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I. Agency
A. Formation
B. Termination
C. Liability in Contract
D. Liability in Tort
E. Governance of Agency
II. Partnership & Limited Liability Companies (33-73)
A. Formation
B. Relations with Third Parties
C. Governance
D. Termination
1. Partners can design own dissolution rules
2. Dividing residual value when partner leaves or partnership is dissolved
3. Fiduciary Duties limit opportunistic dissolution
E. Conflicts/ Fiduciary Duties
F. Limited Liability Successors
III. The Corporate Form (75-101)
A. Basic Characteristics
B. Legal Personality of Corporations
C. Limited Liability
D. Transferable Shares
E. Centralized Management
IV. Creditor Protection (103-141)
A. Mandatory Disclosure
B. Capital Regulation
1. Distribution Constraints
2. Minimum Capital Requirements
C. Standard-Based Duties
1. Director Duties
2. Fraudulent Transfers
3. Shareholder Liability
V. Shareholder Voting (163-227)
A. Election of Directors
B. Removing Directors
C. Proxy Voting
D. Class Voting
E. Separation of Control from Cash Flows
1. Circular Voting
2. Vote Buying
3. Controlling Minority Structures
F. Federal Proxy Rules
VI. The Duty of Care
A. Liability Shields for Directors
1. Business Judgment Rule
2. Liability Waivers for Breach of Fiduciary Duties
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3. Indemnification
4. D&O Insurance
5. Mandatory Reimbursement of Legal Expenses
B. Liability for Omissions: Duty to Monitor
C. Knowing Violations of the Law
VII. The Duty of Loyalty
A. Regulation of Self-Dealing Transactions
1. Self-Dealing Transactions Involving D&Os
2. Self-Dealing Transactions Involving a Controlling Shareholder
B. Corporate Opportunities Doctrine
C. Duty of Loyalty in Close Corporations
VIII. Executive Compensation
A. Agency Costs in Executive Compensation
1. Pay-for-Performance Tools to Mitigate Agency Costs
B. Judicial Review of Executive Compensation
IX. Shareholder Litigation
A. Procedural Requirements in Derivative Suits
1. Standing
2. Demand Requirement
3. Special Litigation Committees
4. Standing
5. Exclusive Forum Provisions
X. Transactions in Control
A. Sales of Control Blocks
1. Market Rule
2. Exceptions to the Market Rule
B. Tender Offers
1. Early-Warning System
2. Regulation of Tender Offers
XI. Mergers and Acquisitions
A. Transactional Forms
B. Appraisal
C. Controlled Mergers
XII. Contests for Corporate Control
A. Judicial Review of Antitakeover Defenses
B. Choosing a Merger Partner: Judicial Review of Board Actions (Active Battle or When
Company is Up for Sale)
C. Deal Protection Devices
D. Corwin Cleansing Effect
E. State Antitakeover Statutes
F. Proxy Contests for Corporate Control
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I. Agency (7-32)
Agency: fiduciary relationship that arises when a Principal manifests assent to an Agent to act
on the Principal’s behalf and subject to the Principal’s control. Arises out of consent (RTA, §1.01)
A. Formation
B. Termination
C. P’s liability for A’s authorized and unauthorized contracts
D. P’s liability for (some) torts committed by A
E. A’s duties to P (“governance” of agency)
A. Formation
Agency is formed by consent.
1. SCOPE
- Special agents: limited to single transaction
- General agents: authorized to perform series of transactions/ actions necessary to
achieve specific goal.
2. 3rd PARTY DISCLOSURE
- Disclosed: 3P knows that A acts on behalf of specific P
- Undisclosed: 3P does not know that A is an agent
- Unidentified Principal: 3P knows A is an agent, but not identity of P
3. CONTROL
- Employee: P has detailed control. P controls A’s work (RTA §7.07)
- Contractor: Less extensive control
Agency may be implied even when not explicitly agreed to:
Jenson Farms v. Cargill: Cargill provided financing to Warren Grain and Cargill reviewed
contracts & financials, had right of first refusal, offered biz advice, exercised control. When
warren defaulted, Cargill held jointly liable. Holding: Agency is created through course of
conduct where the facts show that one party has manifested consent that the other is its agent,
and parties behave as agent and principal. Agency created even if parties did not call it so.
B. Termination
Because agency is formed by consent, it may be terminated at any time.
C. P’s liability in contract
Inherent authority (below) v. approach in Third Restatement (P must have some notice of A’s
conduct)
- Liability by estoppel (§2.05 RTA): P is liable if (1) P intentionally or carelessly caused
belief that P was principal; or (2) P is aware of the belief and didn’t take steps to notify 3P.
- Liability of undisclosed principal (§2.06 RTA): P liable if A acts without actual
authority and (1) P has notice of A’s conduct and (2) doesn’t take reasonable steps to notify
3P.
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Apparent Authority (§2.03 RTA): P liable if a reasonable person in 3P’s position could
infer from manifestations of P that P is a principal.
D. P’s liability in tort
Employers are liable for employees’ torts if employee is acting within the scope of employment
(RTA §2.04, 7.07)
Key elements of liability:
1. Principal’s control
2. Tort w/in scope of employment
**Policy arguments: Incentives, fairness. Monitoring costs, efficiency issues if strict liability.**
Humble Oil v. Martin: Employee of service station found liable in auto accident, and oil
company also liable because contractor relationship broke down to a master/servant relationship
since operator of service station had little authority except hiring/firing. Holding: Humble liable
bc acts as P to Schneider’s A. A party may be liable for contractor’s torts if he exercises
substantial control over contractor’s operations.
Hoover v. Sun Oil: Customer burned at gas station sought to hold franchisor (oil company)
responsible. Holding: Franchisee retained control of inventory and day-to-day operations, so was
independent contractor. Oil company not liable.
**Policy: franchise agreements protect market share, develop customers, provide consistency,
while tort liability protections reduce monitoring costs. Oil companies should be subject to
liability in some cases because agents may be judgment proof and it incentivizes P to control.
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From social welfare perspective, parties will negotiate allocation of costs amongst themselves, so
if doesn’t matter where we place liability.**
E. Governance of Agency (A’s duties to P)
Principal/agent relationship is fiduciary, meaning:
1. Duty of Obedience
2. Duty of Care:
- Duty to act as a reasonable person would do in similar circumstances in becoming
informed and exercising power
3. Duty of Loyalty:
- Duty to exercise power in manner that is best to advance interests of the
principal, not for personal benefit.
- A may not acquire material benefit form 3P through use of A’s position
- A may not use P’s property for own purposes
- Owed by agent to principal (not owed by principal to agent)
**We allow personal transactions that could be conflicts because prohibiting them could
eliminate Kaldor-Hicks efficiencies**
II. Partnership & Limited Liability Companies (33-73)
A. Formation
Partnership: association of two or more people to carry on as co-owners of a biz for profit, whether
or not people intended to form a partnership (RUPA & UPA)
Characteristics
- Separate legal personality
- Tenancy in partnership
- All owners (partners) are liable as principals
- All partners are general agents of the partnership
- All general partners are jointly and severally liable
- All partners share equally in control (unless otherwise agreed)
Benefits
- Cost of debt may be higher than selling an ownership stake
- Partner’s human capital, with aligned incentives
Is it a Partnership? Courts consider: (1) profit sharing; (2) control; and (3) intent of parties
- RUPA: common property insufficient to show partnership, even if co-owners share profits
from use of property; sharing net profits—but not gross returns—is prima facie evidence
of partnership, unless payments are for: debt; IC/ employee svcs; rent; loan interest or fee.
**Net profits shows control, but gross does not**
Vohland v. Sweet: apprentice gets 20% of net profits erroneously called “commission.” Cost of
maintain stock was assigned to expenses prior to payout. No capital contribution, but had
managerial/ supervisory roles. Sued to dissolve partnership and distribute proceeds. Holding:
Sharing net profits is prima facie evidence of partnership.
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B. Relations with Third Parties
Rights of Partnership Creditors (RUPA)
- Partners jointly & severally liable on partnership torts and contracts
- Creditors must exhaust biz assets before pursuing personal assets
Issues
1. Who is a partner (who can be pursued)?
2. When can ex-partner escape debts?
3. What are the third-party claims against partnership property?
4. How are partnership creditors placed w/r/t partner’s individual property?
When can ex-partner escape debts?
Departing partners remain liable but lack control.
- RUPA §701 (UPA §36(2)) releases departing partner if court can infer an agreement
- RUPA §703 (UPA §36(3)) releases departing partner if creditor: (1) knows partner is
leaving; and (2) agrees to material alteration of time/payment of credit.
How are partnership creditors placed w/r/t partner’s individual property?
C. Governance
A partnership is bound by actions of the partners when:
- Partner has actual or apparent authority, meaning action is in ordinary course of biz =
binding, unless;
o Partner was not authorized
o The third party knew
- Other matters are only binding if there is actual authority (authorized by partners)
Ordinary biz needs majority vote, and other matters need unanimous vote.
National Biscuit v. Stroud: *What is “majority* when there are only two partners?* One
partner told supplier that biz would not be liable for any bread delivered after certain date. Other
partner keeps buying bread. Partnership dissolves and bread company wants to collect. Holding:
1 partner in a 2-partner partnership is not a majority, so not binding on ordinary biz.
D. Termination
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Dissociation
- RUPA: partner leaves partnership
o Involuntary withdrawal
o Special events (expulsion, death)
Dissolution
- RUPA: onset of liquidation of partnership assets & winding up of affairs
o At-will withdrawal
o Special circumstances (term ends, agreement, purpose fulfilled)
- UPA: any change in partnership relations (exit)
o Withdrawal (any partner has right to demand dissolution/ wind-up)
o Special events (term ends, agreement, purpose fulfilled)
Termination
- RUPA: winding up is complete
- UPA: partnership ceases entirely at end of winding up
Winding Up
- UPA: Orderly liquidation and settlement of affairs
Partnership Exit Principles
1. Partners can design own dissolution rules (Adam v. Jarvis)
2. Dividing residual value when partner leaves or partnership is dissolved
3. Fiduciary Duties limit opportunistic dissolution (Page v. Page)
1. Partners can design own dissolution rules
Adam v. Jarvis: withdrew from partnership and claimed that withdrawal = dissolution and thus
right to require a winding up under UPA §38. Holding: entitlement to statutory winding up not
allowed if withdrawal is in contravention to partnership agreement (unless otherwise agreed to).
