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Corporate Law Outline

Corporate Lawyer
Khanna 2020
Legal Ethics:........................................................................................................................ 3
A. Client .............................................................................................................................. 3
Who is the Client? ........................................................................................................... 3
Corporate Lawyer.............................................................................................................. 14
Introduction ....................................................................................................................... 14
Agency .............................................................................................................................. 14
Intro ............................................................................................................................... 14
Complications in Agency .............................................................................................. 15
Liability in Contract .................................................................................................. 16
Authority in Agency (Authorization) ........................................................................ 16
Actual Authority........................................................................................................ 16
Apparent Authority ................................................................................................... 16
Inherent Authority ..................................................................................................... 16
Liability in Tort ............................................................................................................. 17
Franchises (& Liability) ............................................................................................ 18
Agent’s Fiduciary Duties .............................................................................................. 18
Duty of Loyalty to Principal ..................................................................................... 19
Joint Ownership: Partnership ............................................................................................ 19
Partnership .................................................................................................................... 20
Partnership Formation ............................................................................................... 20
Agency Conflict Among Co-Owners ........................................................................ 20
Partnerships and Third Parties .................................................................................. 22
Partnership Creditors’ Claims Against Departing Partners .................................. 22
Third Party Claims Against Partnership Property................................................. 23
Claims of Partnership Creditors to Partner’s Individual Property ........................ 23
Partnership Governance and Issues of Authority .......................................................... 23
Termination (Dissolution and Dissociation) ................................................................. 24
Statutory Dissolution of a Partnership at Will .......................................................... 24
Accounting for Partnership’s Financial Status and Performance ............................. 25
Alternative Business Organizations – LP’s, LLP’s, LLC’s .......................................... 25
Contractual Flexibility and the LLC ......................................................................... 26
The Corporation ................................................................................................................ 26
Four Key Features of Corporations: .......................................................................... 26
Types of Corporations ............................................................................................... 28
Centralized Management .......................................................................................... 28
Board ......................................................................................................................... 28
Key Players ............................................................................................................... 31
Creditor Protection .................................................................................................... 32
Shareholder Liability................................................................................................. 34
Equitable Subordination ........................................................................................ 34
Corporate Lawyer
Khanna 2020
Veil Piercing.......................................................................................................... 35
Veil Piercing on Behalf of Involuntary Creditors (Tort) .............................................. 36
Normal Governance: The Voting System ......................................................................... 39
Role and Limits of Shareholder Voting ........................................................................ 39
Electing and Removing Directors ................................................................................. 40
Removing Directors .................................................................................................. 41
Shareholder Meetings & Alternatives ........................................................................... 41
Proxy Voting ................................................................................................................. 42
Class Voting .................................................................................................................. 42
Shareholder Information Rights .................................................................................... 43
Separating Control from Cash Flow Rights .................................................................. 43
Circular Control Structures ....................................................................................... 43
Vote Buying .............................................................................................................. 44
The Federal Proxy Rules ............................................................................................... 47
State Disclosure Law: Fiduciary Duty of Candor ......................................................... 49
Duty of Care ...................................................................................................................... 49
Intro ............................................................................................................................... 49
Statutory Techniques of Limiting Director/Officer Risk Exposure .............................. 49
Indemnification ......................................................................................................... 49
Judicial Protection: The Business Judgment Rule ........................................................ 50
What is the BJR? ....................................................................................................... 51
Duty of Care in Takeovers ........................................................................................ 51
Additional Statutory Protection: Authorization for Charter Provisions Waiving Liability for Due
Care Violations.......................................................................................................... 51
Corporate Lawyer
Khanna 2020
Legal Ethics:
A. Client
Lawyer-client relationship is a special agency relationship  fiduciary relationship
Five C’s – Five duties lawyers owe to their clients
o Control
o Communication
o Competence
o Confidentiality
o Conflict
Who is the Client?
When does an AC relationship form?
o Express Agreement: (1) a person manifests intent that lawyer provides legal services, and
(2) lawyer agrees
 Usually w/ signing of engagement letter w/ terms of rep, lawyer becoming
Principal’s agent
o Accidental Client: (1) person manifests intent that lawyer represent him, and (2) lawyer
fails to make clear that the answer’s no, or
 Lawyer know or should know that the client is reasonably relying on the lawyer
 If reasonable outsider would believe you were giving legal advice, could
have accidental client
o Clients: when you rep a corp, the corp is your client, not its officers (MR 1.13(a))
 Sometimes officers need to know they are not your client
 i.e. can’t keep what officers say confidential from the corp (MR 1.13, cmt 2)
 if there’s trouble, you probably can’t rep officers individually w/o conflict, so don’t
want them to think they are your client
 if you call them a client, and make them think they are a client, court may decide
they are a client (accidental client)
o Prospective Clients: might give you confidential info, owe these prospective clients certain
 Keep info they give you confidential (MR 1.18(b))
 Can’t rep another client in the same/substantially related matter if the info you
learned would be significantly harmful to the prospective client in the matter, and
that conflict is imputed to the firm (MR 1.18(c))
 But firm can rep them if (MR 1.18(d))
 (A) Received the informed consent of both parties, or
 (B) You took reasonable steps to avoid exposure to more confidential info
than was necessary to decide whether or not to rep the client, and
o (1) you are screened from participation in the matter, and
o (2) written notice is given to the prospective client
 Also owe prospective client a duty to:
 (1) protect any property they give you and
 (2) use reasonable care in giving any advice about merits of the claim, when
the action must be commenced, and the existence of any COIs
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o Start-Ups: Raise potential problems bc if you advise the individuals who form company,
might develop COIs (conflict of interest)
 New company is a client, and so are the old people forming the company.
 Going to be conflicts btwn them (e.g. company wants a non-compete, but partners
don’t). Going to place a material limit on your ability to give advice. MR
 MR 1.17, cmt 8: Lawyer asked to rep several inds forming a JV likely
limited in ability to rec/advocate all possible positions b/c lawyer’s DoL to
the others. Conflict forecloses alts that would otherwise be available to the
client. But mere possibility of subsequent harm doesn’t req. disclosure and
o Critical questions: the likelihood that a difference in interests will
eventuate and, if it does, whether it will materially interfere with the
lawyer's ind. professional judgment in considering alts or foreclose
courses of action that reasonably should be pursued on behalf of the
 MR 1.17, cmt 32: Establish/communicate extent of limit on ability to rep.
 Can rep if think can competently get parties where they’re going, w/ them dealing
w/ anything that might involve conflicts and you advising on rest.
 But have to get parties’ informed consent, which req. telling about risks and
desirability of having own counsel, and explaining impacts on
confidentiality. MR 1.17(b).
 Basically, saying what options are available, but not which one to choose.
o MR 1.17(b), cmt 30: Effect on confidentially and A-C privilege is
particularly important
 No A-C privilege as btwn commonly rep’d clients
 Tell clients that if lit, won’t get A-C privilege
o MR 1.17, cmt 31: Equal DoL to each client, so can’t keep info one
party tells you from the other.
 Each client w/ right to be informed of anything bearing on
rep that would affect client’s interests, and right to expect
lawyer to use info to client’s benefit (MR 1.4).
 Lawyer should tell that info will be shared, and lawyer will
have to withdraw if one client decides to keep some info
from the other.
 If give company list of options and don’t include a certain option, can get sued for
breaching DoC
 Also might be fid breach if conflict blinded you
o 3rd Party Beneficiaries—When have responsibilities to 3rd parties who are going to rely
on your work, b/c they know you’re forbidden to make misrepresentations to 3rd parties.
MR 4.1
 E.g. sending a comfort letter to a bank, who knows that you, as the attorney, can’t
make a misrep  rely on you
 Make sure your client knows you’re going to be honest and get a waiver. MR 2.3
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Khanna 2020
B. Conflicts of Interest
Conflict arises w/ current clients when (MR 1.7(a)):
 1. The rep of one client will be directly adverse to another client, or
 2. There’s a sig risk that rep of one client will be materially limited by the lawyer’s own interests
or the lawyer’s responsibility (incl. confidentiality) to another client, a former client, or a third
Firms have to have a reasonable syst for discovering conflicts
 No syst for discovering conflicts  clients can seek disgorgement of fees or (if they’re harmed)
 General rule: When you have a conflict, must disclose and get informed consent, or else decline
rep. MR 1.7
o Can only proceed if you think can give adequate and competent rep to both conflicted
parties. MR 1.7
Conflict that’s “thrust-upon” you by the client (b/c acq. another firm or got acq.)  you can pick one.
MR 1.7, cmt 5
 Conflict re: a firm isn’t necessarily a conflict as to its affiliate/constituent org (e.g. parent and
subsidiary), and vice versa. MR 1.7, cmt 34
o Depends on how close the relationship is, if they have the same GC, etc.
 No hot potatoes, can’t drop a client just to take another, more lucrative client
Informed Consent to a conflicted rep can cure conflict if (MR 1.7(b)):
 1. Lawyer reasonably believes he can competently and diligently rep each affected client
 2. The rep isn’t prohibited by law
 3. The rep doesn’t involve representing one client against the other or in the same lit, and
 4. Each client gives informed consent.
 Notes on IC:
o Judged by a reasonable lawyer standard. MR 1.7, cmts 14 and 15
o Informed = have told them all of the relevant circumstances, the reasonable alts, and the
ways in which the conflict might harm client
o If getting informed consent from Client A req. disclosing confidential info from Client B,
then Client B must consent
o The consent must be in writing.
If lawyer engaging in a biz transaction w/ a client (MR 1.8(a)):
 1. Terms must be fair to the client
 2. Terms must be disclosed in writing, incl. the lawyer’s role
 3. Client must be advised in writing that should obtain the advice of ind. counsel
 4. Client must give informed consent in writing
If the lawyer is a witness (MR 3.7):
 (a) Lawyer can’t act as an advocate at a trial where lawyer is likely to be a necessary witness,
o 1. The testimony relates to uncontested issues
o 2. Testimony relates to the nature/value of legal services rendered in the case, or
Corporate Lawyer
Khanna 2020
o 3. Disqualification of the lawyer would work sub hardship on the client
 (b) Lawyer may act as an advocate in a trial in which another lawyer in the lawyer’s firm is likely
to be called as a witness, unless precluded by Rules 1.7 or 1.9.
For former clients, lawyer can’t:
 1. Oppose that client in any matter in which confidential info obtained from the client would be
 2. Rep a client whose interests are materially adverse to the former client in a matter that’s “sub
rel” to the matter in which the former client was rep’d, or
 3. Use any info obtained from the former client to the former client’s disadvantage
 All of these can be cured by informed consent
Conflicts imputed to a lawyer’s firm, MR 1.10(a), unless it’s:
 1. Personal to the lawyer in question (e.g. sexual relationship, family relation), or
 2. The conflict is based on a relationship to a former client and the conflicted lawyer is timely
screened from the matter, receives no fee, and notice is given to the former client
If a lawyer leaves a firm, the firm is conflicted out of representing any person w/ interests materially
adverse to those of a client of the formerly associated lawyer in matters sub related to the rep if someone
at the firm has confidential info material to the matter.
If lawyer comes from the govt, lawyer’s disqualified from repping a private party in a matter in which the
lawyer participated personally and substantially.
 Matter doesn’t mean “general topic,” it means specific facts w/ specific parties
 Trifling participation doesn’t count
 Ordinary conflict rules apply when going private practice  govt
Lawyer can’t draw up legal doc giving gift to the lawyer from the client, unless the client is a family
member. MR 1.8(c)
Prospective Waivers sometimes allowed, as long as they ID the likely consequences of future actions.
MR 1.7, cmt 22
 Probably enforceable if:
o Prospective waiver narrowly crafted
o Incl. w/ particularity the likely adverse representations
o Is enforced within a reasonable time
o Representation of the client hasn’t changed dramatically from what it looked like at the
time the prospective waiver was sought
If you have a joint defense agreement and learn confidential info about the other D, you can be
disqualified from a representation adverse to that D.
Can get an injunction barring rep or disqualify a lawyer that you think is conflicted.
C. Control
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Khanna 2020
Lawyers w/ duty to zealously rep their clients. MR 1.3, cmt 1
 Duty doesn’t req you to be uncivil or offensive towards your opponent, not get every conceivable
Client gets to make the big decisions (MR 1.2(a)):
 1. Whether to settle
 2. What plea to enter
 3. Whether to waive jury trial
 4. Whether to testify
 5. Whether to appeal
 But the attorney gets to make tactical decisions.
 Both lawyer and client share the decision on whether or not to continue
When can the lawyer leave?
 Lawyer can leave for any reason if it won’t have a material adverse effect. MR 1.16(b)(1)
 Lawyer can sometimes leave even if it’ll have adverse effect if circumstances severe enough (e.g.
lawyer need not continue rep if client’s objective is repugnant to attorney), MR 1.16(b)(4), or
client won’t cooperate, MR 1.16(b)(6).
 Lawyer must withdraw if continuing the rep will req. the lawyer to violate the law or a
disciplinary rule. MR 1.16(a)(1).
o You can’t facilitate an ongoing criminal act, b/c you’re criminally liable if you do
o But you can continue to rep when you learn about past illegal conduct, MR 1.6, cmt 8
 BUT you can’t get yourself involved in continuing illegal conduct by counseling it
 Can’t do anything that will further crim activity, and must withdraw if don’t desist
(MR 1.16(a))
D. Communication
7 events that trigger duty to communicate
 1. Initially, agreeing on fee arrangement and defining scope of the representation (explained in
engagement letter)
 2. Initially and throughout rep, explaining the matter to enable client to determine objectives of rep
 3. Throughout rep, keeping client reasonably informed about the status of the matter, incl. info
about important developments in the rep itself, as well as changes in the lawyer’s practice (e.g.
illness or merger w/ another firm)
 4. When you make a material mistake in the matter
 5. When a client requests info
 6. When the law imposes limits on conduct that a client expects you to undertake
 7. When you must obtain the client’s informed consent, incl. when you:
o Limit the scope of a rep
o Obtain a waiver of a fid obligation owed your client, esp. re: confidentiality and COI
o Obtain a waiver of a fid oblig to a prospective client
o Provide an evaluation for use by a 3rd person that’s likely to adversely affect the client’s
You’re not allowed to make misreps to 3rd parties. MR 4.1, and have to be careful when talking to
unrep’d people
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 If make an unknowing misstatement and later discover incorrect, you have to fix it, and are under
a duty to disclose. MR 8.4(c)
 Must also do the same if your client made a misstatement while under a duty to disclose—if they
won’t, you have to withdraw b/c they’re using you to violate the law
1. What if you think someone at the firm is doing something illegal?
Take direction of the assigned person in the corporation (see above), unless you know (actual
knowledge/willful blindness) they’re about to take or refuse to take an action in a way that will harm the
 Remonstrate w/ the person first to try to get them to do right thing as persuasively as you can. MR
1.13, cmt 4
New MR 1.13: If you (a) know that someone’s doing something illegal or in violation of an oblig to the
corp (e.g. FD), and (b) reasonably believe it might damage the firm, you must report it all the way up the
chain to the BoD. MR 1.13(b)
 May disclose this to regs if corp doesn’t do anything, and you’re reasonably certain harm will
result. MR 1.13(c)
Old version of MR 1.13 only said you could report up if you know something is happening
 Gave you permission to report up, but was permissive, not mandatory
 Old rule is still applicable in most jx’s
What if you get fired b/c of your reporting up the ladder?
 Some states w/ whistleblower protections.
 But confidentiality still applies, so likely have to bring under seal.
SEC rules under Sarbanes-Oxley (SOX):
 Have to go up the ladder if you “become aware of evidence” of a “material violation of the law.”
o SOX concerned w/ fed securities law to protect investors
 And if the execs and BoD don’t do anything, you must report to authorities (maybe even if state
still w/ old MR 1.13)
 Need to keep going up the ladder until (a) you assuage your concerns, or (b) somebody does
 Failure to follow can result in suspension from practice before the SEC
 Junior attorneys must report concern to supervisor, and may do the rest.
UTL Requirements, Rule 1.13, and SOXs
What’s required When triggered
Report UTL, req.
Knowledge that
Rule 1.13 (old)
going up one level something’s wrong
and then optional
to go further.
Rule 1.13 (new) Also UTL, but req. Knowledge
to keep going, all
the way up to the
BoD if necessary
Degree of harm
Think will be
All things corp
could do wrong
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SOX § 307
Req. to go UTL,
and gives
permission to
reach out to SEC
Aware of ev
material violation
of fed securities
Material violation
(damage to
company irrel)
Only financial
securities crimes
(e.g. not enviro
2. Internal Investigations
Conversations w/ employees:
 Conversations w/ employees in the course of an investigation are privileged
o But the privilege is held by the corporation
o Neg w/ DOJ might  waiver of privilege as a term of agreement to defer/avoid
 Employees might be confused that you rep them, when really you rep the firm. So give them
warning to make it clear that you don’t rep the employee (MR 4.3):
o Lawyer can’t misrep role to an unrepresented person
o Can’t make them think you’re impartial
o Must clear up confusion as to role if think unrepresented might be confused
o Don’t give legal advice other than to get a lawyer.
 Lawyering up tricky—ee might lose job if don’t cooperate w/ investigation.
Lawyering up also signals to er that ee did something wrong. And lawyer might 
company not getting info it wants
Rules for plaintiffs lawyers (but not govt investigators), MR 4.2:
 Attorney can’t contact a person directly who’s rep’d as to the matter you’re asking questions about
o Have to go through lawyer
 So who’s off limits:
o Ees of company you’re suing who regularly comm w/ or supervise the lawyers
o Ees who can bind the corp to anything or whose actions could be imputed to the matter
 But former ees may be fair game if your jx has adopted MR 4.2, cmt 7
 But can’t contact former ees if would breach confidentiality agreement or FDs
o Don’t want to aid and abet breaching confidentiality K
 Also can’t compensate witnesses based on what they say or on a contingency basis
o Courts w/ broad view of “payment,” worry payment to former ee is unethical rendering of
 Violating rules  disqualification, dismissal, etc.
 Rule 4.2 also applies to contacting govt officials, unless petitioning for redress of grievances
3. Trial Publicity
Limitations on what lawyer can say about investigations or lit, MR 3.6:
 (a) If participating/participated in investigation/lit, can’t make extrajudicial statements for public
dissemination that will have substantial likelihood of materially prejudicing an adjudicative
proceeding on the matter
 (b) But, lawyer can state:
o 1. Claim, offense, or defense involved, and (unless prohibited by law) ID of person’s
o 2. Info contained in the public record
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o 3. That an investigation of a matter is in progress
o 4. Scheduling or result of any step in lit
o 5. Request for assistance in obtaining ev and necessary info
o 6. Warning of danger re: behavior of involved person, when there’s reason to believe there
exists the likelihood of sub harm to an individual or public interest, and
o 7. In criminal cases:
 i. ID, residence, occupation, and family status of accused
 ii. Info necessary to aid apprehension of accused
 iii. Fact, time, and place of arrest
 iv. ID of investigating/arresting officers or agencies, and length of investigation
 (c) Can make a statement that a reasonable lawyer would believe is req. to protect a client from the
substantial undue prejudicial effect of recent publicity not initiated by the lawyer/client.
o Limit statement to what’s necessary to mitigate recent adverse publicity
E. Competence
Lawyer w/ responsibility to act competently and w/ proper knowledge, skill, thoroughness, and
preparedness reasonably necessary for the rep. MR 1.1. Factors re: skill:
 1. Complexity and specialized nature of the matter
 2. Lawyer’s general experience
 3. Lawyer’s experience and training in the field
 4. Preparation and study lawyer is able to give the matter
 5. Whether it’s feasible to refer the matter to associate, or consult w/ a more experienced lawyer
Consulting/hiring an expert
 Have to talk w/ client before, unless you can use a hypothetical and not giving away info the client
gave you
 Can get green light for experts in advance, but need to explain to client how might come up
 Have to assure that outside expert is (a) good and (b) confidential
Scope limitations?
 Could tell client what you’re competent in, and try to limit the rep
 MR 1.2(c) allows if reasonable and informed consent is given.
Duty of Care to exercise the competence and diligence normally exercised by lawyers in similar
 Don’t have to be perfect, but clients can sue for DoC breach
 Suit usually involves expert testimony re: if a reasonable attorney could’ve made the mistake
 Clear ways of violating DoC:
o Missing a deadline
o Blow a statute of limitations
o Not following instructions
o Basic breaches of a FD
F. Confidentiality
Duty of Confidentiality vs. Attorney-Client Privilege
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A-C Priv: Narrower, product of Rules of Ev, and governs use of things your client tells you in a trial
 A-C Priv = info given to attorney to get legal advice
 Restrictions on A-C Priv
o Must be an attorney
o Must be actually acting as an attorney
o Must be giving advice/info re: law
 Privilege extends to:
o Things client tells you (but not preexisting docs)
o Your own work product. Covers work done:
 1. In reasonable anticipation of lit, and
 2. Prepared under the direction and control of the attorney
 Note: Investigation alone ≠ reasonable anticipation of lit
 Can anticipate lit when on notice you’re a person of interest
 “Legal advice,” “under supervision of attorney,” and “reasonable
anticipation of lit” are all key terms of art.
 Crime fraud exception: if the lawyer services were sought or obtained to enable or
aid anyone to omit or plan to commit what the client knew or reasonably should’ve
known to be a crime or fraud
 To maintain privilege:
o Do your best to keep things from getting out
 Client loses privilege if shares privileged info w/ 3rd party
o Can’t mix it in w/ a bunch of other stuff, keep things clear in priv log (why GCs hate info
 Privilege belongs to the client, not the attorney
o Only the client can waive the privilege
 Could be problematic if corp changes/morphs—might change decision re: waiving
 If other side challenges claim of privilege:
o Court conducts mini trial, look through privilege log.
 Could have expert testimony re: whether or not work product
 In-House lawyers
o They are full-fledged counsel, but sending them everything doesn’t make it privileged
 Courts more likely to view a contaminated conversation as more business than
o Have to be acting as a lawyer to meet standards for privilege
o Priv Test for IHC = looking at purpose of the answer
 Was it primarily motivated by biz decision, or compliance w/ law/prep for lit?
Confidentiality: Broader, stems from ethical duties, bars you from talking about what client tells you in
course of rep and anything related to the rep that isn’t widely known
 Need consent to breach confidence in most circumstances. MR 1.6(a)
 Whether somebody is your client or not is confidential
 Can’t use confidential info—abuse of FD to use confidential info, and client can get πs from you
 Confidentiality obligations don’t exist if client’s crime is ongoing
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 In corp context, these duties attach whenever talking to employee of corp acting in scope of
EXCEPTIONS (when can reveal):
Physical Harm
Future continuing crime/fraud
Financial Harm
Future continuing crime/fraud
Seeking Advice (Ethics)
Lawyer Self-Defense (as
necessary to mount defense)
Required by law/court order
Client’s express or implied
consent. MR 1.6(a)
Future serious bodily harm, even
if past conduct. MR 1.6(b)(1)
Future crime, prevent, rectify,
mitigate sub financial loss where
used lawyer’s services. MR
1.6(b)(2) and (3)
MR 1.6(b)(4)
MR 1.6(b)(5)
MR 1.6(b)(6)
If representing multiple Ds or Ps in the same lit, need joint defense agreement formalizing cooperation,
or else none of your conversations are privileged.
G. Breach/Malpractice/Professional Discipline
Penalty for breaching FDs
 Civil action for breach of FD  injunction/damages
 Might have to disgorge fees if breached FD, even if didn’t harm client
 Prof discipline w/ bar regulator  censor, disbarment
 But aiding/abetting crime or committing crime, even if was part of your prof duties, doesn’t
excuse crim liability
o Client can’t sue you if you say you won’t commit a crime.
When is supervisor responsible for subordinate?
 1. Supervisor ordered or ratified the conduct, or
 2. Supervisor learned of the conduct when consequences could be avoided/mitigated and failed to
take action
 But subordinate is responsible even if ordered if there’s a clear violation of ethics rules
What if junior attorney doesn’t know an answer?
 Can’t go outside for help, so is answer from senior attorney enough cover?
 No, junior attorney needs to reasonably believe what the supervising attorney tells junior is
 Senior’s answer okay if there’s compelling reasons  reasonable person will believe it
What if client asks to commit things you’re uncomfortable with?
 Can either say “no” or withdraw.
 Can withdraw unless client will be materially adversely impacted
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 Noisy withdrawal (signaling to others that there are ethical issues going on here) req. in some jx’s
Malpractice claims
 Four elements (basic tort): duty, breach, causation, harm
 Causation/breach are harder to satisfy, b/c tough to show that attorney malpractice was way lost.
How to prove?
o Could go to other attorneys, but they usually say things like “generally X, but every case is
o Bar associations won’t testify in malpractice cases, past sanctions pretty vague.
o Judges typically w/ common sense measurement—“I wouldn’t do something this stupid.”
 Most cases where clients win look like recklessness or gross negligence
 Lawyer can’t make agreement limiting malpractice liability unless client is independently rep’d.
MR 1.8(h)(1).
H. Attorney’s Fees
Attorney’s fees must be:
 Reasonable, MR 1.5(a)
 Terms of that fee must be communicated to client, preferably in writing. MR 1.5(b)
o Fee can take pretty much anything into account and still be reasonable
o But can’t bill for actual overhead expenses.
 Can req. fee to be paid in advance, but must return unearned portion if fired or withdraw. MR
o But a true retainer for availability doesn’t need to be returned.
 Contingent fees okay, except in criminal or domestic relations, if reasonable and agreement in
writing. MR 1.5
o Need to set forth how contingency fee calculated in writing.
 Can only split a fee w/ another lawyer if:
o 1. Within the same firm
o 2. Under a separation or retirement agreement when lawyer leaves firm, or
o 3. Reasonable, in proportion to services perf’d by each lawyer, and client agrees in writing.
MR 1.5(e)
 Courts might allow you to modify fee structure if things go for very long time, but require very
good reason
 Getting paid in stock is okay, but skepticism
o Getting paid in fees  no incentive to favor any particular corp constituency. But
becoming a SH  incentive to favor SHs, which aren’t fully aligned w/ interests of
o Must comply w/ biz transaction rules
o Fee has to be reasonable, so company may come back and arg to readjust payment that’s
too high
Sending work overseas
 ABA has approved outsourcing, as long as a qualified US attorney can say they’re supervising the
non-US qualified attorneys effectively
o Supervision standards aren’t very rigorous
o Can impose the administrative fee on client
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Corporate Lawyer
Enterprise organizations: agency, partnership, corporations
o These are different ways of organizing business relationships - menu
 Standard forms that can be adjusted a bit to suit specific needs
 Can be restructured – there is a lot of choice in set up to get creative
These laws address both megalith and small relationships.
o Important part of understanding how corporate law operates is understanding what rules &
obligations regulate how managers and shareholders act.
Corporation: a business organization – method of organizing relations among those involved in
collaborative business
o Legal entity
o Many attributes together known as a business organization
Corporate Law: laws regulating the relationships among the players acting on behalf, or directing
the behavior, or a corporation (managers and shareholders)
Agency law: governs the legal relationship among principals, their agents, and third parties with
whom the agent contracts
An agent is someone who works on behalf of another person (principal)
Why have agents?
o They may have expertise and you may have too much to do on your own (frees up your
 If people can specialize in what they are good at they can make/do more of it then
that benefits public welfare
Problems with agency relationships:
o Agents have discretion, so they have the ability to screw things up, don’t always do exactly
what they are told, cannot perfectly control them, their goals don’t align with yours, don’t
care as much as principal
o Agents need monitoring
 Give them instructions – SOPs
 Training – incentives to perform
o Delegation – if monitoring takes too much time, then it is inefficient
o Select, monitor, incentivize = agency costs
o To minimize agency costs, you have to make sure you hire the right agent, set and enforce
standards for the agent, an monitor the agent. Aka: transaction costs
o Monitoring Costs; setting something up to prevent losses (i.e. preventing stealing)
o How can you try to monitor an agent?
 Pay them more to do exactly what you want (efficiency wages)
 Bonding Costs: things like interviewing, costs taken on by manager to reduce
agency conflict
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o Residual Costs: can’t eliminate all social deviation even if you monitor them profusely; i.e.
if you run Walmart you don’t care who steals paperclips, not worth it to set up system to
 Corporations can only act through agents
o Law fills in gap left in contracting to constrain agency costs: regulates ex post
 Corporate law keeps adjusting itself.
 Fiduciary duties
o One person has made themselves vulnerable to another in a contractual sense.
 Law imposes strict fiduciary duties on agent to principal.
 This incentivizes principal to enter into A – P relationship
 Formation – How are agency relationships formed?
o Agency is the fiduciary relationship which results when one person (principal) manifests
assent to another person (agent) that the agent shall act on the principal’s behalf and be
subject to the principal’s control and the agent manifests assent or otherwise consent so to
o Express agency relationships are common, created through express k.
o Implied agency relationships are created by behavior and course of dealing (principal is
liable for thing agent has done).
Jenson Farms Co. v. Cargill (Minn. 1981)
 Farmers (grain) Warren  Cargill
 Facts: Warren, the agent, is a grain elevator, buys grain from farmers and resellers and stores grain
– it is a centralized marketplace for farmers. Warren is losing a lot of money. Cargill, the
principal, makes bread and baked goods. They wanted to get grain first and the easiest way for
them to do that is to get it from single supplier, i.e., Warren. They try to monitor what Warren is
doing (lots of paternal control). Warren kept borrowing more and more money from Cargill to pay
the farmers. Warren goes bankrupt. Farmers sue deep pocketed Cargill. Because Cargill has credit
contract with Warren, farmers claim that the credit contract is actually an agency contract
(creditors are usually not liable for debts of people they lend to).
 Court thinks that this is an agency relationship. Court cares about how relationship actually
works. Because Cargill had significant control over Warren’s actions through credit
contract, the court holds them liable.
 Control gives the ability to influence behavior.
 Takeaway: What you call your relationship doesn’t matter. Courts will look to what the
motivations of the parties are, and what the actual relationship is. The more supervising/control
exercised by one party over another, the more it looks like an agency.
Complications in Agency
1) Agency binds principal in contract to 3rd party.
a. Actual authority: communicating from P  A
b. Apparent authority: P will be held liable because they are cheapest cost avoider to 3rd
party. P  TP
Both parties must manifest their intention to enter an agency relationship.
Agent must reasonably understand from the action or speech of the principal that she has been
authorized to act on the principal’s behalf.
