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Gorton v.

Doty (Idaho 1937)


-Facts: Ms. Doty, teacher, volunteered her car for the purpose of furnishing
additional transportation, designating coach as driver instead of herself (asked if
had enough cars, upon being told needed one more Doty lets coach use hers if he
drives it, calling it a "loan"); son gets hurt in accident and gets judgment against
Doty, she appeals denial of mistrial
-Issue: Was coach an agent of Ms. Doty for purposes of transporting football team?
-Rule: RS 3d 1.01 Agency- manifestation of consent from both parties that one will
act (1) on behalf of the other and (2) subject to other's control
[manifestation of consent that the agent act (1) on principal's behalf (2)
subject to principal's control, and (3) agent's consent to so act]
-three principal forms: (1) principal/agent, (2) master/servant, or (3)
employer(or proprietor)/independent contractor
-agency doesn't require contract or consideration, RS Agency 16
-ownership alone raises presumption that driver is owner's agent, e.g., Willi v.
Schaefer Hitchcock Co.
[control is defining feature of agency and partnership law]
-Majority Analysis:
(1) subject to principal's control established through requiring coach to drive
(2) acting on behalf of b/c her purpose was to furnish additional transport and
could have driven herself, but instead had coach drive on her behalf
-not loan b/c nothing said of loaning or borrowing car, merely that if
coach drove he could use it
-"mulcting" allegation unsupported by evidence, counterpoint that "prudent
automobile owners" wouldn't have acted like Ms. Doty did also improper but not
cause for complaint b/c only made in response to mulcting allegation
-mistrial denied, "prudent automobile owners" read to jury but told to
disregard
-Dissent Analysis:
-agency more than mere passive permission, but request, instruction or
command
-requiring coach to drive was mere precaution, not command
-read record as a loan, kindly gesture
-coach was gratuitous bailee, not agent, b/c for his own use, not of
Doty's account
-prejudiced by "prudent automobile owners" language and also prejudiced by
statement that Doty wouldn't personally pay b/c she had insurance, though
both instructed to be disregarded
Majority and Dissent disagree as to (1) what presumption using other's car creates,
and (2) importance of a contractual relationship
Maybe court is playing distributive justice and allocating risk to insured party,
encourage insurance policies covering third-party drivers
Mill Street Church v. Hogan (Ky. 1990)
Facts: Elders hire Bill Hogan to paint church, decide Petty could be hired to assist,
Sam previously hired to assist but no longer church member; during meeting Hogan
and Waggoner discussed possibility of hiring Petty but Hogan told Petty difficult to
reach w/o other discussion; Bill hires brother Sam, who falls and requires surgery;
church paid Bill and Sam for their work but denies that Bill had implied or apparent
authority to hire Sam
Issue: Did Bill have implied or apparent authority to hire Sam as subagent?
[What is the scope of Bill's agency?]
Rule:
-implied authority: "actual authority circumstantially proven which the
principal actually intended the agent to possess and includes such powers as are
practically necessary to carry out the duties"
-look at agent's understanding of his authority, reasonable belief based
on present or past conduct that principal wished him to act in
certain way
-nature of job another factor
-apparent authority: "the authority the agent is held out by the principal as
possessing ... a matter of appearances on which third parties come to rely"
Analysis: (1) church allowed Sam to be hired in the past (2) no mention made to Bill
of a different arrangement this time (3) possible other helper difficult to reach (4)
unreasonable to believe Bill able to complete job w/o hiring a helper; therefore
implied authority present
also unfair since Sam believed Bill allowed to hired him as in the past and
relied on Bill's representation (relevant to apparent, but to implied as well?)
Dweck v. Nasser (Del.Ch. 2008)
Facts: Dweck 30% shareholder of Kids Intl. and fired after discovered running
competing companies; litigation slow so Wachtel hired by Dweck, and Wachtel
reaches out to Shiboleth, Nasser's friend and long-time counsel, despite Heyman
being attorney of record; Nasser then declines to sign agreement reached by
Wachtel
Rule: (1) actual authority- expressly granted; also attorney of record presumed to
have authority to settle (but that was Heyman, not Shiboleth)
(2) implied authority- derived from actual to (a) do what's "necessary, usual
and proper to" carry out express authority (b) act how agent reasonably
believes principal manifested based on principal's objectives and other facts
(RS 3d 2.01)
(3) apparent authority- "power as a principals holds his agent out as
possessing or permits him to exercise under such circumstances as to
preclude a denial of its existence"
Analysis:
(1) actual- "do what you want or what you understand" "you can talk in my
name"; despite agreement containing "non-negotiable" terms he is bound b/c
said he would "blindly" sign
(2) implied- previous twenty years where he had been given authority to
settle cases and Shiboleth's actions in the current case; "evidence of
acquiescence w/ knowledge of the agent's acts ... acquiescence may be shown by
evidence of the agent's course of dealing for so long" that it's assumed
(3) apparent- Dweck's husband and brothers told Shiboleth and Heyman that
she didn't intend to read the agreement and would sign it when told to do so
Three-Seventy Leasing Corp. v. Ampex Corp. (5th Cir. 1976)
Facts: 370's only employee Joyce purchases computer parts for lease, discussed
buying memory from his friend, Ampex salesman Kays, to lease to EDS; Kays and
boss Mueller meet and submit document w/ price and payment terms, signed by
Joyce but not Ampex, interpreted by court as offer to buy, not sell; Mueller sends
office memo stating Ampex awarded agreement to sell memory and Kays sent
letter confirming delivery dates; Kays letter interpreted as accepance
Issue: Was Kays and Mueller's scope of authority broad enough to complete
contract?
Rule: apparent authority- would lead reasonably prudent person to suppose that
agent had the authority to do "usual and proper" for business which he's employed
Analysis: Kays employed as a salesman, so reasonable for third parties to presume
he had selling authority, which Ampex never dispelled (Mueller sends document w/
signature block, though unsigned; Joyce's request to deal just w/ Kays accepted);
never communicated to Joyce that neither Kays nor Mueller had ultimate selling
authority
Watteau v. Fenwick (Eng. 1892)
Facts: Humble manages bar in his name silently owned by Fenwick, Humble had
authority to buy beer but not cigars, Fenwick sued for cost of cigars given only on
Humble's credit
Rule: "principal is liable for all the acts of the agent which are within the authority
usually confided to an agent of that character, notwithstanding limitations," even if
there hasn't been a holding out of authority
Analysis: within typical authority for manager to accept cigars; bad policy to let
silent owners escape liability
RS 2d Agency 8A: inherent agency power- "not from authority, apparent authority
or estoppel, but solely from the agency relation and exists for the protection of
persons harmed by or dealing with a servant or other agent"
RS 2d Agency 194: principal liable for agent if actions "done on his account, if usual
or necessary in such transactions, although forbidden by the principal"
RS 3d Agency 2.06 Liability of Undisclosed Principal:
(1) undisclosed principal liable to third party justifiably induced to
detrimentally change position by agent if principal has notice of actions and
potential to induce position change, yet doesn't reasonably act - (since Fenwick
unaware, case would come out differently under 2.06?)
(2) undisclosed principal can't reduce agent's authority to less than that third
party would reasonably believe agent to have if principal was disclosed - (maybe
Fenwick still would be liable because if Watteau knew of principal still would
reasonably have believed Humble had authority to buy cigars?)
Classic situations of inherent authority: (1) undisclosed principals and (2) agent
exceeds authority
Botticello v. Stefanovicz (Conn. 1979)
Facts: Mary and Walter Stefanovicz own farm as tenants in common, Walter sells
lease w/ buy option to plaintiff in 1966, who makes improvements and tries to
exercise six years later; trial court finds for P, D's appeal that Mary never party to
sale; trial court finds Walter acted as Mary's agent, court disagrees
Rule: agency is fiduciary relationship from consent manifested by one person for
other to (1) act on his behalf (2) subject to his control, and (3) agent consents to so
act
-P has burden of proving agency relationship by preponderance, which isn't
proven by marital status alone or joint ownership
Ratification is (1) "affirmance by a person of a prior act which did not bind him but
(2) which was done or professedly done on his account" and requires " RS 2d
Agency 82; requires "acceptance of the results of the act with an intent to ratify,
and (3) with full knowledge of all the material circumstances"
Analysis: insufficient proof of agency:
(1)Walter handling business aspects isn't necessarily a delegation of
authority
(2) although Mary and Walter discussed sale and Mary remarked 75k or less
than 85k wasn't enough isn't equivalent to agreement to sell for that amount
(3) most importantly, before the sale Walter never signed anything as Mary's
agent until 1966
Ratification: (1) no intent by Mary to ratify (2) nor knowledge of all material
circumstances and (3) Walter never purported to act on Mary's behalf; accepting
payments could be due to Walter acting on his 1/2 interest or her ratifying a lease
but not a sale, and spending money for the family is Walter being generous
husband
When ratified usually binds both principal and third-party to the whole contract
(room for argument to extend ratification to other transactions or sever parts of the
contract), typically unless some kind of change in circumstances
Has to accept benefits at a time when she has the opportunity to decline
Hoddeson v. Koos Bros. (NJ 1957)
Facts: Lady goes to store to buy furniture, gives 168.50 to older man in suit acting
as if he were a salesman, seeks damages from store as principal
Issue: Is store liable for acts of an unknown criminal imposter posing as its agent?
Rule: bases of agency: (1) express or real authority (2) implied authority- "proper,
customarily incidental and reasonably appropriate to the exercise of the authority
granted" and (3) apparent authority- "principal by words, conduct, or other
indicative manifestations has 'held out' the person to be his agent"
Analysis: express and implied authority definitely not present, apparent authority
must be created by principal's manifestations, not by agent alone
-duty to customer is beyond "removal of banana peels from the aisles" but
goes to "reasonable surveillance and supervision" and "reasonable care and
vigilance" to protect customers from imposters
-forcing customers to verify that the salesman is legitimate is "patently
impracticable" and not within "ordinary prudence and circumspection"
-their manifestations were its poor security measures? no proof that they had
actual knowledge
-no holding out of imposter as agent, estoppel authority due to store's
negligence
Humble Oil Co. v. Martin (Tex. 1949)
Facts: Martin and two daughters injured by Love's rolling car left w/ parking brake
unengaged for repair at Schneider's gas station w/ Manis only employee; Schneider
has franchise agreement w/ Humble Oil purporting no master-servant relationship;
franchise agreement gives Schneider 3/4 rebate on utility bills, required him to
perform other duties by Humble Oil, Humble Oil set working hours, strictly
controlled financial control land supervision, furnished location and equipment and
advertising
Issue: Was Schneider's franchise agreement and circumstances reflect master-
servant or principal-agent relationship?
Rule: What agreement calls itself is not important; "question is ordinarily one of
fact"
Analysis: Consider irrelevant that fact that Schneider was called the "boss" and no
one considered Humble as the employer
-b/c agreement provided for Schneider to perform duties as Humble required
and Humble set the hours and controlled most business aspects;
-distinguished from dealer arrangements b/c the dealer controls and owns the
stock and isn't obligated to perform duties as his boss saw fit, didn't get paid part of
his operating expenses or control his working hours
Hoover v. Sun Oil Co. (Del. 1965)
Facts: Barone operates service station, employee Smilyk negligently starts fire in
plaintiff's car where being filled w/ gas; station and equipment owned by Sun Oil,
rental partially determined by gas purchased but w/ price floor and ceiling; Barone
allowed to sell competing products but not allowed to mix Sun products w/ non-Sun
products; uniforms had Sun logo but owned by Barone; Sun sales rep offered advice
but wasn't required or obligated; Barone set working hours
Issue: Was Barone's relationship w/ Sun master-servant or principal-agent?
Rule: Service station relationships not developed w/ regard to traditional agency
law, so confusing to attempt to classify
-"test to be applied is that of whether the oil company has retained the right
to control the details of the day-to-day operation ... control or influence over
results alone veing viewed as insufficient"
Analysis: Though people rely on representation of Sun products nationwide to come
to the specific store, Sun's "no control over the details of Barone's day-to-day
operation" makes it independent contractor; influence over Sun products merely b/c
both have mutual interest in selling Sun products

RS 2d 220(2) gives factors to be considered in evaluating what kind of relationship


is present
Humble- may give orders; Sun Oil could give recommendations
Humble- owns property and stock; Sun Oil- owns property but not stock, could sell
other products
Humble- terminable at will; Sun Oil- 30 day notice
Humble- volume-based rent; Sun Oil- volume-based but w/ cap and floor
However, both Humble and Sun Oil had many similarities (core part of business, in
the business, (d) moderate (c) local custom? vs. appearance relevant)
Paradox: want to give up control to lessen tort liability, but wants control to ensure
business is run right to protect its money

Murphy v. Holiday Inns, Inc. (Va. 1975)


Facts: Murphy slips and falls on water from air conditioner at Holiday Inn operated
by Betsy-Lin, franchise agreement provides that franchisee pays initial sum of 5k,
makes monthly payment per room but doesn't dictate how day to day operations
are run;
Issue: What kind of relationship between Holiday Inn and Betsy-Lin was present?
Rule: Actual agency is a consensual relationship not negated by formal "consent"
-"it is the element of continuous subjection to the will of the principal which
distinguishes the agent from other fiduciaries and the agency from other
agreements"
-for agency relationship "critical test is the nature and extent of the control
agreed upon"
Analysis: franchisor supplies knowledge and brand and regulates activity for
standardization, while the franchisee has right to profit and risk of loss
-franchisee has no right to control day-to-day operation, no control over daily
maintenance
-no power to control business expenses, room rates, share of profits, hire or
fire employees, or supervising and training employees
[terminable at will is a way to control operators without courts saying there's
control- hard to see who is exerting control through these carefully drafted
contracts, to see who really has the economic power]
Miller v. McDonald's Corp. (Ore. App. 1997)
Facts: plaintiff bites into sapphire in Big Mac, restaurant owned and operated by 3K,
license agreement prescribes facility layout, inventory and operation control, food
preperation, bookkeeping, required compliance w/ McD's policies including
operating hours, similar to other McD's, some McD's are company-run and others
are franchisor-run; agreement said not an agency relationship and not responsible
for PI claims resulting from its operation; P went to restaurant assuming that McD
owned and operated it and only signal otherwise was sign near front counter
Issue: What kind of relationship was entered into between McD's and 3K?
Rule: to be vicariously liable McD has to have right to control method under which
3K performed its obligations
-agency exists if "franchise agreement goes beyond the stage of setting
standards, and allocates to the franchisor the right to exercise control over the
daily operations of the franchise"
Apparent agency: RS 2d 267- representing one as his servant or agent, causing
third-party to rely upon apparent agent's care or skill, and principal is then liable for
lack of skill or care of its apparent agent
-apparent agency creates an agency where it wouldn't otherwise exist, while
apparent authority creates expanded authority of an already existing agency
-most cases have found existence of apparent agency a jury issue
-crucial issue is if principal held third-party out as an agent and if P relied on
the holding out
Analysis: McD's didn't "simply set standards that 3K had to meet" but forced
"precise methods"; retained power to cancel and sent inspectors: retained control at
least for food preparation
-shouldn't have to prove that the other restaurants P went to that caused her
to rely on those experiences were operated by McD themselves; precisely the
point of the McD "system" to ensure that one couldn't tell the differences
between the restaurants
Ira Bushey v. United States (2d Cir. 1968)
Facts: drunk Coast Guard sailor returning from shore leave opens valves that sank
drydock and ship partially; Gov/Bushey contract provided that work be performed
so as not to interfere w/ personnel, personnel have access to vessel at all times and
personnel won't interfere w/ contractor's work; Government challenges liability as
Seaman Lane not acting within scope of employment
Issue: Was Lane's drunken opening of valves done while in the scope of
employment as a seaman?
Rule: RS 2d 228(1)- conduct within employment scope iff "it is actuated, at least in
part, by a purpose to serve the master"
-often broadly construed (drunkenly getting sailor out of bed by attacking
with fist)
Analysis: Cannot be extended this far- returning to ship was to serve master, but
not opening of valves
-expanding liability will not lead to more efficient resource allocation (won't
lead government to take steps to prevent the accident nor likely to screen its
sailors more carefully)
-just b/c government better able to pay for damages isn't good reason to
make them pay
-However, "business enterprise cannot justly disclaim responsibility for accidents ...
characteristic of its activities": seaman are foreseeably going to get drunk and
cause trouble walking up a ship
-liable if damages relate to seafaring activity, not personal life:
-NOT liable for: shooting wife's lover onboard, burning down a bar
-"lacks sharp contours" but imposing liability for this foreseeability is
"question of expediency, of fair judgment"
Clover v. Snowbird (Utah 1991)- Court rejected Bushey argument that liability based
not on whether employee was attempting to serve employer, but whether conduct
was foreseeable
-Reckless skier employed at a resort was going to work and not deviating
substantially enough to constitute "total abandonment of his employment"; Utah
Supreme Court required more than conduct that was not foreseeable, but to the
point of totally abandoning his job duties
RS 2d Agency 228: "not within scope of employment if it is ... too little actuated by a
purpose to serve the master"
Manning v. Grimsley (1d Cir. 1981)
Facts: Heckler annoys pitcher in bullpen, who looks directly at group of hecklers in
the stand, then later pitcher throws 80 mph ball through wire mesh fence hitting
heckler even though facing 90 degrees other way; Orioles challenge respondeat
superior liability
Issue: Was pitcher's conduct within scope of employment?
Rule: In Mass. employee's assault must be "in response to plaintiff's conduct which
was presently interfering with the employee's ability to perform his duties
successfully" Miller v. Federated Dept. Store
-Miller: janitor slaps customer who says "if you would say 'excuse me,' people
could get out of your way"- though annoyed or insulted, didn't justify employer
liability
Analysis: Considers this case "obviously distinguishable" from Miller, fans rattling
the pitcher will definitely get in the way of him successfully performing his duties
-not "mere retaliation for past annoyance" but was "presently interfering"
with his job duties
RS 2d Agency 231: even "consciously criminal or tortious" acts (but not "serious
crimes") can be within scope of employment
-exclusion of "serious crimes" is outdate hornbook law
RS 2d Agency 228(2): "use of force is not unexpectable by the master" then within
employment scope
-i.e. bouncer using excessive force in ejecting patron from a bar
Lyon v. Cary (DC Circuit 1986)- outside edge of VL: Lyon waiting for television
delivery, came with mattress but wanted it taken upstairs first, deliverer demanded
cash and not check and money upfront; Lyon beaten severely and issue of agency
given to the jury, motivated partly by policy?
Could analyze Lyon three ways:
(1) go for direct claim, saying he knew about Cary's violent tendencies
(2) VL under Friendly's Bushey analysis: most courts moved away from this,
look at the foreseeability of the conduct in the situation
(3) VL under Manning/Conoco: stretch to find purpose of serving the master,
beating or having a bad attitude was employee's way of completing a
transaction, albeit ill-advised, and arose out of the transaction
RS 3d Agency 7.07, comment c: in determining whether employee's tort is within
employment scope, nature of tort is relevant, as is whether tort is criminal;
employee's intentionally criminal conduct may be so serious and such a departure
from conduct that it's outside of scope, not a simple escalation
-Comment C Examples: employee w/ duty to set prices conspires w/
competitors to fix prices
-Employee has duty to make statements to customers to induce them to buy,
makes intentional misrepresentations
Arguello v. Conoco (5d Cir. 2000)
Facts: employee in Conoco-owned store in Fort Worth racially abuses Hispanic
customers- manager confirms inappropriate behavior and does nothing except
transferring to another store and only when threatened by protest, similar activity
towards blacks in Conoco-brand store in Ft. Worth, another Conoco-brand store in
Texas refuses toilet paper to Hispanics and call them racial slurs and another
Conoco-brand store also slurred them- customer service supervisor says nothing
they can do because the store was only a franchise
-district court finds insufficient control of daily operations for agency
relationship
-PMA's establish business and customer service standards enforced by
biyearly inspections (though focused on product displays and labeling) and
give power to de-brand a station
Issue: Were employees at Conoco stores acting within their scope of employment or
agency?
Rule:
-Principal-Agent: §1981 discrimination actions against defendants for a third-
party's actions require agency relationship, which requires (1) consent to (2) act
on its behalf and (3) subject to its control
-Master-Servant: RS 219: master liable for torts of servants acting within
scope of employment, of which the court lists five factors:
(1) time, place and purpose of the act
(2) similarity to acts which the servant is authorized to perform
(3) whether act commonly performed by servants
(4) extent of departure from normal methods
(5) whether master would reasonably expect act would be performed
Analysis:
-Conoco-brand stores: though what agreement states itself as is supposed to
be irrelevant, court looks to its disclaimer anyway; review of record otherwise
doesn't show agency existed b/c
(a) no "participation in the daily operations of the branded stores"
(b) no "participat[ion] in making personnel decisions"
-Conoco-owned stores:
(1) occurred during working hours inside of employment premises, and
request to present ID shows purpose of interaction was to "complete the
sale of gas and other store items"
(2) sale of gas, store items, intercom use, and completion of CC
purchases typical of clerks
(3) skipped
(4) "self-evident that Smith did not utilize the normal methods" but just
because she was intentionally tortious doesn't automatically
equal outside employment scope
(5) no evidence one way or the other in the record, but this is matter of
fact for the jury's consideration, which can be outweighed by the
other factors
-Court "reject the presumption that b/c Smith behaved in an unacceptable manner
that she was obviously outside the scope of her employment"
-absence of some factors outweighed by the presence of the others
-also important that Conoco never disputed that the incidents occurred
Fenwick v. Unemployment Compensation Commission (N.J. 1945)
Facts: Cheshire employed as cashier until new agreement entered into establishing
a partnership w/ no capital investment, control, management, or debt liability, and
she received the same salary (15/wk) except for possible 20%/yr. bonus of net
profits; Supreme Court rules entering into agreement and labeling themselves
partners not overcome by conduct of the parties of surrounding circumstances
Issue: Was Chesire a partner or an employee?
Rule: In determining whether partnership exists, look to several elements:
(1) parties' intent
(2) right to share in profits
(3) obligation to share in losses
(4) ownership and control of the partnership property and business
(5) community of power in administration
(6) language of the agreement
(7) conduct of the parties toward third persons
(8) rights of the parties on dissolution
-Uniform Partnership Act in NJ: "two or more persons to carry on as co-owners a
business for profit"
-profit-sharing prima facie evidence of partnership but not if received as
wages
Analysis: "She got nothing by the agreement but a new scale of wages"
(1) agreement made as attempt to compromise financial needs of Fenwick
and Chesire, without altering the rights from Chesire's role as an employee
(2) Chesire had right to share in profits, but this element isn't dispositive
(3) no share in the losses, (4) no ownership or control, (5) no control of
business's management
(6) language used excludes Chesire from most ordinary rights of partners
(7) though filed partnership tax returns and held out as partners to the
unemployment board, but represented as partners to no one else
(8) same rights upon dissolution as she had when an employee (presumably
none?)
-Most important elements were intent, control, and risk of loss
-Uniform Partnership Act:
-Chesire lacked the essential element of co-ownership
-Profit-sharing was part of her compensation as an employee
Meinhard v. Salmon (N.Y. 1928)- Cardozo
Facts: Salmon leased Hotel Bristol from Gerry for 20 years until May 1922, entered
joint venture w/ lender Meinhard to convert into office building; agreement provided
Meinhard pay half of alteration costs in exchange for 40% of net profits in first five
years and 50% thereafter, losses shared equally and Salmon had sole management
and operating control; "coadventurers" subject to fiduciary duties which rested
heavier on Salmon as manager; early on had losses but then provided rich returns;
towards end of lease Gerry's husband had plans for Salmon to develop it and other
tracts, extendable to 80 years and signed in January 1922, Salmon doesn't inform
Meinhard of new lease w/ Gerry and Meinhard demands lease be included as an
asset of the joint venture and court awarded first 1/4, then 1/2, of the lease
[Salmon and Meinhard go from close friends to no contact; disagreement about
allocating losses around 1905, Salmon owned other property around the area and
Meinhard's investment was almost all he had; one of most valuable properties in the
world by the time initial lease expired, new lease 7x square feet and rental value]
-Today called an "partnership opportunity case" (in law firm cases, poach clients
and attorneys)
Issue: Did Salmon owe a duty as co-partner to Meinhard to inform and include him
in the new lease?
Rule: "Joint adventurers" owe to each other a "duty of the finest loyalty" extending
beyond that of arm's length partners, strictly held to high standard of honesty and
honor
[today this not really the rule, fiduciary duties owed by management to
shareholders is very great but largely due to non-reciprocity and power imbalance,
fiduciary duty owed between partners very different and a Cardozo-style standard
could be counter-productive in business contexts]
Analysis: Gerry approached Salmon alone b/c he thought Salmon was the sole
owner of the lease, if he knew it was a partnership or joint venture Gerry would
have approached Meinhard also
-Salmon should have warned Meinhard of his plans, but he excluded him from
any chance to compete and "enjoy the opportunity for benefit" which Salmon
stole due to his more visible role in the partnership
-Unsure what Meinhard's involvement might have amounted to or what its
value was, but the "price of its denial" is Meinhard allowed to extend the trust at his
option, despite its value
-Salmon as exclusive director of the lease had a duty to disclose and without
saying anything else there is not an impossible assumption that the status quo
would be maintained
-As "managing coadventurer" this duty to disclose was utmost
-No matter if they had a falling out, still coadventurers and not
competitors
-Fiduciary duty depends on nexus between their relationship and any
new project, but here the nexus is very strong (enlargement of the
same property subject to the venture)
-Not exactly half b/c Salmon was the leader, so Salmon gets half plus a share
[Cardozo's analysis unclear: enough to disclose opportunity, or require right of first
refusal?]
Andrews Dissent: Doesn't think drastic principles of utmost fiduciary duty applicable
here
-Considers scope of the venture limited to definite project and time, particular
to the one lease
-If lease had contained renewal option, one couldn't force the other to renew
or to extend the terms of partnership into the renewal period
Revised Uniform Partnership Act of 1994 Sec 404 imposes mostly negative
constraints on fiduciary duty (refrain from acting adversely to, competing with, or
acting tortiously against the partnership; also acting in one's own interest isn't
necessarily a violation)
-Cardozo likely would have expected a higher threshold, holding partners to
positivist standards of trust and loyalty
Meehan v. Shaughnessy (Mass. 1989)
Facts: Senior partners Meehan and Boyle leave Parker Coulter to start their own firm
MBC, parties sue each other for breaching partnership agreement- MBC wants
money owed under partnership agreement and Parker Coulter want tortious
interference damages, judge rules MBC owed partnership agreement money and
Parker Coulter owed fees incurred on cases MBC removed to their own firm; poach
Cohen and give thirty days notice, not three months as required (later waived),
associate Schaefer told to delay resolving cases until 1985 instead of 1984; tried to
evade rumors of leaving; agreement provided that retiring partner could, for a "fair
charge," remove cases that came to Parker Coulter through that partner's "personal
effort or connection" which was 103 of 142 cases removed (from 350 total
contingent fee cases);
Be Nicer: tried to keep them in the firm, if unable to keep them be more open to
their needs
Be Meaner: contact clients earlier, insist that poaching clients are breaches, take
files out of office, not waive the three month notice
-Parker Coulter claims MBC breached duties by (1) improperly handling cases
for their own benefit (2) secreting competing w/ partnership, and
(3) unfairly acquiring consent to withdraw cases to MBC
Rule: partners owe each other fiduciary duty of "utmost faith and loyalty" and must
consider partners' welfare, not acting for purely private gain
-partners have obligation to "render on demand true and full information of
all things affecting the partnership to any partner"
-ABA Ethics Committee has standards for attorneys changing professional
association, one of the guidelines is presenting clients a choice between
representation
Analysis:
(1) just b/c Boyle spoke of improper activity doesn't show that the activity actually
occurred, could have been explained by merit and workload, not necessarily
manipulation
(2) fiduciaries may compete w/ their partnership if they don't "otherwise act in
violation of their fiduciary duties," logistical arrangements like executing lease,
preparing client lists, and obtaining financing were permissible
(3) secrecy among themselves for obtaining consent and communications w/ clients
garnered an unfair advantage; three times Meehan denied that he had plans to
leave, all while preparing to leave by meeting w/ clients and referring attorneys,
delayed giving partners their client lists until he had authorization from majority of
clients; violated ABA Ethics guidelines by excluding partners from presenting Parker
Coulter services as an alternative to MBC
Lawlis v. Kightlinger & Gray (Ind. 1990)
Facts: Lawlis joins K&G as a partner in 1972 being paid according to his "units",
became senior in 1975 and became alcoholic in 1982, seeking treatment for couple
years after until disclosing it, which executed w/ a doctor a "Program Outline"
providing requirements for continued employment, including provision that "there is
no second chance"; 1984 Lawlis resumes alcoholism, after which K&G imposes
additional treatment requirements, after which Lawlis never consumed alcohol;
partner tells Lawlis in 1986 Finance Committee recommended severing relationship
w/ Lawlis except for nominal one unit to retain senior partner status and keep
insurance, removes his office files two days later; Lawlis refuses new addendum and
expelled by senior partners
Rule: dissolution occurs w/o violating partnership agreement when it's "bona fide in
accordance w/ such a power conferred by the agreement";
-Indiana doesn't required good faith and fair dealing for at will employment
relationships, but for partners expulsion must be "bona fide" or in "good faith" not
for bad faith or a "predatory purpose"
-fiduciary relationship relating to "bona fide" and "good faith" concern the
business aspects or property of the partnership and prohibit fiduciaries from taking
personal advantage of these subjects
Analysis: Partner telling Lawlis of future action and removal of files didn't qualify as
dissolution, still drew partnership profits, and meeting of minds that he would
continue as senior partner, name not removed from letterhead though placed at
bottom of list; also Lawlis acted as senior partner by refusing to sign proposed
addendum and had vote
-Lawlis's claim that partnership sought to increase profits per partner by
removing him and lowering lawyer to partner ratio wasn't in bad faith b/c it
previously had tried to help his counseling
-after Lawlis failed to fulfill the first agreement partners did give him second
chance and gave him eight months to find other employment while drawing income
-didn't violate good faith b/c Lawlis's conduct threatened partnership
business, similar to controversial political speech by in Holman v. Coie; find nothing
wrong w/ "guillotine method" of involuntary severance for sake of convenience, and
just b/c they gave him six months rather than nothing doesn't change this initial
intent of the agreement
-act in "good faith" regardless of motivation if wrongful withholding of money
isn't involved
[if you scared of being held to Cardozo-style fiduciary duties, craft the partnership
agreement carefully]
Day v. Sidley Austin (DC Dist. 1975)
Facts: Day senior partner from 1963 to 1972, not on executive committee so
unaware of potential merger with Liebman firm, upon learning of it expressed
approval on condition that terms would be approved by the partners, DC office
combined into the Liebman DC office over Day's objection, Day resigns b/c he feels
merger was misrepresented by claiming no partner would be put into a worse
position, Day wanted to remain chairman of DC office w/ authority to control office
space expansion
Rule: partners have duty to make full and fair disclosure to other partners of all info
which may have value to the partnership, courts primarily concerned w/ partners
making secret profits at partnership's expense
basic fiduciary duties: (1) partner must account for profit acquired in manner
injurious to partnership's interests (2) cannot acquire for himself partnership assets
or divert for his own use their opportunities w/o other partners' consent, and (3) not
compete w/ partnership within business scope
Analysis: not a misrepresentation b/c Day not deprived of any legal right, if Day
desired to remain chairman should have specified that provision be included in the
agreement, the authority to control chairmanship was held by executive committee
which was included in his partnership agreements
-failing to reveal information concerning internal structure isn't recognized,
since not dealing w/ profits or loss; non-executive committee members didn't have
information that Day didn't
-bruised ego doesn't constitute a cause of action, risk he assumed when
joining the partnership
UPA- when partner retires there is a dissolution of the firm and new partnership
emerges, unless under dissociation clause of previous agreement (continuation
agreement)
-partnership law allows partner to make any agreement they choose, just
follow contract law
Owen v. Cohen (Cal. 1941)
Facts: Owen and Cohen verbally agreed to become partners in bowling alley w/o
any definite time period on Jan 1940, Owen provides 6987 to be considered a loan
repaid out of business as soon as reasonably possible; bowling alley opens in March
and operated at profit until end of June, but business disputes arose between them
which lowered its profits, court finds parties disagreed on just about every aspect of
the partnership and D had acted in ways necessary to dissolve partnership by court
decree; D tried to dominate the business and humiliate P publicly; D steals money
partnership in receivership sold off and loan repaid
Issue: Does evidence warrant dissolution decree?
Rule: Trifling grievances involving no permanent mischief doesn't authorize
dissolution decree
-but equity courts may so order if disputes of such nature and extent that all
confidence and cooperation destroyed or a party's misbehavior materially hinders
proper conduct of the business
UPA §32: conduct that will "affect prejudicially the carrying on of the business"
"wilfully or persistently commits a breach of the partnership agreement" or conduct
"not reasonably practicable to carry on the business in partnership" or "other
circumstances render a dissolution equitable"
-D objects to repayment of loan on the court's terms and wants to follow
agreement's understanding of repayment, but can't follow partnership when D's
own conduct prevents its continuing
-Needed to seek court decree because contravened agreement to dissolve on his
own
-Court decree's purpose for one to buy out the other to avoid an inefficient fire sale
Kovacik v. Reed (Cal. 1957)
Facts: Kovacik advances 10k and convinces Reed to help him remodel kitchens as
job superintendent and estimator in return for 1/2 share of profits, no discussion of
losses; Kovacik demands money from Reed after money is lost; lower court finds
joint venture and awards 4340 to Kovacik
Rule: General rule that absent contrary agreement there is presumption that
partners and joint adventurers intended to share profits in same proportion as
losses, regardless of unequal capital contributions
-usually applied when each party contributes capital in form of tangible
property
-when one party contributes skill or labor, neither party liable to the other for
loss sustained
-for complete losers, fair b/c 100% of money investment and 100% of
labor inv. lost
-but for partial losers, money man gets back something while laborer
gets nothing
-"upon loss of the money the party who contributed it is not entitled to recover any
part of it from the party who contributed only services"

