Rahul Mukhi
Corporations
– This course is all about how people can organize themselves to make money
(corporations is the main way people will do this).
– Aside: LLC, get the tax benefits of partnership (no double taxation) but limited
liability of corporation, relatively new invention we will not be spending too much
time on it, unclear if it is going to catch on
– Suppose Scott Turow does everything by himself (writes, manages, invests, etc.) we
call him a sole proprietor, he should be compensated more than his work (and
investment) would be worth on the market
– Turow could hire employees (office manager)
– Where is the business risk? In both cases it is going to Scott Turow (employees just
have transitional costs of finding a new job). He is also the one who has all the
control of the operation. He is also residual claimant (he has claim on whatever is left
over)
– What if Turow wants money, he could get loan from bank at interest or theoretically
go to the securities market, issue bonds at a certain interest rate, the business risk is
still with Scott Turow
– He could find other co-owners, who put up money, they would share profits, risks and
control. If you share profits/control, you are a partner. If he doesn’t want them to be
partners he would form a corporation and issue stock/equity and both would buy a
certain amount of stock.
– Corporation is just a collection of people, the issue of who bears the cost, always look
for people (creditors, equity holders, etc.)
– Control and risk tend to go together, when somebody is bearing risk they want
control, if you don’t specify the default rule is that if you bear risk you have control
– Corporations is a variation of K law, these are grown ups entering into relations with
each other, corporate law are a bunch of default rules, if you don’t make any specific
agreements, corporate law controls, try to come up with agreement that people would
have negotiated
o Judges ask what would they have negotiated even though they didn’t;
– We will also talk about fiduciary duties, relations among investors and between the
investors and the managers of their money (the directors), 1st investors are worried
about managers stealing the money, the 2nd thing is that they will be lazy/indolence,
you are worried about risk too but you are not risk averse
o The fact that you lost all your money is not a claim
o The managers are worried about trust, they want to bind their own hands,
they can attract investors by showing them they will be held liable for
damages
– 2 Fiduciary Duties
o Duty of Loyalty: Thou shall not steal
o Duty of Care: Though shall not play golf during the week
– Business Judgment Rule, managers are protected from simple risks
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I. Agency
The way one group of individuals are bound collectively by the actions of another
person or groups of people, covers both contract and tort liability
Bruce Wayne enterprises, tells Alford to make a reservation and then Bruce Wayne
cancels, the hotel can, of course sue Bruce Wayne, not Alford
But suppose Alford makes reservation without telling Bruce, who is liable?
First question is whether there is agency, if there is not then the action that is taken is
not going to bind someone else, 2nd question is once agency established, is what type
of action by the agent will impose liability to principal (express authority, apparent
authority, implied authority, inherent agency power, respondeat superior (tort
liability))
Is there agency? Are there grounds for liability for the principal? Does the agent
violate some sort of fiduciary duty that they owe the principal?
Rest. Says there is an agency relationship when A and B agree that B will act on A’s
behalf subject to A’s control
There has to be an agreement
B has to be subject to A’s control (how much?)
Eleana Kagan is an agent for Harvard University, so is Larry Summers; lawyers are
agents for their clients, your plumber is not your agent
If we think it makes sense for someone to be liable we will call them an agent, thus
often the logic is not the same as the restatement
Two types of agents: those that are your servants and those that are independent
contractors; servants: basic employees independent k’s: lawyers, accountants
Respondeat superior only kicks in for master-servant relationships not for
independent contractor’s, if you control just the end product you are not liable for
torts but if you control the process you are liable
A. Who Is An Agent?
1. Gorton v. Doty
– Doty is a school teacher who offers her car to a football coach to drive to a football
game, Doty tells him Coach Garst can drive, Π sues Doty saying that Garst was her
agent
– What if it was a pro team and Doty was the owner and Garst is the coach? What if
Garst rented car from Hertz? Would Hertz be liable? No, Garst is not acting on behalf
of Hertz.
– In this case it seems like Garst is an agent of the school, not Doty
– Always 3 parties, principal, agent and 3rd party
– Actual Express Authority
– i.e. How do you execute AOL-TW merger? Steve Case is president/CEO, board of
directors votes for the merger, after that the shareholders have a vote, agency comes
in because someone has to sign the merger document, BOD would also vote
authorizing SC to negotiate the terms of the merger (they give actual, express
authority to SC)
– Actual Implied Authority
– SC can charge travel expenses to negotiate the deal, even though the board does not
say so explicitly
– Apparent Authority
– Goes to what the principal tells 3rd party, express and implied authority is based on
what principal tells agent
– Managing Partner typically can hire associates at 120K, but suppose he offered a
partnership, you want to see a document that gives him authority to offer partnership
because it is not custom that managing partner can make partners on his own
– Suppose he also offers you a parking spot, there is probably apparent authority and
there is probably implied authority as well
– Ratification
o Principals know about it and let it happen (estoppel-like)
– Inherent Agency Power
o Hard to come up with plausible realistic examples of this
– Respondeat Superior
o Separate because principals never tell agents to be negligent and if you
could shield yourself by just telling employees not be negligent, seems
like bad policy
– Suppose Michael Eisner tells VP to hire anyone but Spielberg, is he still liable if VP
does? Depends on what VP’s in Hollywood in general can offer, there may be
apparent authority even though ME told his agent he couldn’t.
– A corporation has no way to act except through agents
– Question is who can bind a corporation?
– The greater the control the principal has over the agent the more likely they will be
liable for torts as well
– Two category of agents – servant and IC, if principal can tell the agent how to go
about doing their work they are a servant, if they just tell them what job needs to be
done then they are an IC, IC can bind principal in K, servant can also bind principal
in tort
– There are also independent contractors who are not agents and none of the law of
agency applies
– A VP is obviously a servant
– A lawyer is an IC, no respondeat superior liability for torts, but there is K liability for
all the K’s he enters
– Your waiter is not your agent just because you tell what and how to cook your order
– 3 parties: principal, agent and 3rd party
– Potter goes to work at Nimbus, told to negotiate a merger of 3rd party (slithering);
– If BOD passes a resolution giving him authority to negotiate the merger he has Actual
Express Authority
– Travel Expenses are chargeable under Actual Implied Authority
– What if Potter tells his VP Herm not to pay more than $3MM, then calls Slithering to
tell them Herm is coming over to negotiate, Herm signs a deal for a higher amount, is
he bound? Depends what he said to the 3rd party, if he doesn’t tell them she has a
$3MM limit he and the corporation are bound under apparent authority.
– If BOD didn’t authorize but they like the deal and accept it then we have ratification
– If there is a custom in the industry that these types of agents have the specific
authority, may find inherent agency power
– What if Michael Eisner wants to make a Slasher movie not under the Disney label,
tells Cameroon to make the movie without the Disney name attached
– Cameroon makes contracts doesn’t pay them, is Disney bound? Yes, under actual
express authority.
– What if Eisner tells Cameroon not to hire Bob, but he does anyway and doesn’t pay
him? Is Cameroon liable? Yes, the principal is not disclosed so the agent is liable.
What about Disney’s liability to Bob? No actual express authority, actual implied
authority. Is there apparent authority? This involves communication between the
principal and the 3rd party, here Eisner has not said anything about his agent to the
public at all. There is no apparent authority. What about inherent agency power?
Assuming Cameroon is a general agent and he is doing something that ordinarily is
done in the course of his business Disney may indeed be liable even though they were
not disclosed. No apparent authority because the principal is undisclosed so look for
inherent agency power.
2. Gay Jenson Farms Co v. Cargill, Inc.
– Farmers are suing Cargill
– Farmers had been selling their grain to Warren (an elevator company), Warren
doesn’t pay them
– Why are they suing Cargill? Cargill has lent Warren a lot of money then sent
managers to Warren and told them that they need to send purchases for approval
Cargill.
– Eventually Warren goes under and Cargill gets sued by the farmers, Court says
Cargill is liable for the money owed the farmers by Warren.
– The notion is that Cargill is the principal and Warren is the agent.
– Needs to be an 1) agreement to act on 2) behalf and 3) subject to control
– Seems to be under control on Cargill but neither Warren nor Cargill thought that
Warren was acting on behalf of Cargill
– Suppose it was a branch of C and then manager was a crook, would C be principal of
the crook? The Crook is actually not acting on behalf of Cargill but we still hold
Cargill liable, the reason being that we go based on what they agreed to and they
didn’t agree for him to be a crook
– This is a weird case, usually debtors are not agents of lenders
– Is ATT liable for the torts of ATT wireless (they own 60%)? No because it is a
simply a corporation owning stock in another corporation. If it was 100%, it is a little
trickier. Black letter rule is that parent is not liable for torts of the subsidiaries but
sometimes we pierce the corporate veil. Corporations are not usually treated as
servants.
B. Liability of Principal to Third Parties in Contract
1. Authority
a) Mill Street Church of Christ v. Hogan
– Church hires Bill who hires Sam, question is whether Church is liable?
– Court says yes under implied authority, Bill needed to hire someone to complete the
job
– In the past Bill was able to hire Sam, the logic is that since the past they allowed this
they have made a representation to Sam that Bill had the implied authority to hire him
– If there was no implied or apparent authority, Sam would still be Bill’s agent (agent’s
agent), in this case Bill could be sued for Sam’s torts but not the church.
– Common problem: does agent have authority to hire subagent, the general rule is that
if some discretion is required then there is no authority. If it does not require
discretion then the agent have the authority to hire subagents.
– Example, implied authority
– Implied authority involve actions which are incidental what you are told to do, they
usually accompany it or reasonably necessary
– Frodo marries, Fricka and have a baby, Braun. They go away and hire a babysitter
and leave the number of Doctor and health insurance card. Baby gets sick and the
babysitter runs up a tab above what health insurance will pay, Frodo and Fricka are
liable. Even if there is no AEA, there is AIA for a babysitter to incur reasonable and
necessary health costs for the baby. The fact they left insurance card they are making
a manifestation of apparent authority to the hospital.
– What if she runs a big bill to Saks? They are probably not liable. What if they left
there credit card is there apparent authority? Who knows.
b) Lind v. Shcenley Industries, Inc.
– Herfeld is VP of P&T and Kaufman works for Herfeld and Kaufman offers Lind a
1% commission, the issue is whether the employer is liable
– Herfeld tells Lind that Kaufman will tell him his salary
– Apparent Authority:
– Principal can be liable under apparent authority by representations of other agents
(P&T bound by apparent authority represented by Herfeld)
– Majority finds apparent authority
– Dissent says that 1% is a huge amount, so Π maybe lying and the authority is not so
apparent since it is such a huge amount
– Tom Brady tells secretary to buy a Ford. Bound by express and arguable apparent
authority if she tells ford that she is authorized. What if he tells her not to pay more
than $105K and she charges $120K, is he bound? Yes, because of apparent authority.
If you hold someone out to the world as an agent and then you limit the agency then
you better tell people the nature of the agency.
Three-Seventy Leasing Corporation v. Ampex
– 370 is buying computers from Ampex and then lease it to EDS
– Kays puts together a P.O. (unsigned) sends it to Joyce (370), who signs it
– Kay sends a letter saying we have a deal and then Ampex wants out
– There is no AEA, no AIA but there is apparent authority according to the court
because of the letter even though Kay is a low level employee and it is $500K line of
credit
– Ampex is holding him out as a salesperson, he apparently has the authority to close
sales
– Morale is: watch your lower level employees
– Hypo: Standish tells Alden to ask Priscilla to marry him, is Standish bound? Yes.
– What if after Alden asks Pirscilla (she is thinking about) Standish revokes his agency
and then Priscilla accepts, is Standish bound? Yes, because there was authority when
the offer was made.
– Suppose Alden runs over Pocahontas on the way to ask Priscilla, is Standish liable for
the tort? No, because Alden is an IC not a servant.
– Say Alden commits Fraud is MS liable? Yes, the one tort that IC do make their
principals liable for is fraud.
– Abr. Tells servant to tell get a wife for Isaac, but no cannonites. Servant gets a
cannonite is he bound? No AEA or AIA. Is there apparent authority? Perhaps if Abr.
had held out his servant publicly. But if not then there is no apparent authority
because Abr. never told them and servant cannot make his own apparent authority
because his representation is not truthful when made.
– What if servant cuts a deal that son will be indentured for 6 years in exchange for a
wife, no AEA or Apparent Authority. Probably no AIA. Best case for Inherent
Agency Power.
– JVJ steals a loaf of bread and cop walks in, and he puts on bakery costume and offers
cop all coffee and donuts for $100, is the bakery bound? He is not an agent so don’t
even go through AEA, AIA. The only way the bakery is bound if the bakery is so
careless that they were negligent in letting JVJ break in.
2. Inherent Agency Power
– Invented by Restatement Authors to fit cases that didn’t fit the traditional categories
of agency (some states don’t recognize it)
– Inherent agency power when you have a general agent, if the acts done by the agent
are usually done in the course of what the person is supposed to be doing (or
incidental) then they are bound to the principal
– But the 3rd party can’t be aware that the agent doesn’t have the power and the agent
has to be acting on behalf on the principal’s interests
– General Agents are authorized to do day-to-day business, special agents are
authorized to conduct a single transaction or a series that does not involve continuous
work
– Very seldom that a case fit into Apparent Authority but not IAP, only real cases are
like Watteau v. Fenwick when there is a undisclosed principal. Can’t be apparent
authority because principal is not disclosed.
– One example of a disclosed principal where IAP but no AA
– Manager of foundry told by his boss to order steel, but not from firm F
– Manager orders steel from F, he writes a letter on plain paper and signs it A, Manager
of Foundry
– There is no apparent authority (no letterhead), but not undisclosed because he says he
is the manager, and he can’t create his own apparent authority because it is not true
when he says it
– But foundry is liable under IAP
– If there is letterhead then there is apparent authority (principal has given you access to
the letterhead)
– Review:
– IAP when there is a general agent, no authority and no general authority but pretty
close to what the agent normally does
– Ratification – Principal accepts the agent’s actions after the fact
– Estoppel
– Inherent Agency Power cont’d
– Invented by writers of Rest. To make sense of cases that didn’t fit
– General Agents and Special Agents – General Agents authorized to conduct a series
of actions and doesn’t required fresh authorization each time (GM/VP, etc.); Special
Agent authorized to complete specific transactions
– IAP -- GA is doing something usually accompanies or incidental to what the agent is
supposed to be doing
– When would you have something that meets IAP but not AA? Not very many,
particular when you look at disclosed principals (3rd party knows about the principal;
undisclosed 3rd Party does not know there is any principal out there). IAP takes the
result you would get in disclosed cases through AA and maps to undisclosed
principals. (See Foundry example above)
a) Kiv. Fenwick
– Π is the seller, he thinks he is dealing with Humble but he is suing Fenwick, who
becomes in this case
– Humble – agent, Fenwick – principal, Watteau – 3rd Party
– Humble doesn’t tell Watteau that someone else owns the bar, Humble doesn’t pay
and Watteau finds out that there is a principal and sues them; Fenwicks defense is that
he never authorized Humble to buy cigars and bovral (sp?)
– No AEA, no AIA
– Is there AA? No, there is no manifestation from Fenwick to Watteau, Fenwick has
said nothing
– Court says that Watteau still wins under AA, because court is unsure IAP exists in
NY law
– Restatement writers later on fit this into an example of IAP (see pg. 19)
b) Kidd v. Edison
– Principal is Edison, Agent is Fuller and Kidd is 3rd Party
– Fuller guarantees a full tour’s contract for testing, Edison says that Fuller is not
authorized to offer full tour’s worth of singing engagements
– There is no AEA, no AIA
– Is there apparent authority? Edison is holding Fuller out as a senior representative, to
find AA you would have to say that people who have the title that Fuller does usually
are able to make these promises
– But Hand decides to go beyond saying there is AA to say there is something like IAP
present
c) Nogales v. Arco
– Arco’s Agent is Tucker and Nogales Service Center is the 3rd Party
– Tucker offers NSC a loan, a $.01 discount and keep the service center “competitive”
– NSC sues Arco on the $.01 discount and Arco says that Tucker was not authorized to
do it
– No AEA, No AIE, might be AA but jury says no there isn’t
– The Court says they can’t argue IAP because this should have been argued during the
jury instructions
– This case spells out IAP very clearly and spells out another set of facts you might see
IAP
– By definition you only have this when there is no AA, very hard only when there is
an undisclosed principal or a case like this when the jury says there is no AA
3. Ratification
– A retroactive/ex-post authority, an agent who is not authorized does it anyway,
principal learns about it and says it makes sense and says go ahead
– Has to be that the agent is purporting to act on behalf of the principal, agent does not
have the authority to do it (though principal could have authorized), the agent does
what he/she is not authorized to do, principal manifests something that they think it is
good idea or does something that is only justifiable if they made that choice
a) Boticello
– Mary and Walter are Tenants and Common, Boticello is the 3rd Party
– Boticello goes to Walter, they make a deal to sell the farm for $85K (rental/option to
buy), unclear whether Mary is happy with the deal, Boticello makes a variety of
improvements and wants to exercise his purchase option and Mary Objects (in
between they learn that Mary is co-title owner)
– Mary is the principal, Walter is the Agent and Boticello the 3rd Party
– There is no AEA, AIA
– Court says no AA, IAP just because they are married
– Unclear whether Walter was purporting to act on the behalf of the party
– Walter does not have authority but Mary could have give it to him
– Does Mary manifest something that she was treat the sale as though it was in fact
authorized, court says no
– Walter is liable for the sale and false representation but Court says that taking the $$
is not a manifestation on the part of Mary because she might not be on notice of the
purchase option (as opposed to rental)
– Hypo:
– AV wants to buy a Townhouse, goes to TH Management finds the janitor, who shows
him around and gets AV to sign a K, is the TH liable? There is no AEA, no AIA, no
AA, and no IAP. TH is not bound.
– What if they let AV move in, rent for a couple of months, then can they kick him out?
At that point there would be ratification.
– What AV asks DR to buy a BMW, DR buys him a Porsche? Is AV bound? No AEA,
AIA, no AA (undisclosed), and no IAP (Rodman is not a general agent). But if AV
drives it around there would be ratification.
– Suppose AV negotiates with janitor to for a discount in exchange for mowing the
lawn every week, AV moves in Feb, come June (TH has been collecting 4K/month
rent), AV can probably held liable for mowing the lawn.
– TB has an agent, AV wants a new car and TB’s agent sells his Porsche to AV for
60K, TB takes the 60K it is ratified, what if the agent tells AV that it comes with 90day warranty and the cars break down and AV wants to be paid under the warranty, is
TB bound (no original authorization)? The problem is that the agent stuck in the
warranty. NO, not apparent to TB that there is a warranty; this is the same as the
Boticello problem (taking the money can just indication of rental not necessarily with
an option to buy)
– Could there be a duty of care to figure out exactly what your agent had sold?
– If TB was a car dealership then holding an agent there would be apparent authority to
sell a car warranty
– Can principals ratify tort? Seems weird but the issue comes up
– Oracle has an office on Rt. 128 and comes out with new software, LS drives around
delivering the software and he gets into a car accident and then goes on delivering the
rest of the software, is Oracle bound? Typically you would say that LS is not a
servant, just an agent. But if Oracle gets paid for all the software he delivered, Court
may deem that they ratified his acting as a servant and may be liable for the torts.
4. Estoppel
– This is the bakery/JVP/cop example, JVJ was never an agent, question is whether
bakery was so negligent/culpable that they will be held liable
a) Hodison
– Hodison makes a deal with an apparent salesman in the furniture store (but turns out
to be an impostor) and Hodison sues the furniture company for the delivery (she
already paid)
– Court allows her to collect by saying that even though the apparent salesman was not
their agent but there is a reason they were able to do it and it was because you were
not careful enough
– Could also say it that there is a duty of care to the public (like the duty that the floor is
not slippery)
– Hypo:
– LS turns down an econ prof for tenure, the junior prof goes to a conference and runs
up big charges at the first day of the conference, they notify LS who laughs, and then
the next day Hodison throws a big party, Harvard might be liable
– Divide it up: post notice tab and pre-notice tab
– LS doesn’t really have a duty of care to the hotel, but it does have a Hodison-like feel
– For the Pre-notice charges, the case is less tenuous for estoppel least, but there is case
for apparent authority for the pre-notice charges, LS has held the professor out as a
junior prof, when it revokes the agency that had a duty to notify that the agency
– Why is there not ratification? The junior prof is not an agent of LS, he has been fired.
– Sometimes the agent is liable
– In cases when there is AEA or AIA agent can’t be liable
– When Kagan signs K’s on behalf of HLS she is not personally liable
– If the agent makes a reservation with 3rd party and doesn’t disclose the principal and
Agent is on the hook, the principal is also on the hook if there is AEA
– What if there is no principal, agent is liable (Atlantic Salmon)
5. Agent’s Liability on the Contract
a) Atlantic Salmon
– Boston International Seafood Exchange, Agent is Curran and 3rd Party is dealing with
some Norwegian Salmon Exporters
– Supposed BISE actually existed, BISE would be liable for K’s and Curran would not
be (AEA)
– Suppose there is no corporation such as BISE, Curran is liable
– Suppose there is a corporation called Marketing Designs whose VP is Curran and MD
is doing business as BISE, is Marketing Design’s liable? Yes they would be liable
because Curran is their agent and has AEA, doesn’t matter that the corporation is
undisclosed. Is Curran also liable? Court says yes because he does not disclose the
real corporation he is working for (MD). In this case MD was also non-existent at the
time of the transaction.
C. Liability of Principal to Third Parties in Tort
– When agents commit torts is the corporation liable for the tort? Agent has to be a
servant rather than an Independent Contractor
– One policy question why do this? The actual tortfeasor is always liable (agent). Want
to make the entity which can control risk liable, in this case the employer will reduce
risks of accidents if they are held liable.
– Also, corporations more likely able to pay.
– But why not on the Independent Contractors? IC’s tend to be richer, but the actual
distinction the law makes is that employers controls risk levels of servants but not
independent contractors, but this seems circular. If you made employer’s liable for
IC’s they would start controlling them more. One reason is that it is easier/cheaper for
corps to control servants.
1. Servant v. Independent Contractor
a) Murphy v. Holiday Inn
– Murphy was staying at Hotel owned by Betsy Lane but the franchise is Holiday Inn
– Murphy slips and falls, Betsy Lane is liable the question is whether Holiday Inn is
also liable, in this case the answer is no. Is BL a servant? Has BL agreed to act on
behalf of Holiday Inn.
– Court says they have no control over the day-to-day janitorial work, etc. even though
the franchise may control many requirements
– Court says there is not sufficient control here for respondeat superior
2. Tort Liability and Apparent Agency
a) Billops
– Rents a ballroom at the Hilton, owned by Magnees (franchisee)
– The Banquet Manager makes a reservation and then demands extra money, Billups
says no, the Banquet Manager shows up and ruins the party
– Here the Court says Hilton is liable, even though the facts are very similar to Holiday
Inn
– Of course, the Banquet Manager and Magnus would be liable (Banquet manager is a
servant of Magnus but respondeat superior also requires that the act is within scope of
employment, but court never addresses this).
– The Manager is liable, Magness is liable (Manager is agent & servant, so Magness is
liable for torts of manager within the scope of the manager’s employment)
– Problem is scope of employment, is this the type of conduct he is authorized to do
(well extortion no, but securing reservations, yes), it is during time/place, is this
motivated in part to serve the master, it gets dubious (if he is extorting money for
Magness then yes but not if it is to put it in his own pocket)
– Respondeat Superior, time/place and motivated in part on behalf of the employer (but
in this case looks like Banquet Manager is just trying to extort money for himself)
– If there is no respondeat superior to Magness first then there cannot be respondeat
superior to Hilton.
– For respondeat superior, there needs to be an agent, that agent needs to be a servant
(principal have control over how agent does his business), and the agent be acting
within the scope of his/her employment.
– For liability:
o Within the conduct the employee is authorized to do
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o Time/Place of employer
o Acting on behalf of the employer (tricky one)
If there is force tort, it must be foreseeable
Court is asking whether Magness is a servant of Hilton, then either the manager is a
sub-servant or else the manager is directly a servant of Hilton. The Court is covering
itself by saying not only is their servanthood there is apparent servanthood – they
make it seem like everyone at the hotel works for Hilton.
Why does Hilton control these operations?
They need to maintain a standard of service to get reservations
Why does Magness want to be a Hilton?
More Reservations
Why does Hilton us franchise?
Owners will care more for running the business well than simple employee
Why is the Π not satisfied just suing local outlet?
You would think that Hilton would have minimum capital/insurance requirements for
the franchisees (but you can’t insure against a intentional tort)
Sometimes it turns on what court you want to be in (federal diversity v. court)
More examples:
Lance Armstrong has a 3 yr. old son, hires SW to teach him tennis, she commits a tort
is LA liable? No, she is only a independent contractor.
SW hires JC to teach and she commits a tort. JC is liable, is SW liable? Seems she is
hiring her as a IC (want to know what sorts of hours JC kept) but the skills issue does
not come up (SW can supervise JC [they both are tennis players]) so if there is
regularity of hours. LA is not liable either way.
Client hires B&M, a partner sexually harasses a paralegal, partner is liable and B&M
is liable, partners are liable for the wrongful acts made by other partners during the
course of business. The Client is of course not liable.
Scope of Employment
Ira Bushey
Judge Friendly opinion:
Lane works for the coast guard and he is on leave, he gets sauced and then comes
back to the ship in the dry dock (Π), when he comes back he turns some valves and
the ship and dock are damaged
Court says it is foreseeable that sailors will go out and get drunk and will come back
and cause problems and that is enough to find the coast guard liable here
Manning v. Grimsley
Grimsley works for the Orioles, he is warming up and Manning and his friends are
taunting, Grimsley throws a ball into the stands at Manning, Grimsley is liable
question is whether Orioles are liable
Is this the type of conduct he is authorized to do? He is not authorized to throw balls
into the stands but he is authorized to warm up. Within time/place of employment. Is
he motivated in part to act on behalf of the employer (tricky part)
In this case the court looks to the MA statute saying that employers are liable for torts
committed by employees against people interfering with their work
Friendly would say this is just as foreseeable drunk sailors
Hypo:
– WP works at DP cafeteria and he throws a stray cat out the window and it breaks
antique Southeby eggs, is DP liable? Yes, he is a servant and he is supposed to keep
the kitchen sanitary.
– LA signs a deal with Huffy to run the business, he goes to the bookstore to learn
about business and commits a tort. They didn’t hire him to go to the bookstore but
they did want him to run the business. But it is not during the time, place of
employment thus Huffy is not liable.
– Theater hires HLS student as a bouncer and he commits assault & battery, the theater
is probably liable because it is foreseeable that force will be used. What if the assault
takes place after the show in the street, not in authorized time & place so theater is not
liable.
– What if you prohibit certain type of conduct does that indeminify employer? No
(Arguello).
4. Statutory Claims
a) Arguello v. Conoco, Inc.
– Π’s are all Hispanic, and employees of gas stations subjected the Π’s to racial
discrimination/harassment
– Employees are servants of the gas stations, some of the gas stations are franchisees
and some are owned by Conoco
– Conoco
– Is the employee an agent of Conoco?
o Yes
– Is the employee a servant of Conoco?
o Yes
– Tort committed within scope of employment?
o Doing the type of conduct authorized to do?
 Yes, selling gas, stuff.
o During the authorized time/place?
 Yes
o Force
 No
o Motivated in part in serving the master?
 Doesn’t look like it, they specifically forbid it
– Court says that is allowed to go to jury not precluded because franchise agreement
forbids the acts.
– Franchise-owned station
– In Holiday-Inn court looks how much control and says they are liable in Hilton they
make the opposite conclusion
– Here we have a franchise agreement and there are a bunch of controls but the court
says not liable. They are looking for agency/servanthood. On behalf of the principal
and subject to the principal’s control.
– There is a specific clause in the franchise agreement which they are not agents for
each other, but in Holiday Inn court said they will look to what the parties did not
what they said.
– Back to HLS bouncer:
– Say the theater tells the law student but don’t use a specific type of force, but HLS
student uses it anyways.
– Theater says it is not within the scope of employment because they explicitly forbid it
if you forbid it than you foresee it, you are liable it is foreseeable.
– Courts are very hesitant to recognize specific prohibitions.
– Frolic/Detour distinction
– Nick & Nora drive the UPS truck, if they go to buy personal tickets and they commit
a tort is UPS liable? Classic no – this is a frolic.
– They drive 3 blocks out of the way to get lunch and commit a tort – yes they would
be liable, this is a detour.
– Lines are very blurry but these are the polar lines.
5. Liability for Torts of Independent Contractors
– Sometimes IC’s do impose liability on employers (Majestic Realty)
– Sometimes IC could be a servant for certain purposes
a) Majestic Realty
– Toti is the Contractor; Parking Authority hires the contractor, Π is Majestic
Associates, Contractor damages the building
– Court says demolition is an inherently dangerous activity and thus the principal is
liable for the torts of IC
– Sometimes court will say that hirers are negligent in hiring an incompetent contractor
(does incompetence include
– Non-delegable duty approach – have a duty that can’t delegate to an IC (i.e. keeping
the premises safe)
– So employer can be liable for IC under
o Sometimes a servant for limited purposes
o Inherently dangerous activity
o Negligence in picking independent contractor
o Non-delegable duty
– Hypo:
– M16, INC. M is the president
– VP of Product development is Q
– M hires Money Penny as an accountant who has a junior accountant named James
who commits a tort
– What is MP’s 3 options:
o Non-Agent, IC
o Agent IC (this is it because accounting firm will have a fudiciary duty to
M16)
o A Servant
– James is a sub-agent, so he can bind M-16 in contract.
– He is not a servant of M16 so they will not be liable for his torts
– Supposed M-16 tell Q not to hire anyone, but he hires Felix, who is an agent whether
he is servant or not, with respect to M16 he is an agent’s agent (different from a
subagent, which is authorized); note that the default rule is that agents don’t have
authority to hire subagents so there is no apparent authority
D. Fiduciary Obligation of Agents
– Duty of Loyalty and Duty of Care
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Duty of Loyalty act on behalf of the agency (we see more of these cases)
Duty of Care a minimal level of service to the agency
This stuff is default rules so you can stricter or laxer duty’s of loyalty, etc.
Hypo:
BO hires Spade to find a rare bird and he then he finds the bird on the street
He lies to him and tells him that he go it from Istanbul and costs $10,000 -- this is a
violation of duty of care (straight-forward dishonesty)
If he tells her the truth but then says he will charge $10,000 even though he got it for
free, he can’t do this because he was hired as her agent (different if she just walked
into the store) (could draft around this)
What if he finds the bird on his day off? Same result, courts would find this is too
manipulable (people all of sudden will start finding rare birds on their days off).
What if SS sends BO to MA and SS gets a referral fee, can BO sue SS when he finds
out about the referral fee? No, SS was never BO’s agent so no duty.
What if she had hired him as an agent and he gets a referral fee from one of the
suppliers? If you make any secret profits you are holding them in trust of the principal
(even if there is no damages). Reasons: would they had gone to a competing
dealership that didn’t have a referral fee? Law takes a prophylactic approach.
If you disclose it is fine, when SS discloses the arrangement BO can look at it
accurately gauge the situation.
Suppose SS turns BO into the police? Not normally, but lawyers can get in trouble for
ratting on their clients.
Review:
Agents held to duties to the principal: duty of loyalty and duty of care
(negligence/gross negligence), these things are waivable (can come to an agreement
to the contrary)
Duties During Agency
Reading
UK government is being sued by the Sergeant for the bribery money he received by
guarding smuggled goods with his uniform on. Court says he can’t recover.
If he did it in his own clothes on his own time he would not need to pay it to the
principal (even though it is illegal), he is not gaining secret profits due to his
employment with the UK government. He may have to turn this over to the
government if it is illegal. (can contract around this)
Are fiduciary duties are sometimes limited to agents with decision-making power
(sometimes really low-rung employees)
Yale Prof consults on $500/hr does he owe the money to Yale? No, because it will be
in his contract that he can work on his own stuff for the equivalent of 3 months. Same
thing if he makes money on the side selling crack. (can contract around all of this)
Difference between this and MIT which must turn over the patent he develops as
professor? This is in the K.
SB is partner at Cravath, Professor is at Yale receives $1MM bribe to get a building
named after him, if Yale discovers they can get $1MM from the Prof even though
there is no damages (secret profits are held in trust for the principal)
Hypo:
– S hires PM to buy a book, he buys it for $20 and tells him he bought it for $30, breach
of loyalty
– What if he tells him he bought it for $20, still can’t sell it to him for $30
– What if he already had it in its collection but he bought it $5, if he tells him that he
will sell it for $30 or he can go out to look for it somewhere else. Just because he has
it in his own collection and bought it for $5 does not mean he has to sell it for $5.
– What if he knows that no book exists and still goes out and charges for expenses?
Clearly a violation of duty of loyalty.
2. Duties During and After Termination of Agency
a) Town & Country
– Employees worked at T&C then quit started their own business and solicited business
only from clients from the previous employer
– Court says they cannot they spent a lot of time to figure who needed house cleaning
– Presumably your fiduciary duties don’t stop when you quit, these are former agents
– What if they hire SS to follow around T&C trucks to see who the customers are?
– Not using any trade secrets but Court would be bothered by this, so they find a breach
of duty somewhere thought not clear why (maybe because they are getting jobs only
because they are trusted from before, even though they got the numbers through a
new method)
– We want to give principals incentive to create valuable information so we want to
make it expensive to steal it
– Hypo:
– Cravath call ups a partner of H&D to recruit him to set up Boston office
– Can you ask other H&D partners to come with you? Probably not, breach of loyalty.
– But what if it was another associate? Then court probably will say there is not a
violation of fiduciary duty (associates always talk about jumping ship).
– What about the clients? It is different to T&C because in that case clients were
attached to the firm, here they are attached to the lawyer.
– But there are some “firm” clients too at big law firms, so in that case it doesn’t seem
different. But, in most cases the court will saying practicing law is different.
– A partner is VP of BRUS, they make spider print pajamas and want to expand, offers
$150/share to Disney, hires SA and GS, then he goes and buys Disney stock, the offer
is announced and he makes a profit on the sale. BRUS has not been hurt (no
damages). Principal can still sue him for the profits he made on the transaction?
Policy reasoning: You could have BRUS getting into transactions it doesn’t need to
by a drive of agents to make profits.
– Suppose you have JA, agent to principal of British Navy, SM who is a buddy and
agent of the Navy. He knows that there is new ship that is going to be in the market
for Salted Beef. He buys stock in the Salted Beef Company? Owes the money to the
principal, based on information as part of his employment with principal. What if he
bought stock in a supplier of raw beef? The Federal Insider Trading law would not
say this is insider trading, but the cases involving agency you have someone profiting
in the course of his agency relationship. It looks in fact he cannot do this even though
there is no damage to the principal.
– Note: that you can contract around to allow you to keep profits he gets based on the
information acquired during his agency (this issue is separate for securities law), but
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as far as agency law this is perfectly legal under agency law. Securities law is
supposed to be criminalizing agency law.
What about if he profits after his employment? Well, fiduciary duties don’t end after
employment (T&C) and he is profiting off info he gained because of his agency
relationship. Courts might be hesitant but seems like he would be liable to the
principal.
What if agent tells a third-party can principal sue her? Securities law they both would
be criminally liable, she as an accessory after the fact. But under agency law/civil
liability? Hard to see how she owes a fiduciary duty to the principal (she is not an
agent). Not going to see these types of cases under agency law, all analyzed under
federal securities law.
II. Partnerships
Sole Proprietorship, Partnerships and Corporations, significant legal implications of
all 3 of these but you can structure them so they are similar, so it almost always a tax
decision. When people find partnerships they do so because of tax reasons.
LLC’s basically give you the tax aspects of partnerships and business aspects of
corporation (relatively new invention)
Corporations – Limited Liability can’t lose more than your investments, not liable for
the debts of the corporation, for someone who is wealthy and wants to
compartmentalize your assets (can protect personal assets); in partnership you can
lose everything you have subject to bankruptcy law protections.
If you have a one person corporations, creditors can demand that you personally
guarantee the debt. These are just default rules.
Corporate shares are freely transferability, new partners can only be added by
unanimous consent of other partners.
Difference in the life: partnerships terminate whenever a partner quits, corporations
theoretically last forever.
Partnerships are usually flexible and de-centralized, corporations are usually less
flexible and more centralized (but again these can be worked around)
These are the principle issues that divide the two but they are default issues if you
don’t contract around them to the contrary, lawyers contract around them and you can
get whatever your client wants, so the decision rests on tax treatment
Partnership law is statutory law as opposed to common law of agency – Universal
Partnership Act (adopted by 49 states, LA is the only one that hasn’t adopted it)
In 1992, the RUPA (revised UPA) was put out, which addressed some problems but
also created some new ones, states haven’t adopted by the RUPA yet, compounded
by the fact that there are LLC’s, which are making general partnerships obsolete
Law firms are LLP, limited liability partnerships, some states provide that if you
register your partnership you can get some limited personal liability (but not for
intentional torts like fraud), protections depend on the state and sometimes only
extended to law/medical firms
LLC’s are more under corporate law
There are intra-partnership rules and 3rd-party partnership rules, the intra-partnership
rules are usually always waivable, partner-3rd party rules are not all waivable
How do you know when you have a partnership?
Employee v. partnership
– Creditor v. partnership
– Corporation (must file continuously to be a corporation) v. partnership (2 or more
people carrying on a business for a profit)
– UPA differentiates between gross revenues and profits? Who cares, matters because if
you have an interest gross returns you have less interest in how the business is run. If
you get a cut of profit more involved in day-to-day cost/benefits.
– Courts also look to amount of control. But courts will hold people who don’t have
actual control liable (partner at Skadden Arps who has no control)
– Also can hold liable for apparent partnerships, if you are held out as partner that is
enough is to make you liable for the partnership debts.
A. What is a Partnership and Who are the Partners?
1. Partnership by Estoppel
a) Young v. Jones
– Π’s are going after PW-US after negligence of PW-Bahamas, claiming that PW holds
themselves out as a global partnership
– PW is actually a LLC, which the different PW offices hold shares of, PW LLC is sort
of like a franchisor (like Hilton)
– Court looks to the statute which says if you have held out as a partner and someone
has extended credit to you based on their representation then you can be liable, but in
this case the decision was not made on the basis of PW holding itself as a partner and
they didn’t ever hold out themselves as partners
– Now on the PWC website they disclose they are a network of separate firms
– Review:
– Ramseyer finds out HLS is moving to Fresh Pond, a violation for buying the mall first
or even buying stock in the real estate development corp., what if he buys the Dunkin
Donuts? The language from reading is that he is still profiting from his agency
relationship. The partner at R&G who helped with this acquisition would also have
this duty, but the copier at Kinko’s would not hold a fiduciary duty. Kinko’s usually
not thought to be an agent of HLS, just seller of services.
– There is a rule called Corporate Opportunity rule for employees, in the line of
business rule. Buying real estate is not in the line of business for Kinko’s so they
would not be able to sue employee, but if it was a real estate acquisition firm they
could.
– H&S, what if S is waitress does she have to pay the restaurant her tips, it is money
made on the side after all. Custom is that waiter and waitresses are entitled to tips.
– What if Harry cuts a secret deal to get a $5 discount on a book, can Sally recover it
even if she suffers no loss.
B.
1.
a)
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The Fiduciary Obligations of Partners
Introduction
Mienhardt v. Selman
Fiduciary duties imposed under UAP are close analogs to the agency principals
Seems like you get different standards for law firms than other partnerships
Salmon and Meihnhardt put up the money together for the space they lease from
Gerry, Salmon is manager and they each put up both the money, they split the returns
40/60 and then after a while it is 50/50
– Remember all of these terms are negotiable
– Here they did not negotiate what happens at the end of 20 years and Cardoza and
Andrews disagree about what to do
– They are co-adventurers in that they don’t share control
– Gerry renews the lease with Salmon, Mienhardt wants a piece and sues
– Cardoza gives Mienhardt a stake, he says at the very least Salmon has to tell
Mienhardt about it – Salmon heard about it because he is the only visible party here –
Mienhrdt would then make a competing offer
– What if Salmon had heard about it in some other context, not sitting in the office?
Probably not since it is not in the partnership agency relationship. But is a business
association in the partnership relationship? Tough call, partnerships are more than just
40 hours/week.
– Difference between investors and hired hands. Usually courts would tell Directors to
do what Cardoza says here but may be a different standard for Majority shareholders.
Also courts don’t expect law firm partners to give up all sense of self.
– Hypo:
– Partner at Skadden, client comes with a case, can you take the case for yourself and
dissolve the partnership? 1. Can always dissolve a partnership, formally the
partnership is dissolved (mostly an accounting issue). 2. If the client chooses to go,
the partner can keep the client. 3. But the partner can’t keep the money because it
came to him at Skadden, we will see how to calculate it later on.
– This goes back to Town & Country, as former agents, even after they quit they have
fidicuary duties to the people they used to work for
– If you just anticipate you are going to get a whole new set of cases because you win a
big case for the former partnership and then you do, you can keep the money
2. After Dissolution
a) Bane v. Ferguson
– Bane retires from the firm, enjoys a pension for a while, but then the firm goes
bankrupt
– Bane stops getting his pension
– Court says
– It was a business decision (business judgment rule), Courts do not second guess
business decisions are made non-negligently (mostly need gross negligent) or a
conflict of interest
– He is no longer part of the partnership, they have no more fiduciary duty to him (but
this is not exactly right – see T& C), the plain rule that ex-partners are owed no duties
is plain wrong this is not one of those instances however
– Court is saying you are getting exactly what you negotiated for, if you don’t like it
you should have negotiated a different deal
– Very much like the logic we will read in other cases, the difference with Mienhardt is
that he was not a LAWYER, like the other cases
3. Grabbing and Leaving
a) Mehaan
– PC large Boston law firm, Meehan, Boyle and Cohen decide they ought to move
– In mid 1984 they decide to leave, they do a bunch of planning, shopping for real
estate, recruiting associates, rumors start spreading and they deny the rumors (they lie
over and over)
– Eventually they admit they were lying, the leave and the law firm sues them
– Court rejects that they improperly handled their cases while they were still with P&C
(they put of settlement until they left), the allegation came because they talked about
but they actually didn’t do it (doesn’t matter if you say it and don’t do it), also Court
rejects that they were in secret competition
– They do get in trouble for taking clients improperly
– The letters have to make it clear that they have the option of staying with PC
– The firm has a 3 month notice requirement, but the court doesn’t make it a big deal of
it but lying about the intentions and then wait till the last minute to tell them what
clients they were contacting until too late (need to give law firms time to compete to
keep the business)
– Notice they don’t say you can’t talk to clients as long as you do it right (different
from T&C)
4. Expulsion
a) Lawlis
– K&G, Lawlis is a partner who becomes an alcoholic in 1982, they tell he has to get
treatment and if he does he can get his full privileges back (the agreement says
“There is no second chance”), Lawlis falls off the wagon but the firm decides to give
him another chance, this time he actually gives it up
– The firm doesn’t ever raise his workload back to normal and then a few weeks later
he is told that he is going to be expelled, they remove all the files from his office so
he can’t contact other clients, he gets 1 unit so he can get health insurance and be on
the law firm letterhead
– He says he was wrongly expelled, that he needs to expelled on 2/3 vote, Court says
that he was actually expelled when they had the 2/3 vote which he voted in, so he
obviously was a partner until then
– He also claims that they fired him for a “predatory purpose” and the statute says that
partnership can only be dissolved in good faith
– Same logic that he signed on to this agreement and he could negotiated it differently,
Court is signing off that partnerships can be the equivalent of employment at will,
Cardoza may have found differently
C. Partnership Property
a) Putnam
– What is your interest in the computers at the law firm? Nothing, the partnership has
an interest in it and you have an interest in the partnership not in any of the property
that the partnership owns
– FJG – CP has a 50% interest in the partnership she wants to leave
– If she just quits she is still liable for all the debts so instead she decides to sell her
50% interest to Shoafs, she still continues to be liable to the credit extends before she
left the partnership
– She still sells to the Shoafs, even though it doesn’t effect her liability, she now has a
claim against Shoafs, they agree to indemnify her for all her liabilities
– Shoafs say that they she has to pay $21,000 because they are agreeing to take over her
indebtedness
– After she leaves the partnership wins a new lawsuit against a former employee, she
says that the action took place during her time so she is entitled to it since she is still
liable for the indebtedness.
– The court says that deal that she cut was that Shoafs would owe to you the amount
you would have to pay and in exchange you gave up all future profits, she had no
claim in the underlying property just in the partnership itself and that is what she sold
– When you get a partnership you get an interest in the partnership not in the property,
so if you sell the partnership you are giving all future income
D. The Rights of Partners in Management
a) Nabisco
– A general partnership between Strude and Friedman, they sell food and for that they
need to buy the food they sell and they buy stuff from Nabisco
– Friedman keeps wanting to buy from Nabisco, Strude doesn’t, Strude tells him so and
Nabisco that they won’t pay for anymore food. Nabisco responds by delivering more
food because Friedman contacts them again.
– Court says S is still liable, see UAP, partners are liable for all actions of other partners
in the ordinary course of business
– By default each partner has one vote, strude is out of luck, he could have protected
himself with an agreement or he could have just dissolved the partnership
immediately
– Lesson: If you don’t trust your 50/50 partnership you better get out quick, because
you will always be liable for his/her decisions
b) Summers v. Dooley
(Idaho 1971) p. 144
Facts: S & D were general partners (equal interest in the partnership) in a trash
collection business. D hired X as an employee since he could not work. S wanted
to hire another employee, but D refused. S hired him, paid out of his own pocket.
Empl.: Would argue (if he sued D) that he’s supplying labor and that he ought to get paid
(analogize to Nabisco).
∆:
D will argue that this is not in the ordinary course of business of the partnership
(hiring an employee might or might not be).
Rule: When you’ve got a dispute within the partnership, those are decided by majority
vote. Here, S doesn’t have a majority, so effectively, there’s been no decision and
S can’t recover (changing the status quo).
Notes:
 If S had sued F in Nabisco, the court probably would have ruled against S.
Liability to 3rd parties is a distinct issue from liability of partners to each other.
 Distinguishing Nabisco from Summers → difference btw liability of partnership
to 3rd parties and liability of the partners toward each other.
o Disputes w/in partnership decided by majority vote (i.e., if you’re going to
change the status quo, you have to have a majority vote).
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o Whether partnership is liable to 3rd person is a different question (actual
express or apparent authority).
Hypo: Assume you had a 3-person partnership/copy center (where majority is
possible). 3rd party vendor is a paper supplier. One partner orders paper. If 3rd
party wants to collect from partnership, it can, b/c this is in the ordinary course of
business and partner had at least apparent authority.
o However, if 3rd party vendor is a real estate agent and partner calls up to
buy large tract of land, 3rd party cannot bind the partnership b/c the partner
does not have apparent authority (i.e., not in the ordinary course of
partnership business).
c) Day v. Sidley & Austin
(F.Supp. 1975; affirmed DC Cir. 1976; cert denied US 1977) p. 146
Background:
 S&A merged with Brown & Wood. B&W had a tax partner who was issuing
opinion letters on these tax shelters. S&A fired this partner when they found out,
but now are being sued for tax partner’s actions.
o Requirement on S&A to do due diligence before merging with B&W
(includes looking into the tax advice that B&W was giving).
o If partners at S&A decided to sue the executive board, you would have to
find some way to get around the business judgment rule (ordinarily
protects partners). You could get around that by showing conflict of
interest or gross negligence.
 S&A partners in the 1950s were white, Protestant males (Chicago was highly
segregated). In the 1970s, S&A was dominated by Howard Trienens (who made
executive committee by age 45). He controlled the AT&T account (making S&A
a killing fighting dismantlement of the Bell system). S&A = old white shoe firm.
 Liedman & Williams = younger, crazier, aggressive, upstart firm (did not
discriminate by religion, race, etc.). One of the dominant (name) partners was
Newton Minnow, who had been law clerk buddies on the Supreme Court with
Howard Trienens. L&W (NM) helped start NPR, national public TV, also helped
establish the $1 long distance phone call. Socially, these were very different
institutions. Ramseyer was at S&A in the 80s, and it was still very pronounced
who was a S&A partner and who was a L&W partners.
 S&A have an executive committee (fn. 8, p. 149 → all questions shall be decided
by an executive committee…except determination of participation, admission,
and severance shall require the approval of all Partners (majority)). Executive
committee will look at associates up for partnership, decide which should be
promoted, and then that decision will be approved by the partnership (first cut
made by EC). Voting %s are not equally allocated (some even have no %s). The
EC proposes the slate, and then has a vote, where their %s dominate the outcome
anyway. Salaries are decided by the committees (associates and secretaries), but
partners’ “participation” (take-home pay) is decided by majority vote of the
Partners. 1500 partners at S&A, and 20-25 on EC. EC is chosen by the EC.
 S&A used to be called S, A, Burgess & Smith. Burgess ran the firm. They had
gone for years w/out a meeting, and then they finally had one, one of the partners

