INTRO
Why incorporate? Facilitates contracting; pooling/partitioning assets; limited liability
CORPORATIONS
 Legal personality with indefinite life
 Limited liability for investors
 Free transferability of share interests
 Centralized management
 Appointed by equity investors
Why invest? Transfer value through time / pool resources / diversification
AGENCY – How to deal with agency problem? Fiduciary duties / shareholder voting / securities regs / contracts
Liability in contract – can be bound by actual authority (2.1, 3.01, 2.02) or apparent authority (manifestation to
third party, 2.03, 3.03)
Also: ratification (4.01), estoppel (2.05)
Liability in tort – agent always liable to third party for tort; principle sometimes liable (when acting with actual
or apparent authority, when principle negligently selects agent)
Vicarious liability/repondeat superior – 7.07 – within scope of employment, controls manner/means
Principle’s Duty – pretty weak – duty to follow contract, indemnify, fair dealings and good faith
Agent’s Duty – Duty of Loyalty – prohibition on secret profit (8.02); prohibition on adverse interest (8.03)
Duty of Care – 8.07-12
Agency Problems – shareholders/managers; controlling SH/minority SH; SH/third parties (creditors/employ)
Worse if multiple principles – coordination costs, hurts collective action
Corporate controls should increase value for everyone – higher willingness to pay
Regulatory Strategies – prescriptive, substantive terms that govern relationship, constrain agent
Requires an effective regulatory institution (expertise, integrity), disclosure
Public (SEC) and private enforcement (shareholder suits)
Governance strategies – facilitate principals’ control over agent’s behavior (less successful b/c of
coordination costs in monitoring, deciding)
Basic controls: fiduciary duties + shareholder voting + disclosure obligations
RSA 1.01 – Agency = fiduciary relationship when principal manifests assent (and agent agrees) that agent shall
act on principal’s behalf and subject to principal’s control
RSA 1.04(7) – Power of attorney is an instrument that states an agent’s authority
RSA 2.01 – Actual Authority – At time of act, agent reasonably believes, in accordance with manifestations,
that principal wishes agent to act.
RSA 2.03 – Apparent Authority – Power of agent to affect principal’s legal relationship with 3rd parties when
3rd party reasonably believes agent has authority to act, traceable to principal’s manifestations
RSA 2.05 – Estoppel to Deny Existence of Agency Relationship – principal who doesn’t manifest agency, is still
liable to 3rd party if intentionally/carelessly caused belief; having notice didn’t take reasonable steps to notify
RSA 3.01 – Creation of Actual Authority – principal’s manifestation to agent that expresses assent to action on
principal’s behalf
RSA 3.03 – Creation of Apparent Authority – manifestation; third party reasonably believes actor to be
authorized and belief is traceable to manifestation
RSA 4.01(1) – Ratification – affirmance of prior act done by another; given effect as if done w/ actual authority
RSA 4.02(1) – Ratification Effect – Retroactively creates effects of actual authority
RSA 6.01 – Agent for Disclosed Principal – principal and third party are parties to contract; agent (with actual
or apparent authority) not a party unless agent/third party agree otherwise
RSA 7.03 – Principal’s liability – principal subject to direct liability to 3rd party harmed by agent when acting
with actual authority or ratified; when principal negligent in selecting/supervising; delegates duty of care to
agent who fails to perform. Vicarious liability if agent commits tort while within scope of employment or
acting with apparent authority in dealing with third party
RSA 8.01 – General Fiduciary Principle – Agent has fiduciary duty to act loyally for principal’s benefit in all
matters connected with agency relationship
RSA 8.02 – Material benefit arising out of position – Agent has duty not to acquire material benefit from 3rd
party in connection with transactions taken on behalf of principle
RSA 8.03 – Acting as or on behalf of an adverse party – duty not to act on behalf of adverse party
CHARTERS – very little is mandatory; only board can initiate charter amendment (DGCL 242)
DGCL 102(a) – mandatory elements of corporate charter – voting stock, board (size, terms, removal),
shareholder voting, name incorporators, fix initial capital structure
DGCL 102(B)(1) – Contents of Charter – may contain any provision not contrary to laws of this state
DGCL 102(f) – May not impose liability on stockholder for attorneys’ fees / expenses for internal claim
DGCL 151(a) – Types / Rights of Stock – may issue stock as described in charter
DGCL 212(a) – Votes per share – one vote per share unless charter provides otherwise
DGCL 242 – Amendments – requires board resolution; vote of majority of outstanding stock (and majority of
each class entitled to a class vote); filing of amendment certificate
BYLAWS – must conform to statute/charter; shareholders or board can initiate amendment (DGCL 109)
DGCL 109 – Bylaws – Stockholders have power to adopt/amend/repeal bylaws; Corp can let board also; can
include any provision not inconsistent with the law (but no liability for attorneys’s fees / expenses)
DGCL 112 – Access to proxy solicitation materials – May require minimum stock ownership; submission of
specific info; indemnify for false statements; no nomination if acquiring x% before election
DGCL 113 – Proxy expense reimbursement – may provide but limit
DGCL 115 – Forum selection provisions – may require / can’t prohibit internal corp claims brought in DE
DGCL 141 – board has primary management authority (usually delegated to managers
DGCL 141(d) – default is entire board elected for one year term; but allowed staggered board with up to three
classes
Decisionmaking Power (DGCL Defaults)
 SH only – board election, annual, DGCL 212(b)
 SH and board jointly – fundamental changes (mergers – 251c except 251fh, 253; charter – 242b2)
 SH or board alone – bylaws 109a