UPA 18(a)- partners share profits equally after capital contributions and liabilities
are repaid
-contrary to Kovacik (case treats non-contributing partner better than UPA,
doesn't share moneyman's loss)
40(b)- absent contrary agreement, order of liabilities repaid upon dissolution is:
(1) non-partner creditors
(2) partner liabilities (not capital or profits)
(3) partner capital
(4) partner profits

Default Rules
-Majoritarian default (what most people would agree on ex ante)- rule that most
contracting parties would want most of the time, so most likely that these specific
parties also would have
-saves transaction costs and doesn't have to think as hard
-many parties would care about equity, some wouldn't
-Penalty default- not necessarily what parties would have bargained, can have
inequitable effect
-policy concern to deter certain behaviors the court doesn't like
-sometimes one party has information the other party doesn't
-Address some cognitive bias (e.g. over-optimism, "sticky" defaults, don't contract
around even though you should)- arguing over losses when you only predict profits
can be deemed unnecessarily fractious
-Protect some party- e.g. non-repeat player
-Possible rules:
(1) All capital losses borne by capital partner alone (Kovacik)
-advantage b/c capital partner more able to bear the loss
-disadvantage b/c service partner may walk away untouched while
other party loses
-incentive problem: service partner may not care as much if not liable
for loss, often they are the person that came up w/ the idea and
more control over whether it fails
(2) Sharing of capital losses in accordance w/ sharing of profits (statute)
-
(3)

Buyout agreements
I. Trigger events
A. Death
B. Disability
C. Will of any partner
II. Obligation to buy vs. Option
A. Firm
B. Other investors
C. Consequences of refusal
i. If there is obligation
ii. if there is no obligation
III. Price
A. Book value
B. Appraisal
C. Formula (e.g. 5x earnings)
D. Set price each year
E. Relation to duration (e.g. lower price in first five years)
IV. Method of payment
A. Cash
B. Installments (w/ interest?)
V. Protection against debts of partnership
VI. Procedure for offering either to buy or sell
A. First mover sets price to buy or sell
B. First mover forces others to set price

-Partners have right to dissolve and right to refuse new partners; LLC's don't, so
more important to plan
-partnerships are owned by the managers, while corporations aren't

3 Types of Agreements:
-Restrictions on transfer
-can't sell shares w/o the permission of the corporation or the other
shareholders
-try to have stable direction and management, don't risk too much
involuntary change
-protect non-selling shareholders
-very important in corp., where no restriction on selling
-Grant entity or other investor the right, but not obligation, to purchase if a
triggering event
-protect non-selling shareholders, prevents outsiders from joining and retains
status quo
-doesn't provide liquidity to seller
-Provisions requiring the entity to purchase the interest upon a triggering event
-Protect selling shareholder by providing liquidity
-Important in both corp. and partnership context

Setting the Price:


-Book Value: usually clear and bright-line, but often not close to the fair market
value
-Appraisal: expensive and subjective- may argue on who is the appraiser, so decide
early on
-Formula: usually clear and bright-line, but formula may not be accurate
-usually some measure of cash flow, plus some multiplier to determine PV of
future cash flows
-may relate to duration
-Set price by year: clear price, but don't know in advance how much it will be worth
-sometimes price isn't actually set, so need fallback in case re-estimation
doesn't happen

G&S Investments v. Belman (Ariz. 1984)


Facts: general partners G&S (51%) and Nordale (25.5%) in apartment complex,
Nordale starts using cocaine and damaging business, scares off tenants and squats
in complex apartment, makes bad business proposals, G&S seeks dissolution and
buyout of Nordale's interest, G&S file complaint and Nordale then dies; Nordale's
estate wants to liquidate b/c would receive more than if bought out by G&S
Rule: partnership's agreement: "upon death ... surviving or remaining general
partners may continue the partnership business" and "remaining general partner ...
shall purchase the interest of the retiring or resigning general partner"
-UPA §32: court authorized to dissolve partnership when
(2) partner becomes ... incapable of performing his part of the
partnership contract
(3) guilty of such conduct as tends to affect prejudicially the carrying
on of the business
(4) willfully or persistently commits a breach of the partnership
agreement, or otherwise so conducts himself in matters ... not reasonably
practicable"
-Buy-out formula from the partnership agreement: "retiring general partner's
capital account plus an amount equal to the average of the prior three years'
profits and gains actually paid to the general partner, or as agreed upon by
the general partners, provided said agreed sum does not exceed the calculated
sum in dollars"
-buy-out provision didn't include real estate investment
-capital account was -44.5k while FMV was +76.7k
-Partnerships result from contract, so partner's rights and liabilities are subject to
the contract
-buyout provisions can be less than its actual value
Analysis: filing of complaint was not itself a dissolution, merely leading up to it, only
official when declared by the court
-Nordale's conduct made it impracticable to continue partnership w/ him and
contravened partnership agreement
-Estate claims "capital account" is ambiguous, but accountant later recants and
says it's cost basis
-rest of agreement in "cost basis/capital account" language and not FMV
language

Holzman v. De Escamilla (Cal. 1948)


Facts: Hacienda Farms, Limited, organized in early 1943 as limited partnership w/
de Escamilla as general partner and Russell and Andrews as limited partners;
company goes bankrupt in Dec. 1943 and Holzman appointed estate's trustee;
-Holzman asserts Russell and Andrews liable to creditors as general partners
by having control in the business, R&A "always conferred and agreed" to what
crops were planted, determining that watermelons and string beans should be
planted, even overruling Escamilla's aversion to peppers and egg plant; all three
were involved in picking crops
-R&A ask Escamilla to resign, and replaced by Miller
-checks drawn by 2 of 3 partner's signatures, Escamilla couldn't withdraw w/o
a limited partner
Rule: Civil Code §2483- "limited partner shall not become liable as a general
partner, unless, in addition to the exercise of his rights and powers as a limited
partner, he takes part in the control of the business"
Analysis: Clear that R&A both exercised control:
-controlled types of crops planted, some against Escamilla's wishes
-"manner of withdrawing money .. particularly illuminating"- could control
finances by refusing to sign the checks, and the two had power to withdraw all
the money
-required Escamilla to resign as manager

Revised Uniform Limited Partnership Act: §303(a)- limited partner not liable for
limited partnership unless
(1) also a general partner or
(2) exercises limited partner rights and powers and also takes part in control
of the business
-but liable only to persons transacting business w/ the limited
partnership and who "reasonably believe, based upon the
limited partner's conduct that the limited partner is a general
partner"
-merely consulting w/ and advising general partners w/ respect to
limited partnership's business is not taking part in its control

Mt. Vernon Sav. & Loan v. Partridge Associates (D.Md. 1987)-


-No plaintiff knowledge necessary- limited partner disregarding limited
partnership form to the extent he becomes substantially same as general partner
has unlimited liability regardless of plaintiff's knowledge of his role
-Plaintiff knowledge sufficient, though- limited partner may still have
unlimited liability even when exercising less than general partner's power if
plaintiff knew he was acting as more than a limited partner

-Corporations characterized by 6 attributes:


(1) formal creation prescribed by state law
-file articles of incorporation (charter) w/ state of incorporation, usually
Secretary of State
-MBCA §2.02 requires corp. name, # of shares authorized, name and address
of registered agent, and name and address of the incorporator
-charter must include any classes of shares, D&O indemnification and liability
limitation, and statement of purpose in Del. (but erosion of ultra vires
doctrine)
-initial board of directors holds organizational meeting adopting bylaws and
appointing officers -most corp. affairs governed by bylaws
-difficulty ensues when incorporation is defective (i.e. promoter liability)
(2) legal personality

(3) separation of ownership and control


(4) freely alienable ownership interests
(5) indefinite duration
(6) limited liability

"Promoter": term of art for a person identifying a business opportunity and puts
together a deal by forming a corporation as the vehicle for investment by others
Third-Party Sales- No fiduciary duties nor duty to disclose initial purchase price, but
can't misrepresent
-Even if fraudulent misrepresentations, question as to extent of damages (i.e.
would you still have paid the same amount anyway?)
Principal/Agent Sales- RS 2d Agency 388: agent profiting while transacting on
behalf of principal must disgorge profits to principal, unless otherwise agreed
-promotes fair dealing and openness
-not based on actual damages
Promoter/Corporation Sales- Individual shareholders can't sue personally, must sue
on behalf of corp.
-promoter owes fiduciary duty to corp., so can be compelled to disgorge
undisclosed profits
-i.e. Art forms corp. and sells all its shares to Paula, then sells land to the
corp.
-but if Art sells Paula and Paula is the one who forms the corp. more like
arms-length transaction unless Art acts as Paula's (not the corp.'s) agent
-if promoter has retained interest in corp. and profits from sale (sells land to
his own corp.) courts split whether fiduciary duty owed to person he sells
shares to after few days (Old Dominion)
-problematic if held for more than a few days, complicates due
diligence
-when does promoter's fiduciary duty to corp. end? at sale? depends
on

Southern-Gulf Marine Co v. Camcraft, Inc. (La. 1982)


Facts: Southern-Gulf Marine Co, not yet incorporated, enters Letter of Agreement w/
Camcraft to a 156 ft. boat for 1.35M, providing for delivery date, authority for
Camcraft to begin buying components, and stated that final contract to be formed
later
-condition that Southern-Gulf was U.S. citizen
-Camcraft allowed to assign its interest
-Southern-Gulf pres. Barrett writes letter to Bowman that SG was a Cayman
corp., not US.
-Camcraft pres. Bowman signs acceptance
-Camcraft then defaults, asserts no liability b/c SG not a corporation at time
of contract
Rule:
-One who contracts w/ who he acknowledges and treats as a corporation is
estopped from denying its corporate existence
-"one cannot be permitted to play fast and loose, so as to take advantage of
his own unfair vacillations"
Analysis: Camcraft shouldn't be permitted to escape performance by raising issue
as to character of the organization unless its substantial rights are affected
-doesn't violate contract that SG was incorporated in Cayman instead of
Texas b/c assignments allowed in the contract
-estoppel ruling based on Bowman's letter
-Should be clearer whether Barrett's liability is to end upon incorporation
-Barrett could probably sue personally on the contract b/c signed it
individually
-Barrett could also be sued, though, on contract law or through best efforts
argument (should have incentive to actually form the corp.)
Options for Bowman:
-Post bond
-Demand progress payments
-Discontinue production if not formed by certain date
-Demand adequately capitalized corporation
-Retain indemnification of Barrett personally

Walkovszky v. Carlton (N.Y. 1966)


Facts: Carlton's taxi fleet owned by many corporations, each owning one or two
cabs; cab owned by Seon Cab Corp. runs someone over
-(1) all corp. alleged to be operated as single entity so other corporations
should be liable
-(2) multiple corporate structure is allegedly unlawful attempt to defraud
potential victims, so stockholders should also be personally liable
Rule: incorporation supposed to limit liability, but not without limits
-will "pierce the corporate veil" to prevent fraud or inequity, applies to
commercial acts and negligence
-agency rules determine when liability extends beyond corporation's assets
-if corp. is a part of larger corporation which actually conducts the business,
the larger corporation is liable
-if corp. is used for the stockholder's personal, not corporate, purposes,
individual is liable
Analysis: No evidence that Carlton used the corporations for his personal use, in
their individual capacities or shuttling personal funds "w/o regard to formality and to
suit their immediate convenience"
-just b/c legislatively required insurance is inadequate doesn't mean judicial
expansion of agency is appropriate
-complaint of too-low coverage sounds more like fraud (which it isn't)
than respondeat
-(1) enterprise liability, but no personal liability
-(2) Not shown that Carlton manipulated corp. for his own personal use, and even if
he did, inequitable to hold innocent, passive stockholders liable
Dissent: corporations intentionally setup w/ minimal coverage and funds drained,
undercapitalized
-too obvious that this was meant to avoid the inevitable damages that cars
will create
-legislature intended for 10k as a floor, expecting bigger companies to take
out more insurance

Enterprise liability: when multiple corporations really all ran as one corporation
-might be useless if all corporations equally broke
-easier to get than veil-piercing (so just buy more insurance)
-easier to keep minutes and keep fingers out of corp. coffers than to
buy separate office space, buy extra phone lines, etc.
Respondeat superior: agency should be different than veil-piercing (but Walkovszky
mixes them)
-based on control
Piercing corporate veil: when corporations used for personal ends
-might be useless if individual has all money tied up in other corporations
(then look to enterprise liability)
-in many jurisdictions, lack of formalities by itself insufficient
Difference b/t respondeat superior and veil-piercing: passive investors protected
under respondeat superior b/c don't assert control, but in veil-piercing doesn't
necessarily require passive investors to have control (their money can still be
commingled, formalities can be absent, and corporation can operate for the passive
investor's personal ends w/o the investor controlling or even realizing this)

Limited liability good b/c


(1) makes passive investment rational
-otherwise they'd want more control over their liability
(2) lessens monitoring costs
(3) allows owners to diversify, increasing capital, w/o increasing exposure to
torts, creditors
-otherwise owners liable to risk large judgments from many sources
-otherwise would have to evaluate other shareholders
-promotes free transferability of shares
(4) allows specialization of management
Bad b/c
(1) tort victims, creditors can be shortchanged by undercapitalized
corporations
-more torts b/c corp. can act risky knowing their exposure is capped
-this risk externalized onto the public
-tort victims perhaps worse b/c can't do credit checks on their
tortfeasors, although some consumer contracts don't really have a
choice

Sea-land Services, Inc. v Pepper Source (7th Cir. 1991)


Facts: Sealand ships peppers for PS and PS doesn't pay freight bill; default judgment
entered but PS dissolved with no assets
-Sealand sues owner Marchese and five of his businesses b/c corp. all "alter
egos" of one another and Marchese manipulated them for his own personal
use
-Marchese sole shareholder in the businesses, "little but Marchese's
playthings"
-never held a single corporate meeting
-adds Tie-Net, though only half-owned by Marchese
-no minutes ever taken at Tie-Net meetings
-none of the companies ever passed articles of incorporation, bylaws, or other
agreements
-all corp. ran out of same office and phone line, same expense accounts, from
which Marchese and other corp. borrowed interest-free at will and used to pay
Marchese's personal expenses
Rule: Van Dorn- corporate entity disregarded and limited liability pierced when:
(1) "such unity of interest and ownership" there's no separation b/t
corporation and individual (or other corporation)
-Determined by four factors:
(a) failure to maintain adequate corporate records or comply w/
corporate formalities
(b) commingling of funds or assets
(c) undercapitalization
(d) one corporation treating the assets of another corporation as its
own
(2) circumstances are that allowing separate corporate existence would allow
fraud or injustice
-can be either fraud (intentional wrongdoing) or promotion of injustice
-to disregard corporate entity "some element of unfairness, something
akin to fraud or deception or the existence of a compelling public
interest must be present"
-promote injustice examples:
-holding land adversely to corp. owned only by oneself and wife
-stiffing seller on equip. used for years by corp. which one is
"dominating force"
Analysis: Facts show first prong clearly met, but second prong more problematic
-some wrong beyond creditor's inability to collect, Sealand's
unsatisfied judgment is not sufficient to rise to the level of the
examples (i.e. mocking adverse possession rules, unjust
enrichment), simply an unsatisfied judgment is too permissive
-on remand "injustice" proven by blatant tax fraud, spending corporate
assets and assuring Sealand rep. that bill would be paid while
knowing funds wouldn't be there

Roman Catholic Archbishop of SF v. Sheffield (Cal. 1971)


Facts: Sheffield purchases St. Bernard for 175, payable in $20 installments, from
Switzerland monastery, shipped after first installment, Sheffield agrees to pay 125
freight charge
-after making three installments does not receive the dog but refused unless
Sheffield paid entire price plus fees for delivering dog to airline; also told $60
nonrefundable
-"alter ego" theory : Sheffield sues Roman Catholic Archbishop in SF, Pope,
Vatican, alleging that Switzerland, SF, and other Archbishops all controlled by
central catholic church as a "conduit of their ideas, business, property, and
affairs"
-SF Archbishop answers that they had no knowledge of or participation in
transaction and was legally distinct from Switzerland Archbishop
Rule: "Alter Ego" principle or "piercing the corporate veil" requires
(1) "Must be made to appear that the corporation is not only influenced and
governed by that person [or other entity], but that there is such a unity of interest
of interest and ownership" that separateness ceases to exist, and
(2) "Adherence to the fiction of the separate existence of the corporation would,
under the particular circumstances, sanction a fraud or promote injustice"
Factors considered in applying doctrine:
(a) Commingling of funds and other assets
(b) Holding out by one entity that it's liable for the other's debts
(c) Identical equitable ownership in the two entities
(d) Use of the same offices and employees
(e) Use of one as a mere shell or conduit for the affairs of the other
Analysis:
-Sheffield doesn't contest Church's claim of no business relationship w/ the
other Archbishop
-Unity of Interest prong: Sheffield argues that Swiss Archbishop controlled by
pope, but the issue is whether SF Archbishop, not the Pope, is responsible for
the Swiss Archbishop
-alter ego theory makes parent liable for subsidiary, not subsidiaries
liable to each other
-there is no respondeat superior between subagents
-doesn't address corporate formalities
-Promote Injustice prong: plaintiff being unable to collect from Swiss
Archbishop insufficient to pierce veil
-"purpose of the doctrine is not to protect every unsatisfied creditor"
but to protect "conduct amounting to bad faith makes it
inequitable"

Reasons for parent/subsidiary corp. instead of division within one corp.-


(1) parent not liable for subsidiary's debts
(2) public parent wants to keep subsidiary private or position it for public
offering w/o affecting parent's shareholders
BUT: must be careful not to be liable directly (negligence, products liability) or
indirectly (corporate veil pierced, respondeat superior, enterprise liability)

In re Silicone Gel Breast Implants Products Liability Litigation (Ala. 1995)


Facts: Bristol is sole shareholder of Medical Engineering Corp., breast implant
supplier originally incorporated in Wisconsin, and claims it isn't directly or indirectly
chargeable for breast implant cases, wants summary judgment in its favor
-Bristol does due diligence about MEC's capsular contracture, rupture, and gel
bleeding and buys it, making MEC a Del. corp.
-two other breast implant makers purchased under MEC's name but
negotiated and paid for by Bristol, w/ both Bristol and MEC conducting due
diligence about polyurethane hazards
-MEC's board made of a Bristol pres., Bristol VP, and MEC's president, but
Bristol pres. couldn't be outvoted by other two and former MEC pres. didn't
recall that MEC had a board, w/ one stating he never had a board meeting or call
but instead, had a designated Bristol contact
-Bristol had authority over MEC's budget, maintained MEC's cash, and
approved its capital costs, controlled employment and wages of top
executives, key execs' stock options in Bristol stock and employees
participated in Bristol's pension plans
-Bristol subsidiary distributed MEC's implants, helped MEC w/ marketing and
research, MEC advised by Bristol's counsel, Bristol performed MEC's audits and
quality review and scripted its customer service lines, Bristol name used in all
sales materials to doctors and in the packaging
-Bristol never received dividends from MEC's increased sales, MEC prepared
its own Wisconsin tax forms and Bristol purchased $2 billion insurance for MEC,
Bristol sells MEC's urology division and executes 57.5M demand note to MEC,
MEC's only other asset is indemnity insurance
[opposite of many veil-piercing where parent siphons from subsidiary; here Bristol
gave MEC a leg up]
Rule: Limited liability is rule, not exception, as parent corp. expected and required
to assert control over its subsidiary, but when subsidiary is so controlled to be its
"alter ego" or "mere instrumentality" the corporate form is disregarded in interest of
justice
-factors relevant to "a showing of substantial dominion":
-common directors or officers
-common business departments
-consolidated financial statements and tax returns
-parent finances the subsidiary
-parent caused subsidiary's incorporation
-subsidiary operates w/ grossly inadequate capital
-parent pays subsidiary's salaries and other expenses
-parent gives subsidiary all its business
-parent uses subsidiary's property as its own
-daily operation of parent and subsidiary not kept separate
-subsidiary doesn't observe basic corporate formalities, like separate
books and records and holding shareholder and board meetings
-Direct Liability (negligent undertaking):
-RS 2d Torts 324A: rendering services necessary to the protection of a third
person or his things, is liable for physical harm from his negligence if:
(a) negligence increases risk of harm
(b) undertaken to perform duty owed to the third person, or
(c) harm suffered b/c of reliance of the other or third person upon the
undertaking
Analysis: Most of the factors satisfied by the evidence, "unity of interest" prong
shown
-"fraud or promotion of injustice" prong:
-Delaware don't necessarily require it, and many jurisdictions only
require this prong in contract cases and not tort cases
-tort victims are forced to deal w/ the corporate form while
contract victims could insist that subsidiary make the
principal also liable
-even in jurisdictions requiring this prong, inequitable b/c Bristol put its
name on MEC's products, inducing consumers to believe it vouched
for MEC, but MEC's assets may be insufficient to pay off liability
-Direct liability (negligent undertaking): Bristol held itself out as supporting the
product and issued press releases stating that the implants were safe, so can't now
deny its 324A responsibility

-Tax shelters show tax losses even though economically successful


-limited partnerships (until 1986) would "pass-through" losses to investor's
tax returns even though having limited liability
-limited partnership w/ corp. as sole general partner means no individuals
liable for the debts
Frigidaire Sales Corp. v. Union Properties, Inc. (Wash. 1977)
Facts: Frigidaire enters K w/ Commercial Investors, a limited partnership w/ Mannon
and Baxter as limited partners and also officers, directors, and shareholders of
Union Properties, the only general partner of Commercial
-Mannon and Baxter controlled Union, thereby exercising day-to-day control
of Commercial
-after Commerical breaches, Frigidaire seeks judgment from Mannon and
Baxter
Issue: Do limited partners incur general liability for limited partnership's debts
simply b/c they are officers, directors, or shareholders?
Rule: In Wash. legal for parties to form limited partnership w/ corp. as sole general
partner
-Uniform Limited Partnership Act removes limited liability of limited partner
who "takes part in the control of the business"
Analysis: Minimum capitalization problems not specific to limited partnerships w/
corporate general partners, but anytime corp. has a creditor
-don't impose general liability on limited partners, "piercing-the-corporate-
veil" doctrine enough
-Mannon and Baxter never acted in any direct, personal capacity, but would
"conscientiously keep the affairs of the corporation separate from their personal
affairs"

Cohen v. Beneficial Industrial Loan Corp. (U.S. 1949)