asked for better secretaries, and Burgess said if all they’re going to do is
complain, then no more partnership meetings. Now they have them yearly (vote
on new partners, vote on severance, etc.). Really have only had a vote twice,
partnership agreements signed while drunk…
The EC are not telling other partners how much they’re making. Subject to a
check by Partners, but EC partners have the most %s…
Notes:
 p. 149 → courts are primarily concerned with partners making secret profits at the
expense of the partnership.
 Basic fiduciary duties of partners:
o (1) a partner must account for any profit acquired in a manner injurious to
the interests of the partnership (i.e., commissions or purchases on the sale
of the partnership property); (2) a partner cannot without the consent of
the other partners, acquire for himself a partnership asset, nor may he
divert to his own use a partnership opportunity; and (3) he must not
compete with the partnership within the scope of the business.
Facts: Day joins firm, married Burgess’ daughter, and becomes close friends with Adlai
Stevenson. Eventually goes with AS to work in government, becomes Postmaster
General (when it was a cabinet position), and introduces the zip code. Won prize
for contributions to postal industry. Forms Washington DC office of S&A and
becomes Chair (with Mr. Burgess, father-in-law, on the EC). When firm merges
with L&W, he has to have a co-chair (Mr. Burgess is dead).
Π:
(1) He has a contractual right to be sole chair of DC office; (2) he was promised
that no partner would be “worse off” as a result of the merger.
Held: (1) He had no contractual right (would have to be in writing). (2) He’s not worse
off. He doesn’t lose control – just has to share responsibility.
Reas.:
 The EC always had control over the Chairmanship of the offices – this does not
change anything.
 You wouldn’t want the partnership to be modifiable by anyone who comes into
the partnership. Those calling the shots are the 5 or 6 people who are controlling
the most important accounts. Allow you to get rich, do work you like to do – you
don’t join a firm b/c you want to be a part of democracy.
Notes:
 How could Mr. Day have protected himself?
o He could have requested a K saying that he was the Chairman of the DC
office forever – clearly this would not have worked.
o There wasn’t anything that Mr. Day could have done to protect himself.
Rules:
 You don’t change the partnership agreement at a place like this. The average
partner gets the average deal.
 Fiduciary duties are waiveable, default terms that can be contracted around.
Courts don’t mind adhesion contracts when you have rich, corporate partners
complaining about them.
Dissolution of Partnerships:

Buyout Agreements:
E. Partnership Dissolution
1. Buyout Agreements
a) G&S Investments v. Belman
(Ariz. 1984) p. 181
 G&S Investments is a partner in an apartment house deal with Nordale. Nordale
is living in the apartment house and gets addicted to cocaine, goes crazy, and
eventually dies. Before he dies, G&S tries to dissolve the partnership (under the
UPA, they can dissolve the partnership and carry on the business if one partner is
not capable of performing his part of the K). They have to buy him out (give him
his share of the Partnership Agreement). Then he dies. Nordale’s estate sues,
claiming that the entire partnership should be liquidated (argue that the act of
suing is the dissolution itself). When he dies, G&S want to buy him out pursuant
to partnership agreement which provides for buyouts in the case of death.
Nordale’s estate wants them to buy him out according to rules when you dissolve
the partnership.
 When you dissolve the partnership, you split up assets according to relative
interests (FMV of the property).
 BUT, if you buy out a partner pursuant to his death, then (p. 183) according to
their partnership agreement, the amount of the buyout is calculated by looking at
the capital account. Capital account = book value: what you put in – what you
took out. Appreciation and depreciation are not reflected in the capital account.
FMV is higher here.
 Therefore, they don’t have to pay him anything, and technically, his estate would
have to pay them the debt (they’re not pushing that).
o Would like a provision like this b/c you want to be able to carry on the
business, and don’t want to have to sell off the apartment. You might pick
a capital account provision b/c it’s much simpler (just look at the books).
Often fairly close to FMV (not always). If FMV, you have to figure out
what that is, which is not simple.
Notes:
 Partnerships can choose to have buy-out options, and can choose to use something
other than FMV.
2. Law Partnership Dissolution:
a) Jewel v. Boxer
(Cal. 1984) p. 185
Facts: 4 partners dissolving into 2 pairs each.
LC: Try to figure out time spent, source of case, and result of each in order to allocate
their relative interests in the partnership. Complicated.
Held: Court has them split up cases and continue to work on them, treating them as if
they were still members of the same firm.
Rule: (UPA) Upon dissolution of a law partnership, you continue to work on
partnership cases and split up profits as if you were still in the partnership.
Reas.:
 Court is thinking of incentives (want to keep lawyers from competing over the
most profitable cases, etc.).
Notes:
 If you’re an old partner, and you can choose btw working on old case and new
one that comes in, then you’re going to work on the new case b/c you don’t have
to share. This rule leads lawyers to shun the old cases (not clear that it’s a better
rule).
 The court doesn’t say that this is a better rule, they say that it’s what the UPA
says. Divide up proceeds as if you were still a partner.
General Rule for Law Partnership Dissolution: If you don’t contract around it, the
revenues that are earned after partners have left are held in trust by both sides; divided up
by respective interests that partners had before they left.
b) Meehan v. Shaughnessy
(Mass. 1989) p. 190
Hypo: Suppose there were no partnership agreement on point. You have PC and MBC
partners who decide to leave. In the absence of an agreement to the contrary, how
would these folks divide up revenues and expenses?
 Just like previous case – you would split up just like if they were in former
partnership. Both would have the same revenues coming in that were coming in
when they were at PC.
Facts: Different agreement in effect at PC. They say that any case which came to firm
out of a lawyer’s personal efforts, he or she can take away by paying a “fair
charge” (look to see how much time, money, etc. was invested by firm before
case splits off). When firm splits, some cases go to MBC and some cases go to
remaining partners. These cases have been developed by PC before they leave,
and based on this time and money, the MBC partners pay the market value of
those services. If those cases pay out, then MBC partners keep the profits (and
don’t get reimbursed for losses). Nothing happens with the cases that stay at PC;
MBC don’t get any of the money. Partners that decide to leave PC are at a
disadvantage (partnership agreement is skewed toward giving partners an
incentive not to quit).
Held: This arrangement is acceptable. If law firm partners want to enforce agreements
like this, that’s alright. BUT, in this case MBC didn’t take the cases away
properly.
(1) The court wants to find out whether clients would have gone with them if they
didn’t breach FD.
(2) In the alternative, they still make them pay the “fair charge,” but if they win, they
can deduct expenses (not partner time) and have to pay money back to PC, taking
only their old % interest (because they breached FDs to PC).
 “Fairly removed” cases are covered by “fair charge” (covered by agreement). For
“unfairly removed” cases, you have to pay the fair charge and still split up profits
according to old partnership agreement.
Notes: This decision could definitely affect whether or not the clients really have a
“choice” about which lawyers to go with.
III. Preliminary Corporate Issues

Limitations on limited liability
o Default rule = shareholders are not liable for the debts of the corporation.
o Shareholders can choose to guarantee corporate debts (and small
corporation shareholders usually do).
o Limitations on default rule = piercing the corporate veil
 Suits brought by investors on behalf of corporations (derivative suits)
 Extent to which people who run corporation can deviate from doing things that
maximize shareholder value (FD issues)
o Issue → when agents can use assets of principal to do something that’s not
necessarily in the principal’s best interest.
A. The Corporate Entity and Limited Liability
Forming a corporation:
 (1) Find out whether there is a minimum capital amount by looking at state law
(whatever it is, not a real constraint – probably not more than $10K).
 (2) You have to register the business with the Secretary of State of the state where
you want to incorporate (Delaware (large corporations) or state that you’re doing
business with).
o Call or go to website of CT Corporation (specializes in doing all of this for
you). You tell CT Corporation the state where you want to file and they
send you the form.
o In registering, you are filing your article of incorporation (varies with the
50 states).
 (3) Documents required:
o Articles of Incorporation (Charter)
 2 pages (front and back, tiny print) = Constitution
 You get the articles of corporation form from CT Corporation b/c
what needs to be in it varies from state to state.
 Blanks for incorporators, the name, and the authorized number of
shares, depending on state, it might have something about “par
value” of the shares, place to put in the business of the corporation.
 For “business of the corporation,” you want to put down something
very broad (“all business activities that are legal under the laws of
CA”) – do not limit it in the Articles of Incorporation.
 The incorporators sign it (probably the lawyers).
 Send it back to CT Corporation, who sends it to state (files it with
the secretary of state).
 States will send you a certificate of incorporation, seal, articles,
etc.
 Put in things you want to lock up from easy changes.




Typically, AOI have to be changed with vote of board and
shareholders.
o Bylaws
 Does not vary from state to state.
 Get from law firm word processing department.
 Much more flexible.
 Provides for officers of the corporation, quorum rules for board,
how often you’re going to have board meetings, committees, etc.
 Bylaws can be changed with vote of board or shareholders.
o SEC Filings
o IRS Filings
o Employer ID #
When you get the AOI back, you hold an incorporators meeting.
o At this meeting, you choose to issue stock, choose board of directors, and
adopt bylaws. At this point, you’ve done your job as a lawyer.
The Board of Directors are elected by the shareholders (usually all that the
shareholders do). They elect the BOD at the annual meeting. In large
corporations, they do this by proxy (i.e., they appoint someone as their agent to go
and elect directors). Directors are chosen as those who get the most proxies from
shareholders. Shareholders can come to the annual meetings, and usually do in
small corporations (if there are only a few shareholders, then they are usually the
BOD as well). The BOD hires the officers (President, VP, Treasurer, Secretary),
and the officers hire everyone else.
o Officers and employees are full-time employees; the BOD may or may not
be.
When you form a corporation, it means that you’re filing a legal line around an
abstract entity (group of people).
o Limited Liability → you don’t hold the people liable for the debts incurred
by this legal entity.
o Shareholders “own” the corporation, but they can’t sue. If someone steals
money from the corporation, you lose money. Legally, only the
organization has been harmed, so the organization has to sue. This is
problematic, because usually the person stealing money runs the
corporation and the BOD (who are not going to sue themselves). So, you
as a shareholder have to get the corporation to sue these people =
Derivative Suit
a) Walkovszky v. Carlton
(NY 1966) p. 206 (most famous “piercing the corporate veil” case)
Facts: Π got hit by a taxi cab. The cab is owned by a corporation (which owns 2 cabs).
Carlton owns the 2 cabs, and also owns 9 other corporations, which each own 2
cabs. Carlton takes money out the corporation by paying himself dividends from
time to time (keeps enough to pay for $10K in liability insurance on each cab, and
gives out everything else in dividends (subject to state corporate law limits on
maximum dividends)). When you decide there is more money in there than you
need, you hold corporate board meeting, and decide how much to dividend out.
By giving out dividends, you can keep only the minimum amount of money in the
corporation.
Π:
Alleges that he should be able to collect from Carlton personally.
Held: Carlton is not liable. He is not doing business in his personal capacity, but in his
corporate capacity. It is true that there are inadequate assets, but that’s not
sufficient to pierce the corporate veil – that’s a problem for the legislature.
Reas.: (1) Carlton is not commingling funds. The funds go from his corporate account to
his personal account, but not commingling. If you simply write yourself a check
for $1K, that’s commingling. If you hold a board meeting and decide to pay
dividends, then you won’t be commingling funds.
(2) Do you follow corporate formalities (i.e., holding board meetings, keeping
records, etc.).
(3) You need to show fraud or agency if you want to collect from Carlton.
o Why do we care about fraud here?
o Agency takes us back to respondeat superior and the liability that servants
impose on their master – PTCV doesn’t have a lot to do with respondeat
superior. Inadequacy of assets don’t come up in respondeat superior.
Test: Whether Carlton is running the corporation as his “personal assets;” whether it’s
something that’s distinct from him.
 Under this test, wouldn’t all small corporations be personal assets?
o For corporations owned by a sole shareholder, by straightforward
respondeat superior logic, the shareholder would always be liable (but
that’s not the rule).
o The reason that this isn’t the rule is that the sole shareholder will appoint
him/herself chairman of board of directors and President of the
corporation. When you tell the cab driver to do ____, you will be doing it
as President, and liability won’t extend to you personally.
o If you don’t follow corporate formalities, you potentially can make
yourself liable.
o When agent imposes liability on the corporation, he’s not acting as an
agent for the shareholder, but as an agent for the corporation.
Notes:
 Cab case, where you have cabs 1-4, and X (the garage). X performed various
services for the cabs (washed, repaired, etc.). 1-4 then paid the money to X
(rather than paying out in dividends, etc.). In some circumstances, you can have a
person who is injured by cab (corporation 1) hold X liable (enterprise liability).
Courts require a stronger showing when you’re trying to hold someone personally
liable than when you’re trying to hold another corporation liable.
 The law of PTCV gets less and less satisfactory as you go on (courts follow
formula only if it gives them their desired result).
 Is Walkovsky right?
o It can’t be right at one level – this is a cost of doing business and persons
using corporate form are using it to avoid this cost.
o Typical clients want to “compartmentalize” his or her assets (wants to be
exposed only to a maximum amount of liability in order to plan
investments, etc.). Once you start PTCV, it becomes impossible for


clients to plan b/c they won’t know their maximum liability from various
ventures.
o PTCV makes it impossible to run a stock market. If you start PTCV in
publicly traded corporations, people will not buy shares of stock (in which
case they would incur liability activities of corporations of any stock that
they owned while they owned it).
Would cosigning on a loan be commingling funds?
o Not if BOD met and decided that whoever is authorized to sign on behalf
of corporation would cosign.
PTCV does not happen with every small corporation, so we have to figure out
what puts some over the top.
b) Sea-Land Services, Inc. v. Pepper Source
(7th Cir. 1991) p. 211
Facts: PS ships peppers with SL. SL asks for payment and PS seems to have
disappeared. SL wins, but there’s nothing there to get. PS had one shareholder
(Marchese) and SL wants to hold him personally liable for PS’ debt. Marchese
has a bunch of other corporations (1, 2, 3) that he owns as sole shareholder and a
4th that he owns as 50% shareholder (TN).
Questions:
(1) Is Marchese liable?
(2) Are the other corporations liable?
(3) Is TN liable?
Tests: (p. 213) A corporate entity disregarded and veil of limited liability pierced when 2
requirements are met:
(1) There must be such unity of interest and ownership that the separate personalities
of the corporation and the individual no longer exist; and
4 Factors considered:
 Failure to maintain corporate records and other formalities;
 Whether funds are commingled;
 No undercapitalization;
 Whether one corporation is treating the assets of another corporate as its own.
(2) Circumstances must be such that adherence to the fiction of separate corporate
existence would sanction a fraud or promote injustice.
Held: SL loses the summary of judgment because they haven’t shown the 2nd element of
the test (sanctioning fraud or injustice). SL easily proves that the 1st element
(unity of interest and ownership) is met.
LC: Goes back on remand, lower court finds fraud/injustice (tax fraud, using corporate
funds for personal benefit – unjust enrichment, promised that PS would pay when
he knew that PS wouldn’t have the funds when it came time). Relatively easy on
remand for SL to collect against Marchese.
Issue: SL also wants to collect from corporations 2, 3, and 4 (reverse pierce). Why?
(when you can hold the owner liable, you have access to all of his assets, which
would include C2, C3, and C4). Probably has to do with bankruptcy rules here…
Issue: What about holding TN liable?


Doesn’t seem fair to the other shareholder unless he was actually participating in
the fraud.
Court considers the test to be met since Marchese treated TN like C2, C3, C4.
But, this means that Marchese has been stealing from the other shareholder and
now the court is trying to allow the Π to take even more money from the other
shareholder now.
Notes:
 The problem with PTCV cases is that the courts can produce nice tests, but you
use different tests in different situations in order to get the result that you want.
 Formulas are not worth memorizing (just one) b/c they are used when convenient.
 These cases come up on summary judgment (courts want to get rid of them
without a trial). The reason that the test has “sanction a fraud or injustice,” is b/c
injustice is easier to get on SJ. Fraud is a technical legal term that requires intent,
which is really hard to prove on SJ. Injustice is not a technical legal term, and
gives the courts a way to get rid of the suits on SJ (if you did have a trial, usually
the Πs could show fraud).
 Undercapitalization:
o When do you need to look at undercapitalization?
o All PTCV cases involve undercapitalization (in the sense that there’s not
enough money to pay Π). So it doesn’t become a completely workable
factor.
o Therefore, courts look at what the corporation was formed with (i.e., was
it formed with enough assets to meet its liabilities).
c) In re Silicone Gel Breast Implants Products Liability Litigation
(ND Alabama 1995) p. 221
Facts: Class action lawsuit against Bristol Meyers Squibb. MEC produced breast
implants, which it sold to doctors, who sold to Πs here. MEC is a wholly owned
subsidiary of Bristol (100% shareholder). Bristol basically runs MEC (i.e., 2/3
officers of BOD are Bristol officers, MEC has to get expenditures approved,
Bristol helped MEC with marketing and research for breast implants, provided
legal services, etc.). One some of it, Bristol is following corporate formalities and
on some, it is not.
 Are there less assets at MEC b/c of the way that Bristol has ignored corporate
formalities?
o No – Bristol provided a lot of free services to MEC, so there are more
assets in MEC than there otherwise would be. Bristol is not taking
dividends either.
Issues: (1) Whether Πs can PTCV → have to show that MEC is the “alter-ego” of Bristol.
B/c this is a multi-district proceedings, and a tort case, fraud doesn’t make sense
as an element of the cause of action.
 Why is this torts?
o PL falls under tort b/c courts want to impose a non-waiveable term (and
you can’t do that in K – the easy way to do it is to call it “torts”). PL isn’t
torts b/c it’s non-contractual, its tort b/c courts want to impose nonwaiveable term.


o There are a number of parent companies and if Πs had wanted that
guarantee, they could have paid for it (but the doctors choose the
product…)…
(2) Πs want to hold Bristol liable directly b/c there name was on the product.
Theory = “negligent undertaking” (e.g., if you are a commercial company that
does inspections on a building and you inspect a theatre negligently, and theatre
later catches fire, you can be held liable b/c you negligently provided the service).
Theory here is that Bristol is negligently marketing MEC’s products.
The claim is not that they were distributed negligently, but that they were
designed negligently. Doesn’t make a whole lot of sense to hold Bristol liable
there.
Any theory:
o This looks like a Bristol product (name, etc.). Thus, those at MEC are the
apparent servants of Bristol (“holding out”).
o Doctors want to sell products that have a major corporation standing
behind them (= good products). They would have insisted on a guarantee
from Bristol Meyers if they had known of the situation, but they didn’t
know – they relied on the name on the box. Therefore, you’ve got liability
by some sort of apparent servant status.
Notes:
 Doesn’t make a whole lot of sense.
 Court ends up distinguishing btw tort and contract cases:
o In contract cases, formalities might matter. In a K case, you can check
whether a firm incurs follows corporate formalities, etc. (you can evaluate
the level of risk).
 Because it’s a risky loan, contract lender will charge higher interest
rate.
 If they can collect also because it’s undercapitalized, they would
be able to collect twice.
 Can negotiate a guarantee if you want.
o Doesn’t make any sense to look at corporate formalities in the tort sense.
If a Π gets mowed down by a corporation’s agent, the heir is not going to
care whether the corporation kept decent minutes. She would only care
about undercapitalization. In the tort context, undercapitalization makes
some sense.
Hypo:
 A couple of investors (W & G) want to rehab a bunch of houses in Cambridge.
They each decide to put in $60K, and they go to a bank and borrow $10M. They
buy 6 houses, gut them, rehab them, and sell them for a profit. W has other assets
that he wants to protect. What sort of paperwork should the lawyer suggest?
o Might want to form 6 corporations (one for each house).
o They could have each corporation take out insurance.
o Downside → they would have to hold BOD meetings to borrow money
from the other corporations, etc. (more hoops/formalities to jump
through). Depending on the people involved, this could be a huge
problem (6 different bank accounts, 6 sets of corporate board meetings, 6
sets of stationary, etc.). If they did all that correctly, then a loss at 1 house
only jeopardizes those assets. But, the more complicated you make it, the
more likely they’re going to mess up.
o If you make one corporation, then it makes it more likely that W’s other
assets are going to be protected. If it’s complicated and they mess up, not
only are the other corporations going to be held liable, but W’s other
assets will also be jeopardized.
B. Shareholder Derivative Actions
The fact that you’re forming a corporation means that you’re forming an entity that can
be both a Π and a ∆ in a lawsuit.
Sometimes, a corporation has to bring a lawsuit.
Derivative suits:
 Suppose you’re a shareholder in a corporation that makes look-alike Coco Chanel
coats. The manager runs off with 100 coats, so the corporation has just lost $1M.
Shareholder is hurt (100% owner) b/c stock is worth $1M less. You can’t sue b/c
the entity that has lost the money is not you, but the corporation.
 One of the consequences of forming a legal entity is that shareholders do not
make day-to-day decisions of the firm (managed by the BOD). The shareholder
doesn’t make decision about whether to sue. Suppose the BOD decides not to sue
someone who takes assets from corporation. Shareholder demands that the BOD
sue, and they refuse. If you try to get court to review this decision, we go to
“business judgment rule:”
o Is there a conflict of interest? (not if they have nothing to do with it) –
absence of COI means that duty of loyalty is met
o Is there gross negligence? (hard to prove) – absence of GN means duty of
care is met
o Here, they decided not to sue. There may be good reasons why the BOD
chooses not to pursue every possible claim. If they’ve made a reasonable
decision, courts are not going to 2nd-guess it.
 Suppose that the one who stole the $1M is chairman of the board and the board is
full of her cronies. They are not going to sue themselves, so you take it into court,
claiming that the corporation should pursue this claim against the chairman.
There is a severe conflict of interest (party who should be sued is in charge), so
court will not apply BJR. Therefore, shareholder sues the corporation, asks them
to do something (in equity) (as Π), to bring suit against corporation (as ∆). If
there’s a recovery, it goes to the corporation, not to the shareholder.
o In theory, shareholders shouldn’t care whether the recovery goes to you or
to the corporation (you will be made “whole” either way).
 Direct Suits → if there is a loss that goes to you directly as a shareholder, the
recovery goes to you.
Test:

Derivative = corporation has been harmed (e.g., conflict of interest, stealing
money suits).
 Direct = shareholder (personally) has been harmed (e.g., shares have been stolen).
Difficult to distinguish in practice!
a) Eisenberg v. Flying Tiger Line, Inc. (2d Cir. 1971)
p. 236 (Irving Kaufman, Judge – famous, notoriously irrascible)
Facts: E thinks that FT wants to dilute his voting interest. FT organizes subsidiary
called FTC, which organized subsidiary called FTL. FT merges into FTL, which
changes its name to FT, and therefore FTC now owns FT. FT took over the
operations of the corporation and owns the planes. E starts out as a shareholder of
the company with the planes. His FT stock, in the course of the merger, was
changed into FTC stock. The FT shareholders got stock in a company that’s not
part of the merger. The value of the stock is worth exactly the same thing. But, E
says that he’s hurt and ought to be able to bring this as a direct suit.
Held: Court’s test:
 If the damage is to E personally, then it’s direct; if harm is to corporation, then it’s
derivative.
 Here, E’s rights as a shareholder have been harmed, so it’s a direct suit, not a
derivative suit (E no longer has any voting rights).
o E’s only vote before meant that he could elect directors of company that
owned planes and ran corporation. FT directors are now chosen by FTC,
and he can vote on FTC directors. Only thing that changed is that E could
vote directly on directors of company that owned plane before (adds one
step more). No real damage (couldn’t stop the merger, which involved a
2/3 vote; most decisions are majority vote). He’s trying to assert that he
has a non-financial interest in voting (if he alleges financial interest, then
it switches to derivative suits).
o E doesn’t make argument that the corporation is monitored less closely,
b/c that means that the stock is worth less and the corporation has been
harmed, which would make the suit derivative.
Notes:
 Problem:
In the real world, people don’t really care about voting, they care
about money.
 Why did FT do this?
o They say that it’s a combination of tax reasons and regulatory reasons.
 Hard to tell whether it’s direct or derivative b/c the test centers on harm and in
this case there was no harm.
Rule: If you have a claim where you’re arguing that your rights as a shareholder to vote
have been affected, that will be a direct suit.
 Also direct = suits to compel dividends, suits to enforce stock redemption rights.
 Most cases where you have a senior manager of the firm stealing money are
derivative suit cases.