Here, agreement said withdrawal shall not terminate partnership.
2. Dividing residual value when partner leaves or partnership is dissolved
Procedure
- Physical division of assets (rejected by courts in Dreifuerst v. Dreifuerst)
- Court-appointed appraiser (not in statutes)
- Biz sold as intact, going concern or in parts at judicial auction
Fair Value that Partners Receive
- UPA: Liquidation value. Proportional share in cash of total assets – total liabilities
- RUPA: Higher of: proportional share in going concern or the liquidation value
Page v. Page: One partner seeks dissolution at time that is bad for biz but good for himself.
Holding: Partnership is at-will and can be dissolved lacking evidence of an implicit term. BUT,
fiduciary duties protect remaining partner, so if departing partner attempts to appropriate new
prosperity of partnership for won use, dissolution would be wrongful and departing partner
would be liable for damages.
E. Conflicts/ Fiduciary Duties
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Meinhard v. Salmon: One (of two) partner takes 20-year lease for office space and holds in his
name while running the biz. Other partner is passive investor and supplies 50% capital, gets 40%
for first 5 years then 50% of profits thereafter. First partner re-signs for himself, cutting out
second partner in 80-year deal. Holding: “A trustee is held to something stricter than the morals
of the marketplace.” Salmon breached fiduciary duty of loyalty to partner to allow him to compete
on other projects (right to be informed, not necessarily to participate).
F. Limited Liability Successors
III. The Corporate Form
1. Basic Characteristics
- Independent legal personality
- Limited liability
- Transferable shares
- Centralized management under the board
Variations
- Closely-held vs. public
- Controlled vs. widely-held
Primary Sources of Corporate Law
- Revised Model Business Corporation Law (RMBCA)
- Delaware General Corporate Law (DGCL)
2. Legal Personality of Corporations
Economic Benefits:
- Ability to enter into contracts  reduces transaction costs
- Separate pool of assets  reduces monitoring costs
- Infinite life  increases stability
Governing Documents
Articles of Incorporation (Charter)
o Name, purpose, capital structure
o Amendment requires a board-initiated shareholder vote
o Usually flexible
Bylaws
o Operating rules: Shareholder meetings, board of directors, officers
o Can be amended by shareholders, or possibly by board
3. Limited Liability
Economic Benefits
- Decreases monitoring costs
- Shares become fungible
- Facilitates diversification
- Facilitates takeovers
Costs
- Less care in preventing torts
4. Transferable Shares
Economic Benefits
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Shareholders can leave without disrupting company
Facilitates takeovers
Facilitates development of large capital markets/ promotes investment
5. Centralized Management
Board of Directors: Nature and Powers (wide)
- Appoint/ remove officers
- Declare and pay dividends
- Amend bylaws
- Create committees
- Exclusive authority to initiate major decisions (mergers, sale of assets, dissolutions,
charter amendments)
- Make major biz decisions (product lines, prices, financing)
Structure & Operation of Board
- Elected at annual meeting or staggered/ classified
- Operate via formal resolutions at board meetings (some states permit unanimous written
consent)
Benefits of delegation
- Expertise
- Minority protection
- Efficient decision making
Costs
- Agency costs
o Mitigated via disclosure & voting (shareholders elect/ remove directors who elect
managers)
Automatic Self-Cleaning Filter: Group of shareholders totaling 55% of ownership want to sell
assets. Charter requires 75% approval, so measure fails. Group petitions court to order board to
sell. Holding: Directors are not simply agents, and simple majority cannot override board’s
authority if charter requires 75%.
Jennings v. Pittsburg Mercantile
Director instructs real estate broker to solicit offers for sale & leaseback of company property and
says the executive committee he is on has the power to accept offer and board approval would be
automatic, but board then rejected offer, so broker sued for commission. Company claimed not
bound bc director did not have authority, broker claims company is bound by apparent authority.
Holding: No actual authority bc transaction is not in ordinary course of business and no apparent
authority bc principal never represented that he had authority.
IV. Creditor Protection (103-141)
A. Mandatory Disclosure: Required by Federal and sometimes state law, FBO shareholders
B. Capital Regulation
1. Distribution Constraints: constrain ability of directors to distribute money to shareholders
Shareholders Equity=Stated Capital + Capital Surplus + Retained Earnings=Assets – Liabilities
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Stated Capital = par value * # of shares
Capital Surplus = Mkt value – Par
Retained Earnings = Net Profits
Nimble Dividend Test (DGCL §170(a)): Directors may pay dividends out of Surplus (Capital
Surplus + Retained Earnings) OR, if that’s less than zero, out of Net Profits for either current or
preceding fiscal year. Board may also transfer stated capital to capital surplus. **Weak
protection for creditors, but allowed bc it rewards biz on upward trajectory**
2. Minimum Capital Requirements
Used in EU but not US bc the protection is rigid (might deter entrepreneurship, inefficiently
force liquidation, or otherwise inefficiently interfere with biz decisions) and might be
meaningless.
C. Standard-Based Duties
1. Director Duties (in zone of insolvency)
Credit Lyonnais: In vicinity of insolvency, directors owe duty to consider “community of
interests” of the corporation, not just the shareholders. Problems: Relies on ex post analysis—
maybe creditors protected themselves already; Zone of insolvency is hard to define.
2. Fraudulent Transfers
-
Applies to all debtor-creditor relationships
Regulated by Uniform Fraudulent Conveyance Act (UFCA) and Uniform Fraudulent
Transfers Act (UFTA)
Remedy: transfers made by insolvent debtors are VOID
Conditions: Debtor transfers with actual intent to defraud; OR Constructive fraud (debtor
did not receive “reasonably equivalent value” in exchange; and remaining assets of debtor
are “unreasonably small”)
3. Shareholder Liability
Equitable Subordination : Major shareholder makes loan to corporation, and in so doing, behaved
unfairly to creditors and corporation. Transaction based (like fraudulent transfers)
Remedy
- Available through common law and Bankruptcy Code
- Prioritizes outside creditors over the shareholder in distribution of corporate assets
**Unlike partnerships (under RUPA) subordination is not the default. We do not prohibit these
transactions bc they might be efficient**
Costello v. Fazio: Partners deliberately converted part of their equity into notes, transforming
partnership to corporation specifically to escape liability and “cut in line” ahead of biz’s creditors.
Holding: No fraud, but gross undercapitalization (not sufficiently damning on its own) and
inequitable conduct towards creditors (damning).
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Piercing the Corporate Veil: legal decision to treat the rights or duties of a corporation as the
rights or liabilities of its shareholders
- Lack of separation btwn shareholder and corporation. Presumes:
o Dominance of corp decision
o Disregard of corp formalities
o Undercapitalization
o Co-mingling of assets
- Corp form used as instrument for “unfair or inequitable conduct” (vague)
o Incorporating to avoid liability (Costello)
o Shifting assets to another corporation
o Misrepresenting assets
Sea-Land v. Pepper Source *Shifting assets and dissolving ex post* Sea-land obtains
judgment against Pepper Source for unpaid bill, but Pepper source dissolves and has no assets, so
Sea-Land seeks to pierce corporate veil to reach holding company’s assets, and then reversepierce to reach subsidiary assets. Holding: Remanded for factual determination on second prong,
but YES to first prong, lack of separation bc no formalities, co-mingling of assets. Court says
second prong examples are: incorporating to evade liability, misrepresenting assets, shifting
assets to subsidiary. N.B. (Restrepo): Even if no fraud, could still satisfy prong if dissolution
was strategic behavior intended to avoid liability ex post bc that would violate creditors’
reasonable expectations.
**Reverse piercing raises concerns of no asset partitioning  higher monitoring costs.**
Kinney v. Polan: *Creditor knew about undercapitalization ex ante* Kinney sublets remaining
10 years of 25-year lease to Polan, through his company Industrial, which fails to make
payments. Holding: OK to Pierce. Two-prong Laya test satisfied bc no capital contribution, no
minutes, no officers (clearly a “paper curtain” to avoid liability). Court ignores 3rd prong.
Veil-Piercing for Involuntary Creditors
Tort creditors do not have a contract, so cannot monitor firm/ negotiate protections ex-ante.
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Walkovszky v. Carlton: Man hit by cab wants to hold owner of corp personally liable bc each
cab (treated as individual subsidiary) had limited insurance. Holding: Veil not pierced. In order
to maintain a cause of action for piercing the corporate veil, the plaintiff must allege that a
shareholder used the corporate form to conduct business in his individual capacity. Corp. was not
a dummy corp in service to shareholder(s).
** Limited liability creates incentives to underinvest in safety**
V. Shareholder Voting (163-227)
Corporate voting systems address the collective action problems inherent in widely-held
corporations.
Shareholders vote on:
- Election of directors (all corps must have a board under DGCL §14(a))
- Fundamental changes
o Amendments to corporate charter
o Transformational transactions (mergers, substantial sale of assets, dissolutions)
- Shareholder resolutions
Shareholder voting rules:
- One-share-one-vote (unless otherwise specified in charter)
- Mandatory annual shareholder meeting
- 10 day minimum/ 60 day maximum notice of shareholder meeting
- Default quorum: majority of shares
- Proxy system: if shareholder cannot attend ASM, can find proxy to vote on her behalf
A. Election of Directors
1. Types of Boards
Unitary board: single-class board where all directors are elected at ASM
Staggered/ Classified board: different classes (3 max in Delaware). Each year, shareholders can
elect only one class. Can be adopted by charter, initial bylaw, or bylaw adopted by special
shareholder vote. Have antitakeover effect.
2. Types of Voting
Straight voting:
Plurality: Directors that receive the largest number of votes in favor are elected.
Contested election: If votes for dir. A > votes for dir. B, then dir. A is elected.
Uncontested: Director is elected if pro-votes >0
Majority: Director elected if obtains majority votes (common for uncontested)
Majority of shares present & entitled to vote: Elected if votes for > (votes withheld
+ votes against)
Majority of votes voting: Elected if votes for > votes against
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Cumulative voting: Each shareholder gets votes equal to number of shares owned times number
of seats to be filled. Permits opt-in via charter. Relevant in contested elections. Pro: Improves
likelihood of minority representation on board; Con: could undermine collegiality of board.
B. Removal of Directors
Basic Rules:
- DGCL: Director may be removed with or without cause unless: (1) staggered board (unless
charter provides otherwise); OR (2) cumulative voting
- Poor business decisions alone usually insufficient cause for removal
- RMBCA: directors can be removed with or without cause whether or not board is
staggered.
