Uploaded by Neil Joseph

Outline 11.20

Big Picture
Role of the Corporation
o Shareholder wealth maximization
o Social/political values
o Efficiency
o Stability
Theories of corporations
o Property/Contract Model
 Corporation is the private property of shareholders, with its role as
wealth maximization
 Assume shareholder sophistication
 SHs on notice of some things
o Communitarian Model
 Corporation exists with government permission – thus is an
institution that promotes public welfare
Who is an Agent?
Agency asks when one party is responsible for the actions of another and the
rights and obligations of one party to another
Agency is the relationship resulting by:
o Manifestation of consent by a principal that the agent act on his
o Subject to the principal’s control
o Agent manifests consent
There must be some agreement/understanding – not necessarily a contract
o Fact specific – look @ what they said, how they acted, course of dealing
 Passive permission is enough (Gorton)
PAT Triangle
o Agency relationship between P and A
o A’s dealings with a third party
o Creates legal liability of P to T (and vice versa)
Bases of Authority
Actual (can be express or implied)
o Implied: Actual authority circumstantially given where P intends A to
possess and includes such powers as are practically necessary to carry out
delegated duties (Mill Street)
 Specifically look at relationship between P and A
 Reasonable belief of A that P intended these powers
 Policy: careful contract drafting for P
o Actual authority is designated or implied in P’s manifestation to the
A (R Agency 2.02)
o Not actual authority, but authority the agent is held out as possessing
o Power held by agent/other actor to affect Ps legal relations with third
parties when a:
 Third party reasonably believes that the actor has authority
to act on behalf of P AND
 That belief is traceable to P’s manifestations
Ratification (Botticello)
o Authority granted by P after agreement has been made
o This happens when:
 P manifests his assent to affirm the agreement
 Express
 Implied through acceptance of benefits, silence/inaction, or
trying to enforce a contract
 Law gives effect to that assent
o Limited:
 P must know at the time of the alleged ratification the material
 P cannot partially ratify
 If 3rd party manifests an intention to withdraw from the transaction
prior to ratification, P cannot ratify
 Can be denied to protect innocent 3rd parties
Undisclosed Principal
o This imposes liability when third parties are hurt by an agent’s actions
o R.2 (Inherent Agency):
 Entrust agent with management of business
 Agent enters into transactions usual in businesses
 Transactions on Ps account
 Even if contrary to directions of P, liability for P
o This happens when (R.3 - Undisclosed Principal):
 Third party made a “detrimental change in position”
 P had notice of change in A’s conduct
 Conduct might induce third parties to change positions AND
 P did not take reasonable steps to notify 3rd parties of the facts
 Difference: P has to have notice of change in A’s conduct
o Two classic situations (Inherent agency):
 Undisclosed principals
 Agents exceed authority
o Policy: P is least cost avoider, should absorb transaction costs
Estoppel (Koos Bros.)
o Prevents P from denying an agency relationship exists
o Happens when:
 P is negligent or commits some culpable act, creating an
appearance of authority in the purported agent
 Third party reasonably and in good faith acts on appearance of
 Third party changes her position in reliance on that
Liability of Principal to Third Parties in Tort
Vicarious Liability
o Master is subject to liability for torts of servants while acting in the scope
of their employment
This all turns on the relationship between P and A
o Servant (employee): agent performing services in the master’s affairs
whose physical conduct is controlled or is subject to the right of control by
the master
 Master does not need to control – just have the right to control
 Liable if in scope of employment (Bushey & Sons, Manning,
 This is when performing work assigned by employer or
engaging in a course of conduct subject to the employer’s
o Does not need to serve the master
 Factors
o Time/place/purpose of the act
o Similarity to authorized acts
o Is the act commonly performed by servants?
o Extent of departure from normal methods?
o Would master expect?
 Not when it occurs within an independent course of conduct
not intended by the employee to serve any purpose of the
 Question about foreseeability
 Manning – specific rule about the intentional tort being in
response to conduct interfering with D’s ability to perform
o If this is the case, then the employer can be held liable
o Independent contractor: someone who agrees to carry out some task
but not subject to P’s control
 Agent-type: Limited control by P; has power to act on P’s behalf
 Narrower than servant (not liable except in special cases)
 Retains control of a certain aspects
 Also liable if you hire a known negligent contractor
 Nonagent: Maybe less control, but no power to act on Ps behalf
 No liability
o Special Cases:
 P retains control over aspect of work where tort occurs
 P engages incompetent contractor
 Nondelegable duty
 Activity is “nuisance per se”
Look @ the facts of agreements to determine what the level of control the
“master” had to determine whether servant or contractor
o Example – service station cases (Humble Oil, Hoover)
o Factors to look at:
 Extent of control A and P have agreed that P may exercise over
 Whether agent is engaged in a distinct occupation/business
 Whether type of work done by agent is customarily done under a P’s
 Skill required in A’s occupation
 Whether A or P supplies tools/instrumentalities required
 Length of time during which the agent is engaged by a P
 Whether A is paid by job or time worked
 Whether A’s work is part of Ps regular business
 Whether A and P believe they are creating employment
 Whether P is or is not in business
Also look at the relationship between risk, return, and control
o Those who bear risk reap the return (usually not employees)
o Then those who bear the risk want controlling the risk
o Similar question – what is the franchisor’s level of control over a
franchise? (Murphy)
o Look at:
 Extent of franchisor’s involvement in day-to-day operations
 Franchisor’s right to control operations, which might include
provisions in the agreement such as pricing, audit rights, advert
 Right of franchisor to terminate the relationship
Apparent Agency NOT APPARENT AUTHORITY (Miller v. McDonald’s)
o Right to control test
 Do not actually have to control, just have the right
o Whether the P held out A as an A, and whether a 3rd party relied on that
o Difference: Apparent agency creates agency when there was none,
apparent authority expands the authority of the actual agent
 No principal agent relationship in McDonald’s
o Only used in tort liability
o An association of two or more persons
o To carry on as co-owners of a business
o For profit
Typical characteristics
o Cannot be another entity
o Owners generally make some contribution for their share
o Share the profits and the risk
o Jointly shared management
Partnership or employer-employee? (Fenwick)
o Intention of the parties
o Language of the agreement
o Conduct toward third parties
o Treatment of the returns
 Sharing in profits
 Sharing in losses
o Ownership of partnership property
o Community of power in administration
o Rights of the parties on dissolution
If a partnership, there are certain attributes
o Liabilities
 Each partner is jointly and severally liable for the debts of the
o Control
 Each partner has the ability to participate, regardless of how much
capital they contribute
o Returns
 Profits are shared equally
o Continuity of existence
 Dissolved on withdrawal
Joint Venture (Sandvick)
o Essentially, partnerships with limited scope
o Usually use partnership rules
Fiduciary Duties
Duty of Loyalty (Sandvick) (p. 111, UPA section 404(b))
o Account to the partnership for profits, property, or benefits
o Refrain from acting as/on behalf of a party with an adverse interest to the
 No conflict of interest
o Refrain from competing with the partnership
o Good faith and fair dealing
Partnership Opportunity Doctrine (Salmon)
o There is a duty to not take opportunities that belong to the partnership
o Disclosure alone might be sufficient
o But if it falls within the scope of the business – it is probably not
enough to just disclose
Grabbing and Leaving
Duties to firms (Meehan)
o Partners owe copartners duty of good faith – must consider their welfare
o Certain things you can do before you inform your partners:
 Look for/obtain office space
o Certain things you CANNOT do before:
 Lie to others (those in firm)
 Communicate with clients
 Not tell clients they have a choice
 POSSIBLY associate poaching
When can you kick a partner out?