Facts: stockholder w/ .01% ownership shares sues on behalf of corp. alleging
managers and directors enriched themselves at corp. expense, wasting over 100M
through mismanagement and fraud
-demand refused so derivative action brought, diversity case
-NJ statute requires less than 5% owners must post bond for attorney's fees
in case he loses so corp. doesn't indemnify, here 125k
Issue: Must fed. court in diversity case apply statute imposing reasonable expenses
and attorney's fees on unsuccessful plaintiff and requiring security?
Rule: As management vested w/ other's money and corporate laws lax, mechanism
needed to hold directors accountable and temper their desire to profit personally
from their trust- hence derivative suit
-equity first requires demand for corp. to vindicate its own rights, but when
it's inevitably refused derivative suit emerged
-however this also provided abuse opportunities ("strike suits") by SH's
seeking to gain personally w/o concern for the detriment to their negligible
shares in the corp.
-more often brought by smaller SH's b/c less lost by hassling the corp.
-warranted NJ's security statute
Analysis:
-SH's can vote on directors, but can't vote on the one who represents them in
derivative suit
-Constitution doesn't require SH to proceed w/o state imposing "standards of
responsibility, liability and accountability" to "protect the interests he elects
himself to represent"
-reasonable-ness of security makes it not violation of Due Process
Clause
-not unreasonable to use financial interest as measure of good faith
-Can't call this procedural b/c creates new liability which didn't exist before,
this liability unusual and goes beyond normal conception of "costs"

Eisenberg v. Flying Tiger Line, Inc. (2d Cir. 1971)


Facts: Eisenberg sues on behalf of all stockholders to enjoin merger which allegedly
deprives him of voting rights; Flying Tiger reorganizes his shares from one owning
an operating company to one owning a holding company that owns the operating
company
-NY law requires P to post security in derivative suits
-Eisenberg claims his suit is direct and not derivative
Rule: If injury is to the corp. suit is derivative, but if injury is to P as stockholder
individually and not corp. then it's direct
-Gordon v. Elliman:
(1) "whether the object of the lawsuit is to recover upon a chose in
action belonging directly to the stockholders, or
(2) whether it is to compel corporate acts under a duty owed to the
corp., and through it, to its stockholders
-Lazar v. Knolls: derivative b/c doesn't challenge acts on behalf of corp., but
b/c D's interfered w/ P's rights as stockholders by excluding them from proper
participation in the corp. affairs
Analysis: Gordon fails to distinguish b/t derivative and direct class actions; finds this
case similar to Lazar
-NY legislature responds to Gordon by saying suit derivative only if to procure
a judgment to corp. "in its favor"
-Not on behalf of corporations but on behalf of its shareholders as a class

-NY: direct/derivative law is Eisenberg


-Delaware: used to have "special injury" test for direct/derivative: "separate and
distinct from that suffered by other SH's,... or a wrong involving a contractual right
of a SH, such as the right to vote, or to assert majority control, which exists
independently of any right of the corp."
-Now they have two-pronged standard:
(1) Injury prong: who suffered the alleged harm, the corp. or the SH's
individually, and
(2) Benefit prong: who would receive the benefit of remedy, the corp. or the
SH's individually

-If derivative action against D's settled, corp. can pay their legal fees
-If D's lose at trial, besides insurance they pay damages and may have to pay legal
fees as well
-Incentive for managers to have corp. settle
-P's attorneys usually the drivers
-Court sometimes awards individual recovery (Lynch v. Patterson: wronged SH
owned all of the corp. that the wrongdoers didn't own)

Direct and Derivative Suits


Direct:
-brought by shareholder in his own name
-cause of action belonging to the shareholder in his or her individual capacity
-arises from an injury directly to the shareholder
-i.e. corp. changes rights to prefer common SE's over preferred (preferred has
class action)
Derivative:
-brought by a shareholder on corporation's behalf
-cause of action belongs to the corporation as an entity
-arises out of an injury done to the corporation as an entity
-quintessential case is attempting to compel corporation to sue a manager for
fraud

Roberta Romano- financial recoveries in only half of settled suits, and per share
recoveries small
Thompson & Thomas- many are not strike suits, ones not providing relief to the
corp. are usually dismissed quickly

Primary Corporate Actors


Shareholders- passive investors w/o management powers
• Vote on:
-board of directors
-mergers and other fundamental transactions
-NOT daily operations
-matters that management presents to them (usually b/c director-interested
transactions, cures any future claim the shareholders might have)
• Put recommendations up for vote
• Can amend bylaws
• Can sue
• Can sell shares

Directors- oversee the day-to-day operations


• Inside: directors otherwise employed, typically senior executives (CEO, etc)
• Outside: no other relationship w/ the corporation
-distinction doesn't mean independent/disinterested
-often require buy-in, also compensated through stock options
Officers:
• a

Derivative suits a mechanism of managerial accountability


-potential for bias: directors can't be expected to sue themselves
(1) Cause of action belongs to corporation
-like all assets, litigation under control of board of directors
(2) Shareholder may have interests diverse from those of corporation
-shareholder's lawyers often real party in interest
(3) Therefore board of directors should have some say
Marx v. Akers:
-"By their very nature, shareholder derivative actions infringe upon the
managerial discretion of corporate boards... Consequently, we have historically
been reluctant to permit shareholder derivative suits, noting that the power of
courts to direct the management of a corporation's affairs should be "exercised
with restraint" (quoting Gordon v. Elliman)
Business judgment rule:
-Policy: "If every decision of A is to be reviewed by B, then all we have really
is a shift in the locus of authority from A to B" (Kenneth Arrow)
-presumption that, in carrying out their duty of care, the O's and D's acted in
good faith and in the best interests of the corporation (presumption that they
satisfied the duty of care)
-requires D's to exercise the care and judgment of a reasonably prudent
person under like circumstances
-i.e. in theory, to exercise the same degree of care as the shareholder
himself (aspirational goal)
-but in reality, variances from this standard often insulated by the
presumption of the business judgment rule
-Bayer v. Beran:
-"Only in extraordinary circumstances are directors held liable
for negligence in the absence of fraud, improper motive or
personal interest"
"The Demand"
-typically a letter from shareholder to the board of directors
-must request the board bring suit on the alleged cause of action
-must be sufficiently specific as to apprise the board of the nature of
the alleged cause of action and to evaluate its merits
-RMBCA 7.42: requires written demand on the board in all cases, and further,
precludes SH from bringing suit within 90 days after demand unless corp. would
suffer irreparable injury as a result (universal demand requirement)
-RMBCA 7.44:Two alternatives for internal corporate review of the demand:
-(1) if the disinterested D's constitute a quorum, the demand may be
reviewed by the board of directors, or
-(2) whether or not a quorum, may appoint by majority vote a
committee of two or more independent D's
-If either determines, in good faith after reasonable investigation, that
suit is not in best interests of corporation, then court shall dismiss
the complaint
- Kamen v. Kemper Financial Services, 500 US 90 (1991):
"the purpose of requiring a pre-complaint demand is to protect D's
prerogative to take over the litigation or to oppose it... in most
jurisdictions, the board of director's decision to do the formed ends
the shareholder's control of the suit... While its decision to do the latter
is subject only to the deferential BJR standard of review... Thus, the demand
requirement implements the basic principle of corporate governance
that the decisions of a corporation- including the decision to initiate
litigation- should be made by the board of directors"
The Task
(1) "Preserving the discretion of directors to manage a corporation w/o undue
interference" -Marx
Versus
(2) "Permitting shareholders to bring claims on behalf of the corporation when it is
evident that directors will wrongfully refuse to bring such claims" -Marx
• Needed: a filter to separate cases in which the board is disabled by conflicts
of interest from making an independent decision in good faith (this middle
ground explored in Zapata)
Marx v. Akers (N.Y. 1996)
Facts: shareholder claims IBM director's improperly raised compensation for 15
outside directors of 18 member board and for executives
Rule: Three purposes for the demand requirement:
(1) relieve courts from internal corp. governance disputes by allowing
directors chance to cure
(2) protecting corp. boards from harassment from strike suits
(3) discourage strike suits for personal gain, as opposed to corporate benefit
- Barr provides three bases demand futility, must plead w/ particularity either
(1) majority of directors are interested in the challenged transaction, or
(2) board failed to inform themselves to a degree reasonably necessary, or
-by approving less advantageous offer guilty of "breach of their duties
of due care and diligence to the corporation"
-directors just "passively rubber-stamp[ed] the decisions of the active
managers"
(3) challenged transaction so egregious on its face that couldn't have been
product of sound business judgment
-requires particular, not conclusory, allegations
[latter two have quite high standards]
-Delaware has disjunctive two-pronged test:
-if director interest established, demand excused w/o applying BJR
-evaluate valid exercise of business judgment by looking at procedural
(informed decision) and substantive (terms of the transaction) due
care
-At least 11 states have universal demand requirement
Analysis: Delaware standard too subjective and confusing
-dismissed as to executives b/c only three of the eighteen directors being
executives isn't a majority, and no particular allegation of failing to deliberate or
exercise business judgment
-as to directors demand excused b/c directors always self-interested when
voting on their own compensation, however the complaint's allegations are
too conclusory (just states numbers, which w/o any other evidence aren't
excessive on its face)
[debate whether demand futility exception is appropriate]

Auerbach v. Bennett (N.Y. 1979)


Facts: GTE responds to bribery from other companies by investigating itself, and
finding improprieties, create special litigation committee after shareholder initiates
derivative suit, which finds no violations of due care and SH's wouldn't be served by
continuing claim and corp. resources would be waster
-first-tier inquiry of bribery to customers; complains against 4 of 15 board
members
-second-tier inquiry of committee's decision to drop suit and insulate under
BJR
-committee investigated by getting audit firm, reviewing prior work and
testimony of corp officers and work papers by law firm
Issue: Does BJR apply to 3-person committee acting on behalf of the full board?
Rule: Courts poor judges of proper business judgment
-Decisions of SLC shielded only if they have disinterested independence
-BJR applies where some directors charged w/ misconduct if remaining
decision-making directors are disinterested and independent
Analysis: Undisputed that board members were independent and disinterested in
the transactions
-Board of directors only ones w/ power to direct investigation, so most
prudent thing for them to delegate to special committee
(1) substantive decision of the SLC requires "weighing and balancing of legal,
ethical, commercial, promotional..." and outside scope of review
(2) procedural safeguards can be examined
-require showing that chosen investigative methods are in good faith,
amount of ` scrutiny inversely related to the showing by corp.
representatives
-here insufficient proof by P offered showing that the procedures were
not sufficient or appropriate or a good-faith pursuit

Zapata Corp. v. Maldonado (Del. 1981)


Facts: SH initiates derivative suit alleging breach of fiduciary duty; board creates
investigation committee, and after it determines Company's best interest is served
by dismissal, Zapata moves to dismiss
-Vice Chancellor finds board doesn't have power to terminate derivative suit,
conflicting w/ other court's interpretation of Del. law
-Vice Chancellor states BJR irrelevant to question of committee authority to
compel dismissal
-director's powers flow from Del. law, BJR not a source of power itself
-BJR only implicated after decisions are made, no bearing on whether it
can be made in the first place
Rule: (1) If demand refused, board decision to dismiss claim respected unless
wrongfully refused
-Attacking board's decision falls under BJR
-Sohland v. Baker: refused demand case, language supports SH's right to
initiate lawsuit, but not absolute right to continue to control it
-in that case board supported individual SH's derivative case even
though it refused to proceed on the claim themselves
-holding later expanded into broader rule that SH has individual,
independent right to continue suit as an absolute rule (majority
says erroneously)
-McKee v. Rogers: SH's can't invade discretionary field of director's judgment
and sue on corp. behalf when managing body refuses (but can't refuse if it would
breach fiduciary duty)
-(2) If not demand made, may fall under demand futility exception
-What is the SH's authority to continue in spite of the board's disapproval?
Analysis: This case distinguished from Sohland and demand refusal cases b/c not a
demand refusal case
-Different issue here b/c examining not whether decision to refuse was
wrongful but whether board has power to decide at all whether it can dismiss
-Demand cases should fall somewhere b/t Sohland's expanded absolute right
and McKee's restricted right to continue
-Automatically putting derivative suit's control in SH might not serve corp. interests
best, would serve interest of that person at potential expense of all other SH's
-But when, if at all, can committee dismiss?
-Understandable in demand refusal cases to let SH control litigation, but in demand
futility cases inappropriate to strip board the option to effectively make a "post-
refusal" in corp. interest
-situations may arise when SH unwilling to let go of litigation at the expense
of the greater corp. and should give board option to do so (potential for abuse
by individual SH)
-delegation of board authority to independent committee not necessarily
tainted even if majority of board members are tainted
-But must find balance b/t allowing corp. to take over good faith derivatives and
allowing them to dispose of frivolous ones
-BJR in excused demand cases too permissive towards the board
-unsure about committee members dismissing suits against fellow directors
-Therefore, Court of Chancery's independent discretion will determine whether it will
respect a committee power's motion to dismiss a derivative suit
-evaluating business judgment a difficult task but one that the Chancery
Court can do
-Court will apply two-step test:
(1) committee must prove independence, good faith, and reasonable
investigation; and
(2) apply Court's independent business judgment to whether motion
should be granted
-this is the key in balancing legit claims and corp. best interests
-weigh compelling corp. interest in dismissal against non-
frivolous lawsuit
-in addition to corp. best interest, may consider matters of law
and public policy
-Court may be more interventionist when demand is excused b/c
(1) more likely directors have conflict
(2) demand only excused when already something wrong w/ the board
(3) if committee can dismiss suit during litigation, might do so when
unfavorable facts come out and prematurely terminate legitimate claims

(1) Direct or Derivative?


-If direct, SH just sues
-If derivative, then depending on jurisdiction (universal demand, demand futility),
then ask...
(2) Demand required?
-No, SH sues under special litigation cases
-Yes, then ask...
(3) Demand made?
-No, Marx analysis Q4
-Yes, then ask...
(4) Demand refused?
-No, BOD sues
-Yes, demand refused, then ask...
(5) Was demand wrongfully refused? [Almost always end up here]
-No, then stop; no suit
-Yes, SH sues

In re Oracle Corp. Derivative Litigation (Del. Ch. 2003)


Facts: SH's alleges insider trading against 4 directors- CEO Ellison (holds 25% of
voting shares), CFO Henley, executive committee chair, and chairman of the
compensation committee; in Feb. 2001 Oracle claims it will meet guidance from
Dec. 2000, but cuts earnings and license revenue growth on March 1, dropping
stock price 21% in a day;
-SH's allege trading D's breached duty of loyalty by trading on inside
information
-also allege non-trading directors was so indifferent to gap b/t guidance and
reality it constituted subjective bad faith
-SLC formed w/ 2 Stanford professors, Grundfest and Garcia-Molina joined Oct
15, 2001 (after alleged wrongdoing), paid only as directors (which they were
willing to return), and D's had no ties to them or their advisors
-Grundfest's due diligence finds Ellison's and Henley's stories plausible
-SLC conducts extensive investigation, produces 1110 page report concluding
P's claims shouldn't be pursued and that D's couldn't have possessed material,
non-public information that Oracle wouldn't meet guidance
-much of quarterly earnings come in right at the end, but not for
quarter in question
-Ellison sold only 2% of stock (related to options held for nine years
expiring Aug. 2001) and Henley 7%; Oracle faced no nollapse
-D's had ties to Stanford (gave donations, some for Grundfest's research,
speeches, one was professor and taught Grundfest, senior fellows in same
institute)
-but SLC asserts they're not dominated and controlled b/c can't be fired
by D's, nor by Stanford (b/c of tenure), due to their SLC decisions
-claim law has focused on economic ties, so personal ties can't
preclude independence
Rule:
-Parfi Holding AB v. Mirror Image Internet, Inc.: "independence turns on
whether a director is, for any substantial reason, incapable of making a decision
with only the best interests of the corporation in mind ... ultimately focus on
impartiality and objectivity"
Analysis: "dominion and control" shouldn't dictate independence inquiry (i.e. two
brothers w/o financial ties to one another)
-humans are controlled by other motivations than money
-SLC's decision to proceed w/ claim would cause waves and probably be
accompanied by recommendation to step down pending the lawsuit
-SLC hasn't met burden for summary judgment requiring no material factual
question on its independence b/c of its significant Stanford ties
-Boskin: accusing fellow professor or former teacher of insider trading difficult
to do impartially and objectively
-Lucas: unbelievable that one didn't know or appreciate his large contribution
to Stanford
-Ellison: worth tens of billions of dollars, so heaps on more doubt
-If SLC didn't uncover these deep ties its investigative ability is called into question,
and if they did uncover them and didn't disclose SLC was being misleading
-Vice Chancellor expresses shock at departure of SLC's Report from the actual
picture
-perhaps would have changed the analysis if disclosed?
-Subsequent courts have keyed on lack of disclosure as reason case turned out this
way

-During pre-suit demand-excusal context, P has burden of proving director isn't


independent (Marx)
-Martha Stewart case: "relationship must be of a bias-producing nature ...
mere personal friendship or a mere outside business relationship, standing
alone, are insufficient" to raise a reasonable doubt
-Once pre-suit demand excused, SLC has burden of proving its independence by a
yardstick "like Caesar's wife"- "above reproach" (Lewis v. Fuqua)
-Pre-suit and during suit independence analysis different b/c:
(1) diametrically opposed burdens
(2) discovery helping to reveal conflicts (shouldn't this push to make pre-suit
burden easier?)
(3) reason exists for excusing demand (so presumption of independence no
longer deserved)

A.P. Smith Mfg. Co. v. Barlow (N.J. 1953)


Facts: company makes fire hydrants, valves, for water and gas industries, over the
years has contributed to local community and colleges, then board of directors
donate 1500 to Princeton University; stockholders question the decision so corp.
seeks declaratory judgment;
-president testifies that contribution was:
(1) sound investment,
(2) public expects corp. to act philanthropically and gives goodwill
when they do so,
(3) donations create favorable environment for business operations
(4) corp. furthering their interest in cultivating properly trained
personnel
-others state capitalism depends on independent knowledge centers and
educational institutions for good government
-SH's challenge that:
(1) certificate of incorporation nor common law doesn't authorize
contribution
(2) NJ statute authorizing donations unconstitutionally applied b/c after
corp. formation
Rule: Originally corp. had both public and private purpose, but in 19th century
evolved into just private purpose where common law was that corporate managers
couldn't donate w/o corp. benefit
-in 20th century much of wealth and possibility to contribute has moved from
individual to corp. so more allowed to donate, so this social burden has shifted to
the corp. (WWII, depression- now communism)
-NJ statute allows donations w/o SH notice or approval if less than 1% of
equity
-corporate charters can be altered by legislature's discretion
-early Zabriskie case: railroad line couldn't be extended w/o vital change by
unanimous consent
-reserved power allows alterations in public interest of charter, but
doesn't affect contractual rights b/t corp. and SH's and among
SH's themselves
Analysis: Zabriskie didn't public policy for single SH to restrain corp. decision
approved by directors and majority SH's
-post-Zabriskie cases have said public interest and be promoted by invoking
reserved power even if contractual rights are affected
-advance national interest and interest of taxpayers who would have to make
up difference if corporations couldn't donate
-these interests outweigh the alteration of pre-existing SH rights
-Most of time courts will defer under BJR if amount is reasonable
-Can't be in furtherance of personal ends (no pet charities)
-Have to provide connection to some legitimate business purpose
-very easy to do (no Henry Ford tangents), in CA doesn't even require any
"specific corporate benefit"

Dodge v. Ford Motor Co. (Mich. 1919)


Facts: company started in 1903 w/ 150k investment, Ford 58% majority and Dodge
brothers 10% minority not on board, increased to 2M investment in 1908
-as price went down from 900 to 440 to 360, profits soared to 60M for three
years and cumulative total by 1916 of 174M
-yearly dividends from 1911 of 1.2M plus special dividends, from 1M to 4M to
10M
-used to double wages overnight and hire social workers to improve sobriety
and industry
-in 1916 Ford announces no more special dividend but reinvestment
-Dodge brothers form own competing car company in 1913, after complaining
of new dividend policy and being turned by Ford to sell him their shares, they
sue
-court agrees w/ Dodges and order 19.3M and enjoin new smelting plant
-P's claim reinvestment goes against corp. best interests
Rule:
-Hunter v. Roberts: directors alone have power to set dividends, and equity
courts won't interfere unless clear fraud, misappropriation, or when refusal to
declare dividend when it can is such an abuse of discretion to constitute fraud or
breach of good faith
Analysis: w/ such huge profits it's the practice to declare larger dividends
-in these circumstances, refusal appears an arbitrary refusal
-directors required to justify their facially imprudent decision
-plan to lower price (as low as 80) would significantly lower profits and
shareholder value
-Mr. Ford thinks corp. is too big and too profitable and is seeking to
philanthropically redistribute this wealth to the greater public at the expense of
the shareholders
-there's a difference b/t incidental donations and a general purpose and plan
-general purpose is profits: discretion of directors to achieve this
purpose but no discretion to change the purpose itself
-"judges are not business experts": won't go into their business decision to
expand a new smelting plant, but will meddle into their dividend, upholding
order to pay 19.3M dividend
-business plans and strategy hard to be picked apart, but cash
balances are more transparent, and no apparent need for all that
money w/o distribution, ordered to be paid b/c don't want the cash
otherwise diverted to "operating" costs and donations
-shareholder primacy norm
-this is really a minority shareholder oppression case
-might have turned out differently if these minority SH's weren't being
squeezed out

Shlensky v. Wrigley (Ill. 1968)


Facts: minority stockholder of Cubs appeals dismissal of complaint seeking
installation of lights in Wrigley Field and scheduling of night games
-night games supposedly have higher attendance, hence greater revenue and
income
-every other MLB team has night games, over half of all MLB games at night
-operating losses from direct baseball operations last four years
-Cubs refuse to install lights b/c "baseball is a 'daytime sport'" and
surrounding neighborhood
-allege other directors acquiesce in this mismanagement
-compares to Dodge v. Ford
Rule: Davis v. Louisville Gas & Electric Co.- courts shouldn't resolve corp. policy and
business management and only question director's judgment when fraud is shown
-Helfman: court w/o authority to substitute its judgment for the director's,
their authority to conduct business is absolute if within the law
Analysis: Unconvinced that Wrigley's and director's motives are contrary to corp.
best interests
-patrons might consider the state of the neighborhood
-neighborhood value also affects stadium's property value
-unclear whether the costs involved would really make night games profitable
-just b/c all other teams have night games doesn't mean it's right (many are
losing money)
-motives alleged show no fraud, illegality, or conflict of interest
-no damages alleged

Kamin v. American Express Company (N.Y. 1976)


Facts: Amex acquires 30M in DLJ stock, loses 25M in value, instead of selling and
claiming capital gains deduction of 25M directors vote to disburse shares to the SH's
-no claim of fraud, self-dealing, bad faith, or oppressive conduct
Rule: Leslie v. Lorillard: director's powers unquestioned unless illegally or
unconscientiously executed, fraudulent, collusive, or destructive of SH's rights-
mere errors in judgment insufficient
-Liebman v. Auto Strop Co.: won't interfere w/ dividend discretion unless bad
faith
Analysis: simply pointing out a better option isn't a cause of action
-more than imprudence or mistaken judgment required
-"neglect" of duties more than ordinary negligence for bad decisions w/o mal-
or nonfeasance
-fully realized what they were doing, didn't want to realize loss on the income
statement
-fact that earnings turn on profits doesn't necessarily mean this was attempt
to overstate earnings to earn higher compensation
[maybe pegging compensation towards stock price is better than
short-term profits, stock price less manipulable and better indicator of
performance?]

Smith v. Van Gorkom (Del. 1985)


Facts: Trans Union's CEO Van Gorkom briefly discusses possibility of LBO at 50 or
60, states he would be willing to sell shares at 55, then meets w/ takeover specialist
Pritzker discussing price of 55 based on its feasibility as a manageable LBO price;
Trans Union stock price at 37.25 b/c had large cash flows but little net income
unable to use ITC's
-Meets w/ Pritzer on Sep 13 to discuss cash-out merger, he'd only let them
accept other deals if given 1.75M share option at 38, on Sep 18 takes 1M
option but needs approval in three days
-Senior Management disapproves of deal, but Van Gorkom convinces
directors to approve deal after 20 min. presentation, neither Van Gorkom not board
actually sees deal before signing
-Terms allowed 90 days to receive but not solicit offers, couldn't furnish
proprietary information, framed 55 price not as highest price negotiable but a fair
one
-Board's acceptance claimed contingent on (1) reservation to accept better
offer (2) right to share proprietary information w/ bidders
-GE considers bidding, but drops out when Trans Union refuses to rescind
deal w/ Pritzer
Rule: business judgment rule of 8 Del.C. 141(a): presumption that directors acted
an informed basis, in good faith and in honest belief that their actions were in best
interests of the company, Aronson v. Lewis
-attacking party must rebut this presumption by showing:
(1) directors didn't have all material information reasonably available to them
(2) directors made unintelligent or unadvised judgment
-Directors have duty to act in informed and deliberate manner in considering
whether to submit mergers for SH's approval
-can't abdicate this duty by leaving SH's alone to decide
-141(e): Directors fully protected in relying in good faith on reports by officers
Analysis: thinks gross negligence best standard for deciding whether director's
decision was informed
-Directors were grossly negligent by:
(1) inadequately informing themselves to Van Gorkom's role in forcing sale
and choosing price
-relied entirely on Van Gorkom's 20 min presentation
-no written summary of the terms reviewed
-given no documentation to support 55 price
(2) uninformed to the company's intrinsic value
(3) approving sale upon two hours notice absent emergency or crisis
-Directors can't say they were relying on Van Gorkom's report b/c his oral
statements don't rise to meet the standard of "report," even though report
generally liberally construed- Van Gorkom uninformed about the statements he was
making, and directors relied on them in blind, not good faith
-Margin b/t 38 and 55 price doesn't mean it had to be fair, no investigation was
done to justify this price
-undervalued b/c of inability to use ITC's
-gaining majority control has some value besides the share of a non-
controlling share
[stocks consist of two rights: (1) economic and (2) voting
-single share gives owner negligible control over the company
- price thus reflects just the estimated PV of the share's future dividend
stream
-someone buying controlling block gets ability to elect entire board of
directors and can change corporate management and policies, making it more
valuable]
-"Market test" doesn't cure, doesn't make the price reasonable b/c not designed to
allow others fair access, not allowed to actively solicit or give out proprietary
information
-Relying on director's long experience unconvincing based on court's findings
-Relying on legal advice that they might get sued if not following through w/ deal
unconvincing: so deep into the wrongful conduct they were probably getting sued
whatever they did
-Director's post-Sep. 20 conduct wasn't any better, much less a cure: deal arguably
worse
Dissent: thinks majority overlooked and discounted board's significant experience
and ability to make decisions on the fly, they knew company like back of their hand
-Criticism of the case is that it promotes form over substance: if 55 was actually fair
why make the SH's pay for procedures to show that it was fair?
-maybe tint of self-dealing b/c Van Gorkom nearing retirement trying to get
out of the company
-Post-Van Gorkom: corporate uproar caused Delaware to change legislation to allow
in certificate of incorporation provision limiting director's personal liability besides
breach of loyalty, good faith, knowingly violations of law, or self-dealing
Cinerama, Inc. v. Technicolor, Inc.
-Similar fact pattern to Van Gorkom case of board inattention, except this CEO
bargains hard to get price up from 15 to 20 to 23 from stock price of 11
-factors considered in a Van Gorkom entire fairness analysis are:
(1) timing, initiation, negotiation, and structure of transaction
(2) disclosure to and approval by directors
(3) disclosure to and approval by SH's
-found for directors b/c
(1) CEO bargained hard,
(2) CEO better informed than anyone else,
(3) later well advised,
(4) negotiations led to high price w/ over 100% premium and compared to
other transactions, (5) no indication that more money possible from anyone else
(even if locked up, not that big of an obstacle)
-One way companies can protect themselves is hiring outside investment bankers to
issue opinions to the price's fairness
-On can view the business judgment rule either as a different substantive standard
(Van Gorkom) or a rebuttable presumption of (1) good faith, (2) loyalty, and (3) due
care (Cinerama)

Francis v. United Jersey Bank (N.J. 1981)