Timing:
- Annual Meeting (quorum needed)
- Special Meeting
o DGCL: called by board and others authorized in charter or bylaws
o RMBCA: called by board or 10% of shareholders
- Written Consent
o DGCL: approval requires votes needed to pass resolution to meeting
o RMBCA: approval requires unanimous consent
C. Proxy Voting
Who pays? Froessel rule: requires challengers to identify larger corporate gains before investing
in a proxy fight.
Rosenfeld v. Fairchild: shareholder with 25 shares attempts to force both sides in proxy
contest. Both sides reimbursed themselves from corporate treasury. Holding: board is entitled to
full reimbursement for reasonable proxy expenses made in deference to corporate policies.
Insurgents will be reimbursed only if the decision is ratified by shareholders (as here).
D. Class Voting
Different classes of stock may have different rights to vote.
- DGCL: requires class voting if charter amendment changes (1) legal rights of the class,
OR (2) par value or number of shares of the class. Class voting not required for mergers.
- RMBCA: Class voting in more cases. Generally, when an amendment changes the
economic or legal rights of the class. Includes mergers.
E. Separation of Control from Cash Flows
**We give voting rights to shareholders because they are the residual claimants of the
corporation, so they have incentives to maximize long-term value**
1. Circular Voting
DGCL: Corporations can’t vote (or count toward quorum) two kinds of shares:
(1) treasury shares
(2) shares held by a subsidiary in which the corp owns a majority of the voting stock
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Speiser v. Baker: Court adopts expansive interpretation to find circular voting because
company held 95% of subsidiary’s equity, even though company only held 42% of voting power.
2. Vote Buying
Vote buying is prohibited because pricing would be incorrect since shareholders would sell for
any non-zero value.
Schreiber v. Carney: Def wanted to exercise warrants but could not afford to, so voted to block
merger. Another party offered to lend money to exercise the warrants so that merger could
proceed. Holding: Corporate vote buying is illegal only when done for improper purpose. Voidable
only if it does not satisfy intrinsic fairness. Here, shareholder approval after full disclosure
precludes voiding transactions.
3. Controlling Minority Structures
-
Stock pyramids
Cross-ownership
Dual-Class Shares
o Allows founders to obtain equity but retain control
o Insulates from takeovers
o Potential abuse of power
Mitigating Collective Action Problems:
- Diffusion leads to collective action problems
- Institutional shareholders are partial solution, but research is costly, diversification
undermines incentives to monitor, and institutions have their own agency problems.
- Hedge funds have high incentives to monitor bc of 20% incentive fee and greater
concentration of holdings in fewer companies. But may have incentives to generate shortterm performance at expense of long-term value.
F. Federal Proxy Rules
Virtually all companies with >$5M in assets or >500 shareholders must register under Exchange
Act.
1. Regulatory Requirements for Proxy Solicitation
Under Exchange Act §14(a), it is unlawful to solicit proxies except in compliance with SEC
regulations:
- Rule 14a-1(1)(1)(iii): Solicitation = any communication reasonably calculated to procure
proxy.
- Rule 14-a-3(a): may not solicit proxy unless you provide a proxy statement w/ Sched 14A
info unless exempt bc:
o Solicitation does not seek directly or indirectly the power to act as proxy
o Solicitation to 10 or fewer other shareholders
- BUT: even if exempt, shareholder must file communication and notice of exempt
solicitation after sending.
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2. Short Slates: may benefit company but is less disruptive. Dissidents may want some
influence but not control. Director must consent to be on proxy card. When dissidents run a short
slate proxy contest, dissidents’ card can be rounded by adding some of incumbent directors.
3. Shareholder proposals: under certain conditions, shareholders can submit proposals to
other shareholders through company’s proxy materials.
Rule 14a-8: Must be long-term shareholder: $2k for 3 yrs, $15k for 2 yrs, OR $25k for 1 yr
Rule 14a-8(i): Company may exclude proposals from proxy materials if:
- It is improper under state law
- Relates to ordinary matter of business
- Relates to matter that represents < 5% of biz
- Conflicts with company’s proposal
- *Burden is on company to prove*
N.B.: CSRs, expense reimbursement, access
4. Antifraud Rules
Rule 14a-9: shareholders have right to recover for false or misleading proxy solicitations if:
- Materiality: reasonable shareholder would consider it important when voting (TSC Indus
v. Northway)
- Culpability: Negligence or scienter depending on jurisdiction
- Causation & Reliance: need not prove actual reliance, and causation is presumed if
misrepresentation is material and solicitation was an essential link in accomplishment
of transaction.
Virginia Bankshares v. Sandberg: Freeze-out merger of bank into Virginia Bankshares,
which board supports. Dissenting shareholder claims 14a-9 violation because valuation was
improper. Holding: Materiality = yes (board opinion and underlying facts) but Causation = no
because transaction would have been approved anyway since minority shareholder votes were
not required for corp action under bylaws. Narrow approach to essential link analysis.
5. Fiduciary Superintendence of Voting
D&O have duty to not unfairly manipulate the voting process for their own advantage.
Schnell v. Chris-Craft Industries: directors amended bylaws to move ASM up in order to give
dissidents insufficient time to organize and solicit proxies. Holding: mgmt. violated duty not to
unfairly manipulate voting process by attempting to use corporate machinery for its own benefit.
VI. The Duty of Care
Duty of Care: D&O has duty to corporation to perform functions: (1) in good faith; (2) in a
manner she reasonably believes to be in best interests of corporation; (3) with the care that
ordinarily prudent person would exercise in a like position and under similar circumstances.
A. Liability Shields for Directors
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Types of liability shields in Delaware:
- BJR: presumes duty of care was met
- Waiver of Liability: corp can eliminate directors’ liability for duty of care violations
- Indemnification: corp may indemnify D&Os if D&Os actions were in good faith
- D&O Insurance: corp may buy D&O insurance whether or not corp would have pwr to
indemnify
- Reimbursement of Legal Expenses: even if not in good faith, succss in legal action requires
indemnification for legal expenses.
1. Business Judgment Rule
BJR: D&O who makes biz judgment in good faith fulfills duty of care if D&O: (1) is not interested
in subject of the biz judgment; (2) is informed w/r/t subject; and (3) rationally believes that biz
judgment is in the best interests of the corporation.
Pros: BJR encourages valuable risk-taking, encourages board members to serve, directors
usually in better position to decide bc they are experts and stakeholders, reduces cost of judicial
intervention.
Kamin v. American Express: In derivative action, minority shareholders wanted Amex to
withhold stock dividend because it would offer tax shield, and that to continue to issue was a
waste of corp assets and breach of duty of care. Holding: No self-dealing, so court not going to
evaluate biz decisions. Courts will not interfere with a business decision made by directors of a
business unless there is a claim of fraud, bad faith, or self-dealing.
Smith v. Van Gorkom: There is a rebuttable presumption that a business determination made
by a corporation’s board of directors is fully informed and made in good faith and in the best
interests of the corporation. But directors of a corporation may be liable to shareholders under
the BJR for approving a merger without reviewing the agreement and only considering the
transaction at a two-hour meeting. Holding: directors liable for breach of duty of care.
Standard of judicial review for business judgment rule:
• Is the director disinterested? If he is interested, the standard of judicial review shifts to
entire fairness review (see Duty of Loyalty).
•
Is the director informed? Did he consider “all material information”?
• BJR rebutted if there is gross negligence in becoming informed (Aronson).
• If there is liability waiver under §102(b)(7), plaintiff must prove bad faith.
•
Was the transaction “rational”? Is there evidence indicating that the transaction was so
irrational, so extremely poor, that it is unlikely that the director acted in the belief that it
was in the best interest of the corporation? In practice, the question is whether the action
constitutes waste (exchange of corporate assets for consideration so disproportionally
small as to lie beyond the range at which any reasonable person might be willing to trade)
A more general condition of the BJR is good faith.
o Doctrinally, bad faith is more egregious than gross negligence. DGCL
§102(b(7), in fact, allow firms to waive liability for breach of the duty of
care unless there is bad faith.
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2. Liability Waivers for Breaches of Fiduciary Duties
In response to Van Gorkum, DGCL allows corporations to waive liability for breaches of fiduciary
duty. Charter may include personal liability waiver for a director to the corporation or the
shareholders for monetary damages for breach of fiduciary duty of a director provided that the
waiver does not eliminate liability for:
- Breach of duty of loyalty
- Acts or omissions not in good faith involving misconduct or knowing legal violation
- For any transaction from which director derived improper personal benefit
- *Shareholders approve charter*
3.Indemnification
DGCL 145(a) permits corporation to indemnify D&O except if: not in good faith; in criminal
proceeding, director had reason to believe conduct was unlawful (courts interpret as director is
convicted).
Indemnification is not exclusive of other rights to which those seeking indemnification may be
entitled under any bylaw, etc. (but charter/ bylaw cannot indemnify for something not allowed by
DGCL, like action not in good faith).
4. D&O Insurance: DGCL 145(g) allows insurance whether or not corp would have the power to
indemnify under DGCL 145(a).
5. Mandatory Reimbursement of Legal Expenses: required under DGCL 145(c), even if corp
does not indemnify, must pay expenses.
B. Liability for Omissions: Duty to Monitor
Francis v. United Jersey Bank: Mrs. Pritchard did not intervene in sons’ mismanagement,
ignoring red flags until the firm went bankrupt. Holding: breach of duty of care, because she had
the power to prevent the losses but failed to do it. Failed to read financial statements and failed
to make any reasonable attempt at monitoring for and preventing fraud.
Graham v. Allis-Chalmers: Under Delaware law, corporate directors and officers will not be
held liable for losses resulting from their failure to supervise and manage the business, so long as
those directors and officers reasonably relied on the honesty and integrity of their subordinates.
Reliance is no longer reasonable if the directors and officers are put on notice that wrongdoing
may be happening. Director and officer liability may be imposed if, after such notice, nothing is
done to find and prevent misconduct. Nevertheless, directors and officers are not under a duty to
“install and operate a corporate system of espionage to ferret out wrongdoing which they have no
reason to suspect exists.” The question of when a director has breached the common law duty of
supervising and managing the business is dependent on the surrounding circumstances. Liability
is proper if a director recklessly trusts an employee who is clearly untrustworthy, seriously
neglects her duties, or willfully or negligently ignores “obvious danger signs of employee
wrongdoing.” In this case, the directors had no actual knowledge of wrongdoing.
