duty; i.e.
the plaintiff must show that had the director protested, the rest of the board
would not have gone through with the breach
c) If the whole board violates the duty of care, can an individual director be
excused on the ground that the result would have been the same had he acted
differently – it is not a defense to say that the harm wouldn’t have occurred but
for the actions of the other board members. A director cannot escape liability by
saying that his actions were less harmful.

4. Gross-Negligence

35
 (a) not just plain old negligent
(b) thus, directors can be negligent and avoid liability, but
they cannot be grossly negligent
(c) This encourages risk-taking
Judges give great deference to the business decisions of boards
5. Test to see if the board can assert BLR as a defense
(1) Is there a business decision (either to act or not to act) –
decisions having to do with structure of the board, shareholder voting,
etc. are not business decisions.
(2) The decision has to be made on an informed basis (duty of care)
(3) Was the decision made in good faith (duty of loyalty)
(4) Best interests of the corp and shareholders – rather than the
director’s own personal interest (duty of loyalty)
6. Hypo – you put a car up for sale. You haven’t checked the Blue Book value.
Someone offers 7500, you accept. It turns out the car is worth 20K. The only one hurt is
you. But if a friend asks you to sell his car at a fair price, and you sell it for under value,
you have breached a duty of care and duty of loyalty
7. Exculpatory Charter Provision can relieve directors for breach of duty of
care.
8. Duty to Ensure that the Corporation has Effective Internal Controls
a) In re Caremark Derivative Litigation
(1) Class Notes:
(a) Lack of good faith – a showing by the plaintiff that there
was a systematic failure by the board to ensure that there was
adequate reporting system in place
(2) Caremark was involved with providing healthcare services.
Gave kickbacks to doctors for patient referrals.
(3) Derivative suit to improve internal controls
(4) Rules
(a) Liability for Directorial Decisions:
(i) May arise from a board decision that results in a
loss because the decision was ill advised or negligent
(ii) May arise from an unconsidered failure of the
board to act in circumstances in which due attention
arguably would have prevented the loss
(b) Liability for Failure to Monitor
(i) May arise from loss resulting from unconsidered
inaction – a board has a duty under this principle to
make sure that a corporate information and reporting
system is adequate and exists and that failure to do so
under some circumstances may render a director liable
for losses caused by non-compliance
(5) Negligence Test:
(a) That the directors knew, OR
(b) Should have known that the violations were occurring
and
(c) They took no steps in good faith to prevent or remedy
the situation and
(d) That such failure proximately caused the harm

36
 (6) Holding: the settlement is fair and reasonable
(a) The directors made a good faith attempt to be informed
of relevant facts, and if they did not know the specifics of the
activities that lead to the indictments, they cannot be faulted.
(b) The fact that there was a violation of criminal law does
not automatically mean there was a breach of fiduciary duty
B. Business Judgment Rule
1. ALI-PCG § 4.01 – Duty of Care of Directors & Officers – Business
Judgment Rule
a) A director has a duty to the corp to perform the director’s or officer’s
functions in good faith, in a manner that he or she reasonably believes to be in
the best interests of the corp, and with the care that an ordinary prudent person
would reasonably be expected to exercise in a like position and under similar
circumstances
(1) The duty includes the obligation to make an inquiry when the
circumstances would alert a reasonable officer or director to the need
therefore. The extent of the inquiry shall be such that the director or
officer reasonably believes necessary
(2) A director is entitled to rely on materials and persons (directors,
officers, employees, experts, committees of the board)
b) Except as otherwise provided the board may delegate, formally or
informally, any function to committees of the board or to directors, officers,
employees, experts, or others.
c) A director or officer who makes a business judgment in good faith
fulfills the duty under this section if the director or officer:
(1) Is not interested in the subject of the business judgment
(2) Is informed with respect to the subject of the business judgment
to the extent the director or officer reasonably believes to be appropriate
under the circumstances; AND
(3) Rationally believes that the business judgment is in the best
interests of the corporation.
d) A person challenging the conduct of a director or officer under this
section has the duty of proving a breach of the duty of care
Limits in Liability; Directors’ and Officers’ (D&O) Insurance
2. Liability Insurance
a) Liability and legal expenses of directors and officers for lack of due care
claims, and other wrongful acts, will often be covered by D&O Insurance.
b) D&O Insurance typically has two components:
(1) Corporate Reimbursement – insures the corp against potential
liability for actions for which the corp has indemnified the directors or
officers (indemnification would be in the charter or by-laws)
(2) Personal Coverage – insures directors and officers for acts for
which the corp does not or is unable to indemnify them
c) Exclusions – insurance does not necessarily cover all acts. Some duty of
care claims might be excluded from coverage and there might be policy limits on
the amount of coverage
d) D&O Insurance is a Claims Made Insurance Policy
(1) Let’s say a policy covers us from Sept 1, 2005 through
September 1, 2007.

37
 (2)
Will only cover claims arising and brought during the coverage
period. But if you renew your insurance you would still be covered for
prior acts.
(3) Tail – you can buy a tail that will cover prior acts, so that if your
policy ends, you will be covered for prior malpractice
VII. CORPORATE FIDUCIARY DUTIES: THE DUTY OF GOOD FAITH
VIII. Bad faith categories – 1) subjective bad faith – fiduciary conduct motivated by an actual
intent to do harm, 2) lack of due care- fiduciary action taken solely by reason of gross negligence
and without any malevolent intent, 3) Bad faith – intentional dereliction of duty, a conscious
disregard for one’s responsibilities.
IX. Grossly negligent conduct, without more, does not and cannot constitute a breach of the
fiduciary duty to act in good faith.
X. A corporation can exculpate its directors from monetary liability for a breach of the duty
of care, but not for conduct that is not in good faith.
XI. A failure to act in good faith may be shown, for instance, where the fiduciary
intentionally acts with a purpose other than that of advancing the best interests of the
corporation, where the fiduciary acts with the intent to violate applicable positive law, or where
the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a
conscious disregard for his duties.
XII. To recover on a claim of corporate waste, the plaintiffs must shoulder the burden of
proving that the exchange was “so one sided that no business person of ordinary, sound judgment
could conclude that the corporation has received adequate consideration.” Or a situation where
the directors irrationally squander or give away corporate assets.
XIII. The duty to act in good faith to be informed cannot be thought to require directors to
possess detailed information about all aspects of the operation of the enterprise.
XIV. Only a sustained or systematic failure of the board to exercise oversight such as an utter
failure to attempt to assure a reasonable information and reporting system exists will establish
the lack of good faith that is a necessary condition to liability.

XV. CORPORATE FIDUCIARY DUTIES: THE DUTY OF LOYALTY

XVI. The requirement to act in good faith is a subsidiary element, a condition, of the
fundamental duty of loyalty.
XVII. A director cannot act loyally towards the corporation unless she acts in the good faith
belief that her actions are in the corporation’s best interest.
XVIII. The general rule was that no transaction of a corporation with any or all of its directors
was automatically voidable at the suit of a shareholder, whether there was a disinterested
majority of the board or not; but that the courts would review such a contract and subject it to
rigid and careful scrutiny, and would invalidate the contract if it was found to be unfair to the
corporation.
XIX. The business judgment rule presupposes that the directors have no conflict of interest.
When a shareholder attacks a transaction in which the directors have an interest other than as
directors of the corporation, the directors may not escape review of the merits of the transaction.

38
At common law such a transaction was voidable unless shown by its proponent to be fair, and
reasonable to the corporation.
XX. A contract between a corporation and an entity in which tis directors are interested may
be set aside unless the proponent of the contract “shall establish affirmatively that the contract or
transaction was fair and reasonable as to the corporation at the time it was approved by the
board.”
XXI. Interested directors have the burden of proving that the transaction was fair and
reasonable to the corporation, if the transaction is challenged.
XXII. Shareholders have the burden of proving bad faith in order to rebut the business judgment
rule’s presumption of good faith conduct.
XXIII. Situations where the fiduciary acts with a purpose other than advancing the interests of
the corporation, but not in her own self-interest, are not covered by the traditional duty of
loyalty. Disloyal conduct without self-interest amounts to bad faith conduct.
XXIV. Remedies for violation of the duty of loyalty are restitutionary in nature.
XXV. Fairness requires not only that the terms of a self-interested transaction be fair, but
that entering into the transaction, even on fair terms, is in the corporation’s interest.
XXVI. Corporate fiduciaries must disclose and not withhold relevant information concerning any
potential conflict of interest with the corporation, and they must refrain from using their position,
influence, or knowledge of the affairs of the corporation to gain personal advantage.
XXVII. (Delaware) Line of business test- If there is presented to a corporate officer or
director a business opportunity which the corporation is financially able to undertake, is, from its
nature, in the line of the corporation’s business and is of practical advantage to it, is one in which
the corporation has an interest or a reasonable expectancy, and, by embracing the opportunity,
the self-interest of the officer or director will be brought into conflict with that of his corporation,
the law will not permit him to seize the opportunity for himself.
XXVIII. The corporate opportunity doctrine recognizes that a corporate fiduciary should
not serve both corporate and personal interests at the same time.
XXIX. Full disclosure to the appropriate corporate body is an absolute condition precedent to the
validity of any forthcoming rejection as well as to the availability to the director or principal
senior executive of the defense of fairness.
XXX. A god faith but defective disclosure by the corporate officer may be ratified after the fact
only by an affirmative vote of the disinterested directors or shareholders.
XXXI. A business opportunity that is discovered through the use of corporate property,
information, or position should be a corporate opportunity regardless of the person’s corporate
position.
XXXII. Whether a business opportunity that a person discovers on her own is a corporate
opportunity solely because it is closely related to the corporation’s business may partly depend
on that person’s corporate position.
XXXIII. 1) The corporate opportunity principle, which prohibits a corporate fiduciary from
taking a corporate opportunity. 2) The use of corporate assets principle, which prohibits a

39
corporate fiduciary from using corporate property, information, or position for personal gain. 3)
The noncompetition principle, which prohibits a corporate fiduciary from competing with the
corporation.
XXXIV. An agent is under a duty to account for profits obtained personally in connection
with transactions related to his or her company.
XXXV. The directors of a Delaware corporation have the prerogative to determine that the
market undervalues its stock and to protect its stockholders from offers that do not reflect the
long-term value of the corporation under its present management plan.
XXXVI. A board that in good faith believes that a hostile offer is inadequate may “properly
employ a poison pill as a proportionate defensive response to protect its stockholders from a ‘low
ball bid.’
XXXVII. Defendants bear the burden of showing that their defenses are not preclusive or
coercive, and if neither, that they fall within a range of reasonableness.
XXXVIII. A defensive measure is coercive if it is “aimed at cramming down on its
shareholders a management sponsored alternative.”
XXXIX. A response is preclusive if it “makes a bidder’s ability to wage a successful proxy
contest and gain control of the target’s board realistically unattainable.”
XL. The combination of a classified board and a Rights plan do not constitute a preclusive
defense.
XLI. A board cannot be forced into Revlon mode any time a hostile bidder makes a tender
offer that is at a premium to market value.
XLII. Revlon – when the company is up for sale, the company has a duty to hold a fair auction
and sell to the highest bidder.
XLIII. When the situation involves a parent and a subsidiary, with the parent controlling the
transaction and fixing the terms, the test of intrinsic fairness, with its resulting shifting of the
burden of proof, is applied. (When the parent has received a benefit to the exclusion and at
the expense of the subsidiary.)
XLIV. A parent does indeed owe a fiduciary duty to its subsidiary when there are parent-
subsidiary dealings. However, this alone will not evoke the intrinsic fairness standard. This
standard will be applied only when the fiduciary duty is accompanied by self-dealing – the
situation when a parent is on both sides of a transaction with its subsidiary. Self-dealing occurs
when the parent, by virtue of its domination of the subsidiary causes the subsidiary to act in such
a way that the parent receives something from the subsidiary to the exclusion of, and detriment
to, the minority stockholders of the subsidiary.
XLV. If a plaintiff can meet his burden of proving that a dividend cannot be grounded on any
reasonable business objective, then the courts can and will interfere with the board’s decision to
pay the dividend.
XLVI. If a dividend is in essence self-dealing by the parent, then the intrinsic fairness standard is
the proper standard.