 Board only – business decisions – 141a
Voting – shareholders have little agenda control on what to vote for
 Only board can initiate merger, charter amendment, call special meeting, what to put on proxy cards
(no access for SH board nominees, may get in precatory resolutions i.e. bylaw proposals)
Disclosure Requirements - Securities Exchange Act of 1934
 Disclose ownership above 5% (form 13D)
 If more than 10%, you’re a corporate insider – disclose within two days (Section 16a)
PARTNERSHIPS
 UPA 202 – association of two or more persons to carry on as co-owners a business for profit forms a
partnership, whether or not the persons intend to form a partnership
o Dangerous default rule
 Joint owners of assets
 Jointly and severally liable for obligations (UPA 15(b)) – unlimited liability
 All both agents and principals of partnership; all have control (equal right to manage)
 One partner can force liquidation / dissolution (UPA 31(b), 38(1))
 Partnership interests are not transferable
Why have partnership? Tax benefits, align incentives – but almost entirely replaced by corporations
UNCONFLICTED BEHAVIOR – Duty of Care
If directors are disinterested/reasonably informed/not wasteful, decision will be protected by business
judgment rule (Aronson) – primarily, a process requirement
Possible exception: gross negligence (Van Gorkom), but damages waivable under 102(b)(7)
Also can’t violate the law
To survive motion to dismiss, have to plead fraud, self-dealing, self-interest; specific duty of loyalty violation
(knowingly illegal acts – motion to dismiss denied)
Violation for inaction (Stone v. Ritter) – bad faith - must have utterly failed to implement reporting system or
consciously failed to monitor or oversee operations (more than gross negligence - Disney)
Demand futility – under particularlized facts, reasonable doubt that (1) majority of directors are disinterested
or independent OR challenged transaction was (2) product of valid exercise of business judgment (AND no
sufficiently independent special litigation committee – Zapata/Aronson – tough independence standards,
independent business judgments) (essentially a heightened pleading standard)
Director is partial if – personal interest in challenged transaction; subject to liability by participating
In practice – heightened pleading standard for fiduciary duty violations – particularized facts
I.e. – if bringing suit against former directors, no demand excuse
Duty of Care – act with appropriate care / ordinary prudent person; essentially eliminated by BJR
Aronson v. Lewis – Fink (47%) got huge comp. package; derivative suit claiming no valid business purpose;
waste; claimed demand futility b/c Fink controls board; Holding: not enough facts alleged
Derivative Suit – shareholder against board on behalf of the company; need to own one share
Demand Requirement – DGCL 23.1 – must allege efforts made to get board to bring suit
Demand futility test: under particularized facts alleged, reasonable doubt that directors were
disinterested / independent (essentially a heightened pleading standard)
Must rebut: informed basis, in good faith, honest belief in best interests of company
Can get around by appointing independent committee (Zapata) – court look to independence /
good faith of the committee; independent business judgment (not rubberstamping)
Can’t just say that all directors are defendants, controlled by Fink
Ensure first use corporate democracy, prevent strike suits (settlements)
Business judgment rule:
1. Disinterested and independent (otherwise appoint independent committee)
2. Reasonably informed (look to gross negligence, Van Gorkom)
3. Rationally believes is in best interest of corp (no waste)
Zapata (discussed in Aronson) – even in demand excused case, independent committee can ask for dismissal
1. court will look at independence and good faith of committee
2. review reasonableness and good faith of committee’s investigation
Van Gorkom - shareholders seek merger damages, direct suit; board not adequately informed – no
independent evaluation, short time frame / no emergency; no justification for price (Van Gorkom set it); AND
didn’t disclose all material information to stockholders
Ran numbers to see what cash flow would be necessary for debt (not appropriate value of co.)
Court uses a gross negligence standard; found market test didn’t cure
Board may also face suit for rejection of merger / tender offer
(unlikely DE court would impose liability on these facts today)
Stockholder Action – when majority of fully informed stockholders ratify action of even interested
directors, an attack on transaction must fail (but here stockholders not fully informed)
Takeaway: get better procedure – valuation; don’t agree to deal (no liability)
Delaware responds with DGCL 102(b)(7) – Can have charter provision that eliminates or limits personal liability
of director / stockholders for monetary damages for breach of fiduciary duty EXCEPT for breaches of duty of
loyalty; not in good faith (intentional dereliction of duty; conscious disregard for one’s responsibilities –
Disney) intentional misconduct; knowing legal violation); under § 174 (unlawful dividends); for any transaction
where director derived improper personal benefit
Walt Disney – giant exec comp package; derivative action – breach of fiduciary duty / contract, waste
Claims against Ovitz fail – no duty until deal already made; not breach to get what contract says
Claims against Disney fall – comp. committee didn’t meet best practices, but acceptable
Good Faith Standard – gross negligence without more cannot constitute bad faith; need subjective bad
faith or intentional dereliction of duty; conscious disregard for responsibilities
102(b)(7) waiver – waived liability as long as good faith violation – broader than b. jud.
Takeaway: no duty of care violations unless bad faith if you have a 102(b)(7) waiver
Board Inaction
Graham – Absent cause for suspicion, no duty to “install and operate a corporate system of espionage to
ferret out wrongdoing which they have no reason to suspect exists.”