Facts: Lillian Pritchard inherits 48% interest in reinsurance broker Pritchard & Baird,
sons William and Charles, Jr. on board, management dominated by Charles, Jr.,
brothers "loan" themselves 12M from client's trusts by the time company goes
bankrupt and mother then dies, bankruptcy trustee then sues Mrs. Pritchard's
estate
-Mrs. Pritchard inactive in the business and not knowledgeable of corporate
affairs, though husband warned her Charles, Jr. was greedy, she didn't pay
attention to her director duties
-Drank heavily after husband died and never tried to be effective director
Issue: Fiduciary duty to non-SH creditors? Extent of that duty?
Rule: NJ statute imposes on directors duty to discharge their duties in good faith
and w/ prudent diligence and care (negligence language)
-NY tailors degree of care to (1) type of organization, (2) its size, and (3)
financial resources
-Can be protected by relying on other's opinions, but this can lead to duty to
inquire further, and duty to object if corp. has illegal course of action, and if
they refuse, a duty to resign
-Sometimes besides mere objection and resignation, directors may have to
seek counsel, take reasonable means to prevent illegal conduct, and even threaten
to sue
-Directors should at least rudimentarily understand the corporation's business
-therefore lack of knowledge not a defense
-directors should either learn or quit
-doesn't require detailed inspection, but general monitoring
-Generally don't require fiduciary to creditors when solvent, but to corp. and its
SH's; some corp. like banks have duties to its depositor creditors and when they
hold funds of others in trust
-in other corp. directors' duty normally doesn't extend beyond SH's to third
parties
-Directors voting for or concurring in illegal actions liable to the SH's
-concurrence presumed by being present at meetings w/o dissenting or
objecting promptly after adjournment and trying to persuade other directors
otherwise
Analysis: Reinsurance industry, nature of misappropriated funds, and financial
condition of Pritchard & Baird all indicate unqualified trust and confidence expected
by reinsurers and ceding companies to the brokers, and would expect Mrs. Pritchard
to ensure no misconduct occurred
-resembled a bank by its financial nature, large size, and trust of creditors
-Pritchard should have read annual statements and would have found out the
misappropriations
-breached duty of basic knowledge and supervision and protecting clients
against policies and practices, and reasonably attempting to detect and
prevent illegal conduct of D's and O's
-sons acted so bad even moderately firm objection should have sufficed
-though most directly caused by sons' conduct, her conduct was substantial
factor b/c she was the only other director and no evidence it would have happened
anyway had she intervened
-SEC requires disclosure for directors that don't attend at least 75% of meetings
-p.334 problem: Delaware has made clear in the problem's situation, even though
corp. is on verge of bankruptcy the duty still runs to the shareholder (as opposed to
straight insolvency, when the creditors are owed the duty by the corp.)
Bayer v. Beran (N.Y. 1944)
Facts: Celanese Corp. manufactures "celanese" which it considers different than
rayon, when FTC forces them to use rayon in the product name, consider radio
campaign to distinguish their product;
-many important board decisions made informally, not collectively as a board
-directors initiate radio campaign informally though after few years of
consideration after consulting radio and advertising experts, w/ cost of 1M a
year, no radio advertising done before, no formal action done by board except
ratification of extension
-radio show uses CEO's soprano wife frequently, she suggested the artists
and conductor, but she was not specially featured and product was premiere
target of the program
Rule: Business judgment rule has many reasons:
(1) encourage freedom of action on part of directors
(2) discourage interference w/ exercise of their free and independent
judgment
-absent fraud, improper motive, or personal interest, directors liable for
negligence in only extraordinary cases
-Rule of undivided loyalty: deals w/ all situations where trustee deals w/ another
that advantage to the other might even unconsciously influence the decision-
making
-dealings of director w/ his corp. viewed "with jealousy"; transactions tending
to produce conflict of interest are examined scrupulously
[maybe here tint of In re Oracle structural bias]
-General rule that directors acting separately and not collectively as a board can't
bind corp.
-collective procedures necessary to ensure sufficient deliberation
-directors are SH's agents and given no power by law to act except as a
board
Analysis: If CEO's wife wasn't involved, this would have been summarily dismissed
-even though she was involved, she received less than the other singers and didn't
get special feature ahead of the company
-radio advertising not purposed on advancing wife's career or interests, and it
served the useful corporate purpose of advancing its product
-product gained popularity, wasn't inefficiently produced
-board ratified individual directors' actions, express ratification of radio renewal
along w/ taking benefits of the program implicitly ratified the earlier radio
advertising
-formal requirements not being followed aren't fatal; directors work very
closely w/ one another and customarily acted this way in other transactions, this
practice had served corp. well so far
-19th century used to be that corp. could freely void K's b/t corp. and directors or
officers
-20th century changed to make it so if (1) disinterested majority of directors ratified
and (2) K not unfair, then courts held it valid
-Bayer takes it a step further so that even if not officially ratified by
disinterested majority, still valid if contract was fair

Benihana of Tokyo, Inc. v. Benihana,Inc. (Del. 2006)


Facts: Rocky Aoki owns 100% of BOT until insider trading conviction forces him to
transfer stocks to trust controlled by three children (Kevin Aoki BOT board director)
and Dornbush (attorney and BOT director), when Aoki cuts children out of his will in
place of new wife, directors consider ways to lessen her control, at same time
Benihana needs capital infusion to improve aging restaurants
-BOT owns 51% of common stock (1 vote, 3M shares) and 2% of Class A stock
(.1 vote and 6M)
-executive committee (including Abdo) meets w/ Morgan Joseph, who
discusses alternatives
-Morgan Joseph later meets w/ full board and recommends convertible
preferred, gives directors "confidential" summary of 20M preferred w/ 6%
dividend, 20% conversion premium, and 1-2 seats to the buyer; terms chosen by
looking at comparable issuances and modeling
-Abdo, director, officer, and owner of 30% of BFC, negotiates w/ Joseph two
10M issues, BFC getting one seat and one more if no dividends 2Q in row, refusal
rights on new voting securities, 5% dividend, and right to redeem after 10 years,
and immediate voting rights; would dilute BOT's voting rights from 50.9% to
42.5% to 36.5%; Joseph's most important points satisfied
-Abdo notifies some board members and later whole board, stating he was
BFC's rep. (but not explicitly informing he was the negotiator)
-Board approves sale to Abdo's BFC over Aoki's objections
-Three other financing options rejected as inferior
Rule: Del. 144- safe harbor for interested transactions if:
(1) material facts as to director's relationship disclosed to board and the
disinterested directors in good faith authorize the transaction, even if majority
not a quorom
(2) SH's authorize the transactions
(3) contract is fair to the corp.
-Corporate actions can't be taken solely or primarily for entrenchment, Williams v.
Geier
[specifically rejects old common law rule]
Analysis: Though Abdo never specifically said he was the negotiator, can be
assumed that they knew or that directors understood he was BFC's rep in the
transactions
-didn't breach duty of loyalty by having access to "confidential" term sheet
before his negotiations b/c the terms were not really confidential and they got
what they wanted anyway
-primary purpose of transaction wasn't entrenchment but to obtain the best
financing possible
-Preemptive rights claim and the breach of duty in dilution were direct claims
-Self-dealing and unfair terms claims were derivative
-demand would have been futile b/c majority of board either interested or
independent

Common Stock Debt Normal Benihan


Preferred preferred
Control: Vote Yes No No Yes
Control: No No No Yes
Reserved BoD
seat
Control: No No No Yes
Preemptive
rights
Return: Fixed No Yes Yes Yes*
Return: Growth Yes No No Yes**
Downside No protection Most Some Some
Protection protection protection protection
*Amount of preference not guaranteed, but must be paid before common dividend
(can be cumulative)
**Have to convert first, paying conversion premium

-Directors and officers often have conflicted interest w/ SH's when they have options
b/c their compensation will favor capital appreciations over dividends
-prefers repurchase to dividends (distributes money to SH's while not
lowering stock price)

Broz v. Cellular Information Systems, Inc. (Del. 1996)


Facts: Broz solely owns RFBC, a cellular service provider corp. in Midwest, Broz also
director for CIS, also a cellular service provider, negotiates purchase of service
license for RFBC in Michigan
-CIS not considered by license seller's broker as viable buyer b/c they just
emerged from bankruptcy, had just sold off 15, then 4 more licenses, w/ none
remaining in the Midwest
-Broz meets w/ CEO and two directors who all said CIS aware of Michigan-2
license and not interested in or capable of purchasing the license; all directors
later testify that, if asked, would have said the same thing
-PriCellular gives tender offer for CIS shares while Broz's license negotiations
ongoing and itself enters option to buy Michigan-2 license for 6.7M, defeasible by
someone offering 500k more -Broz buys license for 7.2M, defeating option, nine
days before PriCellular acquires CIS
-trial court rules PriCellular's interest came to merge w/ CIS's, so Broz was
required to consider their prospective, post-acquisition plans in determining
whether to forego opportunity
Rule: Corporate Opportunity Doctrine: if corporate officer or director comes across
business opportunity
(1) corp. financially able to undertake
(2) in corp.'s line of business and of practical advantage to it
(3) corp. has interest or reasonable expectancy of interest
(4) and, by taking opportunity, his self-interest conflicts w/ the corp.
THEN: not permitted to seize opportunity for himself, Guth v. Loft, Inc.
-must analyze situation ex ante to determine possible opportunity rightfully
belonging to corp.
-can proceed himself if one of the above factors absent
-presenting to board provides "safe harbor"
-but "safe harbor" not required if not a corporate opportunity in the
first place
Analysis:
-Broz aware of opportunity individually and not through his corporate capacity
-this absence of any misappropriation of company's proprietary information
lessens burden -not dispositive, but seems to act as a very significant fifth factor
(1) CIS not financially capable of exploiting the opportunity, precarious financial
position
(2) Clearly within corp.'s line of business [but arguably not, given (3)'s distinction of
selling and buying]
(3) Unclear CIS had interest or expectancy b/c their business was shifting, in
process of selling, not buying, cellular licenses
(4) No conflict b/c no duties created conflicting w/ his CIS duties and fully performed
his obligations to CIS by informing the board of the transaction
-competed w/ outside entity PriCellular, which was not the corp. he owed duty
to
-Lack of formal presentation to board not fatal
-no requirement where no interest, ability, or expectancy
-transaction can be okay w/o "safe harbor" if one of Guth factors absent
-Not under any duty to consider PriCellular's interest b/c plan to merge was
"contingent and uncertain"
-right of directors and officers to engage in personal, non-corp. affairs would
be strangled if required to consider all potentialities
-this would create uncertainty and economic inefficiency
-Difficult situation when director owes fiduciary duty to two competing corp. in same
line of business
-maybe best to disclose obligation to both corp. and completely remove
himself from further deliberation on the matter
-Broz can't just remove RFBC completely and let CIS take the opportunity
unopposed
-if RFBC would have had minority shareholders, they could have sued

In re eBay, Inc. Shareholders Litigation (Del. 2004)


Facts: shareholders file derivative suit alleging "spinning" (offering lucrative IPO's to
favored clients) by eBay's investment banking advisor Goldman Sachs to 5 eBay
insiders, including CEO Omidyar, who owned 23% of corp. and largest SH, allowing
them to profit millions
-Goldman was eBay's lead underwriter for their IPO, secondary offering, and
PayPal acquisition
-At the same time Goldman gave Omidyar shares in at least 40 IPO's
-eBay's 1999 10-K: 949M total assets, 554M in equity and debt securities,
181M short-term
Rule: Corporate opportunity doctrine
-RS 2d Agency 388: "unless otherwise agreed, an agent who makes a profit in
connection w/ transactions conducted by him on behalf of the principal is under a
duty to give such profit to the principal"
-if agent acts w/o principal's knowledge and receives something in connection
w/ or b/c of transaction done for the principal, agent has duty to pay to principal
even if otherwise acted perfectly fairly and violates no duty of loyalty
Analysis:
-eBay obviously financially able to exploit the opportunity
-eBay in business of investing b/c integral to eBay's business and cash
management strategy
-over half of its assets were in securities
-eBay never given an opportunity to determine for itself whether it had any
potential interest
-IPO's may be risky, but not up to insiders to choose that for
themselves
-Obvious that these transactions can create a conflict of interest (akin to
bribery)
-Doesn't mean that insiders lose chance to act on all investment
opportunities
-offered as financial inducements for future business and rewards for
past business, not as a typical broker offering personal investment
advice
-undermined by D's positions as directors steering their company's
business to Goldman
-Alternatively, liable as agents held to account for profits made in connection w/
profits for principal
-IPO's were consideration by Goldman for giving them their principal eBay's
business
-Corporate opportunity factor-test, In Beam ex rel. Martha Stewart Living
Omnimedia, Inc. v Stewart:
-"no single factor is dispositive," but "Court must balance all factors."
-"line of business" factor depends on: "fundamental knowledge, practical
experience and ability to pursue" and the intent to profit from the activity
-narrower "line of business" prong than in eBay case
-RS 2d Agency 387: "unless otherwise agreed, an agent is subject to a duty to his
principal to act solely for the benefit of the principal in all matters connected with
his agency"

-Normally directors and officers have fiduciary duties to corp. and not SH's, b/c D's
and O's have active management role in the company while SH's are usually only
passive investors
-but sometimes wholly owned, majority-controlled, or even minority-
controlled SH's can assert great influence over the operation of the corp.
-in that case fiduciary duty is owed to the corp. and all of its SH's therein,
including other SH's
Sinclair Oil Corp. v. Levien (Del. 1971)
Facts: Sinclair organizes Sinven for Venezuelan oil operations, owning 97%,
nominates all board members, and due to this domination Sinclair owed Sinven a
fiduciary duty, Chanchellor holds this means its relationship must meet test of
intrinsic fairness
-minority SH owning other 3% alleges Sinclair depletes Sinven by paying
excessive dividends during period when Sinclair needed cash (108M dividends
and 70M earnings from 1960-66)
-alleges corporate opportunity claim that Sinclair deprived Sinven of
expansion opportunities, giving them to other subsidiaries instead
-alleges breach of contract w/ Sinclair wholly owned subsidiary by paying
Sinven late and not purchasing minimum amount of crude
Rule:
-Intrinsic fairness test involves (1) high degree of fairness and (2) burden on Sinclair
to prove it
-applied in parent/subsidiary situations where
-parent controls transactions and terms- on both sides of the
transaction, and
-self-dealing occurs: parent benefits to the exclusion and detriment of
subsidiary's minority SH's
-dividend declarations can be subjected to the intrinsic fairness test, though
not required in all cases of a dominated board
-Business judgment rule: directors' judgment presumed sound if attributable to "any
rational business purpose"
-Corporate opportunity doctrine
Analysis:
-Chancellor erred in applying intrinsic fairness and not business judgment rule for
dividends:
-not self-dealing b/c dividends paid to all SH's
-motives immaterial unless both (1) shown to be improper and (2) amounted
to waste
-Oil opportunities around world taken by Sinclair and not Sinven not improper b/c
never came to Sinven
-how Sinclair allocates its expansion among subsidiaries is subject to
business judgment rule
-Breach of contract was self-dealing b/c Sinclair benefitted from breach at minority
Sinven SH's loss
-therefore intrinsic fairness test correct for contract claim: Sinclair must prove
that causing Sinven not to enforce contract was intrinsically fair, which they fail to
do
-Pepper v. Litton: directors and dominant stockholders are fiduciaries, their powers
are in trust, and their dealings w/ the corp. subjected to rigorous scrutiny
-for challenged transactions they must show
(1) transacted in good faith, and
(2) inherently fair from viewpoint of corp. and those interested therein
-When SH owns large percentage of corp.'s stock, that corp. is inevitably dominated
by that SH, and however hard SH tries to insulate corp. from himself, and since
managers realize that P can fire or promote them, difficult to protect against
minority SH fiduciary duty suits (M&A possibility?)

-"Par value" is minimum amount corp. had to receive when it sold stock (set in
charter)
-Stock sold by issuer for less than par value was called "watered stock"
-notion of par value as a trust fund for creditors
-SH who bought watered stock was liable to creditors of the firm for amount
underwater
-Par value came to be an arbitrary figure having no relation to price or intrinsic
value
-low par or no par stocks were issued having $1 or less par value
-in Delaware can have no par value but still must set some amount of legal
par
-DGCL 154: "capital" is aggregate par value for SH's equity, and "surplus" is
additional value
-surplus can be distributed to SH's, but capital cannot (held in trust for
creditors' benefit)
-170: board can pay dividends if paid out of surplus
-if no surplus, dividends can be paid out of its net profits for the fiscal
year in which the dividend is paid or the preceding fiscal year
("nimble dividends")

Delaware statutes:
Cumulative dividends: 170 and 151(c)
Convertible stock: 151(a) and 151(e)
Callable stock: 151(c)
Zahn v. Transamerica Corporation (3d Cir. 1947)
Facts: minority SH of Axton-Fisher Tobacco Company, sues majority SH
Transamerica for forcing redemption of stock for 80.80 per share w/o allowing SH
participation in asset liquidation (in which case they would have gotten $240)
-preferred stocks have par value 100, dividend of 6, and liquidation value of
106; Class A stock has 3.20 dividend and Class B has 1.60, A and B share
remaining dividends; upon liquidation Class A receives two times as much as Class
B
-Class A convertible into Class B stock, all Class A stocks callable upon 60
days' notice, for $60
-Class B vested w/ voting rights, but Class A had equal rights b/c 4 straight
quarterly dividends unpaid
-Transamerica builds up about 80% of Class B and 67% of Class A stock,
therefore controlling the majority of the board and its affairs
-Axton-Fisher's biggest asset was leaf tobacco worth 6.3M, Transamerica
knew that market conditions actually made it worth 20M
-complaint alleges that Transamerica sells Class A stock, has the Class A
stocks called for 80.80 (60 call price plus 20.20 accrued dividends), then
liquidates tobacco stock, pocketing proceeds as Class B SH's
[Class A more protected from downside risk, but captured none of the upside
potential, when economy is bad or company is growing and needed quick cash
Class A's preferences facilitated raising of capital; Class B shares for less risk-
adverse investors
-potential conflict of fiduciary duty b/t Class A and Class B: can't maximize
both tranches at the same time, one side will be against a call, depending on
the price]
Rule: SCOTUS Southern Pacific Co. v. Bogert: "majority has the right to control; but
when it does so, it occupies a fiduciary relation toward the minority, as much so as
the corporation itself or its officers and directors"
-directors can't declare or withhold dividends, or any other corp. action, for
personal profit
Analysis: right to call stock reserved to directors, not SH's
-when voting as a SH, can consider one's own personal benefit
-when voting as a director, trustee representing all SH's interests, so can't
use director vote for own personal benefit at SH's expense
-Transamerica was basically Axton-Fisher's puppeteer
-no reason to liquidate assets after Class A redemption
-if there had been full disclosure, SH's would have converted instead of
calling
[court turns this into a disclosure case- damages are what A's would have had done
given full disclosure]
[general rule that fiduciary duty runs greatest to the most junior stock]
Fliegler v. Lawrence (Del. 1976)
Facts: John Lawrence, president of gold and silver corporation Agau, individually
acquires antimony properties under 60k lease
-offered to transfer to Agau but board declines, so instead transfers to USAC,
corp. formed just for this purpose and majority owned by defendants, also giving
Agau option to purchase
-Agau later exercises option, purchasing property from USAC for 800,000
shares of Agau stock
Rule: Gottlieb v. Heyden Chemical Corp.: SH ratification (even if less than
unanimous) of an "interested transaction" shifts the burden to the objecting SH to
show terms so unequal amounts to waste of corp. assets
-144(a): three ways to give safe harbor for interested transactions, including (2)
material facts disclosed to voting SH's, and SH's in good faith approve the
transaction (also safe harbor if disinterested board approves or transaction is fair)
Analysis: Gottlieb rule doesn't shift burden of proof here b/c the majority of votes for
ratification were made by interested SH's, and only about one-third of disinterested
SH's voted
-therefore departure from objective fairness test isn't warranted
[court basically inserts "disinterested" into the statute 144(a)(2)]
-Defendants say 144(a)(2) doesn't require ratifying SH's to be disinterested or
independent
-but this isn't meant to sanction unfairness or removing transaction from
judicial scrutiny
-statute not to provide "broad immunity" but "merely removes an 'interested
director' cloud"
-But transaction still intrinsically fair, the opportunity was lucrative and the price
was well-justified
-144 not meant to fill in deficiencies of disclosure (that goes against basic agency
principles), but meant to protect directors from corporations opportunistically or
arbitrarily voiding K's w/ the director

In re Wheelabrator Technologies, Inc. Shareholders Litigation (Del. 1995)


Facts: Waste and WTI both in waste-management, Waste owns 22% of WTI stock,
elects four WTI directors, and acquires another 33% of WTI stock for .574 WTI
shares and .469 Waste shares per WTI share
-acquisition unanimously approved by WTI's board (minus four Waste
directors) after three hour presentation by investment bankers, reviewing the
agreement, and WTI's attorneys; also approved by the full board
-majority of disinterested SH's also approve the transaction
-complaint alleges nondisclosure, breach of duties of care and loyalty
Rule: Duty of disclosure- board has duty to fully and fairly disclose all material facts
-Duty of care: Van Gorkom- majority vote of SH's can cure failure of board to
reach an informed business decision
-if SH's aren't informed then SH ratification is ineffective (Van Gorkom),
but when they are informed the ratification serves to extinguish
the due care claim
-Duty of loyalty: either (1) interested directors or (2) controlling SH's
(typically parent-subsidiary)
(1) SH ratification under 144(a)(2) invokes BJR and objecting SH has
burden to show waste of corp. assets
(2) entire fairness review, w/ directors having burden of proving
transaction's fairness
-"majority of the minority" SH vote shifts burden to P's
-controlling shareholder necessary to invoke entire fairness
analysis
-reasons that controlling interested SH justifies "need for
the exacting judicial scrutiny and procedural
protection afforded by entire fairness"
-potential to manipulate process
-controlling SH's presence might influence even fully
informed vote
[Ratification:
(1) Duty of Care- kills the claim
(2) Duty of Loyalty (Interested Director)- shifts burden of proof and ups standard to
waste (BJR)
(3) Duty of Loyalty (Controlling SH)- shifts burden of proof, but standard is entire
fairness
-Sliding scale justified by arranging according to degree of control and therefore
abuse potential]
-If interested transaction or
Analysis: Disclosure- three hours consideration sufficient b/c
-investment bankers and outside counsel attended meeting, making
presentations and answering the board's questions
-proxy statement described in detail the various factors the board considered
-Waste and WTI had close business relationship, so reasonable that directors
already had substantial working knowledge to draw upon in considering the
transaction
-Duty of care: even if there had been lack of due care, fully informed SH's
ratification cured the defect
-Duty of loyalty: no evidence besides 22% ownership that Waste exercised de jure
or de facto control
-therefore BJR applied, not entire fairness analysis
-parties unheard, so can't decide this issue yet

Good Faith
-Good faith required for directors in numerous situations:
-to be entitled to legal expense indemnification (DGCL 145)
-full protection for reliance on corporate books or officer reports (DGCL
141(e))
-partial insulation for related party transactions (DGCL 144(a)(1)-(2))
-BJR presumes directors act in good faith (e.g. Aronson v. Lewis)
-Cede & Co. v. Technicolor, Inc. (Del. 1993): P has burden of producing evidence
rebutting presumption that directors acted with good faith, loyalty, and due care
-if P fails to meet this evidentiary burden, BJR attaches to protect decisions of
D's and O's
-if P meets this burden, burden shifts to directors to prove "entire fairness" of
the transaction
-that case created proposition that good faith was freestanding fiduciary duty
In re The Walt Disney Co. Derivative Litigation (Del. 2006)
Facts: When Disney's president dies and CEO Eisner undergoes quadruple bypass,
Disney looks to find replacement in Michael Ovitz, friend of Eisner for 25 years and
powerful partner in prestigious Hollywood agency
-when negotiating employment, Ovitz thinks he will run Disney together w/
Eisner, but Eisner thinks otherwise
-received 20-25M per year from CAA, and refused to give it up unless given
downside protection
-draft of Ovitz's employment agreement (OEA) provided for five-year contract
modeled on previous contracts, with two tranches of options:
-one million options each at end of years 3, 4, and 5, w/ guaranteed
value at least 50M
-two million options upon renewal
-proposed OEA meant to protect both parties from premature termination:
-if Ovitz walked away, he gave up remaining compensation and could
be enjoined from working for competitors
-if Disney terminated w/o fault of Ovitz, he would receive no-fault
payment, consisting of his remaining salary, 7.5M a year for
unaccrued bonuses, immediate vesting of first tranche of options
and 10M cash out for second trance
-though Ovitz's salary would be very high for corporate officers and
draw criticism, still lower than he could receive from a private
company, meriting downside protection and upside opportunity
-executive compensation consultant determined that OEA would provide
Ovitz w/ approximately 24.1M per year
-Eisner tells Ovitz that options reduced from single grant of 5M options to the
two tranches, and that Ovitz would join only as president, not co-CEO; Ovitz
accepts and later signs a letter agreement (OLA)
-compensation committee approves employment agreement, subject to
further negotiation within the contract's terms and conditions; board then
unanimously names Ovitz president
-within few months Ovitz doesn't fit well w/ other executives, Chancellor
rejects claims of malfeasance, lying, and excessive expenses and gift-giving
-Eisner favors a "trade" w/ Sony since Ovitz had connections there and Disney
wouldn't have to pay the severance package, but those negotiations fell through
-legal counsel for Disney advises them that no cause existed, instead of
sending Ovitz letter that he wasn't welcome at Disney, Eisner tells Ovitz two
days later; Ovitz gets 130M severance after serving only 14 months
-SH's file suit against the directors and Ovitz
-allege directors violated due care and good faith by approving OEA,
including NFT, and approving severance payment to Ovitz
-allege Ovitz violated due care and loyalty by negotiating and
accepting NFT provision
Rule:
-De facto officer is one who actually assumes the office via election or
appointment and discharges his duties, but for some reason hasn't yet assumed
the de jure title
-DGCL empowers board to delegate power to a committee for decisions
including compensation
-Bad faith involves three categories:
(1) subjective bad faith- fiduciary conduct motivated by actual intent to harm
(2) lack of due care- fiduciary action taken solely by reason of gross
negligence and w/o any malevolent intent
-gross negligence (including failure to inform oneself of material facts),
without more, cannot constitute bad faith
(3) in between first two ("intentional dereliction of duty, a conscious disregard
for one's responsibilities")
-difference b/t good faith and due care important b/c violations of good
faith are non- exculpable and non-indemnifiable, 102(b)(7)(ii)
-some in between standard needed for violations not involving duty of
loyalty but that is worse than gross negligence ("simple inattention or
failure to be informed")
-i.e. fiduciary intentionally acts w/ purpose other than corp.'s best
interests, intends to violate applicable positive law, intentionally
fails to discharge known duty to act
-but attempting to categorically define entire universe of bad
faith is unwise
-Waste claim requires P to show transaction was so one-sided that no business man
of ordinary, sound judgment would conclude corp. received adequate compensation
-only arises in unconscionable cases of irrational squandering or giving away
-corollary to BJR protecting all decisions "attributable to any rational business
purpose"
Analysis:
-Just b/c Ovitz was reimbursed for expenses and given proprietary
information before becoming president doesn't mean he was a de facto officer
owing fiduciary duties
-Ovitz's actions before assuming office were just preparation activities
-Claim that full board was required to approve OEA rebutted by DGCL
-Due care analysis: compare "best case" scenario w/ what actually happened
(1) Approving OEA
-what should have happened was committee members given spreadsheet of
all possibilities and consequences, including NFT payments in each of the five
years, and entered into minutes
-committee met twice, first approving OEA's terms except for options (which
were approved at later meeting), considered a "term sheet"
-members knew potential 90M in options from previous calculations
made in previous option grants to other executives and factoring in
the 50M up-front bonus Ovitz demanded as down-side
protection from walking away from 150-200M in CAA
commissions (since signing bonuses contrary to Disney policy, instead
packaged as back- end options)
-despite reality not living up to "best practices," board was still adequately
informed of the potential magnitude of the compensation package, including
options
-reasonable that early termination would produce high severance, b/c
less had been earned in salary to make up for the 150-200M that
Ovitz had foregone
(2) Approving hiring of Ovitz
-many discussions had been held to find a top executive, and Eisner made
the board aware of Ovitz's abilities and the lucrative opportunities he would
have to be lured away from
-therefore directors were fully informed of material facts
-Good faith: chancery court determines actions didn't rise to the level of bad faith
-Eisner had authority to fire Ovitz w/o full board's approval b/c of Disney bylaws
-No cause for Ovitz's termination found by Chancellor and Disney's legal counsel
and committee in good faith relied on this report, Eisner's options were pretty much
limited to firing Ovitz
-Payment of contractual obligation cannot constitute waste, unless contractual
obligation is itself waste
-creating "irrational incentive" for Ovitz to leave falls far short of waste,
motivated by Ovitz's need for compensation for walking away from CAA
-There is no "substantive due care" in the BJR, only procedural safeguards on
decision-making
-irrationality is the outer limit of BJR, which may be functional equivalent of
waste or bad faith
Key Holdings:
-"Best practices" not required by the BJR
-Committee, rather than full board, had power to approve Ovitz pay package
-Waste argument "does not come close"
-Three possibilities for bad faith:
(1) Subjective bad faith- obvious
(2) Gross negligence- rejected (this is just due care breach)
(3) "Intentional dereliction of duty, conscious disregard for one's
responsibilities"
-Still technically open question whether good faith is freestanding fiduciary duty
-how can violation of good faith not violate due care or loyalty?