40
XLVII. Absent looting of corporate assets, conversion of a corporate opportunity, fraud or other
acts of bath faith, a controlling stockholder is free to sell, and a purchaser is free to buy, that
controlling interest at a premium price.
XLVIII. Plaintiff – rebut business judgment rule 1) grossly negligent 2) self-dealing –
burden shifts to directors to show the deal was fair -1) fair dealing 2) fair price.

a) 1960 – Judicial Review of the Fairness of the Transaction

(1) General Rule
(a) no transaction of a corporation with any or all its
directors is automatically voidable by a shareholder, whether
there was a disinterested maj. of the board or not.
(b) A court may invalidate the contract if it found the k was
unfair to the corp.
b) DGCL § 144 – Interested Director Statute (also applies to Officers)
(1) no k or xaction b/w a corp and 1 or more directors or officers or
b/w a corp and any other corp in which 1 or more of its directors or
officers are also directors are officers and have a financial interest, those
xactions shall not be void or voidable even if the interested director is
present at and participates in the meeting if
(a) Disclosure to the board is made coupled with
disinterested director approval
(b) Disclosure of the material facts of the k to the
shareholders coupled with a majority vote. The shareholders
must be informed that the contract involves a director or officer
(c) The xaction is objectively fair to the corp – the interested
director has the burden of proving that the xaction was fair to the
corp
(2) For quorum purposes, common or interested directors may be
counted when determining whether a quorum exists, but the interested
directors may not vote.
(3) Under Delaware law we need a majority of the disinterested
directors to approve a deal
c) NYBCL § 713 – Interested Director Cleansing
(1) Pretty much the same as Delaware’s statute, but
(2) Three important distinctions to the DE
(a) Interlocking Directorate or if one director is a
shareholder of the other corp – the financial interest that the
director has in the third party company has to be substantial in
order to spark a conflict of interest and the need to cleanse the
deal
(b) The type of vote you need of disinterested directors
when you are trying to cleanse – 713 (a)(1) says that
disinterested director approval must comply with § 708(d) OR if
not, the disinterested director vote must be unanimous, whereas
Delaware requires a majority all the time

41
 (c) In NY you need a majority of the quorum to approve
a deal. The interested directors are counted for the quorum, but
cannot vote. So if there are 5 directors and 2 are interested,
those 2 cannot vote. Only 3 vote. But we don’t need a majority
of 3, we need a majority of 5. Those three would all have to vote
yes. In this example the vote would also be unanimous, but that
would not always be the case.
d) Delaware says you can cleanse the interested director transaction by
having a disinterested director approval process where a majority of disinterested
directors approve the deal whereby the transaction would be cleansed.
e) If the deal is fair in Del. then you don’t have to worry about cleansing,
but the burden is on the board to prove it was fair.
f) Hypos
(1) Facts
(a) We have a 15 member board of directors. 708(d) says
that board action must be approved by a meeting of a quorum.
(b) Here the majority would be 8. So if 8 people show up
that’s a quorum.
(c) 13 people show up at the meeting – we have a quorum.
Any action must be approved by a majority of the quorum. A
majority of the quorum is 7.
(d) We need 7 of the 13 directors to approve action.
(2) First Scenario
(a) Assume we have 4 interested directors of the 13 – the
other 9 are disinterested. Assume 2 of the 9 vote no. 7 vote yes.
(b) Can we approve this under 708(d)? Yes.
(c) Let’s say that it wasn’t valid under 708(d), this deal
would not be approved because it was not unanimous
(3) Second Scenario
(a) Let’s say we have 5 interested and 8 disinterested. 2
vote no.
(b) Can we approve this under 708(d)? No, because a
majority of the quorum did not vote yes.
(c) We cannot approve under 713 because it was not
unanimous.
(4) Third Scenario
(a) 13 people present, 9 are interest. Only 4 vote. We need
7 of the 13 to vote yes under 708(d). But we only have 4 voting.
We can’t get 7 yes votes, so the vote would have to be
unanimous.
g) Definition of “Disinterested” Directors Wishy-Washy
(1) Interested in the traditional sense means having a pecuniary
interest in the transaction or one in which a family member is involved
such that the director’s impartiality is in question
(2) But in the case of board of directors, can members truly be
impartial when considering business deals involving people with whom
they work closely?

42
 (3) Not really, so the test becomes one of fairness. If the result is
unfair to the corp, the “disinterested” members would be deemed to not
have been as objective, wary, and impartial as they would had they been
dealing with a third party
(4) The directors must also act in good faith – meaning that there
must be some rational basis that justifies voting in favor of the
transaction
2. One of five possible scenarios that duty of loyalty arise
a) Self-interested/self-dealing - Xaction between director and corp
b) Interlocking Directorate – Situation where there is xaction between two
corps but one or more of the directors on Corp. A board also serves on Corp B
board. The concern is that if the common director has a greater value of shares
of one company and thus votes in favor of a deal that would benefit that corp
most.
c) Usurpation of Corporate Opportunities – Director learns of a deal that
could benefit the corp but decides to pursue it himself
d) Entrenchment Activities – any actions that have the effect of
entrenching the director in office implicate breach of the duty of loyalty. If your
interest is in keeping your job is the director really looking out for the best
interest of the corp and shareholders
e) Director favors one class of shareholder over another- this is kind of
like the overlapping director scenario. For example, the concern is that the
director will favor Class A shareholders over preferred stockholders. The reason
they would do this is because they own more of Class A stock than preferred
stock.
3. Remedies for Violation of the Duty of Loyalty
a) Restitution
(1) Rescission; or if rescission is not feasible
(2) An accounting for the difference b/w k price and fair price
(3) If an officer improperly appropriated a corp opportunity, the
remedy is to impose a constructive trust in the corp’s favor
b) Diff. b/w Remedy for breach of Duty of Loyalty and Duty of Care
(1) Breach of duty of loyalty, the director only needs to return a gain
to which he was not entitled to in the first place – the director is no worse
off than he was before the breach
(2) For breach of duty of care, director must pay damages even if he
did not gain from the transaction – the director is worse off than he was
before the breach
c) In some cases, Breach of Loyalty leaves director worse off
(1) If director sells property at a high price to corp ($110K and it is
only worth $100K at time of sale)
(2) Five years later the value drops and the corp rescinds
(3) Director must give back the $110K
(4) Now he can only sell it for $70K
(5) He loses out on the $30K that he could have made had he sold
the property to a third party at the fair price of $100K
d) Repay Corporation for Salary Earned In Addition to Restitution
e) Punitive Damages if there is Proof of Fraud
(1) Fraud

43
 (a) anything calculated to deceive, including all acts,
omissions, and concealments
(b) involving a breach of legal or equitable duty
(c) resulting in damage to another
4. Lewis v. S.L.&E., 1980 – Interlocking Directorate Situation
B. Corporate Opportunity Doctrine and Other Dilemmas
1. General Principles
a) Officers and directors owe a duty of loyalty – a fiduciary duty
b) The standard of behaviour is not just honesty alone – it is the punctilio of
honor
c) Officers and directors must discharge their duties in good faith and in
furtherance of the interests of the corporation
d) They must disclose and not withhold relevant information
e) They must refrain from using their position, influence, or knowledge of
the affairs of the corp to gain corporate advantage
2. Line of Business Test
a) Generally
(1) If an officer or director is presented an opportunity
(2) That the corp is financially able to undertake
(3) Is in the line of the corp’s business and is of advantage to it
(4) Is one that the corp has an interest or reasonable expectancy
(5) And by embracing the opportunity the director or officer will be
brought into conflict with that of his corp
(6) The law will not permit him to seize the opportunity for himself
b) When is it in the line of business?
(1) Closely Associated with what the company does now – so
closely associated that if a director or officer would accept it, he or she
would be in competition with his or her own corp.
3. Fairness Test
a) When a director takes advantage of an opportunity for personal profit
b) and the interest of the corporation justly calls for protection
4. Minnesota Two-Step Test
a) First determine whether a particular opp was within the corp’s line of
business
b) Then scrutinize the equitable considerations existing prior to, at the time
of, and following the officer’s acquisition
5. LaGarde Test
a) The corp opp doctrine applies only when
(1) The director or officer acquires property in which the corp has an
interest already existing; OR
(2) In which it has an expectancy growing out of an existing right
6. ALI § 5.05
a) Corporate Opportunity Rule – A director or senior executive may not
take advantage of an opportunity; UNLESS
(1) He first offers the corp. opp. to the corp. and makes disclosure of
that there is a conflict of interest
(2) The corp rejects the opportunity in a manner that complies with
the business judgment rule; AND

44
 (3) Either
(a) The rejection of the opp is fair to the corp.; OR
(b) The opp is rejected in advance, following disclosure; OR
(c) The rejection is authorized in advance or ratified
following such disclosure, by shareholders and rejection is not
the equivalent of waste of corp. assets
b) Definition of Corporate Opportunity
(1) On the job - Any opp to engage in a business activity of which a
director or officer becomes aware, either
(a) In connection with his function as director or officer, or
under circumstances that should reasonably lead him to believe
that the party making the offer expects it to be offered to the
corporation; OR
(b) Through the use of corporate information the director or
officer should reasonably be expected to believe it would be of
interest to the corporation; OR
(2) Off the job - Any opp to engage in a business activity of which
an officer becomes aware and knows is closely related to a business in
which the corporation is engaged or expects to engage
c) Burden of Proof – a party who challenges the taking of a corp opp has
the burden of proof, unless the party establishes that the requirements of (a)(3)(b)
are not met, then the burden is on the director or exec to prove that the opp was
disclosed and rejected and that the taking of the opp was fair to the corp
d) Ratification of Defective Disclosure – A good faith but defective
disclosure can be ratified if at any time (but no later than a reasonable time after
suit is filed) the original rejection of the opp is ratified followed by the required
disclosure, by the board, shareholders, or the corp decision-maker that initially
approved the rejection
e) Special Rule Concerning Delayed Offering of Corp Opp – Relief
based solely on failure to first offer opp to corp is not available if
(1) The failure to offer resulted from good faith belief that the
business activity did not constitute a corp opp
(2) Not later than a reasonable time after suit is filed, the corp opp is
to the extent possible offered to the corp and rejected in a manner that
satisfies the standards of subsection (a)
7. Northeast Harbor Golf Club, Inc. v. Harris, 1995
a) Holding: Harris violated the ALI Approach to Corporate Opportunity
Doctrine; but the necessary factual findings for an analysis under this rule were
not made, so the trial court will have to conduct further proceedings
b) Rule Discussion
(1) The line of business test is weak for two reasons:
(a) Whether an activity is within the scope of the corp
business can be difficult to answer
(b) The financial ability of the corp as an element creates an
incentive for directors or officers to neglect the corp’s financial
well-being in order to take advantage of an otherwise corp opp
(2) The fairness test is also flawed because if provides no guidance
(3) The court adopts the ALI Approach ALI § 5.05
XLIX. CORPORATE FIDUCIARY DUTIES: TAKEOVERS