Caremark – narrows Graham – should have good info / reporting system to ensure you know what’s going on;
Only liability if “sustained or systematic failure of board to exercise oversight – such as an utter failure to
attempt to ensure a reasonable information and reporting system exists.”
Stone v. Ritter – for oversight, need to establish lack of good faith (Disney – not just gross negligence); at
motion to dismiss / demand requirement stage – argue directors face substantial likelihood of liability; can’t
show information was reaching the board to raise red flags; not enough info to excuse demand
Demand futility test – to get around 102b7 waiver, have to show not in good faith / loyalty violation
Failure to Monitor Test – liability if directors (must show directors knew not following obligations)
1. Utterly failed to implement any reporting or information system or controls
2. Having implemented, consciously fail to monitor or oversee
DGCL 141 – board manages business and affairs of corporation; e – fully protected in relying in good faith on
reports made by officers
DGCL 145 – Corp can indemnify dir/off for reasonable expenses, judgments, fines if person acted in good faith
and not adjudged liable to corporation (and maybe if anyway); if successful defense, must reimburse
expenses; corp can purchase insurance whether or not power to indemnify
Strong incentive to settle before you’re found in bad faith – insurance will stay pay
Why do directors care even with waiver/indemnification? Reputational; huge payout possible; most settle
anyway; in criminal – no reason to think action unlawful
CONFLICTED BEHAVIOR – Duty of Loyalty (Fair Dealing + Fair Price)
Self-dealing transactions – must fully disclose (otherwise entire fairness); should get approval by
disinterested party, approval by minority shareholders
Controlling stockholder – always use entire fairness
Business opportunity (Guth) – can ask for ex ante permission from board – DGCL 122(17)
Duty of loyalty applies to directors, officers, and controlling shareholders (Weinburger)
DGCL 144 – Interested Directors – transaction not void solely because made with interested director if
approved in good faith after full disclosure by majority of disinterested directors or shareholders; or is fair
Weinberger – cash out merger – controlling stockholder w/ board members – problem: feasibility study
performed by company for majority board members; not arms length / didn’t abstain; even though
shareholders approved, burden remains on defendants because they weren’t fully informed
Majority owned 50.5, decided it wanted the other 49.5; directors did study on what they could pay,
didn’t disclose to shareholder/disinterested directors
Fair Dealing – procedural requirement – total disclosure; duty of candor
Fair Price – substantive requirement – economic and financial considerations (courts often punt)
But price is he preponderant consideration
Burden Shifting Framework – If plaintiff shows self-dealing, defendant has to show entirely fair by
preponderance; but if informed vote by disinterested parties (majority of minority shareholders),
burden shifts to plaintiff
If plaintiff shows self-dealing; burden bears burden of showing entire fairness; burden shifts if
independent directors and/or majority of minority approve
Takeaway: fn. 7 – appoint independent committee of outside directors to negotiate, and you’re ok
Demanding standard of review for conflicted transactions w/ controlling stockholder
Sinclair – owns 97% of subsidiary; claim paying too high a dividend, not investing in R&D; found no self-dealing
– parent received nothing to exclusion of minority shareholders – should apply business judgment; but did find
self-dealing in not enforcing contract breach – have to show intrinsic fairness
Test for self-dealing – actions that bestow exclusive benefit on parent at expense of minority
If self-dealing – entire fairness; if not – business judgment
Guth – Pepsi case – unbelievable amount of self-dealing; comingling of assets; require Pepsi assets be given to
Loft; corp. officer/dire not permitted to use position to further private interests; undivided / unselfish loyalty
If business opportunity that belongs to corporation, you have to turn over to the corporation
Business Opportunity Test – In which capacity did fiduciary receive knowledge; did corp have financial
means to pursue; is this kind of thing corp does; does corp have interest / expectancy in this opp; by
taking opp for own, will fiduciary be placed in position inimicable to duties?
May take a business opp if:
1. opportunity is presented to director in individual, not corp capacity
2. opportunity is not essential to corp
3. corp holds no interest or expectancy in opp
4. director/officer has not wrongfully employed resources of corp in pursuing/exploiting
Meinhard v. Salmon – “Joint adventurers, like copartners, owe to one another, while the enterprise continues,
the duty of the finest loyalty. . . . A trustee is held to something stricter than the morals of the market place.”
Broz v. Cellular Information Systems – corporate opportunity – presenting opportunity to board creates a kind
of “safe harbor”, but presentation isn’t necessary prerequisite
DGCL 122(17) – corp./board can renounce any expectancy of corp in specified business opportunities or
specified classes or categories of business opportunities presented by officer/director/stockholder
Self-Dealing?
Approval by
Nobody (or we
don’t know)
Full informed
disinterested
directors
Full informed
disinterested SHs
Self-dealing by
Controlling SH
Director / Officer
Entire Fairness [D] Entire Fairness [D]
Sinclair
DGCL 144
Entire Fairness [?]
BJR / Waste [P]
Kahn v. Lynch
Aronson
Entire fairness [P]
Weinburger, but
Kahn may need
both
Yes.
Controlling SH?
Yes.
Entire fairness
BJR / Waste [P]
Wheelabrator
No.
102(b)(7) waiver or
Caremark claim?
No.
Approval by
disinterested
directors or SH?
No.
Entire fairness
No.
BJR
Yes.
Good faith
Yes.
