CORPORATIONS BOLIEK SPRING 2017
DOCUMENTS
I. General Partnership, LLP, Limited Partnership
A. Partnership Agreement – typically includes addresses, management structure, allocation of profits and
losses among partners, partner taxation, admission and withdrawal of partners, dissolution.
1. Subject to regular K law (ex: good faith)
II. LLC
A. Operating Agreement – covers same as partnership agreement PLUS needs of members and managers.
B. In DE LLC Agreement
III. Corporation
A. Charter/AOI – specifies the corporation’s name, type of stock (common/preferred), rights and preference
of any preferred stock, and an office and agent for the service of process in the state of incorporation.
B. Bylaws – rules regarding the governance of the C including notice and quorum requirements for board and
SH meetings, number and qualification of directors, voting standards, proxy voting, appointment of officers,
and stock certificates.
C. SHs’ Agreements – common for closely held Cs and may address stock transfer restrictions, employment of
SHs, board representation, and buy-sell rights with respect to the Cs shares.
IV. Severability
A. If one article is void, check to see if there is a severability clause. If there isn’t entire K void.
B. ALWAYS include severability clause
V. Order of Hierarchy
A. Statute
B. Charter/AOI
C. Bylaws
OTHER FORMS
I. Limited Liability Limited Partnership (LLLP)
A. Limited and general partners get full liability shield
II. Professional C (PC)
A. Business incorporated under a professional C statute
B. States enacted these to provide liability protection to owners of professional firms like law, accounting, and
medicine
C. SHs must be licensed to render those specific services
III. Professional Limited Liability Company (PLLC)
A. Business organized under a professional LLC statute or provision
B. Usually for rendering professional services and all members must be licensed to render those services
C. 35 states have PLLC statutes/provisions
IV. Close Corporation
A. C that elected to be governed by a state’s close C statute/provisions (statement usually made in charter)
B. Eligibility is usually based on having no more than specified number of SH (usually 25)
C. More flexible than regular corporate statutes
V. Series Limited Liability Company
A. An LLC that segregates its business into separate series
B. Advantage = assets of a particular series are insulated from claims against a different series
C. Ex: If Apartments 1 burn down, tenants can’t go after apartments 2, 3, 4
D. 8 state allow this, but there is uncertainty about taxation
VI. Non-Profit Corporation
A. C formed under a states’ nonprofit corporate statute
B. Limit the form to companies organized for the public benefit, religious purposes, or the mutual benefit of its
members
C. Do not issue stock and are usually exempt from federal income taxation
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VII. Low Profit LLC
A. LLC whose primary purpose is not to earn a profit but to pursue a socially beneficial objective
B. 8 states provide this form
VIII. Benefit Corporation
A. C incorporated in a state with a benefit C statute that elects to be a benefit C by including a provision to that
effect in its charter
B. Must have a purpose of creating general public benefit
C. 11 states have adopted such statutes
D. Statutes explicitly require that directors make decisions based on best interests of all stakeholders, not just
SHs
IX. Business Trust
A. Business organized under a state’s business trust statute or trust law
B. Business is managed by trustees pursuant to trust agreement or declaration of trust for the benefit of the
business’s owners (beneficiaries)
C. Mutual funds usually organized this way
X. Joint Venture
A. When two or more businesses or individuals combine resources to pursue a discrete business opportunity
or venture
B. Typically an LLC or C to house the joint businesses (otherwise falls under general partnership)
KEY CONCEPTS
I. Which Law Governs (very important)
A. All state law
B. Partnership Agreement that has “Governing Law Term” – tells use what state law controls
C. Where you physically were when you signed the K
D. Consider: RUPA or non-RUPA state?
1. CA is RUPA state
II. Internal Affairs Doctrine
A. Business entity can choose which state’s statute it wants to be governed by, even if it does not do business
there (choice of law rule)
B. Internal affairs doctrine applies to those matters that pertain to the relationships among or between the C
and its officers, directors, and SHs
III. Default vs. Mandatory Rules
A. Default rule – can be altered by agreement between parties
B. Mandatory rule – parties cannot K around
C. Bylaws or charter may override corporate law default rules
1. Ex: “A director need not be a resident of this state or a SH of the C unless the articles of inC or bylaws so
prescribe.”
2. Note: typically harder to amend charter than to amend bylaws
D. C statutes are mandatory unless they say “unless”
1. Ex: “The SHs may remove one or more directors with/without cause unless the articles of inC provide
that directors may be removed only for cause.”
E. RUPA mandatory provisions are contained in 1.03(b)
IV. Majority vs. Minority Owner Perspective
A. Unless minority SH insists on alterations to the default rules, he will have zero say on how the C is run
B. Boliek tip – think about C law from perspective of minority SH
V. Public vs. Private Companies
A. Public company – one whose shares or ownership interests are traded on a public market (NASDAQ)
1. Some limited partnerships and LLCs traded, but rare
B. Private company (can be “closely held”) – usually small number of owners
1. Not exchanged on open market
C. Corporate law statutes and the Securities Exchange Act apply to both public and private companies
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AGENCY LAW
I. Agency law dictates when a business will be bound by a K with a 3d party that someone entered into on the
business’s behalf; based in CL
II. When Is An Agency Relationship Created?
A. An agency relationship is created when an agent to be and a principal to be consent to their association
with each other. The relationship arises when [Frawley]:
1. A principal manifests assent to the agent that
2. The agent shall act on the principal’s behalf and be subject to the principal’s control, and
3. The agent manifests assent or otherwise consents to so act
a. Can be signature, verbal, or conduct
B. Consider compensation and principals control over agent
1. Frawley – agency relationship found when bail bondswoman told unpaid friend to stop handing out her
business cards; gratuitous agent = unpaid
III. Who Is An Agent?
A. All employees are agents of their employers because employment is a consensual relationship where the
employee/agent is subject to the control of their employer/principal
B. Nonemployee agents (ex: independent Kor) can still be an “agent” if the elements are met
IV. When Is A Principal Bound To A K?
A. A principal is bound to a K made on the principal’s behalf by an agent if the agent acted with actual or
apparent authority; consider the scope of the relationship between the principal and the agent
1. Actual Authority – An agent acts with actual authority when, at the time of taking action that has legal
consequences for the principal, the agent reasonably believes, in accordance with the principal’s
manifestations to the agent, that the principal wishes the agent to so act.
a. Focus = communication by principal to agent and agent’s reasonable interpretation of that
communication
b. Can be implied or express
● Implied – includes authority to do acts necessary or incidental to achieve the principal’s
express objective
o Ex: “Run the business while I’m on vacation” = implied authority to sign Ks while principal
on vacation
● Express – “You have my permission to sign Ks while I’m on vacation”
2. Apparent Authority – manifestations to a 3d party
a. (1) Actions of principal (reasonably interpreted)
b. (2) Cause 3d party to believe (in good faith)
c. (3) That principal consents to acts of agent
3. The power held by an agent or other actor to affect a principal’s legal relations with 3d parties when a
3d party reasonably believes the actor has authority to act on behalf of the principal and that belief is
traceable to the principal’s manifestation
a. Focus = communication by the principal and the 3d party’s reasonable interpretation of this
communication
b. Boliek – Ask whether its reasonable for 3d party to think that agent can bind K? If principal made it
seem like (to 3d party) that agent had authority, this is reasonable and creates apparent authority.
B. Actual and apparent authority can coexist and often do!
C. Job titles as a matter of law create a rebuttable presumption of an agency relationship
V. Three Other Ways That Business May Be Bound to K Entered
A. Estoppel
1. A business may be bound to a K entered into on its behalf by an agent or other person lacking both
actual and apparent authority under the doctrine of estoppel if:
a. (1) There is a justifiable belief (by 3d party)
b. (2) Detrimental reliance (by 3d party), and
c. (3) Fault by the party
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B. Inherent Agency Power (CL)
1. Courts invoke inherent agency power when fairness dictates holding a principal liable on a K even
though the purported agent lacked authority and one or more estoppel elements is missing
2. R2 provides that inherent authority subjects a principal to liability for acts done on his account, which:
a. (1) Usually accompany or are incidental to transactions which the agent is authorized to conduct if,
although they are forbidden by the principal,
b. (2) The other party reasonably believes that the agent is authorized to do them, and
c. (3) Has no notice that he is not so authorized.