o Pursuant to the agreement
 Still need good faith/fair dealing (Lawlis)
o By unanimous vote of the other partners if it is unlawful to carry on the
partnership business with that partner, if there has been a transfer of all
(or most) of the partner’s transferable interest, or if the partner to be
expelled is another entity that is ending OR
o By judicial determination if certain circumstances are satisfied involving
the wrongful conduct
Rights of Partners in Management
Majority of partners must approve decisions relating to the day-to-day
operations of the partnership business
Otherwise – unanimous approval (Sidley)
But all of these are also subject to the normal duties that partners have
All of these standards can be altered by the partnership agreement
Partnership Dissolution/Dissociation
Dissolution: End of prior constitution of the partnership (Owen) (practical
effect – force negotiation)
o Usually upon occurrence of a specified event in the agreement
o Courts can order dissolution if there are disagreements of such a nature
that all confidence has been destroyed or one party materially hinders a
proper conduct
 Economic purpose reasonably likely to be frustrated
 Another partner has engaged in bad conduct
 Otherwise not reasonable to do so
 Has to be more than petty
Dissociation: Partners withdraw/otherwise terminate their partner status
o Statute based (Giles)
o Similar factors as dissolution
o Can have wrongful dissociation
o Dissociated partner usually receives share of partnership
 This is the greater of:
 “Going Concern” Value: value of it as an operating entity
 Liquidation Value: What you could get if you sold all the
o The partners sometimes end up going forward with full dissolution
Sharing of Losses
Under the UPA, in the absence of other agreements, the law presumes that
partners/joint adventurers intend to participate equally
o UPA Section 18:
 Each partner is:
 Repaid contributions
 Share equally in profits
 Contributes to losses
 According to share in profits
When one party contributes money and the other services (Kovacik):
o By their agreement to share in profits, both agree that the value of their
contributions were equal
o So loss of money/labor = equal sharing in loss
o Exceptions:
 Service partner compensated for his work
 Service partner made a capital contribution – even if nominal
o But the UPA explicitly rejected this
 Section 401, 1997
o So which rule?
 Majoritarian Default: What bargain is struck by most partners
most of the time?
 Penalty Default: Want to penalize one party
Capital partner more able to bear loss
Service partner has more control over success
Buy Out Agreements
o Provide liquidity to selling partner
o Protect non-selling partners
3 types:
o Restrictions on Transfer
 Cannot sell without permission of other shareholders
 Important in corporation – no default rights there to dissolve or
approve new partners
 Prevents unwanted outsiders from joining, no liquidity to seller
o Grant the entity or others the right, but not obligation, to
purchase if a triggering event
 Protect non-selling shareholders
 No liquidity
o Provisions requiring the entity to purchase upon a triggering
 Provides liquidity
 Protects selling shareholder
Valuing? (G&S)
o Book value
o Appraisal
o Formula
 Cash flow + present value of future cash flow
o What does the agreement say?
Limited Partnerships
General partners have personal liability for debts/obligations
o Manage the operation of the business
o Review of action: subjective belief that it is a reasonable that the
determination is in the best interest of LP
o No fiduciary duties to LP
Limited partners are not personally liable – limited to the amount they
o Not involved in day-to-day
o The distinction between general and limited partners is important –
especially because corporations are often the sole general partner
o Can be liable if participating in day-to-day OR you are a general partner
Often used as a tax shelter
Corporate Formation
Critical Attributes:
o Legal Personality
 Has a separate legal existence from its owners
 Has some constitutional rights
 Can be sued
 Is a separate taxpayer
 Double taxation
 Requires formal creation
o Limited Liability
 Shareholders are not personally liable for the corporation
 Only the amounts invested
o Separation of Ownership and Control
 BOD controls, shareholders own
 Individual directors are not corporate agents – only the board itself
can bind
 Shareholders can vote on (Boilermakers):
 Election of directors; amendments to articles/bylaws;
fundamental transactions; other things
 Boilermakers: stockholders explicitly consent to bylaws by
buying in
 Shareholder rights
 Vote on limited things
 Dividends as declared by board
 Can inspect books
 Fairly limited
 Voice (vote); Exit (sell); Sue (fiduciary duties)
o Liquidity
 Provides more liquidity
 Secondary trading markets
o Flexible Capital Structure
 Permanent/long term contingent claims on assets and earnings are
issued pursuant to securities
 Can package them in many ways (Stocks/bonds)
 Terminology
 Authorized - stocks created
 Authorized/Unissued – before sold to SHs
 Authorized/Outstanding – have been sold
Authorized/Issued/Not Outstanding – sold to SHs and
repurchased by corp.
BOD has prerogative to issue stock and issue dividends
 Only shareholders if:
o More shares than authorized
o New class of shares
Limited Liability
Shareholders not personally liable for debts/obligations of the
corporation (Walkovsky)
o Limited to what you invested
o Creditors can only look to assets
Some obligations you have to meet:
o Follow rules/formalities
o Provide notice to the world
o Treat the corporation as a separate entity from its owners and from sister
 Walkovsky discusses this
 Conducting business in individual capacity?