In re Marchese: Friend of controlling shareholder was director and member of audit committee.
Never reviewed accounting procedures, signed forms with material misinformation, approved
dismissal of auditors who raised red flags. Holding: behavior violated federal laws that prohibit
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disclosure of misleading information in financial statements. Independent and dependent
directors both subject to same duty to monitor.
In re Caremark: Expands on Allis-Chalmers. Directors must not just respond to red flags, but
must seek them out. A poor monitoring system can, by itself, be enough to trigger liability.
Stone v. Ritter: Endorsement of Caremark. Absent any red flags, in order for directors to be
liable for lack of oversight of officers & employees, there must be a finding that directors either
failed to implement any reporting systems or, having implemented such systems, failed to
monitor them.
In re Citigroup: Citigroup engaged in subprime lending. Had 102(b)(7) waiver. Claim alleges
breach under Allis-Chalmers (public reports of mortgage crisis = red flags) and Caremark (board
failed to make good faith attempt to follow procedures). Holding: not liable. General market
trends are not red flags, and monitoring is required for fraud, not biz risk. Under BJR, corporate
directors will not be held personally liable for failure to manage the company's business risk
unless their conduct rose to the level of gross negligence.
C. Knowing Violations of the Law
Miller v. AT&T: Shareholder suit alleging that refusing to collect on loan to DNC is intentional
illegal campaign contribution. Holding: Not a biz decision covered by BJR bc it’s an unlawful act.
Therefore, shareholders are entitled to recover.
VII. The Duty of Loyalty
Duty of Loyalty requires directors, officers, and controlling shareholders (corporate fiduciaries)
to act in good faith effort to advance the interests of the company rather than their own interests.
Duty is owed to the corporation and its shareholders (“shareholder primacy”).
Justification: If corporations focus exclusively on maximizing profit, they will engage in
Kaldor-Hicks efficient transactions, which increase social welfare.
This is controversial: public benefit corporations and constituency statutes are initiatives
to ensure that directors act to advance interests of all constituencies in the corporations.
Dodge v. Ford Motor Company: Ford lowered prices and eliminated dividend in order to
squeeze Dodge Brothers, who owned 10% of stock. Ford claimed it was to share success with
public. Holding: Ford has obligation to look out for shareholders first.
A.P. Smith v. Barlow: Corporation has authority to make donation to Princeton because (1)
authorized by NJ statute; (2) modern corporations can pursue greater social good; and (3) may be
in best interests of corp to make this donation. Decision illustrates that nearly any corporate
action can be justified as value-maximizing.
A. Regulation of Self-Dealing Transactions
Self-Dealing Transaction: corporate transaction in which directors, officers, or controlling
shareholders have a personal interest.
Regulation in Agency: agent can engage in transaction in which he has an interest so long as: (1)
transaction was fair; (2) all material facts are disclosed; and (3) the principal approved
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Regulation in Corporate Law: (1) Fairness review; (2) disclosure requirement; (3) approval by
majority of the disinterested parties (directors or shareholders).
A conflicted transaction is NOT VOID if it is fair (i.e., full disclosure). Standard of judicial review
to assess fairness varies by the type of interested party.
Approval by disinterested
parties
Conflicted
director
(burden)
Conflicted controlling
shareholder (burden)
No approval
EF (D)
EF (D)
Approved by disinterested directors
BJR (P)
EF (P)
Approved by shareholders
BJR (P)
EF (P)*
*Majority of the minority approval
Approved by (1) disinterested
directors, and (2) shareholders
BJR (P)
BJR (P)*
*Majority of the minority approval
1. Self-Dealing Transactions Involving D&Os
Entire Fairness Review: no transaction btwn the corporation and any D&Os is void/voidable
simply for being conflicted, provided that: (1) transaction is approved in good faith by majority
vote (of disinterested directors or shareholders) after full disclosure; OR (2) the transaction is
fair.
*For EFR, burden of proof is initially on defendant to show that transaction was entirely fair.
*If approved by disinterested directors or shareholders, standard of judicial review shifts from
entire fairness review to the BJR.
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Entire Fairness = fair dealing + fair price
- Fair dealing = process (did fiduciary reveal all material facts, negotiate with candor,
not pressure corporation?)
- Fair price = substantive (did economic conditions resemble terms of a transaction with
an unrelated party?)
State Ex. Rel. Hayes Oyster v. Keypoint Oyster: CEO & director of Coast Oyster did not
disclose interest in transaction where oyster beds were sold to corp. in which CEO got 50%
equity. Holding: Violation of fiduciary duty of loyalty by failing to disclose interest even though
transaction was fair. Not necessary to prove intent to defraud or injure. Court allowed
transaction to remain, but required CEO to turn over 50% interest to Coast.
To avoid EFR: get approval by majority of the informed, disinterested directors, and/ or
approval by majority of the informed shareholders. Full disclosure is required, but burden shifts
to BJR.
Cooke v. Oolie: Board votes unanimously to pursue acquisition. Minority shareholders claim
that two of four directors breached fiduciary duty bc they were creditors and the acquisition was
self-serving bc there were superior options. Holding: Approval by disinterested directors (50% of
board) changed review from EFR to BJR and under BJR there is no claim.
Lewis v. Vogelstein: BJR applies when disinterested directors approve transaction, EXCEPT
when: (1) majority of shareholders had conflict of interest; and (2) transaction constituted waste.
*Preventing ratification of waste protects minority shareholders.
Situation
Neither board nor
shareholders approve
Disinterested directors
authorize
(ex-ante authorization)
Disinterested directors
ratify
(ex-post ratification)
DGCL § 144
RMBCA § 8.61
ALI §5.02
EF (D)
EF (D)
EF (D)
BJR (P): Cooke v.
Oolie.
BJR (P): RMBCA
§8.61(b)(1) and
Comment 2
BJR (P): §8.62(a)
and Comment 1
Reasonable belief in
fairness (P): ALI
§5.02(a)(2)(b)
EF (D): ALI §5.02(c),
§5.02(a)(2)(A), §5.02(b)
BJR (P): Same as
above
**Why apply EF if the transaction is approved by disinterested directors (ALI)?: Directors have
collegial relationships (sympathy, friendship), so high risk of bias.**
**Why give less deference when the transaction is ratified ex post?: To create incentives to
approve ex ante. Approving ex post involves problems: (1) boards might not reject deals they
would reject ex ante; (2) could be costly to void deal; and (3) transaction costs already sunk.**
**Why have the Delaware approach?: Because of the benefits of the BJR**
2. Self-Dealing Transactions Involving a Controlling Shareholder
Similar to D&O  if conflicted, EFR, if no conflict, BJR (Sinclair)
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Sinclair Oil v. Levien: Sinclair owns 97% of Siven and dominates board. Siven minority
shareholders claim Sinclair payed “excessive” dividends, impeding biz development. Holding:
Court applies BJR to find Sinclair not liable. Dividends were paid pro rata, so no conflict of
interest. Benefit/Detriment Test: Sinclair received nothing from Sinven to the exclusion to and
detriment of Sinven’s minority shareholders.
Weinberger v. UOP: Signal owns 50% of UOP and holds 6/13 board seats. 1 UOP director and 1
Signal director issue report stating that max of $24/pps is good investment for Signal but shares
only with Signal board. Signal offers $21 (55% premium) conditioned on approval by MOM of
UOP. No effort to negotiate, quick agreement. Two Signal directors participate but withdraw for
actual approval. 52% of minority shareholders approve. Holding: Court applies EFR: (1) Fair
Dealing not met bc did not disclose report and fairness opinion was hastily drafted; (2) Fair Price
not met because Chancery court did not consider relevant factors (like report) so cannot be sure
price is fair. To increase chance of meeting EFR standard, controller could have formed a special
committee of independent directors.
Approval by Disinterested Parties (special committee of independent directors): still EFR, but
burden shifts from defendant to plaintiff
**Special committees act as a bargaining agent for minority shareholders, mitigating collective
action problems**
**Majority of the Minority requirement acts as a check on the actions of the special committee,
since committee may be “captured: or might not be competent**
**Failure to disclose = not fair!**
B. Corporate Opportunities Doctrine
Corporate Opportunities “belong to the corporation” and pose potential conflicts of interest.
Ask:
(1) Does the opportunity belong to the corporation?
(2) If so, is there a conflict of interest?
(3) Is the appropriation of the opportunity a breach of the duty of loyalty?
Does the opportunity belong to the corporation?
Delaware’s 4-Factor test:
1. Corp is financially able to exploit the opportunity
a. Did matter come to attention of fiduciary by reason of his corp capacity
b. Does opportunity fall within “core economic activities: of corp
c. Was corp info used to identify/ exploit opportunity
2. Opportunity is within corp’s line of business
3. Corp has an interest or expectancy in the opportunity
4. By taking the opportunity, fiduciary is placed in conflict with corp
Personal Touch Holding Corp. v. Glaubach: *Illustrates expanded line of business test* Corp
was interested in acquiring a building, but seller declined. Co-founder and former President of
corp secretly negotiated for himself. Holding: Court applied 4-Factor test to find usurpation of
corp opportunity. Re: line of biz, court said that it should be applied broadly and flexibly and held
that corp wanted to acquire building in order to expand its business.
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A board’s decision to permit a director to take a corporate opportunity will be upheld if the
decision was made in good faith. The director taking the opportunity bears the burden of
showing that: (1) the decision to reject the opportunity for the corporation was a good-faith
business judgment and (2) the directors making the decision were disinterested.
Under DGCL, corp can waive corp opportunity constraints in charter. This induces directors to
serve, but risks that they will selectively appropriate opportunities for themselves.
C. Duty of Loyalty in Close Corporations
Close Corporation:
- Small number of shareholders
- Illiquid shares
- Controlling shareholder is involved in mgmt. of the company
**Issues with close corporations include illiquidity of the shares and risk of exploitation by
controlling shareholder**
Donahue v. Rodd Electrotype: Company has 4 owners and 3 board members. Offers to buy
half of one director/ family member’s shares. Another shareholder tenders her shares for same
price, but is refused (she was offered much less). Holding: Shareholders in close corps owe one
another substantially the same fiduciary duty of “utmost good faith and loyalty” as partners
(NOT BJR). Remedy: (1) rescind transaction; or (2) honor price for other shareholder. *Specific
remedy of equal treatment is not Delaware law*
Smith v. Atlantic Properties: Three shareholders. Charter requires 80% vote, giving veto
power. One shareholder vetoes every dividend, and corp gets IRS penalty for unreasonable
accumulation of earnings. Other two shareholders claim breach of fiduciary duty. Holding:
Breach of fiduciary duties bc conduct was “beyond what was reasonable.”