Important for E that this is direct, b/c he doesn’t want to post bond (if you lose,
the money goes to the other side) – has to do with the depression. A lot of firms
were doing badly, and there were a lot of shareholder derivative suits. The NY
Chamber of Commerce came out with famous study in which they found that only
8% of all shareholder derivative suits came out with any recovery at all (most
were bogus cases brought to extract settlement). Therefore, states decided to
make shareholder Πs post bond (so Πs make all arguments they can to have
something classified as a direct suit).

Varies from state-to-state how many shares you need to own in order to bring a
derivative suit (e.g., certain % of stock, held for certain length of time,
combination, requirement that you held it during time of wrong).
–
– Armond Hammer bought art because he thought rich people should buy art, near the
end of his life he wanted to donate the paintings and name a wing after him, but they
wouldn’t so he started the Arm & Hammer museum, built by Occidental Petroleum
(Armond Hammer was CEO), should courts intervene? What happened in real life: 2
shareholder suits 1) brought by institutional investor, sued Oxy to sue AH 2) brought
by a plaintiff’s attorney, nominally the same thing sued Oxy to sue AH
– Which one do you settle if you are the board? Settle with plaintiff’s attorney
(cheaper) the other suit loses its cause of action, settle for $800K and that was it even
though the institutitonal investor objected
– Corporate Altruism
– In most cases, corporate giving is legal, the harder question is it wise – we have
drawn legal lines around the entity and courts don’t like to second guess the people
running it, but sometimes they have no choice, how much can agents deviate from a
profit-maximizing strategy
C. The Role and Purposes of Corporations
a) APSmith v. Barlow
– Smith is a high-tech fire hydrant company, they decide to give $1500 to Princeton, a
shareholder decides to sue
– Court says that corporation do have some public responsibility, and donating to
Princeton, private universities, the more we stop communists (benefit for APSmith)
– Why not just leave it up to the shareholders? If they want to give to Princeton they
can give it on their own.
– Well, APSmith gets some benefits, PR at Princeton, wouldn’t get this reputational
benefit if shareholders gave, suggests that we should never allow anonymous gifts
– Should require corporations to advertise their donations?
– American don’t have uniform charitable tastes…poor people give to churches, rich
people give to symphonies, museums, etc.
– Dividends
– Rules limiting the dividends that can be given out (can’t borrow a bunch of money
give out dividends then declare bankruptcy), won’t go over these but be aware they
exist
b) Ford v. Dodge
– Henry Ford doesn’t want to distribute profit dividends but instead expand capacity
and sell the cars cheaper
– The Dodge bros. Are suing want to require that he issue special dividends and stop
Ford from building the smelting plant. Why didn’t they sell their stock? Because it
was not a listed company, totally private company and Henry Ford doesn’t want to
buy the stock. He doesn’t want to give them cash to put into the Dodge company.
– Is it ok for Ford to do this? Seems like he is just preventing the Dodge brothers from
competing with Ford. Might raise anti-trust issues but not corporate issues.
– How about the Dodge Bros.? Is it ok trying to drain profits from Ford so their new
company can succeed. Dodge Bros. Don’t have a fiduciary duty, they are only
shareholders not a director. Controlling shareholders have a fiduciary duties, but 10%
shareholder is trickier (might depend if it is public company or not).
– What is the court worried? He seems to be running the company as a charitable,
public institution – cheaper cars, higher wages, etc.
– The Court does not give the injunction to expand the smelting plant but they do
mandate the dividends because he doesn’t seem to maximizing shareholder profits.
– Why did the case turn out this way? Henry Ford wanted to see as a great man, not as
profit-baron, he couldn’t go into court to say that he was doing it to make money. Not
really clear what the court decided here but Ford came and said “I’m not trying to
make money” and in that case it will require the corp. to issue dividends. A little bit
of coaching would have gone a long way.
– In 1913, top marginal bracket is 7%, in 1920 the top marginal rate 73% so
shareholders will be taxed heavily (Ford and Dodge) but Dodge might b just trying to
cripple Ford
c) Wrigley
– What is the metric do you use to measure whether agent is running the corporation
properly, and how much leeway will we allow non-profitable motivations?
– Here the question is whether to install lights at Wrigley Field.
– Plaintiff is minority owner of the cubs and Wrigley owns 80%, accusation of
negligence and mismanagement, claiming all other teams have night games
– Wrigley says he doesn’t lights because baseball is a daytime sport and also the
neighborhood would be disturbed, here the plaintiff loses
– Suppose Wrigley owned 100% of the White Sox, would the outcome change? Yes,
Court would intuit that he would try to funnel business from his 80% to his 100%
business and also his “baseball is a daytime sport logic is not a convincing”
– Court says only will second guess if it is egregiously out of line
– Don’t want to require that directors just be coached by lawyers, also a lot of people
who invent really successful/popular ideas don’t do it solely for the money
– Court will say as long there is no conflict of interest, they will leave the decision to
the directors
– Ben& Jerry’s hypo:
– Were looking for a new CEO, the rule was that top-paid person could not make more
than 7X the ice-cream scooper, what if B (60%) is rich but Jerry (40%) is poor and
needs the profits, what will court say if Jerry wants to pay someone more? B will win,
even if J shows you can’t get someone at 80K, if B just says he thinks its wrong you
won’t get a Dodge v. Ford result you will get a Wrigley result.
– What if B owned 100% of another ice cream company? Court will intervene.
– New hypo: B&R, B (60%) and R (40%) and B becomes committed to ecofriendly
ice-cream, R tries to stop this change, the difference is that minority shareholder is
trying to stop a change in policy rather than implement a new policy, but there is no
real, technical difference between these two. Only way this changes is if B owns a
rival chain.
IV. Fiduciary duties
– If you meet duty of loyalty and care, Court will defer to the business judgment rule,
duty of care is the trickier of the two, the test is whether the director is using the level
of care they would have used for their own property
– Directors are agents which means they must exercise duty of skill, diligence and care
that prudent person would exercise in the same circumstances with his/her own
property, if you meet this test, just business judgment rule, if you don’t then can be
found to be negligence but really something close to gross negligence
– Met your duty of care as non-negligent, met your duty of loyalty if there is no
Conflict of interest, no fraud, no illegality  BJRs (all these are prerequisites of
getting to BJR)
– Not whether you made a mistake, whether you took reasonable care in making the
mistake
A. Duty of Care
– Business Judgment Rule
a) Kamin v. Amex
– Amex buys DLJ whose values falls from 30 to 4M and the directors want to distribute
to their shareholders as dividend in kind instead of selling it on the market and
distributing the cash, the shareholder wants them to sell it so they can realize $8MM
in tax benefits
– The hint of self-interest is that some directors salaries are keyed to profits, taking the
loss would directly lose salary (conflict of interest), court glosses over it just does a
duty of care analysis
– Brought in consultants, had a special meeting about it, so they were careful about
making this bad judgment so we are not going to second guess it
– This really is the law with respect to dividends, not Ford v. Dodge
b) Eisner
– Disney is run by Eisner, hard to work with
– Michael Ovitz and Eisner are long-time good friends, before this he was called the
most powerful man in Hollywood ran his own talent agency,
– Matstusha bought MCA (through Ovitz) which was disaster and then organized a sale
to Seagram (Bronfmam) who didn’t hire Ovitz and Eisner comes in
– Supposedly their relationship soured right away, the plaintiffs are bothered by
contract that if he is fired without cause all of options immediately vest, he will walk
away with $140MM
– Plaintiffs have three arguments – 1) Old Board – says violated duty of care in
approving the K 2) Old Board – committed waste 3) New Board violated its duty of
care by firing without cause
– The defendant responds that they did meet their duty of care by hiring a compensation
expert, who did not do a numbers crunch (he may have been negligent, which goes to
whether he is liable to Disney for negligence)
– Delaware Corporate Law says that directors may reasonably rely on information
presented by experts as long as you have picked experts with due care (directors are
not responsible for knowing everything), would be liable only if it is not good faith,
not careful, not within expertise, or so unconscionable that it was waste
– Court says $140MM is not waste, the test for waste an exchange that is so once sided
that know reasonable person would think there was adequate compensation (Disney
have revenues of $91B), if you want the most powerful man in Hollywood you have
to pay for it
– Court says BJR fully protects the Board in deciding whether to fire him for cause or
not
– What is the duty of care?
o Director’s need to exhibit a degree diligence, skill and care that a
reasonable person would exhibit in the management of their own affairs
c) Francis
– Company is a reinsurance broker company (Pritchard & Baird), hold a lot of cash
– Was Charles Sr., he’s dead and now run by Charles. Jr. and William, who are both
stealing from the company
– Mom is also on the board, but she is drunk and never gets involved with the company
– Creditors are suing Mom after they go bankrupt, note that usually you don’t have a
fiduciary duty to creditors, but here court says that BROKERS are like a bank and
they do have a fiduciary duty
– Also went you hit insolvency your fiduciary duty switches from shareholders to
creditors
– Charles and William took loans that they never intended to pay back and commingled
funds
– Court says Mom is on notice because Dad told her to watch out
– Court says the minimum level of care is an objective test, if you can’t do the certain
minimal level of work you should just quit
– You can rely on subordinates, but here if she even tried to look at the financial
statements she would have seen something fishy was going on
– There is also a causation argument, she says the sons were the proximate cause, Court
says that she could of stopped it, if they just called it to her attention they would have
stopped
– Court says you have to object at meetings and even threaten to sue to meet your
fudiciary duty
– Hypo:
– Health club is about to go bankrupt, you are a director, if you sign up a few more
customers you may make it by getting money for advertising, deciding to do this is
under BJR
– So then you get your friends to sign up for year long contracts, even though you know
they might lose their $, originally you don’t have a fiduciary duty to prospective
members (probably won’t use Francis logic), when you are insolvent then you do
–
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d)
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B.
1.
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have a fiduciary to the creditors, the question is it fraudulent to not disclose? No, it is
fraudulent to lie if asked but there is no duty to disclose.
What if a law partnership knows they will go bankrupt next year, do they have a
fiduciary duty to not hire summer associates? No.
Question: when can a director not worry about what the lower level employees
doing?
Suppose you are a director and you divide up the company and have separate
accounting and the compensation of each director is tied to the profitability of each
division, you can do this.
Suppose one of the sr. officers decides to start bribing doctors and if he is caught and
then fine is $1MM but only a 5% of being caught, should the corporation be liable?
Maybe under criminal law. Also a question whether there be a derivative suit against
the officer. Caremark question is whether the director would be liable.
Caremark
Criminal charges are settled for $250MM with the government
Shareholders are saying that Caremark suffered the loss because the directors did not
set up a system to monitor illegal activity, Court says this is a weak case
Court says that their subordinates are behaving properly unless specific suspicion is
raised that directors are free to assume (no duty to install a system of corporate
espionage), this might not be the blanket rule anymore
Here the court still says that directors were not negligent
Hypo:
o Own a trucking company, every state has 60K wt. Limit except one which
has 45K limit, going to get caught 20% of the time and the fine is $200,
economically it makes sense and the shareholders would want you to do it,
if there is no negative pr. Same idea as Fedex telling drivers to not worry
about double parking. Suppose you can get around the $200 fine by
paying a $50 fine, should you vote as a director to pay fines? No, but the
more relevant question is whether you should turn a blind eye when you
know it might go on and it is in the corporation’s best interest. The way to
solve this is to start enforcing/raising penalties, it shouldn’t really be a
corporate law issue.
o What if you outsource to an independent trucking co. which you know
will bribe? Not liable. But there is no affirmative duty to hire the
independent co., directors are not supposed to be mere calculators.
o If Directors vote for kickbacks is profit maximization a defense? Depends
on the suit. Not in the criminal suit, of course. Directors are liable in the
derivative suit, but question is whether can you offset the damages by the
extra profits you made because of the kickbacks.
Suppose you have Chrysler telling an employee to hack into the Chevy system and he
gets caught should directors have to pay the fine? Seems quite bad and they should
have to pay. Whether directors will be liable seems to turn on how bad the crime is.
Duty of Loyalty
Directors and Managers
Directors are not supposed to be working for themselves and the corporation at the
same time unless there is consent
a) Bayer v. Barron
– Start an advertising campaign, a radio show and the president’s wife is one of the
actor’s, they hire consultants, advertising execs etc prior to committing to the
campaign.
– Alleged conflict of interest. If she offered to sing for free would that solve the
problem?
– It is not a BJR case, you have a conflict and it is not ratified and the court still says it
is ok. Unusual case.
– Court glosses over the fact that there was no official vote by the board to begin the
campaign
b) Lewis
– SLE owned the property, LGT leased the property for a store
– 6 members of SLE board, 3 of the members comprise the Board of LGT
– There was a lease between LGT and SLE, which ran out and instead of renegiating
the price it stayed the same even though the property taxes, etc had increase.
– The other 3 members agree to send their interests to the 3 LGT members, there is a
dispute over book value, which depends on the amount of cash has come in
– Don brings a derivative suit, on behalf SLE, which has been cheated out of the lease
money
– Could Don sue LGT? No it paid exactly what the K its directors obtained for it
required it to pay.
– Court says this was not ratified by disinterested parties. Could there have
disinterested ratification? Could have bring in a 3rd party without a financial stake in
either.
– This case tells us if you have a conflict of interest, the party that is potentially
benefiting has the burden of proving that the K is fair and reasonable.
– If there are disinterested parties the burden switches and back to the BJR.
– If no COI  BJR, BOP on Plaintiff to prove waste
– If COI  BOP on defendant to prove fair and reasonable
– If COI and disinterested ratification (bop on defendant)  BJR, BOP on Plaintiff to
prove waste
– Statutory framework
– 19th century - Any K between corporation and director was voidable by any
shareholder, didn’t matter if it was fair or ratified
– 20th century – voidable but sometimes you can make deals that stick if they are
ratified and fair
– Now in many states, courts will not void if it is ratified OR fair, so now easy to make
K’s to stick
– Is this an improvement?
– Old  hard to deals to stick, Now  easy to be interested deals, Ramseyer says not
obviously better or worse, depends on the firms, more risk of stealing but can get
better Ks
– Small firms  only people likely to loan money is a director
– Statute on p. 375
– Keep on mind they were drafted to get around the rule that none of these deals stuck,
the statutes try to make this no longer the case
– You can ratify by a vote of only the disinterested directors, or if material facts are
disclosed to shareholders and they vote/ratify it
–
– COL
– Ratif
– BOP
–
– Yes
– No
– Defendant
– Fair & Reason.,
– No
–
– Plaintiff
– Waste (BJR)
– Yes
– Yes
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– Shareholder fiduciary duties, shareholders are only there to make money for
themselves unlike directors who are there to look out for others
– There are situations where shareholders have fiduciary duties, when they control the
directors (controlling shareholders)
– Can shareholders be held responsible for acts of the director’s they appoint?
2. Dominant Shareholders
a) Sinclair
– Sinclair owns 97% of Sinven, who produce oil in Venezuela
– Sinclair International also owned in Sinclair, buys oil from Sinven and distributes to
Sinclair
– Minority shareholder is suing Sinven (3% owner), for giving too many dividends,
saying they should have reinvested
– Sinclair says BJR covers dividends (Amex), plaintiff’s says that in this case you
should have an intrinsic fairness standard. For BJR BOP is P which is very high,
intrinsic fairness BOP is defendant. Court says intrinsic fairness applies anytime there
is a self-dealing transaction between a parent and a subsidiary. But here court says
there is no self-dealing, it’s only giving itself a proportionate amount of money (3%
of dividends going to the minority shareholder), no opportunity for self-dealing. Once
there are 2 classes of stock (one for Sinclair the other for minority) then you have to
start worrying about self-dealing.
– There is also a claim about “business opportunities,” (usually called corporate
opportunity) claiming that Sinven had opportunities to build oil businesses in other
countries but Sinclair board members gave it to other subsidiaries. Court basically
dismisses it and endorses owning country-specific subsidiaries
– The last claim is a K claim that Sinclair allowed SI (owned 100%) to break K’s with
Sinven (97%), here there is an opportunity of self-dealing so the Court says lower
court must apply the intrinsic fairness test
b) Transamerica
– Authorized stock is allowed by charter of incorporation, outstanding stock is actual
stock sold, par value is the value below which it cannot be sold
– The way you gut the par value rule is by putting it at $1
– Preferred Stock and Common Stock;
– Preferred, company has an option – we won’t pay any dividend, or it can say the
preferred get 5 and common also get the dividend, what it can’t say is that common
get something that preferred don’t
– Usually preferred stock holder can’t vote unless dividends are missed, cumulative
preferred means if you missed dividends you have to pay out all the dividends that
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3.
a)
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you missed (can’t just build up common stock dividend and pay it out every 5 years
and skip preferred stock dividends)
Also a standard provision, when you liquidate, preferred stocks get any missed
dividends before common stock gets anything
This case doesn’t involve preferred it involves Class A & B
Class B is common stock, Class A is like jr. preferred stock, but officially common
stock also
Why would company come up with a scheme like this?
Issues:
Company has an option to buy back stock A at $60 plus accrued dividends
Class A shareholders have an option to convert an equal amount into Convert B
Liquidation – A’s get assets 2:1 over B
When B’s tells the company to call the A’s (for $60), the A’s will convert to B’s if it
is to there advantage, assuming the information is available
There are 3 potential zones for owners of common stock A: 1 where there is no
conversion or call, 1 where there is a call but no conversion and then 1 where there is
call and conversion
In this case the B’s (who control the board) called for redemption but did not tell A’s
they were going to liquidate for a large $$ which would have made advantageous for
them to convert
Court says when you have these decisions controlled by one class of stockholder, the
default rule is that you favor the most junior stock (general rule) (corporation itself
doesn’t care how dividends are distributed, can’t violate your duty of loyalty to the
corp. based on dividend distribution)
The class A shareholders in this case did not know they should have
converted/redeemed
10 (b) -5, anti-insider trading rule, Court is saying that Transamerica is participating
in insider trading they are profiting on inside information, class A stock holder did
not know they were in the zone where they should have converted
If this was public traded company it would be obvious/available that they should
convert, but in a private company it hard for shareholders to tell.
Ratification
Lawrence
Mining company named Agau, president is named Lawrence
Lawrence finds/buys some mining property (conflict of interest potential)
He divulges and offers to company, and they say they don’t have the money to buy it
but they do get an option to buy in the future
Lawrence creates a new co. and puts the property he acquired to that corp.
He exploits the land and it becomes valuable and the co. exercises their option and he
gets co. stock in exchange
Court says that Mr. Lawrence has the BOP, according the Delaware statute, Lawrence
says that it was ratified by shareholders, BUT court says that some of them were
interested and some of them weren’t
There was no separation between interested and disinterested voters, a vote of the
both so there is no ratification at all,
– Now the test it is whether it is a “fair” contract and the burden is on the potential
conflict of interest party (Defendant) (see NY statute)
– Hypo
o Scheme designed by Ramseyer’s friend to get around the fact that
paralegals can’t keep their firm retirement contributions if they leave prior
to 5 years
o Create an investment company and tell the retirement trustee to buy shares
of that company and make yourself a preferred shareholder, with a very
high liquidation ratio, when you leave the firm liquidate and you get to
keep most of the firm’s retirement contribution
o Originally, need ratification for COI by disinterested
shareholders/directors of retirement trustee (the disinterested shareholder)
o The associate is violating fiduciary duty, obviously, because he is taking
money from the firm that he is not originally entitled to, when he came up
with this scheme that is when he violated fiduciary duty.
V. Securities Disclosure
– Two federal statutes
o 1933 Securities Act
 Disclosure for IPOs – S1
 Prospectus is the summary of the S1
 Very complicated but irrelevant because mostly sophisticated
investors are mostly looking at it
 Very expensive and firms may disclose info on their own
– 1934 Securities and Exchange Act
o Partly registration/disclosure/regulation
o Insider trading 10 (b)
o Liability for short-swing 16 (b)
o ¼ leg disclo.
– Tender Offers
– Proxy solicitations
– Blue-sky state laws
– Pg. 418 (1933 act)
o Unless a registration statement is in effect cannot sell a security (file with
the SEC and wait a number of days to negotiate with SEC)
o How do you avoid registration?
o Security definition is very broad, covers anything where you are investing
in a common pool with the return being accomplished by work of others
o Certain securities are exempted and certain transactions (non-public
offerings) are exempted
o Criminal and civil liability for violations (sec. 11)
o Registrations have two parts (Expertised parts and non-expertised),
liabilities depend on whether it is part of the expertised portion or nonexpertised and whether the person is an expert or not an expert
– See pg. 431
o Non-exp portion – Exp (No liability) – a4
o Non exp portion – Non-Exp – Reasonabable investigation. 3A
o Expertised portion – Expertised – 3B Reas. Invest
o Expertised portion – Non Exp – 3C – no reason to think false (3c)
a) Escott
– BarChris made bowling alleys, and there is a crash
– They issue bonds to raise money and within a few months become insolvent and
default so shareholders bring a class action
– First thing court decides that there a lot of misstatements (overstated earnings,
understated liabilities)
– Court says only 1960 numbers are expertised, 1961 numbers are not expertised
– Material misstatements, would a reasonable investor deterred from buying the
security
– Barchris itself has no defenses (the issue)
– The accounts can expertise portions but not lawyers
– The fact that they didn’t understand the statement is not a defense
– Court finds the treasurer guilty too, he provided the false numbers
– Young lawyer joined the company as a director and who signed amendments without
looking at it, he is liable too (most law firms have rules against this)
– Partner at the outside law firm who drafted to the statements, the court says there is
more expected from him, court says you are supposed to check the things that are
easy to check
– Pete Marwick (accountant), should have checked further into
– West
o Prudential, Hoffman is an analyst there, he lied to 11 investors that JSB is
going to be acquired at a premium
 If it is true it would be insider trading
o Plaintiff’s are everyone else who bought stock without the information
(the class that wants to be certified), that they paid more for the stock than
they should have
o Eastbrook doesn’t like the plaintiff’s bar, very cheap to file very expensive
to litigate and very expensive for defendants to lose, so usually settle the
company usually gets nothing but plaintiff’s attorney get a lot of money
o He is trying to throw it out before the class is certified (sort of, short
circuiting the jury system)
o 1st point he makes
 Stock markets are relatively efficient, price of stock will reflect
public information
 Price of the stock will be exp’d cash flow
o Demand curve for stock is flat
–
March 15, 2004
b) West v. Prudential Securities, Inc.
(7th Cir. 2002) p. 457 (Easterbrook – loves securities law)
Facts: JH was a Prudential stockbroker/analyst. He lied to 11 investors, telling them that
Jefferson Savings Bancorp was “certain” to be acquired at a large premium (they
would make big bucks quick). If true, then they would be trading on insider
information and there is criminal there. But they weren’t true.
The Πs here are everyone who bought stock while JH was lying (claiming that
JH’s lies drove up the price of the stock to an artificially high price, which then
fell after it turned out that JH was lying and the 11 sold) – general buyers, not the
ones that JH lied to.
Πs:
Notes:
Easterbrook developed economics of securities law – loves this stuff.
If Easterbrook certifies this class, you potentially have liability for $5 for every
stock that changed hands during the 7 month period. That (and below) is what’s
driving the decision here.
 He doesn’t like the securities Πs’ bar.
o Price fall → Πs’ attorneys file claim immediately → then find out who did
what wrong
o Incredibly cheap to file and extraordinarily expensive to litigate, extremely
expensive if ∆’s lose ($5 for every piece of stock that changed hands
through an X month period) → so they often settle for quite a lot of
money. Company typically gets nothing at all; Πs’ attorneys get a large
compensation for their “work” in filing the suit.
o This is a bogus suit and a bogus case – will never go to trial. Prudential
will settle because it doesn’t want this case to go to the jury.
 Easterbrook wants to make sure this never goes to court (i.e., before the class is
certified) because Prudential will settle no matter what (whether there’s a valid
claim or not).
o Only people in the jury pool in these cases are people who are willing to
take 5 months off of their schedules, and the cases involve incredibly
complicated issues, therefore = a crap shoot for the ∆s (regardless of
whether they have a valid defense).
Reasoning: (how Easterbrook goes about stopping this)
 (1) Stock markets are relatively efficient (i.e., the price of the stock will represent
publicly available information) (not controversial).
o Publicly available information gets impacted into stock prices very
quickly.
 (2) The price of the stock will be the present value of the expected cash flow (not
controversial).
o Is there money coming into the firm or not?
 (3) That means that the demand curve for stock is flat (horizontal) (--------)
(controversial).
o B/c (says Easterbrook) the only thing that analysts care about is the PV of
the ECF.
 For most products, as the price increases, the number of people
that will buy the product goes down, so the demand curve is
diagonal. Easterbrook says that this has nothing to do with the
demand for stocks.
o E says that no one cares about having shares of a particular stock – only
care about having a diversified portfolio (will take any stock at a given



price with a given rate of risk and return). If the sellers are trying to get a
penny more than the PV of the ECF, then you’ll switch and go to another
company’s stock (since they are interchangeable).
o Logically, this makes sense. However, there are quite a few articles out
there that are purporting to show that the demand curve for stocks really
isn’t flat. E is getting into dicey areas in order to work through the chain
of logic that he thinks he needs to work through.
 There isn’t a strong theory out there about why the demand curve
for stocks might not be flat. If you go through straight-forward
finance theory, it might be that the demand curve really is pretty
close to flat.
 The reason that stock prices rise right before a tender offer is
because information leaks out into the market. In TGS case, the
stock price is going up because of rumors that the company struck
ore in Canada. INFORMATION in the market will affect the price
of the stock (but absent information, you’re not going to see it).
 Πs says that JH gave us information, we traded on it, why wouldn’t
that increase value of stock?
 E says that pros would discount this information as false.
When they notice increased buying, they would investigate.
When they see who it is that are buying the stock (investors
who talked to JH), they will know that they can’t have any
inside information, they will discount the information, and
the price won’t go up – therefore, the general buyers will
not have suffered a loss/injury, therefore no damages, and
E won’t certify the class.
Information gets incorporated into the stock prices by people betting against each
other.
o There is some controversy over the extent to which not-yet-publicinformation gets impacted in stock prices.
Held: Class not certified (see above).
Notes:
 Isn’t this a factual issue?
o E → yeah, but this is the integrity of the court system, and if you have
bogus claims routinely being brought, it’s my responsibility to throw them
out.
c) Pommer v. Medtest Corporation
(7th Cir. 1992) p. 462 (Easterbrook) (34 Act Case)
Facts: Medtest owns the IP for a self-administered pap smear process. Manning devised
the process and he and his lawyer, West, formed a corporation (Medtest).
Manning sells some of his stock to the Pommers, telling them that they already
have a patent on the product, and are on the verge of closing a $50-$100M deal
with Abbott Labs. It doesn’t have a patent, but eventually does get one, and the
deal with Abbott Labs falls through. The Pommers sue.