BJR/Waste
SHAREHOLDER LITIGATION
Aronson – demand requirement – at motion to dismiss time
America’s Mining – awarded $35,000/hr attorney’s fees – 15% of common fund – incentivize litigation
Common Fund Doctrine – litigant who recovers common fund for benefit of group is entitled to
reasonable attorney’s fee from fund as a whole – 10-33% depending on Sugarland factors
Sugarland factors – benefit achieved, difficulty & complexity, contingent representation,
standing and ability of counsel, time & effort of counsel
In re Riverbed – class action litigation for stockholders with rights extinguished in merger; objector argues
disclosures were worthless; extinguishing potentially valuable claims; result is too modest a benefit to justify
the fee sought ($712.95/hr); uses Sugarland factors to award $330k instead of $500k
Standing – need to be member of class affected by settlement (not need to own share at merger)
Reviewing settlement – policy preference for settlement vs. need to insure class fairly represented
Agency problems in class actions – plaintiffs’ attorneys may favor quick settlement; interest of particular
principal is extremely small
Plaintiffs got a peppercorn (positive result of small therapeutic value), released a mustard seed
In other situations, breadth of release could be troubling
DGCL 102(f) – charter cannot contain fee shifting provision – impose liability on stockholder for attorney’s fees
DGCL 115 – forum selection provisions – may require, cannot prohibit that internal corporate claims be
brought only in Delaware
Ct. Chancery Rule 23.1 – Derivative Actions by Shareholders – must allege that plaintiff was a shareholder at
time of transaction of which shareholder complains; allege with particularity efforts made by plaintiff to
achieve goal from dir/off; class representatives must file affidavit saying not receiving compensation for acting
as rep; action not dismissed without approval of court
SHAREHOLDER VOTING – see this section on H2O
Schnell v. Chris-Craft – mgmt. moved up annual meeting; using Delaware law and corporate machinery to
perpetuate itself in office – complying strictly with the law doesn’t make it ok – reinstate later date
“Inequitable action does not become permissible just because legally possible.”
Blasius – board added new members to defeat proposal to make board much bigger
Business judgment rule doesn’t apply if board acts with primary purpose of interfering with
stockholder’s vote, even if taken advisedly and in good faith
But adopts intermediate standard – not per se invalid
Actions – shareholder/board jointly modify charter, merge; shareholders or board change bylaws
Board alone: everyday business, initiate merger / charter amendment; call special meeting; decide
what goes on proxy cards (board only picks board candidates; shareholder can propose bylaw)
DGCL 141(d)/(k)(1) – Charter (by initial bylaw) or bylaw (adopted by stockholder) may vote on staggered
board (up to 3 classes; 1/3 of board up each year); any director removed with majority of votes unless
staggered board (then maybe removed only for cause), cumulative voting?
DGCL 214 – Cumulative Voting – charter may give shareholders number of votes x number of directors to be
elected, allow votes to be cast for single director or among several
DGCL 112 – Access to proxy solicitation materials – Bylaws may require corp to include shareholder nominate
candidates in materials with requirements – minimum stock ownership, particular info, indemnification
DGCL 113 – Proxy expense reimbursement – may provide reimbursement with limitations
DGCL 213 – voting rights determined on record date – 10-60 days before actual vote
DGCL 242b – shareholders must approve charter amendment
DGCL 252c - shareholders must approve merger
SEA 14a-1 – (federal rule) Definitions – Solicitation = furnishing of a form of proxy to security holders under
circumstances reasonably calculated to result in procurement, withholding or revocation of proxy; not inclue
communication stating how intending to vote in speech / press release / advertisement
SEA 14a-2 – rules apply to every proxy solicitation except when not seeking power (except for officer /
nominee / any person soliciting in opposition to a merger / soliciting no more than 10 people)
SEA 14a-8 – Shareholder Proposals – must hold at least $2000 in market value or 1% for at least one year; no
more than one proposal per meeting; can’t suggest a candidate for board
M&A – buying, selling, joining of entire corporation; only a board can propose a merger
Asset sale – very cumbersome; transfer individual assets, no contract transfer w/out consent;
dissenting shareholders don’t get appraisal rights; don’t automatically assume all liabilities
Merger – very easy; simple majority approval by board/shareholders
Options:
Merger only – appraisal rights, no entire fairness review
Tender + merger – appraisal rights; entire fairness review only on longform merger, not shortform
Asset sale – no appraisal, no entire fairness review
Williams Act Requirements for Tender Offer – disclosure rules – file w/in 10 days of acquiring 5%; amend on
acquiring material change (+/- 1%) (SEC 13D)
14D – requires tenderer offeror to disclose identity and future plans
14E – prohibits any fraudulent, deceptive, or manipulative practices in connection with tender
14E-1 – tender must be open for at least 20 business days
14D4-7 – substantive terms of tenders offer – duration, equal treatment etc
Generally – open at least 20 business days; shareholders can withdraw at any time before offer
closes, all offered best price; open to all shareholders of same class
14D6 – if oversubscribed, offeror must take up tendered shares pro rata
DGCL 251 – normal mergers require approval from board and majority of shareholders in both target and
buyer
DGCL 251(h) – back-end squeeze out – don’t need a vote if you own majority of stock – now allows a shortform merger following a tender offer if the acquirer obtained at least majority for long-form – top up no
longer required!