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Liability in Contract
Authority in Agency (Authorization)
Actual Authority
 Express Authority: When the P expressly endows the A with authority (tells A to “go do X”)
 Implied Authority: What a reasonable person in the position of A would infer from the conduct of
P. Includes incidental authority - implementary steps ordinarily done in connection w/facilitating
authorized act.
Apparent Authority
 What a reasonable third party would infer from actions/statements of P. Designed to prevent
fraud/unfairness to TPs who reasonably rely on P’s actions/statements when dealing with A.
 If agent does something not authorized to do, question becomes whether a reasonable third party
would infer agency from the P’s actions and statements
 Usually third party is safe, but not in extraordinary circumstances, or where the third party is
clearly suspicious about whether the A actually has the authority in question
o Principal ratification: if an agent exceeds his authority, the principal can still ratify the
transaction either expressly or implicitly
White v. Thomas (Ark. 1991) (apparent authority)
 Facts: White told his secretary to buy a plot of land for no more than $250k; she bought it for
$327K and then sold 45 acres to the second-place bidder to drop down her overall price spent. TP
asked secretary if she had the authority to do this and she said yes
 Held: agent claim to authority is not enough, authority must come from P
 Authorization to buy does not equal authorization to sell
o Court thinks that buying and selling are fundamentally different powers.
 Notice: TP was on notice. Asked A if she was actually authorized to sell land – clearly had doubt.
Court thinks that this is very important – if TP had to ask if A was authorized, then TP aware that
she did not have apparent authority; proceeded with transaction anyway, without properly
monitoring the situation
 TP is in best position to monitor Agent here, and since monitoring costs have flipped to TP here,
the court will not hold P liable for A’s acts.
Inherent Authority
Inherent power to bind principals to contracts – power not conferred by principals but represents
consequences imposed on principals by law.
 Inherent authority: diff than implied; when agent has a title like CEO, that a third party would
assume carries certain authority with it
 Gives agent power to bind principal, whether disclosed or undisclosed, to an unauthorized contract
as long as a general agent would ordinarily have the power to enter such a contract and the third
party does not know that matters stand differently in this case.
 i.e. CEO
Gallant Ins. Co. v. Isaac (Ind. App. 2000) (Inherent authority)
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Facts: Isaac bought a new car on Friday, called Thompson-Harris insurance agent, was told that he
was covered.
Crashed car before Monday when he was supposed to pay; Gallant said he wasn’t covered bc TH
agent didn’t have authority to insure him over the phone like that
Gallant’s defense is that there was no contract because Isaac hadn’t paid money at the time (was
told by Thompson-Harris insurance agent it was ok to pay Monday).
Court holds that Gallant is on the hook for payment because insurance agent’s behavior is usual
o TH has history of regularly doing this sort of thing, and Gallant never reprimanded them in
the past – should have monitored better so G is liable for its TH agent.
o This is a reasonable expectation of insurance agents.
Takeaway: if your course of dealing establishes how things usually work, that can give and agent
the inherent or implicit authority to act in that manner
Liability in Tort
Usually principals are liable for torts committed by a class of agents known as employees, which is
different from another class of agents (and nonagents) known as independent contractors. Usually only
employer-employee relationship triggers vicarious liability for torts committed w/i scope of employment.
 Difference in the level of monitoring or control being exercised by the P with employees
compared to independent contractors
 Employer subject to liability for torts committed by employees while acting within the scope of
their employment (same approach for agent crimes – Corp criminal liability)
 Test: the more control you have over the (possible) agent, the more likely you are to be held liable
as a principal. The less control, the less likely
o Control is a good proxy for the amount of monitoring you’re doing
 There is always a tradeoff btwn micromanaging and profit sharing in franchises
Humble Oil v. Martin (Tex. 1949)
 Facts: Car rolls down a hill and injures ppl due to negligence of an attendant; Humble exercised
lots of micromanaging control over this franchise, so Humble is held liable
 Have to show that station is agent for supplier
Hoover v. Sun Oil (Del. 1965)
 Facts: A car caught on fire while being filled with gas bc employee was smoking; employee was
employed by Barone, allegedly an independent contractor of Sunoco
 Sunoco is not held liable for the fire, because the only control that Sunoco had over Barone was a
little bit of training about how to run the franchise; everything else was totally controlled by
Barone, and he made his own profits
Comparing Humble and Sun:
In these two cases, the court focuses on control. Humble has significantly more control over gas station,
so the court finds Humble liable. Sun Oil doesn’t have anywhere near as much control over gas station, so
the court does not find them liable.
 In Humble, Barone wasn’t getting commission; he was essentially getting his own profits and a
percentage of the sales. So again, it looks like Humble was exercising way more control over
agent than Hoover over Barone
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Franchises (& Liability)
 Option 1
o {Exxon – oil supplier} – [Ex] [Ex] [Ex]  owns gas stations
o Own everything top to bottom (produce product, own store that sells product, i.e. Apple)
 Option 2
o {Exxon} – [Exxon] [Shell] [BP]  independent gas stations
o Let others sell product along with other products
 Option 3 (somewhere in the middle)
o gas station owner has restrictions on how they run their business
 some of these options have more control compared to others, why?
o More control = more quality control over final products; i.e. Dominos wants more control
to avoid ppl disliking one and avoiding all
o If you own a gas station and you want clean bathrooms at 6am, who’s going to do that?
Hourly paid employee or share profit employee? Model your company differently to
control certain things
 Benefits of franchise system
o Local party will know more about location because of local knowledge
o Standardized quality – franchise has incentive to maintain quality because they will get a
percentage of profits
o Consistency through monitoring
o Midway between independent retailer (less incentive to standardize customer experience)
and owned (less incentive to work). Franchise gives enough independence to have profit
motive, but also gives incentive to standardize).
 Downsides of franchise system
o People will worry about their profits, not Exxon’s profits
 Humble & Hoover are different kinds of franchises. Because the court in Humble thinks that the
oil company has more control over retailer than Sun in Hoover, they will hold the oil company
liable. Humble is cheapest cost avoider.
Agent’s Fiduciary Duties
Fiduciary Relationship – agent must advance the interests of the principal. Fiduciary is bound to exercise
good-faith judgment in an effort to pursue the purposes established at the time of creation of the
 Special type of relationship since P is vulnerable to A’s actions
 Requires one party to act in the interest of the other and not for his/her own benefit
 One of the highest standards in law
Three categories of duties:
1) Duty of obedience – A’s duty to follow the instructions which created the relationship
2) Duty of loyalty – duty to exercise power of A in a manner that best serves the interests of the P; to
advance the interests/purposes of the principal or beneficiary and not to exercise such power for a
personal benefit (no self-dealing but if A does, then P gets the profits)
3) Duty of care – duty to act in good faith, as a reasonable person would act in becoming informed
and exercising any agency or fiduciary power.
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Duty of Loyalty to Principal
Tarnowski v. Resop (Minn. 1952)
 Facts: P hires A to find jukeboxes to purchase for P’s bowling alley, TP bribed A to use TP’s
jukeboxes; P bought TP jukeboxes and A got secret commission
 Violation of duty of loyalty
 Idea is that if P had gone out and got the jukeboxes himself, he would’ve gotten the commission
 Take-Away: If agent profits from a way not specified in agency contract, the agent owes the profit
to the principal. Agent can’t benefit personally from being an agent
In Re Gleeson (Ill. App. 1954)
 Facts: Mary Gleeson died. In her will, she made Con Colbrook the trustee for her three children.
Colbrook was leasing the land at the time. Colbrook re-leases land to himself. Gleeson’s kids
approved. Kids aren’t principal, Mary is.
 Problem is the Colbrook is choosing to be both trustee and lessee. Gleeson is dead, she can’t
 Takeaway: Colbrook violated his fiduciary duties to the trust by self-dealing. Entending his lease
would’ve been fine if Mary was still around to approve (and waive COI), but she can’t.
 Could’ve refused to be trustee or lease the land to someone else but cannot be both trustee and
tenant, must pick one
Trustee Duty to Trust Beneficiaries: Trustee holds legal title to trust property, which the trustee is under
a fiduciary duty to manage for the benefit of another person, the trust beneficiary
 P can consent to conflicted relationship, in Gleeson P is dead so can’t consent
 Trustee relationship is analogized to agency relationship.
Comparing Tarnowski and Gleeson
 In Tarnowski, these actions would be okay if they were approved by the principal. In Gleeson, the
principal can’t approve the actions, because she’s dead.
Joint Ownership: Partnership
General partnership: earliest form of jointly owned and managed business. Migration since 1960s to LLCs
for limited liability, tax benefits, and contractual flexibility.
People enter joint ownership arrangements bc they want to combine the different strengths of the owners,
share the risks of failure, and give everyone an incentive to maximize efforts. There are a lot of ways to
do this and figuring out which option to choose is difficult
 Benefits of joint ownership:
o Share risks and profits
o Expertise and incentive to work hard: might be more efficient to hire someone and let them
share profits rather than earn a salary, because they’ll be more incentivized to work harder
o Need capital (banks charge interest, partners don’t)
o Entity  reduces contracting costs
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Big question: whether you want to do it in a way that creates a new entity with its own assets, or
with independent partners
Concerns: agency, joint liability,
A partner is a general agent of the partnership, each partner binds the partnership by contracting in the
usual course of business, etc.
 Partner is a general agent of the partnership
 Partners are joint owners, assets are held in the name of the partnership so partnership creditors get
first dibs
 Partners are jointly and severally liable for each other’s actions and are of indefinite life, you can
end by agreement or just leave and trigger division of assets
 Need to screen possible partners and track what they are doing
 Partners may try to abuse when they are about to leave so the ending of a partnership triggers
closer monitoring and closer court scrutiny under fiduciary duty doctrine
 Uniform Partnership Act (UPA): 1914
 Revised Uniform Partnership Act (RUPA): 1997
In partnership, primary agency problem is potential conflicts among joint owners, not between agent and
owner as in agency law.
General partnership imposes personal liability.
Partnership Formation
Agency Conflict Among Co-Owners
Basic agency problem of organizational law: the conflict between controlling and minority co-owners.
Meinhard v. Salmon (NY 1928)
 Active/passive partnership setup: when on partner has the skills, and the other has the money but
not the skills
 Facts: Meinhard (passive) and Salmon (active) has a 20 yr lease from Gerry for NYC plot of land,
built profitable hotel. At end of lease, Gerry and Salmon make deal for bigger lease for 20 more
years; Salmon never mentioned deal to Meinhard; M sues saying he should have the same stake in
the new lease
 Held: as part of a joint venture, S breached his fiduciary duties to M by not disclosing the new
 Managing partner in a joint venture has a fiduciary duty (duty of loyalty) to inform and allow the
investing partner to compete to obtain an opportunity that arose from his status as a partner even
though it would best after the partnership’s anticipated termination.
 Take-Away: joint venturers/partners owe each other the finest duty of loyalty to each other.
Breach can occur by something less than fraud/bad faith.
 There were 3 options for how to decide this case:
o 1) not interfere; so S gets to decide just bc he has the lease offered to him
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 Parties unlikely to pick this bc it seems unfair, but is it a bad option? Would
incentivize M to be less passive, or to K around it (say must disclose opportunities)
 M could also say if S wanted to have better options at the back end, he
should get more at the front end
o 2) Disclose to M that there’s this opportunity, and renegotiate the joint venture to account
for that
 Benefits M not S
 If they decide to compete with each other, Gerry benefits and parties wouldn’t like
 This is what the court chooses, but M and S probably wouldn’t have chosen this
outcome in a K beforehand, would be like making an agreement to agree
o Same term option: any opportunities that come along before the end of the lease belong to
the JV and are kept on the same terms
 Salmon doing all the work wouldn’t want this
 Penalty default: the default is that you have to disclose, so parties will likely contract for the terms
they want when forming a partnership or joint venture
o So Meinhard is rarely cited but when it is, D loses
Court is worried about
1) monitoring costs
2) contracting costs
3) judicial costs
Vohland v. Sweet (Ind. App. 1982)
 Facts: Sweet works at Vohland Sr.’s nursery. Vohland Sr. says that Sweet will get 20% after
expenses and get an interest in the business. Vohland Sr. dies. Vohland Jr. inherits, and doesn’t
want Sweet to have a share in the business. S wants to dissolve the partnership but V said S is not
a partner so can’t do that
 Issue: Did the arrangement between Sweet and Vohland Sr. create a partnership or an employment
 Held: Courts will look at how parties behave, not what the parties call the arrangement. Sweet is a
partner in the nursery because the parties were acting like he was. Profit sharing indicates control
over sales and costs, which indicates a partnership. Profit sharing means you care about income
and expenses so you know how much control you have.
o UPA §7(4): receipt by a person of a share of the profits is prima facie evidence that he is a
partner in the business.
 Takeaway: The more it looks like you are sharing profits the more it looks like a partnership; the
more it looks like you are under the control of one person, the more it looks like an agency
Incentivizing: If you’re getting paid in wages, all you care about is whether firm has enough money to
pay your wages. If you’re getting a share of the profits, then you’re monitoring costs as well as profits. If
you’re monitoring both costs and profits, then you’re influencing how firm is run.
When partnerships break up it is usually kind of chaotic bc they were meant to go on indefinitely and
partners may not have provided for it/. It can happen by physically dividing the party, judicial auction of
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the firm with division of profits, or appraisal with fair payment of a share to partner who no longer wants
to continue if others do.
Page v. Page (Cal. 1961)
 Facts: Brothers entered into oral partnership agreement for linen supply company. Each
contributed equal amounts as starting capital. Business lost money for almost 10 years. Main
creditor was corporation owned by plaintiff. Creditors get paid first so he if he killed the company
he would get all the assets and push brother out
 Issue: Is Big Page leaving partnership in violation of partnership agreement even though there is
only an oral agreement? Is partnership for term or at will?
 Held: This is a partnership at will. A partner has power to dissolve the partnership by express
notice, but cannot act in bad faith or violate fiduciary duties. (no showing of bad faith here, but
had there been, P would be liable for breach of fiduciary duty)
 Takeaway: In a partnership at will, the parties still owe a fiduciary duty to each other, even when
deciding to end the partnership. They can’t make that decision in bad faith. The decision to
terminate a fiduciary duty is subject to a fiduciary duty.
Partnerships and Third Parties
Three main issues:
1. Who is a partner?
2. When can exiting partner escape liability for a partnership obligation?
3. How are claims of partner’s firm’s creditors on partner’s personal property to be balanced against
claims of partner’s individual creditors on this property in the event of partner’s insolvency?
Bankruptcy Rules/Creditor Priority
 When a partner goes into bankruptcy, what creditors gets first shot at the money?
o Brute force – quickest creditor gets first dibs.
 Most jurisdictions don’t have this rule, and instead use priority rules to assess who
gets to come first.
o Priority by assignment – creditors can contract for priority spot
 E.g. can contract to say that you will have first priority. Or can contract for lower
(5th) position and get a higher interest rate.
o Jingle Rule was the general rule for a long time. Now, partnership creditors can go after
partnership and individual. Absent RUPA (bankruptcy), the jingle rule applies.
Partnership Creditors’ Claims Against Departing Partners
Departing partner is liable for partnership obligations incurred prior to her departure, but partner can’t
exercise control over continuing business to satisfy these obligations.
UPA Section 36(2): releases departing partner of partnership debts/liability if the court can infer an
agreement between departing partner, the partnership creditor, and the continuing partners to release the
withdrawing partner. Such agreement may be inferred from the course of dealing between the creditor
having knowledge of the dissolution and the person or partnership continuing the business.
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UPA Section 36(3): Releases the departing partner from personal liability when a creditor renegotiates his
debt with the continuing partners after receiving notice of the departing partner’s exit.
Balance concerns between making it too easy for departing partners to escape partnership debts and
making it too difficult for departing partners to escape liability when continuing partners impose business
risk on their former partners who no longer exercise control over business decisions of the firm.
Exiting partner must give NOTICE to all creditors. Partner not liable for debts after exit. If
partner fails to give notice, they are liable for any debts incurred by continuing partners.
Partners are personally liable for all contracts, torts, etc. while acting on behalf of partnership
Third Party Claims Against Partnership Property
Segregated business assets – otherwise would be available to both personal and business creditors.
Need to create separate pool of business assets conflicted with idea of partnership as aggregate of
Partner has a transferable interest in the profits arising from the use of partnership property and the right
to receive partnership distributions.
Claims of Partnership Creditors to Partner’s Individual Property
A partnership’s bankruptcy usually triggers bankruptcy of its partners. What creditors get priority?
Jingle Rule, UPA §40(h) & (i); partnership creditors have first priority in partners personal property
 Not bankruptcy (i.e. deceased partner)
 Partnership creditors have priority in all partnership assets; individual partner creditors go after
individual assets first
 Whoever you lent to, you have priority over
1978 Bankruptcy Act, RUPA §807(a); partnership creditors have priority over p-ship assets and equal
rights in individual assets
 Partnership creditors can go after partnership assets first and are on the same level as individual
creditors to go after individual assets
Depends on state for which they apply, states that apply UPA usually apply jingle rule and bankruptcy
rules applies to chapter 7 bankruptcy always.
Partnership Governance and Issues of Authority
Partners have the ability to bind each other.
National Biscuit Co. v. Stroud (N.C. 1959)
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Facts: Stroud and Freeman own grocery store. Stroud told Nabisco that he wasn’t going to be
personally responsible for any more bread Nabisco sold to grocery store. Freeman still kept
ordering bread from Nabisco. Twenty days later, Stroud and Freeman dissolved partnership.
Issue: Is Stroud personally liable for bread sold by Nabisco to grocery store?
Holding: Stroud is liable for the bread; Under UPA §18(h), in general partnership, Stroud couldn’t
restrict Freeman’s authority to buy bread for partnership since it was an ordinary matter connected
with the business.
Can restrict Freeman if majority of partners say so; this is 2-person partnership so need both to get
majority (either partner can bind but need both partners to unbind)
No way to get out of or change p-ship unless the agreement expresses otherwise but that needs to
be expressed to third parties
Takeaway: In General P-ship (without agreement to the contrary), one partner cannot restrict the
power of another partners when it comes to ordinary business matters
Small business structures can be very unstable – 1 person leaving can be big problem.
Going concern: business that functions without threat of liquidation for foreseeable future.
Termination (Dissolution and Dissociation)
Have to figure out how much business is worth in order to divide assets
Adams v. Jarvis (Wis. 1964)
 Facts: One doctor is leaving medical partnership. The partnership agreement defines what
departing partner’s share would be (entitled to the balance to his credit on the partnership books;
p-ship agreement provided for continuation of p-ship after withdrawal of a partner
 Issues: (1) Does withdrawal of partner constitute a dissolution of the partnership under UPA §§29,
30? (2) Is withdrawing partner entitled to a share of the accounts receivable?
 Holdings: (1) Parties intended that partnership and partnership business would continue even after
partner withdrew. (2) Agreement provides that AR will remain partnership property, and the
provision is enforceable.
 Departing P wanted dissolution bc when p-ship is dissolved the ct winds up the p-ship, sells
everything and divides profits amongst ps; but here they had an explicit agreement
 Take-away: The continuing partners have a fiduciary duty to withdrawing partner and are
obligated to conduct the business in a good-faith manner (utmost good faith, loyalty, and fairness)
Statutory Dissolution of a Partnership at Will
What happens when the partnership agreement doesn’t address dissolution?
Three possibilities
1) Physically divide the partnership’s assets in a way that seems plausibly fair
2) Conduct a judicial auction of the firm – can be sold intact as a business or for liquidation value
and then profits given to creditors)
3) Appraiser’s valuation of what the partnership’s assets would be worth to the highest valuing
purchaser if they were auctioned off, and allocate a proportionate share of this value to the
partners who no longer wish to continue the firm. (UPA doesn’t have provision for this option)
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Accounting for Partnership’s Financial Status and Performance
Accounting Statements
Balance sheet: as of a particular day, how many assets, liabilities, and shareholders equity you have.
These have to equal out.
Income statement (statement of profit and loss): Over a particular period of time (usually start to end of
year). Usually how profits are calculated. Usually doesn’t balance out. (over period of time) How much
revenue you are generating and what your costs/expenses are.
Cash flow: cash in and cash out. (over period of time)
It is important to consider and figure out what assumptions are being made to understand these accounting
Alternative Business Organizations – LP’s, LLP’s, LLC’s
General Partnerships – Unlimited joint and several liability; any debts that a partner takes on is
applies to any other partners as if they incurred it themselves
Limited partnership –
 2 categories of owners (general partners and limited partners):
 General Partners control and have unlimited liability; must be at least one
 Limited partners have no control, and their liability is limited to what they invest;
if they do exercise control, they expose themselves to liability
 Common in hedge funds, venture capital arrangements for investing in early-stage
 Hedge funds usually run on a 2/20& system: manager takes home 20% of the
increase in value in a year and 2% of assets under management (incentivizes
partners to seek both short- and long-term profits
Limited Liability Partnerships – (allowed by statute) liable for your percentage (only the percent
you invest). This is the midway position. It reduces risks, but not by that much; has centralized
management that runs everything, and every partner has some amount of control
 Concern: sends the message that you are not confident in your work which is why you
want to limit your liability
 Common in law firms
Limited Liability Company –
 Centralized management and limited liability, but all partners share control
 Directors are only liable for what they invest (like and LP), but here directors have control
whereas in an LP they don’t
 Allows for a lower tax break, which is preferable
 Popular among people starting up small businesses
 can’t be publicly traded. Allows all members to make decisions.
 Similar to corporation only owners have a say in how things are run
 Partners have fiduciary duties to each other
 Can opt out of fiduciary duties by K, but courts are really squeamish and disfavor
post-hoc agreements; anything that happens within 6 months of the dissolution
that was known about at the time of dissolution, you have to disclose
Business Trusts/REIT (Real Estate Investment Trust)
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Recently, LLCs and trusts have been most popular form.
These give people wanting to create businesses a menu of options. They can contract to tailor to their
specific needs. State legislatures create these different options to appeal to businesses and are therefore
very responsive to changing needs. States want businesses to be in their state so that they can tax them
(registering and incorporating fees).
Contractual Flexibility and the LLC
Delaware law gives maximum flexibility in LLC creation to freedom of contract and to the enforcement
of limited liability agreements. Delaware law doesn’t require list of initial managers and members to
appear in its publicly registered Certificate of formation.
Delaware case law grants LLC members same fiduciary protection from opportunism as non-controlling
beneficiaries of traditional entities, like minority partners or corporate shareholders.
How explicit do parties have to be to “contract out” of liability for fiduciary breach?
Pappas v. Tzolis (NY App. Div. 2011) (LLC)
 Facts: Parties created LLC for sole purpose of long-term leasing a building in Manhattan. Tzolis
buys out other LLC members at 10x their initial investment before turning around and assigning
the lease at 200x initial rate.
 Issue: In failing to disclose to Pappas et al that he was negotiating sale of leasehold interest at
higher rate, did Tzolis breach fiduciary duty despite Pappas et all signing handwritten certificate
excusing Tzolis from fiduciary duties?
 Held: T violated duty of full disclosure which the certificate did not specifically waive; operating
agreement permitted T to engage in outside business but not to secretly negotiate the sale so duty
of disclosure was not waived by certificate
 Takeaway: You can contract around fiduciary duties, but must be specific about what and which
duties you are waiving
Cf. Pappas to fiduciary duties in Meinhard, Page. Courts will allow LLC members to contract out of
fiduciary duties but it must be explicit.
 Law now says that you CAN opt out of fiduciary duties in LLC format.
 Different structures give rise to different types of fiduciary duties.
Information Asymmetry: Different levels of information access will give rise to this type of problem
 Active and passive investors, the active party will know about new opportunities and will tend to
use information to steer opportunities to themselves. The passive investors will pull their money
when they see losses.
o Most arrangements will try to ameliorate these two problems.
 E.g. hedge fund investors can only withdraw money at certain points during year.
2/20 rule
The Corporation
Four Key Features of Corporations:
1. Separate Legal Entity/Legal Persona
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a. Corporation is a separate legal entity that doesn’t dissolve when SH or mngmnt change
b. Different from the unlimited liability of partnership, where risk assessment of other
creditors is hard when you have 300 partners.
c. Corporation, there is no worry about what shareholder assets are. Only worry is about
corporation’s assets and liability. There is only one thing to monitor. Corporate form
makes it easier to scale up.
d. Entity continues on even if shareholders or management change
e. Easier for creditors to monitor and evaluate creditworthiness, don’t need to investigate all
the partners, loans are protected by company’s own assets
f. Corporations are citizens under Constitution; can’t vote but can exercise first amendment
rights (Citizens United)
2. Limited Liability for investors
a. Capped downside – shareholders can’t lose more than they invested.
i. Can’t take out more than what they put in and corresponding share of profits
b. Corporation has its own assets, so when a corporation gets sued and has to pay, it’s the
corporation that pays (and SH is only liable for what they invest bc investment becomes
part of the corp’s assets)
c. Creditors get priority on assets if bankrupt, but can’t come after SH; Creditors may charge
higher rate of interest accordingly
d. Can also affect third party willingness to deal, and may require some of the following:
i. Assets of corporation, not shareholders
ii. Personal guarantee
iii. Equity/shares
iv. Higher interest rate
v. Upfront/staggered payments
vi. Contract for priorities – this specific asset first
vii. Anyone who contracts with corporation can contract around it to reduce risk.
e. Easier for investors to diversify, since they don’t care what other shareholders are doing
(incentivizes passive investors to invest)
3. Transferability
a. As opposed to problematic signaling of a partner trying to sell partnership interest,
someone buying shares doesn’t need to know as much. Investment in corporation becomes
attractive for someone who doesn’t want a voice and wants to be a passive investor.
b. Very easy to buy and sell shares in a corp bc only liable for how much you paid and not
picking up joint and severable liability each time; much harder to sell stake in partnership
bc you are asking someone to take on all of your liability
c. Allows SH to easily diversify stock portfolio and further reduce risk by not having all eggs
in one basket
d. Short: borrow someone’s shares, sell them to someone else immediately, then later buy
other shares for cheaper and return them to the original SH along with a split of the profit
i. i.e. A has 500 shares at $10 each; B borrow all of them (for free) and then sells
them to C immediately for $10 each (so he made $5k); B promises A that he will
return the 500 shares in two days with an extra dollar each (so A would get extra
$500); in two days, share price drops to $8, so B buys 500 shares at $8 (only spends
$4K), and then he returns the shares back to A along with $500; So A makes $500
and B makes $500
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e. Liquidity – it is easier to turn investment into cash. Don’t have to wait around long to sell
f. Risk averse vs. risk loving. Diversification reduces variation.
4. Centralized Management
a. Agency relationship: management acts on behalf of corporation/shareholders
b. Easier to have a small management team make decisions, rather than having millions of
people weigh in
i. small team should have best interest of the entire company in mind as opposed to
just a tiny stake in the corp as an individual share owner would
c. Managers act on corp’s behalf and are appointed by Board
d. Board is elected at annual meeting
i. Board oversees management but board only meets a few times a year and they get
their info about the company from mngmnt so obviously mngmnt will say they are
doing well
e. Con: collective action problem in dispersely held means most SH don’t care who
management is and won’t investigate, so management basically picks the Board
i. Isn’t board supposed to monitor management? It’s ok bc SH can sell if they don’t
like what Board is doing
Types of Corporations
Closed v. Publicly Traded
 Closed: if you want to buy a share in the company, you have to go to the company, interact with
ppl at the company and buy a share (only a few SHs)
o SHs are the management; so SH is less concerned about incentivizing mngmnt, more
concerned with everyone getting along (worry about other SHs not mngmnt)
 Publicly Traded: go to stock exchange to buy/sell share, more worried about mngmnt
Controlled v. Dispersedly Held:
 Controlled: small amount of people, or even one person, (known as controller) has a large amount
of decision-making power in a company, they decide what happens
 Dispersedly Held: No one has any significant portion of the shares (no controller)
Citizens United v. Federal Election Commission (SCOTUS 2010)
 Take-aways: 1. Corporations are entitled to First Amendment rights (may engage in political
speech). 2. Collective action problems: individuals have small stake, hard to educate them, so
small shareholders rarely vote.
o Corporations don’t have right to protection from self-incrimination; they do have
protection against search and seizure (limited), and protection from cruel and unusual
Centralized Management
 Corporate Charter: constitution of corporation, both Board and SH must approve changes
 Bylaws: are the operational rules and can be changed by Board or SH
 Board structure established in charter
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o Staggered board: one that is elected in part every few years (i.e. board has 9 spots, you
might get to elect 3 members every three years)
 this can lead to the unfireable CEO problem, bc it will take a few years to kick out
mngmnt and gain control; int hat time, remaining managers can easily squeeze
money out of the firm and cut themselves a sweet severance deal
 Role of Board:
o Monitoring to make sure management does its job (prevent abuse)
o Monitoring to make sure the company is following the right strategic path
 Board can establish committees and delegate tasks to them, but cannot delegate decisions required
by statute to be made by the Board
 Board can only act at a duly constituted Board meeting and only by a majority vote that is
recorded in the minutes (Fogel v. U.S. Energy Systems – meeting of outside directors before Board
meeting to fire CEO doesn’t count)
 Boards often meet only a few times a year; concern with how they can actually supervise like this
 Board Selection: Shareholders get together usually once a year (AGM = Annual General Meeting)
to select board (amount of elections can be varied)
o Board typically picked by management in dispersed firms bc of collective action problem
 Generally, shareholders select board, board selects management (CEO, etc.who run operational
stuff and day to day).
o Role of management: make sure the company is running in a good/profitable way
 Board rarely makes day to day decisions or votes on operational matters unless it’s a huge deal
 Board sometimes makes fund/strategic decisions.
 Board members are weak monitors because their info comes from management, how do we
eliminate that problem?
o One solution is to change where the board gets their info, could set up committees with ppl
who are not part of the company
 i.e. audit committee: independent committee that gets financial info about the firm
 i.e. governance and nomination committee: independent group that determines who
would make a good audit committee/board member, this theoretically interferes
with the potentially conflicted incentives of allowing management to make those
 could have substantial shareholder make his own recommendations
 Most corporations incorporated in Delaware: It has a lot of corporate lawyers and expertise and
lead the way towards liberalization. Odd that there is competition b/c you can contract around, but
default rules often adopted when management and owners can’t agree. Leads to race to bottom.