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A. Directorial Duties in the context of Corporate Takeovers
1. Unocal
a) Issue 1 – can a corp buy back shares from some shareholders but not
others.
b) DCGL Section 160a – selective repurchases are in fact allowed under
Delaware state law. (the federal law does not allow this now)
c) NYBCL 513(c) If a company is going to repurchase stock from a
shareholder at a price of 10% or more of the current market price, less than 2
years after the shareholder purchased the shares, you have to get shareholder
approval.
d) Unocal Test - must show 2 things before your strategy gets the benefit of
the business judgment rule
(1) You as target company directors must show you had reasonable
grounds for believing that a danger to the corporate policy existed
because of another’s stock ownership
(2) Assuming there is such a danger, any defensive action must be
reasonable in relationship to the threat posed – a corp. does not have
unbridled discretion to defeat any perceived threat through any
Draconian means available
2. Revlon v. MacAndrews & Forbes Holdings
a) Crown Jewel Lockup – what third party would want to buy Revlon
knowing that it would be forced to sell valuable assets to a third party for less
than their value
b) Revlon Standard – When you decide to sell your company your duties
as a director change from preservation of the corporate entity into that of an
auctioneer. They had to get the best price. What does this mean?
(1) Defensive measures become moot when you put the company up
for sale
(2) You have to get the best possible price – the board’s sole
function is that of an auctioneer charged with getting the best price for
the stockholders
c) Mills Case refined the Revlon Standard – the board must get the best
price reasonably available – not necessarily the highest price – a lower price
might be more reasonable if the bidder is more financially secure than a higher
bidder
d) Issues
(1) Whether lock-up, no-shop, and cancellation fee provisions which
granted Forstmann the right to purchase shares of Revlon, a promise to
deal only with Forstmann, and a $25MM cancellation fee to be paid to
Forstmann
(2) Whether a corporation may consider the impact of a corporate
threat on constituencies other than shareholders – in this case, Revlon
considered the impact to Noteholders
e) Holding – Revlon’s defensive measures were not consistent with the
directors’ duties to the shareholders after they determined that they would
sell the company – they beached the duty of loyalty
(1) The lock-up option and no shop provisions were not permissible
in this case because the provisions were adopted as a result of director
interest, to deny other bidders, and other breaches of fiduciary duty.

46
 (2) No shop provision is not permissible when the board makes a
decision to sell the company.
(3) The cancellation fee is ok only if it is not punitive – 2-4% of the
value of the company is probably ok
(4) Favoritism of a white knight – You can’t favor one party over
another when the company is up for sale. You need to have a level
playing field.
(5) A corporation may consider constituencies other than
shareholders when faced with a takeover threat so long as there is some
rationally related benefit to the shareholders. There was none in this
case.
f) Unocal – The board’s actions in response to Pantry’s takeover threat
were subject to the Unocal standard.
(1) The Rights Plan was a poison pill. The Rights plan was
reasonable in response to the threat posed and was in the best interest of
the shareholders. The Rights plan was consistent with the fiduciary duty
to the stockholders and passes the Unocal test
(2) The company’s own exchange offer was also reasonable, was in
good faith and was consistent with their duty of loyalty and passes the
Unocal test.
g) Business Judgment Rule – when the board realized that a breakup of
the company was inevitable and decided to sell the company to Forstmann, the
board was no longer acting in response to a threat. They were selling the
company and thus the Unocal standard governing defensive strategies was no
longer applicable. After this point, the board was held to the business judgment
rule. Although there is a presumption that the board acted in good faith.
L. CORPORATE FIDUCIARY DUTIES: CONTROLLING STOCKHOLDERS
A. Duties of Controlling Stockholders
1. Sinclair Oil
a) Self-Dealing: Self dealing occurs when a parent by virtue of its
domination over a subsidiary causes the subsidiary to act in a way that the parent
receives something from the subsidiary from to the exclusion of and detriment to
minority stockholders.
b) Intrinsic Fairness Test:
(1) Only when a parent engages in self-dealing the intrinsic fairness
test applies.
(2) Under this test the burden shifts to the parent to prove that its
transactions with the subsidiary were objectively fair to all involved,
including minority shareholders.
(3) The directors usually lose under this standard
(4) There must be a fiduciary duty owed to the subsidiary coupled
with self-dealing in order for the intrinsic fairness test to apply. If the
self-dealing is missing, then the business judgment rule applies; not the
intrinsic fairness
(a) A decision to pay dividends or not pay dividends so long
as all shareholders are treated equally will usually not be found
impermissible under the BJ Rule
c) No, the dividends were not self dealing. The business judgment rule
applies. The dividends are presumptively reasonable absent gross overreaching

47
 d) Analysis:
(1) The parent company did not receive a benefit that the minority
stockholder did not receive. The plaintiff received his proportional share
of the dividends.
e) Issue 2: Was the contract between Sinclair’s subsidiary, International,
and Sinven breached and if so was it self-dealing
f) Holding: Yes. The k was beached because International was to pay
Sinven upon receipt of goods and it waited as much as 30 days to pay. They
were also under a duty to purchase a certain amount of oil from Sinven and it did
not meet that amount.
g) Self Dealing: Here there is self-dealing because Sinclair, through
International, received a benefit (the oil it didn’t pay for) that the minority
shareholders did not receive and the directors did not enforce the contract. This
was self-dealing. It is subject to the intrinsic fairness test.
h) Intrinsic Fairness Test: Not causing Sinven to enforce the contract was
not intrinsically fair to minority stockholders. Sinclair says that International
purchased all the oil Sinven had, but they have not shown that Sinven was not
capable of producing more.
2. Jones v. H.F. Ahmanson
a) Class Note:
(1) Two types of stock splits
(a) Forward Stock split –
(b) Reverse Stock split.
(c) Reverse stock split is also done to squeeze out
minority shareholders – this would be done by giving 1 share
for every 10,000 shares. For shareholders that have less than
10,000 shares would end up with less than 1 share. You can’t
own a fraction of a share so the minority shareholders get cashed
out and squeezed out.
(2) Note: As a majority stockholder, if someone offers to buy your
block of stock for a good price, it is not a breach of duty to the minority
shareholders to not tell the prospective purchaser that they have to also
offer to purchase the minority shares. What you do with your stock is
your business. The problem with the Association case is that the public
offering of UFC stock along with debentures that they promised using
the Association assets to backup the debentures and they didn’t offer this
benefit to minority shareholders. Had they not used the assets of the
Association, there probably wouldn’t be a problem with not making the
Association more marketable.
LI. THE DERIVATIVE LAWSUIT
A. Generally
1. What is a derivative lawsuit?
a) A lawsuit brought by shareholders of a corporation to protect the interest
of the corporation at a time when the corporation itself is unwilling or unable to
protect itself.
b) Typically the harm is being done by the directors or executives
themselves, which is
c) If that is the case, the law allows the shareholders to bring the action on
the corporations behalf

48
 d) It is called a derivative action because the shareholders right to sue
derives out of the corporations right to sue
e) Corporation is an Indispensable Party- The corporation must be a
party to the lawsuit – but since it doesn’t want to be a plaintiff it must be named
as a defendant – but is known as a nominal defendant
2. What’s the downside to permitting derivative lawsuits?
a) Strike-suits – suits brought by shareholders with very small investments
designed to exploit the nuisance value of the lawsuit in order to gain some sort of
settlement
(1) Who benefits from the strike suit?
(a) Lawyers – b/c they get considerable fees
(b) Professional Plaintiffs – someone who owns only a few
shares of stock in all 500 of the Fortune 500 companies and any
time a stock price dipped, they would file a complaint alleging
mismanagement or fraud. Who funds these stock purchases:
Lawyers
(2) Who is the loser from strike suits?
(a) Shareholders, b/c the corporation has to defend the
action and it is taking money out of the shareholders interest in
the company
(3) Strike Suits are All About Procedure
(a) The strike suit lawyer hopes to get beyond the
corporation’s motion to dismiss, b/c then it moves on to
discovery
(b) The strike suit plaintiff does not have much to disclose.
(c) The corporation has lots to disclose – the could request
depositions of every employee
(d) The hopes that the corporation doesn’t want to deal with
turning over docs and that they will just settle
(e) The corporation counsel wants to get the case dismissed
– if the motion is granted it could chill any other prospective
strike suit plaintiffs from attempting a claim
b) Litigation Reform Act
B. Who Can Bring A Derivative Action?
1. Shareholder Status
a) Must hold common stock shares when you bring the action, and must
hold the shares throughout the duration of the lawsuit
b) Contract claimants cannot bring action
(1) Bondholders even if convertible bonds cannot bring a derivative
action
(2) Preferred Stockholders even if convertible preferred stock cannot
bring a derivative action
2. Creditors
a) Creditors, including bondholders, have no right to bring a derivative
action
b) But if the corporation is in bankruptcy, then there is a fiduciary duty
owed to creditors
c) Certain types of corporations owe a duty to creditors even when the
corporation is solvent – banks and bank depositors