Why should the Pommers be able to the recover?
o Because the fact that they eventually acquired a patent doesn’t eliminate
the lie that they already had a patent. If they didn’t have a patent, then the
probability that they would have gotten one would have been something
under 100%, which would have affected the price of the stock (i.e., if there
was a 50% chance of getting the patent, and if the value to the Ps was
$2M, then the value at the outset would be $1M).
 He also told them that there was a $50-$100M deal with AL “just around the
corner.”
o E points out that if someone says that a $50M-$100M deal is “just around
the corner,” you would realize that if the price range was so great, it
wasn’t a certain deal.
o So they should have been on notice that it may not go through. They may
have discounted it, but probably didn’t discount it as much as they should
have (had he not said that it was a “sure deal”). Therefore, they would
have paid a lower price if he had not said that.
VI. Insider Trading
1934 Securities Exchange Act:

Hypo: Suppose that there is a hostile takeover plan in the works for Apple
Computers. The problem is that there are no nerds left at Apple (just stylists who
come up with pretty machines). The Comp Lit department does Larry Summers
in, he leaves, and takes over Apple, claiming that he has a demonstrated ability to
attract nerds. Apple is trading at $100/share. LS decides to do a tender offer for
Apple stock for $120/share (conservative amount).
o Tender offers are not welcomed by the corporate management. Investors
like it.
o Apple stock prices will now hover btw $100 and $120 (depending on
whether people think that this will go through or not). It might not go
through (e.g., LS might not buy unless he gets at least 51% of the stock
tendered to him). Variety of conditions on this. Probability of it going
through depends on the conditions being met (which means that price will
go up and down during this period).
o Basic investors sell out quickly (to the arbitragers (pros) – hold stock and
take the risk that it might or might not go through).
 During the mid-1980s, the most famous arbitrager was Ivan
Boesky. He was famous b/c he caught b/c he was the richest b/c
he cheated (had informational advantage). He knew which tender
offers were about to go through and he also knew when tender
offers were about to be announced.
 To get the money to the make the tender offer, the potential
tender offeror has to go to an investment bank, who would
lend the money or help raise the money. They would form
a new corporation (Apple Acquisition Corp.) which would
get a lot of cash by issuing bonds. Heavily leveraged
company (the bulk of the money is coming through debt

holders). The bonds are high-risk (with potential high
returns) – junk bonds (but are less risky than stock).
 The investment bank’s (that came up with this – Drexel
Burnham) manager (Michael M) allegedly leaked
information to Ivan Boesky. They got him because they
threatened to go after his little brother. There was someone
at DB that had a connection to IB (D Levine).
 IB makes money 2 ways:
o Before a tender offer is announced, he has
information about who the parties are, so he can
buy.
o After announced, he has information about the
likelihood that the tender offer will go through.
Who, if anyone, is harmed by this process?
 The public? Problem = they’re not selling during this
process. IB is trading with other arbs at this point (the
public goes out fairly early on).
 The folks who sold to him? They would have sold at that
point anyway (he offered them more than they valued it at).
But we say that they are “harmed.”
o Saying that the public is harmed by IB means that
we have to distinguish btw his advantage and the
advantage that another pro has over the public.
 The other arbs? They are selling b/c IB is offering them
more than they think the stuff is worth. Saying that they’re
harmed in a way that we care about involves something of
a stretch.
o They clearly are harmed if you think about it in the
following way. The stock was trading at
$100/share. The tender offer price was $120/share.
The total gains out there are $20M, so it has to be
that they are making less money because IB is
making more.
o NOT A REASON FOR BANNING INSIDER
TRADING – INFORMATION is always a valuable
commodity and is always something that people
trade on (e.g., buyers and sellers aren’t required to
disclose facts they know about certain products).
 The Courts initially looked at this and said that LS was
harmed. B/c IB began buying this stuff, word leaked out
that IB was in the market, and people figure that he must
know something. Therefore, before the tender offer is
announced, during the period, the stock price began to rise,
so LS would have to offer a higher price than he originally
planned on offering.
o
o
o

Is this a problem? Sure – because LS is a principal,
the investment bank is his agent, DL is a sub-agent,
and DL is breaching his fiduciary duty to the
investment bank to LS in the form of a side
payment to benefit IB.
There are a lot of agency law violations out there,
but we don’t make federal crimes out of all of them.
Need something more…
You would make this waiveable if it was an agency
law violation and nothing more.
To see how we make this a federal crime…
a) SEC v. Texas Gulf Sulphur Co.
(2d Cir. 1969) p. 480 – Rule 10b-5
Facts: TGS was drilling for ore in Canada. Drilled an exploratory hole which revealed
what probably was a very large deposit of minerals. The company keeps this a
secret, and certain employees buy stock and calls for themselves.
Rule 10b: (p. 443)
 Interstate commerce requirement → people still thought that federal statutes had
to be constitutional – turns out everything is connected to interstate commerce
 Listed and not listed securities
 Not a self-enforcing statute
 Doesn’t mention insider trading → Congress thought that §16(b) would catch a
lot of the insider trading stuff, and this would be other kinds of fraud.
Rule 10b-5 → it shall be unlawful for any person, directly or indirectly, by the use of any
means or instrumentalities 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, (fraud)
(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 light of the
circumstances under which they were made, not misleading, or (misleading
statement)
(3) to engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
 Generic fraud rule dealing with trading in securities – still says nothing about
insider trading.
 How do we know that insider trading is covered by Rule 10b-5?
o Probably the TGS case.
Note 12 (p. 485) → Does TGS have to disclose the fact that it is buying up land because
it knows that there is oil under there? NO – material facts do not have to be disclosed
immediately (timing is a matter of business judgment).

What’s not ok is that the managers start buying up stock and calls.
During the intervening ½ year, they send the core down to be examined by a geologist,
and rumors start circulating, and the price of the stock begins to climb (started at 17, was
in the low 30s when they finally made a release).
 The press writes a story about it, and TGS responds by issuing a press release.
None of the statements in the press release are false, but the entire statement is
kind of misleading (but they don’t want to get in trouble for misleading people).
4 days after they issue it, they issue a press release confirming a 10M ton ore
strike. After this, the price of the stock goes into the high 50s.
Held:



Those who were buying stock for themselves and their buddies before anything
was made public are “fried.”
o Basic rule (p. 484) = abstain or disclose rule → anyone in possession of
material nonpublic information must either disclose the information to the
public or must abstain from trading in or recommending the securities in
question.
o Material? = yes (reasonable investor standard) → whether a reasonable
man would attach importance in determining his choice of action in the
transaction in question (any fact which in reasonable and objective
contemplation might affect the value of the corporation’s stock or
securities).
 The fact that the stock price is affected shows that reasonable
investors did find the information material.
 The fact that the insiders found the information material enough to
trade on it means that it is material to the reasonable investor. The
fact that the insiders themselves trade becomes evidence of
materiality.
 You won’t ever see a case where the information is not
material (if it’s not material, the SEC won’t bring a suit or
the insiders won’t trade on it).
 Courts basically gutted the materiality requirement for
insider trading cases.
Coates trades after the 10M ton announcement:
o Timing → Court says that that’s not ok because he has to allow a
reasonable amount of time for the market to digest the information
(therefore, he won’t be making money on it). If you can make money on
it, it will mean that the market must not have digested the information.
 You can’t just release a whole lot of #s and trade as soon as
information hits the market.
Potential liability to the corporation for issuing the 1st, pessimistic press release:
o The corporation was not buying or selling stock. The 10b-5 rule requires
that anything misleading be “in connection with the purchase or sale of
any security.” Court says that we have to interpret the in connection
requirement more broadly → the information released must be of a type
o
that would cause reasonable investors to rely thereon, and, in connection
therewith, so relying, cause them to purchase or sell a corporation’s
securities (i.e., there are other people out there who are buying or selling).
Is this misleading? Standard (2nd Circuit) → whether the reasonable
investor, in the exercise of due care, would have been misled by it (is it
objectively true based on the facts).
 Sounds as if it’s conditioning liability on whether the company
really did strike minerals or not (sounds like you could say
something which you thought was true at the time which later
could turn out to be false). Not the way it’s applied – there is a
scienter requirement (you have to have had an intent to
defraud).
Problems:
 Martha hires a geologist b/c there is land out West and her cousin has some land
and she thinks that her cousin might be induced to sell his land if she wants to buy
it (which depends on whether there is oil under the land). Geologists does some
tests and says that there’s a really good chance that there’s oil under his land.
Martha offers to buy, cousin says ok and sells to her. Did she do anything wrong?
o No. There is no security here, so it’s not 10b-5. This doesn’t violate
agency law because she is not an agent of the cousin. No duty to disclose
because she is not a fiduciary.
 Suppose cousin asks her why she wants to buy land, and she says, “Why would I
know anything you don’t know?”
o Turns on how egregious her intent to mislead him is.
o If she says, “I don’t know,” then that’s a lie and a fraud and she is liable.
o Absent a false statement, she doesn’t have a duty to disclose.
 Suppose Martha’s real estate agent hires the geologist. The geologist tells the real
estate agent that Martha’s cousin has oil under his land and the real estate agent
buys cousin’s land.
o The real estate agent has a fiduciary duty to Martha (her agent), and has
made secret profits that arose out of her agency (which agents cannot do).
o Even more straight-forward if she discovered that there was oil under
Martha’s land and she purchased land from her.
 Suppose that it’s not Martha, but Juan and Betty and they together have a real
estate partnership. Juan discovers that there is oil in this land and he decides to
buy out Betty. Betty says ok and sells.
o Problem b/c of the partnership relationship – partners are agents of each
other and partners have fiduciary duties to each other. Juan has a FD to
Betty, and before he buys from her, he has a duty to disclose.
o Not a 10b-5 violation because it’s still not selling securities (a general
partnership interest is not a security (see definition of security above)).
 Eve is a shareholder of XYZ Corp. and it’s investing in land out West (looking for
oil). Eve is in the area where XYZ Corp. is doing business and she hears the
management of XYZ talking about amazing discoveries. Eve calls her broker and
buys 10K shares of XYZ Corp.
o
–
–
–
b)
Eve has not done anything illegal because she is only a shareholder. She
doesn’t have fiduciary duties to anyone.
 Suppose she learns it because she slips one of the managers $10K and he tells her
that they just struck oil.
o That’s not legal, because she is affirmatively trying to do something to
become an insider (Dirks).
o The manager has breached his fiduciary duty to the corporation, she has
become an accomplice to his breach, and as an accomplice, she violates
10b-5 as well.
 Suppose the CEO of XYZ gets a report from engineers that they just struck oil
and he goes and buys stock.
o Straight 10b-5 violation.
Suppose you were student at Caltech, you think that a certain biotech company is
undervalued understanding the science, do you have an informational advantage?
o Yes, but you can still do it.
What if you see factory blow up, can you immediately sell before anyone knows?
o Yes, this is not insider info.
There are two notions:
o Fiduciary duty approach – trading on informational advantage, if you have
fidicuary duty to someone you have an informational advantage to
(shareholder) you are required to disclose, otherwise it is fraud, and if it
involves securities fraud (10 (b) (5))
 Problem with this approach is that people like Ivan Boesky get off
o Level Playing Field approach, this is demonstrated in TGS, SEC used this
approach for a while
 But we want stock analysts incentives to get good information, the
incentive is that they can trade on that info, this is a problem with
the level playing field approach
 Chiarella – photocopier figured who was going to be acquired by looking up info
in the WSJ, he bought the stock and made $30K, the SEC noticed charged him
under 10 (b) (5), on appeal the Sup. court says he is not liable because he has no
FD to target co., Burger writes a famous dissent that Chiarella “misappropriated”
the information, it becomes the misappropriation theory, if you broke a rule (like
a house rule) getting the info it violates 10 (b) (5) even if you don’t have a FD to
company with which you trade
o SEC freaks out that acquirers can buy as much target stock as they want,
so they try to overrule the supreme court by issuing rule 14(e)(3), if you
buy or sell stock related to a tender offer based on fo you get from target
or acquirer and it is material and non-public then you violate 14(e)(3).
Dirks
o Equity Funding (ins. firm), Seacrest used to work there, he noticed fraud
and tells Dirks, who is a stock analyst
o No insider has tipped off Dirks, he just checked them out, so he doesn’t
violated 10(b)(5) by telling his clients
o
For some reason SEC decides to go after Dirks, Court says for the tippee
to be liable, tipper (insider) has to break a FD by giving the information
and tippee has to know or reason to know that FD is being broken
o Court implies that because Secrist is disclosing a crime, it can’t be a
violation in FD, but the Court also ties the issue of whether there is FD
breach to personal financial gain of insider/tipper (this creates some
problems later on for lower courts)
 If the tipper has no personal gain, there is no FD breach, the court
did not have to go down this route
 Two GS analysts talk about a potential tender offer in the elevator,
they do violate an FD (duty of care), and you trade on it under
Dirks you have not violated 10 (b)(5) because tippers did not have
personal gain
 The way you get out of this is footnote 14 (pg. 495) of Dirks, under
certain circumstances, when corporate info. Is given legitimately
lawyers, etc. become temporary insiders (they become the tippers,
rather than the tippees) (court will find quid-pro-quo)
 What if there is clearly no quid-pro-quo, seems like under Dirst
there would be no violation (classic overhear information in
elevator)
o BPI makes movies, President negotiates K with Sean Connery for Bond
Movie, can she buy more BPI stock? No, obvious she has inside info over
stockholders who she has a FD to. What about the lawyer who negotiated
the K, no you are temporary insider.
 What if your son overhears you telling your husband, and tells his
boss, are son and boss liable? No FD breach by telling family.
 What if you learn bad info can you not buy stock you were
planning on do it? There is no way you will get in trouble for it.
Non-trading based on inside info is fine for practical reasons.
 Can you buy Ford stock, if you learn Ford will be in the movie,
take this down the misappropriation theory (O’Hagan).
o P&F asks ind. To invest in joint venture with P&F, P&F gives ind. Info
about their company to try to convince him for the JV, can he buy stock?
Court says this is footnote 14, he was a temporary insider.
o Footnote 22, implies an opposite result, but Courts don’t think this right
c) Martha Stewart
o Imclone, founded by Waskal, learns FDA will turn down drug approval,
Waskal sells his stock this is direct 10 (b) (5) violation
o What if Waskal tells daughter, is she in trouble? She is a tippee, not an
insider, generalized reciprocity, also solved as a valuable gift
o Merryl Lynch, turned him down, so he tries to transfers his shares to his
daughters and she was dumping it
o SEC thought that SW told Martha Stewart, is she liable? Is he intending to
make a gift of valuable property, what benefit is he getting under Dirks?
But there was no evidence that this happened.
o
o
o
An advisor at ML is Bok, who handles MS’s account, he tells her SW is
trading so she trades, does Bok have any benefit? Yes, MS is his client but
he is not insider to Imclone.
Bok just knows SW, knows something but doesn’t know what he knows,
MS has the same thought
Under Dirks
 Who is the insider?
 SW
 What is the tip?
 Dumping his stock (breaking a FD)
 MS knows that an insider is trying to break FD
 So one theory is Chiarella + Dirks line (SEC didn’t push
this theory)
 Missapropriation might also get her
 Quite possibly that ML had a rule which prohibited
tagalong trades, can’t trade based on that someone
else is dumping
 MS knows of reason to know that it is violation of
house rule
 SEC did get for her lying to her shareholders that she didn’t
these facts, even though they might not rise to level of SEC
crime
 What happens to Chiarella?
 Have an acquirer firm hires MS, on of the
employees buys stock in a target, court says he can’t
do this, saying this is a misappropriation.
 Few years later, and S&C office manager buys
stock in the T, also misappropriation
 A 3rd case, same thing happens, trading on info
based on therapy patient (but apparently if you
choose to compensate someone with a stock tip,
therapist is off the hook)
 Back to IB, he gets investigated 1980s, he is getting his
info from DL, who is getting from PBL, from acquirer and
he is buying target stocks, he is worried even after
Chiarella because of 14 (3) (e) and the misappropriation
theory in 2nd circuit
 He ran a mutual fund which traded in target
companies (other shareholders in the mutual fund)
 He knows he is about to be charged/indicted, and he
wants to unload his stocks in MF (which he knows
he will crash after he is indicted), the DOJ says he
can sell them, since it is info about DOJ is doing to
him, there is FD breach , info based on himself not
on info on target



Could Martha Stewart have done the same
thing? No, because MS has a FD to
shareholders of her company but IB has no
FD to the targets.
Gets wackier: Winens wrote a investment column in
WSJ, not based on inside information, so
hypothetically cannot/should not effect the price of
the stock. But in fact it did affect the price, so he
tips off friends of the firms he is going to write
about and they buy these stocks and make a bunch
of money. There is no 14 (e) (3) so it has to be
under 10 (b) (5). They have no FD duties to the
companies so the only way you get him is under
misappropriation. The 2nd circuit said WSJ has a
policy against trading on basis of info in articles, so
Winens misappropriated the info. This is has weird
implications – they are criminalizing an internal,
optional house rule. Also WSJ corp. could trade
itself without 10 (b) (5) because it cannot violate its
own rule.
Then the Winens goes up to Sup. Ct., split 4-4
which stands until O’Hagan
d) O’Hagan
– O’Hagan is getting info from acquirer on whether tender offers will succeed or not,
he buys stocks and options in targets and when tender offer is accepted he makes
$4MM, SEC finds him
– Court says misappropriation is good law after all (2nd circuit has been doing right)
– Also says 14(e) (3) does not violate SEC’s rulemaking authority
– There has to be fraud, if you tell law firm you are going to trade on this info you can
do it, you will have other problems (disbarment) but it will not violate 10 (b) (5).
Examples:
– Target, Taimie (CEO of Target) approached by Buyer to tell her about potential
tender offeror
o Can buyer do that? Yes.
o What if Taimie was about to sell her stock but now she decides to wait,
can she do this? Yes.
o Suppose she goes and buys target stock? No, straightforward TGS.
o Suppose she is married with John, and she confides the tender offer to
him, can he do that? Yes, based on Dirks she did not break a FD if she did
not do it for her own financial gain or as a gift, probably not even a duty of
care violation here (can confide with your spouses).
o If John tells Harvey about it because they have Stock Exchange Tip deal,
can he do this? No 10 (b) (5) -- John has no FD to the target, the test is
whether the tippor violates FD. There might be 14 (3) (b) liability.
o What if the son overhears? No, no FD breach by Taimie.
o What if T asks her lawyer if she can buy more stock, he says no, can he
trade? He is not a temporary insider (because he is a personal lawyer, a
counsel to Target would be temporary) but he is breaching FD with T by
trading on it, so he is violating 10 (b) (5) under misappropriation.
– (p. 513) House of JPM, Xandu run by Susan making a new movie, she asks JP for a
loan, but he says no. But then JP buys Xiandu stock on his personal account.
o One approach is to whether he is a temporary insider. Footnote 22 says
that if you receive info in arm’s length transaction you are not a temporary
insider. But some courts might try to pigeonhole into fn. 14.
o But also JP should have presented this corporate opportunity to HOPM, so
he has breached his FD to HOPM, which makes it sound like
misappropriation.
o Can Susan buy stock? No, this is TGS.
o Suppose Susan’s broker decides to trade after Susan tries to buy? He
figures she knows something. Could say that the tip is her attempted
violations. Could also say that broker works for a place that forbids tag
along trades, which constitute misappropriation. This is effectively what
Martha Stewart did and the SEC decided not to pursue it.
– Suppose every time AH goes into hospital stock price OP goes up
o AH calls VP to drive him to the hospital, can VP not sell stock he was
planning to? Yes.
o What if VP tells friend? No, if there is FD violation on VP’s part, is there
any intention to gain (could include stock tip exchange club).
o What about secondary tippe (friend’s friend), only if there is both a FD
violation by VP and secondary tippe knows or has reason to know there
was FD
o What if VP sell’s Exxon stock? No FD to Exxon so depends on internal
policy on trading for misappropriation. Probably no internal policy against
this even though you are trading on material inside info (OP goes up,
Exxon always goes down)
o What if Ramseyer’s wife (internist) sees AH check into the hospital can
she buy OP stock? Doesn’t have FD to OP shareholders. If she had been
treating AH and he had to tell her something then arguably she can trade
on info given in trust and confidence. But there might be a rule at the
hospital, which could constitute a misappropriation.
o What if a patient notices AH has checked in, can he buy OP stock? Yes,
the patient has no FD to shareholders and he is not misappropriating info.
– 16 (B)
o prophylactic rule designed to prevent insider trading
o at the time it was thought that is would cover most of insider trading, but it
misses lots of trading
o This is not a criminal statute, it is a civil cause of action by the
corporation.
o Has to be a public company
o An insider for purposes of 16 (b) an insider is different then 10 (b) (5),
director, officer or 10% shareholder, only have to be a director or officer
at one end of the purchase or sale
o Has to be an equity security, stock or debt convertible to stock
o Purchase and sale must be within 6 months of each other
o When you pair up purchases and sales, you calculate in a way to maximize
corporate recovery
o SEC old rule was that if stock option was part of an employee stock option
plan did not apply 16 (b) if you held it for more than six months
 But in 90’s people were using derivative contracts in the same way
as stocks so SEC now you get 16 (b) liability for transactions in
derivatives as well
– Hypo
–
2.
a)
b)
c)
o 1/1 Buy 10 share $20/share
o 2/1 Sell 10 shares at $60
o Liability is $400
Hypo #2
o 1/1 Buy 10 at $20
o 2/1 buy 10 at $60
o 3/1 sell 20 at $30 (net loss of $200)
o What is 16 (b) liability? 10 x $10 = $100
o So you lose $200 and have to pay $100.
o What if you just sell 10 shares? Nothing changes.
Short Swing Profits
Emerson v. Reliance
o Emerson purchases 13.2% of Dodge to start tender offer
o Dodge finds a “white knight” in Reliance to prevent Emerson takeover
o Emerson decides to make a two-tiered sale, one which brings it down to
9.96% and then sell the rest, all intentional to avoid 16 (b) liability
o Court says you have to be 10% shareholder at time of purchase and sale,
and that it is even ok if Emerson is trying to avoid the liability because at
the time of the 2nd sale they were not a 10% shareholder
Foremost-McKesson
o Provident securities wants to dissolve and they find FM, they will sell
their assets to
o Prov. Gets cash plus debt, debt is convertible into stock
o Prov. Get rid of the convertible in 2 step process (they read Reliance), we
know they won’t be liable for the 2nd part, but Prov. Is saying they are not
liable for any of it
o Court says you have to 10% shareholder immediately BEFORE the
purchase (not after), if you buy 15% all at once and then sell that 15%
within 6 months you are not liable to the corporation
o Stock options are not entirely clear under 16 (b)
Kern County (?)
o Occidental buys stock of Kern as part of tender offer, Kern resist takeover
by merger with Tenneco (white knight)
o Occidental does not want to be minority shareholder of Tenneco-Kern, so
they negotiate an option agreement with Tenneco who have option to buy
all Occidental stocks in 6 months and 1 day for a certain price.
o Two possible times when the “sale” is: when the merger takes place or
when the option contract was completed.
o Court says there is no danger of inside information by a hostile acquirer,
so they say neither of the sales are going to count for purposes of 16 (b)
liability.
o Court is looking to see if there is a speculative abuse risk, seems very
subjective while 16 (b) is supposed to objective.
o This seems like a big exception to the rule for hostile acquirer.
– Pg. 523 Problems
o Bill is CEO of SELAW, on Jan. 1 he purchases 200 @ $10
 Note: He is CEO we don’t have to worry about 10% requirement.
 If he sell 200 shares at $50? Yes, there is 16 (b) liability. Liability
= $8,000
 What if he sells high and buys back low? No difference, still 16 (b)
liability.
 Say he is not an officer or a director, but is holding 200,000 shares
for several years. Ask whether he is 10% shareholder prior to both
buying AND selling the shares? If not, no liability.
 What if he resigns as CEO after selling and then he buys back?
Liability is the same. (check this)
 How about if he sells 100 on 5/1 and on 5/2 he sells the remainder?
16(b) liability for all of it because he is the CEO. The trick is that
he was no longer a 10% shareholder but not relevant because he is
the CEO.
 What if he resigns on 5/1 after selling 110? Still 16 (b) liability,
even though he is not CEO because as long as you are director or
officer at either purchase or sale you are liable.
o Investor Renee, she is 20% shareholder (200)
 Sells on 1/1 200 @ 50, on 5/1 she buys back 50, on 5/2 she buys
back 110 = on neither 5/1 nor 5/2 is she a 10% shareholder so
there is no purchase to match with the sale to find 16 (b) liability.
 Switch the transactions, 1/1 she sells 200, 5/1 she buys 110 and on
5/2 she buys 50 = We can consider 5/2, we have a matching pair,
50 bought $10, versuses 50 sold at $50
 Sells 110 on 1/1 @ $50, 90 on 1/2 @ 50, and buys 300 on 5/1 for
$10. We don’t count 1/2 or 5/1 sales (not a 10% shareholder). So
there is a sale but no purchase to match, no liability.
 Sale 1 $50 @ 70K, Sale 2 $10 @ 130K, Buy back 1 $100, 100K
and buy back $8/90K Shares – she is obviously losing money
overall but irrelevant to 16 (b) liability. Can look at Sale 1 and Sale
2, can’t look at Buy back 1, can consider buy Buy back 2. So you
have 90K @ $8 which we have to allocate to two sales – this is
–
–
–
–
–
–
–
where maximizing to the corporation rule comes in = (50 -8 ) x
70K + (10-8) x 20K.
o CEO buys 100 on 3/1 at $10, 700 on 4/1 @ $90 and sells all his shares for
$30 on 5/1. He is losing money but liability is (100K x $30) – (100K x 10)
o For convertible debentures, we count as if they are converted to calculate
if 10% shareholder. In #4 she is 10% shareholder so she is liable for 16
(b). (900 – 800) x 100.
o Another hypo: B1 100 sh @ 10, b2 50sh @ $15, S1 80 @ 20, s2 70 @ 5 =
match them up in the way so the person owes the most. 16 (b) liability is
80sh (20-10) (I think).
o #5, 3/1 B 100K of A @ $10, 3/2 B 50K of B @ $10, 4/1 S All $50. The
law says that A’s count towards the 10% even though she is not 10% of
each class. So there is liability, 50K (50 – 10) =
VII. Proxy Fights
Difference between proxy fight and tender offer– difference is between voting control
(proxy fight) and ownership.
Shareholders are the principals of firms, which makes sense since they are residual
claimholders, directors are their agents
Shareholders elect the directors at once a year meeting, or if there is a life/death issue
then shareholders vote on that – shareholders do nothing else, most state corporate
laws limit shareholders to these roles but you can change this in the corporate charter.
But shareholders don’t go to the meetings, instead you send back to the corporation
authorizing someone to be your agent, called your proxy.
If you don’t want the current directors to continue you come up with your own slate
and start to solicit proxies. You have two groups fighting for proxies for the annual
meeting vote, the group with the biggest pile of proxy cards win.
Under federal rules when incumbents solicit your proxy they are required to tell you
that have the option to withhold your vote (even if there is not alternative). This is
like how shareholders 40% withheld vote for Eisner, he stepped down as chairman
even though he was not legally required.
Suppose we have a firm that has hot new tech ideas about transportation in So. Cal.,
suppose Hans, Luke, Leia are the directors and suppose they solicit Anakin to invest
and he does. Then the current directors decide to invest in internal combustion,
Anakin thinks this is terrible idea.
o Derivative suit would go no where because it would be thrown out under
business judgment rule, unless you find a conflict of interest.
o Organize a proxy fight
 A) Cannot have a policy proxy -- shareholders can’t vote on policy
according to default rules
 B) Proxy fight over the slate of directors – each side solicit proxies
from shareholders, the groups that has the most proxies wins
o Tender offer
 There is a risk in undertaking a proxy fight for rival slate (doesn’t
get reimbursed if he loses) and you don’t get all of the gains – only
your share. This is why tender offers take place.