Jones v. Harris Associates L.P. (7th Cir. 2008)


Facts: Mutual fund company Oakmark's SH's sue adviser Harris Associates for
excessive fees; pay was 1% of first 2billion, .9% of next billion, .8% next 2billion,
and .75% anything over 5billion, roughly the same as other funds of similar size and
investment goals
-Oakmark has grown more than comparable pools
-P's allege market is inappropriate benchmark b/c competition ineffective in
setting prices and if markets are to be compared it should be compared to
institutional clients, who pay less
Rule: Investment Company Act 36(b)- investment advisers of registered investment
companies have fiduciary duty w/ respect to compensation
-Gartenberg v. Merrill Lynch: fee must be within range of what would have been
negotiated in arm's-length transaction in the surrounding circumstances, and
violates 36(b) only by charging a fee so disproportionately large it bears no
reasonable relationship to the services and couldn't have been the result of arm's-
length bargaining
Analysis: Holding down costs is essential to competition, so unconvincing that
mutual funds can be captive to the investment adviser and its high fees- would just
be driven away
-fiduciary duty isn't rate regulation: fully disclose and play no tricks, but no
compensation cap
-expressly disapproves of Gartenberg test
-differences b/t institutional and retail rates explained by more active trading
advisers do
-similar to public corp. where compensation committee sets pay for
executives
-businessmen can make unreasonable judgments, but a judge's business
judgment is worse
-Car makers don't have price regulated even though only a dozen of them;
8000 different mutual funds should be sufficient to ensure price competition is
efficient
-unsophisticated investors can piggyback off the competitive pressures from
the more sophisticated investors in their fund
-hedge funds have all sophisticated investors, and they pay even more
than Oakmark
Posner dissent: directors voting on CEO pay often biased b/c CEO's themselves and
competition insufficient to solve problem b/c all large entities have similar incentive
structure

Jones. v. Harris (U.S. 2010)


Facts: -Investment Company Act restricts no more than 60% of directors have
interest in adviser, so that potential conflicts of interest and abuse is tempered
-Definition of "interested person" later opened up and fiduciary duty attached
to adviser pay
-SEC wanted a "reasonableness" standard in place of old waste review
for evaluating adviser compensation; 36(b) fiduciary duty was a
compromise
Rule: conflict between Gartenberg and lower court
-lower court holds that, though adviser can't play tricks or not disclose,
wasn't subject to a cap
-Gartenberg said cap was anything beyond the range of arm's-length
transaction in the situation
-all facts must be considered, including adviser's cost of providing
service, economies of scale, and volume of orders
-since competition can be "virtually non-existent," fees charged
by similar funds
shouldn't be used as the principal consideration
-shouldn't be compared to institutional pension funds b/c less
involved trading
-this standard favored by the SEC and other circuits besides seventh
Analysis: Arm's-length bargaining absent from mutual fund industry b/c funds often
cannot easily sever its relationship w/ the adviser
-Gartenberg correct in its basic formulation of what §36(b) requires
-Adopts SCOTUS's test for interested transactions in Pepper v. Litton: "the essence
of the test is whether or not under all the circumstances the transaction carries the
earmarks of an arm's length bargain"
-Investment Company Act modifies this test by shifting burden of proof from
fiduciary (un-ratified interested transactions) to the objecting party
(Jones)

Stone v. Ritter (Del. 2006)


Facts: allege Caremark claim against directors, AmSouth pays 40M in fines and 10M
in civil penalties for employee failures to file SAR's and regulators issue cease and
desist order to improve AmSouth's compliance and anti-money-laundering program
Rule: Rales v. Blasband- for demand futility, particularized factual allegations must
create a reasonable doubt that board could have properly exercised its independent
and disinterested business judgment
-§102(b)(7): directors exculpable for breach of duty of care, but not good faith or
loyalty
-Graham v. Allis-Chalmers: "absent cause for suspicion," there's no duty to ferret
out wrongdoing they have no reason to suspect exists
-In re Caremark Int'l Inc. Deriv. Litig.: boards and officers can assume integrity of
employees, but can't must ensure that information and reporting systems are
reasonably designed to give accurate information to allow them to make informed
judgments
-only a "sustained or systematic failure," like "an utter failure to attempt to
assure a reasonable information and reporting system" will establish lack of
good faith
-though don't need to act w/ suspicion, need to have reliable means of
ensuring that suspicion will reach them when necessary and aren't blind to
potential misconduct
-Good faith is necessary part of loyalty, but not a freestanding fiduciary duty by
itself
-therefore good faith not only a part of loyalty, but can play into cases where
there is no conflict of interest implicating the duty of loyalty
Analysis: Directors failed to implement any reporting system or controls, and failed
to monitor or oversee its operations
-Board seems to have actually done quite a few things to keep themselves
informed
-Bad result isn't same thing as bad faith, some things might still go wrong

Securities Act of 1933- impetus was stock market crash 1929, deals w/ primary
markets, but state regulations began as early as the 1800's ("blue-sky laws"-
focused not only on disclosure, but merits of the investment itself: not too
speculative or immoral)
-rejects merit approach in favor of disclosure approach (i.e. "truth in
securities" act)
-§5 registration
Securities Exchange Act of 1934-
-deals w/ insider trading, short-swing profits by insiders, proxy solicitations,
and tender offers
-viewed '29 crash as a result of fraud, abuse, and market manipulation
-§4 creates SEC
-§13 requires 10K's, 10Q's, and 8-K's
-§14 Williams Act governs proxies and tender offers
-§9 prohibits manipulation of security prices
-§10 antifraud provision prohibits manipulative and deceptive devices
-Rules
-Forms
-SEC informal lawmaking
-SEC no-action letters
-but especially in proxy situations, SEC staff might disagree w/ one another
-Case law
-private litigation
-SEC enforcement actions
-SEC
-5 commissioners appointed by president and confirmed by Senate, only 3 of
which from one party (usually president's); most people only deal w/ the staff
-interpretative guidance to private parties, advises Commission as to new
rules, and investigates and prosecutes possible violations of securities laws

-Business lawyers often run afoul of securities laws b/c they don't realize what they
are dealing with is actually a security; registration only necessary if it's a security
-if sued for failing to register a security, first say it's not a security, then say
it's covered by one of the exemptions, then try to settle on the best terms
-fraud cases much easier for plaintiffs under federal securities laws than state
common law
-security defined by list including stock, notes, bonds, evidence of
indebtedness, investment contracts, and any instrument commonly known as
a security, §2(1) of Securities Act
-§2: security must be defined in the list "unless the context otherwise
requires"
-context clause can be used to give courts wiggle room for new,
confusing devices
Robinson v. Glynn (4th Cir. 2003)
Facts: GeoPhone owner Glynn develops cell phone system called CAMA, contact
Robinson to raise capital, who has no telecommunications experience and agrees to
give 1M to perform field test of CAMA; according to letter of intent Robinson pledges
to invest up to 25M if field test works, and Glynn lies to Robinson saying that it does
work
-Robinson receives 1/5 of GeoPhone's shares, which say "shares" and
"securities" on the back, and says can't be transferred w/o being properly
registered under securities laws
-2 of the 7 board members to be appointed by Robinson and he has own
board seat, Robinson also serves as treasurer and executive committee
-Robinson sues under federal securities laws after learning that Glynn lied
about CAMA, saying he comes under the statute b/c his investment was either
an "investment contract" or "stock"
Rule: §10b-5 claim requires fraud in connection w/ security purchase
-"Investment contract" is an investment of money in a common enterprise with
expectation of profit, solely from the efforts of others, S.E.C. v. W.J. Howey Co.
-courts don't apply "solely" part literally, look instead to "economic reality" of
the investment
-active/passive investor: is he "unable to exercise meaningful control over his
investment"?
-"Stock" refers to narrow set of instruments w/ common name and characteristics
-this label applies only when the instrument is called "stock" and bears its
usual characteristics
(1) right to receive dividends contingent upon apportionment of profits
(2) negotiability
(3) ability to be pledged or hypothecated
(4) voting rights in proportion to number of shares
(5) capacity to appreciate in value
Analysis: Indicia of control not just on paper but also in reality: 3 seats, ability to
select consultants, refusal power over unusual indebtedness
-Robinson exercised too much control to be a passive "investment contract"
-Economic reality guides its true nature, not the labels the parties attached to
it
-Don't have the features typical of stocks (share of profits not in proportion to
number of shares, not freely negotiable, etc.)
-LLC's are hard to classify b/c hybrid of corp., general partnerships, and limited
partnerships, so can't make broader ruling as to all of them

-Securities Act prohibits sale of securities unless they're registered w/ the SEC, §5
requires:
(1) security can't be offered for sale through mails or other means of
interstate commerce unless registration statement filed w/ the SEC
(2) securities can't be sold until registration statement has become effective
(3) prospectus (disclosure document) must be delivered to purchaser before
a sale
-SEC only asks whether there are disclosures accurate, not whether it's a
good investment
-registration requires extensive financial and business information
-b/c of cost involved, businesses try to sell securities w/o registering
them
-some either partially or totally exempt from registration requirement
by being either an exempt transaction or an exempt security,
exempted transactions more common b/c more specialized
Doran v. Petroleum Management Corp. (5th Cir. 1977)
Facts: Petroleum Management Corp. (PMC) organized as limited partnership to drill
oil, contacts four people to invest who decline, then contact Doran to invest in PMC
for 125k, sends him production information but the oil wells deliberately
overproduced and sealed for 338 days by Gas Commission and Doran forced to pay
on note he was personally liable for, Doran tries to refund his investment by
claiming rescission for violation of Securities Act
Rule: §4(2)- exemption for private placement transactions, in determining courts
look at four factors:
(1) number of offerees and their relationship to each other and the issuer
-most important and problematic factor, but not dispositive
-number of offerees, not purchasers
-one offeree's knowledge can't substitute for another's lack of
knowledge
-Applicability of §4(2) depends on whether the class of persons
affected need Act's protection, which then turns on the
knowledge of the offerees, SEC v. Ralston Purina Co.
-requires access to both information and investor sophistication,
sophistication can't replace info
-all offerees must have had available the information in a
registration statement
-relationship b/t issuer and offeree more important when issuer
relies on effective access to the relevant information instead
of disclosure of it
(2) number of units offered
(3) size of the offering
(4) manner of the offering
Analysis: First factor is present as to number of offerees (only 8 offerees), but the
relationship question is still unresolved:
-Did investor have access to information plus an ability to understand that
information?
-some relationships can provide access, ability depends on investor's
background or economic bargaining power
-Regulation D (rules 501-506) relied on by those that try to use §4(2)'s imprecise
language
-if no more than 1M raised, may sell to unlimited number w/o registration
-if no more than 5M raised, may sell to 35 buyers w/o registration
-if more than 5M raised, may sell to 35 buyers who pass various
sophistication tests
-mostly can't widely advertise, and must file notice of sale w/ SEC shortly
after sale
-limits don't apply to accredited investors (i.e. banks, brokers, wealthy
buyers)
-generally exempt only initial sale, so buyer must find another exemption to
resell
-can rely on §4(1) if not "an issuer, underwriter, or dealer"
-but §2(11): underwriter is someone who buys security "with a view to"
reselling it
-court might even invalidate entire issue's exemption, include original
issuer, if she resells shares to a large number of people
-Reg. D provides protection to issuers using "reasonable care" to
ensure buyers are planning to hold stock themselves by
reasonable inquiry into their plans and disclosing that the stock
is subject to resale restrictions
-§144 allows buyers to resell Reg. D offerings if held for 1 yr and
resold in limited volumes
-Before Securities Act, state common law fraud rules were more stringent: must
prove misrepresentation of a material fact, reliance, causation, scienter, and injury
-limited to amount of loss, only some investors relied on or received
misrepresentations
-But federal laws make it much easier:
-private parties can be plaintiffs, plays role as an important deterrent, as
under §10(b)
-implied private rights under certain Securities Act provisions
-§11 principal express clause for fraud in security sale through registration
statement
-no privity requirement, so can bring in officers, directors, experts, and
others
-Due diligence usually the only viable defense to a §11 claim
-standard of liability is essentially negligence, so reasonable
investigation rebuts
-§12(a)(1) imposes strict liability on sellers, main remedy is rescission
-§12(a)(2) imposes private civil liability on offerors of securities in interstate
commerce, w/ prima facie case consisting of 6 elements:
(1) sale of a security
(2) through instruments of interstate commerce or the mails
(3) by means of a prospectus or oral communication
(4) containing an untrue statement or omission of a material fact
(5) by a defendant who offered or sold the security, and
(6) which defendant knew or should have known of the untrue
statement
-reliance not required
-only deals w/ material misrepresentations or omissions connected to
public offerings, not secondary market transactions or private
placements
-§20 gives power for SEC to initiate civil suit or refer to AG for criminal
charges
Escott v. BarChris Construction Corp. (S.D.N.Y. 1968)
Facts: buyers of convertible debt of bowling alley constructor sues under §11 the
signers of the registration statement (the directors, controller), the underwriters,
and the auditors
-increase in bowling lanes spur rise in sales from 800k in 1956 to over 9M in
1960
-raise 1.68B in public equity offering in 1959, followed by issue of the
debentures
-by 1962 industry collapses, BarChris tries to raise more capital in May but
ends up just filing bankruptcy and defaulting on the debentures
-registration statement overstated sales, EBIT, EPS, assets, etc.
-experts could be auditors Peat, Marwick, BarChris's attorneys Perkins,
Daniels, or underwriters' attorneys Drinker, Biddle & Reath
Rule: §11 requires false statement or omission to be "material" for there to be
liability
-SEC regulations define "material" as information "an average prudent investor
ought reasonably to be informed before purchasing"
-enough information to make an intelligent, informed decision
-not concerned w/ minor inaccuracies or errors of no interest to him, but w/
facts having an important bearing upon the nature or condition of the issuing
corp. or its business
-§11(a): "in case any part of the registration statement, when such part became
effective, contained an untrue statement of a material fact or omitted to state a
material fact required to be stated therein or necessary to make the statements
therein not misleading, any [innocent] person acquiring such security" may sue:
(1) everyone who signed the registration statement (issuer itself signs the
statement)
(2) every person who was a director of the issuer
(4) every accountant, engineer, or appraiser, or any person whose profession
gives authority to his statement, and consensually been named as preparing or
certifying part of the registration statement
(5) every underwriter w/ respect to such security
-§11(b)(3): no one, except the issuer, shall be liable if they satisfy that:
(A) for unexpertised, after reasonable investigation, reasonably believed
statements were true
(B) as expert, after reasonable investigation, reasonably believed that the
expert's statements were true or the registration statement unfairly
represented his statement, or
(C) for expertised, no reasonable grounds to believe that statements weren't
an untrue or material omission, or that it unfairly represented the expert's
statement
[for expertised portions, don't need to reasonably investigate just subject to
negative standard;
for not expertised portions must reasonably investigate and have reasonable
grounds to believe it]
§11(c): "reasonable investigation" evaluated by "prudent man in the management
of his own property"
[what is reasonable depends on the defendant, whether inside or outside,
specialized expertise, but can't just rely on clients b/c they lie to you]
Analysis: Much of the misstatements in the prospectus were material
-1960 information seem too small a misstatement to be material, but 1961
information was
-Only portions of registration statement made on Peat, Marwick's authority was
expertised
-just b/c lawyers prepared the whole statement doesn't make it all expertised
-Peat, Marwick only dealt w/ 1960 data, not 1961, which was noted as
unaudited
Vitolo and Pugliese: president and vice-president, "limited education" who dealt w/
construction
-though probably didn't read disclosures, still responsible for them as board
members
-were present at board meetings, knew that their own loans to the company
were unpaid and depended on the financing proceeds to be paid
-therefore couldn't have reasonably believed the registration statement was
wholly true, and no showing that any investigation was made to clarify what
they didn't understand
Kircher: treasurer and CFO, CPA and "an intelligent man," "thoroughly familiar w/
BarChris's financial affairs," contends he didn't know what registration statements
should contain b/c never dealt w/ them before and relied solely on Grant, Ballard
and Peat, Marwick
-credibility issue: withheld info from Grant, Ballard, even if he hadn't, still
should have known that the expertised portion of the prospectus was
incorrect, blind reliance isn't excused
Birnbaum: lawyer, becomes director shortly before registration statement's
amendments filed, making him liable for the its final form
-didn't participate in management, house counsel attending routine legal
matters
-though may not have known of all the inaccuracies, surely knew about some
which he failed to investigate
-should have known as a lawyer that reasonable investigation was required
Auslander: outside director, before joining board obtained Dun & Bradstreet
financial reports and inquired of BarChris's banks, trusted auditors Peat, Marwick b/c
they were the auditors for his bank
-signed registration statement w/o realizing what it was
-as to expertised portion by Peat, Marwick, protected by reliance
-as to non-expertised portion, not protected b/c should have read prospectus
carefully, which would have shown that Peat, Marwick wasn't responsible for all
the figures
-just b/c Auslander was a new director doesn't mean he's excused: even new
directors, if prudent, would have taken the time to gather all material facts before
signing on
Grant: drafter of registration statements and also a director
-honestly believed everything was true, but should have found out all the
errors in the data given to him by his client that didn't need an audit to discover
-cut-and-pasted statements for debentures were inaccurate as financial
position had changed
-nothing like an audit is required, just check of matters easily verifiable
-liable for everything except audited 1960 figures
Peat, Marwick: auditing expert for the 1960 figures, most of work performed by
Berardi, who was not yet a CPA and was handling his first case as a senior
accountant
-Berardi should have realized that Capitol Lanes existed, a falsely reported
accounts receivable
-further inquiry was necessary, relied on unverified oral statements, fell short
of professional accounting standards
Underwriters: all relied on lead underwriter Drexel, who delegate due diligence to
their lawyers
-All publicly traded companies must file Exchange Act reports
-covered corp.'s register w/ SEC by filing initial Form 10, 10-K, 10-Q, and 8-K
-Exchange Act covers registering class of securities, Securities Act covers
particular offerings
-registering class of securities under Exchange Act triggers other
requirements, like proxy rules under §14, tender offer rules of §13 and §14, and
certain anti-fraud provisions
-Before modern integrated disclosure system, overlap existed in the disclosures
required by the Exchange Act and the Securities Act
-inefficient b/c efficient markets hypothesis says all publicly available info
instantly adjusts price
-first look to various forms eligible, then Regulation S-K has substantive
disclosure requirements
-two types of information: information about the transaction and information
about the issuer
-Form S-1, basic registration statement form, requires both
-Form S-3 only requires transaction info: large and seasoned issuers,
regularly provides disclosures so more info is duplicative

-Most important implied private right of action is Exchange Act §10(b):


(1) unlawful for any person, through interstate commerce or mail,
(2) to use in connection w/ sale of any registered security,
(3) any manipulative or deceptive device in
(4) contravention of rules the Commission may prescribe as necessary or
appropriate in the public interest or for the protection of investors
-§10(b) applies to any security, including closely-held corp. which generally
aren't subject to Exchange Act, and government securities
-Rule 10b-5: "unlawful for any person, directly or indirectly, by the use of any means
or instrumentality of interstate commerce, or of the mails or of any facility of any
national securities exchange
(a) to employ any device, scheme, or artifice to defraud,
(b) to make any untrue statement of a material fact or to omit to state a
material fact necessary in order to make the statements made, in the light of the
circumstances under which they were made, not misleading, or
(c) to engage in any act, practice, or course of business which operate or
would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security."
-Rehnquist: 10b-5 now "a judicial oak which has grown from little more than a
legislative acorn"
Basic Inc. v. Levinson (U.S. 1988)
Facts: Basic was chemical refractory manufacturer for steel industries, Combustion
Engineering deterred from takeover bids b/c of antitrust concerns but rekindled
after regulatory action allowed it
-Basic publicly denies merger rumors three times, later asks NYSE to suspend
trading issue release stating another company had approached it w/ merger
talks
-One day later board accepts $46 per share offer
-SH's who sell before deal announced sue over allegedly misleading
statements
-trial court holds that negotiations weren't destined w/ reasonable certainty
to become a merger agreement in principle
-appeals court reverses on "fraud-on-the-market" theory, saying statement
was "so incomplete as to mislead," rejecting lower court's finding that
preliminary merger talks were immaterial, but made material after company
issues flat rejection of any discussion whatsoever
Rule: Judicial application and legislative acquiescence has removed any doubt that
10b-5 constitutes a private right of action
-includes requirements like "manipulative or deceptive practices," connected
to purchase or sale, duty to disclose, scienter, confidentiality, and standard of
materiality
[conflict b/t purpose of disclosure and conflicting purpose of confidentiality for
sensitive transactions]
[duty to speak truthfully and completely, but no duty to say anything- always advise
"no comment"]
[confusion between duty to disclose and materiality of information required to be
disclosed]
-Setting materiality standard too low would cause directors to flood investors w/
irrelevant info
-Materiality: substantial likelihood that disclosure of omitted fact would be
viewed by reasonable investor as significantly altering the "total mix" of
information made available, TSC Industries, Inc. v. Northway, Inc.
-But Greenfield v. Heublein, Inc.: until "agreement-in-principle" as to price
and structure of the transaction, info can be withheld or even misrepresented
w/o being material
-don't want investors to be overwhelmed w/ information, many
mergers talks collapse
-helps preserve confidentiality of merger discussions, shielding from
added problems
-provides usable, bright-line rule
-Materiality depends upon balancing probability of an event w/ its anticipated
magnitude, so for buyouts materiality occurs earlier despite its tiny probability,
SEC v. Texas Gulf Sulphur Co.
-merger discussions depend on the particular facts
-probability factors look to factors of indicia of interest, including board
resolutions, instructions to investment bankers or M&A counsel, and
actual negotiations
-magnitude factors include size of the two corp. entities and potential
premiums over market value
-nothing short of closing transaction is sufficient by itself to render
discussions material
-"[M]ateriality depends on the significance the reasonable investor would
place on the withheld or misrepresented information"
-Fraud on the market theory: market prices are based on available material
information, so misleading statements defraud the purchaser who relies on price
even if he didn't directly rely on the misstatement
-eases reliance requirement for class actions, otherwise would have trouble
proving each party's subjective pricing of the information by each individual
investor, difficult evidentiary burden w/o this fraud on the market presumption
of reliance
-really just fancy justification allowing class actions to proceed w/o
evidentiary obstacle
-though fraud on the market theory eases long-required reliance element,
there are other ways of showing causal connection besides reliance
-modern securities market different from original face-to-face fraud cases, as
today the market, through market professionals, is an agent for the buyer that
makes valuations for him
-investors rely on the integrity of the market price
[Krawiec doesn't like fraud on the market analysis b/c lying about something
doesn't make it material, thinks it confuses duty w/ materiality]
[implicit requirement of efficient markets- if markets aren't efficient than price won't
properly reflect publicly available material information]
Analysis:
-None of Greenfield's rationales actually explains any less significant informational
value
-purpose of Securities Acts was to replace full disclosure for caveat emptor,
achieving high standard of business ethics and not assume investors were
simplistic and incapable of filtering necessary information for themselves
-here not concerned w/ the timing, but the accuracy and completeness of the
disclosure
-ease of application isn't a good reason to compromise the Securities Acts'
purpose
-Therefore reject Greenfield's disallowance of preliminary merger discussions from
materiality that don't have agreement-in-principle as to price and structure
-B/c most publicly available information reflected in market price, investor's reliance
on public material misrepresentations can be presumed for 10b-5 purposes
-could rebut presumption by showing, i.e., that market makers knew what
was really going on, later merger news neutralized earlier denials before
investors sold, sold for unrelated reasons
White dissent: Adds reasons why investor may not have relied: decided months ago
to sell, shorts the stock before misrepresentations made; opposed to the fraud on
the market theory
-Judges aren't business experts, so they shouldn't interpret statutes based on
economic theories they don't understand
-skeptical that individuals really rely on the integrity of the market price
-in fact, many investors buy stock b/c they believe market price is
inaccurate
-so many members and 14 month period so long should weigh against fraud
on the market
-no evidence that misstatements made to manipulate stock prices, also
questions whether this was actually in connection with the purchase or sale of
securities
-some included in the class who purchased after the misstatement was made
but disbelieved it
-price rose significantly during period, showing that market may not
have been misled
-thinks that in the end innocent investors will pay off speculators and
lawyers

West v. Prudential Securities, Inc. (7th Cir. 2002)


Facts: stockbroker Hofman for seven months tells eleven customers that Jefferson
Savings Bancorp is definitely getting acquired soon, either a lie or insider trading
-is Hofman liable to his customers or to everyone buying Jefferson stock
during that period?
Rule: Basic- fraud on the market: investor's reliance on public material
misrepresentations are assumed for 10b-5 purposes b/c market price reflects most
publicly available information
Analysis: but Hofman didn't release information to the public, and his customers
thought they were receiving inside information
-Oral frauds aren't allowed as class b/c details differ from victim to victim and may
be statement-specific
-When class is certified, high risk of catastrophic loss and personal liability on
managers often leads corp. to pay inflated settlements that don't serve SH's best
interests
-therefore certify class w/ caution
-Non-public information shouldn't affect prices: public announcements wouldn't
move prices if the markets already knew the information
-just b/c you have a conflicting expert doesn't mean you get a jury trial on the
merits
-Demand by itself wasn't shown to be the only possible cause of upward price
movement
-demand for stock is perfectly elastic, substitute stocks are widely available
-rises from gullible purchasers negated by larger investors who short it back
to the status quo
[how much credit should be given to economic theory?]
-One stockbroker's lie causing long-term price rise is inconsistent with efficient
markets
-Basic expands the class by using fraud-on-the-market, West narrows the class by
using the same theory
-After revisions to Securities Acts in '70's and '80's, becomes very clear that the law
has built-in the efficient market hypothesis (i.e. disclosing information just once is
sufficient)

Rule 10b-5 elements:


Standing: P's must have actually purchased or sold securities, Blue Chip Stamps v.
Manor Drug Stores
Scienter: liability for misleading statement requires intent or recklessness, Ernst &
Ernst v. Hochfelder
Secondary Liability and Scope of Interpretation: no implied private right of action
against those who aid and abet Rule 10b-5 violations, scope of conduct controlled
by text of the statute and inference of how 1934 Congress would have addressed
the issue using express causes of action as the primary model (not common law
methods), Central Bank v. First Interstate Bank
-but inferring 1934 legislative intent is "awkward task," Lampf, Pleva, Lipkind,
Prupis & Petigrow

Santa Fe Industries, Inc. v. Green (U.S. 1977)


Facts: Santa Fe acquires 60% stock of Kirby Lumber Corp., later increases to 95%,
tries to get 100% by using Del. §253 "short-form merger" statute allowing parent
owning at least 90% to merge w/o consent or approval of minority SH's, given
notice ten days after effective date, but dissatisfied SH's can petition Chancery
Court for payment of fair value based on court-appointed appraiser
-independent appraiser Morgan Stanley values stock at $125, merger terms
offered $150
-minority SH's object to merger but file in federal court to invalidate merger
or get fair value, claiming stock worth at least $772, also claiming that appraisal
fraudulently stated low value to induce minority SH's to give up the excess value to
the controlling SH (Santa Fe)
-complaint alleges merger solely purposed to eliminate minority and
fraudulently low valuation
-lower court says short-form merger doesn't require business purpose
or prior notice
-as to fraud, if full and fair disclosure made the inquiry is over
-but appeals court disagrees w/ lower court, saying misrepresentation
or nondisclosure isn't necessary to a 10b-5 action: the rule reaches
breaches of fiduciary duty by majority against minority w/o such
misrepresentation or nondisclosure
Rule: §10(b)- unlawful to use manipulative or deceptive device in contravention of
SEC rules
-no indication in §10(b) that Congress intended to include conduct besides
manipulation, deceit
-§10(b) read flexibly, not technically and restrictively, but still must include
some deceit element, and not stretched to include simple violations of fiduciary
duty
-manipulation deals generally w/ wash sales, matched order, or rigged prices,
practices meant to mislead investors by artificially affecting market activity
-Shouldn't' create implied federal cause of action where matter traditionally
relegated to state law
-Corporations are creatures of state law, so allowing Rule 10b-5 to displace state
law improper
-Breach of fiduciary duty w/o fraud not a violation of Rule 10b-5
Analysis: Transaction was neither manipulative nor deceptive, and so didn't violate
§10(b) or Rule 10b-5
-private cause of action shouldn't be implied when not necessary to fulfill
legislative intent
-statute meant to promote full and fair disclosure, not fairness of the
transaction terms
-cause of action traditionally relegated to state law? yes (appraisal), so just
give them that
-allowing cause of action here would dangerously expand §10(b)'s reach to
include other merger forms (long-form, tender offer, liquidation) and other
types of fiduciary self-dealing
-federalism: allowing cause of action here could also interfere w/ state
corporate law (corporations created by state law, and investors invest on
understanding that state law controls unless federal law expressly governs)
-may be need for federal fiduciary law, but must be legislatively done, not by
extending §10(b)
-Federal/state balance:
-States: shareholder liability, corporate governance, D/O fiduciary duties, SH
rights/duties
-Federal: transactional disclosure, periodic disclosure by public companies,
fraud i/c/w securities transactions