49
 3. Directors
a) NYBCL § 720 – gives directors and officers the right to bring a
derivative action
C. NYBCL § 626
1. An action may be brought in the right of a domestic or foreign corporation to
procure a judgment in its favor, by a holder of shares or of voting trust certificates of the
corporation or of a beneficial interest in such shares or certificates.
2. In any such action, it shall be made to appear that the plaintiff is such a holder at
the time of bringing the action and that he was such a holder at the time of the transaction
of which he complains, or that his shares or his interest therein devolved upon him by
operation of law.
a) must own stock at the time the action is filed
b) must have owned stock when the injury arose
c) you do not need to hold on to the stock for the duration of the suit
d) In NY, if a is successful, he does not receive anything except attorneys
fees. The proceeds would go to the corporation itself
3. Demand requirement - In any such action, the complaint shall set forth with
particularity the efforts of the plaintiff to secure the initiation of such action by the board
or the reasons for not making such effort.
4. Such action shall not be discontinued, compromised or settled, without the
approval of the court having jurisdiction of the action. If the court shall determine that the
interests of the shareholders or any class or classes thereof will be substantially affected
by such discontinuance, compromise, or settlement, the court, in its discretion, may direct
that notice, by publication or otherwise, shall be given to the shareholders or class or
classes thereof whose interest it determines will be so affected; if notice is so directed to
be given, the court may determine which one or more of the parties to the action shall
bear the expense of giving the same, in such amount as the court shall determine and find
to be reasonable in the circumstances, and the amount of such expense shall be awarded
as special costs of the action and recoverable in the same manner as statutory taxable
costs.
5. If the action on behalf of the corporation was successful, in whole or in part, or if
anything was received by the plaintiff or plaintiffs or a claimant or claimants as the result
of a judgment, compromise or settlement of an action or claim, the court may award the
plaintiff or plaintiffs, claimant or claimants, reasonable expenses, including reasonable
attorney's fees, and shall direct him or them to account to the corporation for the
remainder of the proceeds so received by him or them. This paragraph shall not apply to
any judgment rendered for the benefit of injured shareholders only and limited to a
recovery of the loss or damage sustained by them.
D. Distinction Between Derivative and Direct Actions
1. The Impact of a Determination that an Action is Derivative
a) A derivative lawsuit is a lawsuit brought on behalf of the corporation and
thus any recovery goes to the corporation, and thus, all shareholders
b) A direct action is when the plaintiff is injured personally and recovery
would go to the plaintiff personally – this usually involves interference with
voting rights
2. What if at the end of the case the corporation no longer exists because it is
merged into another company? The recovery is paid out to the shareholders that
existed on the date of the merger on a pro rata basis
3. Reasons for Distinguishing Between Direct and Derivative Actions

50
 a) If the action is derivative, then the corporation avoids multiplicity of
suits brought by a multitude of shareholders
4. Examples
a) Derivative
(1) Wrongful act that depletes or destroys corporate assets and
affects shareholders by reducing the value of stock
b) Direct
(1) Wrongful acts that interfere with the rights that are incidental to
owning shares – voting
(2) Issuing stock for a wrongful purpose – such as board member
entrenchment
E. Individual Recovery in Derivative Actions
1. Basic Principle
a) Normally, in a derivative action, recovery goes to the corporation
b) But under pro rata recovery, the recovery goes directly to the
shareholders – or to the shareholders entitled to participate in the pro rata. Each
pro rata shareholder gets a share of recovery equal to the percentage of stock
ownership.
(1) Pro Rata Example: A and B each own 20% of Stock in
Corporation X. C owns 60%. A brings a derivative action against C, the
controlling shareholder, for $1MM and wins. A and B will each get
$200K. C gets nothing, X gets nothing. In a regular derivative action, X
would get $1MM
c) Pro Rata Reasoning
(1) Prevents wrongdoer shareholders from sharing in the proceeds of
a derivative action
(2) It prevents controlling wrongdoer shareholders who are still in
control after the suit from deciding what to do with proceeds after the
suit
(3) Pro rata actions allows shareholders to sue, when a majority of
shareholders wouldn’t. For example, if the wrongful conduct had been
going on for ten years and a majority of shareholders owned stock the
entire time and acquiesced and therefore are precluded from suing, but a
minority of shareholders just purchased stock recently, they would be
able to sue on a pro rata basis to allow them to recover whereas the
others don’t deserve to.
(4) Where the injured Corporation A, is merged into Corporation B.
Corporation B shareholders would be barred from suing because no
wrong had been committed against them, but the shareholders of
Corporation A would be allowed to sue where otherwise they would be
cut off by the merger
F. DEMAND FUTILITY
1. State Law
a) NY and Delaware require a shareholder to make a demand on the board
to bring a derivative action before the shareholder can bring one himself, unless
he is excused from making a demand
2. Policy Reasons for the Demand Requirements

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 a) Relieve the courts from deciding matters that should be made by a
corporation’s directors. Whether to bring a suit on behalf of a corporation is
within the business judgment of directors
b) Protect boards from harassment
c) Discourage strike suits – if we have a demand requirement and the board
decides not to take action and demand is not futile, frivolous suits will be weeded
out
3. When is Demand Futile and thus excused?
a) Some states, like FL, have universal demand requirements – demand
is never excused in these states
b) NY RULE - When a complaint alleges with particularity
(1) Interested Director - that a majority of the board of directors is
interested in the challenged transaction – interest arises when the
directors have self interest, or when directors lack independence – a
director lacks independence even when he does not have a personal
benefit but because he is controlled by a self-interested director; OR
(2) The board of directors did not fully inform themselves about a
transaction; OR
(3) the challenged transaction was so egregious on its face that it
could not have been the product of sound business judgment
c) Delaware Rule – Two Pronged Test - Demand is Waived if the
complaint creates a reasonable doubt that:
(1) a majority of the directors are interested; AND
(2) the challenged transaction is not the product of a valid business
judgment
d) Universal Demand – Haas prefers this rule because it is clear cut
(1) Plaintiff has to make a demand in every situation before bringing
a lawsuit
(2) Only if 90 days has passed since you made the demand can you
bring an action
(3) You can bring action before the 90 days if:
(a) The board rejects your demand; OR
(b) The corporation will suffer irreparable harm if the action
is not brought immediately (the plaintiff has the burden of truth)
4. Marx v. Akers
a) Facts: Plaintiffs allege that the directors wasted assets by paying
excessive compensation to the CEO and all the directors and even to outside
directors. The plaintiffs did not make a demand because they believed the
demand would be futile because all directors were tainted.
b) Demand was not futile for executives because a minority of the board
made up these excused, thus they should have demanded that the board take
action for this claim
c) Demand was futile for the claim that outside directors received excessive
compensation because a majority of the board were outside directors.
d) Plaintiff’s still lose though because they failed to allege that
compensation was excessive on its face.
G. Federal Securities Law Reform – Made it Harder for individuals to bring strike suits
1. Shareholders brought lawsuits against directors for their lies to the public under
anti-fraud rule 10B5 of the SEC.

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 2. In 1995, Congress got involved because it felt that these anti-fraud class actions
brought by shareholders thinking that the directors must have lied when there was a stock
drop
3. In 1995 Congress passed the Securities Reform Act which added Section 27 of
the 1933 Act and Section 21D of the 1934 Securities Act which says that as a plaintiff
you have to certify:
a) That you have read the complaint
b) That you did not buy the stock of the company at the direction of your
lawyer
c) That you will not receive any compensation as a plaintiff other than your
pro rata recovery or awarded by the court
d) You as a plaintiff have to supply a list of all other actions you have filed
by the court in the previous three years
4. Congress authorizes the court to certify a lead plaintiff – any prospective plaintiff
can petition the court to be a lead plaintiff, but the lead plaintiff selected by the court has
to be a member of the class most capable of representing the interests of a class.
5. There is a presumption that the plaintiff who lost the most money is must capable
of being the lead plaintiff.
6. So, who owns the most shares that would lose the most money – institutional
shareholders like mutual fund companies.
7. The lead plaintiff gets to choose the lawyer.
8. This is how Congress gets rid of the abuses of the system.
9. Some of the things that Congress has done that Haas is not so pleased with
a) The Pleadings requirements that Congress has imposed
(1) Plaintiffs must specify the statements that directors have made
that are misleading and why they are misleading
(2) If the defendant had to have acted with a particular state of mind,
then the plaintiff must specify with particularity those actions that imply
a state of mind.
(3) The problem is that these statements must be made in the
complaint before the benefit of discovery.
(4) Eliot Spitzer is the saviour – he can walk in at any time and
request documents from a company. He collects info and makes them
public. Then the lawyers can find particularized statements and can
make a sufficient pleading
(5) Corporations hate Eliot Spitzer
LII. SHAREHOLDER INFORMATIONALL RIGHTS AND PROXY VOTING
A. Inspection Rights; Need for Proper Purpose
1. Generally
a) There is a tension between shareholders and boards b/c the shareholders
want to know the financial condition of the corp., but the board is afraid that
people who have
b) The board has the burden of showing that the purpose is not proper when
it comes to shareholder lists
c) The shareholder has the burden to show that his wanting to inspect
financial data is proper
2. What is a proper purpose?

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 a) For the purpose of exercising the shareholders right, to determine the
financial condition of the corporation and to ascertain the value of the petitioner’s
shares
b) Mixed purposes: if the shareholder has one purpose that is proper and
another purpose that is not, so long as the proper purpose is the primary purpose,
then he will not be barred from inspecting the books
c) Pillsbury Case:
(1) Pillsbury was a shareholder in Honeywell. Pillsbury opposed the
Vietnam War and wanted to persuade Honeywell from manufacturing
munitions. Pillsbury wanted to see the books to get shareholder support
and stated that contacting shareholders was a proper purpose. The
Minnesota State court interpreting Delaware law said that Pillsbury’s
purpose was not proper because it had nothing to do with the economic
interest of the shareholders. Communication with fellow shareholders is
not a per se proper purpose.
(2) The Delaware courts did not agree with this case as far as
requesting stockholder lists. It seems that the Delaware courts would
give carte blanche access to stockholder lists, but would not be so liberal
with financial data. In such a case, the shareholder would have to show
specific and plausible reasons for needing the financial data.
3. DGCL § 219
a) The officer who has charge of the stock ledger of a corporation shall
prepare and make, at least ten days before every meeting of stockholders, a
complete list of the stockholders entitled to vote at the meeting, arranged in
alphabetical order, and showing the address of each stockholder and the number
of shares registered in the name of each stockholder. Such list shall be open to
the examination of any stockholder, for any purpose germane to the meeting,
during ordinary business hours, for a period of at least ten days prior to the
meeting, either at a place within the city where the meeting is to be held, which
place shall be specified in the notice of the meeting, or, if not so specified, at the
place where the meeting is to be held. The list shall also be produced and kept at
the time and place of the meeting during the whole time thereof, and may be
inspected by any stockholder who is present.
b) Upon the willful neglect or refusal of the directors to produce such a list
at any meeting for the election of directors, they shall be ineligible for election to
any office at such meeting.
c) The stock ledger shall be the only evidence as to who are the
stockholders entitled to examine the stock ledger, the list required by this section
or the books of the corporation, or to vote in person or by proxy at any meeting
of stockholders.
4. DGCL § 220
a) As used in this section, "stockholder" means a stockholder of record of
stock in a stock corporation and also a member of a nonstock corporation as
reflected on the records of the nonstock corporation. As used in this section, the
term "list of stockholders" includes lists of members in a nonstock corporation.
b) Any stockholder shall, upon written demand under oath stating the
purpose thereof, have the right during the usual hours for business to inspect for
any proper purpose the corporation's stock ledger, a list of its stockholders, and
its other books and records, and to make copies or extracts therefrom.