C. Ratification (important concept)
1. The affirmance of a prior act done by another, whereby the act is given effect as if done by an agent
acting with actual authority. It provides that a person ratifies an act:
a. (1) By manifesting assent to be bound by the act, or
b. (2) Through conduct that justifies a reasonable assumption that the person so consents
VI. Agency Rules for Specific Entities
A. Partnerships
1. Default – every partner has actual authority within ordinary course of business (term of art) and
2. Apparent authority by virtue of their partner title
a. Unless 3d party knew that partner did not have authority
3. Partner = agent
4. If partnership worried about partner entering into unauthorized K with 3d party, it can send
notification. A person has received a notification when it:
a. Comes to the person’s attention, or
b. Is duly delivered at the person’s place of business or any other place where person receives
communication
B. Corporations
1. SHs are NOT agents (unless BOD gives actual/apparent authority)
2. Individual director on BOD is NOT an agent (BOD acts collectively only)
3. Authority can be conferred down the line
a. BOD subordinate; CFO VP of Finance
C. LLCs
1. Depends on the state’s statute and the management structure of the company
a. Member managed (default in CA) – members are agents because they’re the decision makers
b. Manager managed
● Members – we don’t know; gray area of the law
● Managers are agents
c. Look to ordinary course of business
VII. How To Avoid Issues With Authority
A. Ensuring authority usually requires secretary’s certificate and opinion letter, or, if partnership/LLC, may
require filing of a certificate of authority
B. Secretary’s Certificate
1. Document signed by entity’s secretary certifying certain action
C. Opinion Letters
1. Letter from attorney of one party to other party regarding legal issues with respect to transaction (and
vice versa)
D. Statement of Authority
1. RUPA 303 – authorizes partnership to file an option statement of partnership authority with secretary
of state
2. ULLCA has similar filing for LLC
3. No equivalent for C under MBCA/DGCL
LIABILITY OF A PRINCIPAL FOR AGENT TORTS
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I.
Rule – Under CL of agency, a principal can be directly or vicariously liable for torts committed by an agent
(respondeat superior). A principal is subject to direct liability, if, among other things, the principal was
negligent in selecting or supervising the agent. A principal is vicariously liable for a tort committed by an agent
if the agent is an employee of the principal and committed the tort while acting within the scope of
employment.
II. Is person an employee?
A. R3 gives the following factors to consider:
1. Extent of control that the agent and principal agreed the principal may exercise over details of work;
2. Whether the agent is engaged in a distinct occupation or business;
3. Whether the type of work done by the agent is customarily done under a principal’s direction or
without supervision;
4. Skill required in the agent’s occupation;
5. Whether agent or principal supplies tools required to perform work and place in which to perform it;
6. Length of time during which the agent is engaged by the principal;
7. Whether the agent is paid by the job or by the time worked;
8. Whether the agent’s work is part of the principal’s regular business;
9. Whether the principal and the agent believe that they are creating an employment relationship;
10. Extent of control that the principal has exercised in practice over the details of the agent’s work
III. What is the scope of employment?
A. R3 says employee acts within scope of employment when:
1. They perform work
2. Assigned by the employer
3. Engaging in a course of conduct within the employer’s control
B. Agent Liability
1. Agent is subject to liability for his torts even if principal also liable
2. Sometimes principal has a duty to indemnify the agent; however, this duty does not extend if losses
result from agent’s own negligence, illegal acts, or wrongful acts
C. Toiler = owner and employee
PRINCIPAL-AGENT
I. Principal-Agent Problem
A. Interest of principal and those of agent will invariably diverge; agent will not always act in the best interest
of the principal.
II. Fiduciary Duties (DOC & DOL)
A. Duty of Loyalty – In order to prevent costs associated with the principal-agent problem, courts have
imposed fiduciary duties of an agent, which include:
1. Not to acquire material benefit from 3d party transactions
2. No conflict of interest transactions
3. Refrain from competing with principal, and
4. Duty not to use property for personal use, not to communicate confidential information
B. Duty of Care
1. Act with care
2. Competence, and
3. Diligence
CHOICE OF FORM CONSIDERATIONS
I. Primary drivers of entity selection are:
A. Liability Exposure
B. Taxation
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C. Attractiveness to Investors
Entity
Multi-owner unincorporated entity other than a limited
partnership (general partnership, LLP, LLC)
Choices
Sub K*
Sub C
Sub S (if eligible)
Sub K*
Sub C
Sub C*
Sub S (if eligible)
Disregarded*
Sub C
Sub S (if eligible)
Limited partnership
Corporation
Single-member LLC
* = default
TYPES OF TAX TREAMENT
I. Sub-K and Sub-S Taxation
A. Sub-K and Sub-S
1. Provide for pass through taxation, meaning that the entity calculates its income/loss for the tax year
and then allocates to each owner
2. Applied incrementally
a. Ex: $0-10K @ 10%; $10–20K at 15%, and so on
B. Sub-S
1. Company with form other than corporation may choose Sub-S taxation because there are fewer
formalities than with corporations.
2. Unincorporated entities can choose Sub-S if they meet the requirements
3. Sub-S taxation is fragile because it is difficult to maintain the requirements
4. Sub-S taxation is based on ownership % (own 40%, taxed 40%)
C. Requirements for Sub-S
1. Domestic entity (incorporated in US)
2. 100 or fewer owners
3. All of its owners are individual, estates, certain types of trusts, or tax-exempt organizations
4. None of its owners are nonresident aliens, AND
5. It has only one class of ownership interests outstanding (disregarding differences in voting rights)
D. Sub-K Qualification
1. Publicly traded, unincorporated entity will be taxed under Sub-C unless at least 90% of its gross income
is comprised of qualifying income, in which case it will be taxed under Sub-K.
a. Qualifying income – includes interest, dividends, real property rents, gain from the disposition of
real property, income and gain from commodities or futures, income and gain from mineral or
natural resources, and gain from the disposition of capital assets.
2. Boliek – only Sub-K allows allocating of losses on basis other than % ownership
II. Sub-C Taxation
A. Must file separate annual income tax return to report income, deduction, and credits, and pay at corporate
tax income rates (double taxation)
B. Applied incrementally
C. Dividends paid by C-Corps usually taxed at capital gain rates
D. Zero-out Strategy – C pays out to its SHs in the form of salaries, bonuses, rent, etc. an aggregate amount
equal to the Cs profit for the year. This helps reduce C taxation.
III. Disregarded
A. Single-owner LLC is taxes as a disregarded entity not separate from its single owner UNLESS it opts for
Sub-S or Sub-C taxation
B. Essentially taxed the same as SPs
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C. Cannot elect to be taxed under Sub-K because Sub-K taxation is only available to unincorporated entities
with two or more owners
LIABILITY EXPOSURE
I. Inside Liability Exposure (refers to owner exposure on business obligation)
A. Generally
1. LLCs and Cs have the strongest inside liability
2. Unincorporated entities have the strongest shield against outside liability
B. Corporations and LLCs
1. Provide full inside liability shields to all owners regardless of state of incorp/organization
C. Most LLPs
1. Provide their partners with full inside liability shields, but LLPs organized in LA/SC partial shields
2. LLP limited to professional practices in CA, NY, OR. Others can organize as LLP, but the state will likely
treat them as general partnership, meaning no liability shield for partners
D. Limited partnerships
1. Afford limited partners full liability shields, but in many states this shield can be partially lost if a
partner has management and control of the business
2. All partners can get a liability shield by incorporating the general partner. Instead of an individual
serving as the general partner of a limited partnership, the individual would become a sole SH of a
newly formed C, and the C would serve as a general partner
E. General partners of a limited partnership
1. Get no liability shield regardless of the state of organization, and neither do sole proprietors or
partners of a general partnership
F. General partnership and sole proprietorship
1. No inside liability protection
G. LLPs and LLCs
1. Taxed the same as limited partnerships, but provide liability shield without needing to incorporate the
general partner
H. Sole Proprietorships
1. First line of defense = liability insurance
2. Personal assets of the owner can only be touched if judgment exceeds the limit of the liability insurance
and the business’s assets
Corporation
LLC
LLP
Limited Partnership
General Partnership
I.
Full Shield?
Partial/No
Shield?
X
X
X
X for limited
partners
unless
management
control
LA/SC
General
partners – no
shield
Miscellaneous
Tip – incorporate the general
partner for FULL SHIELD for
ALL partners
No shield
Veil Piercing
1. Under this exception, a court disregards the liability shield of a corporation, LLC, or other limited
liability entity and holds its owners personally liable for the entity’s obligations.
a. Two part test [Kansas Gas]:
● BUT FIRST, threshold requirement – P must show that person he wants to hold liable is C SH,
officer, director, or similar C rep (someone that is able to exercise control over the C)
o Ownership %?
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o Signatures on important docs?
o Name on annual reports?
● (1) Separate corporate identity: was there such unity of interest and ownership that the
separate personalities of the C and its SHs, officers or directors are indistinct or non-existent?
Consider: (i) Degree to which corporate legal formalities have been maintained, and (ii) Degree
to which individual and corporate assets and affairs have been commingled, based on the
following factors:
o (1) Undercapitalization
o (2) Failure to observe corporate formalities
o (3) Absence of corporate records, and
o (4) Payment by the C of individual obligations
o If these factors are present in significant number and/or degree first prong met
● (2) Would adherence to the fiction of separate corporate existence sanction fraud, promote
injustice or inequitable consequences or lead to an evasion of legal obligations? Consider:
o (1) Fraudulent misrepresentation by C directors
o (2) Use of the C to promote fraud, injustice, or illegality
o If these factors are met court will pierce the C veil, and C and its SHs will be treated
identically
J. Direct Liability
1. Liability shield does NOT protect a business owners from liability arising from the business owner’s
own actions or inactions, such as committing a tort while working for LLC
II. Outside Liability Exposure (refers to business exposure on owner obligation)
A. Outside liability exposure refers to the extent that creditors of individual owners of a business in a
particular legal form can recover against the business’s assets
B. LLC, general partnership, LLP, or LP – P cannot seize ownership interest in the business, but can get a
“charging order,” which entitles P to any distributions made until the judgment is paid off.