Deutschman v. Beneficial Corp. (3d Cir. 1988)


Facts: Beneficial Corp. CEO Caspersen and CFO Halvorsen lie about severe losses in
insurance division to lessen decline in their stock and options, saying problems were
behind them and covered by reserves
-complaint alleges that call option purchased in reliance on market price
created by misstatements declined in value
-district court holds option traders lack standing under §10(b) and Rule 10b-5,
no duty to them
-option price depends on changes in underlying stock price and information
affecting the price
Rule: §10(b) prohibits manipulative or deceptive device in contravention of SEC
rules in connection with purchase or sale of any security
-Standing requirement: P's must be buyer or seller of a security, Blue Chip Stamps
v. Manor Drug Stores
-1934 Act's purpose was protection of actual participants in securities
markets
-P's need not be in privity with D's, serves purpose b/c limits class to P's who
dealt w/ security
Analysis: B/c options responsive to stock price changes, option holders vulnerable to
insider trading and affirmative misrepresentations, though only second type is
alleged here
-calling option holders "gamblers" doesn't merit diff. treatment, can be used
as a hedge
-therefore Deutschman has standing to sue under §10(b) for affirmative
misrepresentations
-Under state law, fiduciary duty not owed to option holders, Simons v. Hogan
-Easier to sue for disclosure under federal law, so disclosure as a state fiduciary
duty is largely died

Cicero example: merchant, knowing many merchants follow behind him, lands in
famished country; duty to disclose?
-why arrive first? b/c first merchant was smarter, better access to info, faster
ships, assume more risk, incur higher costs, sabotage
-efficiency vs. fairness
Types of Insiders
-true insiders (directors and officers)
-temporary insiders (outside counsel, consultants)
-misappropriators (family members, bankers, lawyers, employees of certain
service providers)
-don't have fiduciary or confidential relationship, even temporarily, but
still come into contact w/ confidential or inside information
-tippees (receive inside info from insiders or misappropriators)
Goodwin v. Agassiz (Mass. 1933)
Facts: In May 1926 Cliff Mining Company directors and officers Agassiz and
MacNaughton buy 700 shares of Cliff Mining from Goodwin;
-geologist theorizes that copper exists on company land and directors
purchase options on adjoining land through related company and secretly
purchase Cliff Mining shares
-directors had material knowledge that Goodwin didn't have and didn't it
disclose to him
-plaintiff only knew after hearing in newspaper, wouldn't have sold if he knew
about geologist
Rule: Directors have position of trust in relation to corporation, but no such relation
w/ individual SH's
[old majority rule: D's and O's can trade w/ SH's w/o disclosing material information
"special circumstances" rule (or special facts doctrine): duty to disclose might be
imposed when there were special circumstances, most importantly concealment of
defendant's identity and failure to disclose information having dramatic impact on
price, Strong v. Rampede
"minority" rule: insiders have duty to fully disclose material information when
buying shares from SH's, Oliver v. Oliver
-by late 1930's, special circumstance or minority rule followed in majority of
states]
-Unique knowledge of directors require full attention to fair dealing when directly
buying or selling stock
-fiduciary duties can't be so strict that no one can fulfill them
-but directors personally seeking out SH's to sell him shares w/o disclosure is
closely scrutinized
Analysis: Buying or selling shares on impersonal exchange is too difficult to actually
go out and track down the opposite party to make disclosures
-No fraud is found in the allegations
-theory was only nebulous; "at most a hope, possibly an expectation"
-premature disclosure may have caused suits from those thinking the theory
was correct
-directors made no misrepresentations and no facts required them to disclose
theory
-plaintiff was sophisticated investor
-Disclosure wouldn't have harmed Cliff Mining Co., just another mining company
owned by the directors

-Where is the word "insider" in Rule 10b-5?


Securities and Exchange Commission v. Texas Gulf Sulphur Co. (2d Cir.
1969)
Facts: TGS discovers high mineral content in drilling hole in Canada but company
requires keeping drilling results secret so they can buy land options
-but from 1963-64 employees began buying shares and call options
-after story comes out in newspaper TGS issues press release next day April
12 trying to stem rumors of the discovery, but eventually disclose discovery five
days later
-stock price jumps from 18 to 30 at press release, then after press release
jumps to 58
Rule: Rule 10b-5- "unlawful for any person, directly or indirectly, by the use of any
means or instrumentality of interstate commerce, or of the mails, or of any facility
of any national securities exchange,
(1) to employ any device, scheme, or artifice to defraud,
(2) to make any untrue statement of a material fact or to omit to state a
material fact necessary in order to make the statements made, in the light of the
circumstances under which they were made, not misleading, or
(3) to engage in any act, practice, or course of business which operates or
would operate as a fraud or deceit upon any person"
-based on justifiable expectation that all investors trading on impersonal
exchanges have relatively equal access to material information
-anyone w/ direct or indirect access to info intended for corporate purpose
may not take advantage of information by trading w/ uninformed investors
-must either disclose to investing public or abstain from trading
-"disclose or abstain" rule often just abstain: disclosure often not
allowed by corp. and would violate agency principles
-must wait until official release can be reasonably expected to appear over
the media of widest circulation in order to ensure equal playing field
-Materiality: duty to disclose or abstain only arises in "those situations which are
essentially extraordinary in nature and which are reasonably certain to have a
substantial effect on the market price of the security if [the extraordinary situation
is] disclosed"
-basic test is whether a reasonable man would attach importance in
determining his choice of action in the transaction in question
-encompasses any fact which might affect the value of securities
-major factor is conduct of insiders
[-Modern materiality test: whether there is a substantial likelihood that a reasonable
investor would consider the omitted fact important in deciding whether to buy or
sell securities
-Re contingent facts: probability/magnitude balancing, Basic
-Factors: nature of the information, company response, market response,
conduct of insiders]
-Purchaser or seller only required for private plaintiff's standing, not corp.
defendant's 10b-5 liability
-"in connection with" can be attributed to the victim's reliance, doesn't have
to be corp.'s
-purpose is to protect investing public at large, not simply those who directly
transact w/ corp.
Analysis: People were liable not only who traded on chemical assay, but visual
evaluation as well
-Trial court wrongly based corp. liability for April 12 press release on facts known to
the D's, not what a reasonable investor would have thought
-unclear that investors were actually taken in by the "gloomy or incomplete"
press release

-Open market transactions difficult to analyze b/c markets impersonal and


influenced by many factors
-Alignment of interests: if insider trading is allowed, shouldn't allow people to profit
off of corp. losses
-insider trading can be used as an incentive for executives to improve
company's value
-shouldn't be allowed when executive's actions unrelated to corp. profitability
-argument that long-term investors helped at short-term investors expense
(can't time market)
-For §10(b) private actions, plaintiff must prove (1) material misrepresentation or
omission in connection w/ purchase or sale of a security, (2) reliance, (3) scienter,
and (4) causation

-Texas Gulf Sulphur raises liability for insiders, while Dirks decreases it for tippees
-Chiarella v. United States (U.S. 1980): printing company worker held not liable
under §10(b) and Rule 10b-5 b/c duty to abstain only arises from relationship of
trust b/t SH's and employees, Burger's "misappropriation" dissent later appears in
Hagan
Dirks v. Securities & Exchange Commission (U.S. 1983)
Facts: Dirks, officer of broker-dealer firm, informed from former Equity Funding
officer Secrist that Equity Funding is involved in fraudulent practices
-Dirks uncovers evidence of fraud from interviewing employees, tells WSJ and
some of his clients
-As stock price falls from 26 to 15 in two weeks, trading stops, SEC files
charges, WSJ publishes
-Dirks investigated by SEC but only censured due to his role in exposing the
fraud
Rule: In re Cady, Roberts & Co.: individuals other than insiders can be obligated to
disclose or abstain
-purpose of securities laws to stop "use of inside information for
personal purposes"
-Chiarella: two elements establishing Rule 10b-5 violation:
(1) relationship affording access to inside info intended only for a
corporate purpose
(2) unfairness of allowing an insider to take advantage of that info w/o
disclosure
-duty to disclose doesn't arise from "mere possession of nonpublic
market information"
-no duty to disclose where trading person wasn't a fiduciary
-otherwise, would impose general duty on all market
participants
-only some people, in some situations, cannot trade on nonpublic
material information
-law doesn't require equal information among all traders all the
time
-analyst's job is to try and get a leg up
-Santa Fe Industries: not all fiduciary duty breaches connected to securities
comes within 10(b)
-must be "manipulation or deception" involved
-so insider liable for insider trading only when he fails to disclose and
trades, making "secret profits"
-Tippee's duty is derivative from the insider's duty
-arises from his participation after the fact in the insider's breach of fiduciary
duty
-what makes it a breach is not the nature of the info but the way it was
received from insider
-purpose of the disclosure crucial, Cady
-if no personal benefit to insider, no breach by him and no derivative
breach by tippee
-Tippee assumes fiduciary duty to SH's not to do insider trading only when:
(1) insider has breached his fiduciary duty to the SH's by disclosing the info to
the tippee, and
(2) the tippee knows or should know that there has been a breach
Analysis: Dirks was a stranger to Equity Funding and didn't take actions inducing
SH's to repose trust or confidence in him, no expectation of confidence, nor
misappropriation of information
-Secrist didn't violate Cady duty to Equity Funding SH's b/c he didn't receive
any personal benefit by revealing the fraud, but motivated by desire to expose
the fraud
-therefore no derivative liability
-Can be difficult to prove a personal benefit in connect with a disclosure
-now Regulation FD creates non-insider-based restriction on selective
disclosure: if public corp. discloses info to market professionals or securities
holders, must disclose simultaneously (if intentional) or promptly afterwards
United States v. O'Hagan (U.S. 1997)
Facts: O'Hagan is partner in firm representing Grand Met in tender offer for
Pillsbury, buys many out-of-the-money call options and shares w/ funds embezzled
from other clients' accounts, appeals court says 10b-5 liability can't be based on
"misappropriation theory"
Rule: traditional insider trading theory- 10(b) and 10b-5 violated when insider trades
on material, nonpublic information, which is "deceptive device" b/c breaches
relationship of trust b/t SH's and insiders
-traditional theory applies to both permanent and temporary insiders
-insider takes advantage of uninformed SH's
-"misappropriation theory": fiduciary duty owed to source of the information, under
this theory the fiduciary's self-serving use of the info defrauds the principal of the
exclusive use of the information
-instead of fiduciary relationship b/t insider and purchaser or seller, this is
based on fiduciary relationship b/t fiduciary and source of info
-misappropriators deceive principal by secretly converting his info for
personal gain
-full disclosure negates wrongdoing under misappropriation theory
-but still possible liability under state law breach of duty of loyalty
-deception consummated when securities bought or sold, not when
info received
-protects securities markets from abuses by those owing duty to source, but
not to corp. SH's
-Exchange Act's purpose is to insure honest securities markets and promote
investor confidence
-§14(e) of the Exchange Act: similar to §10(b) except deals w/ tender offers, not
securities transactions
-doesn't require breach of a fiduciary duty for liability
Analysis: Shouldn't treat lawyers differently depending on whether they work for
bidder or target firm
-Rule 14(e)-3(a) is a "means reasonably designed to prevent" fraudulent trading
-prophylactic measures, b/c its mission is to prevent, usually is broader than
the core activity
-way around difficult problem of proving breach of duty of confidentiality, or
other duty
-US v. Chestman: chain of insiders giving inside info to relatives and friends, but
familial relationship alone didn't create a fiduciary relationship
-SEC responds w/ Rule 10b5-2, providing 3 situations where person has
fiduciary duty for purposes of the misappropriation theory: (1) person agrees to
keep info confidential, (2) two people having pattern of sharing confidences such
that recipient knows or reasonably should know that speaker expects
recipient to maintain info's confidentiality, and (3) person receives or obtains
material nonpublic info from a spouse, parent, child, or sibling
-Trading on the basis of nonpublic info vs. Trading while in possession of such info
(i.e. knew the info but was going to sell anyway for medical bills)
-SEC Rule 10b5-1 effectively makes this not matter; subject to narrow
exceptions, one is deemed to have traded "on the basis of" material nonpublic
info if aware of info at the time of the trade

-Securities Act contains prophylactic §16(b): officers, directors, and 10% SH's must
pay to the corp. any profits they makes within six-month period from buying and
selling firm's stock
-smaller group of insiders than under Rule 10b-5
-no tipping liability, no misappropriation liability, no constructive insiders
-SoL of two years, can be brought by SH within 60 days if demand refused,
and must be officer, director, or 10% owner at both purchase and sale
-easily administered but underbroad as well as overbroad
Reliance Electric Co. v. Emerson Electric Co. (U.S. 1972)
Facts: Emerson acquires 13.2% of Dodge for 63/share, but when Dodge engages in
merger talks w/ Reliance, Emerson wants to get out
-upon general counsel's advice, Emerson sells down to 9.96% at 68/share,
then sells rest at 69
-Emerson first claims not liable at all b/c not 10% owner at time of sale, but
appeals court affirms lower court holding that statute satisfied if purchaser
became 10% owner by buying
-only second sale at issue, alleged part of a predetermined plan to
circumvent §16(b)
Rule: §16(b)- corp. may recover profits by owner of more than 10% within six-month
period if held more than 10% at both purchase and sale
-statute's arbitrary and sweeping coverage deemed necessary to insure
optimum prophylactic
-easy administration, cuts down on speculative abuses by reducing
difficulties in proof
-objective standard ignores intent of the insider or existence of actual
speculation
-but also underbroad: no liability if not an "insider" or sells more than six
months later
-10% owners can just sell little bits off until holdings are less than 10%
Analysis: Can permissibly game around the six month requirement by waiting, so
should also be allowed to game around the 10% requirement by selling in bits
-Narrow interpretation meant to compensate for the broad statutory
language? (allows gaming)
-Form over substance: if §16(b) is to be applied strictly, should be strict both ways
Foremost-McKesson, Inc. v. Provident Securities Company (U.S. 1976)
Facts: Provident decides to liquidate by selling off assets, agrees w/ Foremost that
Provident will give 2/3 of its assets for 4.25M cash and 49.75M in Foremost
convertible debt, immediately convertible into more than 10% of Foremost's
outstanding common stock
-closes asset sale on October 15, Provident enters contract w/ underwriters to
sell debentures on Oct. 21, on Oct. 24 Provident distributes 7.25M debentures to
SH's, falling under 10%, then on Oct. 28 sells rest of the debentures to the
underwriters
Issue: Does "at the time of purchase" in §16(b) mean "before" or "immediately
after" the purchase?
Rule: §16(b)
Analysis: Before the purchase
-Congress thought all short-swing trading by insiders vulnerable to abuse b/c of
their close involvement
-but trading w/ mere SH's viewed as abuse-prone only when size of their holdings
afforded potential for access to corp. information
-don't want to unduly restrict SH transactions
-By same logic, should match sales that bring investor below 10% b/c "before", not
"immediately after"
-if meant to deter abuse by influential SH's, divesting all of your shares
shouldn't be treated differently, at least not more favorably, than divesting
less than all your shares
-purchase to get to 10% isn't matched, but selling to go below 10% is
matched
§16(b)
-Issuers: applies only to companies registering their stock under '34 Act, including
companies w/ stock traded on national exchange and companies w/ assets of at
least 10M and 500 or more SH's
-Officers: officers w/ policy-making functions (Rule 16a-1(f))
-can't pair w/ trades before appointment, but can pair w/ trades after
appointment (Rule 16a-2)
-don't get inside info before appointment, but still has inside info after
appointment
-can't resign just in order to commit insider trading, unless waits out
the six months
-Deputization: if X's employee serves as a director for Y, X may be liable for profits
on Y's stock within six-month period
-Stock classes and convertible debentures: under statute to hold 10% of any class
of statute, not necessarily the company's total stock
-applies only to equity securities, including convertible debt but not other
kinds of debt
-Rule 10b-5 applies to all securities, not just equities and convertibles
-once 10% holder for one class, accountable for profits from sales on all
classes
-but different classes of stock not fungible w/ each other
-Litigation: much of it fueled by lawyers, not SH's, in order to claim attorney's fees
-Matching stock: courts match sales w/ purchases however they want, not following
FIFO but matching lowest purchase w/ highest sale to achieve highest profit
-courts interpret statute to maximize gains for the corp.
-but still must be matched within six months
-Unconventional transactions: Exchange Act defines "sale" very broadly (every
disposition for value), but certain transactions are not sales, like "unconventional
transactions," determined by looking at three factors, Kern County Land CO. v.
Occidental Petroleum Corp. (U.S. 1973)
(1) whether transaction is volitional
(2) whether transaction is one over which beneficial owner has any influence,
and
(3) whether beneficial owner had access to confidential info about transaction
or issuer

-Several different situation that might give rise to D&O liability (torts, derivative
suits, employee, customer, competitor)
-Risk of liability may be small, but potential personal liability is huge to the
individual
-If allowed to buy insurance to get around good faith, why not allow them to
indemnify directly?
-can circumvent even more by writing their own policy
-Value of right to reimbursement depends on how favorable the current board is to
the individual and the firm's cash flow position
-§145(a) allows indemnification for judgment and expenses of third party suits, (b)
for derivative suits only allow indemnification for expenses, and if liable to the corp.
only w/ judicial approval (rare that there will be judicial approval if bad faith found)
-both (a) and (b) require good faith and actions "reasonably believed to be in
or not opposed to the best interests of the corporation"
-permissive statutes, power but not the requirement to indemnify
-§145(c): defendant must be reimbursed if successful
-not permissive
-(a) or (b) for unsuccessful defendant
-§145(e) allows advancement of expenses if defendant agrees to repay if
unsuccessful
-Sarbanes-Oxley prohibits loans by corp. to officers and directors (unsure how
this affects (e))
-§145(g) allows corp. to get liability insurance
-method of getting around "good faith" requirement
-§145(f) doesn't restrict defendant's other right to indemnification
-allows written agreements going beyond the statute
-confusion addressed in Waltuch
-Three options w/ the same effect (defendant pays nothing personally):
(1) D not liable to corp.
(2) D is promised indemnification
(3) D is insured against liability
-But can't indemnify against intentional misconduct, violations of duty of loyalty or
good faith, §174 unlawful dividends, or transactions where they received improper
personal benefit
-applies only to directors
-officers also subject to duty of care, but denied exculpation by charter
provision
-102(b)(7) only applies to people acting as a director if both director
and officer
-102(b)(7) is an affirmative defense, at common law corporate employees
were indemnifiable but not directors
-but today all states have statutes allowing some director
indemnification
Waltuch v. Conticommodity Services, Inc. (2d Cir. 1996)
Facts: Silver trader Waltuch sued by angry silver speculators alleging fraud and
market misconduct, all suits settled and dismissed w/o prejudice after
Conticommodity pays 35M to suitors w/o any contribution by Waltuch
-Waltuch pays 1.2M for legal expenses and another 1M defending a CFTC
enforcement action
-Waltuch claims indemnification required by Conti's articles of incorporation
not requiring good faith, but Conti responds that this bylaw violates §145(a)'s
requirement of "good faith"
-Waltuch claims §145(f) permits indemnification outside confines of
§145(a)'s good faith
-Waltuch also claims §145(c) requires indemnification b/c he was successful
Rule:
-§145(a): corp. has power to indemnify for all expenses but must have acted "in
good faith"
-"indemnification rights may be broader than those set out in the statute, but
they cannot be inconsistent with 'scope' of the corporation power"
-§145(f): indemnification shouldn't "be deemed exclusive of any other rights...
entitled under any bylaw, agreement, vote of stockholders or disinterested directors
or otherwise"
-"other rights" must not go beyond the scope of the statute
-indemnification rights can't be inconsistent w/ §145, Hibbert v. Hollywood
Park, Inc.
-in Hibbert, bylaw indemnifying both plaintiff and defendant directors
consistent w/ §145(a) b/c provision didn't distinguish b/t plaintiffs
and defendants
- these rights can't exceed the "scope" of the statute, Citadel Holding Corp. v.
Roven.
-§145(c): indemnification required if defendant "successful on the merits or
otherwise"
-indemnification mandated when defendant "is vindicated"- broadly equates
to "success"
-moral vindication not required, merely dismissal w/o settlement payment,
however achieved
Analysis: §145(a)'s "good faith" requirement limits the scope of indemnification
powers
-if legislature intended augmenting of powers beyond §145(a)'s scope, would
have expressly done so like it did with §145(g) concerning D&O insurance
-Conti's payment doesn't change the fact that Waltuch's claim was dismissed w/o
him contributing towards any settlement
Citadel Holding Corporation v. Roven (Del. 1992)
Facts: Citadel is holding company of S&L's, Roven was director holding 9.8% of its
stock and enters indemnity agreement purporting to provide reimburse for "any
expense or liability"
-but agreement doesn't cover §16(b) short-swing profit accounting
-agreement requires advance payment by corp. of cost and expenses if
defendant agrees in writing to repay if later determined not entitled to
indemnification by the agreement
-Citadel files §16(b) claim against Roven
Rule: §145(e) allows corp. to advance costs of defending a suit
-Corp. obligations under both the statute and agreement subject to a
reasonableness requirement
Analysis: Agreement doesn't condition advancement upon actual right to
indemnification
-required to provide all expenses initially, even if sure to be owed back later
-Citadel not required to advance unreasonable expenses, so protected from
defending absurd or unrelated proceedings

Proxy Fights
-Corp. holds annual meeting to elect directors and vote on important matters
-most investors in public firms don't own enough shares to make it
worthwhile to get informed and go to the SH's meeting to vote
-therefore usually depend on the proxies
-SH meetings usually quiet unless insurgents are trying to control firm by
electing own directors or other matters of basic strategy or up for vote
-proxy fights used to be over social responsibility, not it's about
corporate governance
-proxy fights gave way to tender offers, but as defenses were mounted
against tender offers proxy fights came back as a way to
supplement larger tender offer efforts
-Allowing incumbents, but not insurgents, to solicit proxies w/ corporate funds is
cause for concern
-but also shouldn't allow all 1-share owners to deplete corporate assets
-not allowing any funding of proxy solicitations w/ corporate assets might
leave SH's uninformed
-expense of proxies diminishing w/ technological advances

-§14(a): "It shall be unlawful for any person, by use of the mails or by any means or
instrumentality of interstate commerce or of any facility of a national securities
exchange or otherwise, in contravention of such rules and regulations as the
Commission may prescribe as necessary or appropriate in the public interest or for
the protection of investors, to solicit .. any proxy ... in respect of any security ...
registered pursuant to Section 12 of this title"
-what is a "solicitation"?
-includes not only "direct requests to furnish, revoke or withhold
proxies, but also ... communications which may indirectly
accomplish such a result or constitute a step in a chain of
communications designed ultimately to accomplish such a result" Long Island
Lighting Co. v. Barbash (2d. Cir. 1985)
-after seemingly broad jurisdiction w/ possible First Amendment
implications and other issues, SEC has passed many exemptions
to whittle it down
-i.e. public statements of how SH intends to vote and why,
people not seeking proxy power and don't solicit any
consent, revocation, abstention, or authorization, 10
or fewer, etc.
-an environmentalist group ran newspaper and radio ads critical of the
defendant electrical utility's management and incumbent managers
sued the environmentalists, alleging that their ads constituted a
proxy solicitation
-must provide an annual report: large pamphlet, so big potential for mistakes
-must accompany or precede distribution of the proxy statement
-three-year package of audited financial statements
-brief description of business done
-identity of directors and executive officers, indicating principal
business or occupation
-two years' quarterly range of market prices of an dividends on
common equity
-the annual report to security holders is not deemed to be filed and
part of the proxy statement for liability..
-anyone who "solicits" a proxy must provide a written proxy statement
BEFORE soliciting proxy
-free writing generally permitted thereafter
-§14(a) of 1934 Act prohibits solicitation in violation of SEC rules
-"Solicitation" construed broadly, but Rule 14a-2 says SH doesn't fall under
filing requirement if it doesn't solicit proxies for itself
-Rules require those soliciting proxies to furnish each SH a "proxy statement"
disclosing info and also file it w/ the SEC, more extensive for contested meetings
-For insurgent groups soliciting proxies, Rule 14a-7 causes management to
either give SH list to the insurgents or mail the insurgent's solicitations
themselves
-will usually mail themselves b/c often want to keep the list confidential
-Proxy fights lost cost-effectiveness b/c tender offers more economical
-spending money on proxy fight is expensive and only captures profit in
proportion to their ownership
-most of the benefit goes to free-riders
-hard to get proxies, especially for larger corporations
-no guarantee that spending money will result in a proxy victory
-to profit off of management changes better to buy up majority in a tender
offer
-why incur large risk when you have to share the increased value w/
other SH's?
-more capital required to buy out company than to solicit proxies
-Asymmetrical reimbursement rule for proxy solicitation is slanted towards winning
incumbents, but it's required as an incentive to managers to take over mismanaged
corporations
Levin v. Metro-Goldwyn-Mayer, Inc. (S.D.N.Y. 1967)
Facts: Levin group and O'Brien group vie for control of MGM through proxy
solicitation, Levin complains that O'Brien group used corp. funds to pay for lawyers,
public relations firm, and proxy solicitation firms and used other corp. resources to
help solicit proxies, seeking injunctive relief and 2.5M payment to MGM, each group
has distinct management philosophies
Rule: SH's should be "fully and truthfully informed as to the merits of the
contentions of those soliciting"
-Injunctive power shouldn't be exercised to "unduly influence a SH's [proxy]
decision"
-question is whether illegal or unfair means of communication are being used
to solicit proxies
Analysis: Even if present management has succeeded, whether to keep them
depends on the SH's
-Means used not found to be "illegal or unfair"
-use of MGM funds and retention of proxy firms were all disclosed in the
proxy statement
-125k above and beyond amounts normally spent in proxy solicitations
weren't excessive
[-maybe b/c MGM so big- 251M total assets and 185M gross income in
1966]
-didn't violate any statute or SEC rule or regulation
Rosenfeld v. Fairchild Engine & Airline Corp. (N.Y. 1955)
Facts: 106k of corp. funds spent by old board for soliciting proxies and 28k
remaining expenses reimbursed to old board by new board for reasonable fees
-payment of 127k to new board approved by 16 to 1 shareholder vote
-lower court finds group differences were policy-based not personal-based
(executive employment contract main point of contention)
-challenging SH concedes the charges were fair and reasonable but alleges
that they weren't legal charges to be reimbursed
Rule: Management can tap corporate treasury for "reasonable expenses" of
soliciting proxies to defend its position in a "bona fide policy contest"
-proxy solicitation necessary to secure a quorum and to inform SH's
-must use corp. funds to defend control against insurgents w/ ample funds
-For a contest over policy, not a "purely personal power contest," corp. directors
have the "right to make reasonable and proper expenditures" to persuade
taxpayers for policies which they believe in good faith to be in the corp.'s best
interest
-but can't use corp. funds for individual gain, private advantage, policies not
in corp.'s best interests, or unfair or unreasonable expenses
[Can use corp. funds for proxy solicitations if:
(1) expenses are reasonable
-disclosure statements to SH's
-telephone solicitations
-in person visits to major SH's (wining and dining, private jet to bring to
headquarters)
-reasonableness can depend on size: larger investors might require
closer contact
(2) contest involves "policy" questions and not a "purely personal power
contest"
-but how to distinguish?
-policy and personnel usually spill into one another
-will always be able to make up some kind of policy dispute
For insurgents:
(3) must be successful
(4) SH's must ratify the payment
-if enough proxies to win director seats, probably will have enough to
ratify payment
-just requires more disclosures, so might offer an additional grounds to
sue on]
Analysis: Reimbursement allowed as fair, reasonable, policy-based, and believed to
be in best interests
Dissent: Not all of the solicitation costs were incurred to inform the SH's but to
entertain and transport SH's; SH's only meant to ratify reimbursement to the new
board not the old board
-when directors use corp. money for personal purpose, burden on directors to
show reasonable
-believes burden should be on the directors to prove their expenses were
reasonable and
related to the informing the SH's
-for unanimous SH approval, doesn't matter if action doesn't have a corporate
purpose (b/c no one will file a derivative suit)
-but for only majority approval, action may be adjudged wrongful in a
derivative suit if no
corporate purpose
-impossible sometimes to distinguish policy and personal motivations
-even a purely personal power contest will claim some color of policy
dispute
Typical Annual Meeting
-Nominating committee of the incumbent board of directors nominates a slate of
directors to be elected at the next annual meeting
-Incumbent board identifies other issue to be put to vote (some required by law)
-At company expense: management prepares proxy statement and card,
management solicits shareholder votes (typically w/ aid of proxy solicitor)
-A shareholder (aka the insurgent) solicits votes in opposition to the incumbent
board of directors
-electoral contests: insurgent runs a slate of directors in opposition to slate
nominated by incumbent board
-issue contests: SH solicits votes against some proposal (i.e. to vote no
against merger)
-SH appoints a proxy (aka proxy agent) to vote his/her shares at the meeting
-Appointment effected by means of a proxy (aka proxy card)
-can specify how shares to be voted or give agent discretion
-revocable
-proxy card requirements (mostly Rule 14a-4)
-must identify each matter to be voted upon
-may give discretionary authority to vote in the proxies discretion on
other matters that may come before the meeting, but not elections to
office for which a bona fide nominee is not named
-for, against, and abstain boxes required for each matter other than
election of directors
-for and withhold authority boxes for election of directors so that a SH
may withhold authority to vote for individual directors
-proxies may be revoked and if more than one proxy is given,
-etc.