Delaware is vague and flexible b/c mostly fiduciary duty law.
o Corporate law in the US is not federal, it is state-driven. States make money when
companies incorporate in them (through an original fee and ongoing fees). About 80% of
Delaware’s budget comes from incorporation fees.
o Everyone is very comfortable with Delaware being a corporate hub
o Delaware’s court system is structured in a corporation-friendly way
o Delaware’s laws and court decisions are deliberately vague so no other state can just copy
1. Board Structure and Operation
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a. Elections for board members has collective action problem in dispersely held firm
(blockholders have a lot of power)
b. Board is largely selected by management (but board’s job is to monitor management)
c. Board meets about 6 times a year (is that really monitoring management?)
i. Meetings are announced in advance. This runs into issue like telling a teen to clean
up his room. In order to effectively monitor, board must hire people they trust to
tell them whether firm is running well all the time or just when they visit.
ii. In actuality, the board only monitors a couple things
1. Decisions that would bankrupt
2. Decision to buy or sell firm
iii. There is very small discrepancy in views between board members because they talk
to each other and have probably already made decisions before official meetings
1. Board meetings are usually highly scripted. Recorded in minutes and tend
to be pretty smooth. Decisions are often unanimous.
d. If board and shareholders don’t agree, they vote.
2. Voting
a. Three things must be identified
i. What are you going to vote on?
ii. How often?
1. Fund/merger is boted on when and if it comes before shareholders.
Otherwise, once a year at annual meeting.
2. Directors are elected once a year
iii. Who? Shareholders or board?
b. Management usually makes operational decisions
Jennings v. Pittsburgh Mercantile Co.
o Authority for corporate officers for extraordinary transactions puts third party on notice
o Facts: Jennings is trying to broker deal with PMC through Egmore (VP). Plan is for sale and
leaseback: sell all factories, then lease everything back. Egmore makes representations that if
Jennings finds deal, they’ll go through with it. But then Egmore says no and backs out of deal.
o Sale & Leaseback: Usually do this when someone believes their business is profitable but they
need cash immediately.
o Alternatives: bank loan (but then you’d have to pay interest) or add more shareholders (but
then you’d have to share profits).
o Usually only do a sale and leasback if other forms of financing are unavailable or
unattractive to you. It can be a sign that the company isn’t doing too well and is a bad
credit risk.
o Issue: Does Egmore have apparent authority to do this?
o Holding: It is unreasonable for Jennings to expect Egmore to have authority. It is an extraordinary
transaction that requires monitoring obligation of third party.
o Takeaway: this sort of action requires a board vote and cannot be done by just the VP; the VP
doesn’t have the apparent authority to do this
Automatic Self-Cleansing Filter v. Cunninghame (Eng. C.A. 1906)
 Facts: 55% of shareholder group want ASC to sell assets, but the board doesn’t want to.
Shareholders want to overturn board’s decision, but they need 75% of shareholders.
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Issue: is board breaching its fiduciary duty by not selling shares?
Holding: Board is not breaching its fiduciary duty by not selling shares, since it owes its duty to
the company and not the majority of shareholders.
A 55% owner cannot control the vote if it requires a 75% vote
Notes: It wouldn’t make sense to set up a board to manage company and then have shareholders
dictating what they do. Need to protect minority shareholders, and abide by corporate charter
rules. (55% might force board to do something that would benefit 55% at expense of 45%. But
board is elected by simple majority…)
Problem with board election
Passive investors don’t know anything about board, so friends of management get elected.
Management wants a board they’ll get along with. As a small shareholder, if you don’t like the
way the company is being run, you just sell your stock. This produces an incumbency bias: the
people who are left think company is being run ok.
Defer to board: expertise, minority protection.
Key Players
 Board of Directors: Has a chairperson who has only one vote but sets agenda, sometimeyou have
lead director who is counterbalance and is supposed take things up with Chair. Often the CEO is
the chair of the Board and other managers may be on it, too. All firms have committees, must have
audit. Others vary
o Audit Committee: Must be staffed by independent (non-manager) directors per SEC Rule
10a-3; job is to make sure financial statements are true and fair representation of how
company has done. They have a lot of work. Have to review financial statements, hire
auditor, talk to the auditor. If something goes wrong, they are probably going to be sued
o Risk Committee: Not all firms have. They are supposed to be independent
o Compliance Committee: Make sure the firm doesn’t violate any laws. These are supposed
to be independent directors
o Governance and Nominating Committee: Suggest who should be on the Board, these are
supposed to be independent director.
 Management: Responsible for all day to day activities b/c they are there every day
o CEO: They run everything at the firm on daily basis and have compliance duties and have
to certify financial statements. Must certify annual and quarterly reports per SarbanesOxley. Must certify responsible for controls, designed them well, and evaluated them and
reported defects and changes to auditors audit committee.
 Has overall decision making authority except for those things where board/SH
approval are explicitly required
 CEO will interact with everyone, same with GC. Everyone else has more limited
contact. CEO and GC become focus points when people are trying to regulate what
is going on within the firm.
o Chair of the board: gets one vote, but the chair is elected by the board so board members
often defer to the chair; chair sets board’s agenda
o CFO: Manages all financial matters for the firm and has some compliance duties. Must
certify annual and quarterly reports per Sarbanes-Oxley.Must certify responsible for
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controls, designed them well, and evaluated them and reported defects and changes to
auditors audit committee.
o Internal Audit Executive
o Chief Compliance Officer: makes sure the company complies with the law and any other
agreements/requirements the company has subjected itself to (like environmental
standards). Strength is system design, making sure things are designed to keep things legal.
Sometimes this person is a lawyer
o Chief Legal Officer/General Counsel: Lawyer for firm, some amount of compliance
responsibility, monitoring the firm, run the legal department, liaison. GC is almost always
a lawyer subject to ethical duties
o Chief Risk Officer: risk management; only common in firms that are big enough to split
apart legal and risk departments; could include things that aren’t illegal, but look bad
When pay dividend and who is liable?
o DGCL § 170: the directors may declare and pay dividends either:
o Out of surplus (defined in sections 154 and 244); or
o In case there shall be no surplus, out of its net profits for the fiscal year and/or the
preceding fiscal year
o Directors – DGCL § 174
o But directors are fully protected if they reasonably rely on mngmnt or outside experts - §
o Shareholders – DGCL § 174(c)
o Liable only if they knowingly receive an illegal dividend
o Directors and corp can bring claim against SH
Creditor Protection
1. If a creditor lends you money, you could lose it all or steal it; with those risks, no one would want
to lend money without protections in place
a. One way to minimize risk as a creditor is to do your due diligence on the company, but
there will always be some underlying risk of theft, incompetence, and bad luck
2. Concerns with limited liability
3. Disclosures – statutory response
a. Mandatory disclosure: if you sell assets below a certain threshold or use money for specific
transactions, you have to alert creditors you’re going to do it; this gives creditors the
chance to race to the court and push your company into insolvency or freeze your assets
b. Distribution constraints: Requiring a company to have at least X amount of money in their
company at all times. They can’t give out too big of dividends.
i. People used to start companies, take out loans from a bank, and then immediately
distribute all of that money to shareholders as a dividend. Then, when the bank (the
creditor) tried to sue, the company had no assets, and the bank can’t get to the
shareholders because the company is a separate legal entity. Distribution
complaints solve that problem.
ii. This can be done with the par value of shares; the minimum price that a share can
be sold for. The par value will always go to the company in its stated capital
iii. However, it’s usually easy to get around these.
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c. This protects creditors. Once you disclose, it means creditors can monitor you. They can
also accelerate your debt and push you into bankruptcy
d. There are rules about forcing disclosure
4. Distribution constraints – statutory response
a. Creditors  Corporation – ($100m)  F – ($1m)  Corporation
i. This is a standard problem for creditors – corporation moves its assets into another
entity and is given significantly less value, so creditors can’t get to it (courts won’t
look into adequacy of consideration)
ii. Creditors can’t go after F unless fraud provision or statute saying corporation/F
can’t do that.
b. Case law fills in gaps with 2 broad strategies
i. Claw back: Get assets that were shot out
ii. Veil piercing: - undoing limited liability and adding in shareholder’s assets
iii. Courts are more willing to clawback assets since they’re the old assets of the
company rather than the new assets that come from veil piercing.
Judicial Protection of Creditors
1. Fiduciary duty to creditors near insolvency
a. Generally
i. Shareholders can enforce fiduciary duty
ii. Board and management owe fiduciary duties to corporation.
1. Usually, board can decide who to sue. An exception to this is that someone
besides the board can sue for breach of fiduciary duty. Shareholders (and
not employees, creditors, or government) can because the shareholders
benefit when the company makes the most money. If something bad
happens to company, shareholders get paid LAST. “residual claimant”.
This gives shareholders inventive to make sure company is doing well,
which will make sure that everyone else (including creditors) gets paid.
b. Creditor fiduciary suits
i. Usually don’t let creditors sue for breach of fiduciary duty because SH better
represent corporate interests
ii. Exception: Credit Lyonnais Bank Nederland – Chancellor allowed bc near the end
of corporate life, SH have incentive to keep corp going in hopes of a payoff instead
of folding bc won’t get paid and may do risky things so creditors have the better
incentive; incredibly rare
1. Sometimes shareholders interests diverge from creditors’ interests, like in
risky opportunities. If shareholders are presented with 3 opportunities, they
will generally choose one with biggest payoff. Sometimes courts will let
creditors sue for breach because they are more rational and steady than
Standard-Based Duties: Directors owe obligation to creditors to render the firm unable to meet its
obligations to creditors by making distributions to shareholders or to others without receiving fair value in
o CLSA: could directors be liable to creditors or other constituencies near insolvency?
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o Gheewalla and Schoon seem to limit to creditors suing on behalf of the firm (not on own behalf)
when firm is insolvent (not near it)
Fraudulent conveyance: sell $100m of assets to corp X, get $1m back
 Uniform Fraudulent Transfers Act (September 23 Slides)
o Fraudulent conveyance law imposes obligation on parties contracting with an insolvent or
almost insolvent debtor to give fair value for the benefit or risk being forced to turn them
back over
o Creditors can attack and void transfer on two grounds
 1) an actual intent to hinder, delay, or defraud any creditor of the debtor (present or
future) UFTA §4(a)(1), UFCA §7; or
 2) transfers made without receiving a reasonably equivalent value if the debtor
intended, believed, or reasonably should have believed he would incur debts
beyond his ability to pay as they became due or the debtor becomes insolvent.
UFTA §§4(a)(2), 5(a) & (b)
 I.e. if a company gets a $1 million loan and the next day sells all assets to
another company for $10, the law of fraudulent conveyance/transfer will
unwind the transaction bc that is not a reasonably equivalent value
 Statutory restrictions on the payment of dividends
 Common law
Shareholder Liability
Equitable Subordination
Equitable Subordination: When a creditor is also SH (and typically an officer of the company) and behave
inequitably, the doctrine of equitable subordination sends them to the back of the line of who gets paid so
there is no money left by the time it is their turn
o Courts invoke when compelled by equitable reasons to recharacterize debt owed by the company
to its controlling shareholders as equity.
Costello v. Fazio (9th Cir. 1958)
 Facts: Fazio and Ambrose were 2 of 3 partners in a plumbing company that they could tell was
failing. They withdrew almost all of their investments, 88% of the company, and took out notes (to
become creditors). The company, grossly undercapitalized, failed, and F and A sued to recover
their notes, thinking that because they had made themselves into creditors, they’d be first in line to
get paid. But the trustee in bankruptcy moved to subordinate Fazio and Ambrose on the claim that
they breached their fiduciary duties and should be sent to the back of the line (equitable
 Held: F and A did this for personal gain and they knew the corp was underfunded; exploited
creditors which is unequitable so pushed to the back of the line
 Takeaway: Test – whether the transaction can be justified within the bounds of reason and fairness
 Note: when you switch from partnership structure to corporation, you have to get release from
creditors, who have to sacrifice claim on partnership for claim on corporation.
Trade creditors don’t have signed contracts, instead just have a revolving informal credit line to be paid
back in 30-45 days. This makes sense because small businesses are cash strapped, and if they had to pay
up front they wouldn’t be able to buy.
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Veil Piercing
Most frequent and radical form of shareholder liability. Sets aside the entity status of the corporation to
hold shareholders liable directly on contract or tort obligations.
o Courts agree that some abuse of the corp form is required in order to disregard separate legal id of
o Used sparingly
o Courts consider the following when deciding whether or not to pierce veil:
o A disregard of corp formalities
o Thin capitalization
o Active involvement by SHs in management
o Small number of shareholders
Contract creditor: someone who has lent you money or services, expecting to be paid later
Veil Piercing Tests:
1. Van Dorn Test: Creditors can pierce the corporate veil and go after SHs where (1) there is unity of
interests btwn SHs and the corporation (they aren’t really separate players, i.e. they share a bank
account), and where (2) adhering to the corporate form would sanction a fraud or promote
a. The injustice being some misrepresentation that induced TP to K with corp and now TP
can’t recover
b. Creditor would want to do this if he can establish a basis to hold a corp liable for
something, and the corporation has insufficient assets to pay it – creditor would want to
pierce corp veil to get the parent or SHs assets
2. Lowendahl test: requires that plaintiff show the existence of a shareholder who completely
dominates corporate policy and uses their control to commit a fraud or wrong that proximately
causes plaintiff’s injury. Domination = failure to treat the corporation formality seriously (no
3. Second formulation of test: courts should disregard corporate form whenever recognition of it
would extend the principle of incorporation beyond its legitimate purposes and would produce
injustices or inequitable consequences.
4. Laya Veil Piercing Test (Kinney Shoe) (4th Circuit)
a. (1) unity of interest and ownership such that the separate personalities of the corp and the
individual SH no longer exist
b. (2) Would an inequitable result occur if the acts were treated as those of the corporation
c. If both prongs are satisfied, D might still prevail by showing assumption of risk Simple
formalities of corporate entity.
Sea-Land Services v. Pepper Source (7th Cir. 1991)
 Facts: Marchese was sole shareholder of pepper source; Sea-land, a shipping carrier, shipped
peppers for Pepper Source. Pepper Source didn’t pay. Pepper Source was dissolved when it didn’t
pay state franchise tax and didn’t have any assets anyway. Sealand sues Marchese who may have
money is his other companies (actually reverse veil-piercing).
 Issue: Can Sea-Land recover against the former owner, Marchese and pierce the veil to get to
Marchese and his other businesses (reverse veil piercing)?
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Van Dorn test applied:
o (1) Is there unity of interests and ownership/ shared control? Yes, the companies were
practically M’s personal bank account
o (2) Would an injustice or wrong beyond a creditor’s inability to collect result?
 This was a contract creditor so SL willingly chose to K with M; but M clearly
misrepresented the company to convince SL to K with him; remanded for further
proof of an additional wrong like fraud or deception
Take-away: need both shared control/unity of interest AND overt element of fraud to pierce the
corporate veil
Why do we need both steps of the Van Dorn Test?
o We need the injustice part because it is possible to disregard corporate form without perpetuating
o i.e. husband and wife running a company don’t really need board meetings; or a situation
where the creditor is aware of the disregard of typical corporate form; creditor is aware and
contracted for their compensation then definitely no need for court to get involved
Kinney Shoe Corp v. Polan (4th Cir. 1991)
 Facts: Kinney subleased a building to Industrial Realty which then subleased half to Polan; Both
Industrial and Polan were owned by Polan and neither had assets. They were both sham
companies to protect Polan from liability. Polan stopped paying after one month of the lease.
Kinney sues Polan to recover money owed on a sublease between Kinnney and Industrial Realty.
Polan is sole shareholder of Industrial.
 Held: Veil should be pierced because the elements of the Laya test are met; unity of interest and
Polan took advantage of the corp form to avoid liability so there is injustice. Polan is personally
liable for debt of Industrial.
o Lower court also added third prong to this test requiring Kinney to investigate Polan before
contracting; this is erroneous; it is permissive to investigate but not mandatory
 Notes: K probably knew that Industrial and Polan had no assets and still chose to lease to them
anyway; so why should Kinney still recover?
o Maybe court wants to disincentivize P’s actions bc P is engaging in fraud while K is just
o P also made one payment which might’ve convinced K that he would continue paying
Veil Piercing on Behalf of Involuntary Creditors (Tort)
Tort creditors are different from contract creditors because they don’t look at creditworthiness of
corporation in placing themselves in a position to suffer a loss and they can’t negotiate with a corporate
tortfeasor ex ante for contractual protections from risk. Can’t monitor its capitalization or insurance
Walkovsky v. Carlton (NY 1966)
 Facts: Walkovsky was run down by cab owned by Seon Cab Corp and operated by Marchese.
Carlton, individual defendant, is a stockholder in 10 cab corporations owning two cabs each, one
of which is Seon (minimum insurance reasons). Cabs aren’t worth much so the assets of any one
of these isn’t likely to cover injury. W argues that he can pierce veil and treat ALL of C’s
companies as liable for injury; otherwise, C has set himself up to be virtually judgment proof
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Court applies same test as in contract creditors. Walkovsky cannot pierce corporate veil because
there’s no unity of interest even though it is unjust. C wasn’t abusing the corporate form, he was
actually adhering to the rules and being clever; wasn’t syncing bank accounts w companies
Takeaway: Inadequate (thin) capitalization alone is not enough to justify veil piercing. There
needs to be unity of interest.
o C was following rule, and legislature couldn’t have intended for their rule to be fraud
Contract creditors v. Tort Creditors – court apply the same rule but should they?
o With a tort creditor, there is no opportunity for someone to K or negotiate w/ the creditor
beforehand, so you can’t just charge a different price to account for risk
o So should be easier to pierce the veil in tort cases, based on the theory that a K creditor
chose to K with the corporation after having the opportunity to investigate?
o You can’t monitor a tort situation but you can monitor a contract situation
o Less opportunity to K for tort and crime victims/creditors: so perhaps pro rata unlimited liability?
o Pro rata unlimited liability: SHs would owe their percentage of the liability (own 5% of
shares, pay 5% of the liability)
o Maybe change priority rules (make some K creditors come after tort/crime creditors); make
creditors monitor firm for tort/crime
o Gatekeep liability: firm is fictional entity so imposing liability on anybody imposes
monitor status on that person
Since courts say we are not going to pierce the corporate veil if corporations maintain the corporate form;
legislation has gotten involved
Statutory Veil Piercing
 CERCLA – comprehensive environmental recovery act: require companies that
have engaged in dangerous activities environmentally to pay for the cleanup
o The company that operates the facility is liable for the company cost – operate in fact so
which people actually got people on the ground running it
o Parent sub relationship is not enough; need something more, like agents of parent are
running sub without appointment of that position; doing something more than would be
normal of a parent sub relationship; suggesting that the parent is paying more attention to
this than what would be expected
 Bestfoods
o Derivative liability – veil piercing doctrine
o Direct liability – did Parent operate facility
 Here operate means:
 Agent of Parent operate facility without formal appointment
 Dual parent and subsidiary officers moving beyond norms of corporate
 ERISA similar: employment retirement insurance security act
 Enterprise Theory
o Agency theory (ala CERCLA) for wholly owned subsidiaries
o Single business enterprise – berle argument of networks of firms
 Substantive Consolidation
o Multiple relationships, holding structure, et al.
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o Cost of unwinding high may then push for substantive consolidation
o Equitable doctrine: bankruptcy court is court of equity
o Asking bankruptcy courts to engage in veil piercing
Successor Liability: if company is bought out by another company, who is liable?
o Entity that buys a corp inherits its liabilities, including contingent liabilities (those that are pending
or haven’t happened yet)
o In K scenarios, cts are pushing to make this period of time shorter; in crim and regulatory
scenarios, those periods tend to be longer
o Common Law (some jxs) allows creditor to go after the company that buys the company that went
bust if they are in the same product line (logic is if they are in the same line of business, then they
understand the risk better and probably negotiated it into purchase price
Mini finance unit
 Equity vs. debt:
o Equity: shares/common stock
 Shareholders get paid last, but in return they get voting power
 No interest rate
 Residual claim on corp’s assets and income after expenses and debt paid
 Board declares dividends
 Preferred stock
 Typically has preference over common stock for liquidation and dividends
 Usually doesn’t vote when dividend is current
o Debt: loans, bonds, notes, etc.
 Holder has contractual right to receive a periodic payment of interest and be repaid
principal at stated maturity date
 You expect to get your money back.
 You also get an interest rate, which can be fixed or flexible (changing based on market
 You get first crack at a company’s assets as a creditor
 Better tax treatment than equity for the corp (interest paid is deductible business cost)
Estimating costs and valuing assets
 Time value of money:
o Investment means you’re giving up consumption right now. You have to wait to profit. So
money changes value over time.
o People value things differently at different times. Something that sounds good right now might
not sound as good in ten years.
 Like saying “don’t eat dinner for the next month, but then you’ll get a feast.” That
doesn’t sound too good.
o You’ll need to be paid something to bear the risk of uncertainty. Anything that takes time to
mature/profit comes with uncertainty, and each person has a different risk tolerance for that
o FV=PV(1+r)
 Present value: value today of the money to be paid at a future point
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 Discount rate: based on time value of money and level of risk; how you can figure out
what money is worth in the future, and how much it’s worth to you to deal with the
 When the investment is risk neutral, this is alled the risk-free rate
 When investment is risky, this is called the risk-adjusted rate
 Discount factor = 1 + r
 T = number of years and
 n = number of compounding lperiods of interest per year
o Rate of return: % earned if you invest
o Relationship btwn PV and DR: PV gets higher as discount rate is lower
 Risk is designed to measure the difference between your expected value and the possibilities. If you
say “We’re 50% sure we’ll make $10 million,” the expected value is $5 million.
o Unsystematic risk: Risk that is not determined by the system, and can be offset. For example,
the risk that one company will perform poorly. You can offset that via diversification.
o Systematic risk: Risks that are extremely difficult to offset; i.e. the risk that the stock market
will entirely explode, or that the sun won’t rise tomorrow.
o Net present value (NPV): PV of amounts received minus amounts invested (risk worth it if
positive) (not all use this; i.e. VC funds might want 10x)
o Diversification
 Can eliminate unsystematic risks through diversification
 Perfect diversification: two exactly opposite investments (or partially offsetting)
 Index diversification (buy all 500)
 Discounted Cash Flow method (DCF):
o Says we look at the present value of future cash flows (based on the different considerations of
the time value of money) to get a net present value. If this value is positive, you invest.
 Efficient capital market hypothesis:
o The theory that the market will aggregate all of the available information and spit out a price
that represents the combination of all of that information. Market prices are based on
everyone’s independent evaluation of a stock’s value, for better or worse.
 How does this matter to lawyers: three ways:
o 1) Clients: VCs and PE tend to use simpler methods to value – less information intensive
o 2) Courts: often use discounted cash flow methods when they have to value shares
 Emerging Communications: Appraisal action in which courts need to determine fair
price for minority SHs who were forced into a buyout; Ps say market isn’t efficient bc
not a lot of ppl trading and SHs have more info than the market; Court uses NPV and
picks middle of experts’ estimates; Court can’t always do this—by statute; Minority
SH is one situation where statute allows it
Normal Governance: The Voting System
Role and Limits of Shareholder Voting
Most of the utility of the corporate form comes from centralized management’s broad discretion. This is
restricted by statute and may be restricted by corporate charter but often isn’t.
Default powers of shareholders:
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1. Right to vote.
a. Get to choose board, get to vote on some fundamental corporate transaction
2. Right to sell.
a. If not ok with company’s performance
3. Right to sue.
a. Can sue directors for breach of fiduciary duty in some circumstances.
Rules of the Road
 Shareholders have a collective action problem, and individual shareholders are often rationally
apathetic (not worth it to most SHs to inform themselves about the necessary info to make a
proper decision.
 Institutional investors, who have a larger percentage of shares (roughly 5%) don’t always vote in
the same direction. This is where most of effort is placed.
o Mutual funds: investors park money in don’t manage their own money; mngmnt does;
mutual fund buys for investor based on preferences of investor and hold those shares for
 Stakes in individual firms tend to be small
o Pension funds: mutual funds but for retirement funds (pensions); less risky
o Private equity typically buys control of the firm
o Hedge funds typically take bigger portions than mutual but less than PE
o Index funds invest in the entire market (huge right now) – more passive so less fees than
mutual and hedge
 Typically, any 10% or more SH in a company can request a meeting for a vote (date usually has to
be set at least 90 days in advance)
 Directors are elected (and removed) at annual meeting.
Electing and Removing Directors
Foundational and mandatory voting right. Every corporation MUST have a board of directors,
even if it’s only one member. DGCL § 141(a)
Every corporation must have one class of voting stock. Default is one vote per share. DGCL
You can K around voting terms, even have no vote shares
Default: one share = one vote
Straight voting: everyone gets one vote to case for each empty position
Cumulative Voting
 Increases possibility for minority shareholder representation on the board of directors. Each
shareholder can cast a total number of votes equal to the number of directors for whom they are
entitled to vote, multiplied by the number of voting shares that they own, with the top overall vote
getters getting seated on the board.
o i.e. 3 seats open, multiply amount of votes you have by amount of open seats so if you
have one vote now you have three votes and you can choose where to put those; gives
minority more of a say
o if A splits votes equally (60-60-60), B could go (0-120-0) to ensure it gets at least one
director it wants
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Removing Directors
State corporate law governs director removal.
Common law: directors could only be removed for cause. Director has some due process rights when
removed for cause, but its unclear what ones. (Campbell v. Loews). Also unclear what good cause is.
Fraud or self dealing – yes. But bad business judgment is not.
State corp law bars directors from removing other directors without express shareholder authorization.
Any court of equity supervising performance of any fiduciary has an inherent power to removed for
cause. Board can petition the court to removed director from office if there is cause for removal.
Unfireable CEO
o bylaws can be amended by board only
o charter requires SH and board approvable
***Keep track of what’s in the charter and bylaws and who you need to make changes***
Staggered boards
Makes it harder for a shareholder to gain control of board of directors vs. a unitary board. Elected in
rotating cycles – i.e. 3 year terms. Shareholder seeking control must win two elections (2/3 of seats) to
gain majority control.
o i.e. board has 9 sports; you might elect 3 members every three years
o This is very relevant within context of hostile takeovers and poison pills
o Targets of hostile takeovers are significantly more likely to remain independent if they have a
staggered rather than unitary board. BUT staggered boards tend to entrench boards and managers
in ways that deter value increasing hostile takeover bids (see Unocal/Revlon).
o IPOs benefit from staggered board bc more stability while new firm is finding its feet
o Staggered board plus cumulative voting = delay in overturning board which deters overthrowers
bc it takes years to change person in control
Shareholder Meetings & Alternatives
Other things that shareholders can vote on in annual meeting
 Adopt/amend/repeal bylaws
 Remove directors
 Ratify board actions
 Request board to take certain actions
If board doesn’t hold a board meeting within 13 months of last meeting, courts will hear a shareholder
petititon and require that a meeting be held in a summart action See, eg. DGCL §211
Special Meetings: Shareholder meetings held for a special purpose that is not the annual meeting. These
are very expensive.
Who can call shareholder meetings? How? They are in corporate charter, also state law weighs in.
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Khanna 2020
Shareholder Consent Solicitations: Alternative to special meetings. Statutory provision allows
shareholders to act in lieu of a meeting by filing written consents.
Delaware: any action that can be taken at a shareholder meeting may also be taken by the written
concurrence of shareholder of the number of voting shares required to approve that action at a meeting
attended by all shareholders. DGCL § 228. Other states have different rules, like unanimous consent
(Revised Model Business Corporation Act §7.04(a))
Proxy Voting
Shareholder meetings require a quorum. This is hard for dispersely held firms. Board and officers are
allowed to collect voting authority from shareholders by proxy. This allows management to act on behalf
of and at the expense of the corporation. This is integral to publicly financed corporations.
o Proxy: assign you vote to an agent who will vote in alignment with your preferences
o Paper or card that SH sends saying which way they want to vote on issues
o Proxies count towards quorum bc you want to have enough SHs to make the vote count
(you need like 1/3 or ½ of SH votes to make valid depending on the issue
o Proxy votes are extremely expensive and if a challenger loses he eats the cost
 The cost comes from having to distribute materials about the company: this
disclosure is mandatory under SEC Rule 14a-9
 This rule also hits you with crim penalties if you misrepresent a proxy
disclosure, so they are expensive to fact check and produce
Management proxy expenses are always compensated because management is required by law to put
people up for election. When insurgents win, new management usually passes a resolution to compensate
themselves. If corporations paid for insurgent proxy campaigns, then there would be an incentive for
frivolous candidates (Donald Duck).
Rosenfeld v. Fairchild Engine & Airplane (NY 1955)
 Takeaway: Win or lose, incumbent managers are reimbursed for expenses that are reasonable in
amount and can be attributed to deciding issues of principle or policy. Any disagreement tends to
satisfy the difference in policy requirement for reimbursement.
o Those wanting to put up a proxy have to pay themselves unless mngmnt votes to reimburse
(which usually happens when they win)
 Asymmetrical rule: mngmnt paid no matter what but not insurgents, insurgents are less likely to
bring things forward, imposing cost on SH but not mngmnt so SH has to pick their battles
o If it was more symmetrical, there would be excessive amounts of proxy fights
Class Voting
Company has multiple classes of shares that allow for different rights, and sometimes you just need a
majority of shareholders, sometimes (typically) you need a majority of each class before you can approve
a deal or decision There are different types (classes) of shares. Sometimes, to win, need a majority in all
classes. Other times, may just need a majority of votes. There is no limit on the number of classes of
E.g.: Class A: 1 vote per share
Class B: 10 votes per share
o MBCA presumes that if you want something to pass a vote then it has to be a majority of each
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o Delaware law says K as you like and you can mix it up
This may cause problems in voting on fundamental transactions like mergers and charter amendments,
where it may be necessary to protect the interests of separate classes of shares to ensure that the
transaction is fair not only to shareholders in the aggregate but also to those subgroups.
Shareholder Information Rights
Common law: shareholders had right to inspect the company’s books and records for a proper purpose.
Codified DGCL §220; RMBCA §§16.02-.03; NYBCL § 624.
SH entitled to access to information about the company and can sue for stock list or inspection of books
and records if they aren’t getting the information they need; Courts screen info requests for motives, etc.
Delaware sees two different types of requests.
1. request for stock list (names of shareholders)
a. Two ways to get this
i. Name of shareholder
ii. American Depository Trust Corp. (ADT)
1. Holds shares on behalf of other shareholders
a. NOBO – nonobjecting beneficial owner
b. OBO – someone who objects to being identified
2. request for inspection of books and records
a. much more expensive than giving a stock list. Places legitimate interests of the corporation
at risk – expensive and jeopardizes proprietary or competitively sensitive information.
b. Because of risks, requires plaintiff to carry burden of showing a proper purpose (and
informally screens plaintiff’s motives and likely consequences of granting request).