VIII. Executive Compensation
A. Agency Costs in Executive Compensation
Two competing goals: mitigate mgr risk aversion + discourage excessive risk-taking
**Exec compensation can involve significant conflicts of interest, resulting in overcompensation**
Managerial Power Theory: directors likely to be too deferential to management bc:
- CEOs may influence the re-election of directors.
- CEOs can benefit directors using corporate resources.
- Directors appointed by/ with help from CEO may be loyal to CEO.
- Directors want boardroom to be collegial, not argue about salary
- Dir own only small % of stock = cheap to favor CEO (but costly to bargain hard)
Optimal Bargaining Theory: market forces are strong enough to induce directors to pay
executives in ways that are in the shareholders’ best interests
1. Pay-for-Performance Tool to Mitigate Agency Costs
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Tie comp to stock price
- CEO might still be risk-averse bc he is less diversified than shareholders)
Pay 100% in Call Options
- Pay 100% in Options
o At the money call option: strike price = current market price
o In the money call option: strike price < current market price.
o Out of the money (underwater): strike price > current market price.
- **Helps incentivize execs**
- **Problem: incentivizes excessive risk-taking bc downside is neutralized (CEO can elect
not to exercise option)**
Disclosure requirements
o Clawback: must repay bonuses and gains from stock or option payments based on
financial statement misconduct (SarbOx)
o Say-on-Pay: Shareholders get advisory (non-binding) vote on comp (Dodd-Frank)
B. Judicial Review of Executive Compensation
In re Goldman Sachs: *Illustrates that BJR is standard of review for non-controller executive
comp* Shareholders sued, claiming that comp structure promoted excessive risk-taking and execs
were over-comped to the point of waste. Holding: Court applied BJR and upheld comp structure.
Directors were disinterested, adequately informed (102(b)(7) waiver, no bad faith), no evidence of
waste, no evidence of bad faith.
Tornetta v. Elon Musk: applies the MFW blueprint to comp of controller executive officers:
• No SC or MOM → Entire fairness
• SC or MOM → Entire fairness, with burden of proof shifted to defendants
• SC and MOM → Business judgment rule
Calma v. Templeton: *Illustrates that EF is standard of review for director comp UNLESS
there is sufficiently-specific shareholder approval* Shareholders challenged plan of restricted
stock units grated to directors. Approved by majority of disinterested shareholders, but comp was
essentially unlimited, thus excessive. Holding: No ratification bc shareholders approved overall
plan for entire company, but did not specifically approve the jumbo grants for directors. Thus,
EFR: director compensation is self-dealing decision and comp was not fair.
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IX. Shareholder Litigation
Direct Suit: brought by individuals who are directly harmed by corp.’s actions
- Typically class actions
- Damages go to shareholders/ injunctions are for bene of shareholders
- Ex. Inspect books and records, require entity to recognize investor’s right to vote,
challenging a merger for failure to make disclosures.
Derivative Suit: claims of the corporation, brough by shareholder on corp.’s behalf
- Two suits in one: (1) suit demanding that directors sue on behalf of corporation; (2) suit for
the claims themselves
- If brought as class action, governed by FRCP 23.1
- Special procedural hurdles
- Damages to corporation
- Ex. claim against director that engaged in corporate waste
Tooley v. Donaldson Lufkin Jenrette: Shareholder has no right to a merger, so claim should
be derivative and direct action was dismissed. Test: Issue of whether an action is properly
derivative or direct must turn solely on (1) who suffered alleged harm; (2) who would receive bene
of remedy.
Benefits of Litigation incentivizes cases, which = compensation and deterrence; can prompt
valuable governance changes. Costs of Litigation: atty fees can encourage meritless suits; direct
costs; D&O insurance circularity.
Fletcher v. AJ Industries: Corp. still deserves atty fees even if it received no money from a
restructuring suit because suit generated value and created “substantial benefit” for the corp.
A. Procedural Requirements in Derivative Suits
1. Standing (only an injured party can bring suit). Specific conditions:
- Must own shares for duration of action (“fairly and adequately represent interests”)
- Must own shares at time of alleged injury (don’t buy shares just to sue – remedy limited
to those actually harmed)
2. Demand Requirement: Shareholder plaintiff must request board to bring action unless it is
futile and can be waived.
Aronson v. Lewis: Demand Futility Test: (1) directors are disinterested and independent AND;
(2) challenged transaction was the product of a valid exercise of business judgment. Mere threat
of personal liability is insufficient to challenge independence/ disinterestedness of the directors.
Levine v. Smith: Demand not excused. Clarifies Aronson test: (1) whether the threshold
presumptions of director disinterest or independence are rebutted by well-pleaded facts; OR (2)
whether the complaint pleads particularized facts sufficient to create a reasonable doubt that the
challenges transaction was a product of reasoned business judgment. N.B. second prong does
NOT require overcoming BJR—only reasonable doubt is required.
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Rales v. Blasband: Clarifies second prong of Aronson test in “double-derivative suits.” Where
demand excusal is asserted against a board that has not made the decision that is the subject of
the action, the standard for determining demand excusal is whether the board was capable of
impartially considering the action’s merits without being influenced by improper considerations.
Aronson/Levine Demand Futility Conditions
-
Directors are interested or lack
independence in the decision whether to
bring suit.
-
There is reasonable doubt that the
decision is not a valid exercise of business
judgment (decision not protected by BJR).
-
Interest in the challenged transaction
generally leads to interest in the outcome
of the litigation. i.e. Interest in the
challenged transaction = reasonable
doubt that BJR protects (prong 2) =
interest in litigation outcome (prong 1)
Rales Demand Futility Conditions
-
Directors are interested or lack
independence in the decision
whether or not to bring a suit.
Rales test if:
-
Board was replaced
-
No business decisions (i.e. insider
trading allegations)
-
Different corporation
*In Delaware, universal practice of no-demand, which reinforces courts’ quality screening role.
3. Special Litigation Committees: when demand is excused, formed by board to consider suit’s
merits.
Zapata v. Maldonado: P files derivative suit in Delaware, demand is excused, and 4 years into
litigation, Zapata board appoints two independent director who serve as SLC. SLC recommends
dismissal. Holding: BJR permits independent SLC formed by tainted board to dismiss a
derivative action. Court should apply test to evaluate: (1) has the corporation proved
independence, good faith, and a reasonable investigation; AND (2) does the court feel, applying
its own business judgment, that dismissal is appropriate? Business Judgment Rule shields
directors from derivative lawsuits unless shareholders can prove self-dealing, lack of due care or
good faith, or conflict of interest by directors. This prevents shareholders from being unfairly
trampled by directors while also allowing directors to rid corporation of detrimental litigation.
Self-interest of board did not bar properly-appointed SLC from determining that suit was
detrimental to corp.’s best interests.
In re Oracle Corp. Derivative Litigation: Derivative complaint alleges insider trading
(breach of loyalty). SLC produces report concluding that Oracle should not pursue claims against
defendant directors. Plaintiff challenged independence of SLC. Holding: SLC cannot be
independent when the directors appointed to SLC are personally interested in suit’s outcome.
SLC bears the burden of proving its independence. SLC’s decision based on merits of the claim,
not extraneous considerations// influences. Focus on directors’ impartiality/ objectivity. No one in
silicon valley is independent from Larry Ellison. *Broadened inquiry of SLC’s independence to
include considerations other than domination and control.
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Joy v. North: SLC bears burden of proving need for dismissal. Court applied Zapata and found
that BJR does not apply when SLC recommends dismissal of a shareholder derivative suit in
cases involving direct financial harm to the corporation and a diminishing of the value of the
shareholder’s investment.
4. Settlement
Settlement doctrine + EFP are two ways to reduce meritless suits. If shareholder survives SJ,
strong incentives for both sides to settle so court must approve. SLC can be formed to oversee
settlement process (rare).
Carlton v. TLC Beatrice: court will approve settlement of derivative action negotiated by an
SLC if: (1) committee acted independently, reasonably, and in good faith, and (2) court approves
of the merits of the settlement under its own independent business judgment.
In re Trulia: Settlements must be fair and reasonable. Court rejected settlement bc proposed
class of stockholders did not get sufficient value in proposed settlement to warrant release of all
claims related to merger.
5. Exclusive Forum Provision
Exclusive Forum Bylaws require that any claim related to an internal claim (claims related to:
(1) fiduciary duties; (2) other matters governing relationships btwn/among corp and current
directors, officers, shareholders) be brought only in designated forum. Upheld by Boilermakers.
Corps can adopt EFBs, but same breach can give rise to multi-forum litigation (one in Delaware
and others under fed jurisdiction for ‘34 Act violations). EFPs allow all ’33 Act claims to be
brought in federal court.
Salzberg v. Sciabacucchi: ???
Plaintiff makes demand  Board refuses  BJR
Plaintiff makes demand  Board does not refuse  Corporation brings suit
No demand, Aronson test  Demand excused  Suit proceeds  SLC  Zapata
No demand, Aronson test  Demand excused  Suit proceeds  No SLC  Case continues
No demand, Aronson test  Demand required (e.g. Levine)  Suit dismissed
X. Transactions in Control
Benefits of Control: may be shared with all shareholders (i.e. successful biz plan); or enjoyed only
by controller (“control premium” i.e. salary, notoriety, self-dealing opportunities – these may
increase cost of capital by making investors wary). Want to maximize public benefits and
minimize private benefits.
A. Sales of Control Blocks
1. Market Rule
Market Rule: controlling shareholder can freely sell control block and keep control premium.
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Zetlin v. Hanson Holdings: Minority shareholders challenged sale of controlling block for $15
while stock traded at $7 (wanted to share in premium). Holding: Absent looting of corporate
assets, conversion of a corporate opportunity, fraud or other acts of bad faith, controlling
stockholder is free to sell controlling interest at a premium price.