Still need 90% to do without a vote; 3G Burger King is different – if you negotiate merger up front,
launch tender, has at least 50%, then they can do merger without shareholder vote – negotiate up front,
tender off for all shares, board would have to approve up front anyway
Creates appraisal right for dissenters; if controller from outset – entire fairness; arms length – BJR
Glassman – only applies directly to 253
Could challenge initial agreement
But controlling stockholder will always face entire fairness
Before 251h, everyone used tender and top up
DGCL 259 – Status of corp after merger – at merger, surviving corp shall have all rights / obligations
DGCL 260 – Powers of surviving corp – may issue obligations to pay for merger; may mortgage or issue stock
DGCL 261 – Effect of merger upon pending actions – may continue as normal or substitute surviving corp
DGCL 251 – Merger of domestic corps – both boards agree, approved by shareholder vote (1/2 of all shares)
DGCL 253 – Merger of parent / subsidiary – If parent owns at least 90%, short-form merger; 262 doesn’t apply
DGCL 262 – Appraisal rights – stockholder must deliver written demand for appraisal before vote; may order
expenses to be charged against value (no appraisal rights in asset sale, short-form)
DGCL 271 – Sale, Lease, Exchange of Assets – may sell on majority vote
Hariton v. Arco Electronics – sold assets, effectively creating merger using asset sale statute; court says ok, but
means that dissatisfied shareholders don’t get appraisal rights (DGCL 271)
Weinburger – also involved squeezeout merger
Glassman v. Unocal – parent company executing short form merger with subsidiary; established special
negotiating committee; tried to meet entire fairness (unnecessary) – DGCL 253
Short-form merger – already own 90%, don’t need vote of shareholders/board, just file a form
Supposed to be easier – won’t require the full fair dealing component of entire fairness
Appraisal – exclusive remedy available for non-fraudulent mergers; company won’t have to establish
entire fairness, but duty of full disclosure remains; court will consider proof of value by any methods
generally acceptable in community; all relevant factors; if you want appraisal, have to send in dissent
before vote then file for appraisal (only those who ask get the additional money)
Absent fraud or illegality
Kahn v. MFW – controlling (43%, lots of board) stockholder squeezing out minority; conditioned merger on
both independent committee and majority of minority approve; does entire fairness apply?
Business judgment standard applies when merger is conditioned upon both approval of independent
special committee that fulfills duty of care (independent, can pick its own advisors, able to say no) and
the uncoerced, informed vote of majority of minority stockholders
If plaintiff can plead reasonably conceivable set of facts showing any conditions not met, entitle
to proceed to discovery, trial with entire fairness review
If only one of protections in place ex ante, proceed with Weinburger burden shifting
If both, can resolve on summary judgment (entire fairness determined at trial)
In re Delphi – charter says both share classes get same consideration; but Rosencrantz won’t sell w/out higher
price for his shares; deal conditioned on majority of first class amending charter to allow differential; other
side deals also sweetening pot for Rosencrantz; won’t award injunction but will allow to proceed for damages
Allowing amendment would make charter rights illusory; let controlling shareholder benefit twice
Implied covenant of good faith and fair dealing
Equal Opportunity Rule – benefits shareholders if there is a deal, but controller may prevent deal
Delaware default is that control premium is ok, can change in charter/bylaw
SEA r. 14d/e
SEA r.13d – if you acquire in/directly 5% of shares, must file Schedule 13D w/ SEC w/in 10 days
TAKEOVER DEFENSES
Unocal v. Mesa – Board has power to defend against hostile takeovers, even with discriminatory measures
Strategy: if Mesa successful in bid, buy remaining shares at much higher price; exclude Mesa from offer
Board has obligation to determine whether tender offer is in interests of the corporation
But directors may not act solely/primarily out of desire to perpetuate themselves in office
Defense must be reasonable in relation to threat posed – intermediate review (stricter than BJ)
Claim – grossly inadequate price, coercive bid (two-tier bid)
Target board bears burden of showing proportional to threat
Intermediate scrutiny stsandard of review for defensive actions – must reasonable reasonably
related to threat posed
Board Authority – DGCL 160 – to deal in corp’s stock; DGCL 141 mgmt of corp’s business & affairs
Corporate law is not static. It must grow and develop in response to evolving concepts and needs.