Separating Control from Cash Flow Rights
Circular Control Structures
Using corporate treasury to buy the corporation’s stock and control its voting rights is illegal – law
prohibits management from voting stock owned by the corporation. Need an intermediary – like a
subsidiary or joint venture – in which company owns a minority interest.
Speiser v. Baker (Del. Ch. 1987)
 circular structure with circular voting scheme
 Speiser sues Baker bc Baker won’t show up to a meeting of Health Med. Speiser has total control
of Medallion (which has the most control of Health Med), so Baker knows if he shows up, S will
kick him out of HM and then use all of HM’s 42% ownserhip of Healtch Chem to cote B off HC
 Baker must show up to board meeting at HealthMed. Because the effect of the HealthMed voting
in Health Chem would be to muffle the voice of the public shareholders; breach of fiduciary duty
to HM’s other SHs, but even if S kicks him out, S can’t vote HMs shares in HC
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Takeaway: can’t do anything that violates the spirit of DCL § 160(c), even if it’s technically not a
violation; courts don’t like circular voting schemes that separate the voting power from the cash
Only reason this doesn’t fit squarely with 160(c) is bc Medallion is subsidiary of HC; 160(c) was
only thinking about situations where company A owns party of company B which in turn owns
part of company A
***Agency wedge*** incentives aren’t aligned and the public can’t do anything about it.
Vote Buying
A share represents a vote + cash flow. Why not allow people to split these and just sell their vote?
Normally courts prohibit vote buying.
Rationally apathetic shareholders know that their vote will almost never matter.
Typical US firm is 30% dispersely held public, 70% institutional investors. There is an incentive wedge
between institutional investors and everyone else (institutional investors might get side payments).
EASTERBROOK: don’t let ppl buy the votes that go with stock w/o buying the stock also; they are not
separable commodities. Ppl would not value the vote enough; too tough to value, etc. Even if ppl compete
for the vote, won’t be enough bc won’t always be competitive. AND price will never go about price of
share so will always be below which creates incentive/agency gap
Problems with vote buying:
o How much do you sell shares for if you separate voting power and monetary interest?
o Lower than cost of shares normally otherwise they would just buy share
o How much lower? How much is the vote worth?
 Vote only has a lot of value when it will tip the scale which is not often
o Vote rarely matters so worth very little
o If he gives one cent for vote, then what?
 Ppl wanting to influence corp policy will buy votes for pennies, very cheap to buy a
ton of votes
o Creates agency wedge (securing $5million worth of votes by paying $100k for votes)
 Agency wedge: gap btwn the price of the share and the price of the vote
o Generally prohibited
Schreiber v. Carney (Del. Ch. 1982)
 Facts: Public owns 65% of Texas International. Jet Capital owned remaining 35% shares, which
gave them an effective veto over TI’s planned merger with Texas Air. TI loaned Jet Capital $3.3m
at 5% interest/year for warrants. Independent committee said the loan was a good deal. Agreed to
give them loan if they agreed to vote for merger.
 Issue: Is the loan vote-buying and is vote-buying per se illegal?
 Holding: The loan is vote buying and it is not illegal because an independent committed said deal
was good idea and purpose was not to defraud or disenfranchise the other stockholders but was for
the purpose of furthering the interest of all TI stockholders.
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Take-Away: An agreement involving the transfer of stock voting rights without the transfer of
ownership (vote buying) is not necessarily illegal and each arrangement must be examined in light
of its object or purpose. It is impermissible if the object or purpose is to defraud minority
Khanna thinks this is wrong because it is vote buying and should be illegal
Other Methods of Separating Control from Cash Flow (Controlling Minority Structures – CMS)
1. Dual Class (US courts are totally fine with this): one class for controllers, and one class for
general public
a. i.e. Class A gets 1 vote and a 10% dividend, class be gets 10 votes but 0% dividend
b. common in US
c. a lot of tech companies have dual class when they go IPO and same with pharmaceutical
i. logic (esp in tech): founders are life blood and you want controller to maintain
control after going public; don’t want shares to be diluted when you go public
ii. Telling SHs of IPOs that you are going dual class results in share price change
2. Cross holding structure
a. Not common in US, but very common overseas (especially East Asia)
b. Corporations A, B, C, each own 25% of the others. If they get along, they can block
management changes at all companies – mutual back scratching. These sorts of structures
can be extremely stable, but there is an issue for shareholders because they can’t get rid of
management if they don’t like how company is being run.
3. Pyramid Structure
a. Company with $200m in assets wants to acquire company with $1bil; so buy company
valued at $400m (buy half), then buy $800m company, then $1.6b company
b. [A - $100m]  [B - $200m]  [C - $400m]  [D $800m]
c. Not prohibited in US (bc still not using target’s assets against itself) but not common bc
Dual Class Recapitalization
 When there is one class:
o Management: 20 shs
o Public: 80 shs
 Dual-class recapitalization happens when the company tries to turn itself into company with 2
types of shares
o Types of shares
 A: 1 vps & $0.50 dividend
 B: 10 vps & $0.00 dividend
o Distribution
 Management: 20 A, 20 B
 Public: 80 A, 80 B
o B type shares can be converted to A, but not A  B
o Because the public wants dividends, they will convert their class B shares to class A.
Management doesn’t convert. This results in management controlling higher number of
 Management: 20 A, 20 B = 220 votes
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 Public: 80 A + 80 A = 160 votes
 Only way to convert is to have shareholder vote, which is usually approved 99-1.
Voting in Today’s Corporation:
Don’t really have companies owned by small SHs; we have intermediate investors
Do these index investors do a lot voting wise?
 Index investors invest in an index so they don’t really have a choice; why
would they care to be active in a particular firm? If a firm becomes more
profitable bc of the index investor’s actions, then the index investor’s benefit,
several others are benefiting as well, Microsoft is held by a lot of Blackrock’s
competitors tho so competitors benefit from Blackrock’s actions; big investors
are very unlikely to do something that will benefit both them and competitors
especially when it costs them money (if both index funds are benefiting they
both look equally attractive to investors, doesn’t make blackrock look that
much better to investors); blackrock and other index investors have very little
corporate governance anyway
Proxy Advisory Boards
Funds outsource how they wanna vote
A lot of financial investors have commited already to following the proxy
advisory boards
Index funds haven’t said if they are going to follow proxy advisory boards or
Hedge Funds: interested only in their 6 companies and get informed just enough and will push for what
they want; some say hedge funds are better at regulating than index, but counter is they are only doing
stuff to jack up share price right now
 Harder for company to plan in the long run
 No clear answer
Lending Shares:
Index investors like blackrock lends shares; lendee wants to short the stock
Asset managers make a ton of money off of lending shares
What happens when you lend a share at the time of a vote? Borrower of shares
has the vote on the voting date but they know they will be giving share back
after the vote
This is worrisome bc they have very short-term incentives; creates agency gap
Since using own money and not corporations, it is not prohibited but maybe it
should be
People trying to lobby a vote, don’t even know how to lobby
Proxy solicitors go around and figure out who has the vote (costly)
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The Federal Proxy Rules
The Federal Proxy Rules influence voting. Originated with Securities and Exchange Act of 1934. § 14(a)
– (c) regulate almost every aspect of proxy voting in public companies
Solicitation: whenever you are going after votes you have to send SH all kinds of materials/info
New Proxy Voting Advice Rules:
 Proxy advisor recommendations are solicitations unless specifically exempted,
for which they need to:
o Disclose material conflicts of interest
o Provide subject firm opportunity to review, react and provide feedback and notify
o Provide firm with opportunity to hyperlink
 Asset managers must consider firm responses
 Proxy advisor recommendations subject to antifraud rule (14a-9)
14a-8: reduces the cost of a challenger to bring a proxy challenge to about 10K bc allows them to tack
stuff on to the mngmnt circulation
1. Disclosure requirements and mandatory vetting regime that allow the SEC to assure the disclosure
of relevant information and to protect shareholders from misleading communications.
a. Why shareholders should vote one way or another
b. Dictate format and how much information. Number of requirements disincentivizes lying.
c. Section 14(a) - Only have to disclose if you are soliciting vote.
2. Substantive regulation of the process of soliciting proxies from shareholders.
a. In 1991, SEC changed the rules to only require wjem solicing affirmative vote. From here,
institutional investors vecome more active. When doing disclosures, have attention to…
3. Anti-Fraud – Rule (14a-9) – allows courts to imply a private shareholder remedy for false or
misleading proxy materials.
a. Because there is a high penalty for misleading information, tend to speak generally and
vaguely (compliance, sanitization)
b. Disclosure required is high cost ($1.5m - $2m)
c. If battling management, it’s going to be expensive. A way to get around this is…
d. If you lie in disclosure, 14a-9 will impose sanctions (criminal and civil)
e. You cannot solicit proxy without proxy
f. Annual reports
g. Must disclosure material conflicts of interest
4. Shareholder town meeting provision (Rule 14a-8) that permits shareholders to gain access to the
corporation’s proxy materials and to thus gain a low-cost way to promote certain kinds of
shareholder resolutions.
a. Insurgent/challenger can refer to management’s disclosure
i. Then they can add their own ~5 page discussion, which reduces insurgency costs to
b. This makes it easier to challenge management.
c. There is a lot of litigation about whether or not it’s ok to use 14a-8
(need more in this section)
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Short slate proxy contest: insurgent offers nominees for only a few board positions; the other positions
on the insurgent’s proxy card are filled in with some of the company’s nominees
 Get some now, can get more later
Shareholder proposals – Rule 14a-8
Allows a challenger to tack on a proxy challenge to the management’s existing mandatory disclosure.
So that GREATLY reduces the cost of running a proxy vote as a challenger.
o But shareholder proposals almost always fail. Like 90% of the time.
 Even if you win a shareholder proposal, that’s only a recommendation to management. It’s not a
command; it just lets management know where shareholders stand, with the understanding that if they
don’t do what shareholders want, they’ll be voted out.
 If management wants to omit a proposal, it can only do so if given a “no action” letter from the SEC.
The grounds for exclusion:
o Ordinary business operations
o Objections to form (if you try to “command” or “require” management to act)
o Violates state or other law
o Relates to an election to office (if you’re challenging officers, you have to wage your own
proxy contest)
 Corporate governance proposals: You can propose a general strategy/approach to corporate
governance, but you can’t specify exactly what you want directors to do.
 Corporate social responsibility proposals: Things like environmental goals, maybe social
responsibility. Sometimes it’s hard to tell if this falls under an ordinary business operation.
o Sometimes bring proposal forward and then they all agree on what to do so they drop the
o Cracker Barrel is an example of hard to tell (shareholders proposed for Cracker Barrel to stop
discriminating based on sexual orientation, but the SEC says that looks like a proposal to
interfere with the ordinary business duties of Cracker Barrel’s hiring); Rule: you can put
forward proposals that are CSR but if it seems like you are trying to micromanage the firm
then not ok
 Micromanage: specific ways to achieve a particular goal
Skadden Schemes: you can put in charter/bylaws that SH can only vote on management resolutions and
statutory things like M&As; this is permitted, SHs can limit their own ability to vote
Schnell v. Chris-Craft Industries
 Management was worried that it would face a proxy challenge to be voted out of office, so they move
up the voting date at the last second, and move the vote to the middle of nowhere NY. The effect of
this is that fewer shareholders would show up, and those who did would be more likely to be
management-friendly since they’ll have to have been monitoring closely to know that it happened.
Corporate charter allows for date change
 Court says doesn’t matter what charter says because board needs to exercise powers consistent with its
fiduciary duties; violated fiduciary duties here
 Takeaway: You can’t game the voting process by influencing who actually shows up. That’s a
violation of fiduciary duty.
 Consideration: It would be harder to shoot down a decision by management to push back the voting
date rather than move it up, allowing more shareholders to show up. It’s possible that those additional
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shareholders would be preferable to management, but courts would just say that it gives management
a better sense of what the shareholders actually think.
State Disclosure Law: Fiduciary Duty of Candor
State disclosure Law: Fiduciary Duty of Candor - Don’t lie to the shareholders.
Duty of Care
Duty of Care: duty to exercise the degree of skill, diligence, and care that a reasonably prudent person
would exercise in similar circumstances
 Gross negligence: nobody knows what this means; as long as you make a good
faith effort, you’ll satisfy the duty of care; have to do something grossly
negligent to be held liable as a director (i.e. making a hasty decision without
being informed
 Del §102(b)(7): allows a company to waive a damages remedy against directors
for breaching the duty of care
Corporate directors fiduciary duties generally fall into one of two categories:
 duty of loyalty (next chapter): corporate fiduciaries must exercise their authority in a good-faith
attempt to advance corporate purposes. Can’t compete with corporation.
 duty of care: reaches every aspect of officer/director’s conduct. It requires these parties to act with
the care of an ordinarily prudent person in the same or similar circumstances.
 These are pretty much the same – basically, directors must not be disloyal to their principals.
However, we are worried that if we impose duty of care liability for everything on directors, they would
be too risk averse to be willing to make the calls necessary to make a firm profitable. Therefore, courts
insulate directors from liability for duty of care breaches based on negligence.
Statutory Techniques of Limiting Director/Officer Risk Exposure
Business Judgment Rule is most fundamental protection against liability for simple mistakes in judgment.
But statutory power to indemnify losses of corporate officers for expenses is most reliable protection
(attorneys fees, judgments, insurance),
Mandatory indemnification rights + elective ones. Allow corporations to commit to reimburse reasonable
expenses for losses of any sort arising from actual or threatened judicial proceeding/investigation. DGCL
§ 145 (a), (b), (c).
Indemnification: corporation agrees to pay expenses to defend against litigation this is allowed as long as
they don’t lose on the merits (“acting in good faith”) DGCL § 145
 Settlements don’t count as losing on the merits (Waltuch)
 Delaware says you have to have the good faith condition
 Can come in form of D&O insurance; corps often purchase this Director and
Officer insurance to indemnify directors or to provide a fund for payment of
plaintiffs if an action results in settlement or judgment
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o D&O insurance will indemnify as long as good faith is satisfied
 Director indemnification has effectively turned into director insulation; they are
almost never liable
Waiver: Most states have statutes allowing corps to waive Director liability for violations of duty of care
as long as not conflicted DGCL § 102(b)(7) – only applies to damages and not injunction
Waltuch v. Conticommodity Services (2d Cir. 1996) (indemnification)
 Facts: Commodity futures silver trader sued by Commodity Futures Trading Commission for
fraud, market manipulation, and antitrust violations (cornered silver market). Trader suing his old
firm to pay for incurred expenses in previous litigation
 Holding: (1) Even though Conti’s articles of incorporation do not explicitly require good faith to
recover, it cannot be inconsistent with DGCL §145(a) & (f), which requires good faith. Therefore,
trader can’t recover because he didn’t act in good faith. (2) Settling a claim is not losing. If a
director settles a suit and can show they were acting in good faith, they can take advantage of
 Cannot indemnify loyalty claims bc you cannot be acting in good faith if you are disloyal
Judicial Protection: The Business Judgment Rule
The BJR is an exceptionally powerful judicial insulating device. A director is not liable for losses under
the BJR if he is unconflicted and informed. The burden of proof is with the defendant to prove that they
DID NOT breach. This is decided early on in proceedings.
- Protects a decision of a corporate board from a fairness review (entire fairness under Del Law)
- Only applies when the board actually makes a decision about something; if mid-level manager
makes a decision then no BJR; must be board action
- BJR shifts burden of proof to the challenger; if rebutted, board must prove entire fairness
BJR Requirements:
 Good faith
 Informed
 Unconflicted
o It is possible to keep the BJR if you were uninformed, as long as you acted in good faith;
but no exceptions if no good faith
Idea behind BJR: courts shouldn’t second-guess good faith decisions made by independent and
disinterested directors.
 Making money involves risks and we want directors to be incentivized to take
risks that could benefit the company and SHs; but no directors would do this if
they knew they’d be liable in the event it doesn’t work out
o Shareholders can diversify their portfolios to protect against bad decisions, but directors
wouldn’t have any other protections besides the BJR
Exceptions to BJR:
 Corporate waste (tremendously inadequate consideration)
 Knowing/intentional violations of the law
Kamin v. American Express (NY 1976)
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Facts: Directors of AmEx bought stock in a firm for $29m. Value of stock dropped to $4m.
Directors chose to distribute the stock to the shareholders as a special dividend (taxable for
shareholders) instead of liquidating at corporate level (corporate tax deduction for loss).
Shareholders sued.
Holding: The director’s concern that the liquidation of DJL stock at the company level would
negatively impact the company’s accounting net income figure was sufficient for the court to give
the directors the BJR. As long as the board adopted informed and unconflicted decision, their
decision gets the BJR and complaint is dismissed.
Decision was made in good faith, by an informed and unconflicted board, so court applies BJR
and doesn’t second guess board decision
What is the BJR?
One formulation is ABA’s Corporate Directors Guidebook:
A decision is a valid business judgment when
1. it is made by financially disinterested directors or officers
2. who have become duly informed before exercising judgment, and
3. who exercise judgment in good faith effort to advance corporate interests
Why have the BJR?
1. Converts question of fact (inquiry into whether directors exercised reasonable care) into legal
question for court.
2. Converts question whether the standard of care was breached to whether the directors were
disinterested and independent and whether actions so extreme/inexplicable/unconsidered to not be
good faith judgment.
Duty of Care in Takeovers
Smith v. Van Gorkom (Del. 1985)
 Holding: Financially disinterested directors are personally liable for the consequences of their
business judgment when they are grossly negligent in decision making (directors didn’t
investigate, approved merger and deal protections in 10 minute hastily called board meeting.
Directors must take their time in making decisions, must see documentation, get disinterested fair
price opinion, etc.
 No way they could read hundreds of pages in 2 hours, no way they were informed, NO BJR
Additional Statutory Protection: Authorization for Charter Provisions Waiving Liability for Due
Care Violations
DGCL §102(b)(7): validates corporate charter amendments to provide that a corporate director has no
liability for losses caused by transactions in which the director had no conflicting financial interest or
otherwise was alleged to violate a duty of loyalty.
 corporations can waive liability for duty of care breaches
 over 90% of corporations have adopted 102(b)(7)
o only damages not injunctions
o doesn’t cover officers, only directors
o SHs like the idea of insulating liability for directors
o Statutory indemnification, insurance, BJR, and 102(b)(7); don’t really see duty of care
cases but we still see duty to monitor
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“A provision eliminating or limiting the personal liability of a director to the corporation or its
stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision
shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to
the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from
which the director derived an improper personal benefit. No such provision shall eliminate or limit the
liability of a director for any act or omission occurring prior to the date when such provision becomes
effective. All references in this paragraph to a director shall also be deemed to refer to such other person
or persons, if any, who, pursuant to a provision of the certificate of incorporation in accordance with §
141(a) of this title, exercise or perform any of the powers or duties otherwise conferred or imposed upon
the board of directors by this title.”
Created to fill hole after Van Gorkom.
The standard is basically gross negligence. Boards must take reasonable steps to inform themselves
and to monitor for suspicious behavior. If they find anything suspicious, they have to go deeper.
Failing to monitor in certain situations can be a duty of care violation.
Prologue to Caremark:
Francis v. United Jersey Bank – completely failing to monitor is a breach of duty of care
 Pritchard and Baird was a reinsurance broker, that basically helps an insurance company pay if there’s
a big disaster in one area, like an earthquake. So reinsurance brokers have lots of money floating
through their fingertips, and it can be very enticing to pull some of it out when you don’t think you’ll
need it, which is usually okay as long as you put it back….once the owner died, his stupid sons
basically stole all the money from the company, and the creditors sued to get their money. They sued
the wife, saying that she didn’t do anything to monitor the situation.
 Court imposes liability on the wife, even though she was entirely clueless that the sons were stealing.
She had a duty of care to at least find out if her sons were stealing from the company, and failing to
monitor was a breach.
 Takeaway: A complete failure to monitor is obviously a breach of the duty of care.
 Consideration: Perhaps the court was motivated by the fact that the money would just go to the sons
if they didn’t impose liability here. What could the wife have done?
o Made some kind of “noise” to oppose the stealing
o Talked to the company lawyer/general counsel
o Go up the ladder
o Have a noisy withdrawal
 BJR not discussed bc she didn’t make any decisions
 Do you want a watchdog who will blow the whistle, or somebody who will actually take a stand and
try to stop the wrongdoing? Khanna would take the “savage” approach and do both
Graham v. Allis-Chalmers Manufacturing
 In the past, A-C employees had been price fixing, a violation of antitrust law. A-C agreed to a consent
decree where they paid a fine and would change how they did business. However, the violations kept
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occurring, which led to a new set of fines. Shareholders were upset that the board hadn’t monitored
for this, and sued the board for violating the duty of care.
 Court disagrees, saying that the board had not been put on notice that the behavior was still occurring
(it had been 20 years since the first fines). The board had asked employees if they were following
guidelines (which is a pretty weak way to monitor), but that’s good enough.
 Takeaway: Board is entitled to rely on the rely on the representations of the employees unless there
are red flags that something suspicious is going on. If there are red flags, then the board should be on
Federal Sentencing Guidelines
 Base fine x (some multiplier)
o Base fine: how bad the activity is that took place
o Multiplier (can be less than 1): based on the steps you took to either report, deter, or prevent
the activity. How much effort did the firm put in to avoid wrongdoing?
 If you’re engaged in monitoring, you’ll reduce the punishment
 If top management wasn’t involved and there was a good compliance program,
the fine can actually end up lower than the base fine.
 On the flip side, if management is involved in the activity, that will jack up the
Compliance Programs/Monitoring Programs
 Helps to reduce increasing liability risks
 Good compliance programs reduce liability that a firm can face
 Who provides compliance services? Law firms, accounting firms, tech firms, etc.
 Large industry that has developed around monitoring
In re Caremark International – extends Allis-Chalmers; affirmative monitoring duty
 Caremark was a healthcare services provider. There was a big concern that specialists might offer
“kickbacks” for referrals from general practitioners, to incentivize referrals even when they weren’t
necessary. To police this, the federal government created the Anti-Referral Payments Law (ARPL),
and companies all put out compliance programs to comply with the new law. Caremark put out a 400
page compliance program, but the kickbacks were still happening, and Caremark is eventually slapped
with a $250 million fine.
 Court says that Caremark’s board did not violate its duty of care, because it had put out a 400 page
compliance program. Clearly the program wasn’t an especially good one if the violations still
occurred, but you just have to have a program in place. Caremark also had lots of board meetings, and
there were no red flags that suggested a need for more monitoring.
o Duty to Monitor: board has obligation to supervise the firm and they cannot do that cannot do
that unless they monitor the firm
o What to monitor: different areas of underlying law; what areas of law? All that apply to your
o Good enough: did the board get informed on what type of compliance system they should put
in place? Were they un=conflicted? Did they act in good faith?
o Court won’t look to whether the compliance system was effective
 Takeaway: Boards have an affirmative duty to monitor, but unless there are any red flags, that can be
as simple as imposing a compliance program. You still can’t intentionally not monitor, but Caremark
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was at least doing the bare minimum, so they’re fine. Effort to monitor here made in good faith which
is enough.
 Consideration: Why does the court impose a new standard, but then say that Caremark was okay?
o Because Caremark wins, they won’t appeal, and the standard won’t be challenged. Clever!
 Different than Allis because Allis was about whether or not you can rely on employee testimonies,
this is about monitoring system
Caremark Aftermath:
 Caremark made it attractive to SHs to put compliance systems in place
 Both directors (Caremark) and SH (statutes) want compliance program in place
 Del 102(b)(7): gets rid of duty of care for directors; most companies adopt this so courts made a move
with Caremark to impose some obligation
 Bad Faith Meaning:
o Good faith means you actually tried to do your job at monitoring
o Stone v. Ritter: if it looks like you didn’t even try, court will treat that as a good faith
violation of duty of loyalty (not covered by 102(b)(7))
o Bad faith: consciously disregard the risks that your firm was producing
Citigroup – business risks vs. legal risks
 Citigroup was involved with Collateralized Debt Obligations (CDO’s), which were considered risky
investments. When the market collapsed in 2008, a lot of people couldn’t pay their mortgages, and
looked to their CDO’s as assets. So Citigroup had to pay up on the CDO’s, to the tune of $55 million.
 Shareholders argued that Citigroup didn’t do a good job of monitoring how its CDO’s were being
bought and took on too much risk, but the court says that this was just a bad business decision that
will be evaluated under the BJR. Just because there’s a huge loss doesn’t necessarily mean that there
was carelessness; this was just an unwise business plan.
 Takeaway: Legal risks will be assessed under the Caremark standard of affirmative monitoring, but
business risks will be evaluated by the BJR. As long as there’s a good faith, informed decision by an
unconflicted board, the board is good.
Marchand v. Barnhill
 Bluebell listeria outbreak. SH derivative suit against directors for breaching duties of care and loyalty
(under Caremark) by knowingly disregarding contamination risks & failing to oversee safety of foodmaking operations; company lost a lot of money
 In order to prevail on Caremark claim, plaintiff must show that a fiduciary acted in bad faith; but
management had a monitoring system here so why does this case proceed?
 Caremark is about the duty of the board and the board didn’t implement a monitoring system
 This is a one product company so if you aren’t monitoring that one product, what are you monitoring?
Food safety is essential to this company
 In contrast with Allis, you can’t just rely on management anymore
 Takeaway: if you are in a single product business, board needs to know a lot about that product and
take action to know a lot about it; duty to monitor isn’t about mngmnt, it is about the board
 Notes: compliance is a state standard
Miller v. AT&T – Caremark Progeny
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AT&T provided about $1.5 million in telecom services to the DNC, but didn’t collect on the debt.
This is a violation of campaign finance laws (corporations can’t finance campaigns). The decision not
to collect was an actual board decision, and this is actually a crime.
BJR only protects your business judgment and if your business judgment is to break the law
(knowingly), you are not protected
o BJR protects you if you accidentally/inadvertently breach the law
o Here board is knowingly violating federal criminal law so not covered by BJR
o Since federal criminal violations are not protected by BJR so now board must prove they
didn’t breach fiduciary duty
o Breach of fiduciary duty is not covered by insurance because it is duty of loyalty and not duty
of care
Takeaway: If you knowingly commit a crime, you don’t get the BJR.
Consideration: You would much rather be busted under the Caremark standard, which is just a civil
penalty saying that you violated the duty of care (and you’ll likely be indemnified anyway with a
§102(b)(7)). But here, you’re not indemnified, and it’s actually a criminal conviction. So you’re much
better off just not learning if you’re violating the law, because at worst you’d get busted for failing to
monitor and thus violating the duty of care.
Duty of Loyalty
Definition: The duty to exercise power of an agent in a manner that best serves the interests of the
In this context, the principal is the shareholder, and the agent is the director.
o Thus, corporate officers, directors, and controlling shareholders may not deal with the
corporation in any way that benefits themselves at its expense.
Shareholder primacy norm: In the US, directors owe a duty of loyalty to the shareholders to do
what’s best for them. This is defined very broadly. See Dodge v. Ford Motor Co (if Ford said he was
doing this for the benefit of the corporation it would have been fine but he said it was for the benefit
of the public)
o If you want to form a benefit corporation that’s primary goal is to do something other than
maximize shareholder value, you have to custom make the governance of your enterprise so
the courts will know to not just force the board to maximize shareholder value.
o Focus on SHs because SHs are residual claimants (they get paid last); high duties paid to those
who get paid last because that way, everyone gets paid
The rest of the world has the stakeholder norm, which says that decision makers (usually controllers)
owe duties to employees, government, shareholders, creditors, consumers, etc.
o The US doesn’t use the stakeholder norm because we think that it’s very difficult to appease
all of these different groups. Somebody’s always going to be unhappy.
 But also, if someone is unhappy about a decision, it’s too easy for a manager to just say
“I did it to appease X,” which is very hard to disprove.
A.P. Smith v. Barlow – (Princeton donation)
 Corporation had given a donation to Princeton, which the shareholders objected to. They argued that
they weren’t going to benefit from a donation to Princeton.
 Donation is valid bc company made an informed, unconflicted decision and have a valid justification
for how it benefits the corporation, made in good faith
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Court says that the donation makes NJ better (even though most Princeton grads leave NJ…) and that
maybe more Princeton grads will go work for AP Smith (really?) or will become customers
(maybe…). So the court applies the BJR
Takeaway: as long as your decision was unconflicted, in good faith, and informed, it’ll stand under
the BJR, even if it seems ludicrous on its face.
Constituency Statutes:
 Statutes that provide that directors have the power but not the obligation to
balance the interests on non-SH constituencies against the interest of SHs in
setting corporate policy
 Enacted in response to the hostile takeover wave of 1960s
 State legislatures bought the argument that we are benefiting the corporation
and not necessarily the managers but these statutes rlly only benefitted SHs
Corporate Purpose Debate:
 Focus on long-term sustainable value
 Index funds and others putting forward what they want firms to start discussing
 Push to use ESG rankings to provide useful information for how companies
function and their sustainability
 Climate risk: corporations recognize that this area will soon be regulated
extensively so they understand the need to start conforming
Public Benefit Corporations:
 SHs elect the directors, formed like any other corporation; major difference is
that statutes contemplate the inclusion in the corporation’s charter of one or
more specific social purposes along with profit-making purpose
 Gives directors and officers of PBCs provide explicit legal protection to pursue
the stated social mission and to consider additional stakeholders as well as
equity investors
 Derivative suits by SHs may only be initiated by SHs owning the lesser of 2%
of the company shares or $2million in value of those shares
 Managers enjoy some protection from hostile takeovers bc PBCs required a
super majority SH vote; 2/3 vote rather than conventional majority (Delaware
removed this requirement and now a simple majority is required)
 Board members in PBCs are expected to think about profits as well as public
Self-Dealing Transactions: Director of company is on both sides of a company
Conflicted transactions - directors
When a director engages in a transaction with the corporation.
o They may argue that they’re doing it for shareholder gain, but the concern is obviously that
they’re conflicted if they’re dealing with a company as both an individual and the company’s
The default is that the conflicted director has to show that the transaction was entirely fair.
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o 2 step test for entire fairness:
 Fairness of price
 Fairness of process
 It’s really hard to show entire fairness. You have to show that everything you did was fair.
 Nondisclosure is almost always a violation of fair process. (Hayes v. Keypoint)
Hayes Oyster v. Keypoint Oyster
 Verne Hayes owns 23% of Coast and 25% of Hayes Oyster. Coast needed to raise some cash, so
Hayes negotiates a deal where Hayes Oyster partners with Engman, a coast employee, to form
Keypoint, which will buy 2 oyster beds from Coast. Hayes Oyster owns 50% of Keypoint, which
means that Hayes himself owns 12.5% (25% of 50%). But Hayes never discloses that he owns part of
Keypoint to Coast.