 Or is the corporation but a fragment of a large corporate
o Be a real business
Think about policy for Limited Liability
Piercing the Corporate Veil (Sea-Land)
o Can a creditor show that separate existence between the
shareholder and the corporation has not been respected?
 Unity of interest/ownership such that separate personalities of
corporation and shareholders no longer exist
o Most courts require a creditor to show a second category of
wrongdoing – injustice or fraud-like conduct
 Sometimes not (if there is already bad action in the commingling
and such) but usually yes
 This injustice is beyond the creditor’s inability to recover
o If the veil is pierced:
 Corporation and shareholders become jointly and severally liable
o Factors
 Follow corporate formalities?
 Minutes, elect officers, etc.
 Maintain separate accounts?
 Mingling personal funds/corporate funds
 Undercapitalize?
 Not enough funds or enable it to operate as a business
 Treat other assets as own?
Reverse Piercing
o Claim against individual shareholder is enforceable against corporation in
which the individual is a shareholder
o Makes the shareholder’s creditor a creditor against the corporation –
higher in line than if just a claim against shareholder
 On equal footing with normal creditors
Three ways to find liability against corporation
o Enterprise Liability
o Respondeat Superior
o Piercing the Veil
Role and Purpose of Corporations
Corporation Donation (A.P. Smith)
o State law has an impact on what corporate charters may or may not allow
o Shareholder donations are not outside of the power of directors
o Donating is OK as long as there is some benefit to the corporation, even if
it is very tangential
 Courts are pretty deferential
 Also cannot constitute waste – so there is some monetary limit
o Example of the broad discretion that directors have
 But focus is always on maximizing wealth for shareholders
Dividends (Ford)
o Directors of a corporation alone have the power to declare a dividend
o There has to be justification if there is a refusal
o Corporations are carried on for the profit of the stockholders
 Not to benefit mankind
Corporations do not need to follow the lead of other corporations
Directors are elected, and the court cannot require directors to do exactly what
other companies do (Shlensky)
Courts are generally very deferential to the choices of directors
Duties of Officers, Directors, and Other Insiders
Duty of Care
 This duty requires that each member of the BOD act:
o In good faith
o In a manner the director reasonably believes to be in the best interests of
the corporation
 On a claim that there is a violation of duty of care, the director is entitled to the
protection of the Business Judgment Rule
o Gives directors wide latitude in taking steps to benefit a corporation
o Avoids second guessing
A plaintiff usually has to show one of the following for the director to
not have protection under BJR:
o Fraud
o Illegality
o Conflict of interest (Kamin)
o Bad faith
o Egregious/Irrational Decision
o Waste
o Uninformed Decision
o No Decision
 Failure to act falls under this
Business Judgment Rule
o Procedural Requirements
 Essentially, a board/director must take appropriate steps to inform
itself – find and learn about the material information (Kamin, Van
 Standard is gross negligence
 Examples:
 Keep informed about/oversee corporate activities
 Informed about corporate business, interests, and issues
 Possess minimum level of skill/expertise
 Be aware of financial status
 The process by which directors come to their decisions is
very important
 Fact-specific inquiry (Francis)
 Could be different requirements for different industries
(reinsurance, nature of funds, etc.)
o Substantive Requirements
 If the procedural requirements are met, P must show a substantive
violation to avoid the BJR
 Illegality, egregious decision, conflict of interest, waste, bad
o May still have to show a duty of care violation (negligence)
 Sometimes, can have a substantive/procedural violation and there
could not be a duty of care violation
Entire Fairness Doctrine
o Defense to duty of care claim
o Look to timing, initiation, structure of transaction
o Look @ disclosure as well
o Have to show that it was fair
o Even if fail BJR – can be protected
Duty of Loyalty
 Fiduciaries must put the interests of corporation ahead of their own
 Mostly comes into play when there is a conflict of interest
o Director or a person related to him:
 Is a party to the transaction AND
 Has a beneficial financial interest in the transaction
 BJR yields to the rule of undivided loyalty (Bayer, Benihana)
o Self-interested transactions are carefully scrutinized
 Transactions can be cleansed if (DGCL 144):
o Approved by a vote of a majority of the fully informed, disinterested
 Could vary by state
o Ratified by informed shareholders
 Could vary by state
o Transaction is shown to be “intrinsically fair” to the corporation
The Corporate Opportunity Doctrine
A fiduciary may not take, for personal gain, an opportunity like a business
venture or new opportunity, in which the firm has a property right, and use it for
his own advantage without first offering it to the corporation
Applies to:
o Corporations officer’s/members
o Certain other individuals who have a fiduciary relationship with the
What is a corporate opportunity? (Broz, In re eBay)
o Can the corporation financially exploit the opportunity? (eBay)
o Is the opportunity within the corporation’s line of business?
o Does the corporation have an interest/expectancy in the transaction?
o By taking the opportunity for his own, has the fiduciary been placed in a
position inimical to his duties to the corporation?