(although discriminatory self-tender is now illegal under SEC regulations)
Moran v. Household – approved the poison pill – only goal: deter hostile acquisition; never intended to trigger
Effectively stops all hostile takeovers; fundamental power shift from shareholders to boards
Court finds statute silent to this particular technique; corporate law should grow and change (Unocal)
Finds board authority under DGCL 157, 141
SEC amicus: court seriously underestimates impact; will deter all hostile offers
Defense: burden with board to show reasonable grounds for believing danger to corporate policy
existed; look for evidence of bad faith / entrenchment
Why are we ok with the pill? Better than the other defenses people had used before
Sale of discounted stock, sale of stock to other party, acquisition to create antitrust problem
DGCL 203 – can’t merge if you’ve recently acquired a lot of stock unless you own 85%; 2/3 majority vote of
other stockholders + board consent; waivable by charter or bylaw
Revlon – if board decides to sell/break up company, can no longer defend selectively against some bidders
Lock-ups / no-shops permitted only where untainted by director interest / breach of fiduciary duty
OK that board initially chose poison pill, but then not ok to agree to sell elsewhere, prevent other sale
Once board permitted management to negotiate, duty only to maximize company’s value for
shareholders (not note holders)
Revlon used scorched earth tactic – issued notes with major restrictions
Today – generally ok with giving first bidder 4% break up fee – valuation process is very expensive
Some defenses still available -
Airgas – board must act in good faith, after reasonable investigation and in reliance on outside advisors who
say legitimate threat before instituting poison pill; inadequate price is sufficient to show coercion
Board can maintain a poison pill for as long as it likes and for the mere reason that it believes offer
price to be inadequate
But board must show it’s aacting in good faith, after reasonable investigation and reliance on advice of
outside advisors – showing tender poses legitimate threat to corporate enterprise
Just forces the bidder into a proxy fight to elect majority of board
Under existing Delaware law, inadequate price alone is a threat – shareholders will mistakenly tender
into an inadequately price offer – substantive coercion
Quickturn Design Systems v. Mentor Graphics – dead-hand pill violates DGCL 141(a) – deprives new board of
power to manage the business and affairs of the corporation
Paramount v. Time – inadequacy of price is sufficient threat (when combined with shareholders may elect to
tender in ignorance) = substantive coercion
Stock deal only triggers Revlon duties in stock deal if change of control; not triggered if corp widely
held both before and after merger
Burger King – go shop provision
UK Approach – both takeovers and defenses very restricted in the UK; not allowed to defend
Probably shouldn’t worry about short termist investors, but do worry about shorttermist managers
i.e. put stuff on sale, cut R&D budget – one strategy: unstaggered boards
SECURITIES LAW
SEC Rule 10b-5 – unlawful to make any untrue statement of a material fact or to omit to state a material fact
necessary; engage in act/practice/course of business which creates fraud/deceit in connection with purcuase
or sale of any security
Insider trading made to fit in here: insiders commit fraud by omission when not disclosing
SCOTUS stipulated duty to abstain from trading or disclose
10b-5-1 – safe harbor for execs to precommit to buy/sell at certain times in the future
Securities fraud – usually litigated by class action; insider trading – usually litigated criminally (no
plaintiffs incentives – damages capped at gains derived by defendant)
Basic v. Levinson – Fraud on the market (who would knowingly roll the dice in a crooked crap game?): false or
misleading statement of a material fact made with scienter that plaintiff reasonably relied on that causes
injury (can always rebut fraud on the market theory – show others knew, other reason for sale)
Materiality: omitted fact is material if substantial likelihood that reasonable shareholder would
consider it important in deciding how to vote
Scienter: intent or knowledge of wrongdoing; someone must know statement was wrong
Reliance: assume you relied on any material information there
Problems: most people don’t rely on market price – assume undervalued; why do we want the rest of
shareholders (who didn’t trade) to suffer to pay out the ones who did?
Purpose of securities acts: “to substitute a philosophy of full disclosure for the philosophy of caveat
emptor” “achieve high standard of business ethics” not to “attribute to investors a child-like simplicity,
and inability to grasp the significance of negotiations”
Rule vs. standards – any test with dispositive factor is necessarily over/underinclusive
No agreement-in-principle bright line rule
Dissent – people purchase stock because they don’t think the market price reflects value
SEA Section 16 – Corp directors, officers, principal stockholders must disclose every transaction in securities
(including derivaties) within 2 days; corp right of action to recover so-called short swing trading profits from
o/d/ps made within 6 months; liability also fits with 10b-5; state law (unjust enrichment)
SEC 14e3 – relates to information regarding tender offers – Allegan – if any person has taken a substantial step
to commence a tender offer, no other person can trade unless that information is first disclosed
Safe harbor trading plans – executives precommit to buy/sell at certain times – 10b5-1
State law claim – Kahn v. Kolberg – claim no limited to damages sustained by corporation or even loss of
corporate opportunity, but on unjust enrichment based on misuse of corporate confidential information
Is it a bad thing? Reveals info to market, pushes price in the true direction; but insiders may want price more
volatile, riskier businesses, divert attention
Chiarella – printer – no violation – fraud to not disclose only if under a duty to disclose
If not an insider or a fiduciary, no obligation to reveal; not everything unfair is fraud
Not recognizing a market-wide duty to disclose; possible another violation you could bring
Dissent – would find a violation of information obtained by unlawful means – person who has
misappropriated nonpublic information has an absolute duty to disclose or refrain from trading
Would be decided differently today – 14e3; O’Hagan 10b5 misappropriation
Dirks – received material nonpublic info from insiders to corp with which he had no connection; disclosed
information to investor client who relied
Test – was the first passing of information a breach; if not, likely ok
No actionable violation here – tipper received no monetary/personal benefit for revealing; purpose
was not to make a gift but to expose fraud (contacted WSJ)
Dissent – shouldn’t have motivational requirement on fiduciary duty doctrine
O’Hagan – misappropriation theory – fraud when misappropriates confidential info for securities trading
Misapp can target trading by corporate outsiders in breach of duty owed to source of information
Classical theory – trading on insider, material, nonpublic info is deceptive device b/c of duty to SHs
Applies to officers/directors/insiders/attorneys/accountants/consultants/etc
Duty to the source of the information
US v. Newman – building on Dirks- only liability if tipper got personal benefit from tipping
Gov must prove beyond reasonable doubt that tippee knew insider disclosed confidential information AND did
so in exchange for a personal benefit
1. Corp insider was entrusted with fiduciary duty
2. Corp insider breached his fiduciary duty by
a. Disclosing confidential information to tippee
b. In exchange for personal benefit
3. Tippee knew of tipper’s breacher (confidential & divulged for personal benefit)
4. TIppee traded anyway
Gov argues presumed to know that info was illicit (“must have known” standard); sophisticated parties
Absent some personal gain, there has been no breach of duty
Liability requires scienter (mens rea) – acted willfully; knew insider breached for personal benefit
State liability – self-dealing – faces entire fairness review; could sue derivatively
But until SEC regs, no liability for traders, just corporation
NON-SHAREHOLDER CONSTITUENCIES
Delaware corps owe fiduciary duties only to common stockholders (Revlon, Trados, Gheewalla, Ebay)
Problems with expanding realm of fiduciary duties – conflicts of interest; but what about NEPAish?