 Court says that Hayes’ nondisclosure makes this an unfair process, so he has not proven entire
fairness. He doesn’t get the BJR because it’s a conflicted transaction to begin with.
 Nondisclosure by an interested director/officer is unfair; even if no actual harm, the law requires a
fiduciary to refrain from entering into potential conflicts with the principal’s interests
 Verne had an obligation to disclose his interest in Keypoint to Coast and its SHs
 Takeaway: A failure to disclose is presumptively an unfair process.
 Consideration: Wouldn’t Hayes still presumably value Coast more than Keypoint, since he owned a
higher stake in Coast than in Keypoint?
Standard of Review
Full disclosure, accompanied by independent approval on the part of the company.
o If this happens in a director conflicted transaction, the courts will resurrect the BJR.
Test: There’s a director conflicted transaction. Was there full disclosure of the conflict? (includes
o If no  Director violated the duty of loyalty (Hayes v. Keypoint)
o If yes  was there approval by a majority of disinterested board members, shareholders,
or an independent committee?
 If yes  the transaction will get the BJR
 Shareholder approval (Lewis v. Vogelstein), board approval (Cookies/Cooke)
 If no  The director will have to prove entire fairness.
Lewis v. Vogelstein - when disinterested shareholders approve the transaction - BJR
 We’re not given any factual background, other than there’s a director conflicted transaction that is
approved by a majority of the company’s shareholders.
 The court applies the BJR, as long as there was an informed, uncoerced, disinterested shareholder
ratification. The only exception would be for a court to declare that this was corporate waste.
o Exception: can ratify waste if the vote is unanimous
o Waste standard: consideration is so small that no reasonable person would be willing to trade
 Three groups of disinterested groups
o 1) independent committee
o ???
o 3) shareholders who are not interested in the underlying action
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Cookies Food Products v. Lakes Warehouse – when disinterested board members ratify - BJR
 Herrig owns Lakes Warehouse distribution company, which helped Cookies distribute its BBQ sauce.
Herrig was a minority shareholder in Cookies. Cookies ran into financial problems, and asked Herrig
to get involved. Herrig eventually became a controller in the company, but the shareholders
complained about how he was giving himself more and more compensation.
 Herrig is subject to entire fairness because he has a controlling interest
 Under entire fairness have to prove the price was fair and the conduct was fair (defendant’s burden to
prove these things)
 Court notes that Herrig fully disclosed everything that he was doing, and got board
approval/ratification. They’ll apply the BJR in those situations (even though the court doesn’t
explicitly apply the BJR here)
 Takeaway: Full disclosure and board ratification gets the BJR.
Cooke v. Oolie – when disinterested board members ratify - BJR
 TNN pursued a merger proposal by USA, which TNN shareholders argued would benefit creditors
before shareholders. The two director defendants were actually creditors, so they would benefit more
than the other 2 directors of TNN’s 4 person board. But the 2 independent board members approved
the merger.
 Court applies the BJR due to the ratification by the independent board members. That removes the
concerns about disloyalty from the transaction; the independent members must have believed that this
merger was in the best interests of the company.
 Takeaway: Ratification by a majority of disinterested board members will get the BJR, assuming
there has been full disclosure.
Ratification can come from a special independent committee if there are not enough disinterested
board members.
Conflicted transactions - controllers
Controller conflicted transactions: Controllers owe a duty to minority shareholders should they
undertake to exercise or command the exercise of corporate powers, but they’re also shareholders
themselves. Thus a conflict arises. This typically arises in the parent-subsidiary context.
o Test: There’s a controller conflicted transaction (with the controller on both sides). Was there
full disclosure of the conflict? (includes motivation)
 If no  Controller fails entire fairness (not fair process), and thus violated duty of
 If yes  Was there approval by a majority of disinterested board members,
shareholders, or an independent committee?
 If no  Controller still has to prove entire fairness (and will likely lose)
 If yes  Burden of entire fairness shifts to plaintiffs.
Sinclair v. Levein – no actual conflict existed in a controller transaction
 Sinclair Oil owned 97% of Sinven, and wanted Sinven’s money to make its way to another oil field
somewhere. But Sinclair didn’t want the 3% minority owner of Sinven to have any part of the other
oil field. So Sinven pays out dividends to its stockholders (essentially paying itself 97% of the total
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dividend) so it can reinvest that money elsewhere. The 3% owner complains that this was a conflicted
 Court says no conflict exists here, because the minority shareholder still got 3% of the dividends like
he was owed. That wasn’t unfair. Just because he didn’t like the business strategy doesn’t mean it was
 Takeaway: There is no conflict here, because in order for there to be a conflict, the controller has to
be getting something that the minority is not (differential treatment). Here, they’re both getting their
fair shares.
o If there’s no self-dealing, the decision gets the BJR, rather than the entire fairness test.
Weinberger v. UOP
 Signal owned 50.5% of UOP, and minority shareholders owned the other 49.5%. So Signal was the
controller, and UOP is Signal’s subsidiary. Signal had placed 7 of UOP’s 13 board members in their
roles. Signal wanted to execute a cash out (freeze-out) merger, where they’d pay the minority
shareholders for their shares and end up with 100% of UOP. This is a conflict, because 7 of UOP’s
board members, who negotiated this deal with Signal, were placed there by Signal (the controller).
That’s what makes this a controller conflicted transaction; the controller is on both sides of this deal.
 Signal conducted a study using confidential UOP information that said that anything up to $24 per
share was a good price for UOP’s shares. But Signal offers $21, which is accepted as still being a
“good” price via a shareholder vote. Signal never disclosed this $24 figure to UOP, and UOP never
told their shareholders about it; in fact, they decided to go through with the deal in only 4 hours, but
led shareholders to believe that they had actually negotiated at arm’s length over it, and arrived at the
$21 price legitimately.
 Court says that because Signal never disclosed that they arrived at share price using UOP info, they
are treating UOP shareholders differently than Signal SHs
 Signal doesn’t have to share Signal information to UOP, only UOP info to UOP
 Signal doesn’t have to tell UOP how much it is worth to Signal, just how much it is worth; Signal
doesn’t have to disclose how high they are willing to pay per share
 Solution: Controller uses own info and comes to a price, discloses that info to a special independent
committee who makes recommendation to the board
 If controller uses acquired company info, it is going to have to disclose reservation price and probably
pay it
 Takeaway: If a controller is trying to execute a freeze-out merger, he has to prove entire fairness.
o This may include disclosing what the controller’s top end price would be.
 Consideration: Isn’t it weird to force a controller to say what his top price would be? We don’t
require that in any other kind of negotiation. The price WILL be $24 here.
What should UOP Board have done in Weinberger?
 They need to produce a report to value and Signal needs to know how to price.
If they don’t, no one is going to call that fair process. BUT if they do then
everyone knows Signal’s reservation price and you don’t make usually do that.
 They should have created an independent committee that would negotiate on
UOP’s behalf. The committee members might be appointed under Signal’s
control but as long as the court is convinced they are actually independent and
had power (did the price change, where there communications, etc.) it will be
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inherently coercive, if minority doesn’t vote for it they get stuck with a mad
800 pound guerilla. AND to get this you need a strong independent committee
and minority ratification.
Key problem with freeze out mergers is that controller (like Meinhardt and Page) tries to kick minority
out as soon as things start to pay off
Duty of good faith claims cannot be unsured or indemnified so treated the same
as loyalty (cannot get 102(b)(7) or BJR)
How director can get insurance anyway: contract ex poste – they know that SH
is suing to get damages so settle with SH and say we are settling on care
violations and not good faith violations and then it is covered by insurance and
indemnification (morphing good faith claims into care claims)
Corporate opportunity doctrine (see Perlman v. Feldmann): If a director is offered or sees an
opportunity that the corporation could reasonably take advantage of (is it within the current or future
line of business?) he cannot take it unless he gets it ratified by an independent committee.
o If he takes it, the company can get disgorgement of all the profits.
o Three tests:
 1) expectancy/interest test: something you could expect the corp to have interest in,
similar to line of business test but includes more than line of business; e.g. how likely
is it that you would be able to take this even if it something that would otherwise be in
your line business (if you don’t have the assets or you are otherwise prohibited due to
 2) Line of business: more narrow; whether or not this is something in your line of duty
 3) ???
o When may a fiduciary take a corporate opportunity?
 If they disclose to the board that there is a conflict and can either send it to the board or
own company and disclose all the necessary information and board waives it, then safe
from suit
 If you have to approve every conflicted opportunity, then the directors may say that we
prefer that any time there is a conflicting opportunity, it is automatically approved
(common in Venture Capitalists and PE funds bc tend to work within on specialized
 Del Subsection 112 (17)
 Board can vote ex ante to waive corporate opportunity doctrine
 Can opt out because statutory provision allows it
 Alarm: Court held that the corporate opportunity waiver is binding, ABS is doing
exactly what it described in the waiver
 Statute wants waiver to specify what exactly it is waiving; super broad is not
going to get court approval
Donahue v. Rodd Electrotype
 Harry was the president and general manager of Rodd Electrotype Co.; he held 200 of Rodd
Electrotype’s shares (out of 250, 80%); Rodd’s sons Charles and Frederick became managers and
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Rodd gave most of his shares to his children; Charles and Frederick controlling the board had the
corporation purchase 45 of Harry’s shares for $800 per share; when the Donahues learned about this
purchase, they offered to sell their shares to the corporation on the same terms they gave Harry but the
board rejected
 Close corporations are corporations which consists of small # of SHs, have no market for their shares
and are substantially controlled by majority SHs
 Court finds that same offer should have been made to all SHs
 SHs in close corps must exercise utmost good faith and loyalty (UGFAL) in their dealings with one
 Implications: makes retirement less likely which leads to old people running corp badly as they get
o Retirement is more expensive, if you have to pay controlling SH the same as minority
o Implying that controlling SH has no additional value according to Donahue
o Court pulled back in Mass: Qualified UGFAL (QUGFAL) – controller can selfishly harm
minority if it has legitimate business purpose and choose least harmful way to obtain that
Smith v. Atlantic Properties, Inc.
 D and Ps each owned 25% of Atlantic shares; A’s bylaws stated that no corporate action could be
taken w/o an affirmative vote of 80% of the outstanding stock (any decision would require all partners
to approve). Corp wanted to declare dividends but D kept voting against it and they were penalized by
IRS for excess of profits
 SH in close corps owe to one another a duty of utmost good faith and loyalty (UGFAL)
 D breached his fiduciary duty of UGFAL to the Ps and is therefore liable to Atlantic for the IRS
Duty of loyalty in controlled mergers: See Kahn cases below
 Basically, if a controller sets up a majority of the minority ratification, and an SIC that is actually
independent, he’ll get the BJR. If he doesn’t do any of that, he has to prove entire fairness. If he sets
up some protections but not all of them, he’ll shift the burden of proving entire fairness to the
Executive Compensation
Executive pay is the quintessential self-dealing transaction, so no default BJR; the default is entire
o To get the BJR, you have to get a majority of informed, uncoerced, and disinterested
shareholders to approve a specific compensation plan decided on by the board of directors
(Calma v. Templeton).
 If executive comp is given the BJR, the only way for shareholders to attack that is to
allege that it’s SO egregious that it constitutes corporate waste.
Paying executives creates incentives and you want incentives to align with corporate goals
How are directors paid?
o Typically by a salary, maybe with a bonus. But a salary doesn’t really incentivize you to work
as hard as you can.
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o Stock options: opportunity (not requirement) to buy stock in company for a set price and for a
set number of shares (i.e. in one year you will be entitled to receive a thousand options)
 Your stock becomes more valuable if the company does better, so your incentives are
more aligned with shareholders (because you actually become a shareholder yourself);
incentivizes CEO to make company successful and increase value of stocks
 Doesn’t always work, other factors play into the success of a company (i.e.
even if you have the best restaurant manager in the world during the pandemic,
it isn’t going to do much and you cannot measure the manager’s success on the
restaurant’s success in that situation)
 Stock options are huge in the US because of tax structure on non-incentive based
 Stock is more popular than options because options incentivize behavior and can be
very volatile; stock is better aligned with incentives than options as part of exec
compensation package
 Problems with stock options?
 You’re only incentivized to maximize stock price on the day you can exercise
your option. If the next day the firm goes bankrupt, you don’t care.
o Could be addressed by staggered vesting dates
 You might withhold bad info from the public to keep the stock price artificially
 Are stock prices really influenced by directors? Can you really say that any
increase in stock price is due to any managerial effort?
 How to design options that track managerial success only:
 The strike price we are going to give you is not the strike price of our company
but rather the average of firms like ours
o Strike price: fixed price at which the owner of the option can buy or sell
the stock
o Index funds: index by industry or index by entire market
 Vesting: earning stock option over time
o Vesting schedule requires manager to up the stock price on a consistent
 Also allows company to give more options later on so instead of
incentive to maximize share price now rather than over time
Corporate law puts very few regulations on executive compensation. It’s just treated like a Cookies,
Cooke, or Lewis scenario.
Are CEO’s paid too much? How can we evaluate that?
o Look at the lowest paid employee and see how much more the CEO makes
o How much value does the CEO contribute to the company? Hard to measure at times
o Look to historical patterns
o Look to other similarly situated executives in whatever market you’re in
o Maybe even look to other countries’ executives
o Average pay is around $30m for the top thirty firms in US
o CEO position is unstable in the US
 Other countries CEOs have retirement funds and tenure
o Justification for CEO pay in the US:
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 Example: $20m incentive-based structure in a year that the company loses $30m
 Imagine how bad it would have gone without me (the CEO)
 Execs negotiate their pay by looking at both situations in which things work out well
and those in which it works out badly
 i.e. agreement where they get zero if it goes bad ad $50m when it goes well v.
agreement that CEO negotiates: $25m in either good or bad situation or $2m in
bad and $35m in good
 How can an executive argue that he should get paid more?
o Argue that they’re unique and thus more deserving of compensation
o You’re much more likely to get fired in the US than in other countries
o It’s much easier to execute a takeover in the US than in other countries
 Varying Academic views:
o 1) this is fine; market views are at play; bigger company + more risk of being fired and
different job than that in Germany or wherever; pay is find and if CEO does a bad job, the
board fires them
o 2) rent extraction: managers are negotiating with other managers so why would they want to
undercut how much this executive is getting paid
o 3) shouldn’t try to compare executive pay to arms-length negotiating; we pick CEO bc we like
you and then we come up with pay/incentives; reason for selecting CEO is board likes person
and thinks they are a good fit which is not how arms-length negotiation works
 Federal Regulation:
o Disclosure: disclosure based on in the best state of the world, how much would exec get paid
and in bad state how much
 Reaction to disclosure was actually higher pays; GM exec saw how much Ford exec
gets paid and demand higher pay (overall exec pay increased)
o Peer comparisons: how does your pay scheme compare to that of your peers
o SOX and Dodd-Frank enacted claw back requirements that require bonuses or incentive pay to
be returned if received within three years after disclosure of incorrect information to the
public, extends to any current or former executive
o Dodd-Frank also requires a non-binding SH advisory vote on compensation, a “say on pay.”
But this really doesn’t matter bc most of them were doing it anyway to get BJR.
 State Corporate Law Regulation (Delaware)
o Special committee and/or Shareholder vote: quintessential self-dealing so do not get BJR but
try to get ratification from independent committee and/or SH vote to resurrect BJR
o Doesn’t do much beyond disclosure
o Delaware subject special committee decision to good faith
 What else could we do?
o Increase taxes? Corporation will just increase pay to compensate
o Tie to ratio of lowest employee? This just leads to fringe benefits that hide the compensation
o Do nothing? The logic behind this is that compensation matters; market sets it and no one
cares how much Hollywood stars make
Judicial Review of Executive Compensation
If compensation agreement is qualified for BJR, then the only thing left is waste claim. To make a waste
claim, the Plaintiffs must plead particularized allegations that “overcome the general presumption of good
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faith by showing that the board’s decision was so egregious or irrational that it could not have been based
on a valid assessment of the corporation’s best interest.” (In re Goldman Sachs). To do that, they have to
show that there is an absence of any consideration. (Michelson v. Duncan).
There is a “good faith” prong also. BUT this isn’t duty of care, it is duty of loyalty. No circumvention
around BJR or §102(b)(7) waiver allowed. Basically, need to start process, listen, vote and look like
you are paying attention, we are talking about willful failures to inform oneself. (In re Walt Disney).
Goldman Sachs – defer to boards exercising their business judgment
 Goldman Sachs’ executives were paid very well even when the market crashed and shareholders were
losing money. Goldman’s executives were paid a % of their net revenues each year, which would
always be a positive number even if the net revenue was decreasing. The shareholders argued that this
pay structure incentivized risky business strategies that could bring short-term profits, just so execs
could make more money each year.
 Here there is a §102(b)(7) provision so failure to inform is not enough, would have to show willful
 Court says that determining executive pay is a key function of the board exercising its business
judgment, so it gets the BJR. Just because the shareholders didn’t like the plan doesn’t mean it was
corporate waste; if they’re unhappy, vote out the board. The board was still acting in good faith.
 Good faith: did the special committee on the board consciously disregard good faith in their decision?
o duty of good faith rarely invoked in compensation cases; board had a lot of discretion and they
did everything they needed to satisfy good faith
 Takeaway: Courts are EXTREMELY deferential to boards in determining executive pay. Boards get
the BJR because that’s part of their regular business judgment. As long as the board was informed,
they’re good (and here they did some research, so they’re good).
In Re The Walt Disney Company Derivative Litigation
 Disney has two CEOs, second is basically in waiting. CEO 1 hires friend and then fires him.
Agreement basically says CEO 2 gets paid even if everything goes to hell. SH file derivative suit
alleging directors violated duty of loyalty bc they just rubberstamped what CEO put in front of them.
 No duty of care here bc § 102(b)(7)
 Court condludes that there is a duty of good faith tied into duty of loyalty, but it is met here bc the
board listened to CEO, didn’t entirely try to avoid doing their job or utterly fail at performing their
 Takeaway: BJR applied in exec compensation cases unless board deliberately fails to try to be
In Re Investors Bancorp, Inc. Stockholder Litigation
 Bankcorp proposed Equity Incentive Plan (EIP) under which certain stock awards and options would
be given to officers, employees and directors; EIP had limits on (1) how much of each classification of
stock could be allocated; (2) how much stock could be issued to one employee; and (3) how much
stock, in total, could be issued to non-employee directors; result in extremely high payment to
executives. SHs brough suit challenging compensation awards
 If there is informed, uncoerced approval then board gets BJR
 SH may ratify compensation plan if they know what they are approving but since directors here were
able to exercise discretion, SH approval of the general plan does not equate ratification
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Board action is still subject to a claim for breach of its fiduciary duties and as a self-interested action,
this is subject to the entire-fairness standard
Blindfold Case: delegate executive compensation to board without any detail on how to issue stock and
options, just let directors figure it out court says no you can’t just waive those concerns
If you set up as an LLC or an LLP, court doesn’t get involved in compensation maters.
Calma v. Templeton
 Court says that because this is a director conflicted transaction, there has to be informed, independent
ratification to get the BJR. And because the shareholders were just given a plan without any details,
that’s not an “informed” ratification, even though they approved it. So because there’s no BJR, the
standard is entire fairness, and this is not a fair process.
 Takeaway: Executive compensation plans need to have some sort of specificity in order to satisfy the
requirements of an informed ratification for purposes of the BJR or EF.
Shareholder Suits
Direct suits: Something that injures that specific shareholder, not the entire company. The
shareholder is expected to pay his own attorney’s fees, but if he wins, he recovers.
Derivative suits: brought by SH against the Board on behalf of the company as a whole, claiming that
board violated its fiduciary duties; any recovery goes to the company; bc company’s suits it pays legal
fees which are awarded if they win or settle
o The injury was done to the corporation as a whole, and SH is suing on behalf of the
corporation, not just herself. Representing all shareholders.
o The company pays the cost of the suit, not the individual. But any recovery goes to the
company, not to the individual shareholders. 90% of the award goes towards attorney’s fees,
Courts see direct suits as being more meritorious than derivative suits, simply because there is an
incentive to not bring frivolous direct lawsuits when you have to pay your own fees.
Derivative Suits come with Quadruple agency problem:
o Problem 1: Claim is against board but Board normally has to authorize corporate litigation
and it doesn’t want to authorize suit against itself
o To address Problem 1, need to bring in outside people to determine who to sue and when;
Problem 2: SHs are suing on behalf of corporation, making them an agent that might have
divergent interests.
o Problem 3: not all SH are suing, just a small class of representatives so they are agents of all
o Problem 4: Usually it is a plaintiff’s attorney doing all of the representative work on behalf of
the representatives including motivating them, so attorney is really the agent of all SHs
 Attorneys are incentivized to bring suits but that can lead to frivolous suits; screen out
frivolous suits (sanctions through statutes)
Another consideration with derivative suits is that any award goes to the company, and then the
company has to pay legal fees. So really the only outcome if the plaintiffs win a derivative suit is that
the company has to pay legal fees. The directors won’t bear any cost, because of indemnification and
D&O insurance (most likely).
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o So a settlement will actually be wasteful for the company. So why bring it?
 Governance changes are a legitimate benefit
 You might also uncover information that could be relevant to the market.
Fletcher v. AJ Industries
 Attorneys/shareholders brought a derivative suit, and settled for governance changes. The attorneys
argue that they should’ve gotten attorney’s fees, because they brought about governance changes to
the company, and have prevented frivolous suits in the future (both “benefits” to the company,
according to the attorneys).
 Court agrees and says that the attorneys should recover attorney’s fees for bringing about governance
changes and ending the lawsuit.
 Takeaway: Governance changes and ending a derivative suit are “benefits” to the company and
attorney’s fees should cover suit
 Considerations: Is it really a benefit to end a lawsuit? They brought it in the first place…
Standing Requirements:
1. Representative must be SH at time alleged wrong occurred
2. Representative must remain SH at time of suit (be a current shareholder, reason is if not then you
don’t care about the cost the corp suffers throughout the suit)
3. Representative must be unconflicted representative of all shareholders; and
4. Representative must have made demand on board is had demand excused (unless futile)
Demand requirement – FRCP 23.1
Demand Requirement: P must be able to show that they asked the board to bring the suit or that they
couldn’t ask the board
Remember that a derivative suit is the corporation suing itself/its board. So the plaintiff-shareholders
have to essentially ask the board to sue. This is called making demand.
If a majority of the board is conflicted in some way, and demand would be futile, demand is excused.
BUT NOTE that in Delaware, if you make demand, you’re admitting that the board is unconflicted.
And if you make demand and the board refuses to sue, that gets the BJR (because it’s an unconflicted
board making an informed decision in “good faith”).
o So nobody EVER makes demand in Delaware.
 What happens is the plaintiff wont’ make demand, the board will move to dismiss
saying that the plaintiff should’ve made demand, and then the plaintiff will have to
show that it was futile or excused.
Levine v. Smith – Levine 2 step
 Ross Perot, a GM board member, was very critical of GM’s cars, and eventually sold his Class E
stock back to GM for $743 million. Part of the agreement was that Perot would stop his criticism of
GM. Shareholders argued that this deal was conflicted and not in the shareholders’ interests, because
they just tried to silence Perot. The plaintiffs don’t make demand, arguing that the board is conflicted,
and that demand is therefore futile.
 Court disagrees, and lays out the “Levine 2-step” test.
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o On the first step, the plaintiffs had only sued 2 of the 14 board members. There’s no reason
why the other 12 couldn’t be disinterested and unconflicted.
o On the second step, the board was informed, and was therefore able to determine if the
underlying transaction would get the BJR.
 Takeaway: Two prong test for showing that demand would be futile: 1) showing that the board was
interested, or 2) showing a reasonable doubt that the challenged transaction was a valid exercise of
business judgment.
Rales v. Blasband – a double derivative suit
 EASCO invested in high risk junk bonds, and then merged with Danaher, converting all of their
shares into Danaher shares. The junk bonds took on a crazy interest rate, and the shareholders wanted
to sue EASCO’s board. The problem was the merger, because Danaher was now the only stockholder
of EASCO. So the Danaher shareholders were no longer shareholders in EASCO, and didn’t have
standing. So they try to initiate a double derivative suit, where, as Danaher shareholders, they will
get Danaher to sue EASCO. The question is whether the plaintiffs had to make demand on Danaher.
 Double Derivative suit: SHs of Dan brings a derivative suit against Dan to get Dan to sue East Co
 Court says demand is excused, because the Danaher board was interested. The Rales brothers and one
other guy served on the Danaher board who had been on the EASCO board at the time they made the
decision to take on the junk bonds. So Danaher is interested.
 Takeaway: In double derivative suits, the only time demand would be excused by a showing that the
board is interested is if there is an overlap in the two boards.
Note: If you show underlying transaction as being unlikely to get the BJR so the board may be worried to
get liability and refuse to bring suit, court will waive demand
Special Independent Litigation Committees (SLC’s)
Delaware courts have created a way for conflicted Boards to partially get around their conflict to stop
derivative suits in cases where demand would be futile
Special Litigation Committee that can decide to move to dismiss the suit if it is not in the
corporation’s best interest
SILC’s are not interested, and therefore their decision to (potentially) refuse to bring a derivative suit
gets the BJR (this falls under the standard from Cookies, Cooke, and Lewis).
Motion will be granted if (Test for SILC)
o 1) SILC was independent, acting in good faith, and reasonably informed
o 2) the court, exercising its own business judgment, balances the interests and decides the suit
should be dropped (Zapata)
 Why have the second step?
 The worry is that the SLC was appointed by an interested board, so how
disinterested is the SLC really?
 This is a decision about litigation, and courts are well versed in litigation
 The court is making the decision ex ante, while the case is still alive. With
business decisions, they’ll encounter the hindsight problem, since they’re
approaching it ex post, after the decision was made. So having courts weigh in
on litigation decisions seems less problematic.
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Zapata (Zapata 2 step regarding SLC’s and the BJR)
 Maldonado sued Zapata, and demand was excused because Maldonado was able to allege that the
entire board was interested. Four years later, Zapata created an SLC which decided to dismiss the suit.
Zapata expected the decision of its SLC to get the BJR.
 Court is not treating this like any other BJR bc rejecting directors claim means they are going to get
sued; an independent committee deciding if corp is gonna go ahead with a transaction is different than
independent committee deciding if corp is gonna go through with litigation
 Instead, the court creates the Zapata 2-step test, which says that the court itself must exercise its
business judgment and determine if dismissing the suit is a good idea.
o Although courts are normally hesitant to apply its own BJR, in a conflicted transaction the
litigation is ongoing so court can see in real time what is going to happen and suffer les
hindsight bias
 Takeaway: The Zapata two step test, which has the normal BJR test along with the court’s own
business judgment.
 Consideration: This is distinct from Levine because there, the board was independent to begin with.
Here, there is an SLC selected by a conflicted board.
Marchand v. Barnhill
 Cites oracle even though it is not an SLC case
 Plaintiff didn’t bring demand and claims board is not independent
 7 members seem to be independent but one doesn’t bc the founders of the firm basically built his
career (a ton of social connections even though no financial connections at the moment)
 Takeaway: independence means impartial and it seems difficult that one would be able to act
impartially towards someone who has supported that person financially and social for so long
Problems with independent members:
 Want independent committee made up of people who are independent but also
o Experts: someone who works in the industry preferably for a long time but if you work in
the industry for a long time and you are good at your job, you are going to have a lot of
social connections in the industry
 The more we expand the definition of independence, the more you are going to
have to encroach someone the definition of expertise
 How far can you push independence if you are considering social connections;
need to limit it
 i.e. you cannot hire a professor at any law school in the country bc they know
everyone per se and may seek donations wo who can you hire
 In Marchand the facts are better than in Oracle bc in m, his entire career was
driven by the family of Bluebell but the Stanford professors’ careers don’t
depend on Oracle at all
 You need insiders on the board bc hey tell you how to read information
 Other arms of the corporation can give you information: compliance (providing
monitoring information to the board and to management), management also has
a lot of inf but board doesn’t
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How to prove independence:
 Show no financial connection
 Show no strong personal connections
 You would have some reason to hold back your actual ideas due to your
connections (this is the type of social connection we want to avoid, not just
running into ppl at a restaurant)
In re Oracle – courts can look at social connections to establish a lack of independence
 Oracle shareholders bring a derivative suit, and Oracle appoints 2 Stanford professors to its SLC. The
SLC recommended dismissal of the suit in a massive report.
 Court says that the SLC had not shown that it was independent, because Oracle makes many
donations to Stanford, and one of the Oracle board members actually taught one of the SLC members
at Stanford. So there are many social connections at play.
 Takeaway: Social connections can show a lack of independence.
 Consideration: There’s a balance between competence and independence.
Joy v. North – Court’s judgment (2nd part of Zapata test)
 The court lays out what considerations it can have when evaluating a SLC’s decision via its own
business judgment:
o The likely damage award (the amount, and the likelihood of it actually happening)
 This is weighed against attorney’s fees and other costs
o The distraction of executives from the ongoing litigation (a cost)
 Court counts legal cost as a cots; the court will exclude insurance payouts or premiums, and they
don’t consider governance changes as a benefit.
o Incentivizes attorneys to play games with fees
 Takeaway: Courts can basically consider anything under its own “business judgment” in following
through on the second part of the Zapata test.