1. This is an advantage that unincorporated entities generally have over Cs
C. Single Member LLCs are an Exception [In re Albright]
1. In a single member entity, there are no non-debtor members to protect, so the charging order
limitation serves no purpose because there’s no other parties’ interests affected
D. Reverse Veil Piercing
1. When creditors of a business owner may be able to reach the assets of a business, which applies to all
limited liability entities (C, LLP, LLC, etc.)
a. Same factors as regular veil piercing
ATTRACTIVENESS TO INVESTORS
I. Venture Capitalists
A. VCs raise money from institutional vendors (pension funds, endowments, insurance companies, etc.) and
wealthy individuals by selling them interests in an investment fund formed and managed by the VC
B. VCs prefer to invest in businesses organized as corporations and taxed under Sub-C because:
1. They want preferred stock options (only C-Corp can issue preferred stock)
2. They want to avoid dealing with pass through taxation
3. They want the possibility of IRC § 1202 favorable tax treatment with the gain on a sale of stock
C. VCs do NOT want S-Corp because:
1. S-Corp cannot have an entity as an investor (VC funds organized as LLCs or limited partnerships)
2. S-Corp can’t issue preferred stock
II. Angel Investors
A. Wealthy individuals who directly invest in emerging growth companies, typically prior to a VC investment
B. Usually individuals, so they can invest in S-Corps
C. Usually have strong preference for C-Corps because they know that’s what VCs are looking for (and
eventually want to sell to a VC)
III. Equity Financing
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A. Raising money for a startup by selling ownership interests to investors
OTHER CONSIDERATIONS FOR ENTITY SELECTION
I. Formalities
A. Example:
1. C requires filing a charter, adopting bylaws, electing directors, appointing officers, issuing stock, but SP
has no filings
II. Allocation of Profits/Losses
A. General partnership
1. General – divided equally
III. Expense
A. More formalities means more fees such as filing fees, legal fees, franchise fees
B. DE imposes a $200 annual fee per partner (not to exceed $120K) on LLCs
IV. Continuity Existence
A. C – exists perpetually regardless of found death or selling shares
B. LLC – can likely exist perpetually, but some states impose max duration
C. SP – terminates upon death of the sole proprietor
D. General partnership/LLP/limited partnership – withdrawal of a partner may terminate the existence
depending on state of formation and partnership agreement
V. Fiduciary Duty Waivers
A. Fiduciary duties imposed on owners and managers, regardless of form
B. Fiduciary duties generally cannot be waived in corporate context
VI. Form Eligibility
A. Some types of businesses are prohibited by licensing requirements or ethical rules to operate in particular
forms (ex: in some states, law firms cannot operate as LLCs or Cs)
VII. Management Default Rules
A. LLC and partnership default assumes all owners will participate equally
B. C default provide for centralized management by BOD and control by a SH with the majority of the Cs
outstanding stock
C. LLC and partnership rules vary by agreement
VIII. Buyout Rights
A. Partnership (and many LLC) statutes include default rule requiring the entity to buy out a departing owner
B. C law statutes do not have this, but in closely held Cs, it’s common
IX. Newness
A. LLCs and LLPs – less case law to rely on because they are newer forms
CONVERSION
I. Business can change forms via merger
II. Unincorporated entity to different unincorporated entity usually no tax implications
III. Unincorporated entity to corporation tax implications
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UNINCORPORATED ENTITIES
PARTNERSHIPS
I. Governing Law
A. A partnership is governed by the partnership statute of the state in which it is organized
1. Partners usually agree on this up front
B. If you don’t realize you formed a partnership, the CL rule is the law of jx where the partnership agreement
was MADE governs
C. RUPA – “the law of the jx in which a partnership has its CEO governs relations among the partners and
between the partners and the partnership”
D. There are 12 UPA states, 37 RUPA states, and 1 loner LA
II. Formation
A. No formalities are required to form a partnership. A partnership is formed when:
1. Two or more people associate to carry on as co-owners a business for profit, and
2. They do not file the paperwork (ex: AOI/org.) to operate the business in some other form
B. Inadvertent partnership – when people form partnership and did not know they were doing so
C. RUPA – a person who receives profits from the business is presumed to be a partner (unless profits paid on
debt or as compensation)
D. Joint venture – relationships that fall under joint venture are partnerships if they otherwise fit the
definition
1. Boliek note – these are susceptible to anti-trust review
E. Three types of partnerships:
1. Definite term
2. Particular undertaking
3. At will (RUPA 101(8))
III. Management
A. Default rule under RUPA – “each partner has equal rights in the management and conduct of the
partnership business.” This usually occurs in the form of a vote (mostly when partners disagree). Each
partner gets one vote regardless of capital or time contributed.
1. Variations to RUPA usually include the following:
a. Allocate votes based on capital (65% capital = 65% vote)
b. Delegate decision-making to one partner (managing partner) or committee of partners
(management committee)
c. Require supermajority votes for certain decisions
d. Changing approval requirement (ex: something less than unanimous partner approval)
IV. Partnership Agreement
A. Includes address, management structure, allocation of profits/losses among partners, partner taxation,
admission and withdrawal of partners, and dissolution
B. RUPA 103(a) “except as otherwise provided in subsection (b), relations among the partners and between
the partners and the partnership are governed by the partnership agreement”
C. Under RUPA, partners are free to alter or opt out of any statutory provision UNLESS the provision is listed
in RUPA 103(b). If partnership agreement is silent on a particular issue addressed by a default statutory
rule, the default statutory rule applies.
D. Amendment requires unanimity (to protect minority)
V. Fiduciary Duties
A. When analyzing fiduciary duties, ask:
1. Is the duty to the partnership,
2. The other partner, or
3. Both?
B. RUPA 404(a) – the only fiduciary duties a partner owes to the partnership and the other partners are the
DOL and the DOC set forth in (b) and (c)
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C. RUPA 404(b) – DOL is comprised of a duty to account to the partnership and hold as trustee for it any
property, profit, or benefit derived from a use by the partner of partnership property and prohibitions
against self dealing and competing against the partnership
D. RUPA 404(c) – DOC is comprised of a duty to refrain from engaging in grossly negligent or reckless
conduct, intentional misconduct, or a knowing violation of law in connection with partnership business
E. Partnership agreement CANNOT eliminate the DOL or DOC
F. RUPA 103(b)(3)(ii) – DOL may be waived if all partners or certain % as specified in the partnership
agreement authorize or ratify
G. RUPA 103(b)(4) – don’t engage in grossly negligent or reckless conduct, intentional misconduct, or a
knowing violation of law
VI. Obligation of Good Faith & Fair Dealing
A. RUPA 404(d) – A partner shall discharge the duties to the partnership and the other partners under this act
or under the partnership agreement and exercise any rights consistently with the obligation of good faith
and fair dealing
B. Good faith and fair dealing is undefined in RUPA, but good faith = subjective and fair dealing = objective
C. Partnership agreement can’t eliminate the obligation of good faith and fair dealing, but it can set the
standard by which it is measured, subject to manifest unreasonableness
VII. Liability Exposure
A. RUPA 306(a) – Each partner is jointly and severally liable for the obligations of the partnership i.e.
judgment creditors of the partnership can recover the entire amount of the judgment from any partner
after exhausting the partnership (RUPA 307(d)) (called Exhaustion Rule)
B. RUPA 401(c) – if a partner must pay, the others must reimburse in an amount determined by the
partnership’s applicable rule for sharing losses (this is an indemnification right)
C. Partners are each others agents
VIII. Transfer of Partnership Interests
A. RUPA 502 - An ownership interest in a partnership is not freely transferable in its entirety (partners can
transfer economic but not management rights)
B. When a partner dies:
1. Management rights die, but
2. Economic rights are transferable
IX. Allocation of Profits/Losses
A. 401(b) – default = each partner gets an equal share of profits as well as losses in proportion to their share
of the profits
B. Allocation is the amount of profits that gets listed on tax returns
C. Distribution is the actual payment of profits to partners
X. Dissociation
A. Doesn’t immediately lead to winding down
B. RUPA 601 – Partners can disassociate by notifying the partnership of their express will to withdraw. Auto
dissociation occurs upon partner’s:
1. Expulsion from partnership pursuant to the partnership agreement
2. Bankruptcy
3. Death
C. Also partners can unanimously vote to expel a partner if all or substantially all of their ownership interest
was transferred
D. RUPA 701 – default rule is that dissociated partner must be bought out in cash
1. Partnership must buy out the partner itself or facilitate the purchase by a third party or one or more of
the partners
XI. Dissolution
A. Dissolution is when the partnership begins the winding up process
B. Winding up – process followed for distributing or liquidating partnership assets after dissolution. Includes
selling assets, paying debts, distributing net balance to partners, etc. Partnership terminates after winding
up.