2. Exceptions to the Market Rule
Thorpe v. CERBCO: *If sale of control block takes away corp opportunity, controller must share
premium* Controllers refused to sell subsidiary but offered to sell controlling stake in holding
company. Did not disclose initial subsidiary offer to board and rejected board’s idea to sell
subsidiary instead. Minority shareholder filed demand that proposed sale be rejected. Outside
directors formed special committee. Sale was not completed. Minority shareholder filed suit
claiming that controllers usurped corporate opportunity. Holding: A director violates his duty of
loyalty to the corporation when he takes for himself an economic opportunity that belongs to the
corporation, or when he does not inform the rest of the board that a corporate opportunity exists.
Expectation damages are not appropriate bc corp could not actually have taken the opportunity,
but usurping director is prevented from benefitting from breach of duty of loyalty and must
return the $75,000 deposit received from prospective buyer.
Perlman v. Feldman: Controller sells stake, giving control over steel supply to another
company during Korean War steel shortage. Holding: breached fiduciary duties to minority
shareholders by taking away opportunity. Remedy: return of control premium. But this is a
derivative action, so recovery goes to corp. Therefore, court directed recovery to minority
shareholders. Policy: Dissent argues that question should be whether buyer was a looter.
Scholars argue that case was wrongly decided bc price rose after deal was announced. Looters are
hard (expensive) to detect, so defer to market rule and punish if discovered ex post.
Harris v. Charter: *duty of controller to not knowingly sell to a looter is triggered by red flags*
Judicial Review: another limit on the shareholder’s right to receive a premium.
• If controlled company is sold and controller receives special consideration: EFR.
• However, BJR applies if deal was approved by: (1) SC + (2) MOM
In re Delphi: *If there is coercion on the minority, the court will intervene through EFR*
Charter prohibits a different consideration for two share classes in case of acquisition. B-share
controller pressures special committee into amending charter and giving him higher
consideration (otherwise, he will oppose deal). Holding: B-share controller exerted coercion,
meriting EFR, but court declined to proceed with trial bc it seemed like a good deal even though
the process was “imperfect.”
B. Tender Offers
Williams Act: implements early-warning system and provides substantive regulation of tender
offers. Both measures are designed to give shareholders more info and time to decide.
Williams v. Dickinson: Acquirer buys 34% by making simultaneous calls to 30 institutional
buyers and 9 accredited buyers tendering fixed above-market price for one hour only. Is this a
tender offer? Holding: Yes. Court applied 8-part Wellman test and found all were true except not
widespread:
1. Active and widespread solicitation
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2. Solicitation made for a substantial percentage of issuer’s stock
3. Offer for premium over prevailing market price
4. Terms of offer are firm, not negotiable
5. Offer contingent on tender of fixed minimum number of shares
6. Open only for limited period of time
7. Offerees subjected to pressure to sell
8. Public announcements of purchasing program precede or accompany rapid
accumulation
Brascan v. Edper Equities: Edper buys 10% via broker who contacts 40-65 institutional &
accredited investors. Tells officials it will not purchase more, but then buys another 14% the
following day. Brascan brings suit claiming violation of ’34 Act §14(e) and Rule 10b-5 (fraud).
Holding: Not a tender offer bc only three factor met (substantial block; premium; contingent on
minimum number of shares).
1. Early-Warning System
Basic Rule (Rule 13d-1(a)):
- Investor must file 13D report w/in 10 days of acquiring 5%+ “beneficial ownership.”
- Must disclose identity and whether plans to take control of company (Rule 13d-1(c))
- Updating requirement (Rule 13d-2): Must amend previous Schedule 13D promptly if there
is a material (+/- 1%) change to investor’s holdings
- Key Definitions:
o Beneficial owner: individual with power to vote or buy/sell stock (13d-3(a)).
o Group: anyone who acts together to buy, hold, vote, or sell stock (13d-5(b)(1)).
• Each group member deemed beneficially to own each member’s stock.
**Policy Considerations**
- Advantage: increases pay for minority, who may thus charge less ex ante for their capital
- Disadvantage: may deter efficient controllers
2. Regulation of Tender Offers
•
General Disclosure: (§14(d)(1)): requires tender offeror to disclose identity and future
plans, including any subsequent going-private transactions.
•
Anti-Fraud Provision (§14(e)): prohibits “fraudulent, deceptive, or manipulative” practices
in connection with a tender offer.
•
Terms of the Offer (§14(d)(4)-(7)): governs the substantive terms of the tender offer.
• 14e-1: Must be open for 20 business days.
• 14d-10: Must be open to all shareholders; all purchases must be made at best price.
• 14d-8: Where shares tendered exceed scope of offer, acceptances must be pro-rated.
• 14d-7: Shareholders who tender can withdraw while tender offer open.
• 14e-5: Bidder cannot buy “outside” tender offer.
**Policy Considerations**
Regulations increase the price (esp. 20-day window, which creates auction)
- Advantage: attracts higher-bidding buyers, increasing pay for minority, who may thus
charge less ex ante for their capital
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Disadvantage: may deter efficient controllers bc of higher prices/frustration
Hart-Scott Rodino Act (HSRA)
- Gives FTC and DOJ time to examine antitrust implications of some acquisitions (30 days
for mergers and negotiated deals, 15 days for tender offers) (§18a(b)(1)(B)).
- DOJ or FTC may extend review window or waive review.
- Applies only to large companies.
XI. Mergers and Acquisitions
Motives That Create Value
• Economies of scale: Increasing production volume decreases marginal costs.
• Economies of scope: Spreading costs across broader range of related businesses lowers cost
of running each business.
• Vertical integration: Economy of scope where company acquires supplier of inputs,
ensuring uninterrupted supply of materials and reducing production costs.
• Management efficiencies: Increase value of acquisition by improving its operations.
• Project diversification (“smoothing”): Diversifying corp’s income streams reduces risk.
Motives That Transfer Value
Harmless transfers
• Tax transfers: by shifting NOL (and thus right to deduct previous losses from current
income) to a firm that is earning income, value is shifted from government to shareholders
of the acquiring, profit-making firm.
Potentially harmful transfers
• Transfers from consumer:. By acquiring competitors and using market power to increase
prices, value is shifted from consumers to the shareholders of the monopolistic firm.
• Transfers from minority shareholders: Where majority shareholder acquires the minority
shares in the corporation (“freeze out),” majority may extract wealth from minority.
Motives that destroy value
• Empire building: Managers may pursue mergers simply bc they want to run larger firm.
• Poor incentives: Mgrs may pursue value-destroying mergers just to get golden parachute
N.B. D&O usually make biz decisions, but bc of agency problems, mergers require shareholder
approval.
A. Transactional Forms
MERGER Voting Rules
- Target shareholders always vote (DGCL §251(c)).
- Buyer shareholders do not have to vote if, inter alia, buyer issues no more than 20% of its
outstanding shares to pay for target (DGCL §251(f). similar to RMBCA § 11.04).
- **20% is rough proxy for big transactions; if the deal is not big, it makes sense to
avoid the cost and delay of shareholder vote**
- Per NYSE Manual § 312.03(c), buyer’s shareholders must vote if the buyer’s shares
increase by > 20%. Requires approval of 50% of shares voting on the matter.
**Vote ensures that buyer does not become controlled w/o shareholders’ permission.**
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Statutory Merger: Target collapses into acquirer; exposes buyer’s assets to target’s liabilities.
- Buyer and target boards negotiate merger.
- Target’s and (sometimes) buyer’s shareholders vote.
- If shareholders approve, target assets merge into the acquiror and target shareholders get
cash or stock in the buyer.
- Certificate of merger filed with secretary of state.
- Dissenting shareholders who had a right to vote often have appraisal rights.
Triangular Merger: Addresses liability issue of straight mergers.
Forward Triangular Merger: Target is absorbed into wholly owned subsidiary.
Reverse Triangular Merger: (most common) Wholly owned subsidiary of acquirer is
merged into target.
ACQUISITION Voting Rules
• Buyer’s shareholders’ do not vote.
• Seller’s shareholders must vote in sales of substantially all of the assets of the corp=
(DGCL §271; similar rule in RMBCA § 12.02).
“Substantially All”
• CERBCO: qualitative analysis: “transaction that affects the existence and
purpose of the corporation.”
• Hollinger Inc. v. Hollinger International: nearly all the assets.
**Acquisitions vs. mergers, Disadvantages: High transaction costs: title to each asset must be
transferred individually; Advantages: Low liability cost (buyer does not acquire target’s
liabilities); Do not require buyer’s shareholders’ approval unless buyer issues more than 20%;
Acquirer avoids appraisal rights.**
Asset Acquisitions (NOT MERGERS) Under DGCL §271
1. Boards negotiate the deal.
2. Only target’s shareholders get voting and appraisal rights – if “substantially all” of the
target’s assets are sold.
3. Buyer generally distributes consideration to its stockholders.
Stock Acquisition: buyer acquires controlling block of shares; identity of target unaffected
- If buyer wants 100% of shares:
o Short form merger If buyer holds ≥ 90% in target, can cash out minority w/o
shareholder approval.
o Intermediate form merger Merger is treated as having been approved if:
 Buyer executes tender offer whose terms are fixed by both boards
 Buyer obtains enough shares in tender offer to approve a merger
 Merger is for same price as tender offer.
De Facto Merger Doctrine: treats business combinations that resemble the effects of a merger as
a merger. (e.g. sale of substantially all the assets in exchange for stock in the buyer, followed by
dissolution of the seller and distribution of the buyer’s stock to the seller’s shareholders).
Rejected in Delaware. **Shareholders may want de facto merger bc appraisal rights may be
triggered (RMBCA gives appraisal rights in more restructuring circumstances including sales of
“substantially all” assets); buyers get to vote in some mergers.**
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Practical M&A considerations: timing, regulatory approvals, deal protection
B. Appraisal
Appraisal is a remedy that gives shareholders the right to demand that a court calculate the
value of their shares and order a cash payment. Delaware allows shareholders to adopt appraisal
rights in charter (but they are rare).
**Historically, appraisal was part of compromise allowing corps to be acquired with < unanimous
consent. Also, merger is “last period” for managers, so their interests may not be aligned with
shareholders.**
Appraisal Steps
• Shareholders get notice of appraisal right at least 20 days before shareholder meeting.
• Shareholder submits demand for appraisal to corp before shareholder vote, then votes
against or refrains from voting for merger.
• If merger is approved, shareholder files appraisal petition with Chancery Court w/in 120
days after merger.
• Court holds valuation proceeding under DGCL §262(h).
• Not a class action, but Chancery Court can apportion fees among plaintiffs as equity
may require.