If a corporate opportunity, then determine if it was properly disclosed:
o If no, and taken for self – breach of duty of loyalty
o If yes, and taken for self – no breach
o If not properly rejected and taken for self – breach
Liability here is based on taking the opportunity
Dominant Shareholders
If a shareholder is dominant – they are bound by certain fiduciary duties
o Certain duty of loyalty transactions are implicated
Policy: if the shareholder has a large enough ownership interest to
control the BOD, any transactions involving that shareholder and
treat him different are suspect
o When this happens – the only thing that can affirm these
transactions is “intrinsic fairness” (Sinclair)
 Dominant shareholder needs to prove fairness
 This fairness asks whether it is fair to minority shareholders
o Duty when voting as director/majority shareholder is much different than
when voting as merely a shareholder (I )
Ratification occurs when the BOD or committee of the Board in good faith
authorizes the contract/transaction by affirmative votes of a majority of
disinterested directors
o Board is almost NEVER disinterested in dominant shareholder situation
DGCL 144:
o Material facts as to the director’s/officer’s relationship/interest and as to
the contract are disclosed or known to BOD and BOD or committee
in good faith authorizes the transaction by votes of a majority of the
disinterested directors OR
o Material facts . . . disclosed or known . . . shareholders approve by
 No requirement of it being disinterested shareholders
Shareholder ratification shifts burden to objecting shareholder to demonstrate
terms are unequal
The Obligation of Good Faith
 Compensation (In re Walt Disney)
o Three different categories of behavior are candidates for “bad
 Subjective bad faith: fiduciary conduct motivated by an intent to
do harm
 Lack of due care: just gross negligence (not bad faith)
 Intentional dereliction of duty: non-exculpable, nonindemnifiable violation of fiduciary duty
o Intentional dereliction of duty is a form of bad faith
 Oversight (Caremark, Stone)
o Falls under Duty of Care
o A director’s obligation includes a duty to attempt in good faith to
assure that a corporate information and reporting system, which the
board concludes is adequate, exists, and that failure to do so under
some circumstances may, in theory at least, render a director liable for
losses caused by non-compliance with legal standards
 Graham - Absent suspicion of wrongdoing – no duty on Board to
install a corporate system to find wrongdoing they don’t believe
 Caremark says a sustained or systematic failure of board to
exercise oversight establishes a lack of good faith
 Example: utter failure to attempt to assure a reasonable
information and reporting system exists
o Stone subsumes the duty of good faith into the duty of loyalty
Shareholder Derivative Actions
 Direct Suits (In re Medtronic)
o Brought by the shareholder in his own name
o Cause of action belongs to shareholder in individual capacity
o Arises from injury to shareholder
o Happens when:
 All shareholders share the injury
 Shareholders would receive the benefit of recovery
 Injury NOT suffered by the corporation
 Derivative Suit
o Brought by shareholder on corporation’s behalf
o Cause of action belongs to corporation as an entity
o Arises out of injury to corporation as an entity
Director Independence
Can personal relationships/business relationships ruin a director’s
independence? (Sanchez)
o Must look at the full context and all inferences
o Look @ whether someone alleges that a director cannot act impartially
because of their relationships
Derivative Aspects of Oversight Cases
Vast majority of cases are dismissed because a shareholder files a derivative suit
without making demand
BOD has the power to determine remedial action that should have been taken
Only can have derivative suits if the directors refuse to pursue the claim or
directors are incapable
So then, the court determines whether demand should be excused as futile (In
re China Agritech)
o Aronson Test:
Applies when a derivative plaintiff challenges an earlier
decision made by the same directors who remain in office at
the time a suit is fault
 1. Examine the independence and disinterestedness of the directors
with respect to the decision the derivative action would challenge
 If transaction was approved by disinterested/independent
majority, then:
 2. Has P alleged facts which support a reasonable doubt that he
challenged transaction was the product of a valid exercise of
business judgment?
 For example, that the Ds were grossly negligent
o Rales Test
 Board members have not participated in the underlying
decision that the derivative action would challenge
 So no Aronson
 Whether or not the allegations of the complaint create a
reasonable doubt that, as of the time the complaint is filed,
the BOD could have properly exercised its judgment and
disinterested judgment in responding to a demand
 Three scenarios for this:
 Business decision made by the board, but majority of
directors making the decision have been replaced
 Subject of the suit is not a business decision
 Decision was made by a board of a different corporation
Disclosure and Fairness
 See slides for general background on federal securities law
What is a security?
Stock, note, bond, debenture, option, voting trust certificate
Evidence of indebtedness and investment contracts
Characteristics of (stock)
o Right to receive dividends
o Negotiability
o Ability to be pledged/hypothecated
o Voting rights accompanying them
o Ability to appreciate in value
Context is important in evaluating whether it is a security
o Language is not super important – even if it is called a security, context
may tell us otherwise
Investment contract (Howey Test) (Robinson)
o Investment of money
o Common enterprise
o Expectation of profits
o Profits solely from the efforts of others
 This has been relaxed
 What matters most is the economic reality
 Question is whether the investor can exercise meaningful
To sell a security to public, must either be registered or have an exemption
Exemption: Private Placement (Doran)
o Factors:
 Size of the Offering
 Money being raised
 Number of Units Offered
 How many shares available and what percentage of company
 Manner of the Offering
 How do people hear about this?
 Number of Offerees + Their Relationship to Each Other and
the Issuer
 How many people are offered the deal?
o More offerees – more likely to be public
 How sophisticated are the investors?
o Some may not count sophisticated investors as offerees
 What information do these investors have?
o That could have a large impact on whether they are
Section 11 of the 34 Act regulates registration statements and creates
various responsibilities
o Those who are responsible:
 Those who signed the registration
 Every director or partner in the issuer (officers)
 Every person who is named as about to become a director
 Experts who assisted in the preparation of the statement
 Accountant, engineer, appraiser
 Underwriters
o There is essentially strict liability for issuers for anything
misleading in the registration statement (Escott)
o For others:
 Liable if the registration statement contains an untrue statement
of material fact or an omission to state a material fact
 Material: prudent investor ought reasonably to be informed
o Due diligence defenses (available for those other than the issuer)
 Read the statement
 Investigate the statement to make sure that the statements and
assertions are true
 Key: reasonable investigation, reasonable ground to believe
that the statements were true
o Registration can be divided into an expertised and a nonexpertised portion (Escott)
 In expertised portion – experts have gone through information
 They must conduct a reasonable investigation and have
reasonable belief
 Non-experts only need to show they had no reason to
believe and in fact did not believe that this portion
was misleading
Section 12 of 34 Act
o 12(a)(1)
 Imposes SL for sellers of securities for offers/sales made in
violation of section 5
 Liability arises if they improperly fail to register, registers
but fail to deliver prospectus, or any other section 5 violation
 Main remedy is recission
o 12(a)(2)
 Private civil liability on any person who offers/sells a security
interstate, makes a material misrepresentation/omission in