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C. Bankruptcy does not necessarily lead to dissolution
D. Dissolution by type of partnership:
1. At will – whenever a partner notifies the partnership of his express will to withdraw as a partner
(default) (this is a problem because that means whenever a partner wants to leave, the entire
partnership will end, unless partnership agreement specifies otherwise)
2. Partnership for a definite term or a particular undertaking – RUPA default is that the partnership must
begin to wind up when the term expires or the undertaking is completed or by the will of the partners
E. Regardless of the type of partnership, they can be dissolved by an event that makes it unlawful for
substantially all or all of the business of the partnership to be continued (90 day grace period)
F. Court ordered dissolution:
1. By application of a partner –
a. If the economic purpose of the partnership is likely to be unreasonably frustrated
b. Another partner has engaged in conduct relating to the partnership business which makes it not
reasonably practicable to continue
c. It is not otherwise reasonably practicable to carry on the partnership pursuant to the partnership
agreement
2. By application of the transferee of a partner’s ownership interest:
a. After term expiration or completion of undertaking if the partnership was for term/undertaking at
the time of transfer or entry of charging order that gave rise to the transfer of ownership interest
b. At any time if partnership was at will at the time of transference
G. Court ordered dissolutions are mandatory and can’t be contracted out of
H. RUPA 807 – default rule for settling accounts among partners during wind up = any surplus after paying
debts is divvied up pursuant to each partner’s capital account balance, then their profit sharing percentage.
1. Capital account: A partner’s contributions made to the partnership and their share of profits less the
amount distributed to them and their share of losses.
a. Sweat equity gets you nothing
2. If the surplus is less than the capital accounts of all partners, the shortfall is allocated pursuant to the
allocation of loss.
LIMITED LIABILITY PARTNERSHIP (LLP)
I. Formation
A. 1001(b) – requires partnership vote approving that partnership become LLP
B. Partners aren’t required to revise partnership agreement; however, it is advisable when it becomes LLP
because partner contribution and indemnification are likely to change
C. 1001(c) – requires partnership to file statement of qualification with secretary of state
II. Liability Exposure
A. Same statute governs partnerships and LLPs, with a handful of provisions applying only to partnership that
elects to become LLP
B. 306(c) – partner is not personally liable, directly or indirectly, by way of contribution or otherwise, for such
an obligation solely by reason of being or so acting as a partner. Thus, unlike partners in a general
partnership, partners in an LLP are not personally liable for the obligations of the LLP just because they are
partners.
LIMITED LIABILITY COMPANIES (LLC)
I. Formation
A. Formed by filing a certificate of formation with the secretary of state
B. Less formalities than a C
C. You can have an LLC in an LLC...
II. An LLC can be a partner in a partnership
III. Governing Law
A. Governed by LLC statute in which it filed its certificate of organization
B. ULLCA hasn’t been widely adopted
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IV. Operating Agreement
A. DLLCA uses “LLC agreement,” but = operating agreement
B. An LLC/operating agreement has different purposes depending on management
1. Member managed = partnership agreement
2. Manager managed = combo corporate charter and bylaws
C. Can be oral or implied
D. Addresses address, management structure, allocation of profits/losses among members, member taxation,
transfer of membership interests, and dissolution
V. Management
A. Member managed (default) – similar to partnership or decentralized management: the statute vests the
members with authority to manage the LLC
B. Manager managed – similar to corporate or centralized management: the statute vests management
authority in a board of managers elected by the LLC members
C. Manager managed needs to be specified in operating agreement along with how manager(s) would be
chosen
1. Typically, managers chosen by member voted based on % ownership of the LLC
D. Voting is based on % of ownership rather than per capita (like RUPA) (18-402)
VI. Fiduciary Duties
A. DLLCA does not have a provision specifying the fiduciary duties owed by managers and members of DE
LLC. It’s left to LLC agreement and courts.
B. Default (CL) appears to be that managers of a DE LLC owe the LLC a duty of care and loyalty [William Penn],
but still unsettled whether members owe other members duties
C. Fiduciary duties of care and loyalty can be modified or even entirely eliminated (this is distinguishable
from other entities!)
D. Entire Fairness Test – when D is standing on both sides of the transaction, D bears the burden of proving
entire fairness of the transaction. Two blended elements:
1. Fair dealing – involves analyzing how the transaction was structured, the timing, disclosures, and
approvals (procedural fairness)
2. Fair price – relates to the economic and financial considerations of the transaction
a. Consider comps, economy
3. When these two elements are met, there is no remedy because it was a fair deal
VII. Obligation of Good Faith & Fair Dealing
A. DLLCA does not allow an LLC agreement to K out of the covenant of good faith and fair dealing
B. Applies in every K
C. Requires parties in a Kual relationship to “refrain from arbitrary or unreasonable conduct which has the
effect of preventing the other party to the K from receiving its fruits of the bargain”
D. Implied covenant does not apply when the subject at issue is expressly covered by the K
E. Test – whether it is clear from what was expressly agreed upon that the parties who negotiated the express
terms of the K would have agreed to proscribe the act later complained of as a breach of the implied
covenant of good faith had they though to negotiate with respect to that matter
VIII. Liability Shield
A. 18-303(a) – An LLC’s debts, obligations, and liabilities of an LLC, whether by K, tort, etc, shall be solely
borne by the LLC and no member shall be personally liable solely by reason of being a member or acting as a
manager of the LLC
1. Italics imply there are situations where LLC members/managers would not be shielded by this
provision
B. 18-607(b) – If member receives distribution knowing that LLC is becoming insolvent, LLC member is liable
to the LLC for the amount of that distribution
IX. Transfer of LLC Interests
A. Default under DLLCA – an LLC interest is freely transferable, BUT per DLLCA 18-702(a), the assignee of a
member’s LLC interest shall have no right to participate in the management of the business and affairs of an
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LLC except as provided in an LLC agreement or, unless otherwise provided in the LLC agreement, upon the
affirmative vote or written consent of all the members of the LLC
1. Can assign economic rights, not management rights (unless stated in operating agreement)
2. Economic rights entitle assignee to profit/loss and distributions
X. Allocation of Profits/Losses, Distributions
A. Default DLLCA – On the basis of the agreed value (as stated in the records of the LLC) of the contributions
made by each member to the extent they have been received by the LLC and have not been returned
B. Typically, LLC agreement will tie ownership interests in an LLC to contributions (60% cash = 60%
ownership)
C. Mandatory distribution for taxes (18-504)
XI. Dissolution
A. Voluntary dissolution
1. Default DLLCA 18-801(3)(a)– an LLC is dissolved and must would up:
a. At the time specified in the LLC Agreement (if specified),
b. Upon the happening of an event specified in the LLC Agreement as triggering dissolution, or
c. Upon affirmative vote of members holding more than 2/3 of the LLCs ownership interests
B. Judicial dissolution (18-802)
1. Three prerequisites for a judicial order of dissolution:
a. Corporation must have two 50% stockholders
b. Those stockholders must be engaged in a joint venture, and
c. They must be unable to agree upon whether to discontinue the business or how to dispose of its
assets (consider exit strategy)
d. Extraordinary remedy
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CORPORATIONS
INCORPORATION PROCESS
I. Pre-Incorporation Activities
A. Promoter – person who engages in ordering supplies, getting incorporated, hiring, entering into Ks, etc. and
other pre-incorporation activities. Two legal issues related to promoter Ks:
1. Whether the promoter is personally liable on a pre-incorporation K, and
2. Whether the C is liable on the K following incorporation
B. Promoter Liability on Ks – if company doesn’t start as planned, the general rule is that the promoter is
personal liable on pre-incorporation Ks even after the corporation is formed
1. Promoter signs his own name – promoter personally liable under basic principles of K law
2. Promoter signs in soon-to-be-Cs name – if C has not been formed and other party is unaware that the C
has not been formed, the promoter is personally liable under agency law rule that an agent who acts
on behalf of a nonexistent principal is personally liable
3. Courts have held that a promoter is not liable on a K if he can prove that the other party agreed to look
solely to the C on the K (ex: signing under “a C to be formed”)
4. MBCA 2.04 – all persons purporting to act as or on behalf of a C, knowing there was no incorporation
under this Act, are jointly and severally liable for all liabilities created while so acting
C. C Liability on Promoter Ks – C is not liable on a pre-incorporation K unless that C adopts it. C adopts a K by
manifesting assent to be bound by it. Adoption can only occur after the C is formed and is valid only if at the
time of adoption, the C has knowledge of all material facts concerning the K.
1. Adoption can either be by express action or implied through conduct:
a. Implied adoption may occur when a C receives the benefits of the K or accepts goods or services
under the K with knowledge of the K
b. Implied adoption can also occur if the C makes payments under the K or attempts to modify or
enforce the K. This is sometimes called “through acquiescence.”
c. Some court say ratification can bind. C is deemed to have been bound to a ratified K as of the date
the K was executed, whereas a C becomes bound to an adopted K on the date it adopts it
2. Adoption does not relieve a promoter from liability on a K unless the other party agrees to substitute
the C for the promoter on the K. This is called novation.
3. Both the promoter and the C will be liable on an adopted K, although the promoter would probably be
entitled to indemnification by the C if he has to pay out on the K.