A.
B.
a)
b)
C.
Tender offers are now often combined with proxy fights – get a
new board which will removed poison pills. (we will see this in
chapter 7)
Strategic Use of Proxies
Reimbursement of Costs
Levin
o Two rival groups vying for control of MGM, Levin is the insurgent and
O’Brein is incumbent.
o Levin is objecting to the fact that O’brein is charging the corporation for
their proxy fight expenses. Court says they can do it as long as they are
reasonable expenses.
o Directors wouldn’t take the jobs if they had to use their own resources for
proxy fights (directors don’t get paid that much in their capacity as
directors)
o Hypo:
 Incumbents hire a fancy PR firm, they can charge to the firm.
 Suppose incumbent CEO hires his brother’s firm, seems like a
COI, wanting to keep your job is NOT a COI
 Proxy fight is over who is on the board not about the policies
directly
 If insurgents lose proxy fight no reimbursements, if insurgents win
they can be asked to be reimbursed for reasonable expenses
Rosenthal
o Proxy fight – case is over reimbursement
o No shareholder vote to reimburse incumbents and a majority shareholder
vote to reimburse victorious insurgents
 Incumbents get reimbursed whether they win or lose
 In uncontested cases, the company pays for incumbents
expenses doesn’t seem to make sense to not reimburse
them in contested cases
 Insurgents can be reimbursed if they win by majority vote
o Court does say that the a proxy fight over policy not a personal fight in
order to be reimbursable – this distinction seems tenuous everything is
always over personality AND policy
o Also a general requirement of reasonableness of expenses
Shareholder Proposals
o In 1950s shareholder proposals tended to be over business issues
o Changed with Vietnam more institutional activism (animal rights, baby
formula, etc.)
 In a typical year only 1/3 of shareholder proposals get through,
most of them are negotiated away – the usual fight is over whether
you can propose it again next year (need increasing support)
o In 1990s changed back to corporate governance proposals and
management resisted
a) Lovenheim
o Resolution calls for committee to investigate animal testing of French
company – why don’t shareholders just directly call to stopping import,
this is because shareholders know they are better off not fighting directly
over policy so they cloak it in a “investigation”
o Two rules over stockholder proposals
 Proper subject for action (based on the principle that company run
by directors not shareholders)
 It concern ordinary business of the company (p. 573)
 Not trivial part of the business
o The company wants to leave out these proposals on the grounds that it is a
trivial part of the business (less than 5% and not significantly related to the
issuer’s business, p. 566)
o The Court says it cannot exclude, the shareholders say it meets the
exception because it raises substantial social, moral and ethical issues thus
it is significantly related to the business (Does this make sense?)
Proxy Fights continued
 Proxy fights = fights over direct control of a corporation
 You’re not trying to buy the corporation, as with a tender offer- you are just trying
to get other shareholders to vote your way
 Most shareholders don’t go to the meetings- they appoint someone to act as their
“proxy”- if you support management, this is usually a director
 Insurgents can also collect proxies- that’s one way to take over
 2 cost allocation cases- Levin and Rosenfeld
o Levin says that incumbent managers can charge the company for the costs
of soliciting proxies on their behalf- wine and dining big shareholders,
paying for glossy materials, etc.
o Rosenfeld:
 Here you have a fight that insurgents win
 Insurgents reimburse not only incumbents but also themselves
 This cool
 Requirements for reasonable reimbursement
 Must be a dispute over policy and NOT personal
o BUT- this case was about somebody’s pay- so we
have a very broad definition of “policy” here- one
that encompasses almost anything
 Incumbents always get reimbursed- if incumbents are
unconstested, this is just a regular cost of doing businessyou need a shareholder quorum
o BUT- insurgents are risking their own money- why
shouldn’t incumbents as well
 Insurgents don’t necessarily get reimburses- only if they
win and if a majority of the shareholders confirm their
reimbursement. You can’t just walk in off the street and
manipulate this stuff without showing some benefit to the
company

Shareholder proposals
o Yet another persistent source of litigation- in 1950s these tended to be
business-related proposals- trying to curb manager discretion
o In 1960s this stuff becomes more political b/c of Vietnam War- activist
shareholders want to keep company from doing business with DoD- in
1970s and 80s other issues pop up- animal rights, SA divestment, baby
formula in the 3rd world
o Management does not want to send these proposals out- not only is it no
fun to be called immoral, plus if this process is made easy, proposals will
be frequent and costs will go up
o In 1990s actually, pendulum switches back, proposals become more
business focuses
o Usually only about a third of these get accepted- the rest get negotiated
away
o Reasons you can exclude (not an exhaustive list)
 Proposal related to operations that account to less than 5 percent of
total assets, net earnings and gross sales and is not otherwise
significantly related to issuer’s business
 OR- if proposal does not concern a proper subject for action by
shareholders
 If proposal deals with a matter relating to the conduct of the
ordinary business operations of the company- kind of a subset of
the above- shareholders are not supposed to micromanager day-today operations of the company
 Tiered system- proposal was included within the last few years and
the percent of its vote is not rising enough
 If proposal deals with a matter beyond the company’s power to
effectuate
 Ex: proposals to support introduction of nationalized heath
insurance
 If proposal violates proxy rules- this one is used to catch
misleading statements- you are not allowed to have a misleading
proxy solicitation
 Proposals geared towards a personal grievance
 Union proposals- one subset of the company trying to get
doe for itself
o Lovenheim
 Food importation company that imports a very small amount of
pate de fois gras
 Proposal is to organize a committee to review importation of pate
 Company: this is an insignificant (must less than 5 percent of the
company’s business) – so its too trivial
 Court: this raises a significant ethical and social issue and so
FAILS the “otherwise significantly related to issuer’s business”
test
 This is probably not what the drafters of this rule intended

You might argue that shareholders would LIKE to know this info
 BUT- in fact these proposals usually fail
 This is why there is the tiered exclusion rule
 If this was just pate company- would they have wanted to know
about torturing little duckies?
 Probably not- if you buy significant amounts of stock in a
company like this you are kind of signifying that you don’t
care
o Suppose you have stock in a company that sells a particular line of
expensive, badly-made sports cars on which is looses money BUT the
sports car keeps its image going
 Series of shareholder proposals- hypos from p. 578
 “Resolved: company shall stop making the car”
o this is not within the purview of the shareholders
o it is also about ordinary business operations, which
the shareholders should not meddle with
o Could we also exclude it a la Lovenheim as an
insignificant part of the company’s business
 Well, this is what “otherwise significantly
related” rule was meant to really deal withdespite the fact that this car is a small part of
the company’s actual sales, it has an image
spillover for the company’s boring,
profitable sedans and thus should be
considered as an important part of the
company’s business
 SO- you probably could exclude it on those
grounds
 “Resolved: shareholders recommend that car be
discontinued”
o well, its proper for the shareholders to recommend
something
o Arguably this is still part of ordinary business
operations- this is why proposals require stuff like
commissions to examine- trying to get around
ordinary business operations requirement
 “Resolved: amend the by-laws to require that the company
can produce only 4-door luxury sedans:
o well, it is ALWAYS proper for shareholders to
suggest by-law amendments
 directors OR shareholders can amend bylaws (cf w/ articles of incorporation, which
both directors and shareholders must amend
together)
 this is not ordinary business operations
 Nor is it trivial
 SO company couldn’t exclude this
o Suppose you have a hot start-up- you know you’re good, but nobody else
does- to prove how different you are, you institute a radically different
director selection machinery that is basically a ballot- anyone with more
than 5 percent of stock can nominate someone for the board
 Remember: standard way to do things if you don’t like how the
company operates is that you have to nominate your own slate and
launch a proxy fight
 The point is that if folks don’t like you, it’ll be really easy to dump
you
 This ain’t such a great idea- lots of waste
 Plus- directors need to be able to make tough decisions without the
fear of immediately being dumped
 This is kinda like trying to get a professorial job by saying “I don’t
want tenure b/c I’m so good you’ll never fire me”
D. Shareholder Inspection Rights
o You approach a company and say- I’d like to solicit the shareholder to
oust you
o They have a choice
 They can either mail your materials for you and charge you
 OR- they can give you the shareholder list
o Inevitably they will want to do number 1- all shareholders are not created
equal, and company is going to want to keep the insurgents from figuring
out who has the most stock
o This is broader than it sounds-this is not just about a list of names, it’s a
broad array of business documents that reveal lots of info
o Access to all this material is governed by state law
o Remember:
 on the one hand shareholders are residual beneficiaries of a
company and should be allowed to protect their investments
 On the other hand, shareholder lists can be easily abused
o Common law solution:
 there are good reasons to want corporate documents
 To evaluate your investment
 Communicate with other shareholders
 BUT- there are also bad reasons
 Improper use of shareholder list- for instance to do a mailorder solicitation or if you are a competitior or if you want
to use to corporate machinery to get support for your social
or political agenda
a) Crane v. Anaconda
 Crane is trying to acquire Anaconda- launches a tender offer
 offering subordinated debentures- this is basically risky
debt (a decade later these would be called junk bonds)- in
exchange for Anaconda stock

In order to launch its tender offer, Crane wants a shareholder list- it
don’t got access initially ‘cause it don’t own any stock
 BUT – after the tender offer has gone on for a while Crane owns
about 11 percent of the stock, so it can get the list under NY law
despite having not been a shareholder of record for the last 6
months
 NOTE: Anaconda is a Montana company- why does NY
law govern
o Its doing business in NY, but default rule is that
internal rules of company are governed by the state
where you are incorporated
o Statute being applied, however, is one that applies
to foreign corporations doing business in the state
 Anaconda: it doesn’t have to give up the list b/c Crane’s tender
offer does NOT relate to company’s business- this is not a “good
purpose”, i.e. its not about what the company is doing, its about
transactions btw shareholders
 See section (b) of the statute (p. 580): shareholder must
demonstrate that his purpose is NOT different from the
business of the corporation
 There is a certain formal logic to this argument: Anaconda
is in the business of doing certain things, which have little
to do with Crane’s TO
 Court: Anaconda is being way too formalistic- this is obviously
something that shareholders will really care about- somebody is
offering to buy their stock at a 50 percent premium, because they
think they can run the company better
b) Pillsbury v. Honeywell
 Honeywell makes shrapnel- used on the front during WWII (to
kills people after they are driven out of their hiding places by
napalm), but during Vietnam we start dropping it on villages that
contain a lot of civilians- by 1969 a lot of people are wondering
what the fuck we are doing- Pillsbury is one of these folks
 Pillsbury bought some stock in Honeywell so he could get access
to shareholder’s list – presumably to try and convince the
shareholders that this is wrong and it ought to be stopped
 Cf w/ Lovenheim
 This is NOT a situation where nobody knows that company
is doing this- everyone knows that Honeywell makes
Shrapnel
 The people who will still buy Honeywell stock probably
don’t care Court: this is not a proper purpose to want a shareholder list- see
statute at bottom of p. 583 and p. 584 “proper purpose” required for shareholders to see
documents- statute distinguishes btw shareholders who

want access to the list, versus other business documents
(this might be to prevent against competitors buying stock
to root out trade secrets
 BUT- proper purpose burden is lighter if all you want to
see is a list of stockholders- company is the one with the
burden of proof of showing that this is a bad reason
o “proper purpose” is basically gonna be about
making money- trying to effectuate a social or
political goals does not count
This sort of case is not likely to come up again because any lawyer
worth their salt will now couch these requests in financial termsi.e. shrapnel has created a massive PR problem for Honeywell Moral: if you are willing to modestly perjure yourself you
can get the list
VIII. Control Issues
A. Shareholder Voting Control Issues
– Closely held corporations:
o These cases are not cases of non-disclosure, cases between consenting
adults who knew what they are doing, ask yourself why they are doing it,
usually 1) Part of an employee agreement (giving employees who don’t
have enough money to buy real stocks voting power) 2) Part of a lender
agreement, banks want a say in the management of their creditors
o Ways to limit: 1) Unequal voting rights (different classes of stock which
can outvote each other) 2) Vote pooling agreement 3) Voting trust, trust
separates voting rights from economic rights, trust votes for you but still
get dividends, etc. 4) Irrevocable proxy, for a term
 These are not different in substance, just different ways you can
separate the economics of the stock with the voting of the stock
a) Strobe v. Blackhawk
o Blackhawk
 Class A -- $ + Votes
 Class B -- Votes
o Lots of B’s and not a lot of A’s, the founders own all the B’s so they have
almost all control
 Why would anyone buy A’s? Because they trust the B owners as
good managers and they can turn a profit without having much
voting control.
o The Illinois Constitution at the time banned non-voting stock (they no
longer do that), founders got around this rule by issuing a lot of B’s
o A shareholder sues saying that B is not stock because they are not
associated with any economic benefits
o Court disagrees and says that stock must include either economic rights or
voting rights, each one is independently sufficient
B. Control in Closely Held Corporations
a) Ringling Bros.
o Ringling North had saved Ringling Bros., got a big loan from a bank, but
until the loan was paid off the bank had voting control, they created a
voting trust
o When the loan was repaid the voting trust was dissolved and all 3
shareholders had all their voting control back
o Edith R. and Aubrey H. got mad at North for running the show during the
period of the loan, so they try to figure out a way to get control of North
o Could have created a voting trust, with Loos as the trustee and this would
not have been a problem, but Edith and Aubrey resist
o So Loos designs a vote pooling agreement, with Loos as the binding
arbitrator, seems to be just like a voting trust but Delaware court had not
seen before
 Cumulative voting
 A way to empower minority voters
 Multiply number of shares by number of slots to be filled
(multiplying might be gratuitous?)
 In normal voting A, B, C could remove D from the board
by proposing a slate which does not include him
 But under cumulative voting if D is an equal shareholder he
can vote himself on
 Vote on individuals but it is one simultaneous vote rather
than a separate vote for each slot
o Aubrey and Edith R. set an agreement with the idea that they could secure
5 of the 7 board slots
o Aubrey and Edith have a falling out of the Hartford Circus fire of 1944
and Aubrey tries to get out of the vote pooling agreement, the vote goes
like this:
Edith
Aubrey
John
R.N.
Edith
Bob
Ally
882
882
441
Aubrey James
1103
John
RN
Woods Griffin Total
1102
863
864
863
2205
(315
x 7)
2205
(315
x 7)
2590
(370
x7)
o Aubrey and James have nothing to gain by not voting for Ally (Griffin
will just replace him who they are also not aligned with), but they still
decide to screw over Edith
Review:
– Courts say there are good and bad reasons for getting stockholder lists, incentive for
perjury
– Abnormal voting arrangements
o Default: 1 share equals 1 vote (proportionate)
o Abnormal voting arrangements: can get a lot of control without investing a
lot of money, at first legislature was skeptical but it can actually make a
lot of sense: 1) giving employees control 2) giving major lenders control
 How do you do this?
 Different classes of stock with different voting power
(Strobe), or even no voting power
 Voting Trust – appoint a trustee over how the stock gets
voted, but owner of stock still has all the economic
incidence
 Vote Pooling Agreement – does the same thing as a trust,
but owners decide together how to vote (with
majority/arbitrator controlling)
 Irrevocable Proxy – can make it a term agreement – as long
as the person is an employee or as long as a loan is
outstanding
– Back to Ringling
o Cumulative voting, 7 people with the 7 highest votes get elected
o Agreement between ER and AH itself is on page 607
 Agreeing that they will agree how to vote and if they don’t agree it
is submitted to Karl Loos as arbitrator and his decision is binding
 Lower court says we’ll treat it as an irrevocable proxy – ruling in
favor of ER and treating it as if ER voting with AH
 This Appeals court says that they will treat it as if AH did not vote
at all (This gives ER 3 out of 6 rather than 3 out of 7, better for
her) – final board member will be decided at annual meeting
 Most likely that JRN gets 4 and ER gets 3, comes out the
same if AH votes or doesn’t vote
o Could have prevented all of this by just sticking with a vote pooling
agreement
o What do we have?
 Shareholders don’t owe each other FD’s with exceptions (Sinclair
– majority shareholder)
 Now what happens if they try to bind themselves not only as
shareholders but what they will do once they vote each other onto
the BOD, courts are much more skeptical as this – the reason is
that Director’s do have FD’s.
b) McQuade
o Stoneham is the majority shareholder in Giants, McQuade is minority
shareholder
o They have an agreement to 1) vote for each other to be on the board 2)
once on the board vote for each other to be officers 3) vote for specific
salaries
c)
d)
e)
–
o McQuade gets voted off, Stoneham says the K is void because Director he
has a FD to shareholders thus he can’t be bound by the requirements of the
agreement in respect to BOD
o What if the agreement says only vote them in as officers if they were
“efficient, competent, etc.”?
 See next case, but still have the salary issue
o Why is an employment contract like this not also invalid?
 Because the BOD has to exercise independent Fiduciary judgment
in approving the employment K, in this scenario there is no
independence
o Court rules the agreement is invalid as a matter of public policy
(shareholder agreement about what they will do as director)
Clark v. Dodge
o Clark owns 25%, Dodge owns 75% but Clark has secret formula
o Make an agreement where Dodge’s son gets the secret formula in
exchange for promise to be an officer and ¼ of income stream
o After this Mr. Dodge reneges on the deal
o Court says it will enforce this agreement because doing so will not hurt
any other shareholders (distinct from McQuade); only 2 shareholders
Galler v. Galler
o Ben (married to Emma) and Isadore (married to Rose) own the corp. 50/50
o They make an agreement to take care of their wives in case they die, they
arrange an agreement whereby the spouses gets the salary but no position
o Here there are no other shareholders which would seem to imply that it is
enforceable (Court just ignores Rosenberg)
o Ben Dies, Emma wants to collect under the agreement, Isadore ignores
her, she then sues
 Isadore has an incentive to get Rosenberg to complain about the
agreement (another bad incentive)
o Court rules that the agreement is enforceable
Ramos
o Ventura group and the Broadcast Group (Ramos dominant shareholders,
Estrada are minority shareholders)
o The two groups join – Broadcast gets 5 of 9 BOD
o Ramos and Estrada make an agreement to vote together, if they don’t they
will automatically sell their shares to the other at a very low price
 Usually ok for shareholders to vote for each together to be on BOD
(shareholders don’t have FD’s)
o Then Estradas decides to vote against Ramos and the agreement says that
she has to sell her shares to the Broadcast group
o Is there an implied agreement to appoint Ramos as President (officer) once
they vote together as shareholders?
CAL law
o If you have close corporation (opt-in, defined) and a shareholder
agreement (unanimous) you can agree what you will do once you are on
the board (in addition to who is on the board), as a shareholder you have
same FD’s as a director
C. Abuse of Control
Freeze-outs
– Typical FD problem
– Peculiar to close corporations – can’t sell your stock, listed stocks just sell
– Some of the cases you can mitigate these risks by planning in advance, but not
always, keep in mind could a good lawyer have reduced the problem and if so, what?
a) Wilkes
o Wilkes (plaintiff), Richie, Quinn, Pitman form the Springside nursing
home, each have a 25% interest (shareholders)
 They are all directors and officers and Wilkes is the janitorial
supervisor
 They could pay out dividends if they wanted to (tax reasons,
salaries are deductible)
o Wilkes falls out with Quinn, because he convinces the others to sell
property at an excessively high price – they vote to fire Wilkes
o So now they pay no dividends but keep their salaries (calling it a salary
instead of dividend) – what are Wilkes options? Not many. Even
liquidation rights they could run the value into the ground and no
liquidation value.
o What would have happened if this was a default partnership of 4? He can
always dissolve the partnership, forcing a sale to them of his interest. But
can’t do this in corp (default).
o In general sh don’t have FD to each other, Court says that partnership
there is good faith (FD) and in CC there is a duty of good faith but they
can get around it by proving a legitimate business purpose.
o So if the defendants can show they had a legitimate business purpose they
win, but Wilkes can respond with a defense that the same objectives could
have been met without harming his interest
o Should bother you a little bit?
 This is a lot like a partnership, why are we giving more flexibility
here?
 It is also redundant because they have FD’s as directors, and they
all are, so don’t need to find FD for their roles as shareholders
 Also have Sinclair which says majority shareholders have an FD to
the minority
o What if Wilkes didn’t get fired but he was poor so he wants dividend but
other 3 don’t? Are either one of them breaching a FD?
– Routinely there are buy out agreements in small corporations
o Can Include
 Restrictions on sales (Partnership – veto/must be unanimous to add
a new partner)
 Forced Sale (Partnership – unilateral dissolution)
o They can be valuable because
 You care about identity of your co-investors
 There is no market for the stock
o Situations need to be dealt with
 Death
 Co-investor concerns
 Your own death/Estate taxes
 Legal issues
 Registration of 33 Act (did this become a public offering?)
 S-Corporations – small corporations with limited number
shareholders, better have a restriction of sale if you are
close to the magic number
Freeze out:
– Majority shareholders trying to freezeout a minority shareholder
o Paying themselves salaries with disguised dividends
o If this is a public corporation, dividends don’t matter that much, stock is
worth more if the dividend is not paid if it is they have cash, held to the
business judgment rule
o BJR is not the norm in closely held corporation, because of the fact there
is no buyer for the stock, this is where stock transfer options come in
 Two reasons/methods:
 Identity of Co-investor: Restrictions on sale
 Cash-in your investment (built in market): Forced Sale
 In partnerships, the default term is that you get both of these
 Unanimous approval of sale
 Can cash in your investment whenever you want (dissolve
the partnership at will)
– Marion C meets Norman, decide to start a hotel chain
o MC wants to restrict sale of his stock
 Common techniques: Right of 1st Refusal (if Norman gets an offer
to sell, she has a right to buy at that price), Consent (simplest)
 Difference is that consent really diminishes ability to get
rid of the stock, Right of First Refusal does scare off some
potential buyers obviously
 Forced Sale to who?
 Co-investor
 Firm (usually in the articles of incorporation)
o In this case with 2 co-owners/investors, so doesn’t
matter
 Securities 33 Act
 Not registered in this case because there is no public
offering