connection with the offer/sale, and cannot prove he did not
know of the misrepresentation and could not have known
even with reasonable care
o Gustafson
 Most lawyers, till this case, assumed that 12(a)(2) was broader than
Section 11
 Most thought it also applied to fraudulent selling
materials/oral communications, exempt offerings, and
reached secondary market transactions
 But this held that liability here only arises to material
misrepresentations/omissions in written docs or oral
communications in connection with public offerings
Rule 10b-5
Probably the most important piece of antifraud securities legislation
Creates liability for anyone who makes a misleading representation or
omission that is connected to the purchase or sale of a security
Unlawful for any person:
o To employ any device, scheme, or artifice to defraud
o Make any untrue statement of a material fact or omit to state a
material fact necessary in order to make the statements made, in
the light of the circumstances under which they were made, not
misleading OR
o To engage in any practice, act, or course of business which operates or
would operate as a fraud or deceit on any person
Elements to be met:
o Interstate commerce jurisdictional requirement
o Must involve a security
o Involve a purchase/sale of security
There is an implied private cause of action to enforce this:
o Untrue Statement
 D must make a false/misleading statement or omit information
o Scienter
 D must have acted with intent to deceive, manipulate, defraud
o Materiality
 A reasonable investor would likely consider the
misstatement/omission important
o Reliance (Halliburton)
 No direct proof of reliance needed
 Invoke a rebuttable presumption of reliance
 “Fraud on the market theory”
o Market price of the shares reflects publicly available
o Presumption that investor relied on integrity of the
market price
o Only invoked when there is a public affirmative
misrepresentation and the market is an efficient
o Does not apply in private market (West)
o Proximate cause
 Misrepresentation needed to have caused the loss itself (West)
 Need a causal link between non-public information and securities
10b-5 does not encompass a mere breach of fiduciary duty sans deception (Santa
o Needs to be manipulative or deceptive
 Manipulation: practices that artificially affect market activity in
order to mislead investors
o Should not create an implied federal cause of action where it is
traditionally regulated to state law
o States:
 Shareholder liability
 Corporate Governance
 Director/Officer fiduciary duties
 Shareholder rights/duties
o Federal:
 Transactional disclosure
 Periodic disclosure by public companies
 Fraud in connection with securities transactions
 Example: Matched Orders
o Contemporaneous buy and sell orders
o Convey appearance of renewed interest
o Price of security rise
 Example: Wash Sale:
o Individual is the buyer and seller in the same
10b-5 includes the buying and selling of options
o This is a security
o Market value of options is responsive to changes in market price of
underlying stock, so option holders are susceptible to two types of
deceptive practices
 Insider trading
 Affirmative misrepresentations
o Call option: right to buy
o Put option: right to sell
Insider Trading
 Types of Insider Traders
o True Insiders: Corporate Officers/Directors
o Temporary Insiders: Someone who gains knowledge
o Misappropriators: Someone who improperly acquires knowledge
 Evolution of State Common Law (Agassiz)
o Majority Rule: Except instances involving fraud, officers/directors may
trade in corporation’s stock without disclosing material information
o Special Circumstances Rule: Duty to disclose before they trade with
shareholders if there are special circumstances, such as (Goodwin):
 Highly material information
 Officer/director conceals his/her identity or engages in some other
act of fraud
 Officer/director is trading with an especially vulnerable person
o Minority Rule: Duty to disclose material information whenever buying
from a shareholder, at least in face-to-fact transactions
o Special Circumstances + Minority is the “majority”
Rule 10b-5
This is usually analyzed under 10b-5 when someone “deceives” by omission
o Omission: someone is in possession of material, nonpublic
information, which if known, would impact the price of the stock
The Old Rule (SEC v. Texas Gulf Sulphur Coal)
o Blanket duty to “disclose or abstain” while in possession of material
nonpublic information
o Essence of this rule: anyone who is trading their own securities and has
access to information that is not intended to be available for all cannot
take advantage of the situation
 This includes insiders
 But also anyone who has material information
o In these situations, there is a duty to disclose
 Not from superior knowledge
 Question: Is the information material? Would a reasonable
man attach importance to these information?
o Policy: Equal Access Theory
 Want everyone in the market to have equal information
 Information for purely corporate purpose should not be used in a
o “In Connection With” Requirement
 In connection with something causing someone to purchase
 Do not have to engage in securities
The New Rule
o Primarily restricted to situations in which the use of nonpublic
information could be traced to breach of fiduciary duty
 Cannot trade in stock if you are an insider in possession of material
nonpublic information
 Needs to be a breach of the duty of loyalty
 Insider – by virtue of position – has a duty to shareholders
 Essentially – insiders (or constructive insiders) must
disclose or abstain from trading
o Steps:
 Material nonpublic information?
 How did the person come to be involved with that information?
 What did the person do with the information?
 Was there a breach of duty involved in the use or dissemination?
Tipper-Tippee Liability
Comes from 10b-5 (Cady, Roberts)
Insider trading rules limit dissemination of material nonpublic information
(tipper) AND use of that information (tippee)
o Duty of loyalty is breached by asking if the insider received a
“personal benefit” by tipping the other person
o Tippee liability is based completely on the tipper’s liability
 Tippee can inherit tipper’s fiduciary duty ONLY when the tipper
tips in violation of fiduciary duty AND if they know/should know
that the tip was a breach of the tipper’s duty
Tipper Liability:
o Disclose material, nonpublic information to other AND
o Disclosure is a breach of a fiduciary duty AND
 Did the tipper obtain a “personal benefit”? (Salman)
 Does not need to be pecuniary
 Broadly defined
o Someone trades on that information (does not have to be the person who
you tip to – anyone in the chain of information).
Tippee Liability
o Receive material, nonpublic information which was disclosed in breach of
a fiduciary duty by an insider (Dirks) AND
 Purpose of disclosure matters
o Tippee knew/should have known that the tipper was breaching a duty by
providing the information AND
o Tippee trades on that info OR
o Becomes a tipper (give information to others, receive a personal benefit,
someone trades)
Broadens liability to include those who breach a duty to the source of the
information (14(e))
Fiduciary duties to the source of the information
Someone is still committing fraud in connection with a securities transaction
o Liability premised on the deception of those who entrust you with access
Very similar analysis as a traditional insider trading analysis
Policy: this is in tune with what 10(b) seeks to accomplish – honest markets
o Also is a “deceptive device” because the misappropriators deal in
deception and pretend loyalty to the principals
o Also is “in connection with” because the fraud is consummated when they
use the confidential info to purchase securities
Rule: someone commits fraud when (O’Hagan):
o Misappropriating material, nonpublic information
o In breach of duty (typically duty of trust/confidence) owed to the source of
info (Chestman) AND
o Does not disclose his intentions to trade to the source AND
o Trades on that info
o Possession of nonpublic info?
o Was that info material?
o Was it acquired under a fiduciary relationship or a relationship of trust
and confidence?
o Was the information within the scope of that duty?
o Did defendant trade on that info?
o If so, did they fail to disclose their intention to do so?