II. JX of Incorporation
A. A business is generally free to choose any of the states to incorporate
B. If operating only within one state, it makes sense to incorporate there unless it will need VC funding or
plans to go public (those Cs should incorporate in DE or where HQ will be)
1. DE advantages – better to attract VCs, widely known law, respected, Court of Chancery
2. DE disadvantages – can be sued there, pay additional fees
III. Incorporation Mechanics – state’s C law statute will specify what must be included in the AOI/charter
A. Name Selection
1. State usually requires distinguishable name
2. Has to have designation (inc, co, etc.)
B. Authorized Shares (nontrivial)
1. Authorized shares – represents the max number of shares the C has the authority to issue
2. Par value – minimum amount of consideration the C must receive when issuing a share. Not the price at
which the C has to sell shares.
a. Customary to set par value at nominal amount ($0.01)
b. MBCA doesn’t require a par value
3. Filing fee and franchise tax based on shares AUTHORIZED. Franchise tax max in DE is $180K when
there’s over $23Kish authorized shares. Filing fee usually stays the same.
a. Most other states have flat fees (DE requires more $ because “premium product”)
C. Purpose
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1. Some states require, but should be as broad as possible, otherwise C might experience “ultra vires”
(beyond the powers) issues
a. Under this doctrine (ultra vires) a C that exceeds its purpose is invalid
b. MBCA doesn’t require purpose
D. Charter/AOI
1. General rule – only include in the charter required provisions and desired optional provisions that the
statute requires to be set forth in the charter. Everything else goes into the bylaws.
a. Because charter is more costly to amend than bylaws
2. Incorporator and his address must be listed in charter
a. Incorporator must sign charter as well
E. Organization of the C
1. After incorporation, the incorporator elects a BOD
2. BOD then completes organization of the C by adopting bylaws, appointing officers, and approving stock
issuances
F. Doing Business in Other States
1. Domestic C – C operating in its state of incorporation
2. Foreign C – C operating in a state other than its state of incorporation
3. Most states require foreign Cs transacting business to obtain a certificate of authority from the
secretary of state (referred to as “qualifying to do business”) have to pay fee
a. Qualifying to do business in a state has consequences:
● Foreign C has to pay annual fee/franchise tax charged by state
● Foreign C will be subject to service of process in the state
● Foreign C will have to file an annual report with the state
4. NC examples of when a foreign C is NOT transacting business [Harold Lang Jewelers]:
a. Defending an action
b. Holding directors or SH meetings or other internal affairs
c. Bank accounts
d. Offices or agencies in relation to its securities
e. Soliciting or procuring orders if they don’t need state approval
f. Making/investing in loans with independent agencies within the state
g. Taking security for or collecting debts due to it or enforcing rights in property
h. Transacting business in interstate commerce
i. Conducting isolated transaction within a period of 6 months
j. Selling through independent Kors
k. Owning, without more, real or personal property
IV. Defective Incorporation (BAR likes to test on this)
A. Usually arises when there’s a dispute about K, D discovers defective incorporation, and thus argues that the
person signing on behalf of the nonexistent C is personally liable.
B. Under agency and partnership law, the D should win, but courts have recognized that this is unfair. Two
court-created equitable doctrines address this [Pharmaceutical Sales & Consulting Corp.]:
1. De facto corporation, which exists when:
a. There is a law under which a C with the power assumed might be incorporated,
b. There has been a bona fide attempt to organize a C in the manner prescribed by the statute, and
c. There has been an actual exercise of C powers
2. Doctrine of corporation by estoppel which is: one who Ks and deals with an entity as a C thereby
admits that the entity is a C and is estopped to deny its incorporation in an action arising out of the K or
course of dealing; however, one of the stated limitations to the general rule is that it doesn’t apply in
the case of fraud.
V. Ethical Issues
A. Who is the Client?
1. This issue arises when there are several founders with different lawyers
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2. Standard practice is for lawyer to get informed consent from each founder and have each sign a conflict
waiver
B. Investing in a Client
1. Attorneys can receive stock in company instead of cash for payment
C. Practicing the Law of Other States
1. Unauthorized practice of law is a criminal misdemeanor or is punishable by injunction or contempt of
court in some states
2. Can practice on temporary basis if services arise out of or are reasonably related to the lawyers practice
in his home state (no single test for this)
FINANCIAL STATEMENTS
I. Balance Sheet
A. Reports assets, liabilities, and owners equity of a business as of a particular date
B. Owner’s equity = assets – liabilities
II. Income Statement (P&L)
A. Depicts business’s financial performance over a specified period of time
B. Revenue – expenses = net income/loss
III. Cash Flow Statement
A. Depicts a business’s cash inflows/outflows over specific period of time; concept of accrual is not apply to
the cash flow statement
1. Cash flow usually from operating activities, investing activities, and financing activities
IV. Miscellaneous
A. Profit = revenue – costs
CORPORATE FINANCE
I. Three primary categories of financing:
A. Debt
B. Equity
C. Internally generated funds
II. Debt
A. Debt – borrowed money that the business has to pay back to the lender with interest
1. Negotiations may include: loan amount, interest rate, repayment schedule
B. Credit Risk
1. The risk that a bower will default
C. Loan Agreements
1. A K between the borrower and lenders and includes (i) representations and warranties and (ii)
covenants of the borrower
a. Representations and Warranties
● Assertion of fact designed to provide a lender with recourse in the event that financial info
turns out to be erroneous or incomplete
● If representation (assertion of fact) is false lender has breach of K/fraud/breach of warranty
against borrower and can accelerate the loan by requiring the borrower to immediately pay
back the principal amount plus interest
b. Covenants
● Promises by the borrower to do something (affirmative) or not to do something (negative).
They are included in loan agreements to allow a lender to closely monitor how the business is
doing and protect against a business taking actions that may negatively impact the business’s
ability to repay the loan.
● Negative covenants are designed to prevent a business from engaging in a transaction that
would negatively impact the business’s ability to repay the loan. Standard negative covenants
include prohibitions on distributions, bonuses, acquisitions, capital expenditures, and
additional indebtedness.
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●
Most loan agreements also include financial covenants that stipulate specific financial ratios a
borrower is required to maintain.
D. Liens
1. Used to secure the loan
2. Can be mortgage on all of the borrower’s real property and/or a security interest on all of a borrower’s
personal property
3. Basic idea is that if the business defaults on the loan, the lender can foreclose on this collateral and then
sell it to satisfy all or part of the loan
E. Guaranties
1. Kual promise (in writing) by 3d party to pay amounts owed on the loan if borrower defaults
2. General rule – if a bank lends a C $, and the business fails to repay the loan, it can look only to assets
held in the name of the C and not to the personal assets of the Cs SHs for repayment, even if the SHs
have funneled large amounts of money out of the business through distributions/salaries and therefore
could easily repay the loan.
F. Types of Debt
1. Term loan – loan made to a business, typically by a bank, that calls for regular periodic payments of
interest and principal, usually over the period of ten years
2. Line of credit – loan that a business can draw down when needed. Money that can be used when fall
short of a purchase. Company will owe interest on the amounts it draws down based on how long they
are outstanding, and lender may also charge commitment fee for making the line available. Also called
revolving line or revolver.
3. Equipment loan – loan made to business to buy capital equipment; usually 50-80% of the equipment
cost; can also be loan secured by capital equipment
4. Equipment lease – financing transaction where a finance company buys a piece of equipment selected
by a business and leases it to the business. Payments are set at a slight premium.
5. Inventory loan – loan secured by a business’s inventory of finished goods. Banks are generally willing to
lend a business 50% of the value of the inventory securing the loan.
6. Mortgage loan – loan secured by a mortgage on the business’s real estate. Business can usually get up to
85% of the value of real estate.
7. Subordinated debt – loan or debt instrument that ranks below other debt in payment priority (junior).
Usually riskier and higher interest rate.
8. A/R loan – loan secured by a business’s A/R. Business may be able to finance up to 85% of it’s A/R.
9. Syndicated loan –loan funded by a group, or syndicate of lenders. Used to spread risk of borrower
across multiple lenders.
10. Corporate bond financing – debt raised by a business through the sale of bonds to investors. A bond is a
debt instrument issued by a company in exchange for money. Usually backed by business assets and
issued in denominations of $1000. Maturity ranges from 3-10 years and interest (coupon) paid.
11. Debenture financing – debt raised by a business through the sale of debentures, which is basically the
same as a bond but unsecured (not backed by collateral).
12. Junk bond financing – debt raised by business through the sale of bonds with a credit rating below
investment grade (BB+ or lower).
13. Commercial paper – short term, unsecured loans to companies with high credit ratings. Proceeds used
to fund current transactions.
14. Trade debt – money owed to a supplier or other creditor of a business for goods or serviced sold by the
trade creditor to the business on credit, that is, it provided the business with the goods or services, but
did not require the business to pay until a later date.
G. Lawyer role
1. Lawyer to review term sheet created by loan officer
2. Term sheet – nonbinding enumeration of the basic terms of a deal agreed to by the parties
III. Equity
A. Ownership stake in a business (common stock or preferred stock)
B. Issued stock (total) – treasury stock (what C is holding onto) = outstanding stock (what SH have)
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C. Common Stock (CS)
1. Stock that is entitled to:
a. Full voting rights (right to elect directors and vote on fundamental changes of C), and
b. Receive the net assets of the C upon dissolution (residual claim)
2. CS entitled to one vote per share
3. Does not entitle you to pre-dissolution payouts from the C, but it can choose to via dividends
4. Dual class capitalization – two different class of CS that allows for different voting structure, but default
is one vote per share
5. Issuance of CS requires board approval
6. If C has already issued all of the CS it has authorized, it will need to get SH approval to amend its charter
to increase its authorized shares
D. Preferred Stock
1. Means stock that has a preference over CS in either the payment of dividends (dividend preference) or
the distribution of assets upon dissolution (liquidation preference)
a. (1) Dividend Preference
● Specifies per share amount (usually fixed $ amount, but sometimes a formula for determining
the amount) the holders of the particular shares are entitled to receive before any dividends are
payable on the CS
o Non-cumulative or Cumulative?