54
 (1) proper purpose - a purpose reasonably related to such person's
interest as a stockholder.
c) If the corporation, or an officer or agent thereof, refuses to permit an
inspection sought by a stockholder or attorney or other agent acting for the
stockholder pursuant to sub-section (b) or does not reply to the demand within
five business days after the demand has been made, the stockholder may apply to
the Court of Chancery for an order to compel such inspection. The court may
summarily order the corporation to permit the stockholder to inspect the
corporation's stock ledger, an existing list of stockholders, and its other books
and records, and to make copies or extracts therefrom; or the Court may order the
corporation to furnish to the stockholder a list of its stockholders as of a specific
date on condition that the stockholder first pay to the corporation the reasonable
cost of obtaining and furnishing such list and on such other conditions as the
Court deems appropriate. Where the stockholder seeks to inspect the
corporation's books and records, other than its stock ledger or list of
stockholders, such stockholder shall first establish (1) that such stockholder has
complied with the provisions of this section respecting the form and manner of
making demand for inspection of such documents; and (2) that the inspection
such stockholder seeks is for a proper purpose. Where the stockholder seeks to
inspect the corporation's stock ledger or list of stockholders and such stockholder
has complied with the provisions of this section respecting the form and manner
of making demand for inspection of such documents, the burden of proof shall be
upon the corporation to establish that the inspection such stockholder seeks is for
an improper purpose. The court may, in its discretion, prescribe any limitations
or conditions with reference to the inspection, or award such other or further
relief as the court may deem just and proper. The court may order books,
documents and records, pertinent extracts therefrom, or duly authenticated copies
thereof, to be brought within this State and kept in this State upon such terms and
conditions as the order may prescribe.
d) Any director (including a member of the governing body of a nonstock
corporation) shall have the right to examine the corporation's stock ledger, a list
of its stockholders and its other books and records for a purpose reasonably
related to his position as a director. The Court of Chancery is hereby vested with
the exclusive jurisdiction to determine whether a director is entitled to the
inspection sought. The court may summarily order the corporation to permit the
director to inspect any and all books and records, the stock ledger and the list of
stockholders and to make copies or extracts therefrom. The court may, in its
discretion, prescribe any limitations or conditions with reference to the
inspection, or award such other and further relief as the court may deem just and
proper.
5. NYBCL § 624
a) Corporation must keep books at its office of the names and addresses of
shareholders, the numbers of shares and the minutes of board meetings

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 b) Any person who shall have been a shareholder of record of a corporation
upon at least five days' written demand shall have the right to examine in person
or by agent or attorney, during usual business hours, its minutes of the
proceedings of its shareholders and record of shareholders and to make extracts
therefrom for any purpose reasonably related to such person's interest as a
shareholder. Holders of voting trust certificates representing shares of the
corporation shall be regarded as shareholders for the purpose of this section. Any
such agent or attorney shall be authorized in a writing that satisfies the
requirements of a writing under paragraph (b) of section 609 (Proxies). A
corporation requested to provide information pursuant to this paragraph shall
make available such information in written form and in any other format in
which such information is maintained by the corporation and shall not be
required to provide such information in any other format. If a request made
pursuant to this paragraph includes a request to furnish information regarding
beneficial owners, the corporation shall make available such information in its
possession regarding beneficial owners as is provided to the corporation by a
registered broker or dealer or a bank, association or other entity that exercises
fiduciary powers in connection with the forwarding of information to such
owners. The corporation shall not be required to obtain information about
beneficial owners not in its possession
c) An inspection authorized by paragraph (b) may be denied to such
shareholder or other person upon his refusal to furnish to the corporation, its
transfer agent or registrar an affidavit that such inspection is not desired for a
purpose which is in the interest of a business or object other than the business of
the corporation and that he has not within five years sold or offered for sale any
list of shareholders of any corporation of any type or kind, whether or not formed
under the laws of this state, or aided or abetted any person in procuring any such
record of shareholders for any such purpose.
d) Upon refusal by the corporation or by an officer or agent of the
corporation to permit an inspection of the minutes of the proceedings of its
shareholders or of the record of shareholders as herein provided, the person
making the demand for inspection may apply to the supreme court in the judicial
district where the office of the corporation is located, upon such notice as the
court may direct, for an order directing the corporation, its officer or agent to
show cause why an order should not be granted permitting such inspection by the
applicant. Upon the return day of the order to show cause, the court shall hear the
parties summarily, by affidavit or otherwise, and if it appears that the applicant is
qualified and entitled to such inspection, the court shall grant an order
compelling such inspection and awarding such further relief as to the court may
seem just and proper.
e) Upon the written request of any shareholder, the corporation shall give or
mail to such shareholder an annual balance sheet and profit and loss statement for
the preceding fiscal year, and, if any interim balance sheet or profit and loss
statement has been distributed to its shareholders or otherwise made available to
the public, the most recent such interim balance sheet or profit and loss
statement. The corporation shall be allowed a reasonable time to prepare such
annual balance sheet and profit and loss statement.
f) Nothing herein contained shall impair the power of courts to compel the
production for examination of the books and records of a corporation.

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 g) The books and records specified in paragraph (a) shall be prima facie
evidence of the facts therein stated in favor of the plaintiff in any action or
special proceeding against such corporation or any of its officers, directors or
shareholders.
B. Proxy Control Under State Law
1. Proxy
a) The process they use in soliciting votes, getting shareholders to support
their position
b) Federal law focuses more on disclosure as to what the shareholders are
voting on
c) State law focuses on mechanics
d)
2. How do we figure out who gets to vote
a) All states require a corporation to fix a record date and all shareholders
who are shareholders on that date get to vote
b) Let’s say that Mary owns stock on the record date. She sells her shares
to Jim the day after the record date. The meeting is two weeks after she sells, but
because she was the owner on the record date, she gets to vote. How can Jim get
around this? He can purchase shares with an irrevocable proxy.
c) It is very unlikely that Mary would vote now that she no longer has an
interest
d) Companies hire proxy solicitors to request that shareholders vote,
because they are worried about not getting a quorum and not being able to put the
issue up for vote.
e) As a board you would want to fix the date closest to the
3. Delaware
a) DGCL § 212 – Voting Rights of Stockholders
(1) One vote per share
(2) Each stockholder is entitled to vote at meetings or to express
consent or dissent without a meeting or to delegate someone to vote by
proxy
b) DGCL § 213 – Fixing Date – The Record Date
(1) For voting: No more than 60, not less than 10 days before the
date of meeting
(2) If the board fails to fix a date, the default record date is the close
of the business day before the day that notice was sent out.
(a) Let’s say notice is mailed on June 5, the record date
would be June 4. The record date is the day before notice of
meeting was sent out.
(3) Dividend record date cannot be more than 60 days prior to
payment of the dividend.
(a) From the Mary/Jim example above, if Mary sold her
shares a day after the dividend record date, she would get the
dividend even if the payment of dividend is after she sold her
shares to Jim.
(i) He will pay a slightly lower price for the shares
taking into account that he won’t get the dividend
c) DGCL § 222 – Notice of meetings

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 (1) Written notice which shall state the place, date and hour of the
meeting. The notice for annual meeting does not need to state the
purpose of the meeting unless it is a special meeting of the shareholders.
If it is a special meeting, then the notice must state the purpose. If you
send bulk mail you have to mail at least 24 days before the meeting. If
first class mail you can mail in between the ten and sixty days
(a) Note: under federal regulations, the notice must
always state the purpose. Del. and NY state law do not
require this
(2) Written notice shall be given not less than 10, no more than
60days before the date of the meeting to each shareholder that is entitled
to vote
d) DGCL § 225 – Contested Election of Directors
(1) The Court of Chancery has the power to hear and determine the
validity of any election and can determine the result of any vote of
shareholders upon matters other than the election
e) DGCL §277 – Powers of Court in Elections of Directors
(1) The court can determine the right and power of persons claiming
to own stock, or in the case of a corp w/o capital stock, of the persons
claiming to be members to vote at a meeting of the stockholders or
members
(2) The court can appoint a master and hold any election and may
punish officers or directors for contempt of court order
4. New York
a) NYBCL § 604 – Fixing Record Date
(1) The board may fix in the bylaws a date no more than sixty but no
less than ten days before the date of a meeting, or no more than sixty
days before any other action, for the purpose of determining the
shareholders entitled to notice of or to vote at any meeting or to express
consent or dissent from any proposal without a meeting; or for the
purpose of determining shareholders entitled to receive payment of
dividends
(2) If no record date is fixed:
(a) The record date for the determination of shareholders
entitled to notice of or to vote at a meeting of shareholders shall
be at the close of business on the day next preceding the day on
which notice is given, or if no notice is given, the day on which
the meeting is held.
b) NYBCL § 605 – Notice of Shareholder meetings
(1) Whenever shareholders are permitted to take action at a meeting,
notice shall be given stating the place, date and hour of the meeting. The
notice shall also state the purpose of the meeting.
c) NYBCL § 608 – Quorum of Shareholders
(1) The holders of a majority of the votes entitled to vote shall
constitute a quorum
(2) The cert of incorp may provide for less than a majority to equal a
quorum, but no less than on third of shares. The cert can also make more
than a mere majority a quorum
d) NYBCL § 609 – Proxies

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 (1) Every shareholder entitled to vote at a meeting of shareholders or
to express consent or dissent w/o a meeting may authorize another
person to act for him by proxy
(2) No proxy is valid for more than 11 months unless otherwise
provided in the proxy. Every proxy is revocable at the will of the
shareholder
(3) Proxies are still valid after the death or incompetence of the
shareholder, unless written notice of adjudication of the incompetence or
death is received by the corp orricer responsible for maintaining the list
of shareholders
(4) A shareholder cannot sell his vote for money or anything of
value
(5) Irrevocable proxy – a proxy that is entitled as such and which
states it is irrevocable, is irrevocable when it is held by any of the
following or a nominee of any of the following
(a) A pledgee
(b) A person who has purchased or agreed to purchase the
shared
(c) A creditor of the corp who extend credit tto the corp in
consideration of the proxy
(d) A person who has contracted to perform services as an
officer of the corp, if the proxy was given in consideration of the
employment
(e) Even if the proxy is irrevocable, it becomes revocable
when the pledge is redeemed, the debt of the corp paid, the
period of employment terminated
e) NYBCL § 612 – Qualification of Voters
(1) Every shareholder is entitled to vote one vote per share in his
name
(2) The corp cannot vote treasury shares and those shares are not
counted for quorum purposes. Treasury shares and shares held by
another corp, if a majority of the shares entitled to vote in the election of
directors of that other corp is held by the corp. shall not be entitled to
vote
(3) Shares held by fiduciaries may vote by proxy
f) NYBCL § 619 - Powers of Sup Ct. respecting elections
(1) An aggrieved shareholder may petition the sup ct to intervene –
the court may confirm the election, order a new election, or take such
other action justice may require
5. Treasury Stock – any shares originally issued by a corporation and later bought
back by the corporation. The corp is entitled to reissue them at a later date if they so
choose. But if they buy them back and retire and cancel them, they cannot reissue them.
Treasury shares are authorized shares, but the corp does not get to vote those shares, and
they are not counted for quorum purposes.
a) Why would a corporation do this?
(1) It is often a sign that management thinks the stock is trading
below what the stock is worth and they are willing to take the risk that
the stock will go up
(2) When they are trying to avoid a hostile takeover