If NB decides to sell to 15 others, court might collapse on it
and say it was a public offering, NB as an underwriter,
subject to the 33 act
o The way you prevent this is by putting security
restrictions in the articles of incorporation
Also might want some sort of arrangement to buy back stocks
when co-investor dies (don’t want to pass to heirs)
How do you set the price for the buyout? Want to mimic market
price:
 Hire an appraiser
 Some sort of formula
o Present value of net Cash Flow
o Discount Rate
 Book value
o Easy and cheap to calculate (value of assets, etc.)
o Usually a conservative estimate of market value,
although not always
 Buy-Sell
o B names price
o A chooses to sell to B or buy B’s stock at the named
price
o Both parties need to have creditline and no
emotional attachment
Close-Corp statutes (some of the terms above are written in by
default)
 Can elect to be treated under a certain state’s closed-corp
statutes
 I.E. California
o Right to force dissolution
 Close Corp
 S/h
 Allege Mismanagement
 Going Concern Value
o Scrap $1000
o GCV $2000
o ¼ int. scrap $250
 He will get a price
between $250 and
$1249
o Auctions
 Appraisal of GCV and split it 4 ways
b) Smith v. Atlantic
o 4SH – 25% each -- A, B, C, and Wolfson
o Corp owns Apartments – can either retain their earnings or payout
dividends

Problem is that at this time there was an accumulated earning tax,
if you just hold money in the bank to avoid income tax you get
taxed
 W and A, B, C get into deadlock over whether to issue dividends
or make repairs, so they accumulate the earnings (each shareholder
has veto power)
o Suit is over whether W is liable for the tax penalties the firm gets charged
for Accumulated Earnings
o Two potential: routes FD of dominant shareholder and FD of BOD
o Remember Sinclair
 Sinclair was 97% shareholder
 Court said no self-dealing because minority shareholder was
receiving its fair share of dividends
o In this case there is no dominant shareholder, they all have the same %
o Is there self-dealing? Just because he has an interest in not getting
dividends because of his high-tax bracket doesn’t mean there is COI, as
the minority shareholders would also have COI by being in low taxbracket.
o Board of Director FD
 Duty of Loyalty – seems like it should be same analysis as above
 Duty of Care – if they don’t reach an agreement there will be a loss
to the corporation – this also cuts both ways, both sides would
have a duty to reach an agreement to avoid AET, sensible to push
the loss onto the firm so they split 25% each
o But the court pushes all the loss onto Wolfson, they say he is the only one
to violate Duty of Loyalty and Duty of Care (under Wilkes), if controlling
shareholder is imposing a loss on the other shareholders can be held liable
for it
o Court is saying Wolfson is dominant shareholder because he has veto
power (using Wilkes/Donahue line of cases), but Wilkes/Donahue should
only apply to freeze out where majority shareholders are redistributing
wealth to themselves
o In Smith v. Atlantic this makes no sense at all, because each shareholder
has the same power bargaining hard, they fail to reach an agreement but
they are either all guilty or none guilty and the best way to handle is to
give a proportional loss to the firm
c) Jordan v. Huff and Phelps
o Jordan is an employee who works for the firm and he buys stock (240
shares) and as part of employee agreement if his employment terminates,
he must sell the stock to the corporation for book value
o At-will employee, there is no employee agreement
 Easterbrook says default is no opportunistic firing (because he is a
shareholder?)
 Posner says he can be fired for any reason, the shareholding
agreement explicitly says it gives no additional employment rights
o Francnik resolution – board passes a resolution which says if you are fired
you can keep your stock
 But this could be repealed at any point so Easterbrook ignores it
o Jordan gets an offer in Houston
o President convinces him to stay on to 12/31 because the book value will
increase and he does and quits on 12/31
o During Aug, D&P is also in discussions to be acquired for 20X book
value, but deal falls through
o In January, after he quits D& P announces that it has a new deal to be
acquired, which also fails
o Then 2 years later, they are actually acquired
o Jordan says he should have been told in Aug. about acquisition discussions
because he should have known that there was such a good market for D&P
to be acquired
o Majority holds for Jordan
 If we had the opposite result – could have an employee who
increases the market value of the firm, an acquirer appears and
other shareholders decide to fire the at-will employee to cheat him
out of the returns
o Two aspects of his relationship to the firm:
 Employment K
 S/H FD
o Another issue
 Is this information material?
 CEO negotiating a merger, previous MV is $60/share,
Merger price is $100/share, but merger falls through
 CEO buys stock from investor without disclosing the
merger negotiation, Investor claims he was injured
 Even though the merger didn’t go through, the value of the
stock was higher than $60, he should have been able to sell
the stock at a higher price
 Jordan is saying that he would have hung on to the stock if he had
the information
o Abstain or disclose rule
 Posner says does not apply, because they could fire him whenever
they want, so he has no right to hold on to the stock, even if he was
given the info he could have been fired, so 10-b (5) can’t require
disclosure (don’t want to penalize the firm for being nice)
 Easterbrook says that they didn’t fire him and they can’t fire
someone opportunistically to make more money for themselves
(Posner says yes they can), also says that can’t take advantage of
shareholder the same way you can at-will employee under Wilkes
line of cases, but Posner responds by saying SH agreement
specifically says you get no more rights
o Summary

Easterbrook: Generalized duty of to minority SH prevents him
from firing him opportunistically for conflict of interest reasons
(Wilkes), thus Jordan could have responded to the merger, thus
abstain/disclose applies so they had a duty to disclose
 Posner says that abstain/disclose does not apply when you can’t
necessarily use the info (Wilkes does not apply), since he could
have been fired for any reason he had no way to respond and thus
there was no duty to disclose
o Suppose a public corp. with the same situation, is there a duty to disclose?
 BOD will include some independent directors (not affected by COI
that D&P are)
 If they disclose info to him there is a chance it will leak and then a
chance the merger will fail (director has an FD), but if he is
making a decision whether to work or not based on the merger
info, they have a 10-b-5 duty to disclose
 At this point the Directors have a FD to fire him, because then he
doesn’t have the right to respond and they don’t release the
information
 Is this an opportunistic firing? No because it is public corporation
and they are acting to fulfill their FD to maximize the value to all
the shareholders. (How is this different if D&P had 40
shareholders?)
– Cases – can a controlling shareholder sell his shares to someone else for a price
higher than the market price? We know controlling shareholder have FD to minority
shareholder, do they have a duty to negotiate take me along provisions? I.e. get the
same offer for the minority shareholder that you get for your controlling stake or does
FD only apply in the way to run the company not the sale?
o Why does this happen? Why doesn’t buyer just buy off the market? Well,
sometimes the price creeps when you buy it off the market.
o When you are controlling shareholder/officer, should you be able to get
compensated to give the buyer your office? Should raise red flags, there is
a general FD of officers and seems to conflict with buying offices.
D. Transfer of Control
a) Zetlin
o Zetlin has 2% interest in gGble
o Controlling shareholder (Hansons) has 44% in Gable, who sell it to
Flintkoke for an amount much higher than market price
o Zetlin says that he is entitled to take-along for the premium, court says no
that premium sales on controlling
o Basic rule: in Delaware no take-me-along provision
b) Frandsen
o J family has 52%, Franzen has 8% in J-S
o Franzen has right to first refusal
 If J family sells their stock then they first offer to Franzen at the
same price


If Franzen refuses, then J will buy Franzen’s stock
FWS wanted to acquire First Bank (owned by J-S)
 Originally they proposed a merger, where shareholders of
J-S get cash, Franzen says he would claim right of first
refusal
 FWS decides to change their offer just to buy assets, F says
that the right was kicked in by the offer
 Posner says Right of First Refusal does not apply
 Hypothetical
 If JF negotiates a merger then F has right to buy J family
Stock at the merger price (merger as opposed to sale)
 Reasons for negotiating these clauses
 Want part of any control premium they negotiate (covered
under clause 1 & 2)
 Wants to avoid people he doesn’t like (wants control over
controlling s/h identity) (covered under clause 1 & 2)
 If Jansen family decides to sell the company he wants the
option to buy without a bidding war (then you need 1 & 2
AND the hypothetical #3)
o Posner says there a good reasons that you would only negotiate 1 & 2 and
not 3
o Suppose Frandzen wins, he does enjoin the merger and he does buy the
52% interest, F now has 60% and you 40% other shareholders, does F
have FD to look for another merger?
 F is controlling SH and has a FD to minority shareholder to get as
much as possible for all shareholders
 Stock is trading for $60 and someone had offered $100,
presumably FWS is still interested – unless he is confident that he
can make the stock worth $100 he arguably has an FD to sell the
stock
c) Perlmann v. Feldman
o Feldman owns 37% in Newport (controlling) he is going to sell Willford,
which makes steel
o There is a shortage of steel because of Korean War, but there is custom of
not raising prices – what is the FD of BOD in this case? Try to get around
this custom in some way – they come up with the Feldman plan: requiring
buyers to give them interest-free loans.
o Wilford is an end-user of steel
o Feldman is getting a big premium for his controlling share – court
suspicious that Wilford is buying at a premium so they can control the
board and not have to be subject to the Feldman plan
 3 reasons to pay a premium
 Assembly cost
 Increase performance
 Bad reason
o Court says that if there is transaction that looks like it is for a bad reason
they will enjoin the merger
o One way would be to say control premium always illegal – this is not the
case in Delaware (Zetlin), says they can find bad reasons, once in awhile
Court will stop control premium for bad reason but Delaware now
hestitant to enjoin
d) Essex
o Yates has 28% interest and negotiates a sale to Essex
o There is provision that Yates will organize the resignations of current
directors and appoint directors sympathetic to Essex
o Do this without a shareholder because board can appoint immediate
replacement if director steps down
o Yates backs out the deal for non-related reasons and then claims that the
entire K is invalid
o Court says that the K should be valid because (check…)
o But firm had a staggered board policy – Essex would not get immediate
control at the first shareholder meeting
o Law of selling offices – seems like FD breach to sell an office, but you
can effectively do it
IX. Mergers and Acquisitions
A. De Facto Merger Doctrine
– Form v. substance – what do you with something that looks like Merger but not
technically one.
– Tax consequences affect how structure deals
– Another consequence that affects form is appraisal rights, state statutes have switched
from unanimity to 2/3/majority for mergers to go through – but is this fair? A
shareholder who thinks they are investing in a small company and then they are part
of a big conglomerate. Also want to protect shareholders from bad deals.
o So many state statutes allow for a dissent, vote against a merger you can
demand that firm buy your stock
o Companies don’t know how many dissenters there will be, so very hard to
plan on how much cash will need for appraisal rights
o Why don’t we just make dissenters sell the stocks?
 Some states have gotten rid of dissenters rights in the case of
publicly-traded companies
– Issue whether a de facto merger invokes appraisal rights
a) Farris v. Glen Alden
– Facts: List owns 38% of Glen Alden. The natural way for these to combine is for
little corp to merge into big corp. They don’t want to do this, because if there is this
type a merger, there are appraisal rights. So they structure the combination so that
GA issues stock to List, and in exchange for GA stock, List provides assets (GA
buying List assets for GA stock). List becomes the holding company with GA stock.
At that point, List liquidates and gives its stockholders GA stock (who now own
76.5% of GA). GA becomes List Alden, and is now primarily owned by old List
shareholders.
– If you sell all or substantially all of your assets, you have to have a shareholder and
BOD vote. So List would have had to conduct a vote.
– To buy List assets, GA shareholders would not have had to vote. They do have a
shareholder vote because they now have to issue a ton of stock. You cannot issue
stock that has not been authorized and you cannot authorize more stock than you
intend to have issued and outstanding. The decision to issue stock can be made by
BOD; to change articles of incorporation, you have to have a vote of the shareholders
(most corporations provide for more stock in AOI than they plan to issue). GA needs
to issue more stock than it could possibly have authorized, so they need to amend
articles of incorporation – so GA needs shareholder vote.
– The shareholders of both companies vote.
Notes:
– List is a DE company and GA is a PA company. PA law applies to GA and DE law
applies to List.
– This could be structured as a merger, or by having one company sell their assets to
the other company, followed by liquidation. Same end result (one corporation has all
the assets, shareholders of both companies now own the combination).
– Trying to avoid dissenter rights through this transaction so structure the deal as sale of
List sell of assets to GA, even though List is much larger than GA
Dissenter Rights
Pa (GA)
Del (List)
Merger
Yes
Yes
Buy Assets
No
No
Sell Assets
Yes
No
– Court says this is a de facto merger and thus there are dissenter rights
o There is a PA statute which says you don’t get appraisal rights by selling
assets, but the court ignores it, in response PA legislature passes it again,
and the court more or less backs down later
– In Delaware now Dissenter rights are optional, if you want to give them you can if
you don’t that’s fine too
– Avoiding Dissenters’ Rights:
o Merging the 2 is out, because that would automatically give right to
dissenters’ rights.
o If GA sells assets to List, List shareholders would not have dissenters’
rights, but GA shareholders would.
o If List sells assets to GA, neither corporations’ shareholders have
dissenters’ rights.
– p. 722 ¶2 → court claims that there is serious financial loss to GA shareholders upon
consummation of the agreement. The court talks about book value, but tells us
nothing about what the stock is worth. Book value might be close to market value,
but there’s no reason to think that it does. Both shareholders approved the
transaction, so probably is a gain to both.
Held: Court applies the de facto merger doctrine, which says that if it looks like a merger,
if it could be done as a merger, then they’re going to call it a merger. Presumption
that something that looks like a merger should be done as a merger.
Reas.:
– PA statute (§908, subd. A) → the shareholders of a business corporation (e.g., GA)
which acquires by sale all the property of another corporation (e.g., List) by issuance
of stock shall not be entitled to rights of dissenting shareholders.
o Court says that the statute doesn’t matter. We will still characterize this as a
merger.
– pp. 722-23 → comment from members of the committee that drafted statute says that
the statute was intended to override cases that gave dissenters rights in these kinds of
cases.
o Court says that the committees’ intent does not = legislature intent and
ignores it.
Notes:
– PA legislature passed yet another statute like this after the case, and the court finally
backed down and gave the corporate lawyers what they want.
– Review
o Reasons to pay a control premium
 Insert
 Willing to pay because you believe you can turn it around
 Bad reasons – Loot the firm, put your buddies on the board who
vote to pay you a lot
 Court’s used to require a take me along provision, this is
what we saw in Perlman but court’s don’t require this
anymore
o What do you with something that looks like a merger but is not negotiated
as a merger for tax reasons, etc.
 Also avoid appraisal – some states give rights to “dissent” from
transaction, you get the appraised value of the stock, how do you
appraise it? Delaware says it is value immediately prior to the
transaction.
 Corporations have a hard time planning for the amount they will
have to pay so lawyers and managers try to get around it, Court in
Glen Alden says just because you structure something as an asset
purchase rather than a merger we won’t let you get away with it
b) Harrington
– Another de facto merger case
– Loral acquires assets of Arco under section 271
– Plaintiff’s say that they are entitled to appraisal rights
– Court says thaat asset sale statute and merger statute are of equal dignity
– What this means is that, in Delaware, appraisal rights are an option, corporations can
always restructure the transaction as an asset sale (this is an advantage of being
incorporated in Delaware)
o Why would corp. choose to pay appraisal rights? You may want the tax
consequences of the merger.
B. Freezeout Mergers
– Remember Sinclair
o If you have a transaction involving a subsidiary and the transaction has the
potential of self-dealing then plaintiffs can sue the majority shareholder
for breach of FD; as a majority sh Sinclair has a FD duty to make fair
transaction
o Sometimes want to get rid of minority SH, if you do it by just buying them
they will extort you, but you are willing to pay a fair price – the answer is
you merge it
o What do minority shareholders get?
 Stock in parent company (old shareholders join the new
shareholders)
 Pay them cash, shareholders of disappearing corporation would be
paid in cash, you can do this in almost states (Delaware statute is
on 753)
 So what are the standards whether you can do this?
a) Singer
– TMC corp. has a sub, and is going to merge Magnovok into it’s sub (Singer case,
1977).
– TMC makes a tender-offer for Magnvox gets 84%, what happens in tender-offers is
that you don’t get all the stocks – holdouts, slackers, etc. (tender-offer price is $9)
– Now TMC wants to get ride of the other 16% so it merges into the sub, with price of
$9 to the 16%, Court says no because there is no business-purpose – it says if you
want a cash-out merger you have to show business purpose
– At the same time the Supreme Court decides Tanzer, court says it can be businesspurpose at the shareholder level (business=purpose for TMC, not necessarily for
Magnovox)
– In 1983, we get Weinberger, which Delaware gets rid of the business-purpose test
b) Weinberger
– Signal decides to buy UOP
– UOP trading at $14/sh, Signal gets 51% of stock at $21/Sh, but signal does not want
the whole thing they just want majority control
– 3 years later it decides it wants the whole thing so it creates a sub and decides to
execute a cash freezeout merger at $21/Sh but Signal determined that anything up to
$24/sh would be profitable to signal
– What is the problem? Signal is majority S/H in UOP and has FD to minority
shareholder
o Does it need to pay its reservation price?
 NO
o Does it need to disclose the reservation price?
 Probably not
o Directors at UOP were using UOP resources to figure out reservation price
 This is the issue
– What does the Delaware court do?
o Throws out the business purpose test but says there has to be fair
procedure and fair price
o Here fair price is not the issue but the procedure, said the Court, was
unfair because some internal documents were not disclosed, they had a
conflict of interest in preparing it and the whole process was rushed so
they hold it illegal
– What should have the UOP done?
o They should have created an independent negotiating committee, should
not be dealing with directors with conflict of interest
o This takes us back to Sinclair law:
 You have a minority SH who wants to challenge a cash-out
merger, the Minority SH has to allege some sort of misconduct
(doesn’t need to rise to fraud); then the question becomes can the
defendant (controlling defendant) show that there has been full
disclosure and ratification of majority by minority then plaintiff
has burden of proof on fairness
 Plaintiff does not have to show waste, so we are not going all the
way back to BJR, unfairness is a lower standard
 If there is not full disclosure, then the defendant has the BOP on
fairness (standard BOP shifting)
o So this where the Delaware court left it after Weinberger
o What do you get from procedural fairness suit, isn’t price fairness enough?
 If you can actually enjoin the merger, you can settle for a large
settlement
 Also courts think they can police procedure better than they can
police price
c) Coggins
– Sullivan buys franchise and then forms corporation with 9 others, which will run the
Patriots (10,000 each)
– Issue public nonvoting stock for $5
– Sullivan is voted out as president, he wants control back so he buys the remaining
90,000 shares
– To get the money he takes out a loan, Bank says they want the corporation to secure
the debt, which would be a breach of FD to minority shareholder, so this is why he
needs/want to get rid of the minority public SH
– So Sullivan founds a the New Patriots, cash-out merging with Old Patriots
o Under MA law, nonvoting shares DO get a vote on mergers or eliminating
their own stock
o Here the nonvoting stock do vote in favor of the merger (of course with
the two boards which are identical)
– Aside: In 1986, Sullivan tries to go public again with New Patriots and the NFL
blocks the sale, sells to Victor Kiam
– The litigation is from Coggin, dissenting shareholder
– MA court establishes a new hybrid test – combining Singer (business purpose) and
Weinberger (fairness)
– Court says there is no business purpose, it is only for personal purpose of paying off
his debt, but isn’t this a shareholder business purpose? So this would probably be fine
under Tanzer.
o Also there are standard corporate business purposes that Sullivan could of
argued but he didn’t think he needed them!
 Increased costs of being public is off-the-rack corporate purpose
– Also there is a ratification by majority of the minority, so the BOP would be on
plaintiff, this also gets missed by the Court
– SO MA. SJC is saying that you need to have a corporate level business purpose
– Here it is way to late to enjoin the merger, so instead he gets the value of what his
stock would be worth if the merger did not take place
– Cashout mergers equivalent of dissolving the corporation, shareholders are parting
ways
o If you just wanted to dissolve the corporation would not need a businesspurpose
d) Rabkin
– Delaware law:
o No BP
o Fair Proc.
o Fair Price
– In all of this burden of proof matters
o If disclosure and ratification (bop on plaintiff)
– Olin buys 64% of Hunt at $25 from T&N with 1 year commitment that if it buys the
rest it will also pay $25 (not clear why T&N negotiated this no requirement of take
me along in DE)
– Olin waits 1 on year and 1 one day and then makes merger offer to Hunt whereby
they pay $20 for the rest of the shares
– Court says this is possibly unfair even though there is no fraud or deception
– Exception to the rule that Delaware court will enforce clear lines (this seems like it
should have come out of MA)
C. De Facto Non-Merger
a) Rauch
– GE merges RCA into GE Sub
– Common stock of RCA gets $66.50
– Preferred shareholders get $40/SH
– Preferred shareholders says this look like liquidation of RCA or redeeming preferred
shares, which according the articles of incorporation they were entitled to $100/sh
– This could have been structured as sale of assets followed by redemption, so claiming
this merger is grossly unfair
– Why would RCA have this provision?
o Ceiling on what Preferred shareholder can receive in a sale of the
company (since the board would redeem the stocks first), this is a right of
the corporation not the shareholder
o Hypo:
 Luke & Anakin create LSF
 S & W create a sub to which will merge (cash-out) of LSF
 LSF has 1000 Common Stock ($61/sh) and 1000 SH PS ($35/SH);
96K total; S& W is willing to pay $106K total – question is how
the money will be allocated between Common Stock and Preferred
Shareholders.
 Preferred Shareholder has right for $100/sh on merger