▪ Non-cumulative – means if the specified dividend per share is NOT paid in a particular
year (ex: because BOD decides not to pay it), the SHs are NOT entitled to it in a
subsequent year
▪ Cumulative – means that a missed dividend is carried forward and will have to be paid
before the C can pay any dividends on the CS (“in arrears”)
o Non-participating or Participating?
▪ Non-participating – do not participate in dividends paid on CS
▪ Participating – holders of the preferred stock first get their dividend preference and
then if the C decides to pay dividends on its CS, the preferred stockholders participate in
that dividend as well
b. (2) Liquidation Preference
● Can be participating or non-participating (same definitions as above)
● Specifies a per share amount (either a fixed $ or a formula for determining the amount), the
holders of the particular shares are entitled to receive before any amounts are payable on the
CS following the liquidation of the C
● Preferred stock holders argue that sale of the company = liquidation
2. Conversion
a. Preferred stock is convertible into CS at the option of the holder, but holders of PS generally do not
convert into CS unless:
● (1) The C has agreed to be acquired and converting (as part of the acquisition) would result in a
bigger payout, OR
● (2) There is a public market for the CS but not the PS, and a holder of PS wants to cash out of his
investment
b. Conversion rate typically set so that PS holders get same amount of shares of CS had they
purchased them at the time they purchased PS
● Ex: $1M at $100/share in PS, so C issued you 10,000 shares; CS at $2.50
● When converted = 400,000 because 10,000*(100/$2.50)
c. Standard for PS to automatically convert into CS upon IPO of CS, merger, or by the C meeting certain
criteria
3. Anti-Dilution
a. Conversion feature usually coupled with anti-dilution provisions, which refers to a decrease in the
% interests of existing SHs with respect to earnings, book value, voting power, etc.
b. Example:
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C has 200 shares of stock outstanding; A owns 100, B owns 100; Cs book value is $100K, so A
and B hold 50% of the voting power and the book value per share is $500 (book
value/outstanding shares or $100K/200). C then issues an additional 100 shares to a new
investor for $20K. As a result the book value of its shares has been diluted from $500 to $400
($120K/300), and voting power is diluted from 50% to 33%.
o Dilution occurred because investor paid less than the then existing book value per share for
her shares.
c. Two Ways to Rectify Dilution:
● (1) Weighted Average – formula takes into account the number of shares issued at a price lower
that the effective Series A Conversion Price with the more shares issued the greater reduction
to the conversion price
o CP2 = CP1*(A+B)/(A+C)
o CP2 = Conversion Price after add’l stock issued
o CP1 = Original Conversion Price
o A = original outstanding stock
o B = # new stock issued*(new price of stock/old price of stock)
o C = # new stock issued
o Answer of this formula tells you what the conversion rate is, not the # stock per person
● (2) Full Ratchet – more favorable to holder of PS. Conversion price is simply ratcheted down to
whatever lower price at which the C issued additional shares.
o Conversion rate = whatever new stock price was
Protective Provisions
a. Common feature of PS; these provisions prevent a C from taking specified actions that may harm
the holders of PS without their approval (pg. 284 example)
Voting Rights
a. Voting on an “as-converted basis” means preferred gets on vote for each share of CS into which it is
convertible
b. If terms of PS do not address voting, under corporate law default, each share gets one vote
Electing Directors
a. PS oftentimes provides its holders with the right to elect directors, but provision must be added via
K
Redemption
a. Enables the holders of PS to require the C to buy the stock back
● This is called a “put.” Ex: “At XX price, I can force you to buy.”
b. Redemption price usually set at the price the investors paid the C for the PS
c. Call right – right to buy back the PS at a specified price
d. Staggered redemption – spreads it over a few years so company doesn’t have to come up with all
the money at once
Careful Drafting
a. If merger adversely affects the rights, preferences, or privileges of preferred stock, nothing can be
done unless drafters included protective provisions for the PS holders [Benchmark Capital Partners]
Public Company Preferred Stock
a. Terms are normally set in consultation with an investment banking firm that will lead the sale of
the stock to investors
Corporate Law Requirements
a. Terms of PS have to be in charter
b. C won’t know in advance what terms investors in a particular round of stock financing will require,
so C will have to amend its charter to specify terms once they are finalized
c. Blank check preferred provision – board can amend the Cs charter to create a new series of PS
without obtaining SH approval
d. Once PS series created, board adopts resolution for approving issuance. Board must also adopt a
resolution reserving authorized but unissued shares of CS for issuance upon conversion of PS CS
●
4.
5.
6.
7.
8.
9.
10.
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IV. Internally Generated Funds
A. Includes proceeds from the sale of goods and services
V. Capital Structure
A. Refers to a mix of capital and debt used to finance a business
1. Ownership dilution
a. Percentage ownership of the company’s existing owners is diluted down by equity financing (as
shares increase, % ownership decreases)
2. Leverage
a. Refers to the fact that a borrower retains returns earned on borrowed money in excess of the
interest a lender charges
b. Allows you to increase your returns, but also exposes you to more risk if things don’t turn out how
you planned
3. Repayment obligations
a. Debt obligations may cause a company to be more cost conscious. Equity is permanent capital that a
company never has to pay back.
4. Priority
a. Debt claims have priority over equity claims upon the liquidation or bankruptcy of a company. Debt
holder is entitled to be paid back first (before preferred or common). That’s why lender’s return is
fixed – doesn’t participate in the upside of business.
5. Taxation
a. Interest payments on debt are deductible by a borrower for tax purposes. Business does not get to
deduct cash distributions it makes to its equity SHs. This includes dividends paid by a C on
preferred stock.
6. Bottom line
a. Companies generally prefer debt financing over equity financing because of the lack of ownership
dilution, leverage effect, and tax deductibility of interest
b. Emerging companies are almost entirely equity financed because they don’t have hard assets or
cash flow to secure debt on reasonable terms
VI. Introduction to Federal Securities Regulation – Boliek expects EXPERT PRECISION with language!
A. What is a Security?
1. The term security means any note, stock, bond, debenture, evidence of indebtedness, transferable
share, investment K, voting-trust certificate, put, call, straddle, option, any interest or instrument to or
purchase, and of the foregoing.
a. Very broad
B. How to Determine What Is a Security?
1. Family Resemblance Test [Reves v. Ernst & Young]
a. (1) Examine the transaction to assess the motivations that would prompt a reasonable seller and
buyer to enter it (what’s it for?)
● If seller’s purpose is to raise money for general use of a business enterprise or to finance
substantial investments and the buyer is interested primarily in the profit the note is expected
to generate probably security
● If note is exchanged to facilitate the purchase of a minor asset probably not security
b. (2) Examine the “plan of distribution” of the instrument to determine whether it is an instrument in
which there is common trading for speculation or investment (what’s the distribution plan?)
c. (3) Examine the reasonable expectations of the investing public (what’s public expectation?)
● The court will consider instruments to be securities on the bases of such public expectations,
even if economic analysis suggests they’re not
● This factor weighed most heavily; this factor alone can make something a security
d. (4) Examine whether some factor such as the existence of another regulatory scheme reduces the
risk of the instrument (what other regimes govern it?)
e. Overarching policy – we want to inform people of risk so they make the right decision
2. Not securities:
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C.
D.
E.
F.
a. Note delivered in consumer financing
b. Note secured by a mortgage on a home
c. Short-term note secured by a lien on a small business or some of its assets
d. Note evidencing a character loan to a bank customer
e. Short-term notes secured by an assignment of A/R
f. Note for open-account debt incurred in ordinary course of business
3. Stock = security, but a note is not always a security
Registration Requirement
1. Every offer and sale of a security must be registered with the SEC (default)
2. UNLESS
a. (1) Offer and sale are exempt from registration, or
b. (2) Security is exempt from registration
Registering an Offering
1. File registration statement (with disclosures, audited financial statements, financial info, management’s
discussion and analysis on financial info; also include description of properties, business, exec
compensation, etc.)
2. SEC reviews and adds comments
3. Company revises
4. SEC makes “effective” company offers prospectus to investors
5. Registered offering = public offering
Exempt Offerings
1. Not all securities offerings require registration (due to inefficiency and cost)
a. Exemption: Section 4(a)(2)/Rule 506
● Exempts transactions by an issuer not involving any public offering
● If an offering complies with 506, it is exempt under 4(a)(2)
● Requirements of 506:
o (1) Offering limited to accredited investors and no more than 35 non-accredited investors
▪ Accredited investors = banks, insurance companies, mutual funds, etc.,
o (2) OR individuals with net worth over $1M, annual income over $200K, or joint annual
income over $300K
▪ Has to be sophisticated, meaning knowledge and experience in financial and business
matters and capable of evaluating the merits and risks of the prospective investment
b. Exemption: Rules 504 and 505
● 504 – A company may offer and sell securities to an unlimited number of persons
o Total dollar amount cannot exceed $1M
o No requirement about accredited investors
● 505 is the same as 506, BUT
o Total dollar amount cannot exceed $5M, and
o No sophistication requirement for accredited investors
● 506 is preferred because it falls under “covered security,” meaning its exempt from state
registration and qualification requirements. Security sold under 504 and 505 are NOT covered
securities.