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 (3) There might be a shareholders agreement that if a given
shareholder dies, his estate must sell the shares back to the company. In
such a case, the corp might have a life insurance policy on the
shareholder so that when he dies the corp is sure to have money in order
to buy the shares from the estate. Corps do this because they don’t want
the heirs who they might not know having voting rights in the corp.
C. Federal Control of Proxy Solicitations for Public Corporations
1. Generally
a) All publicly held companies are subject to federal proxy law
b) Privately held corps are not subject to federal
c) Federal laws are primary about disclosure so that purchasers have the
info needed to make a wise choice. the gov’t was concerned about the quality
and quantity of information disclosed to shareholders
2. Proxy Solicitation
a) 14a governs the solicitation of proxies
b) the fed gov’t is very concerned that people will be communicating with
shareholders (like hostile parties or even mngmt) that won’t give the shareholders
all the info needed. Governed by the Securities Exchange Act of 1934
c) 14a3 the main operative rule – you can’t solicit a proxy from someone
unless you have or simultaneously send them a proxy statement – the concern is
that the person soliciting will give one sided info
d) 14a7 – important from a hostile party perspective, b/c once a hostile
party has filed a proxy statement, how does the hostile party get the statement to
the shareholders. 14a7 allows for that
e) 14a8 - shareholder proposals – typically cover social policy items or corp
governance items. 14a8 says that these must be included with the corp’s
proposals
3. Shareholder Identification
a) There is a problem with identifying shareholders because the beneficial
owners (the ones who get dividends and have voting rights) are often not the
record owners (the people listed in the corp’s books as the owner)
b) Street name: the shares are registered in the name of bank or broker
dealer (UBS or Merrill Lynch) and they keep on their books who truly owns the
shares. You are in their computers as the owner, but
c) Street name facilitates the electronic trading of shares. In the old days
there were stock certificates and when you bought shares you would be sent a
certificate and when you sold you had to mail the certificate to the buyer. Now
we use computers.
d) Under state law, you are entitled to demand a stock certificate.
4. Primary Market
a) Instead of issuing thousands of certificates to individual shareholders, the
corp issues one combined certificate to a depository trust company (DTC). The
DTC does not take the certificate in its name, it takes it in the name of Cede &
Co. (Cede is a depository trust co)
b) Cede & Co. is essentially the record owner of the shares, but DTC on its
books knows that it is holder the shares for its member institutions (like Merrill
Lynch, etc.). DTC will notate that Merrill is the holder, but then on Merrill’s
books it is notated that the individual is the beneficial owner of the shares.

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 c) The corp cannot send just one proxy to Cede & Co. They must send
boxes and boxes of proxy statements to Cede & Co. who then ships to the
individuals.
5. Proxy Materials
a) Proxy materials contain
(1) Proxy statement - Consists of the disclosure document telling
you what you are going to vote on
(2) Proxy card – the card that you send in your vote on
b) Federal Regs:
(1) The federal government defines proxy and solicitation very
broadly
6. 14(a)(1) – Defines
7. Proxy includes every proxy consent or authorization, which may take the form of
a filure
8. Any request to execute or not execute or revoke a proxy
9. The furnishing of a form of proxy or other communication
10. Safe harbor provision in proxy rules:
a) In theory the general proxy rules prevent shareholders from
communicating with each other, but the federal gov’t allows shareholders to
communicate without having to file for public view with the SEC if the
communication does not involve proxy cards
11. De Minimus Solicitation: Solicitations to not more than 10 persons do not need
to be filed with the SEC
12. Let’s say there is a
a) What disclosure tdo we have to give to shareholders
b) 114(a)-3 – tells us that you cannot make any solicitation subject to the
proxy rules unless each person solicitated is currently furnished or previously
furnished with a proxy statement. You cannot solicit votes until you send
concurrently with the solicitation or previously sent proxy materials that have
been filed with the SEC
13. 14A – requires that you give out general information such as:
a) date, time, place of meeting
b) specify the identity of the person making the solicitation of your vote? Is
it existing management, a disgruntled shareholder
c) Specify who gets to vote – like if you have a multiple classs corp with
common stock and preferred stock – depending on the issue, preferred
stockholders might not get to vote
d) Identify any large shareholder and how that shareholder is going to vote
if the corp knows how the shareholder is going to vote
e) If you are a public company that has cumulative voting – you have to tell
the shareholders that they have cumulate voting and you must explain to them
how it works.
f) State what the required vote is – like the percentage of votes required to
pass the issue
g) State what the quorum requirements are
h) If electing directors, must give the background of the nominees
i) If amending the charter, must state why they want to change the charter

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 14. If you want to initiate a hostile takeover, 14a7 says that the target company has to
assist the hostile party by providing a list of shareholders, which includes the DTCs
holding shares in street name, OR you on behalf of the hostile party can mail out the
materials and the hostile party will reimburse the target company for the expense of
mailing out materials. The target company would much prefer mailing the materials
themselves than give the hostile party a list
15. Shareholder proposals not relating to the election of directors – must a board
include shareholder proposals in the board’s proxy materials?
a) Yes depending on what the topic is:
(1) Social policy proposals must be included in the proxy
statement, such as
(a) Stop apartheid in S. Africa
(b) Stop building nuclear power plants
(c) Stop manufacturing tobacco products
(2) Corporate governance proposals, such as
(a) redeem the company’s poison pill
(b) repeal a classified or staggered board of directors
(c) stop paying the CEO so much money
b) General rule is that if a shareholder timely sends a proposal, then the
corporation has to include the proposal in the proxy materials
c) But there is a laundry list of exclusions that allow a corp to exlude a
proposal. If the board feels there is an exclusion, the must tell the SEC why they
think it should be excluded. The SEC will then respond as to whether they agree
– the no-action letter
(1) Illegalities
(2) Fraudulent Statements
(3) Personal Grievance
(4) Immateriality – if the proposal concerns a corp operation of less
than 5% of the corp’s income
(5) Absence of power or impossibility – if the proposal relates to
something not within the power of the corp to effectuate, e.g. a proposal
for world peace
(6) ORDINARY BUSINESS OPERATION EXCLUSION – this si
the main one
(a) If the proposal relates not to policy matters, but to
ordinary business ops, the proposal does not need to be included
in the proxy
(b) The DUPONT CASE – the shareholder wanted DuPont
to accelerate its phasing out of CFCs. The court agreed that the
corp did not have to include it in the proxy materials because
DuPont was already committed to phasing out CFCs (policy),
but the shareholder just wanted them to do it sooner (timing is a
matter of routine business judgment) so it was a matter of
ordinary business ops, so DuPont did not need to include her
proposal
(7) Dividend Exclusion – if proposal concerns paying out dividends,
the corp does not have to include it because whether or not to pay
dividends is at the discretion of the board
LIII. CLOSELY HELD CORPORATIONS

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A. Generally
1. the shareholders generally know each other
2. shareholders are generally, the shareholders, officers, directors, and have to make
the Subway sandwiches when you walk up to the counter
3. no open market for the shares – no liquid secondary trading market
4. closely held businesses are not publicly traded – any co. that is not publicly
traded have no requirement to publicly disclose info about themselves – no reports to the
SEC – but this is true for even large non-closely held, non-public companies
5. contractual restrictions on the shareholders to sell their shares – if you are a
closely held business you are probably all friends or family and you don’t want strangers
buying shares – transfer restrictions controls the identity of who owns shares
6. Bears resemblance to a partnership – it’s kind of a hybrid between a
partnership and a corporation – they get the limited liability that the corporate shield
provides, and the contractual restrictions
7. The duty of loyalty resembles that of a general partnership – the utmost duty of
care and loyalty. The duty only applies when a shareholder takes action concerning the
enterprise. If you find an independent third party to buy your shares, you can sell your
shares for as much as you can get without regard to the fact that the minority shareholders
don’t get the same opportunity.
8. What’s the diff between closely held corp and LLC
B. Statutory Close Corporations v. Closely Held Corporations
1. Donahue v. Rodd
a) Facts: Rodd and Donahue were the only 2 shareholders. Rodd owns
80%; Donahue 20%. It used to be called something else, but through a
shareholder vote Rodd voted to change the name. Rodd is about to die. He
wants to leave an inheritance to his kids. He gives 2 shares back to the corp.; and
117 of his 120 shares to his three children. He wants the corp to buy back 45
shares at a price of $800/share. The minority shareholder Donahue says what’s
good for the goose is good for the gander and wants the corp to buy back 45 of
his shares at $800/share. The corp says we are not going to give you $800/share
but says they will give something between $45 and $200/share. But the book
value is $800. Donahue dies and his wife takes over and brings a lawsuit against
the corp and the directors alleging that the controlling shareholders (the Rodds)
breached their fiduciary duties to her by offering the same opportunity as the
controlling shareholders.
b) argues: that there is no right to an equal opportunity in corporate stock
purchases for the corporate treasury (when the corp is buying back its own
shares)
c) Issue: is like Sinclair Oil. That the controlling majority stockholder is
given an opportunity not made available to all stockholders.
d) Holding: This only applies to closely held corporations.
e) The Court defines Closely Held
(1) Small # of shareholders
(2) No liquid secondary trading market
(3) Substantial majority of stockholder participation in management
(4) Bears a resemblance to a LLC
f) The Court defines the fiduciary duty owed

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 (1) So, the shareholders of a closely held corporation are not entitled
to treat each other like strangers and they thus owe each other a duty of
fiduciary duty (duty of finest loyalty – Cardozo’s coadventurers
statement from the Meinhard case). Duty of finest loyalty is stricter than
the duty of loyalty in the standard corporate duty of loyalty context.
(2) They owe each other substantially the same fiduciary duty in the
operation of the enterprise that partners owe to one another. The
standard is one of utmost good faith and loyalty. This applies to both
controlling shareholders AND minority shareholders (contrast this to
publicly held corps where the controlling shareholders owe a duty to the
minority but not vice versa)
g) What is the danger of being a minority shareholder in a closely held
corp
(1) Majority freeze-outs
(2) The majority can vote to fire a minority holder from the corp
(3) They can stop the corp from making dividend payments and
since the minority is no longer employed by the corp he no longer draws
a salary but the others do so they are not hurt by the lack of dividends
(4) Since there is no secondary market, the minority shareholder
cannot sell his shares once he is freezed out, so his only option is to sell
his shares back to the corp
(5) This does not happen in publicly traded company because when
they see something going on in the corp they generally just sell their
shares, privately held shareholders can’t do that
h) What if the controlling shareholder wants to sell his shares to
someone else?
(1) That’s fine. The problem isn’t that they do something with their
control that nets them a benefit – it’s when they use their control to
control the company in a way that garners them a benefit. If he finds
someone that is willing to buy his shares, he can do that. It is when the
corporation is buying back treasury shares that the controlling
shareholders owe a duty.
(2) Tag along rights – the minority shareholder might be able to get
the controlling shareholder to give him tag along rights. Essentially say
that if the controlling stockholder sells his shares to someone, the
minority shareholder gets to sell a pro rata share of his own shares at the
same price.
i) Remedy
(1) The court says that the corporation can either
(a) rescind its purchase of Rodd’s shares, or
(b) buy back Donahue’s shares as treasury shares at the
same price it purchased Rodd’s
C. Legislative Responses
1. NYBCL § 620
a) Allows NY corps to create agreements amongst the shareholders that
allow them to be effectively governed like a partnership. They look a lot like
partnership agreements. So there is no need to opt in to the regulatory
framework – in contrast with Delaware