 Courts will consider a variety of factors in evaluating under its own business judgment: (1) cost of
litigation in fees and distraction of personnel, (2) probability of win (most important factor); but
courts do not consider presence of insurance
 Consideration: The court is trying to evaluate damages and attorney’s fees before the litigation even
begins. So it’s basically just guessing. It also ignores the most important cost (insurance) and the most
important benefits (governance changes)
Exclusive Forum Bylaws:
 Provision in bylaws designating where you can bring claims
 Federal courts are less plaintiff friendly and also there can be parallel litigation
in both state and federal courts
 Boilermaker says these bylaws are binding, as long as there is nothing in the
charter that blocks you from selecting the forum
 Bound by what is in the charter and in the bylaws
 Can put in an exclusive forum bylaw to designate forum so we can increase
costs on the plaintiffs’ side we get less suits
 Ps side came back and said instead of bringing Delaware court and being
pushed in Indiana, they brought federal claims in state courts
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So company started putting in federal forum provisions: even if the suit is
allowed in state courts, Delaware companies put in this provision to push these
suits out of Delaware and into state courts
Salzber v. Sciabacucchi – Abundance of SH Derivative Suits
 Blue Apron, Roku, and Stitch Fix are all public corporations incorporated in Delaware and they all
have federal-forum provisions (FFPs) in their charters; Sciabacucchi bought shares in each company
an is seeking declaratory judgment that the FFPs are invalid under Delaware law
 Section 102(b)(1) authorized two broad types of provisions:
o 1) any provision for the management of the business and for the conduct of the affairs of the
corporation and
o 2) any provision creating, defining, limiting and regulating the powers of the corporation, the
directors, and the SHs, or any class of the stockholders…if such provisions are not contrary to
the laws of the state
 FFP can easily fall under 102(b)(1)
 FFPs involve a type of securities claim related to the mngmnt of litigation arising out of the Board’s
disclosures to current and prospective SHs in connection with an IPO or secondary offering
 The drafting, reviewing, and filing of registration statement by a corp and its directors is an important
aspect of a corp’s mngmnt of its business and affairs and its relationship with its SHs
 Thus, a bylaw that regulates the forum in which such “intra-corporate” litigation can occur is a
provision that addresses the “mngmnt of the business” and the “conduct of the affairs of the
 Court’s prefer fed courts because you can stay discovery during motions to dismiss or something as
opposed to state courts where it starts right away (as sib as discovery starts, costs start racking up)
Carlton – Zapata 2 step test also applies to SLC decisions to settle
 An SLC agrees to a settlement deal of about $15 million. Carlton said that this settlement was more
than the suit was worth. The question was whether courts could evaluate a SLC’s decision to settle.
 Court says it can, and that it applies the same Zapata test. Judge says he has no idea how to exercise
his business judgment here, but he looks at how the SLC was informed and acting in good faith, and
that the settlement amount seems reasonable.
 Takeaway: Zapata test applies to SLC decisions to settle.
Settlement and Indemnification
In re Trulia Inc. Stockholder Litigation
 Prior to Trulia, there was a spike in deal related litigation related to M&As; every time someone
proposes a merger, someone sues and most of these suits would settle
 A lot of SH Plaintiffs would just settle for disclosure (disclosure only settlements)
 Zillow agreed to acquire Trulia in a stock for stock merger Four Trulia SHs brough suit claiming T
directors breached fiduciary duties by not receiving enough value in the transaction; a few months
later, all parties agreed to settle: settlement required T to produce documents about the merger in
exchange for dropping all claims
 Court here is evaluating disclosure only settlement to see if it is valuable
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Terms of the proposed disclosure settlement were found to be not fair or reasonable bc none of the
supplemental disclosures were material or even helpful to the acquired corp’s SHs so no meaningful
consideration to warrant release of claims to defendants
Court finds that irrelevant disclosures are not good enough so court starts policing disclosures
Court expects to see what you are disclosing and it must be plainly material
Objective Test: if a reasonable person would think that this info would contribute to the total mixture
of information to the corporation, then it is plainly material
M&A Generally
Sale of control
You must have a preexisting controller.
Someone who has control of a company can generally demand a premium price for their shares,
because they’re also selling power and control. The market price is just for one share.
The US uses the market rule (see Zetlin), whereas other countries use the equal opportunity rule
(where the control premium is shared with minority shareholders, and a buyer has to give the same
price to minorities as he does to the controller)
Market Rule: controller getting a premium is fine, don’t care what price he gets but there are some
exceptions (below)
The question we ask here is whether the control premium was acquired through something
3 exceptions to the market rule:
o Looting – is the incumbent controller going to let the new controller come in and loot the
o Extinguishing a corporate opportunity (Perlman)
o Sale of office
Zetlin – Market rule
 Takeaway: market rule: the controller is not required to share his control premium with any other
shareholder. A buyer can pay two different prices, one to a controller and a lower one to the minority
 Idea is someone buying control usually pays a premium which is fine bc it is more than just the share,
they do this bc they think they have good plans and don’t want to be a minority anymore
Perlman v. Feldmann – harming the corp is an exception to the market rule
 Newport steel made steel sheets, and Feldmann was a controlling shareholder. Feldmann sold his
control block to Wilport, which would then be able to just manufacture all the steel it needed any time
supply got low (because of the Korean war). This means that Newport had lost the ability to bargain
for higher deals in times of short supply (which could be very valuable).
 Court says that Feldmann sold off Newport’s ability to bargain for good prices during times of short
supply, which likely cost Newport some incalculable amount of profit. This was a violation of
Feldmann’s fiduciary duties, and thus he shouldn’t be allowed to keep the control premium he got.
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Controller had to share the premium he received when he sold steel company to customer bc company
would lose opportunity to take out loans from customers for infrastructure and therefore get around
cap on steel prices
Takeaway: Controlling stockholders owe fiduciary duties to minority stockholders, and if the sale of
control harms the company, the controller won’t get to keep a control premium. Harming the company
is sort of a proxy from stealing from the company, and can come in the form of extinguishing a
corporate opportunity from the company (that’s what happens here).
Consideration: Feldmann’s scheme is actually illegal, so it’s weird that the court treats it as
something of value. But the court still gives it value anyway.
 Rosenkranz had all of Delphi’s class B shares, representing an effective control block at 49.9% of the
vote. TMH offers to buy Delphi’s shares for $46, but Rosenkranz says “no, I want you to pay $54 to
me and $44 to everyone else.” So he wants a control premium. The problem is, Delphi’s charter had
attempted to apply the equal opportunity rule via contract. This is essentially a minority veto, which
probably incentivized most of the minority shareholders to invest.
 Rosenkranz creates an SIC to make the decision, but he basically threatens the SIC and says “if you
don’t allow me to amend the charter, I’ll kill the deal.” So obviously, the SIC recommends to the
board that they go through with the merger and amend the charter.
 Court says this was a violation of Rosenkranz’s fiduciary duty as a controller, and that if he wants to
change the charter, he’s free to do it as long as he doesn’t coerce the minority’s vote (which he is
totally doing by threatening to kill the deal).
o Remember that as a controller in a conflicted transaction, Rosenkranz has to show entire
fairness. Coercing the minority shareholders into voting to change the amendment is pretty
clearly not fair process.
 Takeaway: You can’t coerce minority shareholders into allowing you to get a control premium. This
is an abuse of your position as a controller.
 Consideration: This coercion wouldn’t have existed if there wasn’t an active deal. So Rosenkranz
could’ve postponed the deal for a few months to get the charter amended, and then resurrect the deal.
But he’s afraid that if he tries to do that, TMH will back out.
After Delphi, how do you get a control premium if you’re a controller?
o You have to somehow check on the buyer to make sure they’re going to treat the minority
shareholders well, and that’s hard to do.
 You could have minority shareholders cast a vote to show that they’re on board, but
Delaware courts treat all minority votes as inherently coerced.
 One way to get around that is just to not ask for a minority vote, and hope that
the minority assumes that you’ve done your due diligence in checking out the
new controller.
o This avoids looking like you coerced the minority, but it risks a lawsuit
down the road if the new controller pisses off minority shareholders.
Do these cases limit the market rule, or do they eliminate it entirely?
o If you have to do 1,000 things before getting a control premium (making sure you’re not
harming the company, making sure a minority vote isn’t coerced, checking out the buyer, etc.),
you’ve had to work for it, so you’re not really getting a control premium.
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o Maybe the old controller will just think it’s easier to pay the minority shareholders the same
rather than run through all these hoops to get a premium.
Sale of Office
Typically when a controller sells control, the new controller doesn’t want to have to wait for the next
minority vote to assume the old controller’s role on the board, as a director, etc. They want to exercise
their new control immediately.
So a lot of new controllers will say that the old controller has to fire the old directors and appoint the
new directors before the deal goes through, so the new controllers can come in and have power right
Courts typically don’t have a problem with this as long as the new controller buys a controlling stake
in the company. But if a buyer only buys a small percentage of a company, courts won’t let them
come in and take over immediately like that.
The new controller will still face the looting problem, so the old controller will have to show that they
did their research on the new controller. Looting just means that a new controller comes in and
messes things up/steals from the company. So the old controller has to have some sort of screening
process. (Harris)
o This is why controllers typically want to have some kind of independent committee evaluating
the deal, so there won’t be as much of a question about if they did their research.
Acquiring control from dispersed shareholders
 Saturday night special
o Controllers want to close a deal as quickly as possible to prevent other higher bidders from
coming in. So they’ll make an offer on Friday at 5:01 PM (right after the stock market closes)
and you give them until Monday at 8:59am (right before the market opens again).
o The idea is that shareholders will recognize that the company has gotten an explosive offer and
that they will take the money and run. Because the company was dispersed to begin with but
would now have a controller, their power as minority owners will be substantially reduced. So
the money sounds like a better deal.
o The problem with the SNS is that it drastically reduces the company’s ability to negotiate, and
shareholders are put under intense pressure to make a decision.
 Williams Act of 1968
o Tries to deal with the problems of a Saturday night special.
o §13(D): Early warning signal: if you acquire 5% or more of a company before doing a tender
offer, you have to disclose whether or not you’re planning to do a tender offer (§14(d)(1))
o Any offer must remain open for 30 days. If you change any terms of the deal, you add another
30 days (time starts over if you change the terms)
o You have to disclose what your plans are should you succeed on your tender offer (this is
backed up by an antifraud rule, so you can’t lie about it).
 Antifraud provision: prohibits misrepresentations, nondisclosures, and any
fraudulent, deceptive, or misrepresentative practices in connection with a tender offer
(14e-3 prohibits trading on insider information in connection with a tender offer)
 Substantive Regulation of Terms (14(d)(7) terms): Keep open for 20 business days
and have to wait 90 days if it is a closed offer, have to offer to all SHs and have to pay
all who tender the same price
o Strangely, the Williams Act doesn’t define what a “tender offer” is.
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Note that there’s no reason why the highest valuing bidder (not necessarily the winner of a SNS)
couldn’t just make an offer to the buyer who offers the SNS and gets the company at a lower price.
But then the bulk of the profits go to the offeror of the Saturday night special, not the person who
actually made the underlying company profitable.
o If we allowed this to happen, then nobody would be incentivized to try to discover valuable
companies and make offers to them, because they wouldn’t get to keep the profits.
 If you told the CA gold rushers that they couldn’t keep the profits on any gold they
found, nobody would ever go to CA to try to find the gold.
Arbitragers: push hard for deal to get through bc they want to make money; once you initiate the
arbitrages they will lose money and interest so they will be desperate to sell if you pull out; so six month
prohibition if you pull out
Arbitragers will buy shares if current price of company is lower than what they expect price will be in
very near future. If, after arbitragers buy shares, market price goes up to $14, offer is withdrawn, and
price drops down to $10, arbitragers will do fire sale because they borrowed money (with high interest
rate) to buy shares then the company that made tender offer will buy up shares at the discounted price,
which will allow them to acquire large number of shares at lower price.
If SHs own diversified portfolio, really unclear
Reason early warning system kicks in at 5% because idk
Tender offer and public offer are not defined in act so case
Tender Offers
Tender offers are given directly to shareholders, so they’re bypassing management (and are therefore
inherently hostile).
This essentially sets off an auction, which is the best way to get the maximum value for shareholders.
However, it also opens the door for someone else to come in and outbid you.
Brascan v. Edper
 Strangely, the Williams Act didn’t define what a tender offer is.
 Brascan’s management sued Edper, claiming that Edper didn’t disclose that he was making a tender
offer as required by the Williams Act (he had acquired 5%). This is called a stealth acquisition, where
Edper didn’t want the minority to know that he was trying to acquire control (because once they
know, they have way more leverage to negotiate a higher price)
 Court looks to 8 factors laid out by the SEC in an amicus brief for what constitutes a tender offer,
which are not binding, but useful:
o Was the offer made to everyone/the public?
o Was solicitation made for a substantial % of the target’s stock?
o Is the offer at a premium?
o Was the offer firm (non-negotiable)?
o Was the offer contingent on the tender of a fixed minimum number of shares?
o Only open for a limited period of time?
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o Offerees subjected to pressure to sell?
o Were there public announcements preceding or accompanying rapid accumulation?
 Court concludes that this is not a tender offer; all Edper did was acquire a large amount of stock
through regular market purchases. So Edper didn’t violate the Williams Act by not disclosing a tender
offer. There wasn’t that high-pressure type of offer.
 Takeaway: If it looks like a tender offer and smells like a tender offer, it’s a tender offer.
 Consideration: Since the Williams Act was intended to address the Saturday night special kind of
tender offer, the court is basically just looking to see whether Edper’s actions here look like a
Saturday night special or a tender offer.
Hart-Scott-Rodino Act
 Basically says whenever a merger occurs that involves the culmination of assets above a certain
threshold, we’re going to require the government to actually vet it, to make sure it’s not going to
lessen competition in the market.
o So it’s actually an antitrust concern.
 When two competitors in the same market merge, that by definition means you’re reducing the
number of competitors. But it doesn’t necessarily mean that you’re reducing competition.
o It all depends on what the existing market looks like.
 So the US government will look to see if the merger will lessen competition. It’ll stop the merger if it
will (but that’s rarely been done)
Pros and cons of mergers:
o Pros:
 Synergy: when two companies have complementary products or services that would
work better together than separately.
 Economies of scale: A proportionate savings in cost caused by an increase in
 Economies of scope: A proportionate cost saving by producing two or more goods,
when the cost of doing so is less than producing each good separately.
 Tax benefits: For example, you can write off tax losses against profits
 Regulatory reasons
 Product diversification
 Corporate governance benefits: With an active mergers market, it’s easy for
shareholders to sell shares. And that ease can make it easy for management to lose their
jobs. So it can incentivize them to work hard to keep their jobs.
o Cons:
 A merger might be used to hurt minority shareholders, who might get a low price for
their shares
 Some mergers are just mistakes and are not profitable
 Reducing competition can be a bad thing
History of mergers
o Used to need all shareholders to agree (unanimity) but now, you just need 51%
o We developed appraisal rights
o We eventually advanced to our current market, where if you get a majority vote, you can ram a
merger through.
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Types of mergers & acquisitions:
o Sale of substantially all assets (SSAA)
 company will sell one asset after another to the acquiring company
 afterwards, the target firm dissolves
 Why? When you buy the assets you may or may not be buying liability
 Reduces risk (doesn’t completely avoid) but price is higher since not buying the
 Usually, if you’re selling above 50% you’re definitely above the threshold, and if
you’re below 50% that doesn’t preclude it from being a sale of substantially all, but
courts will look at how important those assets are. If you’re a tech company but your
tech assets are only 25% of your total assets, selling those 25% will be a sale of
substantially all assets because that’s what you do.
 Each asset has to be purchased separately, which carries a high legal cost
 Doesn’t trigger appraisal rights (because no shares are being bought, and they’re
hard to value) – this is called the market out rule.
 Approval: Target shareholders and target board. Acquiring shareholders only have to
approve if more than 20% of assets are being offered as consideration, since that will
create a new controller.
 Katz v. Bregman said that you didn’t have to even sell “substantially all” of your assets
to have triggered a shareholder vote, but this has largely changed now. In Delaware,
substantially all actually means “substantially all” assets.
o Stock Acquisitions
 Share exchanges, two step mergers, and DGCL section 251(h)
 Del has two step deal: run tender offer to get majority of shares, and then they can
force through the back end a merger without an SH vote
o Mergers
 Unification of two or more companies
 Purchase both assets and liabilities
 Must do due diligence: make sure you are actually buying what you think you are
(confirm assets/liabilities)
 The acquirer buys all the shares of the target and then merges the boards into a
surviving company.
 Requires target board to say yes, then the SHs have to say yes; need majority vote
unless target charter says otherwise
 Approval: Acquiring shareholders only have to vote when their interest is being
substantially changed. Target board and majority of target shareholders must approve,
along with the acquiring board.
 E.g. if Microsoft buys a tiny company, nobody will notice. But if two equally
sized companies merge, the acquiring shareholders will actually be getting
something different than what they originally bought.
 Consideration for target shareholders can be anything you want: could be cash, other
shares, or any good
 Triggers appraisal rights for minority shareholders (since you’re buying shares)
 **But no appraisal rights if it’s a part cash part stock offer**
 Can be one-step or two-step
 One step is where you buy all shares at once
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Two-step is where you acquire control on the front end (done quickly, to reduce
competition and keep prices down), and then you freeze out the minority on the
back end.
o A tender offer on the front end just requires 30 days because of the
Williams Act. A merger takes 3-6 months
o Triangular mergers (only in Delaware)
 The acquiring company creates a subsidiary that it owns 100%, and puts some money
or other consideration into the sub. Then it merges the sub with the target company.
Done to keep the acquirer separate from the target, which means that the only way to
get to the acquirer to impose liability is to pierce the corporate veil.
 So it avoids the liability downside of a merger. But not all jurisdictions allow
for it.
 Which name survives as the surviving company determines if it’s a forward
triangular merger (subsidiary name survives) or a reverse triangular merger (target
name survives).
 Usually use reverse triangular merger when there is some sort of brand loyalty
or goodwill associated with that name
o Note: de facto mergers are not a thing in Delaware – legislature has given corps the option and
courts cannot change that; so if corp structure deal as SSAA, corp gets SSAA rules; if you
structure as a merger, then you get merger rules; if you structure as SSAA but the end result is
a merger, it is treated as SSAA
Considerations for what form of merger to use
o Timing: you want the merger to be fast and furious so as to not risk another bidder
o Voting: You’ll need the target shareholders to vote in each scenario, but occasionally you’ll
need acquiring shareholders to vote too, and that can be a consideration
o Appraisal rights: (See below) if you want to avoid appraisal rights, you’ll do a sale of assets
o Risk
o Costs
o Regulatory issues
o Liability
o Accounting treatment
o Tax: If you’re worried about tax, you’ll lean towards a stock consideration, since it’s hard to
figure out tax consequences when you use stock (because stock prices fluctuate)
o Due Diligence: hugely important in trying to figure out the value of a target
Lessons from the Timberjack example
o It’s a reverse triangular merger (finish co is creating US sub)
o It’s a two-step merger (goal is to kill off competition)
 The objective of any two-step deal is to keep the price down by acquiring control
quickly, which eliminates the risk of higher bidders coming in
 They pay the same price on the front and back ends, which is a safe way to show that
you’re being entirely fair.
o Proposal of $25/share and gives 6 month time frame
o Offering same price to phase one and phase two so what is the point?
 Usually when offering the same price in both phases, the only reason is to avoid
contested SH vote
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 Acquired control of the company so if you do a merger now it is a done deal, already
have 70% of the vote which will favor the merger
 Target SHs will take a $25 cash deal over a promised $30 bc they suffer from a
collective action problem
 Now use 251(h): offer $25 tender offer to the 70% and then comit to $25 later and if
tender offer is accepted, the whole thing is voted in
 If you offer a bigger back end price, nobody would ever sell on the front end,
and your front end tender offer wouldn’t work. But if you over a lower back
end, that looks like the second, freeze-out price isn’t fair and you’ll get sued
Weinberger style (which says that you have to disclose what your best price
would be, and that’s obviously at least whatever you offered on the front end).
Minority protections
Appraisal rights/Arbitration
o You don’t think you’re being offered a fair price for your shares during a freeze-out, so you go
to the court and ask it to determine what a fair price is.
o Procedure: You must be a shareholder during a merger, and you MUST have voted against
the merger (you can’t just not vote). Then, you must initiate an action in your own name.
 Class actions are rare, and might not be allowed. So typically only big shareholders
will seek appraisal given the costs (because it’s a direct suit – recall shareholder suits
 Because it’s not a class, the court will determine a price that goes to just that
specific plaintiff-shareholder.
o Market out rule: Appraisal rights aren’t triggered if you receive stock as consideration rather
than cash (because courts find it hard to value stock).
o Courts use the DCF method to try to determine the time value of money, which allows the
court to determine the value of a minority owner’s shares.
o Appraisal rights are a spotty protection, because they only cover individual minority
Appraisal arbitragers: You get a much higher interest rate from a court (about 6%) than you do from
a bank (about 1%). So sometimes a hedge fund will buy a bunch of shares of a target company right
after a merger is announced, and try to negotiate for a good price for their shares. If they don’t get a
price they’re happy with, they can vote against the merger, and seek appraisal, knowing that they are
usually protected from loss due to the generous interest rate (courts very rarely find value at a lower
amount than what the deal was for).
Quasi-appraisal: If a material nondisclosure impacts a minority shareholder’s decision to vote for the
merger or to seek arbitration, the theory of quasi-appraisal allows them to sue and seek a fair value for
his shares, which will be awarded as damages on top of the consideration he’s received from the
o Very problematic for target boards, because every single shareholder could bring this type of
action if there is a material nondisclosure.
Fiduciary Duty Class Actions (FDCA’s)
o Unlike appraisals, which are individual, these are class actions, so one shareholder can bring a
suit that covers every other minority shareholder (including those who voted FOR the merger).
So there is better coverage than appraisal rights.
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o The person who brings suit doesn’t have to have voted against the merger; they just have to
show that they were injured in some way.
o Recall Weinberger which says that the controlling shareholder has the burden of proving
entire fairness in a squeeze out merger.
 Which is a better protection for minorities: Appraisal or FDCA’s?
o Appraisal coverage is spotty, and is much better for FDCA’s
 You can also avoid appraisals by doing a sale of assets
o FDCA’s are processed easier and harder for boards to avoid (you don’t have to dissent), but
involves litigation (costly) and the burden of proof
 Also, arbitration is an individual recovery
o Appraisals are easier to recover from, since you don’t have to show that anybody breached any
fiduciary duty. The court just comes up with a valuation.
 So somebody who has dissented from a merger might prefer appraisal rights
Verition Partners Master Fund Ltd. V. Aruba Networks – The Nature and Judicial Determination of
“Fair Value”
 HP approached Aruba (both publicly traded companies) about a potential unity; Aruba hired
professionals and in addition to negotiating with HP, began to shop the deal; after several months of
negotiations, Aruba board decided to accept HP’s offer of $24.67/share; news of this caused Aruba
stock price to jump
 Fund filed an appraisal proceeding in the Court of Chancery asking the court to appraise the fair value
of their shares (respondent is Aruba which is 100% controlled by HP)
 Dispute over what fair value should be; Fund alleged fair value was $32.57/share and Aruba claimed
around $19.75
 Chancery Court finds it to be $17.13 (30 day average market price before the deal announcement)
 Supreme Court of Delaware held the Court of Chancery abused its discretion in arriving at that 30-day
average bc the use of stock price instead of the deal price minus synergies was erroneous and lacked
factual support
 Delaware SC awarded fund $19.10/share which reflected the deal price minus the portion of synergies
left with the seller as estimated by the respondent in this case, Aruba
 Synergies: notion that agency cost will be further reduced bc HP is buying this company
 Problem with using market prices here: in these deals, buyers get access to confidential information
that the market does not have meaning market price is based on less information than the buyer and
seller have
 Court does not discuss discounted cash flow (courts were using DCFs normally)
 Takeaway: Courts generally use Discounted Cash Flow when the process is unfair and use deal price
less syngergies when the process is fair
Fir Tree Value Master Fund, LP, Et Al v. Jarden Corporation
 Negotiates half a deal without the board and then when he tells them they give him guidelines which
he ignores; agrees to deal price t $59.29
 Investor seeks appraisal thinking they deserve a higher price and founder seems to be doing things not
in fair deal process
 Court says this is not a fair deal process because CEO has dominated the deal and ignore the board so
court ignores deal prices and looks to other valuations – unaffected market price
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Market price is actually less ($48.13) meaning CEO got a higher price and he went through
negotiations and he owns a lot of shares so he clearly wants a high price; what is the problem
o He acted like a controller even though he isn’t a controller which worries the court
Land on basically the same price they would’ve if they thought the deal was fair so the suit was a total
Even if you get past that unfair deal process, the price you get is relatively the same as the deal price
Stark decline in cases after this
 Quasi-appraisal: actions for breach of disclosure duty claims, but potentially much larger than
 Some constraints – must be material disclosure issue
 Courts impose that the disclosure has to be material
 Unusual bc it is a court created disclosure requirement not imposed by statute
If you have appraisal, what = fair value?
 Attributes of Fair value: whatever the value of the company is at the time of the merger, including
hidden value (things the public is not aware of, e.g. secret business plans)
 Won’t count speculative gains, but will count future value embedded in future price
 Used to use Delaware discounted cash flow method but not so much anymore
 Appraisal is direct suit so plaintiff has to bear own costs
Freeze Outs-Interested Mergers:
 Fiduciary duty class action suit: acquirer owes duties to minority of target so need to act with entire
fairness to us
 Court imposes fiduciary duty and fair dealing
 Controller has burden of showing fair dealing
 Rescissory damages: put them in the position they would’ve been in had the fiduciary duties not been
breached so the only way would’ve been if the deal wasn’t made; so court assumes highest price
possible, penalty for the purchasers
The Controller’s Duty of Loyalty and Freeze Out Mergers
Freeze out merger: strategic merger transaction that is accomplished for the purpose of eliminating
unwanted minority shareholders; Corporate transactions whereby two entities are merged into a single
entity, which may be one of the preexisting entities or a newly formed entity, whereby the minority SH is
forced to sell their stock for a caseh buyout as part of the transaction
Short form Merger: Delaware statutorily provides a mechanism for mergers where a parent corporation
owning 90% or more of each class of stock in a subsidiary may merge with the entity and force the
minority SHs out for a fair value cash buyout Del Sec. 253(a)
Two Step Freeze Out: tender offer followed by a short-form merger
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Weinberger says that if the controller is going to buy out the minority has to show entire fairness unless
unless (1) independent committee approves and (2) majority of minority ratifies. If so, we keep entire
fairness but flip burden to P to show not entirely fair.
Kahn v. Lynch – controller can shift burden of EF to plaintiff
 Lynch wanted to merge with Celwave, but Alcatel, which owns 43% of Lynch, vetoed the deal.
Lynch’s charter requires a 60% shareholder vote to approve a merger, and since Alcatel has more than
40%, it can veto any deal. Alcatel proposes that it just buys Lynch. Lynch, aware of Weinberger,
establishes a SIC to negotiate with Alcatel on the price (because 5/11 of Lynch’s board was appointed
by Alcatel). Alcatel offers a final price of $15.50 and says that if Lynch/the SIC doesn’t accept it,
Alcatel will do a hostile tender offer at $14.75 (investment bankers said that $14.75 was too low, and
that $17 should be the minimum).
 But, because of Alcatel’s veto power, the SIC realizes that they’ll never get a better offer than that. So
they agree to take the deal, because $15.50 is higher than $14.75.
 Court says the SIC was not independent due to this compulsion; it wasn’t an arm’s length deal. So the
burden of EF stays on Alcatel, and there’s no way they can prove a fair process given how they had so
much control over the SIC.
 Takeaway: Controller can shift the burden of proving entire fairness to the plaintiffs if they get a
majority of the minority vote, or if they have an independent committee approve it. Here, the
independent committee was not actually independent.
 Consideration: The mere existence of an SIC isn’t enough to shift the burden; the controller has to
prove that the SIC was actually independent and not controlled by the majority shareholder, and that
an actual arm’s length negotiation was possible.
Delaware has DGCL § 253, which is called a short form merger statute, which doesn’t require and SH
vote if controller has 90% or more of the stocks. This leads courts to view freeze out mergers where
controller does tender offer and then buys out remaining minority differently from the usual Wienberger
rule. The theory is that the tender offer regulations make sure that price is fair, so we don’t have to worry
so much about fairness if same price is being offered.
In re Siliconix Incorporated Shareholder Litigation
 Held that controlling shareholder tender offers to minority shareholders were not subject to entire
fairness review
 Reason is that a tender offer is a voluntary transaction between SHs and does not justify heightened
judicial scrutiny where basic safeguards are in place
Two Step Freeze Out:
1st step: Controller tender offer to minority (which is not subject to entire fairness)
2nd step: cash out minority at tender offer price (if tender offer is accepted then evidence of fair price and
if offeror gets 90%+ of shares in tender offer then invoke section 253 SF merger and no entire fairness
Cox: if a freeze-out merger is both (i) negotiated and approved by a special committee of independent
directors and (ii) conditioned on the affirmative vote of a majority of the minority stockholders, then the
BJR presumptively applies; if transaction doesn’t meet those standards, the plaintiff can plead
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particularized facts sufficient to raise a litigatable question about the effectiveness of one of the devices,
then the transaction is subject to entire fairness.
In re CNX Gas Corporation Shareholders Litigation
 Defendant Consol owned 83.5% of CNX Gas (defendant); after unsuccessful attempt to acquire CNX
outstanding shares, CONSOL eliminated CNX board committees and decreased number of directors;
only one director, Pipski was independent. Consol negotiated with TRP (held 6.3% of CNX stock;
CONSOL commenced two step freeze out merger; offer was conditional on a majority of the minority
shares being tendered. CNX board authorized a special committee consisting of Pipski to consider the
merger and complete form for SEC; Board refused to ad additional director or authorize committee to
 BJR doesn’t apply
 Under Cox, here the committee did not approve the transaction and lacked authority to negotiate; the
agreement with Price practically guaranteed the tender offer’s success and nullified the protection
majority of the minority condition
 In TOFO (tender offer followed by freeze-out) mergers, controller can get the BJR if:
o 1) majority of minority ratifies
o 2) independent committee approves
o 3) there is no coercion
o 4) the back-end freeze out is at the same price as the initial tender offer, and
o 5) they are done within a short time of each other (bc worried value could change if what)
Majority-of-the-Minority Approval Requirements:
 Majority of minority approval: approval by the holders of a majority of the
outstanding shares of Company common stock, voting together as a single class
 CNX examines motives of MOMs; ruling that a MOM may not have been an
adequate safeguard where a large minority holder’s interests potentially
diverged from those of other minority SHs
Kahn v. M&F Worldwide – controller can get BJR if ALL protections are in place
 M&F conditioned its deal on both approval by a SIC and a majority of minority SH votes. M&F made
it clear that the SIC could say no to the deal if it wanted to, and that the SIC had to act with care (by
getting informed and getting an investment banker’s opinion, etc.).
 Because of all of these minority protections, the court says they won’t just shift the burden; they’ll
actually give the controller the BJR.
 Takeaway: If a controller uses all of these protections, he’ll get the BJR. If he does none of them, he
has to prove entire fairness. If he does some of them, the Lynch standard applies, and the burden of
entire fairness shifts to the plaintiffs.