J.I. Case Co. v. Borak (U.S. 1964)


Facts: SH claims that merger was influenced by misleading proxy statement
violating §14(a) but trial court says only remedy under §27, also alleges self-dealing
and breach of fiduciary duties
Rule: Private parties have a right under §27 to bring direct or derivative suits for
violations of §14(a)
-§14(a) meant to prevent authorizing corp. actions through deceptive or inadequate
disclosures
-promote SH's free voting rights
-purpose of §14(a) to protect investors implies judicial relief should be
available to accomplish it
-Deceptive proxy solicitation claims are usually derivative b/c damage inflicted on
the corp. rather than directly on the SH
-Proxy solicitations must explain to SH's the real nature of the issues for which
proxy authority is sought
-remedies can be adjusted to grant necessary relief
-when legal rights are invaded and federal statute provides a general right to
sue, federal courts may use any available remedy to make good the wrong done
-the power to enforce implies the power to make effective the right of
recovery, which implies the power to use any of the procedures or actions
normally available to the litigant, Deckert v. Independence Shares Corp.
Analysis: Holding that these claims aren't within §14(a) would basically deny private
relief
-shouldn't be limited to declaratory relief b/c road is uphill enough for victims
of deceptive proxy statements (security for expenses statutes, etc.)
-similar to anti-trust treble damages in that private actions is big deterrent
weapon
-SEC reviews over 2000 proxy statements a year and doesn't have time to
independently verify all the representations made in the statements
-Courts must alertly provide remedies necessary to effect the legislative purpose
-remand to trial court to determine causation of proxy statement to the
merger
Mills v. Electric Auto-Lite Co. (U.S. 1970)
Facts: SH's of Electric Auto-Lite sue to enjoin SH vote on merger w/ Mergenthaler
and American Manufacturing Co. b/c of allegedly misleading proxy solicitation
-TRO not sought so now suing under §27 to set aside merger b/c misleading
proxy statement violated §14(a) and Rule 14a-9 by stating the board of directors
recommended the merger w/o disclosing that the board was nominated and
controlled by majority SH Mergenthaler -Mergenthaler Auto-Lite's
majority SH and American Manufac. Mergenthaler's controlling SH
-lower court finds that the proxy statement contained material omission and
the securing of 317000 votes needed for Mergenthaler's 54% to get 2/3
majority was caused by the omission
-appeals court reverses on question of causation
-if defendants can show that sufficient vote would have been secured
w/o the misleading statement then no relief is owed
-hard to show common-law element of reliance for hundreds of
thousands of votes, so determine causation instead by looking at
fairness of the terms
Rule: Borak policy of "fair corporate suffrage" to promote "free exercise of voting
rights of SH's" by fairly and fully disclosing reasons for proxy solicitation
-SH's would be bypassed if judicial fairness appraisal can be substituted for
an informed SH vote
-would insulate even outrageous misrepresentation as long as it didn't relate
to the deal's terms
-private action should be broad enough to serve as a "necessary supplement
to [SEC] action"
-smaller SH's already burdened enough in litigation, so shouldn't pile on by
forcing them to rebut fairness
-Causation: materiality of misstatements alone implies that it would be important to
reasonable SH's
-serves purpose similar to causation of ensuring cause of actions can't be had
for trivial or unrelated defects
-materiality is enough of a causal relationship, don't have to further prove
that it actually had a decisive effect on the voting
-just have to prove that the proxy solicitation, not the specific defect in
it, was an "essential link in the accomplishment of the transaction"
-this objective test of (1) material misstatement and (2) proxy solicitation
being "essential link" eliminates impracticalities of inquiring into the
hypothetical acts of potentially millions of votes and avoids unfairness of
appeals court's fairness test
[but Virginia Bankshares, Inc. v. Sandberg (U.S. 1991): causation can't be
established in situations where management controls sufficient votes already
w/o needing minority votes]
-Relief: "be alert to provide such remedies as are necessary to make effective the
congressional purpose," Borak
-same factors for determining relief for similar fraud or illegality, which
includes fairness of term
-forms of relief may include damages, setting aside merger, or other
equitable relief, depending on the equities of the case
-unscramble the wrongful transaction only if in the best interest of the
SH's as a whole
-money damages only to extent they can be shown, though if there is
"commingling of the assets and operations" damages can be
extrapolated from the merger's terms
-Legal fees: absence of provision for attorneys' fees under §14(a) doesn't preclude
award in these cases
-American rule that attorneys' fees not ordinarily recoverable as costs
-but exceptions have emerged, notably where plaintiff successfully sues on
behalf of a class and benefits others in the same class as himself (prevent free-
riders)
-lack of a monetary award doesn't preclude a fee award, chancellor can still
award fees
-some courts even extend to cases of "substantial benefit on the
members of an ascertainable class" that isn't capable of monetary
expression
-"substantial" benefit is more than technical, corrects or
prevents an abuse that would prejudice corp. rights or affect
an essential SH right
-charge fees to corporation to spread costs among all SH's sharing the
benefit
Analysis: Already established misstatements were material and an essential link, so
defendants liable
-as to the relief, remanded to trial court for determination
-appeals court should have affirmed summary judgment on liability, which
would have put costs of appeal on defendants instead of the plaintiffs, so now
the P's should be reimbursed
-plaintiffs conferred a substantial benefit by exposing misstatements
-Borak establishes a cause of action, Mills talks about causation, relief, and fees
-Expected sanction= nominal sanction * probability of conviction
-SEC has limited resources (low probability), so must have high nominal
sanction to compensate
-Investors rarely read proxy statements, so Mills doesn't really serve their interests
-mostly helps attorneys get more fees
-Publicly traded stocks may be less deserving of judicial protection b/c investors can
sell shares easier than closely held corporations where objecting SH may be unable
to "talk with his feet"
Seinfeld v. Bartz (N.D. Cal. 2002)
Facts: Cisco SH sues corp. and directors under §14(a) of 34 Act and Rule 14a-9 for
raising outside director options from 20k to 30k shares upon joining board and from
10k to 15k shares annually
-alleges negligent proxy statement preparation b/c Black-Scholes calculation
of a 1M option value at time of proxy statement wasn't included, and stating
compensation as 32k plus stock options was misleading
-statement that options had no value unless stock rose was incorrect b/c
either issued in the money or had implicit value upon grant that could be
realized by selling during the option period
[-but aren't there restrictions preventing directors from selling options
instead of exercising them?]
Rule: §14(a)- unlawful to solicit proxies in violation of SEC rules
-Rule 14a-9 prohibits proxy solicitations using "false or misleading declaration
of material fact" or "an omission of material fact that makes any portion of the
statement false or misleading"
-"Material" if "there is a substantial likelihood that a reasonable shareholder would
consider it important in deciding how to vote," TSC Industries, Inc. v. Northway, Inc.
-Causation doesn't require showing disclosure would have cause the reasonable SH
to change vote
-only needs to show that it "would have assumed actual significance in [his]
deliberations" or "substantial likelihood that the disclosure... viewed by the
reasonable investor as having significantly altered the 'total mix' of the
information made available"
Analysis: Persuasive that four courts have previously held that Black-Scholes
valuations aren't material
-plaintiff claims cases are distinguishable b/c based on state duty of candor,
but the same "materiality" standard was used
-plaintiff also tries to cite Ninth Circuit calling Black-Scholes a reliable
valuation method, but that was a tax case dealing w/ a loan, not payment for
services (IRS regulations require option valuation at time of grant but SEC
regulations do not)
[-but in 2006 SEC passed regulation requiring treatment of options as
expenses in financial reports of registered companies]
-therefore Black-Scholes valuations not material

Shareholder Proposals
-Rule 14a-8 allows qualifying SH's to put a proposal before their fellow SH's
-can have proxies solicited in favor of them in the company's proxy
statement
-expense thus borne by the company
-requesting a report seems unproductive, but it's better than just writing a
letter, and it's a way to suggest to management how SH's feel about issues
-Likely proponents of SH proposals:
-hedge and private equity funds (proposals to make company more
profitable)
-pension funds: union (i.e. AFSCME) and state and local employees (i.e.
CALPERs)
-individual activists (aka Lovenheim)
-charities
-Current issues of SH proposals generally fall into two categories
-CSR corporate social responsibility (global human rights, discrimination,
environment, etc.)
-governance (more important in the wake of the recent economic crisis )
-average votes for governance proposals are 24% and 7% for social proposals
-Responses:
-attempt to exclude on procedural or substantive grounds (must have specific
reason to exclude
that is valid under Rule 14a-8)
-procedural standards:
-proponent doesn't meet ownership/format guidelines
-proposal not timely
-issuer must provide proponent w/ opportunity to cure most
errors within 14 days after submission (relating to format, not
timeliness or ownership/format)
-substantive reasons:
-improper under law of issuer's domicile
-person grievance/special interest
-management functions
-substantially implemented
-and others
-not really a bright-line rules
-include w/ opposing statement (board recommends to vote against)
-negotiate w/ proponent (wide range of possible compromises)
-adopt proposal as submitted
Process of excluding:
-management files a notice of intent to exclude w/ the SEC accompanied by
an opinion of counsel if any of the stated reasons rely on legal issues
-under Rule 14a-8(f), management must notify the SH-proponent of
remediable deficiencies in the proposal and provide an opportunity for them
to be cured
-a copy of the firm's notice and statement must also be sent to the proponent
-Staff level action:
-staff determines can be excluded: issue a no-action letter
-staff determines should be included: notify the issuer of possible
enforcement action if the proposal is excluded
-intermediate position: proposal not includible in present form, but can be
cured
-Review:
-commission
-court
-Eligibility:
-Rule 14a-8(b)(1): proponent must have owned at least 1% or 2k (whichever
is less) of the issuer's securities for at least one year prior to the date
-Rule 14a-8(c): only one proposal per corporation per year
-no limit on how many companies a proponent can submit proposals to
14a-8(h) if the proponent fails to show up at the meeting to present the
proposal in person, the proponent will be ineligible to use the rule for the
following two years
-Per Rule 14a-8(i)(12) a proposal can be excluded if it (or a substantially
similar one) was submitted:
(1) once during the preceding 5 years and got less than 3% of the vote
(2) twice in the preceding 5 years and got less than 6% of the vote the
last time it was submitted
(3) 3 times in the preceding 5 years and got less than 10% of the vote
the last time it was submitted
-Precatory (i.e. nonbinding) phrasing
-Why?
-Primary reason: some proposals that are excludable if phrased as a
requirement must be included if phrased as a request
-Rule 14a-8(i)(1): "If the proposal is not a proper subject of
action for shareholders under the laws of the
jurisdiction of the company's organization"
-it must be an action which it is proper for SH's to initiate (i.e.
CA v. AFSCME)
-look to state law to decide that question (e.g., DGCL 141(a))
-Also want SH's to have input, but not necessarily to run the company

-What happens if precatory proposal passes and board refuses to act?


-BJR (unless board acts recklessly or in self-interest)
-but board often won't ignore proposals getting enough votes (don't
want to upset SH's)
Lovenheim v. Iroquois Brands, Ltd. (D.D.C. 1985)
Facts: 200-share holder sues to force Iroquois to include his proposal to examine if
its pate de foie gras suppliers force-feed geese and what to do about it
-Iroquois has annual revenues of 141M, 6M in annual profits, and 78M in
assets
-pate de foies gras accounts for 79k in sales, a 3k loss on sales, and 34k in
related assets
-one element of a TRO is likelihood of prevailing on the merits
Rule: Rule 14a-8- "if any security holder of an issuer notifies the issuer of his
intention to present a proposal for action at a forthcoming meeting of the issuer's
security holders, the issuer shall set forth the proposal in its proxy statement and
identify it in its form of proxy and provide means by which security holders
[presenting a proposal may present in the proxy statement a statement of not more
than 500 words in support of the proposal]"
-but Rule 14a-8(i)(5): issuer may omit a proposal and its supporting
statement "if the proposal relates to operations which account for less than
5% of the issuer's total assets at the end of its most recent fiscal year, and for
less than 5% of its net earnings and gross sales for its most recent fiscal year,
and is not otherwise significantly related to the issuer's business"
-use of "otherwise" in the exception ambiguously implies that rule's
drafter might have intended to include other noneconomic tests of
significance
-look to history of SH proposal rule to clarify this ambiguity
-prior to 1983 the exception didn't contain an objective economic
significance test
-for Arab economic boycott of Israel, SEC stated that exception
shouldn't be solely based on the proposal's economics "if a significant
relationship to the issuer's business is demonstrated on the face of the
resolution or supporting statement"
-"significant relationship" not limited to economic significance
Analysis: Pate de foie gras obviously makes up less than 5% of operations
-but plaintiff argues his proposal is "significantly related to the issuer's
business" b/c it has "ethical or social significance" and thus not eligible for the
Rule 14a-8(i)(5) exception
-says humane animal treatment is a foundation of western culture and
cites various state and federal animal protection laws, also
supported by interest groups
-given the ethical and social significance and the implication of significant
level of sales (???) plaintiff has likelihood of prevailing on the merits of whether
proposal is "otherwise significantly related"
[-Potential for abuse by crazy interest groups (i.e. AT&T white supremacist story)
-must not just be a significant issue, but significantly related to issuer's
business
-what is test for "significantly related"? affects share value?]
-No-action letters mean that the staff won't recommend SEC enforcement actions
-can also send letters saying SEC may bring enforcement, or even
intermediate positions saying that certain revisions would force inclusion
-in theory losing side can ask actual Commissioners to review, and then fed.
D.C. appeals court
-but management will typically acquiesce if on the losing side
-losing SH can seek an injunction in federal district court (as in
Lovenheim)
AFSCME v. AIG, Inc. (2d Cir. 2006)
Facts: AFSCME is one of the largest public service employee unions and its pension
plan holds 27k shares of AIG stock
-AFSCME submits SH proposal for inclusion in proxy statement to amend
bylaws to require publishing of name of SH-nominated director candidates
together w/ board-nominated ones
-SEC's Division of Corporation Finance (office handling investor disclosure
matters and no-action letters) issues AIG no-action letter stating it could exclude
the proposal
-after proposal is excluded, AFSCME brings suit in S.D.N.Y. to compel
inclusion, which is denied
Rule:
-Rule 14a-8(a): SH proposals are recommendations or requirements that the
company and/or board take some action, which submitting SH's intend to present at
the next SH meeting
-If SH meets eligibility and procedural requirements, corp. required to include
the proposal in its
proxy statement unless one of the thirteen exclusions apply
-Rule 14a-8(i)(8) "town meeting rule"- corp. may exclude a SH proposal "if the
proposal relates to an election for membership on the company's board of directors
or analogous governing body"
-"relates to an election" is the difficult part: a particular election or elections
generally?
-guided by agency interpretations at the time the regulation was
implemented
-to follow a changed interpretation requires the agency to offer
sufficient reasons for the change
-agency interpretations of statutes don't warrant deference, but do
warrant deference for regulation interpretation
-1976 SEC statement clearly reflects that exception limited to
proposals opposing solicitations dealing w/ identified board
seats, not things like cumulative voting and general director
requirements which merely increase the likelihood of election contests
-in 1990, interpretation changes to include general procedures to
nominate and elect
Analysis: newer conflicting SEC interpretation doesn't merit deference b/c SEC
hasn't provided any reasons for its changed position
-SEC has discretion to alter its interpretations of its own regulations, but in
doing so it has a "duty to explain its departure from prior norms"
-Congress has vested SEC w/ authority to set regulations, so even if there are
good reasons for excluding proposals, it's not the court's role to do so and it can
only follow the regulations
-SEC proposes new Rule 14a-11 in 2003 that would in some situations allow SH's to
put their nominees on the company's proxy statement and ballot
-but never acted on the proposal
-SH activists like AFSCME try to adopt bylaws allowing SH's to nominate
directors and to elect by majority vote rather than the traditional plurality
-in Nov. 2007, Rule 14a-8(i)(8) amended to "if the proposal relates to a nomination
of an election for membership on the company's board of directors or analogous
governing body or a procedure for such nomination or election"
-but SEC will revisit in 2008
CA, Inc. v. AFSCME Employees Pension Plan (Del. 2008)
Facts: CA's SH AFSCME sues CA to include proposed bylaw amendment in proxy
materials for 2008 annual meeting providing reimbursement of reasonable
expenses to nominate director candidates if (a) fewer than 50% of seats are
contested, (b) one of more SH-nominated candidates wins a seat, (c) SH's can't
cumulate their director votes, and (d) election and expenses incurred after bylaw is
adopted
-CA's present bylaws didn't specifically address reimbursement of proxy
expenses
-decision to reimburse previously subject to board discretion, subject to law
and fiduciary duties
-CA claims allowed to exclude proposal under Rule 14a-8(i)(1) and (2)
Rule:
-Rule 14a-8(i)(1): may exclude proposal from proxy statement if "not a proper
subject for action by the SH's under the laws of the jurisdiction of the company's
organization"
-Rule 14a-8(i)(2): may exclude proposal if it "would cause the company to
violate any state law to which it is subject"
-§109(a): "After a corporation has received any payment for any of its stock, the
power to adopt, amend or repeal bylaws shall be in the SH's entitled to vote ...;
provided, however, any corporation may, in its certificate of incorporation, confer
the power to adopt, amend or repeal bylaws upon the directors... The fact that such
power has been so conferred upon the directors ... shall not divest the SH's ... of any
power, nor limit their power to adopt, amend or repeal bylaws."
[§109(b): "bylaws may contain any provision, not inconsistent w/ law or w/
the certificate of incorporation, relating to the business of the corporation, the
conduct of its affairs, and its rights or power or the rights or powers of its
stockholders, directors, officers or employees"]
-sounds like board and SH have equal power to adopt, amend and repeal
bylaws
-but §141(a): "The business and affairs of every corporation organized under
this chapter shall be managed by or under the direction of a board of directors,
except as may be otherwise provided in this chapter or in its certificate of
incorporation."
-SH's don't have similar statute providing broad management power: SH's
can't directly manage w/o specific authorization by statute or certificate of
incorporation
-therefore SH power to change bylaws limited by the board's management
powers of §141(a)
-otherwise SH's could effectively run company w/ bylaws, swallowing
up §141(a)
-Well-established that bylaws don't affect specific substantive business decisions,
but the procedures by which those decisions are made
-i.e. bylaws fixing number of seats, requirements for a quorum, requiring
meeting for board action, unanimous board attendance and approval for any action
-whether "bylaw is process-related must necessarily be determined in light of
its context and purpose" [declines to create bright-line standard of what is or
isn't procedural]
-Even if bylaw is procedural, it cannot limit the board's exercise of their fiduciary
duties
-"no shop" provision of a merger agreement invalid b/c requires board to act
in a way that limits the exercise of their fiduciary duties, Paramount
Communications, Inc. v. QVC Network, Inc.
-doesn't matter whether this limitation by contract (voluntarily imposed on
board) or SH bylaw (involuntarily imposed)
-but can limit by amending the certificate of incorporation (but requires
board to present to SH's for vote, §242(b)(1), which is unlikely
here)
Analysis: CA tries to overread §141(a) to make impermissible any bylaw that limits
the board's power in any way, effectively swallowing up §109(a)
-almost all bylaws would change the rules and procedures binding the corp.
board and SH's
-only limit the scope of SH actions to the extent it will "improperly intrude
upon the directors' power to manage corporation's business and affairs under
§141(a)"
-CA argues that bylaw requiring reimbursement goes beyond procedure to impose a
substantive requirement to use corp. funds
-but hypothetical requirement that board meetings must take place in corp.
HQ's are undeniably procedural, yet corp. funds must similarly be used to
reimburse travel costs
-requiring expenditure of corporate funds doesn't by itself make a
bylaw improper
-this bylaw's purpose is to "promote integrity of the election process" by
encouraging nomination of non-management board candidates through
financial incentive of reimbursement
-CA argues that bylaw would violate common law principles
-will certainly limit board's ability to exercise fiduciary duties in some
situations
-i.e. SH group nominating directors to misappropriate strategic information
for a competitor
-giving board discretion over amount (via determining what is "reasonable")
not enough: fiduciary duty may require the board to sometimes deny expenses in
full
-If SH's really want this bylaw, their only options are:
(1) amending the certificate of incorporation, or
(2) seek new legislation from Delaware General Assembly
[(3) could enact bylaw w/ the requisite fiduciary out (board allowed to decline
carrying out task if it would violate their fiduciary duties)
-standard might be BJR, but burden could shift to directors attempting
to decline action
-if court makes preliminary determination of self-interest (b/c
reimbursement denied for entrenchment, not in corp. best
interests), use intrinsic fairness analysis instead]
-Easier to include proposals if framed as a bylaw amendment
-State/federal law tension:
-if state law gives SH right to elect directors, doesn't matter if federal law
doesn't give access to the proxy materials
-can spend own money to solicit proxies, but only reimbursed if they win and
SH's ratify
-"Ordinary business" and "major strategic decisions" are separate grounds for
exclusion
-if not relating to "ordinary business" can still say "otherwise significantly
related" (Lovenheim)

Shareholder Inspection Rights


-SH's wishing to correct perceived mismanagement can attempt to solicit proxies
for their proposals
-corp. must include proposal in proxy statement if no Rule 14a-8 exceptions
apply
-but if seeking to elect directors, not just submitting proposals, corp. doesn't
have to do any soliciting for you, so must solicit yourself
-can force corp. to mail solicitations
-but would rather get SH list to target larger SH's
-b/c it's valuable to insurgents, management tries to resist efforts to
obtain SH lists
-federal proxy rules don't require handing over list (Rule 14a-7 gives
corp. option), but federal rules don't impair rights under state law, so
sue under state law to compel
-DGCL §220(b): "Any stockholder, in person or by attorney or other agent, 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, and to make copies
and extracts from: (1) the corporation's stock ledger, a list of its SH's, and its other
books and records...
-plus a limited right w/ relation to subsidiary records
Crane Co. v. Anaconda Co. (N.Y. 1976)
Facts: Crane offers to exchange up to 100M in debt for up to 5M Anaconda shares,
Anaconda's management objects and tells SH's offer not in corp.'s best interests,
Crane required to file registration statement w/ SEC detailing offer's material facts
-Crane, owning no Anaconda stock, requests Anaconda SH list to distribute
prospectus, claiming Anaconda had fiduciary duty to present SH's w/ all info
relating to pending tender offer, and management refuses
-next month 2.35M shares are tendered to Crane, making it Anaconda's
largest SH, and then Crane makes formal written demand to produce stock
book for inspection under §1315 and common-law right to inspect corporate
records (also claim only motivated by Anaconda business); Anaconda
refuses again but offers to mail itself
-lower court finds Crane's purpose of furthering its tender offer improper to
allow SH list release, appeals court reverses b/c matter was of general interest to all
Anaconda SH's
Rule: NY §1315 of Business Corporation Law allows any NY resident owning at least
5% of corp. for at least six months to examine record of SH's
-may be refused if no affidavit attached stating inspection desired for "a
purpose which is in the interest" of business of the corp. and haven't sold SH list
in last 5 years
[apply NY law b/c:
(1) §14 only applies to companies registered under the 34 Act
(2) may want things like minutes of meetings]
Analysis: SH's should be allowed to inspect SH list to inform them directly of its
exchange offer and solicit tender offers unless sought for purposes contrary to corp.
or SH's best interests
-manner of communication should be within SH's judgment
-Crane's refusal to allow Anaconda to mail b/c too expensive and
unproductive is proper
-selectively and directly approaching target SH's is much more
effective
-right to inspect SH list is frequently litigated, illustrating its importance;
tender offers are also the primary method of acquiring corporations
-Defendants claim convincing SH's to sell their shares doesn't involve the business
of the corp.
-but SH's necessarily affected whenever they face situation w/ potentially
substantial effect on value or well-being
-doesn't matter that petitioning SH's are the cause of the potentially
substantial effect
-right inherent in ownership of share and meant to protect its interest
[but is Crane protecting its interest by hurting the interests of other
SH's?]
-statute should be liberally construed to benefit affected SH or corp.
State ex rel. Pillsbury . Honeywell, Inc. (Minn. 1971)
Facts: After plaintiff learns that Honeywell produces Vietnam munitions, buys 100
shares of stock in order to convince company to stop bomb production
-submits formal demands for SH ledger and corporate records and Honeywell
refuses
-plaintiff contends business records necessary for accuracy
Rule:
-DGCL §220: any SH upon written demand has the right to inspect "for any proper
purpose" the stock ledger, SH list, and other books and records
-"proper purpose" is "reasonably related to such person's interest as a
stockholder"
-for stock ledger or SH list, burden of proof is on corp. to establish improper
purpose
-Where "stockholding is only colorable, or solely for the purpose of maintaining
proceedings of this kind," the person isn't really a "person interested" entitled to
inspection rights
[-can't just buy stock for the voting rights and management access w/o the
economic portion]
Analysis: "Proper purpose" must concern investment return
-Inspection involves concerned owners checking on what is partly their property
-but for larger companies this inspection right can turn into a weapon
-allowing all the SH's to comb through records would hamper not only record-
keeping but the carrying on of the business
-Plaintiff only interested in owning stock to challenge Vietnam policy, not for any
economic benefit from dividends or price appreciation
-plaintiff must show at least some effect of his cause on long-term wellbeing
or share value
-Claiming broad social purpose can force inclusion in proxy materials but can also
stop getting SH list
-maybe Pillsbury would have turned out differently had he claimed more
economic substance instead of pure social issues (like Dodge v. Ford)
-Pillsbury probably too stubborn to advance a business purpose
-social cause cases: Dodge v. Ford, A.P. Smith, Lovenheim, Pillsbury
-moral: frame social cause in economic terms to establish a business
purpose
SH lists vs. Business records: perhaps stronger grounds for demanding SH lists than
business records b/c SH lists are probably more easily available and contain less
sensitive business information
-inspecting business records: bigger potential for abuse, worse if falls into
wrong hands, corporate secrets could be lost
-but on the other hand, SH's wanting to check company's books want to see
corp. is run right
-Poison pills: typically provide that upon some trigger event- frequently a SH
attempting to cross some ownership threshold (often 20%) by buying more stock-
other SH's can buy more shares at a steep discount to (1) dilute shares and (2)
discourage tender offer by lowering share value
-makes poison pills so unattractive that they have to redeem the pill first
-in tender offers usually made directly to the SH's
-collective action problem of people wanting to get out just to avoid
being screwed on the back end
-poison pills put directors back in the driver's seat
-theory is that SH's get a better deal by forcing takeover firms go
through the directors
-must be careful ex ante how to design and ex post over fiduciary
duties b/c potential for self-interest and entrenchment
-well-designed poison pills could prevent anyone from ever taking over
management
-usually put in the charter
Sadler v NCR Corporation (2d Cir. 1991)
Facts: AT&T beneficial owner of 100 shares of NCR stock, begins tender offer for all
of the stock and NCR mails offer to all SH's under Rule 14d-5, board rejects tender
offer and decline to redeem poison pill, AT&T responds by soliciting SH's to replace
directors
-AT&T requests NOBO (non-objecting beneficial owner) and CEDE (street
name put in custody of depository firm) lists
-NCR board refuses, alleging improper purpose and §1315 interferes w/
interstate commerce
Rule: NY §1315 of Business Corporation Law allows any NY resident owning at least
5% in record for at least six months to examine record of SH's
-may be refused if no affidavit attached stating inspection desired for "a
purpose which is in the interest" of business of the corp. and haven't sold SH list
in last 5 years
-statute should be liberally construed in favor of the SH, Crane Co.
-"facilitate communication among SH's on issues respecting corporate affairs"
to "place SH's on an equal footing w/ management in obtaining access to SH's,"
Bohrer v. International Banknote
-doesn't specify whether §1315 applies to NOBO lists in corp. possession or
also those readily capable of being compiled
-liberal construing
-but some cases hold NOBO lists are different than CEDE lists in that
CEDE lists can be easily generated by computer, while a NOBO list
can take 10 days and "plays no central role in a proxy contest,"
RB Associates v. Gillette Co. (Del.)
-Access to SH lists is a recognized exception to the internal affairs doctrine (internal
affairs governed by incorporation state, external affairs governed by place of
business state)
Analysis: Liberal construing in favor of SH- an agreement AT&T makes to act as
Sadler's "agent" doesn't prevent right to invoke §1315
-corp.'s duty to show improper purpose or bad faith
-Despite NOBO/CEDE list differences, NOBO lists are still "relatively simple
mechanical" tasks
-functions are also similar, facilitating direct communication w/ SH's
-take broader view of §1315 than Delaware, at least w/ respect to NOBO lists
-NCR already has votes of those NOBO's who decline to vote b/c of lack
of solicitation, so has all the access it needs
-Given established SH list exception to internal affairs doctrine, would take a
substantial interference w/ interstate commerce to invalidate right to SH list
-After Sadler, NY law amended to provide that "corp. shall not be required to obtain
information about beneficial owners not in its possession." §1315(a)
-Given liberal construing in favor of SH, as long as there is a legitimate argument
that it is closer to a tender offer or something having an effect on stock price
instead of a mass marketing campaign or bleeding heart social cause (Pillsbury)