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 b) You can enter into shareholder agreements that govern the way you will
vote your shares
c) You can put a provision in your cert of incorp that restricts the board to
only one member – like a general partner
d) These apply to any NY corp so long as the shares are not publicly traded
2. DGCL § 341 – 356
a) Allows shareholders of closely held corps to enter into shareholder
agreements that address how the business will be managed – govern the selling
of shares, and govern the voting of shares
b) Allows corporations to conduct themselves as if they were a partnership
c) One main diff from NY is that in Del you have to opt in to take
advantage of these provisions and if you opt in you are called a statutory closely
held corp.
d) You can opt in right off the bat or file an amendment later on to opt in –
but you would need a 2/3 majority vote to do so
e) Statutory reqs to opt in
(1) § 342 says that the corp cannot have more than 30 shareholders
(2) stock has to subkject to some or all of the restrictions of § 202,
which allows corps to enter into shareholder agreements re governance
(3) you cannot make a public offering of your stock – you must be a
private company
f) How do you know whether a Del. corp is closely held? you look at the
charter of the corp and it will tell you whether it is a close corporation
D. Contractual Responses
1. Two biggest issues that contractual provisions address are control and ownership
2. Control
a) All about voting
b) It’s an important issue to closely held corps b/c there are many investors
out there who will not buy stock in a business unless they know who is
controlling the business. Many times they want representation on the board so
they know what is going on with their investment. This is because there is a risk
with small companies. So it is not unusual to see closely held corps giving
voting rights when it needs the money from the investor
c) Shareholders agreement might address the issue of voting
(1) The agreement would commit the shareholder to vote in a
particular fashion. The shareholder gives up the right to vote. This
could not happen in a publicly traded corp.
(2) What if there is a breach of shareholder agreement and the
shareholder does not vote the way he is supposed to – specific
performance. The court will force a revote
d) A second way to change the natural flow of voting is through irrevocable
proxies
(1) If someone gives you an irrevocable proxy to vote. You can
vote the way you want and the right to vote could never be taken away.
Del § 212(e); NY § 609(f)
e) Voting Trust

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 (1) You get a group of people that want to vote collectively and they
establish a trust, deposit their shares into the trust, and nominate a
trustee. The trustee votes in accordance with the trust agreement, the
shareholders that deposited the shares in the trust get the dividends and
stuff.
(2) In NY the voting trust can only last for ten years, with a one ten
year term extension
(3) You have to file a copy of the agreement with the corporation
3. Ownership
a) Many people form companies together because they want to form a
group of owners, like friends or families
4. Three basic ways you can control how people vote
a) Contractually obligating them to vote one way or another – these types
of contracts are enforceable under NY and Del. law
b) Irrevocable proxy – once a person gives you their irrevocable proxy,
you not them are entitled to vote those shares as you see fit. These are legal in
NY and Del. so long as the proxy says it is not revocable and the proxy is
coupled with an interest
c) Voting Trust – another agreement established through a trust instrument
– a declaration of trust and a trust agreement – you and other shareholders put
your shares into the trust, you retain the economic advantages of the shares –
dividends, etc – but the voting rights are in the hands of the trustee who is to vote
according to a script
E. Share Ownership
1. Generally
a) we want to make sure our shares don’t fall into the hands of undesirable
individuals – we want to keep the shares in the hands of friends or family or
people we trust
b) Two methods to control share ownership
c) Often a shareholders agreement will have one or both types of
restrictions
2. Restrictions on Alienation – transferability
a) Generally – 4 types of transfer restrictions
(1) Right of First Refusal – must be in the shareholders agreement
in order to apply. If a third party comes to a shareholder offering to buy
his shares, the shareholder cannot accept the offer until the shareholder
makes that offer to the corporation and the other existing shareholders
first, and the corp and shareholders refuse. NY does not have a statute on
this, though it is still permitted in NY. Del does: DGCL 202(c)(1).
(2) Right of First Offer - This is not common. Before you shop
around for third party offers, you first have to offer your shares to the
corp and other existing shareholders and only if they refuse can you
solicit third party buyers. What are the terms that you make to the
corporation – typically spelled out in advance in the shareholders
agreement – the terms are fixed, the price is already set. This works
more in the corporation’s favor b/c the price fixed in the agreement
might be less than market value. If they refuse you can then solicit offers
at a higher price.

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 (3) Consent Restraint – You must get the corp’s permission before
you can sell to a third party. Typically, written consent is required
(a) DGCL 202(c)(3) allows consent restraint
(b) Consent restraints can’t be exercised unreasonably – you
must have a provision that says that the corp has to consent to
transfer, but that such consent shall not be unreasonably withheld
(4) Group Restrictions – you can transfer your shares but only to a
select group of people. Typically you would restrict transfer of shares to
people within the same family and you would define family (parents,
children, and current spouses)
(a) 202(c)(5) – legal so long as the group designation is not
manifestly unreasonable
(5) Notes
(a) What do you do if someone transfers shares via will or
divorced decree – you can actually bind the spouse to sell the
shares back to the company – this is fine b/c the divorced spouse
generally just wants the money
(b) You need a legend on the stock certificate alerting
potential transferees that the sale is limited by the shareholders
agreement. The legend must be conspicuous – someone who
takes ownership without notice of the restrictions is not bound by
the restrictions
(i) UCC 8-204
3. Forced Resale Provisions
a) Generally
(1) Another way to ensure
(2) Upon the occurrence of one or more events, a shareholder must
resell the shares back to the corp or other shareholders, even if she wants
to keep holding them
b) What are the typical events:
(1) Termination of Employment - Employee shareholders must
sell back shares upon termination of employment
(2) Death of a shareholder – typically you will have in a
shareholders agreement that the estate must be bound to sell the shares
back if the shareholder dies – the estate gets what it wants – money – and
the remaining shareholders get what they want – the shares back rather
than falling into the hands of heirs that they do not want to be in control
c) Where does the corp. get the money to buy back shares?
(1) You can as a company take out life insurance policies on your
key shareholders that specifically covers the dollar amount that you
would have to pay for the shares
d) One of the biggest questions is what price are you going to pay –
what do you put into the shareholder’s agreement that you would pay?
(1) A specific dollar amount could be listed
(2) Pricing formula is more likely to be listed – book value per share
(a) BV = (TA-TL)/#outstanding shares

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 (b) There are a number of problems with book value – it is a
good number for the person who is writing the check, but not
necessarily good for the person receiving the check, b/c it does
not reflect “going concern” value.
(c) What do we know about the book value?
(i) Assets are listed at their historical cost, or at
lower value if their value has been permanently
impaired, so the BV does not recognize that assets
(land/bldgs) go up in value. The land would still be
listed at the price paid for it.
(ii) BV is a terrible measure for businesses that are
not capital intensive – businesses that don’t have a lot of
tangible assets, like cars, trucks, equipment (like a law
firm or doc’s office where the main assets are the human
capital and the customer list – these are not listed as an
asset and they are the most valuable parts).
(3) Discounted Cash Flow – try to predict the net cash flow going
into the future to see what the profit will be
(4) Appraiser – hire people to appraise the corp. there might be a
dispute as to who the appraiser will be
4. Allen v. Biltmore Tissue, NY Case 1957
a) Facts
(1) The buyback provisions were set out in the bylaws
(2) In the case of death of any shareholder the corp shall have the
right to buy back the stock at the price that they sold it to the shareholder
originally. If the option is not exercised then the legal rep should. The
xfer restriction was clearly legended on the certificates. The guy wants
to sell seeking to know what price the corp would be willing to pay to
purchase his shares. Before he gets an answer he dies, and his son, the
executor, sends a letter asking to know if the corp wanted to buy back the
shares and at what price (they apparently hadn’t read the bylaws and
didn’t know about the provision). The corp offers $20/share (which is
more than the dead guy paid for it). The executor decides not to sell at
that price and sues for unreasonable restriction on transferability. The
corp counter sues seeking specific performance
b) Holding: the court finds for the corporation – the executor must sell at
the price in the k.
(1) The Court of appeals says that the forced resale at the original
price is entirely valid and enforceable because it was just a restriction on
transfer it was not a flat out prohibition on resale
(2) They say that even though the price to be paid is vastly lower
than the market price there is a contractual provision and it will be
upheld.
5. Evangelista v. Holland – Mass. Case. Forced resale. The court notes that the
price of sale in the shareholder agreement is unremarkable in comparison with the market
value, but that the order and time of death of the stockholders was an unknown and there
was mutuality of risk. So how do you fix the unknown when there is a set of bylaws like
this and you are a shareholder? One thing you can do is try to change the bylaws once
you are in. Try to convince everyone that it doesn’t make sense to not get market price.

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 6. the forced resale purchase price is totally fine even if the value pursuant to the
formula is not reflective of market value. The court’s don’t give a shit that the formula
is undervalued – that’s what’s in the contract.
F. DISSOLUTION FOR DEADLOCK
1. What Happens When Shareholders of a Closely Held Corporation No
Longer Get Along?
a) Board deadlock is extremely severe because no decisions can be
made
b) Shareholder deadlock is dangerous because they can’t elect new
directors
c) Severe disharmony can result in deadlock at either the BoD level or
shareholder level, and can lead to oppression of minority shareholders by
majority shareholders
d) Deadlock is where the board is able
e) Sharehodlers are unable to effect their voting rights to elect board of
directors – like they can’t get a quorum
f) In a board deadlock situation the corp just treads water – half of the
board disagrees with the other half
g) Successive electors can never be elected because the shareholders can’t
agree on who to vote in
2. DGCL § 226 – Allows Chancery Court to Appointment a custodian or receiver
of corp on deadlock – any shareholder can request this of the court. The custodian is
a) The Chancery upon application of any shareholder may appoint 1 or
more persons to be custodians and if the corp is insolvent to be receivers for a
corp when
(1) The shareholders are so divided that they have failed to elect
successors for directors whose terms have expired
(2) The business is suffering or is threatened with irreparable injury
b) The corp has abandoned business and has failed w/I a reasonable time to
take steps to dissolve, liquidate or distribute its assets
c) The custodian’s job is to run the business, not to dissolve or liquidate the
corp. Keep the corp going. Shareholders who hate each other/directors who hate
each other hate the custodian more and generally agree to do something.
3. NY § 1104(a)
a) Holders of shares representing 50% of the voting power can petition a
court for dissolution if:
(1) The directors are so divided that directors can’t come to a vote
on anything
(2) Shareholders are so divided that they can’t vote on directors
(3) Factions of shareholders are so divided that it would be more
beneficial
4. Diff between NY and Del.
a) Dissolution is more severe b/c the corp falls apart, whereas in Del. where
a custodian is appointed, the corp is kept going
b) It is harder for a shareholder to be granted relief in NY because 50% of
the shareholders must join in a shareholder’s request, whereas with Del. any
shareholder can petition

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 c) In NY there is a strong judicial desire to keep a corporation going. Even
though courts have the power under 1104 to dissolve, they would rather appoint a
receiver (like a custodian) and keep the corp going
5. Oppressive conduct
a) Kemp & Beatley
(1) 2 employee shareholders both left the employ of the corp after
42 and 35 years of service. Before these two men were forced out they
received the vast majority of there earnings as salaries. So stock
ownership was basically a union card to be able to work there and they
were a cohesive group of people at one time. There were also dividends
paid and bonuses paid. This ultimately leads to a low profit for the corp
which is great because as a C-Corp you pay less tax. Although you have
to pay employment tax, it is less than the profit tax would be. When
these two guys are forced out, they stop paying dividends. Before these
two guys left there was a history of the corp buying back the shares of
employees that would leave, but the corp did not do that with these two
guys.
(2) These two guys file a claim of oppressive conduct – because
they own stock that is basically worthless because they are not getting
dividends – the other stockholders are getting salaries and bonuses. They
can’t sell the stock because there is noone out there to buy it. It isn’t
worth anything.
(3) They file a petition for dissolution on the basis of oppressive
conduct – filed under 1104-a (this is a different provision than 1104(a).
Under 1104-a a petitioner must own at least 20% of the shares to file for
dissolution for oppressive conduct.
(4) There is no statutory definition of oppressive conduct. The court
comes up with its own definition:
(a) Reasonable expectation: the conduct of majority or
controlling shareholders substantially defeats the reasonable
expectations of minority shareholders in committing their capital
to the enterprise. But you don’t look to the minority shareholder
expectations – you look objectively at the shareholder’s
expectations as a whole
(b) What is the reasonable expectation of a shareholder of a
closely hold business? It is different than the shareholder of a
publicly held corp. A shareholder of a closely held corp is
ownership and control and employment for himself. He might
not anticipate a big return on his shares, he wants a salary –
typically the investment return of a closely held corp is salary,
retirement benefits. When you are fired you don’t get these
benefits.