–
–
–
D.
a)
–
Luke & Anankin will go to preferred shareholders and ask them to
waive their right to $100, because otherwise no one will get
anything; if merger does go through they will get more than $35
 So even in this case if they could enforce the redemption provision
they would have waived it
Here court says that you negotiate something one way we will enforce the way you
drafted it; the merger statute and the asset sale statute are of equal dignity so the
merger will be enforced
Problem on pg. 755
o 10MM shares of common selling at $10/SH  total MV $100M
o 1MM preffered shares at $30/SH  total MV $30 MM
 Liquidation prerference ($100/SH) – total $100MM
o Market Value = $130MM
o Buyer reservation price = $150MM
o Would this shareholders vote firm buy assets and then liquidate?
 $100MM would go to preffered
 $50MM would go to common (worth $100MM)
o So how would you allocate the surplus of $20MM then?
 There is no neat way to do it
 Two polar examples
 All to the common, they would get $12/SH ($30 to
preferred)
 All to the preferred, they would get $50/SH ($10 to
common
 Where does “equal sharing” get us?
 10/13 to common or 10/11 to the common? (3 different
ways could share it equally)
 Zahn says always have to favor most junior security (this would
seem to imply that it should all go to common) but preferred SH
have a veto (merger/liquidation right)
o So there is no easy way to do this
Greenmail
o Potential Acquirer buys an interest in Target and target wards it off,
because knows that Acquirer wants to change the management style
o Acquirer has a large stake in the firm, how does target do this? One way
would be for target to buy back the acquirer’s stock. Whether the company
can do this, if the company does it really hurts the other shareholders.
o 10 SH at $10/SH, value of company is $100 total suppose
o Greenmail buys back 5SH at $14, what’s left in the company? They just
paid $70, the company is now worth $30 and there are 5SH, they are now
worth $6. So basically in greenmail you are taking from the other
shareholders.
Takeovers
Cheff
Maremount is buying an interest in Holland (run by Mr. Cheff, investors include his
wife and Hazelbank (Cheff family assets)
– Maremount wants to change the sales force/strategy of Holland, Cheff is opposed to
this
– Holland starts to investigate Maremount and claims he is a corporate raider
o How do you make money liquidating companies?
– Holland sales force are actually committing fraud, going door-to-door claiming to be
government inspectors (this seems lost on the DE court)
– Maremount then demands place on the board, they say no so he starts buying more
stock, he can’t get control because majority shareholders (Cheff allies) won’t sell to
him
– Maremount offers to give up if they buy his stock back – the issue is whether the
Holland corporation will buy it back or if it will be Hazelbank
o Could be FD issue even if Hazelbank buys stock, he runs it and evidence
that he is buying stock to keep his job, defenses to takeover always raise
FD issue because you are always trying to keep your job, but at least in
this hypo you are buying with your own money so probably ok
o Court decides that it is also ok for Holland Corp. to buy it (this is at the
expense of other shareholders, this is why FD issue is raised)
o The Court leaves us with a test that requires perception of a reasonable
threat to corporate policy and then they have to show they acted in good
faith and that they acted after reasonable investigation (duty of loyalty &
duty of care, more demanding than just BJR)
 Outside Directors
o DE courts seem really hospitable to incumbents
2. Development
– Acquisitions broadly – in the business of turning around badly run companies, two
ways of acquiring- talk to the managers and let them agree to turn it over or you can
go to shareholders to ask them to sell them your stock
o Chances are it is cheaper to pay off managers than costs of a tender offer
o See tender offerors in the larger picture of the two ways of acquiring a
company
– How might you negotiate with management?
o Managers live at the headquarters who tend to be local, so the
beneficiaries of tender offer legislation are local; so the legislation that is
out there makes tender offerors more costly
– Federal legislation;
o Williams Act (1965):
 suppose you are Maremount, if you hit 5% you have to announce
who you are within 10 days
 if you make a tender offer you have to make an expensive
disclosure statement of who you are and what you are going to do
the company (is this really relevant to the target? Seems like they
would care more about credit)
 If you raise price, you have to raise for all
 Have to hold the offer open for 20 days (used to be that they used
to be Saturday Night Specials), this gives management time to
figure out what sort of defenses to take
– Do shareholders benefit from these things?
o Yes, a better chance they will get $ from a bidding wars, target tries to get
a white knight to match or raise a hostile acquirer which may bring
interest from others. But this bidding wars may scare off potential
acquirer.
o Also the effect of having a market in corporate control is that managers
work harder to do a good job.
o But the legislation results in less tender offers, does this help
shareholders? Unclear, the only reason we have it is because of lobbying
power of local businesses (shareholder are dispersed)
– Hypo:
o Summers decides raise money by having law students make movies, he
goes to videomaker and decide want to buy it up and buy it up cheap
 He can buy as much as he wants but if he hits 5% he has to
disclose
 What if he gets all his buddies to buy 4.99%, if it is part of
coordinated group SEC requires adding it up (related to Michael
Milken charges); its called stock parking
 If he decides to make a tender offer, does he have to disclose
which movies he will make? Have to disclose what they are going
to do with the firm.
 Has to hold it open for 20 days
 He can raise prices but it has to be for all stock
 Suppose he just wants to buy 51% can he buy the first 51%
tendered to him? William Acts required a pro-rata requirement
(have to buy 51% of each person who tenders stock you); so if
100% of shareholders tender you are required to buy 51% of each
person’s stock
a) Unocal
– Two-tiered front-ended loaded Tender Offer
o Hypo: Steven Brill wants to by SF Law School, say that FMV: $100/SH,
SB thinks it is worth paying $120/SH (he can make it worth $140/SH)
o Suppose he makes a tender offer, it might go through or it might fail,
indepedent of each investor decision
 What if the shareholder doesn’t tender but the sale does go
through, they have the potential to make $40 instead of $20 (Brill
raises stock price $40)
 The classic problem with tender offer of shareholder to not tender
priggyback on the new management, this is the purpose of twotiered front-ended loaded Tender Offer
o The way SB would do it:
 Tender Offer to buy 51% at $130
 Merger for 49% at $110
 Create a sub, and this firm will be the one to which the SF
Law School will merge into
 Effective cost is $120/SH but changes the whole dynamic

–
–
–
–
–
b)
–
–
–
–
–
–
Now if you tender you get at least half of your stock tendered at
$130
 If you don’t tender you get $110 because you get cashed out
 Seems like everyone will tender, so they will wind up with $130
for half and $110 for half, so SB pays the same amount and makes
sure the thing goes through
 Are they coerced? Sure, but because they make more money, so
very hard that they are being taken advantage of.
 Defensive lawyers start coming up with defensive techniques.
Mesa wants to make a two-tiered offer to acquire Unocal, first put him over 51% and
second a cash-out merger
o Front-end: is $54/SH
o Back-end: junk bonds (highly subordinated, unsecured debt) which they
say is worth $54, but almost certainly this is worth less ($33-$48)
In response, Unocal says they will buyback their stock at $72 that is not tendered (not
trying to get a vote, when corps buy stocks back they don’t become voting)
o Ways to look at this defense
 Scorched earth defense – if I can’t have it you can have it either,
get rid of all your cash by overpaying to buy your stock
 But in actuality they don’t have to pay anything because their
tender only goes into effect if Mesa’s tender offer goes through,
which will be undermined by Unocal’s offer so they will not have
to pay anything
Court says that you can buy back your own stock if you perceive a reasonable threat
to corporate policy (like Cheff)
o Notice that it is the outside director’s are making all these decisions,
which let you take advantage of more lax standards
o Threats: coercive offer, junk bonds are sketchy, potential greenmail
Once you show the reasonable threats have to show that your actions are in good faith
and under reasonable investigation, and then your defense will be fine, here they do
pass the test – it is fine to exclude Mesa from the offer, usually you can’t but in tender
offer context is ok.
What finally happened?
o Mesa loses in court but cuts a deal where Unocal buys back Mesa’s stock
o This could be challenged by securities lawyer as a derivative suit, turning
around to sell the stock at a profit
Revlon
Three issues:
o Poison pill defense
o Buyback of stock
o Deal with Forstman (white knight)
Pantry Pride initiates discussions with Revlon about buying Revlon, they oppose it
Revlon is trading at $30/SH
Pantry Pride makes a Tender Offer of $47
Target brings in Lazar Fairs, bring in Roh and Lipton (of wachtel/lipton)
Pantry Pride brings in Skadden Arps
– Lipton offers the Poison Pill option (no purchase rights plan) and buy back plan
o Poison Pill – If Pantry buy 20% of Revlon each shareholder gets a right to
take share to turn it into the company for $65 (a way to get around the
two-tiered offer), won’t tender because can get $65 instead of $47
 Variation, the flip over – if Pantry Pride gets a majority/controlling
interest then when they try to do a backend statutory merger,
pursuant to the Revlon charter you have the right to buy shares in
the new company at a deep discount
 Endless variations you can come up all called poison pills
– Pantry attaches a condition to their $47 offer conditional on poison pills being
redeemed (PP were redeemable, so a deal was possible)
– They don’t cut a deal, then they buyback their own stock is for 1/3 of the company at
$47 in notes and in stock worth $10, ostensible compensation at $57. The notes have
various conditions subject to restrictions what can be done for company assets but can
be waived by the Company board.
o Shareholders give up 1/3 of their stock, the value of the 2/3 of stock goes
down but it matches up it is just like one big dividend (maybe a tax hit)
o Shareholders who are sleeping on their investments, they will be
completely hurt because they don’t have any offsetting gains.
– At this point, Pantry lowers their offer from $47 to $42, which reflects that they
bought back 1/3 of the company at an excessive price and is now in debt
– Lazar Fairs says that the new price just reflects this
– Pantry Pride also says that $42 is conditional on getting 90% to tender, has to do with
the poison pill, one way is to get the board to redeem them or a condition that only
goes through if a few shareholders exercise the poison pill
– Then Pantry Pride starts raising the price, with all sorts of conditions
– Then Forstman comes in and he suggests a LBO – leverage buyout (management
buyout in this case)
o Forstman forms a sub called Forstman Holdings, Inc. which would form
Forstman Acquisition Co.
o Fortsman Holdings would have a large amount of equity in Forstman
Holding, also Revlon Management will invest in this company which will
be financed mostly by debt financing (this is why it is called leveraged
buyout) and then Revlon is merged into Forstman Acquisition
o Managers were planning to get their investment money from Golden
Parachute (if you get canned over merger you get a huge settlement), but
depending on how you draft them they could be construed that if Revlon is
acquired by FA they got a huge settlement which they could then use to
invest in FH
o Golden parachute supposed to be so they go away and they are being used
to stay
o Now Revlon is owned by a hugely leveraged company
o But they need to waive the covenants to be acquired and to acquire the
debt (bondholders want them waived)
c) Time
– Time is doing magazines and HBO, had a conservative-style management, and Time
wanted to expand so talked about joint venture with Warner Bros. But it was
abandoned for tax reasons
– Long-time director was wary of getting more into entertainment, because of this they
talked about merging with Warner but only with cash this way Time would not be
controlled by Warner Bros. Shareholder, but who cares? Stockholders don’t care
about corporate culture. But the Warner Bros. CEO, Ross, says only on a stock basis,
Time agrees but says Ross has to leave within 5 years.
– So now it is a stock for stock deal
– Before the deal Time’s stock was $110 and and Warner Bros. $42 (.381) but the ratio
they agree to .465 (for every share of Warner you get .465 Time stock)= $51.15/SH
– They make all sorts of agreement to prevent another acquirer from targeting one of
them
– There is also a “no-shop” agreement, won’t shop themselves around
– But Paramount comes in and offers $175/SH for Time but it’s got a bunch of cavaet’s
one of which is that the consolidation with Warner Bros. Does not go through
– Time doesn’t like this, it also switches from stock acquisition to cash acquisition of
Warner and they borrow $10Billion? Why would they do that?
o Is it a gutting technique to make Time less attractive with a huge amount
of debt?
 Probably not the case because they are actually getting a valuable
asset for $10Billion
 Shareholders would need to vote on acquiring Warner stock
merger but borrowing cash is not subject to shareholder approval?
If there was a vote, shareholders would have just accepted the
$175/SH from Paramount.
 Another defense: Pac-Man, also encouraged franchisees to sue
Paramount
– Paramount increases offer to $200
– Time shareholders sue and Paramount sue and they raise different claims
o Shareholders raise a Revlon claim – should shop around for the highest
bidder
 Court says Revelon duties only kick in if 1) The management puts
the company up for grabs or 2) when incumbents look for white
knights looking to bust up the company (Revelon);
o Also a Unocal claim—Court says it’s not just going to apply BJR rule,
good faith, reasonable investigation, and reasonable defenses
 Paramount says where is the threat? In Unocal there was a twotiered, coercive offer and only 20% above market.
 Here you have a 1-tier offer and they are offering almost $200
 Court says there is a threat of shareholders getting confused, Time
reasonably investigating that Warner Bros. Is a better “deal”
– This is not the way De. Courts leave it because this opinion got so much slack, they
get something closer Revlon duties applying more broadly
d) CTS Corp.
– Raises the 3rd broad set of hindrances to tender offers
o 1) Williams Act (Fed.)
o 2) Poison Pills & Other Defenses (installed before they are on the block)
o 3) State Statutes, the state in which companies are headquartered (all
incorporated in DE), target interests almost always trump when it comes to
state legislation
 MYTE – 1st generation of legislation, which didn’t work that well
and Supreme Court struck it down as unconstitutional (?)
 CTS – less draconian than MYTE and Supreme Court lets it stand
o Dynamics makes a tender offer to increase their holding of CTS from
9.6% to 27.5%
o CTS agrees to be governed by Indiana anti-takeover statute
o 7th circuit says the Indiana statute interferes with the market of corporate
control, and says it violates dormant commerce clause and Williams Act
preempts it
 Easterbrook argues that there should be total passivity of
management when there is tender offer
 Court sided with Bebechuck saying there is a strong right of
management to fight off tender offers
 Also a debate of how the market for corporate control contributes
or opposes the Race to Bottom of state corporate laws (the one that
cheats shareholders the most is the most attractive to management)
 Nader wants to federalize corporate law
 But anti-takeover laws short-circuit Winter’s theory that it will be a
race-to-the top, takeovers of corps. in states that cheat shareholders
o Indiana statute that once there is a tender offer over a certain amount a
shareholder meeting is called and they vote whether to allow it (1/5, 1/3,
½)
o Applies to any company that is incorporated in Indiana, does business in
Indiana, and has shareholders in Indiana
o In MYTE the statute it wasn’t just Ill. Co’s, 20 day window after you
announce tender offer when acquirer can do absolutely nothing (no
negotiating, pleading, etc.) and there is Administrative review
o This statute is only Indiana Corps., no administrative review, and no
indefinite delay
o The two issues are preemption and impermissible burden on interstate
commerce.
o Court says that there is no discrimination against out-of-state buyers (same
to both Indiana and out-of-state buyers)
o Preemption – Court says you can meet the terms of both statutes so there
is no preemption issue
o Court says that the statute stands
X. Review
– In Dirks, the VP doesn’t want any financial gain from the inside info he just wants to
stop the massive fraud, the Court says it is not a breach of FD because he is doing for
public purposes
– Suppose there is an accountant who gets info from the VP of Equity Funding, the
accountant is not insider, he was not given an illegal insider tip (have to give
accountant inside info), seems to suggest accountant/lawyers can trade freely – Dirks
said this would be silly so fn. 14 says these folks are temporary insiders, they are are
treated as though they are insiders
– Unocal duties, if you are a disinterested director they have to show they acted in good
faith, after reasonable investigation and the measures they adopted were reasonable
given the threat – Revlon sayif s there is a point which have to stop a hostile takeover,
specifically is if you are looking for white knight to liquidate you must go with the
highest price – the problem with Time is that it guts Revlon since Court said can
prevent a fair one-tiered, but since then it has gone back especially if the new
management won’t keep the company in tact
– Typically poison pills can be redeemed by vote of the board
– Last Year’s Exam
o Just raise every single issue you see
o BEI, runs a saloon RCA and Blaine is it’s president
o 8 Equal Investors/Shareholders are Blaine, Lund, Laszlo, Renault, Ferrari,
Ugarte, Strausser and Dooley
 Is there are controlling shareholder? If they make blocs, maybe FD
issues or if unanimous voting required they all have veto power, no
one that though in this exam
o Directors Blaine, Laszlo, Renault, Ferrari, Dooley
 Important to keep track of Directors v. S/H, Directors will have
FD’s while SH will not unless they are controlling
o
S/Hs
Dirs
Blaine
Blain
Lund
Laszlo
Laszlo
Renault
Renault
Ferrari
Ugarte
Strasser
Dooley
Dooley
o Dooley has at-will employment and he gets stock which he must sell back
at 5% above purchase price (ring Jordan v. Duff bells)
o Hire a lobbying firm to lobby for casino, no problem here, fits under BJR
o Renault opposes on moral grounds (whether a director can safely oppose a
profit-maximizing venture for non-economic grounds – the answer is sure,
the SH are not just buying a calculator, they want Directors to use their
own ethical standards too), but in the exam for a reason so look out
o Ferrari opposes the project because he owns a restaurant next door, and
casino will draw patrons away from the establishment, which he has a
higher ownership which is a classic FD Duty of Loyalty breach, classic
COI (ok that he is on the board in general but should not participate in
transactions where he has COI)
o Stock offering – needs to change articles of incorporation requiring vote of
directors and shareholders
o Part A
 Renault and Ferrari vote against it, bases directors 3-2 and s/h’s 62 (presumably)
 Dooley votes in favor to keep his job (potential breach of FD), he
is supposed to look out for S/H’s not his job
 Laszlo – fine
 Renault sues to enjoin – Might he win or not?
 Maybe, because Dooley is the swing vote and he had a
potential COI, this won’t work with SH vote because SH
look out for their own interest except if there is Controlling
Shareholder
 It’s going to be hard though unless he explicitly says that
he voted this way to save his job
 If Ferrari was ok and Dooley was not – it would be 2-2, so
this decision is improper
 Most states need both director and s/h votes to amend the
charter and if you haven’t got it you don’t, no S/H
ratification for changing charter
 Question 2 – Is derivative or direct?
 It is derivative, it is damages to the corporation not to the
shareholders
 Puzzle, why pick Ferrari and Strasser?
o Suppose he picks Blaine, will he win?
 No, because it BJR, it is straightforward
o Against Ferrari?
 No, he didn’t vote for it – it went forward
despite his opposition
o Strasser?
 He is not on the board, he voted on S/H
level but he was not controlling so he had no
FD, so no reason why he would be liable
o Part B
 Renault never bought his stock, but Blaine gave it to him for
looking the other way for impropriety
 He either got it from Blaine or the Corporation
o There is a problem if you get it directly from the
Corporation, most stock has par value if you don’t
give it you can be sued for that amount, but Renault



will say the consideration is that he didn’t turn the
corporation in but that it is tricky
o If it is Blaine then the par value problem disappears
but the fact the consideration was illegal should
raise flags
He also signed a SPA, which he had to vote with Blaine or sell for
$1
 This ok, you can make agreements on how to vote your
stock
In the Director’s vote, Blaine votes against it but this ok, because
he is acting as a Director not a S/H, as S/H Renault votes with
Blaine
Blaine is still upset, creates a new slate with Renault off the board
and Renault refuses to vote for the new slate with his S/H vote,
does he have to sell?
 This raises an issue raised in Ramos, if he we took their
approach they would require a sale
 Agreements by shareholders on how they will vote once
they are directors are illegal -- what Blaine is doing is a
facially valid SPA to penalize the way Renault acted as a
director, so in the instant case it is not as clear cut as Ramos
o Part C
 Knows it is going to pass board 3-2, but decides to make a separte
partnership owned by Blaine, Laszlo, and Ugarte
 Casino is a wild successes, Dooley who is a S/H and Director sues
B, Laszlo, Ugarte and Ferrari saying it should have been a BEI
project, will he win?
 The makeup of the partnership is important
 Ferrari – could he somehow be held liable? he opposed it
for a bad reason and that is what drove the partnership but
mention that this claim would probably fail
 No claim against Ugarte because he is just a noncontrolling shareholder
 Case against Blaine – p.g. 381, straightforward corporate
opportunity case against Blaine, opportunity for the
corporation
o Is this in the line of the corporation and officer is
liable and liable for paying corporation for profits
o You even came up with this idea specifically for
BEI, this is developed by corporate resources
 Laszlo is a director, NOT AN OFFICER, the test is a little
more narrow not just in the line of the business but an
opportunity developed with corporate resources and in this
case it meets this test, or did you hear about it under yoru
board status, this helps in cases where director is on
multiple boards

Can Blaine fire Dooley in retaliation and must Dooley sell?
 This is obviously based on Jordan v. Duff-Phelps, point out
the issues raised on that case – what does at-will covering?
Does it cover opportunistic firing? Easterbrook v. Posner
 On top of this you raise Wilkes problem, Dooley is also a
shareholder in closely-held corporation, then that would
mean Blaine has a duty to Dooley as a shareholder and that
would prohibit opportunistic firing – in the agreement in
Jordan it said SH agreement did not give any new rights but
here that is not the case so an opportunistic firing may
impinge on shareholder rights
o Part D
 Blaine proposes to the board, it passes, then it passes S/H then
Ugarte (S/H not a director) is arrested, he hires an attorney the
lawyers at police station and overhears Renault talking about BEI
liscnese with State Officials, the lawyer learns this is going to pass
and reasons that it is going to profitable, can he buy Ugarte’s stock
or Lund’s stock?
 Can he buy it?
 Can’t buy Ugarte’s because he is his lawyer/agent, has
fudiciacry and can’t make secret profits involving your
client, straightforward violation of agency, would also be
10 (b)(5) violation because there was a duty to disclose
surrounding a security, does not matter that it was a public
company
 What about Lund?
o Maybe if there is a rule at his firm that he couldn’t
profit on this info then it would be a
missappropriation
o He is not Lund’s attorney, so seems like this is ok
o What if he was BEI’s attorney? Then he owes
duties to all S/H
o Why doesn’t Dirk give us a problem, he’s not a
temp. insider, he does not owe FD to Lund, and it is
in transactions unrelated to BEI, is tipeee somehow
receiving a tip in violation of FD. He is a tippee but
when Renault was talking, it could have been a duty
of care violation but not a duty of loyalty, does not
involve financial gain to the tippor so under
straightforward Dirks
 Second part: Casino is going into the partnership not into BEI
 In order to become a partner you need full ratification by
partner, Ugarte can’t just give him the partnership
 Can the attorney try to buy the partnership without
breaching any other duty?
o No 10-b(5) violation because a general partnership
interest is not a security, 10 (b) (5) only applies to
securities, because you are a manager
o But you still are breaching FD as an agent, by not
telling him the info
o Part E
 Issues preffered stock registered under ’33, ’34 Acts (kicks in:
ongoing disclosure requirement and there is now potentially 16(b)
problem lurking), there is a dividend preference and a liquidation
preference
 Question 1:
 Stewart willing to invest but doesn’t want bidding war, so
wants to agree to no-shop agreement and $500K if there is
another acquirer
 Another acquirer appears announces a tender offer, can she
enforce the no-shop and lock-up?
o Raises Revlon, if Revlon duties have kicked in you
have to get as high a bid as possible thus a lock-up
like this would not be enforceable but what this
introduces the problem is that you only got this far
precisely because you had the lock-up – but there is
no breakup here
o Lock-up is supposed to get assets of firm way
below for value, if anyone tries to acquire the firm
they are going to shovel cash outside the door
o No-shop, they are not trying to negotiate so in that
sense there is no-shop
 Question 2
 Suppose Stewart wants complete control, offers two-tiered
offer
 Can preferred enforce $100/SH?
o This is Rauch, in deleware this is no de-facto nonmerger, merger and liquidation are of equal dignity
 Is Blaine liable to Laszalo?
o No 16(b) gains are to the corporation not person
who sells it to you
o Part F
 Is Blaine liable to RCA? Who would enforce the claim?
 Say it is BEI’s money going to Renault, you are paying a bribe to
cop
 Problem is structured where illegal payment is profit-miximizing,
doesn’t BJR apply? The BJR only kicks in if there is no COI,
fraud, negligence or ILLEGALITY. This is means you (S/H) can
sue BEI in a derivative suit and get Blaine to give 30K to
corporation.
 Sue BEI to sue someone else




Suppose it is not just $30K but $1MM which goes to the state,
obvious question is whether Blaine is liable? Yes, no BJR.
But the question is whether Renault liable? Yes, because he is also
a complicit DIRECTOR.
What about Lund? She is only a S/H, no part in this decision she
can’t be liable there is no breach of FD. Can you pierce the
corporate veil? One wouldn’t think so, it was raise all the issues –
fraud, illegality, etc. And here there is no unity of interest.
Blaine liable under 16(b) because he is a director and 10%
shareholder