● 506 additional advantages:
o (1) Having no monetary cap on the size of the offering, and
o (2) Allowing general solicitation so long as the offering is limited to accredited investors
c. Accredited Investor
● Institutional investors: banks, pension funds, VC firms, mutual funds
● Natural person with more than $1M net worth
● Natural person with $200K income in last 2 years and expects to make the same this year
d. Private Placement Memorandum (PPM) – how companies solicit investors for exempt offerings;
same info as prospectus, but not reviewed by the SEC
Avoiding Registration
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1. Limit the number of offerees
2. Limit the size of the offering
3. Minimize the formality of the offering (phone call)
4. Place restrictions on resale (so it doesn’t get out to the public)
G. Blue Sky Laws – the applicable legislation in each state
CORPORATE GOVERNANCE
I. Shareholders
A. General
1. Owners of a C, but limited control in matters
2. Corporate law statutes provide SHs a vote on the following matters ONLY:
a. Election and removal of directors
b. Amendments to the Cs charter
c. SH (as opposed to board) initiated amendments to the Cs bylaws
d. Dissolution of the C
e. Merger of the C
f. A sale of all (or substantially all) of the Cs assets
3. Charter or bylaws can specify more items for SHs to vote on, if board wants, but expansion is usually
uncommon except to PS holders
4. Things SHs usually don’t get a vote on:
a. Whether to fire CEO
b. Issue additional shares of stock
c. Go public
d. Borrow money
e. Build a new manufacturing plant
f. Relocate overseas, etc.
B. SH Meetings
1. Two types: annual and special
2. Annual meeting – 7.01(a), 211(b)
a. Regularly scheduled meting held by a C each year so that SHs can vote on the election of directors.
Other things can be voted on as well, such as amendment to charter
● Statutes require Cs to hold annual meetings, unless the Cs directors are elected by written
consent
3. Special meeting – 7.02, 211(d)
a. One held between annual meeting to have SHs vote on matters that cannot wait until the next
annual meeting
● Statutes specify who can call a special meeting and its normally supplemented by the Cs bylaws
(7.02, 211(d))
4. For a vote at a meeting to be valid:
a. (1) A C must provide its SHs with notice of the meeting (subject to waiver [7.06, 229]), and
b. (2) A quorum of shares must be present at the meeting
5. Notice (7.05, 222)
a. MBCA and DGCL require a C to notify its SHs of the date, time, and place of the meeting at least 10,
but not more then 60 days prior to the meeting
● For a special meeting, notice must include a description of the purpose(s) for which the meeting
is called
6. Quorum
a. Minimum number of shares that MUST be present at a SHs meeting. NOT the number of SHs that
must be present (because voting based on SHARES, not headcount)
● Default for MBCA and DGCL is that a quorum is a majority of the Cs outstanding shares (7.25(a),
216))
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MBCA allows a C to have a greater quorum requirement through a provision in its charter
(7.27)
o DGCL allows a C to have a lower (but no less than 1/3 outstanding shares) or greater
quorum requirement through a provision in its charter or bylaws (216)
Proxies (7.22, 212)
a. SH doesn’t have to physically attend SH meeting for his shares to be considered present for
purposes of a quorum and votes. SH can appoint a person who will be attending the meeting to
serve as the SHs proxy at the meeting.
b. Proxy is an agent appointed by a SH to whom the SH gives express actual authority to vote the SHs
shares at a SH meeting
c. Appointment must be reflected in a written transmission (includes email)
d. Grant of authority = proxy appointment
e. Document = proxy form
f. Person = proxy
Written Consent (7.04, 228)
a. C law statutes provide for SH approval of a matter through written consent (instead of a formal SH
meeting). Basically, SH signs a piece of paper to give their approval. This doesn’t require notice.
● MBCA requires unanimity unless revised in AOI (7.04(b))
● DGCL default has minimum number of votes standard (228(a))
b. Written consents are usually utilized by closely held Cs because it’s easier to get signatures (fewer
SHs)
Voting Requirements
a. MBCA default – “more votes for than against.” Unless the AOI require a greater amount of
affirmative votes, a matter passes if the votes cast favoring the action exceed the votes cast
opposing the action. (7.25(c)).
● Abstentions don’t count
b. DGCL default – “majority of a quorum.” Unless a different requirement is set forth in another
section of DGCL, charter, or bylaws, the affirmative vote of the majority shares present in person or
represented by proxy at the meeting and entitled to vote on the subject matter shall be the act of
the SHs. (216).
● Abstention = “no”
c. Plurality – director candidates who receive the largest number of votes are elected, up to the max
number of director slots up for election. (7.28(a), 216(3)).
d. For mergers, sale of all (or substantially all) of a Cs assets, and amendments to the Cs charters,
voting is different.
● MBCA – still “more votes for than against”
● DGCL – majority of OUTSTANDING shares (instead of quorum)
Class Voting
a. The issue of class voting arises when a C has more than one class or series of stock outstanding.
Could be:
● CS and PS collectively
● Only CS
● CS and PS separately
b. To determine whether shares vote together or separate depends on:
● (1) What the charter says with respect to voting, and
● (2) The particular matter up for vote, because for some matters the DGCL requires one or more
types of shares to vote as a separate class
c. Most common circumstances requiring a separate class vote is when the board has proposed a
charter amendment that would alter the rights or preferences of a class of shares so as to affect
them adversely (242(b)(2) and 242(b)(1)).
● Voting requirement = majority of outstanding shares
o
7.
8.
9.
10.
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d. Even if a Cs charter provides that a class of stock is nonvoting, C law statutes afford the class a class
vote on a charter amendment in a limited number of circumstances, including on an amendment
that would adversely affect the rights or preferences of the nonvoting shares (10.04(a) & (d),
242(b)(2)).
C. Directors
1. General
a. Default – ultimate managerial authority resides in a Cs BOD
b. BOD elects officers to run the business, subject to oversight
2. Number & Qualifications (8.03(a), 141(b))
a. Bylaws typically dictate the size of the BOD because provisions addressing board size can normally
be amended by board action only, while such a provision in a charter would require SH approval
b. Both MBCA and DGCL allow a board of a single person
3. Board Action
a. Two types of board meetings:
● (1) Regular – dates are specified in bylaws
● (2) Special – those held in between regular meetings
b. Default MBCA – directors must be provided at least two days notice of a special meeting, but this
period can be, and normally is, reduced by bylaw provision
c. Default DGCL – does not have a default provision, so notice is normally specified in bylaws
d. There must be a quorum present at a meeting for a board to act. Under default rule, the presence of
a majority of directors constitutes a quorum (phone counts) (8.20(b) & 8.24(a), 141(b)(i)).
e. MBCA and DGCL allow a C to lower the board meeting quorum through a bylaws provision to as
little as 1/3 of directors (8.24(b), 141(b))
f. Board can act through written consent (8.21(a), 141(f))
4. Elections
a. Default for MBCA and DGCL – SH elect directors using straight voting, which means each SH can
cast the number of votes he has on her preferred candidates for the board seats up for election
(7.28(a), 216(3)).
b. Under this default, whoever controls majority of votes, determines the board, but cumulative voting
can be utilized to protect minority voters (more on this later!)
5. Terms
a. Default – Director’s term is generally one year (or next election) (8.05(b), 141(b)).
b. Alternatively, C can choose to stagger, meaning the terms of only a portion of its directors expire in
a particular year (8.06, 1441(d)).
● Staggered board reduces the impact of cumulative voting because minority SH will need a
greater number of votes to elect a director than if the entire board were up for election
● Staggering helps transition the board
c. COI or bylaw provision that divides directors into classes may authorize the BOD to assign
members of the board already in office to such classes at the time such classification becomes
effective
6. Removal
a. Statutes give SH the right to remove directors at any time, and under default it can be done without
cause (8.08(a), 141(k))
b. Common for a C to impose a “for cause” requirement in its charter
● Cause usually includes fraudulent or criminal conduct and gross abuse of office amounting to
breach of trust (8.08 comments)
c. DGCL flips the rule for directors on a staggered board. A director on a staggered board may only be
removed for cause unless the Cs charter otherwise provides (141(k)(1))
d. To remove a director, SHs generally need to call a special meeting or do written consent. Voting
requirement:
● MBCA – more yes than no (8.08(b))
● DGCL – majority of outstanding votes in favor of removal (141(k))
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e. If opted into cumulative voting,
● MBCA – “a director may not be removed if the number of votes sufficient to elect him under
cumulative voting is voted against his removal” (8.08(c))
● DGCL – “no director may be removed without cause if the votes cast against such director’s
removal would be sufficient to elect such director if then cumulatively voted at an election of
the entire BODs” (141(k)(2))
f. Only SHs can remove director, not a vote by the board
7. Filling Vacancies
a. Vacancy can occur because of:
● Death
● Removal
● Resignation
● Increase in seize of board
b. Vacancies can be filled by SH or remaining directors. Usually done by board because easier for them
to meet or vote via written consent. (8.10(a), 223(a)(1)).