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 (c) What is the remedy: Statutory dissolution, but courts
are reluctant. So, typically the court orders a less drastic remedy.
The Court of Appeals says that before dissolution, the court will
offer to the other shareholders to buy out the oppressed
shareholders shares at fair market value so as to avoid
dissolution. This is good for the oppressed shareholder – he
wants money and it is good for the shareholders that want to
keep the corp together – just without the oppressed shareholder’s
involvement
(d) If they can’t agree on what fair value is, the court can
decide for them under 1118(b).
b) Why aren’t the duty of care and loyalty enough to protect the oppressed
shareholders in this case? Why do we need dissolution statutes?
G. DISSOLUTION FOR OPPRESSION
LIV. APPRAISAL RIGHTS AND CORPORATE VALUATION
A. Generally
1. When shareholders are forced into an investment they don’t agree with because
other shareholders voted to merge with another corp. So, what happens when some
shareholders voted no to the merger and don’t want to invest in the merged entity?
2. Appraisal rights provide a safety valve mechanism for shareholders that don’t
want to go along with the will of the majority. Appraisals are not permitted in all
mergers. Only in certain circumstances.
3. In an appraisal proceeding the disgruntled shareholder will sue to receive the fair
value of his shares to be paid to him in cash. The fair value is determined by a court.
4. Appraisal rights are statutory in nature
5. Synergy – benefit related to the accomplishment of the merger – not to be
considered when determining the fair value of the dissenter’s shares. You cannot get off
the train and then expect to have the value of the destination included in your share’s fair
value. But any actions the board takes that might increase the value of the shares in
anticipation of, and up to the point of, the merger would be included.
6. Minority discount
a) If the shareholder has a 1% stake, you can value those shares in isolation
– what would the market value the shares at? – b/c the shares are so few there
really is no voting value – you would see what the stock is voting at – this is
giving them no control premium, b/c they don’t have any control – they get to
vote but it doesn’t matter b/c there are people out there with more voting power.
b) The Del. court said this was the wrong way to do this. B/c the dissenter
doesn’t want the corp to merge, they don’t want to sell, so the Del ct said the
appropriate way is to value the whole company is to include a control premium –
well above what the share trades at in the stock market. So the value of his 1%
stake should get his 1% share of the control premium.
B. DGCL § 262 – the most poorly drafted statutory provision
1. (a) The perfection of appraisal rights. If you are disgruntled with the merger and
stock you are going to receive and you seek appraisal rights you have the obligation to
show that you owned the shares at the time you demanded appraisal rights and that you
owned the shares through the date of the affected transaction. Moreover, you cannot vote
in favor of the merger and seek appraisal rights.
2. (b) A shareholder of a Del. corp gets appraisal rights when:

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 3. The corp that is engaging in a transaction must tell the shareholders that they are
entitled to appraisal rights. So, when the corp issues the proxy statement before the
shareholder vote, it must include that they have appraisal rights. Once a shareholder is
aware of appraisal rights, he must notify the board that he intends to assert his appraisal
rights. Only then can the shareholder petition a court.
4. Holders of publicly traded stock that are listed on NASDAQ or NYSE are NOT
entitled to A/R (same in NYBCL) b/c sh may sell secondary traded stock easily at market
price which would be better then letting a court decide the value of the stock
a) The one exception is the cash out exception – if you are being forced by
the will of the majority to go through a merger and the shareholders voted to
receive cash for their shares rather than a stock swap
b) Public shareholders in significant transactions like mergers who are
receiving cash for their shares still get appraisal rights even though Why? The
trading value of the shares is artificially affected by the announcement of the
merger, because if the board offers $42/share for the cashout, when the market
gets announcement of the merger, no one in the market will purchase shares for
more than $42 even if the shares are worth more than that. So, shareholders that
want to sell before the cashout happens but after the announcement is made are
pretty much fucked.
5. Basically, to get appraisal rights:
a) The shareholder must have voted no to the merger
b) The stock can’t be listed on NYSE or NASDAQ
c) The shareholder must own shares up until the merger
d) Must notify the board that he intends to assert appraisal rights
e) Must file a petition in court if the board didn’t do so, because the board
probably won’t
C. Valuation of Fair Price
1. the most common statutory formula instructs courts to determine the fair value of
shares
2. the court can figure it out however it wants, it does not have to rely on the
evidence given by the parties
3. (h) when the court values the corp it must value the corp excluding any value that
the merger will bring. The shareholders are jumping ship so they can’t get any benefits
of the merger that they didn’t want.
4. Many times, investment banks perform the valuation of shares. They will look at
many different types of valuation methods.
D.
E. NYBCL § 910
F. NYBCL § 623
G. Piemonte v. New Boston Garden Corp. – the Delaware Block method is not used nay more,
but use to be the way to value corps. The nice thing about the block method was that it looked at
several factors that contribute to the value of the corp. The different factors were then assigned a
weight. The problem with valuation is that there could be so many variations on the value.

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 1. Facts: s are shareholders in Boston Garden Arena Corp. The shareholders voted
to merge with New Boston Garden Corp. The circumstances of the merger allowed s
who did not vote for the merger to demand payment for stock from the surviving corp.
Under Mass. Law, the s sought a judicial determination of the fair value of their stock.
The Garden Arena owned stock in a subsidiary that owned the Bruins and the Braves.
They also owned the Boston Garden and the concessions at the Garden. The judge
determined the market value of the shares, the Earnings Value of the shares and the Net
Asset Value.
2. Block method – Market Value = 10% ($2.65); Earnings = 40% (21.04); Assets =
50% (51.58). The block method comes out to $75.27/share
3. Market Value (the stock price): In determining the market value, the judge
based his decision on the price per share of the last prior sale, which was $26.50. The
defendants argued that the judge should base the decision on comparable companies and
reconstruct market value, because the stock was not regularly sold on the market. The
court found this was permissible and it was within the judge’s discretion to prefer actual
sales price over reconstruction of market value
4. Valuation Based on Earnings: The value based on future profits. The court
looks at historical earnings to use as a baseline to determine where earnings will go
to in the future. The judge determined the average per share earnings of the Garden
Arena was $5.26. He then multiplied this by 10 to come up with $52.26. In selecting the
multiplier the judge determined the stability of the company’s earnings based on other
companies. He found that the corp’s favorable earnings aspects were the popularity and
success of the sports teams, the high attendance record of home games, the popularity of
certain players and the radio and tv contracts. He found negative however that the
creation of the World Hockey Association might take some key players away and give
the players bargaining power as far as salaries. The argued that the judge should base
the earnings on dividends that had been issued. The court disagreed because it is up to
the board to distribute dividends and is not a reflection of the earnings.
5. Valuation Based in Net Asset Value:
a) The judge considered the value of the Arena, the value of the Bruins and
the value of the concessions. He found that the Arena was worth $9.4MM, the
Bruins worth $9.6MM, and the concessions at $2.3MM.
b) The defendant argued that there was $1,116,000 that was being counted
twice and that the concessions should not have been valued apart from the
Garden. They say that the 1,116,000 is the goodwill of the Bruins …
c) The court held that the because the judge did not give an explanation of
his valuation of the Garden, it is possible that he did not give adequate
consideration to the Garden
d) With respect to the valuation of the Bruins, the judge stated that he felt
constrained to accept the defendant’s expert valuation of the team even though it
seemed low, b/c the plaintiff’s expert’s valuation was way too high. The court
said that the judge was not required to limit his ruling to the evidence offered by
the parties and was free to come up with his own valuation so long as it is
reasonable. This he must do on remand.
e) Same thing for the valuation of the concessions. The judge said he had
to go with the plaintiff’s evidence on the valuation since the defendant offered no
evidence on this issue. The court agrees with the that the valuation was high
because the earnings were incorporated into the earnings value and are counted
twice being counted in the net asset value.

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 6. Weinberger Case: The Del. Sup. Ct. overturned the Delaware block method of
weighing factors. Courts may use the block method, but it is no longer controlling. A
more liberal approach would include techniques that are acceptable in the financial
community. The fair value under § 262 must include consideration of all relevant
factors.
7. Then the Mass. Sup. Ct. is embarrassed that it adopted
8. You can plead any valuation you want that is generally accepted in the
community
9. What is important is how you value the shares, not the method used.
a) Value the entire company
b) Find out what his slice is worth.
c) By forcing the corp to value the company 100% that includes a control
premium, then when you take the 5% will also be receiving a piece of the control
premium.
d) A minority shareholder does no really have any control so his 5% would
not entitle him to much control, but if he forces the corp to value the whole corp
and divide it up he gets a piece of the control value
e) You don’t get the merger consideration, you aren’t getting cashed out,
you aren’t getting the new shares. § 262(h) says that you do not get your money
until the bitter end – after they determine what the value is, through appeals.
Your money is going to be tied up until this time. You get interest on the amount
of money that the corp ends up owing you until the date you are paid out. A
better way of doing it is the RMBCA § 13.24 has this: it says the corp has to
immediately pay the disgruntled shareholder what rthe corp believes the value of
the shares is. If the shareholder is not satisfied with that payment he can send a
letter to the corp saying no, the value is this, then the corp has to commence
proceedings and then at the very end if it turns out the shares are worth more,
then they have to pay the difference.

20 multiple choice – 2 pts each – about 3 minutes each

10 short answer – 60% - about 10 minutes each short answer – answer and analysis – “answer ix X,
because” Questions that are math oriented, don’t just put a number, show how you reached a number
We need a calculator

He doesn’t ask any questions “which section of the DGCL says…” But if you know a section number
and we throw it in and it happens to be right he will know that we know what is going on.

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