Constituent interests so diverse as to be pretext for managers to favor themselves?
PBC – Public Benefit Corporation – DGCL 365, 362 – shall manage to balance pecuniary interests of
stockholders, best interests of those materially affected by corp’s conduct, and the specific public benefit or
public benefits identified in certificate of incorporation
One example where this matter – Dodge v. Ford Motor Co
Why protect only shareholders? No legal means other than fiduciary duties to get their money back; no
contract rights; bankruptcy protections; can’t withdraw equity
Junior/Senior Conflict (Equity/Credit)
 Junior/Equity prefer riskier projects, underweight downside; will gamble for resurrection
 Senior/Credit underweight upside – favor excessive caution
 Neither consistently maximizes value of company as a whole
 How to deal with this? Management incentive plan
Trados – directors must maximize common shareholder interest; found directors conflicted by obligations to
VCs, preferred shareholders
Management Incentive Plan – receive portion of sale price
Entire fairness review – found satisfied because common stock was worth zero
Failed process – no independent committee to represent common stockholders, no
independent evaluation for fairness, no majority of disinterested stock to approve
But ok on price
Gheewalla – creditors of Delaware corp that is either insolvent or in zone of insolvency have no right as a
matter of law to assert direct claims for breach of fiduciary duty against corp’s directors
When company goes insolvent, creditors take over SH role, can bring derivative claims
Direct claim – would have implied duty owed to creditors; assumption to maximize their value
Corporations only owe fiduciary duties to common stockholders (also Revlon, Trados)
MetLife v. RJR – no express covenant restricting incurrence of new debt; won’t read implied covenant of good
faith to read in terms
Contracts specifically permitted mergers and assumption of additional debt; Court won’t create
contractual terms post hoc
Statutory Rules to protect creditors
EU has minimum capital requirements (25,000 euros) – basically worthless
Some industries have more finely calibrated requirements – bank debt to equity ratios
Distribution Constraints – restrictions on dividends and share repurchases
Directors held jointly and severally liable for negligent violations – big stick
DGCL 173 – Dividends can be paid out of surplus; DGCL 154 – surplus = net assets – capital
DGCL 1601a – share repurchases may not impair capital
Fraudulent Transfer – creditors should be able to claim back an asset from transferee who obtained without
paying equivalent consideration (transfer asset to wife, e.g.)
Equitable Subordination – in bankruptcy, may subordinate some creditors on equity grounds; may treat
shareholder loans like equity
Piercing the corporate veil – hold shareholders directly liable for corporate debt – look for unity of interest and
ownership b/w shareholder and corp; disregard of corporate formalities; commingling of funds;
undercapitalization (usually only applies to small single owner corps)
eBay v. Newmark (Craigslist)
Rights plan – faces Unocal intermediate scrutiny – objective reasonableness – reasonably perceive
threat to craigslist’s corporate policy and effectiveness, and if so, proportional response?
Paramount Communiations v. Time – corporate culture can be ok, but must relate to
stockholder value; craigslist’s corporate culture not protected here
Corporate vehicle is not an appropriate vehicle for purely philanthropic ends
Fails first Unocal Plan
Staggered board is ok; stock exchange / dilution not ok (self-dealing)
DGCL 226 –Appointment of custodian or receiver of corporation on deadlock or for other cause – court may
appoint when stockholders or directors are so divided
DGCL 341 - Law applicable to close corporations
DGCL 342 – close corp defined – no more than 30 stockholders, transfer restrictions, no public offering
DGCL 350-353 CORPORATE CRIME
Why have corporate crime? Deterrence, Incapacitation, procedural enhancements (wiretaps), government
enforcement when private parties don’t have incentive
Federal Sentencing Guidelines – when possible, make victims whole; if org primarily for criminal purpose,
divest org of all assets
 Fine based on seriousness (pecuniary gain / loss) & culpability (involvement / tolerance of crime, prior
history, violation of order, obstruction of justice, effective compliance program, self-reporting,
cooperation, acceptance of responsibility
 Probation appropriate when needed to ensure other sanction will be fully implemented
Yates Memo – Most effective way to combat corporate misconduct is seeking accountability from individual
who perpetrated the wrongdoing
1. to qualify for cooperation credit, corp must provide all relevant facts relating to individuals reason for
misconduct
2. criminal and civil corp investigations should focus on individuals from the beginning
3. Crime and civil lawyers should be in communication
4. Absent extradordinary circumstances or approved departmental policy, not release culpable
individuals from civil or corporate liability
5. Don’t resolve matters with corp w/out clear plan to resolve related individual cases
6. Civil attorneys should consistently focus on individuals
How much do we want to incentivize? May be socially wasteful to have big compliance department
GM Lawsuit – wire fraud + statutory – didn’t report to regulatory agency
INTERNAL AFFAIRS DOCTRINE – applicable corporate law governed by state of incorporation
Radical choice of law rule;
CTS v. Dynamics – new Indiana corporate law was not preempted by Williams Act
Doesn’t really say constitutionally mandated; some things could be burden on interstate commerce
Vantagepoint Venture Partners v. Examen – only the law of state of incorporation governs a corporation’s
internal affairs; issue of notice – prevent corps from being subject to inconsistent legal standards
Delaware court wants to say constitutionally mandated