 Considerations:
o This is the only kind of conflicted transaction where the controller can get the BJR
o One way to look at this decision is not that the court is giving the controller the BJR, but rather
that the court is just defining what entire fairness is. The court could just be saying that if a
controller sets up all these protections, it’s proved entire fairness.
Hostile Takeovers
Corporate Lawyer
Khanna 2020
Hostile takeovers are “hostile” because the target board opposes the merger, not the target
shareholders. The target shareholders might be more than happy to take a hostile tender offer.
Hostile takeovers cannot happen in a controlled firm bc controller can veto if they don’t want it
Remember that if the objective is to get target shareholders the highest price, the target board will
have to negotiate with the acquirer. But the target board is conflicted, because they don’t want to get
fired once the takeover happens. So how do we allow target boards to negotiate these deals without
just never agreeing, to avoid losing their jobs?
Unocal test: 1) Is there a reasonable threat? If so, 2) is the target board’s defense proportional and
reasonable given that threat?
o Any attempt to manipulate the voting structure requires a compelling justification (Blasius)
o An investment banker’s opinion that a price is too low is enough to show a threat, and a
proportional response just requires that additional offers can still be made.
Key Concerns – striking a balance between entrenchment and low price. We want target boards
to be able to negotiate with acquirers to avoid their shareholders getting a low price, but we don’t
want target boards to just never agree to a deal in order to keep their jobs.
Greenmailer: Someone who acquires some percentage of a target company, and then goes to the
target board and says “we’re planning on buying 50% of your company, but we won’t do it if you buy
back our shares at a premium.” Purely a way to get money.
Unocal v. Mesa Petroleum
 Mesa, owned by well-known greenmailer T. Boone Pickens, offered a two-tier deal to Unocal; first
tier was to acquire 37%, giving them control (since they already had 13%), and the second tier was a
freeze-out. The first tier was for $54, but the second tier was for $54 in junk bonds (highly risky, so an
expected value of less than $54). This is coercive bc people in back end could get screwed so it
pressures people to take first offer.
 Unocal got two investment banker’s opinions that said that $54 was inadequate, and that $60 was the
minimum fair price. But Unocal was worried that its shareholders wouldn’t believe them, because
their stock was trading at $37 (and SH might just think that Unocal’s board was trying to entrench
themselves by lying about the value of their stock).
 So Unocal comes up with a defensive self-tender offer, where they say that if Mesa acquires 50% like
they want to, Unocal will buy the remaining 50% with junk bonds worth $72 a share (so an expected
value of $58). $58 is higher than $54, so many Unocal SH would likely not buy into Mesa’s deal in
the hopes of getting the $58 back end expected value. And if not enough SH take Mesa’s front end
deal, they won’t get to 37%, and Mesa goes away.
o And if Mesa goes crazy and still gets 50%, then they suddenly have to take on this $600
million debt that Unocal just offered. Mesa won’t do that.
 Mesa sues claiming discriminating between SHs is breach of duty
 Board can protect from low price offer, but to get BJR they need a fairness opinion showing that it
was a low price, threat to competition (structurally coercive tender offer counts) and response needs to
be proportionate (discriminatory counter conditional tender offer is fine, no costs)
 Court says Unocal’s defensive measure was fine and sets out the new 2 step test.
 Takeaway: 2-step test: 1) is there a reasonable threat? 2) Are the target board’s defenses
proportionate and reasonable given that threat?
o Also, it’s okay to discriminate against a shareholder when that shareholder is trying to execute
a takeover that presents a threat.
Corporate Lawyer
Khanna 2020
o If an individual does something that has a preclusive effect, but it’s not the board acting, it’s
not clear that that violates the second prong of the Unocal test.
Unitrin – Reasonable Threat Meaning
 Reasonable threat isn’t just low price
 When hostile takeoverer is substantially coercive, meaning own SHs will prefer that low deal more
than their own target board’s higher projections for the future
 If corp can prove that then reasonable threat to corp prong is satisfied
 If target board thinks the corp is worth more doing something, court will defer unless hostile
takeoverer can show they are conflicted or are not acting in good faith
 Target corp can prove this via an independent opinion saying target board is going to be worth
something more under target management
Poison Pills (a shareholder’s rights plan)
 Once triggered, poison pills entitle shareholders to either buy more of the target company’s shares at a
huge discount (flip-in) or to buy shares in the acquiring company at a huge discount (flip-over/out).
o The target company can pull off a flip-over pill by having it as a contingent liability. When
you buy a company, you acquire its assets AND its liabilities. So the acquiring company is
acquiring a liability that says the target shareholders get to buy shares in the acquiring
company at a huge discount.
Flip-in Pill
 Acquiring firm buys X% of target firm and makes it known that it is planning to make acquisition
 Target Board can hold meeting to decide if potential offer is at good or bad price. Invariably price too
low. Enact plan that
o Gives all SH besides acquirer a Right
o Right allows non-acquirer to purchase shares of Target at massive discount if Acquirer goes
forward. This is an issue of new shares.
o At the same time, if the Board of the target decides the price is acceptable, the Right can be
redeemed for a trivial amount (e.g. ¼ of a cent)
 This gives power to block acquisitions; Delaware says it is fine as long as there is a
way to unblock
 This makes Acquiring firms run away: it buys at high price and then that share gets incredible diluted
bc others purchased at way lower price. This make Acquirer have to go buy more from target SH who
would use Rights bc they would get a premium so no one wants to trigger this
o Price will fall, but they will still have to pay more than the discounted price it was sold to SHs
Flip-Over Pill
 All non-acquiring SHs would have option to buy shares in acquiring firm
 Target can do this bc those commitments are liabilities that you buy when you purchase the target.
You saw contingent liability and paid for it .
 Basically, if buy target, it’s like biting into a poison pill. Now target SHs own target instead of
acquirer owning target
Corporate Lawyer
Khanna 2020
General Poison Pill Notes:
 Nobody has ever actually triggered a poison pill; they’re purely threats.
 They can be redeemed by the target board for like $0.01, so the target board can get rid of it whenever
they want. So it’s still a proportional defense under Unocal, because it doesn’t actually prevent you
from receiving any other offers. The firm is not “takeover proof.”
 A pill can be implemented with no notice whatsoever, and just takes a few days. First you get an Ibanker’s opinion of the value of your stock, and then a law firm can get you the boilerplate language
in less than 24 hours.
 One way to ensure that a pill will be redeemed is if an acquirer replaces the target board. So
sometimes, hostile acquirers will make a tender offer and try to change the board. This would require
a proxy vote and take 3-6 months, but if the acquirer succeeds, the pill will be redeemed and the
acquirer can take over.
Selling the firm – are duties different once you’ve decided to sell?
 In theory, if the target board has decided to sell, that eliminates the concern about entrenchment. So
the only remaining concern is that shareholders would get a low price.
 Unocal is a defensive mechanism and it doesn’t apply when the Board has actually decided to
relinquish control; including when (1) switching from diverse to controlled, or (2) switching
 Revlon standard: You have to try to maximize shareholder value.
 When does Revlon apply?
o When management is changing and SH at target firm will no longer be in same position to
vote them out
o When the target will be busted up
o A cash merger
o When a merger would transform a dispersedly held firm into a controlled firm (see Paramount
v. QVC)
 Both of these involving releasing your decision-making authority
 When does Revlon not apply?
o When you are pursuing a pre-existing long-term business plan and a dispersedly held company
is going to remain dispersedly held (Paramount v. Time)
Smith v. Van Gorkom
 Trans Union has been taking losses for years, so they want to sell themselves to someone who can use
their debt for tax purposes. Van Gorkom negotiated with his friend, Jay Pritzker, behind closed doors.
Van Gorkom told Pritzker that he could pull off a takeover at $55 per share, and Pritzker agreed
within ten minutes. When Van Gorkom brought Pritzker’s offer to the Trans Union board, nobody
asked him how he got that $55 price, and they only discussed it for 20-30 minutes. The board never
got an I-banker’s fairness opinion (so they can’t get the BJR, since they can’t say there was a threat).
 The board tried to argue that they acted with entire fairness because the merger would take 3-6
months, effectively creating an auction period during which time they could accept other bids. But this
wasn’t really a fair auction, because they had a “stand-still” agreement, a big termination fee to
Pritzker if the deal didn’t go through, etc. Also, when they amended their merger agreement, what
they actually did was say that Trans Union could only back out of the Pritzker deal if they actually
consummated a more favorable merger; simply receiving a better offer wasn’t enough to allow them
to back out (which it should’ve been).
Corporate Lawyer
Khanna 2020
Court says that because this auction was rigged to prevent other competing bids, the Trans Union
board has not proven entire fairness. The Trans Union board couldn’t just back out of the Pritzker deal
without facing a huge breach of contract suit from Pritzker, since the amendments said the only way
they could back out is if they actually consummated a better deal with someone else.
No way reasonably informed in that short amount of time
No BJR = have to prove entire fairness
o Entire fairness not prove; auction had too many limitation to be considered fair; no need for an
auction to prove entire fairness but what they did is definitely not entire fairness
Takeaway: This was a violation of the Trans Union board’s duty of care, because they failed to get
informed about the adequacy of the $55 offer price, and they totally locked up their deal with Pritzker
to the point where they couldn’t accept other offers. That all looks bad.
o You also can’t rely on somebody who has no experience in financing to give you a fairness
evaluation. They have no idea what they’re doing, and that’s not enough to get informed.
 AND IF THEY RESPOND, that might be an ethical issue; they’re giving you
information about something that they don’t actually know about.
Consideration: It’s not getting “informed” if all you do is just compare the acquisition price to the
current trading market price of shares. Just the fact alone that you’re getting a premium doesn’t make
that a good deal, and a target board needs to do more to get informed in order to exercise their
business judgment.
o This is the only case that seems to apply a Revlon-like duty when there is no bust up, no
change in control, and no cash merger. And it predates Revlon.
Revlon – have to try to maximize shareholder value
 Ronald Perelman wants to buy Revlon for $58. Revlon consults an I-banker, who says that a
reasonable price is $62-65. So Revlon enacts defensive measures under Unocal – a poison pill, and
they repurchase shares for notes. The notes convert the shareholders into creditors, and Revlon also
says that if it gets taken over, its assets can’t be sold unless the creditors vote to okay the deal. In
response to this, Perelman increases his bid to $60.
 Forstmann then matches Perelman’s offer, but the problem is that Forstmann also wants to bust up the
company, and Revlon had inserted that covenant about how assets could only be sold with creditor
approval. So Revlon removes that covenant, which pisses off all the noteholders (because their
collateral was just slashed). The noteholders sue. On top of that, Perelman says he’ll beat any offer
Forstmann makes.
 To try to solve the problem, Forstmann says he’ll pay the noteholders to make the noteholder suit go
away, and Revlon agrees to that. Perelman’s suit continues, as he argues that Revlon took a deal that
was basically the same as his, except it would absolve Revlon’s board from liability to the
noteholders. That’s a prima facie case of a conflict of interest.
 The court agrees, saying that Revlon effectively cut off the auction to get rid of their personal liability.
 When target has settled on selling the company and busting it up, then target’s fiduciary duty becomes
to look for the highest price. The adoption of defensive measures have to be suited for that (highest
price) purpose.
 Here, Revlon was favoring an alternative bidder (and screwing over SH that it put in bad position with
notes as defensive maneuver) bc that bidder would do something nice for the board
 Takeaway: Once the board realizes the firm is going to be sold, the board’s duty is to maximize
shareholder value, not to absolve themselves of liability or maximize noteholder value.
Corporate Lawyer
Khanna 2020
Paramount v. Time (Time-Warner)
 Time really wanted to merge with Warner, citing a synergy in their management and their services.
This is evidenced by how there were going to be co-CEO’s for 5 years after the merger. Then
Paramount jumped in and offered $175 per share, way over the current market price of $50. Time was
worried that shareholders would jump on that huge premium, so Time drops its stock-for-stock merger
with Warner, and instead makes a cash tender offer. Time argued that the long-term benefits from
merging with Warner were better.
o This tender offer means that Warner’s shareholders will have to vote, but not Time’s. So if the
merger goes through, Time’s shareholders won’t be able to vote on Paramount’s offer until
after the merger, and $175 will look inadequate for the new Time-Warner company.
 Time also had to borrow a whopping $10 billion in junk bonds to afford this tender
offer. So even if Paramount takes over, they’re acquiring $10 billion in debt.
 Court says that this isn’t a sale, because neither Time nor Warner is releasing their decision-making
authority. They’re just merging as equals because they can help each other. So the court applies
o The threat is to Time’s long-term business strategy, and this is an okay response.
 Claim is that Time-Warner synergy is higher than anyone things, the cultural fit is so good that the
value of the company will be worth twice as much in the future which will benefit shareholders more
than a larger deal now
 Court ultimately defers to board and decides yea the board has done research and knows what is best
o Threat here is having to merge with a bad fit so the court applies Unocal
o Reasonable response because they don’t think shareholders will say not to the offer because it
is so high
 Bank debt is proportional (not assessing whether it will bankrupt company but rather assessing
whether it would make it impossible for someone to takeover the company without both SH and board
 Takeaway: If you’re pursuing a preexisting long-term business strategy with a merger, and a
dispersedly held company is going to remain dispersedly held, Revlon does not apply; Unocal does.
 Consideration: It’s impossible to prove what your “synergy” or “culture” would be, so this decision
seems like it grants target boards a “just say no” power. Management can always just lie and say that
company X is a better fit long-term than company Y.
o Then again, it’s relevant that Time wanted to merge with Warner BEFORE Paramount’s offer
entered the picture.
Paramount v. QVC – Change of Control Triggers Revlon
 Paramount was negotiating a deal with Viacom, and knew that other buyers might want to come in
and break up the party. So they put in 3 deal protections: a no-shop provision, a termination fee, and a
stock option agreement. Still, QVC (controlled by Summer Redstone) came in and offered $80.
Viacom raised its bid to $85, and QVC raised theirs to $90. Paramount rejected QVC’s bid.
 P/V folks make the strategic fit argument and it works even better here than in Time bc P/V is more
 Court says that because Paramount’s shareholders were going to go from a situation where there was
no controller to one where Redstone controlled, Revlon applied, and Paramount’s board had a duty to
maximize shareholder value before they lost all their control (change of control triggers Revlon)
Corporate Lawyer
Khanna 2020
Takeaway: Revlon applies with a change in control. When the target shareholders no longer have the
power to vote out management, Revlon is triggered, because the shareholders have lost their decisionmaking authority.
Courts are willing to defer to the board if they think the SHs can hold the board accountable
 The SH can observe what is happening and can fire you so if they think didn’t
like what the board was doing they could fire them, why would court get
 Only gets involved were the SHs can’t control the board
 Discussion of information: when target board has more information about their
value, the court defers more; if the company is going to be bust up, there isn’t a
lot of information they are going to have, no future plan
 In a cash deal, SHs are gone (Revlon applies?)
 In stock for stock deal the SHs are still there and can exercise their vote so
more deference
Lyondell v. Ryan – Applying Revlon in Non-Bidding Contests
 Basell wanted to buy Lyondell, and after making a few increasing offers, offered $48, which Lyondell
informedly concluded was a fair price. They agreed to the sale in less than an hour.
 Lyondell is clearly selling itself, so this isn’t Unocal. Arguably Lyondell was careless because they
took less than an hour to decide to sell the company, but they’re exempted from that by a 102(b)(7).
So the only way Ryan can claim that this fails Revlon is if Lyondell’s board didn’t try to meet their
Revlon duty (aka an intentional dereliction of duty, which is a breach of the duty of good faith). But
that’s almost impossible to win on, since the board was informed (they had known that Basell was
interested for about a year, and the price wasn’t good enough. It’s not hard to reject an inadequate
price very quickly). So the only way Ryan could win a Revlon claim is if the board is conflicted, and
the board wasn’t conflicted here.
 Takeaway: Revlon doesn’t mean much. Lyondell basically sat there and did nothing because of their
“wait and see” approach, and the court still says that’s fine. They may have breached their duty of
care, but they’re immune from that because of the 102(b)(7) waiver. Thus, the only way the board
would be liable here is if they completely failed to undertake their duties (which is a lack of good
faith) and thus breached their duty of loyalty.
 Don’t have to have a bidding contest, have to try to get the highest price possible
 If board is unconflicted, informed, and they tried, it satisfies Revlon (similar to BJR)
 Consideration: Isn’t this just the BJR? The court is saying that the only way Lyondell will have
failed Revlon is if it was conflicted, not acting in good faith, or not informed. Those are the 3 prongs
to the BJR.
Protecting the deal:
 No-Shop Provision: target won’t look for other bids, might be ok but you have to show you did it to
induce higher bids
 Force the Vote: provision in K that the directors have to put forward to the SHs the vote; so boards
says yes and in six months the SH votes but what if board gets soft on the deal in that time, so acquirer
wants vote sooner
 Shareholder Lock-ups: individual SHs sign agreement to vote in favor of a deal
Corporate Lawyer
Khanna 2020
 NCS is about to become insolvent/bankrupt (meaning shareholders wouldn’t get anything), so they
want to sell themselves to at least get something for shareholders. Omnicare says they’ll pay enough
to cover NCS’ creditors, but shareholders wouldn’t get anything. NCS says no, and goes to Genesis.
Omnicare has scooped Genesis in the past, and Genesis doesn’t want that to happen again. So Genesis
says they’ll only bid if the deal is locked up as much as possible.
 Genesis gets NCS’ controlling shareholder to agree to vote in favor of a NCS-Genesis merger if there
is a vote. Then, Genesis negotiates a “force the vote” provision into the deal that say that NCS’ board
will recommend the proposal even if a better offer comes along. NCS did not put a fiduciary out
clause into the agreement.
o So basically, Genesis has set themselves up where NCS will have to propose this merger to
shareholders, and then the controllers will have to vote it through. So Genesis is guaranteed to
get NCS. This is known as a shareholder lock up.
 Then, Omnicare jumps back in and makes a competing bid that would actually pay NCS’ shareholders
more than Genesis’. Because of this, Genesis only gives NCS like 48 hours to make a decision. NCS
has to approve the Genesis offer even though it doesn’t want to.
 Even though this looks exactly like Revlon, the court applies Unocal. The court says that as soon as
NCS decided to deal only with Genesis, they were no longer really trying to “sell” the firm (but this is
o In reality, had the court applied Revlon, this deal would’ve been upheld, since if NCS had
never agreed to these lockups, Genesis’ bid would’ve never materialized. So NCS WAS in fact
doing what was going to maximize shareholder value.
o Also, this is the opposite of a QVC situation, because NCS had a controller, but Genesis did
not. So there was no sale of control issue.
 Court applied Unocal and says there is a threat but this isn’t proportionate response to the threat
because it makes it impossible for target to get a higher price; Court says this fails the second prong of
Unocal, because they were coercing the shareholder vote without any fiduciary out clause.
 Consideration: Khanna thinks this would’ve been way easier as a simple sale of control case. The
NCS controller would sell to Genesis, and then minority shareholders of NCS would sue the controller
who signed the stupid deal for a breach of fiduciary duty (because of a loss of corporate opportunity to
make more money from Omnicare, similar to Perlman) and recover any damages.
Controlled Merger: when the acquiring corporation, prior to the merger, exercises such significant
control over the acquired corporation that the transaction cannot reasonably be viewed as negotiated at
arms’ length
Corwin v. KKR
 Not a controlled merger and have informed, uncoerced disinterests SH vote in favor of merger. KKR
technically doesn’t control KKR financial, the ppl who really control are KKR financial advisors;
KKR controls KKR financial advisors; trying to prove separate entities. Planning merger, stock for
stock deal
 If not treated as controlled merger, Revlon and Unocal holdings
 Not a controlled merger because:
o They don’t actually own a majority of the stock
o Even though they own part of KKR financial, that can be severed
Corporate Lawyer
Khanna 2020
Using Revlon and Unocal here
When it comes to vote, the KKR financial advisors say yes lets do the vote
BJR applies: if you have what looks like a SH ratification that has the same effect as a director
If the SHs have decided w/o being coerced and being informed, then BJR is met
Revlon and Unocal are relevant PRE-closing of the deal to stop defense or uphold defense to a deal
BJR is after closing
Takeaway: if SHs have agreement on most things (e.g. freeze-out, etc.) and it is disinterested and
informed then it stands; as long as the process looks good, court will not interfere
When can Plaintiffs challenge
Court will interfere for example if SHs have no option but to vote on that deal
In re PLX – Aiding and Abetting in Violation of Breach of Fiduciary Duty
 Hedge Fund Activist (Potomac and its co-managing director, Singer). PLX seems to be a firm doing
connectivity work, involved with discussions with IDT to sell but those fail; Potomac buys 5% of
PLX. Singer pushes and gets on Board and committee negotiating sale.
 Singer understands there is a buyer but one that cannot do it right now; Singer doesn’t tell anyone;
Avago becomes available and is interested in buying; Singer pushes his board, again without telling
them what is going on, to buy within a matter of weeks for around $6
 PLX deal going on; SH find out what is going on and bring suit alleging that target board aided and
abetted in breaching duty to SH
 Target board appears to be defendant but what duty did they breach bc they didn’t know about the
stuff going on
o Not a conflict claim
o Not a care claim
o Is this good faith? That the board was…
o Board is uninformed so no BJR but what duty? Maybe care bc uninformed but they have been
deliberately lied to
 Other claim: board puts forth another set of projections which are lower than earlier ones, could make
claim that they made those projections with lack of good faith and care because they were uninformed
 Why is disclosure important here?
o Corwin: lack of disclosure, SH vote doesn’t cleanse the deal
o Since SH doesn’t know about deal with Klaus then uninformed and no BJR
o Breach: target board doesn’t know about Kraus’s price points
 Really Singer bad behavior and not board but board is negotiating without being
 Looks like they are not making informed decision
 Feel like duty of care claim but court is never really clear
 PLX’s board has already settled, only one that hasn’t settled is Potomac?
 Agreed to duty of care so covered by insurance
 Court: lack of disclosure poisons deal process, Singer is aiding and abetting the board that owes duty
o No damages bc price paid is ok
 Precedent saying SH can be held liable for aiding and abetting breach of duty of care
 Here, Kraus said hey we aren’t able to buy now but when we are, we will buy for around $6
 Suing singer for fraud? They can
Corporate Lawyer
Khanna 2020
The fiduciary duty that the PLX board had was violated and if you aid and abet in violating that
breach of fiduciary duty, you can be held liable
o No one had ever held this in a hedgefund situation
o Hedgefunds normally treated differently because they have short term interests and may push
corp to do risky things
Test/elements for Aiding and Abetting:
(1) Existence of fiduciary duty
(2) Breach of fiduciary duty
(3) Knowing participation by non-fiduciary defendant, and
(4) Damages caused by breach
Del Code, Anti-Takeover Laws (Delaware Moratorium – Section 203)
 Once someone gets 15% of something they cannot do a deal to get control
unless they…wait three years or make a big offer
o Deters junk bond bust ups
 Once you acquire 15%, you cannot try to acquire control unless you meet one
of three conditions:
o You prove your offer is a fair price
o You wait three years
o You don’t just acquire control, you own 85% of the shares
 Point is to make it harder for junk bond financers
 So, don’t acquire 15 percent, acquire 13
 Proving fair price isn’t that hard
 Similar era now with hedgefunds pushing firms to do certain things
Broader trend:
 If you have an informed, disinterested, unconflicted shareholder vote, you
aren’t getting anywhere
Constituency Statutes: generate quite a bit of skepticism because of context for enactment and that give
discretion to target board to consider non-SH but not require it
Blasius – compelling justification
 Blasius, 9% owner of Atlas, wants to restructure Atlas’ management and sell a ton of assets. Atlas
thinks this is a terrible idea, but they’re worried that Blasius will be able to change the board at the
next annual meeting and force through the deal. Atlas’ charter says the board could be increased from
7 to 15 seats. So instead of letting Blasius get 8 guys on the board, Atlas increases the board to 9 and
puts two of its own guys on it.
 Court strikes down board’s move, BJR protects business decisions not allocation of power decisions
between board and SH (kinda slippery slope argument but whatevs)
 Court applies Unocal (even though no hostile takeover), since this doesn’t look like Revlon (there’s
no auction/bidding war).
o Although there is no hostile takeover, the court finds the threat to be a threat to the board’s
strategic plan which the board is trying to protect
o Court finds that under standard Unocal principals the board’s actions are fine because they
don’t make it impossible for the shareholders to prevail
o However, the court decides that in this sort of interest, board needs a compelling justification
Corporate Lawyer
Khanna 2020
Takeaway: In a Unocal deal protection, if you do something that messes with a shareholder vote, you
have to show a compelling justification for it. We won’t give voting manipulation much deference,
because it’s not part of a board’s business judgment.
Consideration: The court does not outline what WOULD be a compelling justification. But Khanna
thinks it would be hard to show. The idea is that boards are given deference for business decisions, but
shareholders don’t elect you because they think you’re better at voting than them. So anything that
messes with the voting structure is suspect. Reason courts give SHs so much deference is because if
SHs don’t like boards’ actions, they can vote them out.
o Remember how Speiser and Schreiber (circular voting and vote buying cases) never mention
the BJR, because those aren’t situations where a board is using its business judgment. They’re
just manipulating the voting systems.
It seems like both Revlon and Unocal are moving towards the BJR, but Delaware courts still treat
them as separate things.
Rise in fair process: determinative of whether deal passes fiduciary duty scrutiny…?
 Deal litigation
 Limit to deals
Broader interpretation: trend to permit reliance on contractual protections over equitable review
 Is the process fair
If the process if fair, courts don’t want to get involved but if it is unfair, court will get involved
Insider Trading
Insider Trading: trading by people (insiders) possessing material non-public information (MNIP)
without disclosing that they are trading on MNOP
o Doesn’t seem like any one really loses here; not like insider got someone to trade, they go to
market and buy shares on the open market
o Seller doesn’t know they are selling to insider, they were going to sell at that price anyways so
who really suffers? No causal harm is apparent
 Management of a firm can’t trade off of info that it gets from the firm.
 Insider trading is usually legal, but the problem is that outsiders won’t want to trade with an insider,
because they’ll assume they’re going to lose. So corporate law gives insiders a duty to disclose that
they’re insiders.
o There was also a big push to regulate insider trading after the market crash
 State corp law only regulates if/when the insider makes an in person contact with seller but on
faceless, nameless, exchange, don’t know who is selling
 §16: §16(b) – Insider (as defined by 16(a)) can’t buy and sell and sell and buy shares within a 6
month window. If you do, those profits go back to the company. This prevents people from
“pumping and dumping,” the idea being that if you’re buying and selling with such a short time frame,
you’re probably just trying to screw the market and make quick money off of insider info.
o This doesn’t stop directors, who usually get stock options as compensation, so they’re not
actually buying or selling any shares. They’re just getting the difference in cash between their
option price and the market price. So this gets them around §16.
o Also doesn’t stop you if you’ve held shares for a long time and learn that the firm is doing
poorly; you can sell without any problems.
Corporate Lawyer
Khanna 2020
o §16(a) defines insider as an (1) officer of the company, owns 10% of shares, etc. Disclosure
by certain insiders that trading within 10 days of trade
 10b-5: it shall be unlawful for any person
(a) to employ any device, scheme, or artifice to defraud,
(b) to make any untrue statement of material fact or to omit to state a material fact necessary in order
to make the statements made, in the light of the circumstances under which they were made, not
misleading, or
(c) to engage in any act, practice, or. Course of business which operates or would operate as a fraud or
deceit upon any person,
In connection with the purchase or sale of any security
 §10(b), enforced through Rule 10b-5: Anything that amounts to deception or fraud is illegal.
o To make silent trading “deception” or “fraud,” you need to have had a duty to disclose.
 Courts construe the “duty to disclose” as broadly as possible, which leads to the equal
access theory. If you have ANY access to inside info, you have a duty to disclose it so
everybody can have an equal access to the info/market benefits.
 Rule 14e-3 applies the equal access theory to tender offers.
 Rule 10(b) only applies if you’re an insider. But what exactly is an insider?
o If you’re a waiter and you overhear a conversation between execs, are you an insider?
o If you’re a cab driver who works near Wall Street and overhear a phone call, are you an
 The SEC says it depends on who the waiter or cab driver works for.
 If you’re a waiter for a kitchen inside an investment bank, you’re probably an
insider. But if you work at the restaurant right next to the I-bank, you’re
probably okay.
 Similarly, if you’re a chauffeur for CEO’s, you’re probably an insider because
you have a differential access to information. If you’re just a regular cab driver,
you’re probably good.
SEC v. Texas Gulf Sulphur – Materiality
 Large mineral deposit under land; buy the land; before publicly announce deposit executives buy
shares (i.e. profit on disclosure news)
 Materiality “depends at any given time upon a balancing of both the indicated probability that the
event will occur and the anticipated magnitude of the event in light of the totality of the company
 “totality” means court will decide
 Structure of how court wants to see your argument, probability of the event, magnitude of the event.
 Individuals with knowledge of material insider information must wither disclose it to the public or
abstain from trading in the securities concerned while the inside information remains undisclosed
 Materiality of a statement depends on the significance that a reasonable investor would place on the
withheld or misrepresented information
 Inside info about the specifics of the drilling-site was material bc the high mineral content of the site is
information a reasonable investor would have liked to have known the information would certainly
have affected the price of the stock
Santa Fe – Misrepresentation
Corporate Lawyer
Khanna 2020
SF owns 95% of Kirby and does Short Form Freeze Out (section 253). Tells minority will pay $150
(market is $125), but valuation report suggests $600+ per share. Minority sues.
US Supreme Court: No misrepresentation/deception 9no misstatement of material fact) as Santa Fe
accurately stated what it was doing
§ 10b: covers deceptive practices, doesn’t cover unfairness
Chiarella – SCOTUS: RETAC (relationship of trust and confidence) theory
 Chiarella is a financial printer, and he gets sent a project to print 5 announcements for corporate
takeover bids and is able to figure out who is buying who. He buys and sells shares in the target, and
makes a $30,000 profit in 14 months.
 Court says Chiarella is not liable for insider trading, because he did not have a duty of trust and
confidence to the shareholders of the target company (i.e. the company he was theoretically harming
by trading in them). He’s not an insider, and he had no fiduciary duty to target shareholders.
 Court explained that there must be a relationship of trust and confidence between the parties to the
transaction in order to give rise to a duty to disclose inside information or refrain from trading. (if
buying, SH and officer have relationship; also if selling, bc new SH is buying into corporation)
 Takeaway: You will only be liable for insider trading when you have a duty to disclose your info to
the party whose shares you’re buying. You must have a RETAC to the company you’re dealing with.