10b5-2 – three situations where a person has a duty of trust for purpose
of the misappropriation theory
o Agree to maintain info in confidence
o Two people who have a pattern/practice of sharing confidence such that
the recipient knows/should know that the speaker expects confidentiality
o Receiving material nonpublic info from a spouse, parent, child, or sibling
Short-Swing Profits
 Section 16(a-b)
o Everyone who owns more than 10% of an equity OR is a
director/officer, must disclose a statement indicating his ownership at
the end of the month and changes in ownership
 Reliance: can have two different transactions, first that bring you
below 10%
 Foremost-McKesson: transactions that bring you above 10% are
NOT counted
 Officer: President, CFO, chief accounting officers, VPs of principal
business units, and people with significant “policymaking function”
o Profits realized by these people from any purchase/sale of any equity
within six months is recoverable by issuer
 Sale/purchase must occur within six months of each other
o Only applies to companies registered under 34 Act
o Only applies to stocks, options, convertible debt
o Recovery:
 Goes to company
 Shareholders can sue derivatively, lawyer gets contingent fee
 Problems p. 511-12
 See Disclosure, slide 89
 Three ways to limit liability
o D not liable for X
o Corporation indemnifies D against X
o Corporation insures D against X
 Statutes:
o Disclosure, slide 102
o DGCL 102(b)(7)
 Exculpation
 Corporation’s articles may contain a provision eliminating personal
liability of directors
o DGCL 145
 (a): Suits by SH’s or third parties
 Corporations have power to indemnify the directors for
expenses plus judgments
 If the person acted in good faith and reasonably
 (b): Derivative suits
 Can indemnify only for expenses, including attorneys
 If in good faith and reasonable
 If liable – then indemnification only with court approval
 (c): Success
 Corporation MUST indemnify director who has been
successful on the merits or otherwise
 Look just at the end result (Waltuch)
o Includes settlements
 (e): Advancement of Expenses
 Corporation MAY advance expenses
 Look to the agreement to see what the company agreed to
 (f): Indemnification by Agreement
 Corporation can enter into written indemnification
agreements beyond the statute
 But there are limits (Waltuch)
o Cannot be inconsistent with the substantive
provisions of 145
 Including good faith
Problems of Control
Proxy Fights
o Typical Annual Meeting
 Nominating committee of incumbent BOD nominates a slate to be
elected at next meeting
 Incumbent board identifies other issues
 At company expense:
 Management prepares proxy statement/card
 Management solicits votes
o Proxy Contests
 Shareholder solicits votes in opposition
 Can be for a slate of directors or on an issue
o Proxy Voting
 Shareholder appoints proxy to vote his/her shares
 Appointment effected by means of proxy (proxy card)
 Specifies how shares are voted or give discretion
 Card is revocable
 See slide for Proxy Card requirements
o SEC Proxy Rules
 Incumbent directors must provide annual report before soliciting
 There are requirements for this report – see slides
 If you solicit a proxy, must provide a written proxy statement
 Solicit: not only direct requests to furnish, revoke, or
withhold proxies . . . but also communications which may
indirectly accomplish such a result or constitute a step in a
chain of comms designed to accomplish such a result
o Exempts public statements
o Exempts those who do not seek the power to act as a
proxy and do not furnish a form of revocation,
abstention, etc.
o Exempts 10 or fewer people
o Exempts furnishing advice by someone with whom the
shareholder has a business relationship
Under current law, there is an asymmetry between insurgents and incumbents –
incumbents don’t have to pay (Levin)
o Management can use funds/communication as long as it is not
Reimbursement of Funds
 Rules vary from state to state
 Management can use corporate funds to pay for expenses they incur in
conducting proxy solicitation (Rosenfeld)
o As long as:
 They are reasonable
 Ex: target large shareholders, drafting reports, in person
visits to major shareholders
 Contest involve policy questions and NOT pure personal power
 This is blurry
o For incumbents – can be done whether they win or lose
o For insurgents –only if they win and only if the corporation’s
shareholders ratify
Policy: if corporate directors cannot incur reasonable expenses to solicit proxies,
the corporate business in interfered with
This makes proxy contests less attractive than tender offers
o Costly – only reimbursed if you win
o Shareholder apathy – shareholders own small percentages, may not
inform themselves
See notes, p. 11
Private Actions for Proxy Rule Violations
 There is clearly a right for private parties to bring suit for proxy violations
o Purpose of the 14(a) of 34 Act was to prevent management from obtaining
authorization for action by means of deceptive/inadequate disclosure in
proxy solicitation
o Chief purpose of the act was to protect investors
o So a broad remedial purpose
o Courts can’t just say that the transaction was intrinsically fair –
would be bypassing the shareholders
 The defect needs to be of such a character that it might have been
considered important (Mills)
o This requires a showing of materiality – significant propensity to
affect the outcome
 Do not need a test to show how many votes were affected
 But there may be a causation problem if you violate rules and don’t
need the votes (Virginia Bank Shares)
o TSC Ind. (after Mills) – material if “there is a substantial likelihood that a
reasonable shareholder would consider it important”
 Remedies
o Borak – remedies “as are necessary to make effective congressional
o Factors are similar to fraud
 May include fairness
Not all things are violations of proxy rules
o Think about a sophisticated and rational shareholder (Seinfeld)
Shareholder Proposals
 Rule 14a-8
o Qualifying shareholders can put a proposal before their fellow
 Placed on company’s proxy statement – company bears the
o Who wants this?