Lidow v. Superior Court – CA court found could apply CA law on wrongful termination
Found this wasn’t really internal affairs – if really strong CA interest, then can apply state law
SUM UP
If everyone is acting voluntarily and can look out for own interests, private law is the best solution, not
regulation
Notes from book on M&A
Tender offer bypasses target’s board – achieves control through purchase directly from stockholders
Merger – approved by board/shareholders of each constiuetn corporation (typically majority)
Usually, shareholders of target receive premium for shares over market price
Board proposes, majority of outstanding shares must approve (not just present shares)
Shareholder vote not required if qualifies as short-form merger – parent/sub; owns 90% of outstanding
stock; only parent’s board must approve (assumption – votes would be foregone conclusions)
Open market purchases
SEC 13d requires disclosure once you get over 5% within 10 days; once you get over 10%, may have to
disgorge profits on subsequent sales within next 6 months to target corp (16b – short-swing profit
provision)
Proxy contest – prospective acquirer nominates slate of directors
Asset sales – board has almost unconstrained authority to dispose of assets, unless disposing of all or
substantially all corporate assets – DGCL 271a – majority of outstanding voting shares
Even with voting, has benefits to merger (no appraisal rights, only target SH, less liability)
Ensuring exclusivity – cancellation fees, no shop / best efforts clauses
Appraisal remedy – DGCL 262(a) – hold shares continuously through effective date of merger; perfect
appraisal rights (send notice before vote), and don’t vote in favor or consent to merger
Once you acquire 50.1% of stock, you can do whatever you want, but can take a long time, get really
expensive as arbitragers moe in
Tender offer – offer to buy certain number of share for specified price for fixed period of time
Takeover defenses
Within the charter – staggered boards, supermajority requirements
Would want to put staggered board in charter, so only board can initiate change of it
Require supermajority for mergers – ok under 102b4, make it changeable only with supermajority vote
Poison pill – shareholder rights plan – option to pourchase new shares
Issuance of rights does not require shareholder approval – only board
Usually cannot be traded separately from common stock, priced so that exercise would be
economically irrational
Only become exercisable on distribution event – announcement of intent to acquire 20% e.g.
Once triggered, rights holders get option to buy new stock at extreme discount
Transactional options
Dual Class Stock – allowed under DGCL 151, will likely have to issue a bigger % of stock, because it’ll be
worth less, but you can keep way less for yourself (but you’ll get a smaller percent later)
Make differential rights dissolvable on transfer – transition into other class of stock
Fix board size in the charter (if only in bylaws, majority stock ownership could change, DGCL 228,
shareholders always have right to amend bylaws under 109)
Staggered board – ok under DGCL 141(d) – wait longer
Probably don’t want cumulative – allows proportional representation, get minority on the
board; when staggered board can only remove for cause (DGCL 141ki
Give board right to amend bylaws – 109 (can they just undo whatever bylaw amendments
shareholders make?)
Indemnify yourself as much as possible in the charter
Reasonable expenses taken in good faith, insurance – DGCL 145
Waiver of liability under 102b7
Can’t indemnify from duty of care violations – if only board members, can’t have vote of disinterested
directors
As controlling shareholders, would face entire fairness
Although, may not be controlling if less than 50% (Aronson)
How to get financing
Sell Assets – if substnaitlaly all – DGCL 271 (shareholder approval)
Get a loan
Sell equity – gives someone a stake in your company doing well; maybe put them on the board
Arbitration clauses
Exacerbate collective action problem of shareholders; removes deterrent incentives, but
removes expensive litigation inefficiencies (especially those driven by plaintiff’s lawyers)
Empirical question – do we have evidence for it?
Eliminating Fiduciary Duties – problem in the middle, but maybe not problem ex ante
Can’t contract away good faith and fair dealing
Do we need fiduciary duties in partnership – personally liable
Questions
If board is given power to amend bylaws, can it just undo anything shareholders propose?
DGCL 251(h) – top up no longer required – so if you tender and get 50.1%, you can proceed
without a shareholder vote – but does that actually save you much? Entire fairness?
Summary judgment – does that actually ever happen? Seems like you deal with business
judgment on motion to dismiss; entire fairness on trial
Possible to sue one board member but not others?
Reasons why you wouldn’t want to squeeze out someone when you have 90% ish
Law not clear on what sort of independent burden shifting you would need
Control premium – not making an offer to everyone
Intentional dereliction of duty – don’t have to actually being inted to harm
if just the board
If not listed, can’t pay employees in stock; can’t easily newly issue stock, regulatory requirements (local
ownership requirements e.g.)
DGCL says board cannot amend shareholder passed bylaw
Board is always thinking about what the public would think
If competing board proposal, shareholders can’t bring one – 14a SEC (but board can’t announce something ex
post)
Long form – board proposes, shareholders approve
Written consent – most charters exclude it – antitakeover measure – also subject to proxy rules
What can you not put on proxy
Business decision, nothing for this year’s director election
Can’t nominate directors using 14a8
Could propose bylaw amendment 112 which would give you right to put your candidates on corp’s proxy
But can only do that prospectively
But Blasius – used written consent