Common Stock as a Bundle of Rights


-Economic rights
-receive dividends when and as declared by the board
-residual claim on assets in liquidation
-Voting rights
-elect directors
-approve some extraordinary matters
-Classes of stock give different mixes of economic and voting rights
-but having too disparate voting rights may create adverse incentives for
those holding a lot of voting rights and little economic rights to use their voting
rights to benefit them in a private manner while damaging the corp.'s economic
well-being (i.e. entrenchment and self-dealing)
-"power without having to pay for it" could be bad: w/o getting
economic benefits SH's won't care if their actions hurt the corp.
-but also can be used in ways that benefit the company
-giving votes can attract talented managers by providing an assurance
that the company won't be mismanaged
-might also be used for start-up companies that don't have a lot of
cash
-some people see the good in allowing SH's who just want a voice and
no money
Stroh v. Blackhawk Holding Corp. (Ill. 1971)
Facts: Blackhawk's articles of incorporation authorize 3M Class A shares w/ $1 par
value and 500k Class B shares w/o par value, 88k Class A shares sold to promoters
for $3.40 and 500k Class B shares sold for 1/4 cent each
-500k Class A shares registered for sale at $4, no Class B shares offered b/c
already all sold
-each Class A and B shares gets one vote, but Class B shares don't get
dividends or liquidation
-in 6/1968, 1.24M Class A shares outstanding, so Class B represented 29% of
voting shares
Rule:
-Ill.'s constitution guaranteed SH's right to vote based on number of shares owned:
nonvoting shares prohibited
-shares can be divided into classes w/ if special rights stated in articles of
incorporation, and articles can't limit any class' voting power
-may issue shares having preference over other classes over dividends or
liquidation proceeds
-"Shares" means units into which proprietary interests in a corp. and divided
-"proprietary" means a property right, so must represent some economic
interest or interest in the property or assets of corp.
-proprietary rights conferred by virtue of ownership of a thing must consist of
participation in:
-control of the corporation, or
-surplus or profits, or
-distribution of assets
-only restriction over these rights imposed by law is that voting rights can't
be limited but the economic rights (dividends, liquidation) can be limited or
even removed
-Right to vote must only be proportionate to shares owned, not total investment
-classes often w/ different shares and dollar investment per vote, this case
just on the high end
-No evidence of fraud or overreaching or public policy concerns, which would be
other matters
Dissent: thinks economic rights are the primary rights of stock ownership, removing
these while leaving only voting rights is not "stock" in the usual sense
-May want control b/c expect to be employed by corp. and want to protect/enhance
job
-After Blackhawk, Ill. revises constitution to state corp. "may limit or deny voting
rights or may provide special voting rights as to any class or classes or series of
shares"
[-Midstream recapitalizations can be coercive
-if only some SH's take advantage of offer to buy additional shares at
discount, their wealth increases at the expense of the nonparticipating SH's
-if given choice b/t buying normal shares or noneconomic voting shares, only
reasonable to buy voting shares if SH can get enough votes to make a
difference
-if favorable tender bid predicted, should disfavor voting shares b/c they
would allow management to help entrench themselves, preventing SH's
getting more value from tender]

-Straight voting: mechanism favoring larger SH's


-directors elected one at a time
-for each board seat election each SH gets one vote for each share owned
-majority SH can elect every director
-diff. w/ cumulative voting in that SH's can't cumulate all their votes into one
seat
-Cumulative voting: mechanism by which minority gets to elect some directors
-directors are elected all at once
-each SH gets number of votes= # of board vacancies * # of shares owned
-may cast all votes for one (or more) member of the BOD
-someone w/ less than 50% can still be guaranteed board seat
-formula for number of shares necessary to elected desired number of
directors:
-(# of directors desired)*(# of shares outstanding)/(# of directors
being elected + 1)+1
Courts concerned that SH agreements will inhibit board's ability to discharge its
fiduciary duties
-minority preemptive rights
-triggering events
-employment usually considered part of the bundle of rights in the investment,
along w/ control
-liquidity
-mandatory minimum board seat, cumulative voting
-buy-sell agreements
Control in Closely Held Corporations
Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling (Del. Ch.
1947)
Facts: Ringling family owns all 1000 shares in corp., 315 each by Edith Ringling and
Aubrey Haley and 370 by John Ringling, women contract to vote together and
resolve disputes by arbitration through Karl Loos, whose arbitrating shall be binding
-John revitalizes corp. w/ 100M secured by voting trust, giving bank one seat
on board and John gets three and Haley-Edith get three
-Haley and Edith want to control board so come up w/ voting agreement
-at first 3 SH meetings to elect 7 directors, women vote together to elect 5
directors when individually would only have enough to elect 2 each
-get into fight before 1946 meeting so unable to decide on fifth director to
elect
-Haley sends husband to vote and Mrs. Ringling wants adjournment to decide
fifth director and Loos supports it but Haley's husband votes against it along w/
John; chairman still declares adjournment but continues w/ the vote
-instead of voting w/ Ringling for fifth director as directed by Loos, Haley's
husband just votes for his two candidates
-Vice Chancellor rules agreement a valid "stock pooling agreement" and
arbitrator's disobeyed directions made willing party an implied agent holding
irrevocable proxy for recalcitrant party
Rule: Delaware law established that one cannot irrevocably separate voting power
from ownership, except by an agreement complying w/ §18
-§18: pledgor of stock can vote unless pledgee is empowered to vote thereon;
can also transfer stock to a "Voting Trustee" for ten years, vesting in the trustee
the right to vote
-Chancery Court may reject votes of registered SH where voting is in violation of
another person's rights
Analysis: Arbitrator only necessary as a means to force joint action
-Loos had no personal interest here and the women weren't bound to him,
only to each other
-therefore arbitrator couldn't enforce agreement himself, only by one
of the women
-would be more convenient if they had bargained to create powers to
vote for one another, but this was not bargained for
-not improper to protect a legal voting agreement w/ reasonable provisions to
ensure concerted action
-Various other transfers of voting rights besides voting trusts have been upheld by
courts
-how someone votes or for what motivations doesn't matter as long as no
duty to SH's violated
-If Mrs. Ringling desires, Mrs. Haley's votes should not be counted
-election shouldn't be invalid, only Haley's votes ignored
-John and Ringling get three directors each they voted for
-have no idea what to do about seventh director so leave blank for next SH
meeting to fill, or upon judicial mandate if the parties require it
McQuade v. Stoneham (NY. 1934)
Facts: Majority owner of NY Nationals Stoneham owns 1166 shares, McGraw and
McQuade own 70 shares each, four other directors on 7-member board controlled
by Stoneham
-the three agree to use best efforts to continue the three as directors and
officers at fixed salaries as long as they keep owning stock
-after challenging Stoneham's use of corp. funds McQuade is fired as
treasurer and director
Rule: SH's can't by agreement control directors' exercise of judgment to elect
officers and fix salaries
-directors cannot abrogate their independent judgment by agreements as
SH's
-no agreement may "contravene any express charter or statutory provision or
contemplate any fraud, oppression or wrong against other SH's or other illegal
object," Manson v. Curtis
-directors can't "remain passive or mechanical to the will and word" of the
agreement
Analysis: Directors owed corp. and SH's a duty as trustee, but not to McQuade as
employee
-SH's can combine to elect directors, should be allowed to take advantage of their
rights to fullest extent
-majority SH's often unite through voting trusts, which are valid
-employee agreements are also common in close corp.'s as way to guarantee
investment return
-but SH's can't control directors' judgment to elect officers and fix salaries
-SH's duties not towards McQuade individually, but only to the corp.
-not required to treat McQuade fairly if counter to public policy of directors
managing the hiring
-Other grounds for the defendants: McQuade, as a city magistrate, was prohibited
by law from engaging in other businesses or professions
Dissent: SH's together owning majority of stock should be allowed to do anything a
single majority owner can do
-single majority owners effectively have advantage over group owners b/c
they don't require an agreement to make sure all their stock is voted the
same way
-should treat these two situations equally by recognizing this control
agreement
-court is ignoring reality that directors are already under majority SH
control: stopping explicit control agreements won't prevent implicit
control agreements
-many close corp.'s do this anyway so don't want to make waves
-directors can't disregard best interests of corp. and minority SH's, but they
inevitably will be subject to some amount of sway from majority SH's
-absolute control obviously isn't good (entrenchment), but some level of
continuity in corp. policy is efficient
-Directors here weren't restricted in their powers, only to extent of election and pay
of certain officers
-the purpose was legitimate and didn't contravene any express charter or
statute
Clark v. Dodge (N.Y. 1936)
Facts: Clark owns 25% and Dodge 75% of two corp.'s making medicine, both Clark
and Dodge serve as directors and officers in the corp.'s but only Clark plays active
role in the businesses and Dodge controls the other directors
-Dodge agrees that Dodge vote his shares for Clark to continue in
management and control and receive 1/4 of net income as long as he stays
"faithful, efficient and competent" to manage the corp., and in exchange
Clark gives secret formula for the medicine to Dodge's son
-Dodge fails to vote to keep Clark as director and manager
Issue: Is the contract illegal against public policy?
Rule: "The business of a corp. shall be managed by its board of directors," N.Y. GCL
§27
-McQuade might suggest that any slight variation from this doctrine is invalid
-would be a simple test, but shouldn't strike down agreements that
don't harm anybody
-McQuade's broad statements limited to that case's facts
-damage suffered or threatened is the better test
-where directors are the sole SH's, no SH's are left out of the
agreement and there would be no disagreeing SH to challenge it in
court anyway
-therefore nothing wrong w/ enforcing these agreements
Analysis: No attempt to sterilize board as in McQuade, and all contract terms were
legal and not harmful
-any invasion on board's powers are negligible
-no harm to anybody
-§620 now allows agreements to restrict board's management powers if (1) all
incorporators or holders of record authorize it, and (2) before provision adopted, all
shares sold only to those w/ notice
-in Del., §142(b) says officers chosen according to by-laws, board, or other
governing body
-§141(a): directors manage the corp., but articles may modify this duty
-Issues present in employment contracts:
-duration
-number of year, then what?
-termination for cause (by whom? what is cause?)
-effect of illness, incapacity, etc.
-compensation
-salary
-adjustments (e.g., inflation)
-bonuses, stock options, etc.
-benefits
-travel and other expenses
-perquisites
-duties and status
-job description
-other duties
-amount of time; vacation
-outside activities
-competition and trade secrets
-consequences of termination (liquidated damages, duty to mitigate)
-parties (mergers, guarantee by majority SH)
-"Pooling" agreements like in McQuade and Clark v. Dodge are commonplace
-agreements to elect themselves or others as directors are generally upheld,
some by statute
-SH's already have power to elect directors, pooling just allows them to
combine it
-more difficulty w/ agreements to elect officers
-SH's taking away from board hiring authority, which is important
aspect of managing
-b/c directors, not SH's, control hiring, these agreements actually made
among the group as directors, not as SH's
-directors can't agree to unduly restrict their independent
judgment
-but modern view is that these agreements are enforceable for close
corp. as long as signed by all SH's, Galler v. Galler
-Voting trusts
-SH's turn shares over to a trustee, who votes all the shares in accordance w/
trust-establishing document
-often used in groups that must memorialize their understanding b/c of
distrust
-as SH's don't normally hire employees, these trusts involve election of
directors, not officers
-any employment agreement must be made as an ancillary agreement
` -generally must be made public
-States generally allow corp. to elect close corp. status
-in Del., corp. must not have more than 30 SH's, §342(1)
-§351: articles may provide that SH's manage the business instead of the
board
-close corp. doesn't require as many corp. formalities to avoid piercing of the
corp. veil
-but close corp. status isn't necessary to protect interest: adaptations to the
articles and bylaws and ancillary agreements like voting agreements,
employment agreements, and buy-sell agreements should be enough if
they are drafted carefully enough
-LLC's can confer control through the "regulations" or "operating agreement" or
other name to the members (like partnership) or to managers (like corp.)
-infinite variety available
-additional flexibility by option of LLP's and LLLP's
-Involuntary dissolution by court order can operate as a bail-out for SH's who failed
to negotiate effective control or buy-sell agreements

Wilkes v. Springside Nursing Home, Inc. (Mass. 1976)


Facts: Wilkes acquires option to buy former hospital building and shares w/ three
others, forming a corp. to avoid the personal liability of partnerships
-at the time of incorporation, agreed that all parties would be directors and
actively manage and would receive equal compensation as long as they helped
operate the business
-job duties split up and the four begin receiving regular payments from the
corp.
-one investor Pipkin sells interest to Connor, who is elected a director but no
other office
-Quinn buys up portion of the other three's interests, but Wilkes' hard
bargaining to force Quinn to pay higher price antagonizes Wilkes from the
group
-Wilkes gives notice to others that he intends to sell for appraisal value
-at next directors' meeting Wilkes removed as salaried officer, then not
reelected as director
-no indication that removal of Wilkes was for misconduct or neglect of duties,
but he was removed b/c of personal tension
Rule: "Stockholders in the corp. owe one another substantially the same fiduciary
duty in the operation of the enterprise that partners owe to one another," Donahue
v. Rodd Electrotype Co.
-"SH's in close corp.'s must discharge their management and SH
responsibilities in conformity w/ this strict good faith standard," Donahue
-standard of duty b/t partners is of "utmost good faith and loyalty," Cardullo
v. Landau
Analysis: Close corp. presents opportunities for majority SH's to freeze-out minority
SH's
-no ready market for close corp. shares, so basically forcing them to sell for
less than fair value
-One way of freezing out minority SH's is depriving them of corp. employment
-this technique successful b/c courts reluctant to interfere w/ internal corp.
decisions -implies there is a zone within which controlling
SH's or directors can personally benefit at the minority's expense
-employment guarantee often a basic reason for minority investors to
contribute capital
-close corp. earnings primarily distributed through salaries, bonuses,
and retirement
-denying employment to minority SH's "especially pernicious" b/c loses
most of the return on his investment
-Must balance asserted business purpose w/ less harmful alternatives
-easy to apply Donahue's good faith standard to these cases
-but not tempering w/ majority's right to "selfish ownership" would limit
legitimate corp. action
-controlling group in corp. must have discretion to establish the
business policy
-there is a zone that majority SH's can be selfish, but must balance
against fiduciary duty
-Here, no legitimate business purpose based on personal tension
[personal aspect which affects business, by itself, probably not "legitimate
business purpose"]
-duty of utmost good faith and loyalty required acknowledging the SH's
understanding

courts don't care about creditors until in the zone of insolvency


-if creditors want protection, need to contract for it
-fuzzy middle ground b/t corporate and employment law (w/ some contract law
thrown in)
-employment agreement is major reason a minority SH contributes capital
-hard to raise capital w/o this guarantee
-Wilkes could also have been decided on implied contract grounds, interested
director transactions (fiduciary duties of directors), SH fiduciary duties (Sinven)
-casebook authors don't like opinion b/c effect on informational form and
good lawyering
-lawyers should have drafted a buy-sell agreement and an employment
contract
-Wilkes court says balancing of legitimate business purpose w/ less harmful
alternatives is a loyalty test
-but seems like watered-down version, real duty of loyalty analysis is
different
-intermediate-level fiduciary duty: not as strict as BJR, but also not identical
to partnership duty
-could be viewed as just a default rule, forcing participants in close corp. who
don't usually think about contingencies to contract carefully or else have a default
fiduciary duty imposed on them
-some people say law shouldn't just offer a choice, but a substantial choice:
stricter standards and less flexibility (partnerships), or less strict standards
and more flexibility (close corp.)
-cutting of job duties along w/ no paying of dividends deprived Wilkes of any return
on his investment
-Wilkes views this as most important factor, but other courts have come out
differently
-b/c salaries and deductible and dividends aren't, corp. has incentive to
characterize as salary
-contrast w/ public corp.:
-don't care if dividends being paid or not b/c you can just sell
-for close corp.'s, dividends not being paid should add to the share value, but
since there isn't a public market to sell shares, not always easy to realize
this increase in value
-if organized as partnership, Wilkes would have to be bought out and couldn't have
been frozen-out
Smith v. Atlantic Properties, Inc. (Mass. 1981)
Facts: Dr. Wolfson and three partners split 350k investment in realty, articles and
bylaws contain 80% provision giving each SH a veto for any corporate action,
Wolfson antagonizes rest of the group by refusing to vote for any dividends,
resulting in multiple IRS §531 penalties for unreasonable accumulation of corporate
earnings; claims withholding of dividends for property improvements but lower
court finds no plan by Wolfson to actually follow through w/ these renovations
[80% b/c some courts hostile to more facially-obvious unanimity provision]
Issue: To what extent can SH exercise his veto power w/o violating his fiduciary
duty?
Rule: Close corporations similar to partnerships, so SH's in close corp.'s owe one
another "substantially the same fiduciary duty"
-SH's must act w/ "utmost good faith and loyalty" and not "avarice,
expediency, or self-interest"
-Donahue case recognizes that sometimes provisions in articles or bylaws can turn
minority SH's into ad hoc controlling SH's, reversing the usual roles
Analysis: Wolfson was unreasonable in refusing to vote for dividends, had been
warned many times that it was adverse to the business yet continued refusing
-ignored risks in a way that was "inconsistent w/ any reasonable
interpretation of 'utmost good faith and loyalty'"
-had Wolfson been reasonable, either by allowing some dividends or giving
business reason for refusing, would have been a lawful exercise of his rights
as a SH
[SH's, especially minority SH's, typically don't owe fiduciary duties unless in special
or egregious cases]
-in Del., Nixon v. Blackwell goes opposite direction
-investors in close corp.'s have more protection b/c of ability to bargain
(articles, bylaws, buy- out provisions, voting trusts, employment agreements,
and other voting agreements)
-Mass. is more protective and Del. less protective of minority investors in
close corp.
-Smith v. Atlantic's version of SH's w/ only controlling negative rights, and not any
power to control positive acts, is more dangerous than general SH's: power to
destroy w/ no power to create
-Del.'s Nixon would find this a reason why close corp. minority investors don't
merit protection
-Ramseyer disagrees w/ case:
-normally don't impose fiduciary duties on SH's, but here a special case
where they look like controlling SH's
-dividends weren't the only way to use the corp. funds: could also have
reinvested in the corp.
-all parties, not just Wolfson, was voting in their own self-interest, so all
parties were therefore equally responsible and expense should have been
imposed on the corp. as a whole
-Klein thinks Wolfson lost b/c he looked like a bad and stubborn person
Jordan v. Duff and Phelps, Inc. (7th Cir. 1987)
Facts: credit rating agency Duff & Phelps hires Jordan as securities analyst, later
allows Jordan to purchase about 1% of shares outstanding at book value
-agreement required Jordan to sell back stock at book value upon death or
termination
-Jordan later learns of resolution which allows fired employee to keep stock
for five years
[probably invalid resolution, so not used as grounds for decision]
-Duff board was in merger negotiations while Jordan was searching for a new
job to move away from his mother
-Jordan notifies Duff that he will resign but waits until end of year to receive
extra book value
-before cashing check, notices Duff's merger announcement; merger
increased book value from 23k to 452k
-Duff refuses to take back the check and return the check
-later merger is abandoned b/c of regulatory restrictions and later
management buys w/ LBO
Rule: Arms-length transactions don't require disclosure of material information,
Dirks v. SEC; Chiarella
-in fact, material information is developed by investment firms for the
purpose of trading on it
-but close corp.'s purchasing their own stock must disclose to sellers all
material information, Michaels v. Michaels
-"special facts" doctrine based on principle that insiders in closely held firms
can't buy from outsiders w/o informing them of new events substantially
affecting stock value
Analysis:
-Don't want people staying just for the stock appreciation, so maybe reasonable to
divorce the stock value from any employment decisions
-but unlikely that firms and employees would prefer to keep stock and job
separate
-stock designed to increase employee loyalty by increasing the compensation
package
-so Jordan-Duff employment relationship probably didn't contemplate a no-
duty clause
-Duff didn't force Jordan out, but instead allowed him to stay long enough to get
extra book value
-merger talks were material b/c Jordan might not have moved anyway
-Dissent argues no need to disclose b/c it would have been useless to Jordan, who
was terminable at will
-but being at-will doesn't really mean for any reason
-implied term in every contract is that neither party will try to take
opportunistic advantage of the other (purpose of contracts is to
discourage opportunistic behavior among contracting parties and to obviate
costly self-protective measures)
-opportunistic discharge is a breach of contract even if employment is at will
-but admittedly hard to prove in less obvious cases (perhaps this is
why so prevalent)
-Liability is a question for the jury on remand
-Damages even though merger fell through
-misrepresentation is still material even if later events makes it not so
(overstatement is still wrong even if profits miraculously go up)
-one bidder willing to pay 50M shows that others would be willing to also
-Causation is bigger problem: can Jordan prove that, upon learning of the merger,
he would have stayed on throughout the failed mergers until the successful LBO?
-difficult, but some couples would put up w/ mother-in-law for financial gain
-submitting of a bid could imply that others would follow
Posner Dissent: agreement didn't confer any job rights and agreement didn't create
any duty to disclose
-information is a valuable commodity, and its value is decreased if forced to
share it
-Fiduciary relationship alone doesn't require disclosure of material information to
SH's, further inquiry is required
-Employment at will and shareholder agreement left "nothing to the judicial
imagination"
-contrary to majority, Posner thinks opportunistic firing would be permissible
-no requirement for Duff to retain Jordan as SH made him a "shareholder at
will"
-"No duty to give SH's information that they have no right to benefit from"
-SH agreement effectively an option to Duff, which denies Jordan right to
profit from information Duff chooses to not disclose
-Jordan, like other employees, protected by employer's self-interest in preserving
business reputation
-good will is one of corp.'s most important assets that attracts talented
employees
-Jordan gambled that he would stay long enough to profit from growth
-parties can protect their interests well enough through contracting w/o
judicial interference
-Market constraints against exploiting employee SH's doesn't imply an assumption
of contractual duties
-unnecessary to impose a legal obligation to not do something that goes
against its best interest
-employment at will better b/c of the uncertainty and cost of enforcing
contractual obligations
-Employment at will is voluntary, not contractual, as the majority claims
-no contractual provisions that protected Jordan's job, actually it cut against
that conclusion
-Is stockholding contingent on employment or is employment contingent on
stockholding?
-if really an employment relationship, the at-will part of the relationship
should trump
-if really a stockholding relationship, its fiduciary duty part of the relationship
should trump
-Posner says 10b-5 irrelevant here b/c in this case its purpose of giving investors a
fair chance to respond is absent from Jordan's case: he couldn't negotiate for
different price or refuse to sell
-but Easterbrook views Jordan as having more of a say in staying employed,
so has some bargaining power in deciding when to quit and sell his
stock
-"disclose or abstain" rule applies whenever investor has a fair chance to respond
Wilkes-like duty
-disclose or abstain rule doesn't apply when SH can't use any of the information he
receives

-Some mergers require SH approval, but not all do:


-short-form merger (parent already owns 90% of target)
-not considered a fundamental change
-target corp. SH's still have to approve in Del.
-small-scale, or non-dilutive, merger (parent's voting stock not increased
>20% and articles unchanged)
-might not technically be a merger (asset purchase)
-After board approval (and SH approval if required), file appropriate paperwork, and
target corp.'s assets and liabilities are lumped into parent company's books
-Appraisal or dissenter's rights
-force corp. to pay the value of shares as judicially determined through
appraisal
-Del. doesn't give dissenter's rights for asset purchases, even if it's a de facto
merger
-Statutory merger less complicated than asset purchases
-less transaction costs in tracking down all parties to contracts w/ the target
corp.
-only one filing is necessary
-But there's a cost
-some of the target corp.'s assets and liabilities are undesirable, but parent
must take them
-SH approval is required
-SH's also get appraisal rights, which might be a cash drain
-could be offset by selling stock to other investors
-but high transaction costs in registering these issuances
-appraisal value might also be higher than proceeds from new
issuances
-Triangular merger:
-P creates subsidiary S, then P transfers to S the consideration used in the
merger w/ T in exchange for all S shares
-S and T proceed w/ a typical statutory merger (board approval, SH vote, file
paperwork)
-T distributes consideration to its SH's and dissolves
-Triangular vs. Statutory Merger:
-triangular better for eliminating P's SH's appraisal rights or SH approval
requirement
-subsidiary structure better for insulating parent corp. from target corp.'s
liabilities
-Asset Purchase:
-boards of P and T must approve
-SH approval only by T's SH's (seller), but no SH approval for P's SH's (buyer),
Del.
-P only assumes T's known liabilities
-various areas of law (CERCLA, prod. liability, etc.) determine who assumes
contingent liabilities
-contingent liabilities, but not known liabilities, make transactions more
difficult b/c less certain bargaining process
-Asset Purchase vs. Statutory Merger:
-asset purchases have more flexibility, freedom
-P SH's don't get a vote in asset purchases
-target corp. not necessarily dissolved (unlike statutory merger)
-Tender Offer:
-offer to buy shares directly from SH's (often dependent on acquiring certain
number of shares)
-Most common reasons for avoiding statutory merger:
-tax considerations drive much of the different structures
-avoiding appraisal rights or SH approval
-dissenter's rights vary by states: some only for statutory mergers,
others for anything that's effectively a merger, others not even
for all statutory mergers
-shouldn't be forced into a fundamentally different investment, even if
value doesn't change (or even goes up)
-now just a historical relic: modern investors don't really care about the
nature of the investment, just the bottom line return
-hold-up problem of opportunistic investors seeking payoffs at corp.'s
expense
-meant to protect SH's from losing value in forced transactions
-some don't think costs of dissenter's rights are worth the benefits
-Del. eliminates dissenter's rights for publicly traded corp.'s ("market
out")
-investors can sell their shares more easily
-therefore doesn't matter if investment fundamentally changes,
b/c can investors can easily shift their money into
the investment they want
-but other policy for dissenter's rights: protect investors from unfair
transaction
-but other mechanisms could substitute: fiduciary duty,
derivative suit
-also, prior SH approval should limit the degree of unfairness
-De facto merger doctrine:
-SH asks court to treat transaction as if it were a merger even though
structured differently
-doctrine of independent legal significance:

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