Appraisal is NOT AVAILABLE in acquisitions in Delaware, unless charter provides otherwise.
Appraisal IS AVAILABLE under the RMBCA in more restructuring situations, including sales
of substantially all the assets.
Appraisal IS AVAILABLE in mergers unless the market exception applies:
Consideration
Type of company
Public corporation
(traded on an exchange
or has more than 2,000
shareholders)
Private corporations
(with less than 2,000
shares)
Stock in the surviving
corporation or another
public corporation
No appraisal rights
Appraisal rights*
Cash
Appraisal rights
*In some cases, no appraisal if
shareholders have no right to vote.
Appraisal rights
In Delaware, petitioner must hold >1% of shares or >$1M to petition for appraisal, and firm may
pre-pay merger consideration to dissenters when petition is filed, to reduce interest charges.
Determining Fair Value
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Shareholders are entitled to pro rata portion of firm’s value as a going concern less “any
element of value arising from the accomplishment or expectation of the merger.”
Synergies are excluded.
Since 2015, courts look to deal price, provided there are no significant defects in the sale.
If deal price is unreliable, courts use other methods, like unaffected mkt price.
**Shift away from using part performance or DCF bc courts are not well positioned to
questions use of technical methods and wanted to stop “appraisal arbitrage.”**
Verition Partners v. Aruba Networks: Chancery court appraised using mkt price instead of
deal price because (1) no other bids emerged when deal became public and (2) court would have to
calculate and deduct agency cost reductions bc target was previously widely held and became
controlled via acquisition. Holding: Reversed Chancery court. Fair price = deal price – synergies.
Mkt price is important indicator of fair value, but deal price is better bc buyer has greater
incentives and is better informed than ordinary traders to value target accurately. As long as
there was opportunity to bid, sales process is not flawed just bc there were no other bidders. Do
not have to calculate and deduct agency costs bc they are already part of synergies and not clear
that transaction generates agency cost reductions (transaction is just swapping one group of
public shareholders for another, not becoming controlled)
Firt Tree Value Master Fund: Chancery court used unaffected stock market price as fair
value, said could not use deal price as fair value bc sales process was flawed bc CEO dominated
the process and there was no market check (bc board granted buyer exclusivity during due
diligence). Also, no comps. Holding: Chancery court did not abuse discretion – no precedent
disallowed certain valuation method here. No material nonpublic info about target’s prospects, so
market price was good proxy, no good comps, plus flaw in sales process.
Quasi-Appraisal
• Applies if (material) defective disclosure impaired ability of shareholders to seek
appraisal.
• Unlike regular appraisal actions, this is an opt-out class action.
Appraisal vs. Entire Fairness Action
Characteristic
Appraisal
Entire fairness review
action
Does the shareholder need
to dissent?
Yes
No
Remedy
Pro rata share of fair value
minus synergies
Broader set of remedies
(e.g., revision of price,
rescission, rescissory
damages)
Who benefits from the
action?
Petitioners (opt-in action)
The entire class (opt-out
class action)
Merger & Tender Offer Freezeout: controlling/ majority shareholder(s) negotiate merger
agreement with target board.
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Tender Offer Freezeout controlling/ majority shareholder(s) buy directly from minority
shareholders.
Reverse Stock Split: consolidates the number of existing shares of stock into fewer,
proportionally more valuable, shares.
C. Controlled Mergers
EFR
Freezeouts are subject to EFR. Court strongly encourages controllers to implement special
committee of independent directors. (Weinberger v. UOP)
Kahn v. Lynch: * SC OR MOM Approval* Target formed special committees to negotiate with
acquirer, which already owned 4.3%. Rejected 3x then recommended a price on threat of hostile
bid from acquirer. Minority shareholders alleged breach of fiduciary duty by acquirer. Chancery
court said SC had simulated 3rd party transaction, so no breach. Holding: EFR applies. If SC
approves transaction, burden of proof shifts to plaintiff. Mere existence of SC does not shift
burden—if SC was subject to domination or coercion, then burden remains on defendant. Here,
acquirer threatened committee. N.B. Rosenblatt extends the principle in Lynch to MOM
approval.
In re CNX Gas Corp: *SC AND MOM Approval, tender freezeout* After negotiating with
institutional investor that owns 6% in target and 6% in acquirer, 83% owner of target announces
tender offer for remaining shares of target. Deal is subject to MOM, which includes institutional
investor. Target also formed special committee, which remained neutral. Holding: Applied Cox
standard to find that EFR is appropriate if there is no SC and MOM (otherwise, BJR is
appropriate). Here, EFR applied bc SC did not recommend deal and MOM was defective since
institutional 6% owner was conflicted.
Kahn v. M&F Worldwide (MFW): *SC AND MOM in merger freezeout* minority shareholders
challenged freezeout arguing for EFR. Chancery court applied Cox and used BJR. Holding:
SCOTUS affirmed, but clarified that freezeout is only reviewed under BJR if deal was subject ab
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initio (ab initio = before any substantive economic negotiations begin. The idea is that the
controller must disable himself from control from the beginning rather than implement the
conditions as a concession when trying to obtain a lower price) to: (1) approval by independent
and fully empowered SC which fulfills duty of care and (2) uncoerced and informed vote by MOM.
Presence of only one protection would shift burden of proof. ** Only both protections together
replicate an arm’s length transaction: (1) SCs provide a negotiating agent; and (2) MOM
condition provides a backstop against ineffective directors or directors that are captured by the
controller**
** Deal prices are sensitive to the threat of EFR: If investors do not have the protection of EFR, they
will simply pay less ex ante for their shares. Tender decision is not a sufficient protections. This
matters because controllers might opportunistically freezeout the minority when the price of the
company is transitorily lower than the intrinsic value – and this is hard to price ex ante**
** Controlling shareholders do appear to consider the standard of judicial review, possibly with
aim of paying lower prices when the standard is lower.**
** Gains of the target did not increase significantly after MFW, meaning perhaps MOM does not
make a significant difference, and MFW and EFR provide similar protections**
**We let MFW be prevalent standard of review for conflict transactions instead of requiring EFR
or prohibiting these transactions bc some conflict transactions may be efficient and applying EFR
to all transactions would underestimate the cost of judicial intervention, and courts are not good
at determining fair price**
N.B. MFW has been extended to non-freezeout transactions: 3rd party acquisitions of controlled
companies, executive compensation, corporate recapitalizations
XII. Contests for Corporate Control
A. Judicial Review of Antitakeover Defenses
Unocal v. Mesa Petroleum: Mesa has 13%, makes tender offer for addt’l 37% at $54, and plans
to freeze-out remaining 50% for junk bonds with face value of $54. Goldman says minimum
liquidation value is $60. Board implements defensive recapitalization with self-tender for 30% at
$72, plus, if Mesa gains 50%, will tender remaining 19% at $72 in debt securities. Chancery court
cites BJR to grant Mesa an injunction. Holding: Standard of review to evaluate defensive
measures is “enhanced BJR,” which evaluates whether: (1) directors had reasonable grounds for
believing there was a threat to corp policy and effectiveness (consider: Inadequate price, nature
and timing of offer, impact on other constituents, risk of non-consummation, quality of securities
offered); and (2) defensive measures must be reasonable in relation to threat posed. * Mesa
engaged in greenmail.
Prong 1: Mesa offer is structurally coercive bc shareholders are paid unequally. Paid more for
first movers and less on back-end.
Prong 2: Unocal’s revised offer is a defensive maneuver because it eliminates incentive to tender
to Mesa (directly punishes Mesa).
Under Unitrin, Prong 2 is a two-part proportionality test: (1) was the defensive tactic coercive or
preclusive (draconian); and (2) if not, does it fall within a range of reasonable responses? If
defendants can show proportionality, BJR applies. Otherwise, EFR applies.
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Board passivity policy argument: as costs and frustration risk of acquisition increase, efficient
buyers are deterred. Defensive measure policy argument: shareholders need protection, defensive
tactics are ordinary biz decisions and thus merit BJR (but beware bc mgrs. may be selfinterested).
Poison Pill: right for shareholders who have not acquired a large block of stock to buy shares at
substantial discount.
Flip-In Pills: target shareholders can acquire at substantially discounted price
Flip-Over Pills: target shareholder arguably have right to buy shares in the buyer
(uncommon bc validity is debatable).
To Implement Pill:
- Board adopts “shareholder rights plan” plan by vote. No shareholder vote necessary.
- Rights distributed as dividends embedded in the shares
- Triggering event occurs when prospective acquirer buys significant number of shares
- Rights are exercised and all shareholders except acquirer can now buy shares at deep
discount, cancelling acquirer’s rights
Moran v. Household International: Two directors bring suit to enjoin poison pill as outside
the board’s authority/ invalid exercise of biz judgment. Holding: DGCL give broad authority to
adopt a pill and the adoption of the pill withstands Unocal (it is valid under 2nd prong – does not
prevent hostile takeover from ever winning (could try proxy contest), just makes it harder)
Smith v. Van Gorkum: board’s personal interests can affect not only its takeover defenses in
hostile bids, but also its choice of a merger or buyout partner. Board had been “grossly negligent.”
Court signals that antitakeover defenses CAN involve conflicts of interest.
B. Choosing A Merger Partner: Judicial Review of Board Actions (Active Battle or
When Company is Up for Sale)
Revlon v. MacAndrews & Forbes: Hostile all-cash tender offer at $47 when Revlon is trading
at $25. Revlon resists with poison pill and buy purchasing 20% of shares with Revlon notes.
Notes contain provision that prohibit Revlon from selling or lending against its assets without
permission from independent directors. Takeover bid raised to $56.25, offers more if pill is
removed. Board elects to go with white knight buyer at $57.25, which requires removing assetsale provision from notes, causing value of notes to fall. White knight gets asset lockup, no-shop
provision, and breakup fee in exchange for supporting par value of notes. Holding: Injunction
against white knight provisions affirmed. Board breached duty of loyalty by playing favorites
between buyers. White knight buyer note provision reduced risk of director litigation, and
instead directors should have tried to maximize shareholder value, not look out for own interests.
Not maximizing value breached duty of care. Conflicts of interest can exist in a board’s decision
to go with one buyer over another. Lockups are OK, but here, the lockup brought about an invalid
end to the auction. N.B. Duty of Care (but not loyalty) violations can be waived under DGCL
§102(b)(7).