 Hedge/private equity funds
 Pension funds
 Activists
 Charities
o Biggest question: what criteria in order for shareholder proposals to
“qualify” to be included in the statement
 Companies respond to proposals by:
o Attempting to exclude
o Include with opposing statement
o Negotiate with proponent
o Adopt proposal
 Procedural Requirements
o Must hold $2K in market value of stock (1%) and must have held for 12
o No more than one
o No more than 500 words
o At least 120 days before proxy statement
o Shareholder/representative must attend the meeting
 Substantive Requirements
o Must be proper under state law
 Look to state law
 Most are cast as recommendation
o Cannot be binding on the corporation
o Cannot cause company to violate law
o Cannot be personal grievance/special interest
o If related to operations, must involve 5% of assets, earnings, sales OR
significantly related to company’s business (Lovenheim)
 “Significantly related” is not just economic significance
o Cannot violate Proxy Rules
o Cannot beyond the company’s power
o Not ordinary business operations (Trinity Wall Street) (analysis, p. 124 of
Example: whether the company sells particular products
Even social policy issues must transcend normal business
 If disengaged from core of business – more likely to
 But if it is a narrow business, a stop-selling proposal may
relate to the company’s very existence
o Not specific amounts of cash/dividends
o May not directly conflict with company’s own proposal
o If received within last 5 years and failed
 But if more than 10% - than will not be
Companies (if they want to exclude) send a notice of intent to SEC and
o SEC then either issues a no-action letter, notice of enforcement, or
possibilities if it being cured
Also can exclude if relates to an election for membership on BOD
o Limited to shareholder proposals used to oppose solicitations dealing with
an identified board seat
o Not a broader interpretation
o Dodd-Frank however, changed the rules
 Certain shareholders can nominate a director for inclusion
 But then the new rule was struck down in Business Roundtable
Amending Bylaws + Certificate of Incorporation
o DGCL Sec. 109(a) (CA, Inc.)
 Did not allocate board/shareholders the same power
 Shareholder has power to change that cannot be
eliminated/limited by anything other than the legislature
 But the BOD has broad management power (DGCL 141(a))
 So the power to change bylaws is limited by management
 So – bylaws (and shareholders) can regulate the processes
 E.g.: number of directors, etc.
 Procedural nature is determined in light of context/purpose
 Amending bylaws also cannot cause the company to violate state
 E.g. violate fiduciary duties
o Section 242
 Amending incorporation:
 BOD adopts resolution
 Special meeting of stockholders
Shareholder Inspection Rights
 Internal Affairs Doctrine
o Law of state where they are incorporated controls internal affairs
 DGCL 220
o Any stockholder, upon written demand stating the purpose, shall have the
right to inspect the books
 Key Question: what is a proper purpose? (Crane Co.)
o Can do so to inform stockholders of an exchange offer and solicit tenders
of stock
 Tender offers involving the sale of stock is clearly for a business
o Access of records has to do with principal place of business – that
is the law that governs (wherever the PPB is)
 Exception to internal affairs doctrine
o NOT something that is not involved with the business (Honeywell)
o Examples of proper purpose (Sadler):
 Efforts to gain control (for one’s self or someone else)
 Investigate mismanagement/malfeasance
 Effort to gather info to assess the value of shares
 Effort to communicate with other shareholders for a proxy fight or
shareholder proposal
o Improper Purpose
 Personal business venture
 Social/political concerns that has NOTHING to do with economic
concerns for the corporation
 Strike suit
 Seek proprietary information
 Info to aid a competitor
Shareholder Voting Control
Common stock is a bundle of rights
o Economic rights – receive dividends, claim on assets in liquidation
o Voting rights - elect directors, approve some matters
Why might shareholders give up control?
o Trust others to do a better job (expertise)
o Maybe need a loan who won’t loan unless they get control
o Maybe want to lure someone away
Entrenchment Effect (Notes p. 139)
o Companies could issue shares with no economic rights but merely voting
rights (Stroh)
Voting – even the technicalities – matter (Zuckerberg)
o Even if a controlling stockholder manifests an intent to ratify outside of
the meeting, the company needs to meet technical requirements
o If no formalities – bad to minority stockholders
 Ratification affects them
 They should have the benefit of transparency
Control in Closely Held Corporations
Control in closely held corporations is different because the shareholders often
serve on BOD and as officers
Voting Trust
o Shareholder place shares in trust
o Trustee votes the shares
o Little question about enforcement
Vote Pooling Agreements (Ringling Bros)
o Shareholders agree to vote in a certain ways
o Cumulative Voting: shareholder spread out their votes for several
directors or accumulate their votes for one or two
 Helps minority shareholders
o Court has the power to reject votes of a shareholder
 If in violation of rights of another (e.g. contract breach)
Shareholder Agreements
o Sometimes deal with voting/control
o Can sometimes agree about how they will vote as shareholders
o Also sometimes deal with specific matters – who is appointed to what
o But there are limits on this (McQuade)
 Cannot divest directors of their powers to fire unfaithful employees
 Cannot restrict board discretion
o Board owes duty to shareholders
o But may be different if the directors are the sole
stockholders (Clark)
 No concern about minority stockholders
 Does not sterilize the BOD
Abuse of Control
Generally, shareholders do not owe fiduciary duties to other shareholders
In closely held corporations, however, there are additional duties that
o The duties in a closely held corporation are similar to partnership duties
 Policy: Close corporations are peculiar because the majority can
disadvantage minorities
Problem: There is little space between a close corporation
and a partnership
o These duties impose a strict obligation on the part of majority
stockholders to deal with the minority in good faith
o A majority shareholder action must have a legitimate business
 This becomes a defense for the majority shareholders
o If there is a legitimate business purpose, minority must
demonstrate that the same legitimate objective could have been
achieved through an alternative course (Smith)
At-will employees who happen to shareholders do not have fiduciary duties
protecting their right to employment (Ingle)
o But anyway, most of the time that is solved through the employment
o But an “opportunistic” discharge is still a breach even if at-will
Close corporations that purchase their own stock have a duty to disclose to
sellers all material information (Duff & Phelps)
o Material info is all info that would significantly alter an investor’s
decision making with regards to the particular stock
o This can even apply to at-will employees
 May matter what is contingent on what
 If shareholding is contingent on employment – merely at-will
 If employment contingent on shareholding – fiduciary duties
should trump
 Can happen when:
o Majority refuses to declare dividends
o Drain earnings
o Corporate funds paid in salary to employee-shareholders
o Frozen-out shareholder does not have a paying position
o So, the minority shareholder’s expectation of benefit from an
ownership of shares is frustrated (Brodie)
 A majority shareholder action must have a legitimate business purpose
o This becomes a defense for the majority shareholders
 If there is a legitimate business purpose, minority must demonstrate
that the same legitimate objective could have been achieved through an
alternative course (Smith)
 Remedy in these situations is to restore minority shareholders to where
they would have been absent the wrongdoing
Corporate Debt
Two types of debt:
o Debentures: Long-term unsecured debt obligations
o Bonds: Long-term debt obligations secured by debtor property
o Both are highly tradeable
Creditor rights are heavily protected by contract
o But most of the time, the parties are sophisticated, so do not want to read
many provisions into the contract
Sale of Substantially All Assets
Does a sale of substantially all assets equal a liquidation, thus requiring payout
to debtors? (Sharon Steel)
o Depends on what’s in the clauses
o Rights of holders of debt securities are a contract matter
o When contractual language is designed to protect both parties and they
argue that there are conflicting interpretations – should construe to
sacrifice the principal interests of each party as little as possible
Incurrence of Additional Debt
A company is not obligated to avoid new debt by some sort of covenant or duty to
current debtholders (MetLife)
o Only “fruits of agreement” are payment of interest and repayment of
o One-sided elasticity otherwise – destabilize the market
o Only remedy is a breach of express covenant
 No implied covenant to do otherwise
Exchange Offers
Relationship between a corporation and its debtholders is contractual (Katz)
o Rights and obligations are clearly spelled out
o But both sides are always bound by good faith
 What would the parties have considered this action to be at
the time the contract was negotiated?