 Consideration: The court is basically taking a step back from the equal access theory. Under that
theory, Chiarella would’ve been liable here, but the court doesn’t want to hold him liable because he
lacks any fiduciary duty. So the court is implicitly saying that having unequal access to information on
the market isn’t immediately insider trading.
o This case leaves open many loopholes:
 Tipping:
 I, an insider, give info to you, an outsider, and you can trade on it since you
don’t owe any duties to my company.
 Cross trading:
 Say you’re an exec of Coke, and you figure out that Coke is going to do poorly.
So you trade in Pepsi based on that info. You assume that Pepsi will go up if
Coke goes down, and you make a profit that isn’t prevented under Chiarella,
since you don’t owe any fiduciary duties to Pepsi.
o People within Coke and Pepsi probably hang out together; we don’t
want them trading off of each other’s info.
 Third party trading:
 Employees, friends, and family can trade freely in target shares, because even if
they learn confidential info from an insider, they don’t owe any fiduciary duties
to the target themselves. So this isn’t prohibited under Chiarella.
Dirks v. SEC – closing the “tipping” hole
 Equity Funding was committing fraud. Secrist, a former Equity Funding executive, told Dirks about
the fraud. Dirks made a big ruckus about it and told everyone he could, which led to large institutional
investors liquidating their Equity Funding shares, the share price dropping, and the fraud being
 Court says that Dirks isn’t liable for insider trading under Rule 10(b), because this is a “good” kind of
tipping, where he was being a good Samaritan and exposing a crime.
Corporate Lawyer
Khanna 2020
Takeaway: 2 part test for tipping: 1) the insider needs to benefit personally from giving the tip
(quid pro quo), and he has to violate a RETAC to the company being traded on. 2) The person
receiving the tip must reasonably know that he’s aiding and abetting the tipper in breaching his
fiduciary duty (his RETAC).
Consideration: Secrist wasn’t receiving any quid pro quo here, so Dirks isn’t liable because the first
part of the test isn’t satisfied. The court was unwilling to take a hard stance against all trading based
on tips, because some tips, like the one in this case, are good.
 Del and NVIDIA; Once these people know info they start talking to a long chain of people that ends
in Newman and Chiason who are the ones actually trading; looks like a chain of tips designed to avoid
liability (i.e. I tell you, you tell chad, chad tells Brad, Brad trades…next time brad has info, tells Chad,
Chad tells you, you tell me, I trade)
 Will newman and chiason be held liable? Court doesn’t get them
 For tipping liability, you need tipper to breach fiduciary duty by receiving a gain, and that tippee knew
about tipper’s breach (Dirks rule)
 Court needs: “meaningfully close personal relationship that generates an exchange that is objective,
consequential, and represents…potential gain of a pecuniary or similarly valuable nature.”
 Career advice, social acquaintance not enough – more like personal loans or favors
 Government did NOT show that Defendants knew info came from insider or any personal benefit
 Court is saying they want more evidence
 Is info still non-public
 Final tippee needs to know that tipper is gaining personal benefit
Salman – broadening Dirks, limiting Newman
 Tipping chain but unlike Newman, this isn’t professionals having repeat interactions, this is between
family members
 Court says we don’t need level of clarity of personal benefit that Newman suggests
 Dirks simply says that to get the tippee, the tipper must receive personal gains
o This can include giving info to a relative who trades
 Tipping to a family member with the intent of giving them a gift is a personal benefit, don’t need
more than that
 Tippee has to know that the tipper received a personal benefit but don’t need to know what the benefit
 Takeaway: Any time a friend or family member benefits from tipping, that will be treated as a
sufficient benefit to you as the tipper to impose liability on you and whoever you give the tip to.
Tippee not required to know what the benefit to the tipper was.
Reg. FD:
 Selective disclosure to some subsets of analysts is a no-no
 If do it, then immediately must disclose to all (if intentional) and if unintentional then promptly
disclose to all
 Some suggestion analyst predictions less accurate post-reg fd
o Bc now they don’t get as much advance info as they used to
Corporate Lawyer
Khanna 2020
o Not something to be worried about, the goal was to prevent analysts from getting info
beforehand, this show it is successful
o Is the less accuracy more harmful to the market than tipping?
o If you know more quickly what company is better, then that enhances efficiency of market
o How much earlier is necessary
 Allows something close to the equal access theory in the case of tender offer
o If you have access to info of a tender offer and trade on it, then SEC will come in and bust
 SEC clarified when a duty of trust and confidence arises with rule 10b5-2
o Agree to maintain confidence
o History of relationship leads to reasonable expectation of confidentiality
o Receive info from close relative (i.e. spouse, parent, child, sibling)
O’Hagan – third party trading hole – requires disclosure to the source of the info
 O’Hagan is a partner at the law firm D&W, which is representing Grand Met’s takeover of Pillsbury.
O’Hagan wasn’t working on the deal, but he knew that Pillsbury would become much more valuable.
So he bought a ton of Pillsbury options in his own name (he’s an idiot). He made $4.3 million from
Pillsbury shares, which he actually needed to pay off money to get embezzlement charges dropped.
 Under Chiarella, O’Hagan would be fine, because he didn’t owe any RETAC to Pillsbury. But the
court creates another duty to disclose, and holds O’Hagan liable because he misappropriated the
information. He got the info from Grand Met, and in theory, Grand Met could’ve traded on this info.
But O’Hagan took that corporate opportunity instead of Grand Met (remember that Grand Met was
doing a takeover of Pillsbury, meaning they were paying well above market price, whereas O’Hagan
just paid market).
o Court says that O’Hagan had to tell Grand Met that he was going to trade on their info, since
he owed Grand Met a RETAC as an attorney in Grand Met’s law firm.
 Court says RETAC is like a loyalty conflict and the misappropriation is like taking an asset from the
 What asset was taken here? Information belonging to the principal and using if for his own benefit
 Thing being misappropriated is information; misappropriation has to be fitted into 10b
 Takeaway: You can’t misappropriate information from the source of that information unless you
disclose what you’re doing to that source. You don’t necessarily need to have a RETAC to the
company you’re trading in order to be liable for insider trading; you just need a RETAC to the source
of your information, even if that’s not who you’re trading in.
 Consideration: This is a strange way to protect Pillsbury’s shareholders, because it’s like we’re
actually trying to protect Grand Met in order to protect Pillsbury.
o Also, if this logic was applied to Chiarella, he’d have been found liable, since he owed a duty
to the acquirer.
Notes on O’Hagan:
- Insider trading is supposedly bad for the market because investor confidence would be reduced if
they thought ppl like O’Hagan could trade with them
Corporate Lawyer
Khanna 2020
From Chiarella until O’H, ppl like OH could trade and the stock market didn’t crash so what is the
proof that it is bad for the market?
o After OH liquidity went through the roof after just a few years
One interpretation is that a) chiarella didn’t scare people away from market but Ohagen
encouraged more people to enter market or …?
Democratizing trading, goal is for corps to get capital and if people don’t trade bc they believe
they will get burned by insiders, then corps don’t get capital
How to cure deception? Avoid trading, disclose info (may breach fiduciary duty), disclose that you
are trading on insider info but not the actual insider info, who do we disclose to? Not
misappropriation if you tell the source that you want to use the asset and the source says it is ok;
deception is cured by disclosure so if you tell the source, it is no longer deception, whether or not
the source says it’s ok or not
o This doesn’t make anyone feel better about trading
o This is just another loophole and the source doesn’t care
Dysfunctional tree
o Keep trying to fit duty to disclose into all of these other fiduciary duties gives us this
very few insiders actually disclose to the source, why?
o Why do they want to keep it secret? Disclosing to the source would give them liability but
 In context of a lawfirm, lose a lot of credibility if you tell ppl you are trading on the
inside info you give law firm
Rocklage – policing third party trading
 Takeaway: To police third party trading, you have to make your O’Hagan disclosure that you’re
going to trade on info before you receive it. So you have to say “I’m going to trade on any info I
Dozorkho – lying = deception
 Hacker had to fake his identity to hack into the system
 Faking is lying which is deceptive
 Trying to go under misrepresentations and deceit prong
 Takeaway: If you identify someone as accessing information by lying because that is the only way
they can get it, that counts as deception
Most recent developments:
 Draft law sitting in congress right now
 Redefines what insider trading is, prohibits trading on “wrongfully obtained information"
o Gets rid of misrepresentation
o Gets rid of escape for hackers
o Very close to equal access theory except it focuses on wrongfully obtained info
o Examples include theft, misrepresentation, espionage, violation of Federal law protecting
data, misappropriation, other breach of trust
 Concerns:
o If you are worried about scaring away investors, we need confidence that they wont be
dealing with insiders
Corporate Lawyer
Khanna 2020
o Information can get out and be traded on but it also gets out when companies don’t lock it
up well
 Maybe better way would be to encourage companies to protect their information
more clearly
o Maybe insider trading has benefits for market – this is widely rejected these days
 May be better way to compensation managers for doing good work – with stock
options, this is irrelevant
 Might induce managers to take on riskier/more volatile projects
 Speed discovery
Who is your client?
The organization – Model Rule 1.13(a).
o When you represent a corporation, your duties are to the corporation. If that means the CEO
going to jail or shareholders losing money, so be it.
 Remember that the corporation is a separate legal entity
Accidental clients (“implied”)
o Typically, executives of the organization. If you have any interactions with them in the way
that a lawyer interacts with a client, you’ve created an accidental client.
Prospective clients
o If you ask a prospective client “what do you want me to do for you?” and they give you
confidential information, you suddenly owe them a duty.
o Beauty contests: When a company interviews multiple law firms to decide who to work with,
those firms probably learn confidential info about the company and can no longer represent
that company’s opponents.
o Chinese walls and screens come into play here
Joint clients
o When you explicitly wish to represent two people who have conflicting interests.
o A frequent problem with start-ups: You represent both the company and the individuals
behind it, but if one person asks you for advice, you might have to advise him against the other
people or against the company. So you should tell him to get other counsel.
 You can’t handle a start-up’s internal conflicts; they have to resolve them.
5 C’s:
Control by the client
o The client sets the goals, not the lawyer. Client gets to make the major decisions. Remember
the authority doctrine; the lawyer is the agent of the client (the P).
o All relevant info must be communicated between lawyer and client.
Corporate Lawyer
Khanna 2020
o At least 7 communication triggers:
 Fees and representation
 How will you charge fees?
 What are you representing the client over? Not always everything…
 Explaining how a matter is changing over time
 This requires informing the client, but also making sure the client is telling you
everything that is relevant (and they might not even know the full extent of
 Keeping the client reasonably informed; making sure they know what you’re actually
representing them about and what your ability is
 Don’t let the client think you can handle something that you actually can’t
 Owning up to mistakes (pretty much immediately)
 You might not be able to fix the mistake until the client gives you the green
 When the client asks
 Sometimes, when the law requires you to communicate (like whistleblowing)
 Only matters for ongoing crimes
 When you need the client’s informed consent about something
 You need to fully communicate the situation to them, otherwise their consent
isn’t really “informed”
 Also, if your client tries to talk to you during this, you might have to say “no”
to them even though you came to them for their consent in the first place.
 Competence
o You have to be able to do the work, or give it to someone who is
 Confidence (as in, keeping information in confidence)
o We want to incentivize clients to ask lawyers for advice before acting, and if they’re thinking
about doing something illegal, we want them to still ask. That can only happen with
 Conflict of interest resolution
o You must disclose your conflict and get it approved.
Things attorneys can’t do/when you have to say no
 You can’t allow your client to commit a crime, or cover up an existing/continuing crime
 You can’t engage in fraud by saying something you know is untrue, or misrepresenting something to a
third party
 You can’t aid and abet their crime. It’s not always obvious when you’re doing this; you have a duty to
ask about anything that looks suspicious.
Supra + sub attorney
 If you don’t know the answer to something, you can and should ask a senior partner for advice. But
you have to disclose anyone else you’re talking with to your client, so they can be aware of it, and
especially if the senior partner might want to bill the time.
Withdrawal from representation
Corporate Lawyer
Khanna 2020
If something is happening that isn’t strictly speaking illegal but that violates your personal ethical
code, your best option is to withdraw from representation, because if you continue to represent the
client, you have to keep confidential about it.
You can’t withdraw from representation at the last second before trial; you’ll be liable for any harm
your client suffers as a result.
It’s sometimes tricky to know who you have to tell about your withdrawal besides the actual client
o If you represent 4 people in a startup, you have to tell the other 3 that you’re withdrawing from
representing the one person (a noisy withdrawal).
Ethics in the corporate context (confidentiality):
 Obviously, there’s the attorney-client privilege. But if chief legal officers have some other title (which
they usually do), it’s not always clear if they’re acting as an attorney or as a businessman.
o If you’re an attorney and you’re asked to give your advice on something that isn’t a purely
legal question, courts are usually unwilling to extend privilege to the business question. So
people might think that the conversation is privileged when it’s not.
 Courts don’t just want you channeling all communications through the GC so they
can’t see it. They will only protect the privilege of stuff that is actually necessary for
legal advice.
Whistleblowing – Rule 1.13 (old vs. new) – up the ladder – depends on your jurisdiction
 Old rule 1.13: If you learn something bad, you should tell the actor to stop, and if they say no, you go
to their boss, and you keep going until you get to the board. That’s your cutoff.
o You need to “know” that something is going on (and “willful blindness” counts as
“knowing”), and once you know (so, not just “suspect”), you have to start going up the ladder.
o You also don’t have to go up the ladder, but you may.
 New rule 1.13: You MUST go up the ladder, and don’t have to just stop at the board; you’re allowed
to go to the feds or regulatory agencies and blow the whistle if the harm is continuing.
 The problem with these rules is that nobody likes having someone go over their head, and it can
potentially ruin relationships within the company.
o But being fired is better than being disbarred or going to jail
o Some states also have whistleblower statutes that allow you to recover a ton of $$$.
 SOX §307: Requires you to go up the ladder if you “become aware of evidence” of a “material
violation of the law” regarding securities fraud. And if the board and executives don’t do anything,
you have to keep going to authorities until somebody does something. Failure to do so can result in
suspension from practice by the SEC.
o No mens rea applies to §307; you must become aware of evidence that a violation is likely
(rather than certain under rule 1.13). Something being likely is much easier to meet than
something being certain.
o QLCC: An independent organ that can’t be fired, like a compliance committee. You can go to
them, tell them whatever you think you found, and wash your hands of the situation.
Corporate Lawyer
Khanna 2020
You should have a bit of healthy skepticism about anything that an employee or manager tells you if
you’re a general counsel, because your client is the company, so your incentives are different from
Authority doctrine
 Because your client is technically the corporation, who do you take orders from?
o Generally, the corporation will tell you who (a constituent). But if the constituent is doing
something that is illegal or against the client’s interests, you don’t have to follow their
Miller on Compliance and Internal Investigations
 Companies ensure compliance with all existing laws, industry standards, and code of ethics through a
compliance program. This involves information gathering and information use.
 Compliance departments are like car brakes; they allow you to go fast, knowing that you can be
stopped quickly if you need to be. Otherwise, you’d have to be super careful all the time, and that can
slow down business.
 Compliance programs work in three ways:
o Hiring:
 Lots of background investigations; companies want to know what they’re getting with
o Training:
 People need to know how to stick with your code of ethics. Companies will make sure
that employees have read and understood the guidelines.
o Monitoring:
 Testing and surveillance (like drug/alcohol tests, and reading company emails)
 Compliance is ongoing and consistent.
 Incentives for compliance; one form is compensation; i.e. Microsoft gives bonuses for diversity
hiring; other companies make your year-end bonuses and stock options based on your compliance,
escalating option scheme, some companies say if you haven’t met our compliance standards then we
are going to give you less stock option compensation or other bonuses you would have gotten
Internal Investigations
 Sporadic spot inspections of what’s going on at a particular company.
o Breaks up the monotony/regularity of what’s going on, and allows you to catch people off
guard and see people doing their normal day to day affairs.
 They’re hard to plan around, so you can surprise people, and thus can be more accurate
 Allows you to catch bad behavior and implement changes to improve your compliance efforts. Can
also have a strong deterrent effect among employees, and can allow you to stop bad behavior before
you get caught
 Also gets you credibility with the government (and maybe even a sentence reduction)
o And one easy way to do this is to show that you perform internal investigations on a somewhat
regular basis. This shows that you’re serious about your compliance program.
Corporate Lawyer
Khanna 2020
Can be big scale (usually government involved and high stakes) or small scale (usually internal and
unlikely to lead to a government lawsuit)
To convince the government that your investigation is worth anything, you have to show that it was
done in an independent way. Things to look at:
o Who ran the investigation?
 The GC is not an independent player regarding his own company
 Typically handled by an outside law firm, but be careful not to use the company that
already does most of your work, because that won’t actually look independent.
o How thorough was the investigation?
 Were there any limits on outside counsel’s ability to gather information? Hopefully
o Did the company put any budgetary limits on how much it was willing to spend?
 It looks bad if you limit spending on this, which is one reason why law firms love it
o Disclosure?
 Show the government exactly what you uncovered, and make their job easier.
 You’ll get a sentence reduction if you self-report a violation
 The more you can identify the specific bad apples, the more that takes the focus away
from the company as a whole.
 Remember that bad employees will be very hesitant to say what they’ve been doing.
Ethical issues related to internal investigations – F&M
 During an internal investigation, if you’re the GC, your client is the company, not the employee
you’re talking to. So the employee needs to know that the information you’re gathering isn’t
privileged, and that the employee might have to give that info to the government. So a good employee
should know not to talk to you.
o It’s a misrepresentation to not tell an employee this info; called Upjohn.
 It’s usually best to tell the employee about this at the beginning of a conversation rather
than in the middle, because they might freeze up and stop talking.
 Can you get information from an ex-employee?
o Yes, as long as you don’t pay them (then it looks like a kickback).
o Your only obstacle might be a confidentiality agreement
White Collar Crime – Siegel extract
Attribute criminal liability to the corporate entity through individual acts as representatives to the corp
Low standard in US; just need to show that the agent was acting within the course of their
employment with the intention to partially benefit the firm
Assistant US Attorneys have a ton of discretion to determine what crimes to prosecute.
Having a good compliance program can de-incentivize prosecutors from going after your company. If
it looks like you’re doing everything right, prosecutors will probably just ignore your crime.
There are lots of whistleblower protections for people who expose white collar crime
o Remember that under SOX §307 you have to disclose this type of crime
o Dodd-Frank Act applies here too
Guyden – SOX claims are arbitrable; arbitration is a private remedy, and the point of SOX is to
provide a private remedy for the aggrieved employee, not to publicize alleged corporate misconduct
Corporate Lawyer
Khanna 2020
9 – 28.300: Factors to consider in deciding whether to charge a company for white collar crime:
o The nature and seriousness of the offence
o The pervasiveness of wrongdoing within the firm
o History of misconduct
 Is it repeated? Repeat offenses look worse
 If you have an old CEO, that’s bad. If you have a new CEO, maybe the corporate
culture is bad?
o Willingness to cooperate with the government
o Current compliance program
o Timely and voluntary disclosures
 Are you helping the government by reducing their need to investigate?
o Any remedial actions the company has taken
 Trying to fix any problems makes you look like a good corporate citizen
o Collateral consequences of the wrongdoing
 What impact will a conviction have on consumers, innocent shareholders, innocent
employees, etc.?
o Adequacy of alternative remedies available
 If you can find an adequate civil remedy, you don’t have to go after criminal penalties
(even though there might be moral value to a criminal conviction)
o Adequacy of the prosecution of individuals
 9-28.800: Corporate Compliance Programs
o Says the existence of compliance programs are relevant, but not dispositive
o The standards are vague for what the government looks for in determining whether a
compliance program is effective, but that’s why so many companies do it; it’s hard to say that
a compliance program is insufficient if the standards are vague.
Notes on Compliance Programs:
o Not just compliance with the law, also compliance with company policies and norms
o Compliance is department of no; not that they like saying no but you only go to the
compliance department if you are unsure of the legality of the conduct so usually the
compliance dept is also unsure or they say no
Designing Compliance Program:
o How you get your employee base
o Background info
o Training good people
 Sentence reduction credit: prove to prosecutor that training was designed to
actually convey information
 Be attentive to how you do training; throw in questions that ensure trainees
actually did the work
o Group events
o Surveillance
o Tapping employees company phones
o Software on company sponsored things to track where employees are and what they are
o Company emails are surveilled
Corporate Lawyer
Khanna 2020
o Some companies have employees send a bunch of incriminating sounding emails that
aren’t even incriminating in order to muddy the water when ppl do look for
incriminating information
o Drug testing; i.e. in sports
Impact of this info:
o As firms gather info, they learn things about their employees and can change their structure
o Are they expected to enhance their governance systems when they obtain this info? Not really
Internal Investigations:
 Small internal investigations are typically just internal and not motivated by gov, usually in-house
investigation team just runs with it and usually employee has no idea about investigation until firm
decides what to do
o If internal team reports to gov, it could reduce penalty and could build relationship with
 Large scale
o Gov investigation is coming
o Want investigator to look independent so typically go for outside law firm
 Corporation can pre-commit to disclosing so that prosecutors are more likely to give them more
A. Internal Compliance Systems
Even though Courts aren’t real rigorous when deciding whether a compliance system satisfies Duty of
Care, prosecutors have higher standards when deciding whetheror not to prosecute the corporation. This
encourages firms to really put their back into it.
Compliance concerns accelerated in the 1970s onward because of governmental concern about business
activities. As government began regulating more, they wanted people to have systems in place to ensure
they are obeying. This can also involve internal policies like CSR
A lot of legal focus in on how you structure the program so as to make sure that it actually happen: Who
to use? How do you create the right incentives? Happens at many different levels in corporate operations:
 Hiring: criminal history, employment history, credit report, social media, etc. (Hire good people
and don’t have people screwing things up to begin with.) How far can companies go? Pretty far.
Not all companies are the same.
 Training: Make them watch a video at beginning and periodically. Online things are dumb b/c not
interactive; live training may be more effective.
 Surveillance: Once you hire them you have to make sure they do what you want them to do.
o Spot Checks (e.g. drug tests)
o Email, etc. (i.e. they can look at anything you do with email, etc. provided by the
o Inspections . . .
Corporate Lawyer
Khanna 2020
Why not just go full bore with compliance to protect from liability? Because there are tradeoffs if you
want to motivate employees who won’t like Big Brother.
Most interesting thing for law firms is when there is a problem, now have to transition from
 Need to figure out what is going on because you can’t figure out a strategy until you know what
you are dealing with. Do an INTERNAL INVESTIGATION.
o Small scale internal investigation is single employee or problem that is threatening whole
o Large scale internal investigation is about big, systemic problem that make jeopardize
whole company. Law firms love to specialize in this because super expensive.
 Internal investigation is really weird word; part of a broader investigation mentality. Government
may also investigate and may be going on at the same time. This is tricky to manage.
o Government can compel; but company can be more intrusive.
o There are other kind of weird tradeoffs. This creates a lot of problems for employees.
Companies typically turn everything over.
o Because of this, need to remind people that firm is investigating and can turn over
whenever you do an internal investigation
B. Government Investigations vs. Internal Investigations
What if something goes wrong? You probably don’t know about governmental investigation until they
have enough to fry you or somebody. Have to make decisions about the scope of and necessity for
internal investigations.
1. Internal Investigations
In internal investigations, you want to get counsel that is truly independent, and if you want it to mean
anything to regulators they have to be able to say that there were no limitations placed on the
 To be considered independent, Courts want someone you haven’t been paying for other services,
but regulators often look deeper for other social relationships, etc. The latter could be problematic
b/c experts in the field tend to know each other.
 You better not be putting many or any limitations on investigation, but corporations don’t want to
allow access to corporate strategy, etc.
2. Government Investigations
See also US Attorney’s Manual Sections giving DOJ prosecution considerations.
Generally the government will want cooperation in order to make a deal. Typically expect (even if don’t
admit it):
 (1) Waiver of attorney client privilege to give access to info obtained by an attorney during an
internal investigation. This is why internal investigations are so popular.
o Firms like to selectively waive attorney client privilege, but prosecutors don’t. They may
not view this as cooperation because will be suspicious as to what you are hiding.
 (2) Handing over any other information that you have obtained, perhaps through other forms of
Corporate Lawyer
Khanna 2020
o Prosecutors may assume that if you did an internal investigation, but don’t want to hand
over information, it is worse than they think. Prosecutor will think the company discovered
a lot more wrongdoing or worse wrongdoing.
 They will take action to discover the information.
 Subpoena is possibility, but that will alert you and allow cover up
 BUT more commonly will deepen investigation without letting the
company know; then they will issue subpoena to see where the ripples run.
In Re Vioxx Products Liability Litigation
 Special master report discusses the law of attorney-client privilege
 1) legal advice must be the primary purpose: difficult to apply AC privilege in the corporate context to
communications between in-house corporate counsel and the corporation bc lawyers are involved in
all facets of the enterprises they work for
o Here had to determine purpose behind seeking the assistance from in house counsel and the
responsive services that were rendered by in-house counsel
o Differentiating between the lawyers’ legal and business work when the attorney-client
privilege is asserted for their communications within the corporate structure
o Whether counsel was participating in the communications primarily for the purpose of
rendering legal advice or assistance
 2) Pervasive Regulation Theory: bc drug industry is so extensively regulated by the FDA, virtually
everything a member of the industry does carries potential legal problems
o Doesn’t resolve question of whether legal advice was the primary purpose behind comments
and edits by Merck’s in-house lawyers of specific scientific reports, articles accepted for
publication in noted journals, and research proposals
o It is Merck’s burden to successfully establish that a document is covered by ACP
 3) Corporation’s choices have consequences: when Merck sends communications to both lawyers and
non-lawyers, usually doesn’t fall within ACP bc can’t claim that the primary purpose of the
communication was for legal advice bc it was used for both legal and non-legal use
o Non-legal departments of corps make comments among themselves about matters within their
corp responsibilities, those communications are no protected ; when lawyers make the same
comments, still not protected unless Merck demonstrates that those comments are primarily
related to legal assistance
Special master’s Substantive guidelines:
 If memo addressed solely to attorney with limited circulation, class example of ACP
 When email messages were addressed to both lawyers and non-lawyers we concluded that the primary
purpose of such communications was not to obtain legal assistance
 Email threads sent to others after initial interaction with lawyer ended; no longer privileged when sent
to a non-lawyer unless being circulated to those in the corporation who needed the advice to fulfill
their corporate responsibilities
Companies have an incentive to rat out their employees, and then employees that have gotten caught have
an incentive rat out others (and particularly those further up the food chain). This is toxic environment in
which not much work gets done. This also creates a lot of ethical considerations for the attorneys
representing the company and doing the investigation. (See below).
Corporate Lawyer
Khanna 2020
You cannot instruct employees not to talk to anyone b/c DOJ sees that as obstruction of justice; but you
can tell them that they are not required to talk and the choice is theirs, that they have a right to counsel,
that company will provide one, and urge them to contact lawyer.
Means of Settlement
 Deferred Prosecution Agreement:
o AUSA says not going to drop the prosecution, just going to let it sit there like a sword of
Damacles. Usually there is a timewindow that it stays open and it is dismissed if you do X,
Y, and Z (usually 3-5 years)
o Parties enter into this because it saves time and expense for both sides and company fears
loss of sales because of the story
o The longer it stays in the news, the bigger the problem. Convictions may result in 2 years
of down sales.
 Conditions to get one:
 You must waive privilege in most cases (this is why Miranda-like warnings
to employees become important)
 Governance conditions (change Board structure, etc.)
 Terms related to actual wrongdoing
 Appointed corporate monitor
 Not really regulated
 Common in regulatory entities, particularly healthcare and financial
o Non-Prosecution Agreement:
 Similar to DPA, but without actually filing the charges
o These settlements do not do anything to collateral civil liability; but whatever you say in
your DPA or NPA may be available to those plaintiffs. You should be cognizant of this.
o These are a relatively new phenomenon, so there aren’t really any rules to govern this.
How do you get information about corporate wrongdoing?
Usually information from government information (often through civil regulators who find stuff first) or
through whistleblowers (though this usually refers to an employee)
 Frequently civil regulators do own investigation first and impose civil penalties, they pass off to
criminal authorities if they think it is bad enough; FBI typically does a lot of investigation for DOJ
 The government doesn’t come to you when they don’t have any information when they come to
you, so feigning ignorance is a really stupid strategy. They probably don’t want much more
information about you, they targeted you for a reason.
 Whistleblowers
3. Whistleblowers & Qui Tam
There are many laws that govern whistleblowers (including witness protection program), Khanna has
selected three.
 SOX:
o This creates the up the ladder requirement for lawyers. If you do not blow the whistle, we
penalize the putative whistleblower
Corporate Lawyer
Khanna 2020
o SOX also provides protection for the whistleblower’s job
o Increases some penalties, provides greater protection, gives incentives
Whistelblowing to executives has not worked very well according to MOBERLY, b/c they don’t do
anything. Many people don’t speak out b/c afraid.
Qui Tam
Qui Tam actions allow a private citizen to bring a suit on behalf of the government to collect money
owed to it. They get a portion of the claim if they win; DOJ has option of taking up the case. Today
mostly relates to the False Claims Act. Applies to a claim where “any portion” of the funds came from the
US Treasury, broadly defined. See, e.g., United States ex rel. DRC, Inc. v. Custer Battles, LLC(4th Cir.
2009) (misspent funds by contractors hired by the Provisional Authority of Iraq fell within False Claims
Act, b/c money cameat one point from US and Authority employees were acting as officers of the US
Massive incentive for people to report overcharging the government
There are several problems with this type of regime:
 False positives, after all 90+% of all cases settle
 No incentive to report to corporation to give them a chance to fix it
 They have incentive to let the wrongdoing get bad, because they will get a bigger reward (but if
threat that someone else or government will figure it out first, this is less of a problem).
Only 2% of the leads given to whistleblower hotlines, etc. are meritorious.
Ethical issues related to white collar crime
 Third parties might rely on your representations even if they’re not your client. You owe those third
parties a duty of reasonable care.
o For example, if an attorney oversees some kind of a loan that the company is making, a bank
will rely on that attorney, even though the bank is not the attorney’s client. So the attorney is
expected to exercise reasonable care when dealing with the bank.
 Malpractice: You can’t give your client incompetent information or advice.
 Misrepresentations: You can’t make misrepresentations to any court or any other party, even when
your client wants you to lie.
 Aiding and abetting: “Substantial assistance” is the standard for aiding and abetting a crime the crime.
This might not be too high of a threshold, so attorneys need to be careful.