Paramount Communications v. Time, Inc.: Time & Warner agreed to stock-for-stock merger,
but before shareholders could agree, Paramount announced a tender offer for all of Time’s shares
at a premium. Time rejected and changed WB deal to cash & securities deal (avoids required
shareholder vote). Paramount raised and Time rejected again bc WB was better long-term value
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option. Claim argued that under Revlon, the WB agreement put Time up for sale so board was
obligated to maximize short-term value increase and under Unocal, Time’s belief that Paramount
posed a threat was unreasonable and that board failed to fully investigate. Holding: Time’s
conclusion that inadequate value was not the only possible threat to its future is reasonable
(threat that Time shareholders would tender offer without knowing long-term benefits of the
Paramount deal; threat to the Time “Culture”; and general threat to Time’s business model since
it would be entering new field of entertainment). A board of directors may enter into a
transaction in order to defeat a reasonably perceived threat to the corporation’s business so long
as the board’s decision is reasonable in relation to the threat posed. Also, no evidence that under
Revlon, breakup was inevitable. In Unocal, threat was “structural coercion,” (offering unequal
payment to distort shareholder tender decision) here, it’s “substantive coercion” (risk that
shareholders will mistakenly accept underpriced offer in ignorance of the benefits of alternate
course of action).
Revlon duties are triggered if: (1) target initiates active bidding process to sell itself or effect a
reorganization; or (2) in response to an offer, target abandons its long-term strategy and seeks an
alternative transaction involving a break-up/ sale.
Paramount Communications v. QVC: Merger agreement btwn Paramount and Viacom had
no-shop provision and Viacom got $100M termination fee and right to buy %19 if merger failed.
QVC offered tender offer, which gave Paramount more leverage to renegotiate with Viacom. QVC
raised offer beat Viacom’s new terms, but Paramount rejected as “too conditional.” Holding:
Revlon was triggered bc Paramount initiated an active bidding process to sell itself by agreeing to
sell control to Viacom. When a corporation undertakes a transaction which will cause a change in
corporate control or a break-up of the corporate entity, the directors’ obligation is to seek the best
value reasonably available to the stockholders, since change in control could decrease
shareholder voting power. Viacom deal transferred all power to Viacom (diminishes voting power,
removes shareholders from biz strategy) and shareholders were not adequately compensated for
this. No-shop provision could not limit board’s duty to negotiate with both suitors in good faith.
Board breached fiduciary duties by not fully informing themselves about QVC deal.
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Case
Holding
Open question
Unocal
Defensive tactics
are judged using
intermediate
scrutiny: (1) there
is a threat; and (2)
the tactics are
“reasonable in
relation to the
threat posed.”
What constitutes a
threat justifying a
defensive action?
The cases illustrate two:
• Structural coercion (Unocal)
• Substantive coercion (Time)
In dicta, Unocal also mentions
inadequate price and
consummation risks.
Moran
Poison pills are
authorized in
Delaware and
survive Unocal.
When will a court
force a target to
redeem its pill
because it has
“arbitrarily reject[ed]
the offer”?
In practice, never. The board is not
required to give up its long-term
business plan for short-term profit
“unless there is clearly no basis to
sustain it.” (Time)
Revlon
When Revlon
duties are
triggered, the
board must
maximize
immediate
shareholder value.
1. What situations
trigger Revlon duties?
1. In response to an offer or a
unilateral decision, the company is
up for sale (Time).
2. What is a “sale” of
the firm?
2. Some transactions (cash deals &
acquisitions by controlled buyers)
are more likely than others (QVC)
3. How should the
board maximize
shareholder value?
3. When several suitors are actively
bidding for control, must level
playing field among bidders (no
playing favorites, like in Revlon)
When board considers single offer
and has no reliable grounds to
judge its adequacy, fairness
requires canvas of the marketplace
(OK to skip market check if board
has reliable body of evidence to
determine price). (QVC, Barkan)
Judicial review: Enhanced BJR
4. Is board liable for
damages if it fails to
maximize shareholder
value?
4. NO, if there is: (1) a 102(b)(7)
liability waiver; and (2) duty of
loyalty is not breached and the
board acts in good faith.
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Revlon Less Likely
Revlon More Likely
All Stock
Consideration
All Cash
Widely Held
Acquiror Shareholders
Controlling Shareholder
In general, cash consideration triggers Revlon, stock consideration where target is widely held
and buyer is controlled triggers Revlon, and stock consideration where target and buyer are both
widely held does not trigger Revlon.
Benefits of Revlon: more active bidding contest = higher price for shareholders and can lower cost
of capital
Costs of Revlon: As costs and frustration increase, may deter efficient buyers.
Lyondell Chemical v. Ryan: Lyondell board agrees to sell after rushed process with no market
canvas for higher bid. 99% shareholder vote approval, but others claim price is inadequate.
Lyondell had 102(b)(7) waiver, but Chancery court denied directors summary judgment Holding:
Reversed. Revlon does not create new fiduciary duties, must just perform existing duties to
maximize price. So, if there is a liability waiver, then board is not liable for damages absent bad
faith or breach of duty of loyalty (a high bar)
C. Deal Protection Devices
Termination/ break-up fees: cash payments in event that target fails to close merger, triggered by
specific events. *After Revlon and QVC, breakup fee becomes dominant form of protection (~3% of
value)
Asset lockups: right to acquire corp assets at specified price, triggered by specific events
Stock lockups: right to acquire block of target stock at specified price, triggered by specific events
No-shop: agreement by target board not to shop for alternative transaction
No-talk: extreme “no-shop,” requiring target not to talk with other bidders
Agreement to recommend merger to shareholder
Force-the-vote provision: agreement to submit merger agreement to shareholders for a vote
regardless whether board continues to recommend merger
Match-rights: right to match any competing offer *becoming increasingly common
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N.B. Fiduciary Outs: allow target to terminate contract if required by fiduciary obligation to get
highest price. Target does not breach, but term fee may still be triggered.
**Deal protection devices reduce consummation risk and compensate bidder if deal doesn’t close.
This incentivizes first bidders to engage. Risk: makes deal more expensive for subsequent
bidders.**
-
In Revlon deals, lockups are subject to Revlon analysis –must permit shareholder value
maximization
If Revlon doesn’t apply, lockups still subject to Unocal analysis (Omnicare v. NCS
Healthcare)
D. Corwin Cleansing Effect
Corwin v. KKR Financial Holding: Stock-for-stock merger approved by majority of
shareholders. Plaintiffs challenged transaction, seeking damages, and arguing that EFR applies
bc, under mgmt. agreement, KKR controls/ manages daily operations of target. Alternatively,
even if EFR does not apply, Revlon should apply bc it is a biz sale. Holding: Court rejects EFR bc
KKR is not really a controlling shareholder since they only own 1% of stock and no right to
appoint directors or contractual veto, plus target had independent assets it controlled. BJR is
appropriate standard for post-closing damages where merger is not subject to EFR (no freeze-out)
and deal was approved by fully informed and uncoerced majority of disinterested shareholders.
Court says it does not matter whether Revlon applies because BJR is appropriate. Unocal and
Revlon are primarily intended for injunctive relief.
**Corwin’s deference to BJR here has policy benefits of reducing litigation costs and managers’
risk aversion. Judges are also poorly-positioned to second-guess biz decisions.**
Corwin is also extended to tender offers (In re Volcano).
Corwin does not “cleanse” if a specific director induced an entire board to breach its duties in the
sale process, because shareholders would not truly be informed if the disclosures are inaccurate.
That director may be individually liable, absent a §102(b)(7).v
E. State Antitakeover Statutes
1. Acquiring a Control Block
- Control Share Statutes: (Ohio, Indiana) require disinterested shareholder vote to approve
purchase of shares by any buyer crossing certain ownership threshold levels
- Constituency Statutes: (Pennsylvania, Indian) allow board to consider non-shareholder
constituencies in adopting defensive measures to resist hostile bids.
- Disgorgement Statutes: (Pennsylvania, Ohio) require bidders to disgorge profits made
upon sale of stock in target or assets of target (i.e. if sale is w/in 18 months of becoming a
controller).
2. Second-Step Freeze-Out
- Business Combination (freeze-out) Statutes: eg DGCL §203 – prevents bidder from
freezing out minority before 3-5 years following acquisition of controlling stake—unless
target board approves.
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Fair Price Statutes: (e.g. Maryland) require that minority shareholders who are frozen out
in the second step of a two-step tender offer receive no less for their shares than the price
of the first step.
F. Proxy Contests for Corporate Control
DGCL §203 bars biz combinations btwn acquiror and target for a period of three years after
acquiror crosses 15% threshold unless:
- Takeover is approved by target board before bid occurs
- Acquiror gains more than 85% of shares in a single offer excluding inside directors’ shares
- Acquiror gets board approval and 2/3 vote of approval from disinterested shareholders (i.e.
minority who remain after takeover).
With poison pills, buyer seeking to replace mgmt. has two alternatives: (1) negotiate with board;
or (2) run a proxy contest to replace the board. This enhances importance of preventing undue
mgmt. manipulation of proxy system.
Acquisition Before Pill
Control of board was essentially a sure thing
after acquisition of majority of shares
1. Bidder makes tender offer and gains
majority of shares
2. Board will almost certainly resign bc
directors are doomed in next election
Acquisition after the Pill
Board control is, in practice, a prerequisite to
buying a majority of shares
1. XXXXXXXX
2. Once in office, new directors redeem the
pill, clearing way for new bidder to proceed
3. If directors stay they will be voted out over
one (no staggered board) or two (staggered
board) annual elections
Blasius v. Atlas: 9% shareholder’s restructuring plan was rejected by board, so it announced
intent to solicit shareholder consent to increase size of board from 7-15 and to fill board with its
own nominees. Target board preempts by amending bylaws to add two new board seats and fill
with own candidates (board packing). Holding: Board actions designed for primary purpose of
interfering with shareholder voting are subject to enhanced judicial review, even if taken in good
faith. Board bears heavy burden of demonstrating a compelling justification for its actions.
Liquid Audio v. MM Companies: *provides guidance on when to apply Blasius instead of
Unocal.* Target rejected cash offer, so acquiror plans to (1) challenge two incumbent directors up
for reelection; (2) propose bylaw amendment expanding board from 5-9 members. Target adds 2
directors. At meeting, shareholders elect the two acquiror candidates to replace target’s
incumbents, but reject adding 4 new seats. Holding: XXXXX
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