Call Protection and Redemption
Mergers, Acquisitions, and Takeovers
Statutory Merger
o Write out agreement
o Director’s Approval – Boards of Purchaser and Board of Target have to
adopt the Merger Plan
o Shareholder Consent – Merger submitted to SHs of both companies, and
both company’s shareholders have to approve (most states require 2/3)
 Exceptions:
 Short Form Merger
o Purchasing company owns enough shares of target
company, can skip a number of steps in statutory
o Idea: company already controls another company, so
final consolidation does not fundamentally change the
 Small Scale Merger
o Shareholders of target company will make up less than
20% of the combined shareholders of the new
corporation, no vote required.
o This does not fundamentally change the acquiring
o Purchaser files the proper documentation
 As soon as this happens, merger is complete
 Shares exchanges, P assumes assets of merged/consolidated
corporations, become assets of the survivor
 Dissenters Appraisal Rights
 Dissatisfied SHs usually have appraisal rights
 Statute creates a buyout agreement for dissatisfied SHs
 Can require company to pay value of shares through
appraisal process
Triangle Merger
o After negotiating terms, P creates subsidiary and transfers to S common
o Subsidiary of acquiring company mergers with T
o Steps
 Negotiating of terms
 After, P transfers down to S consideration used in merger (P
shares). Makes it a wholly owned subsidiary, assets are only those
in consideration for the merger
 Steps for statutory merger, different characters:
 Boards of S and T have to approve
 T and S SHs have to approve
 This bypasses shareholders of P
 T then mergers as a matter of law with S
 Assets and liabilities transferred to S
 S distributes P shares to T SHs
Asset Purchase
o Acquiring Company
 Board approval, may need SHs to approve if issuing more shares
o Acquired Company
 Board approval, shareholders need to approve
o Acquiring company buys assets using its own shares
 Can also require liabilities, or seller can use cash to pay those off
o Seller distributes P shares to shareholders and liquidate
o Exact same thing as triangle/statutory merger in the end
o Section 271 requires approval of a sale of substantially all the corp’s
assets by board and SHs
 Must be by a majority
 No appraisal rights
Tender offer
o Buy all of the shares
o Public offer made to all SHs of T
o At end of offer period, either the bidder purchases the shares or returns
De Facto Merger
In a de facto merger, a company acquires another and does something aside from
the set statutory merger
P in acquired company sues
o They would have dissenter’s rights in a statutory merger
Focus on the substance of the transaction rather than the form
o Question is whether the transaction has the substantive effect of
the merger (Farris)
 Does the combination fundamentally change the corporate
character of the corporation?
 Does the combination change the interest of the P as a shareholder,
such that refusing him the rights of a dissenting shareholder forces
him to give up his stock in one and against his will accept shares in
Section 271 gets to basically the same result as a merger, through different
o That is OK – legislature did that for a reason, even though the
shareholder has different rights (Hariton)
An effort to acquire sufficient shares to control the BOD, replace the BOD with
the Acquirer’s own slate of directors
Williams Act (Slides) governs tender offers
Defensive Tactics:
o Greenmail: payment to potential acquirer to incentivize them to leave
the company alone; occurs when a person has started to acquire a bunch
of shares of a company, and target buys them back for price above market
o White Knight: company sought by a target company to avoid a hostile
o Poison Pill: creation of a device that multiplies the rights of
shareholders, so the acquirer would find that increased shareholder rights
made the takeover expensive
Fiduciary Duties (Cheff)
o Because hostile takeovers represent a threat to the positions of BOD and
other officers, there is not as much deference as the BJR
o Need to examine both the specific actions taken and the Board’s
motivation for taking them
 Any defensive measures must be scrutinized
 Especially if “inside” directors (who would lose their jobs), as
opposed to outside directors, who do not have a pecuniary
o There must be a proper business purpose for the actions of the BOD
 Cannot merely attempt to entrench themselves
 Fact-specific inquiry as to whether the BOD had justification to
believe there was a threat, and whether their response is
reasonable in light of the threat
o Typically evaluated according to the Unocal Test
 Two elements:
 BOD must have shown that it acted in good faith and, after
reasonable investigation, concluded that a danger
existed to corporate policy and effectiveness AND
o Different from BJR – need to show a threat - Many
factors to consider (inadequacy of price, nature of offer,
risk acquisition may not be consummated)
o Also can consider groups other than shareholders –
but not at their expense
The action taken by the Board must have been
reasonable in relation to the threat posed
o If reasonable – courts will most likely defer
o The Revlon Rule adds another layer if there are no longer
defensive measures, but a breakup OR a change in control is
 Two situations where this is implicated (Time):
 Active bidding process
 In response to bidder, target abandons a long-term strategy
and instead seeks an alternate transaction involving breakup
 This is not extended to mere corporate transactions because
they might be construed as putting a corporation either “in
play” or “up for sale”
 Sole responsibility then is to maximize the value that is received by
the shareholders
 Value is not just the dollar amount
 Cannot fend off a bidder if a threat becomes a reality
 Some actions which may not be bad may become bad in this
 Directors must (QVC):
 Be diligent/vigilant in examining the transaction
 Act in good faith
o Similar to the good faith in Walt Disney or Stone
 Obtain all reasonable available information
 Negotiate actively