8. Committees
a. Statutes allow the board to delegate power to committees comprised of one or more directors
(8.25(a), 141(c))
b. MBCA and DGCL prohibit committees from taking certain actions such as amending the Cs bylaws
or approving a matter that requires SH approval (8.25(e), 141(c))
c. Board creates ad hoc committees on occasion
● Ex: negotiating committee to handle large transaction
d. Committees act through committee meeting or written consent. Same rules regarding notice,
quorum, and required vote apply to board meeting and committee meetings.
II. Officers
A. Oversee day to day management and are elected by the board or appointed by more senior officers
B. MBCA and DGCL – C must designate an officer to prepare and maintain board and SH meeting minutes and
authenticate C records (8.40(a), 142(a))
III. Bylaws
A. Overview
1. Bylaws specify rules regarding the governance of the C. These rules address:
a. Notice and quorum requirements for board and SH meetings
b. Number and qualifications of directors
c. Voting standards
d. Proxy voting
e. Appointment of officers, and
f. Stock certificates
2. When drafting bylaws, consult applicable statute and charter to ensure no conflict
3. Statute trumps charter, which trumps bylaws
4. If a bylaw provision is inconsistent with the statute or the charter, the statute or the charter controls
5. Limit officer actions in turn limiting respondeat superior
B. Amendments
1. Default MBCA – Both the board and SH have the power to unilaterally amend or repeal the bylaws. This
power can be limited or eliminated with respect to the board (but not the SH) through a charter
provision (10.20)
2. Default DGCL – SHs have the power to unilaterally amend or repeal the bylaws, but the board does not;
however, a C may confer such power to its board through a charter provision
a. Ex: “The BOD of the C is expressly authorized to make, alter, or repeal the bylaws of the C.”
3. Amendments can be adopted via board meeting or written consent
4. MBCA and DGCL – SH have the power to unilaterally amend or repeal a Cs bylaws, and this power
cannot be taken away. Unilaterally, meaning the SHs can initiate and adopt a bylaw change with no
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involvement of the board. This is unique and essentially the only corporate governance power SHs
possess that is proactive rather than reactive to the board.
IV. Charter Amendment Process
A. See Example pg. 378–384
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FIDUCIARY DUTIES
I. Fiduciary Duties of Directors
A. General
1. Default – governance structure is centralized management with ultimate authority vested in a Cs BOD
a. Disadvantages – principal-agent issues
2. Two laws imposed on directors: duty of care and duty of loyalty
a. Judge-made under DGCL
b. Statutory under MBCA
B. Business Judgment Rule: No Liability for Bad Decisions
1. Director is not liable for a breach of fiduciary duty solely on the grounds that he made a bad business
decision, even if the decision resulted in the demise of the C
2. DE – “Presumption that in making a business decision the directors of a C acted on an informed basis, in
good faith and in the honest belief that the action taken was in the best interests of the C.”
3. This rule prevents a P from prevailing on a breach of fiduciary duty claim against a BOD for a bad
business decision unless the P can prove that the board’s decision-making process was inadequate or
tainted
4. Exception to BJR – some decisions may be so egregious that liability for losses they may follow even in
the absence of proof of conflict of interest or improper motivation [Trifoods].
C. Duty of Care
1. DOC requires a board (and its individual directors) to be adequately informed when making a decision.
The focus of DOC is on the decision-making process as opposed to the substance of the decision itself.
Standard = gross negligence.
D. Exculpation Provisions (2.02(b)(4), 102(b)(7))
1. Gorkom is seminal case because first time directors of a public company were held personally liable for
breach of the duty of care; also sets standard for determining whether a board was adequately
informed when making a decision as gross negligence, which DE defines as “reckless indifference to or
a deliberate disregard of the whole body of stockholders’ or actions which are without the bounds of
reason . . . a wide disparity between the process the directors used to ensure the integrity of the
company’s financial statements and that which would have been rational.”
2. Exculpation provision in a Cs charter forecloses a claim against directors for monetary damages for
breach of the DOC
a. Does NOT apply to a breach of duty of care claim seeking equitable relief instead of monetary
damages
E. Duty of Loyalty
1. General
a. DOL requires the board and its individual directors to act in the best interests of the C; C officers
and directors are not permitted to use their position of trust and confidence to further their private
interests
b. DOL is implicated in:
● (1) Conflicting interest transactions
● (2) Failure to provide adequate oversight
● (3) Failure to act in good faith, and
● (4) Usurpation of a C opportunity
2. Conflicting Interest Transactions
a. General
● Any transaction between a director and the C
● CL rule was that any transaction between a C and a director was voidable at the option of the C
or its SHs, regardless of the merits of the transaction
● This has evolved so that a conflicting interest transaction is not per se voidable if:
o (1) A majority of informed disinterested directors approved the transaction,
o (2) A majority of informed disinterested SHs approved the transaction, OR
o (3) The transaction was fair to the C
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Statutes shield director conflicting interest transactions from per se voidability, they do not
shield the director(s) who engaged in a transaction from a breach of DOL claim
o Policy – we don’t want to discourage transactions between director and C, because
sometimes they’re beneficial, but we do want to make sure they’re fair
● Analyzing whether the DOL was breached in DE:
o (1) BJR
▪ P rebuts by showing director entered into transaction; usually both parties stipulate this
o (2) Director has the burden of proving the transaction was fair to the C
▪ If met no breach of loyalty
▪ If not met breach of loyalty and personally liable
o (3) Director can avoid proving fairness by having the transaction approved by a fully
informed majority of disinterested and independent directors or SH (cleansing device)
▪ This shifts the burden to the P to prove waste
(1) Fairness (Two Components: Fair Dealing & Fair Price)
● If director is on both sides of a transaction, he has the burden of establishing its entire fairness,
sufficient to pass the test of careful scrutiny by the courts
● Directors will be found to have acted with entire fairness where they demonstrate their utmost
good faith and the most scrupulous inherent fairness of the bargain
● (1) Fair dealing – embraces questions of when the transaction was timed, how it was initiated,
structured, negotiated, disclosed to the directors, and how the approvals of the directors and
the SH were obtained
● (2) Fair price – relates to the economic and financial considerations of the proposed merger,
including all relevant factors:
o Assets
o Market value
o Earnings
o Future prospects
o Any other elements that affect the intrinsic or inherent value of a company’s stock
(2) Disinterestedness (Or, When Is a Director Interested?)
● Disinterestedness goes to whether or not a director or SH has an interest in the transaction at
issue
● A director is considered interested where he will receive a personal financial benefit from a
transaction that is not equally shared by the SHs. Directorial interests also exists where a
corporate decision will have a materially detrimental impact on a director, but not on the C and
the SHs.
● For a director to be interested because of receipt of a benefit, the benefit to be received by a
director must be material to that director. It must be significant enough in the context of the
director’s economic circumstances, as to interfere with personal interests and fiduciary duties.
(3) Independence
● Independence goes to whether a director or SH can exercise independent judgment with
respect to a decision as opposed to simply voting in accordance with the conflicted director’s
wishes
● To establish lack of independence, P must show that a director or SH is so “beholden” to the
conflicted director that his discretion is “sterilized.” The following may be sufficient:
o Financial ties
o Familial affinity
o Particularly close or intimate personal or business affinity
o Evidence that in the past the relationship caused the director to act non-independently
(4) Fully Informed
● To be fully informed, directors and SH must be furnished all material info concerning the
conflicting interest transaction at issue
●
b.
c.
d.
e.
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A fact is material if there is a substantial likelihood that a reasonable SH or director would
consider it important in deciding how to vote
3. Duty to Monitor/Provide Oversight
a. BODs duty to monitor/provide oversight of Cs business and employ oversight mechanisms to
ensure illegal activities aren’t occurring
b. Director oversight liability [Stone]:
● (1) Directors must have known that either [different from Caremark because it said “should
have known”]
● (2) They utterly failed to implement any reporting/info systems or control OR
● (3) Having implemented such a system/control, consciously failed to monitor/oversee its
operations, thus disabling themselves from being informed of risks or problems requiring their
attention
c. DOL so NO EXCULPATION
d. The P alleges that had the board been fulfilling its oversight function, the misconduct would not
have occurred and the C would not have lost they money
4. Duty of Good Faith
a. Duty of good faith requires true faithfulness and devotion to the C and its SHs
b. The concept of intentional dereliction of duty, a conscious disregard for one’s responsibilities, is an
appropriate standard for determining whether fiduciaries have acted in good faith. Deliberate
indifference and inaction in the face of a duty to act is conduct that is clearly disloyal to the C. Three
categories of fiduciary behavior are candidates for the “bad faith” label:
● Subjective bad faith – fiduciary conduct motivated by an actual intent to do harm
● Lack of due care – fiduciary action taken solely by reason of gross negligence and without any
malevolent intent
● “Intentional dereliction of duty, a conscious disregard for one’s responsibilities”
o This is a nonexculpable, nonindemnifiable violation of the fiduciary duty to act in good faith
c. Disney Case – Ovitz hired to be groomed as future CEO, but it didn’t work out so Disney let him go
firing as a “non-fault” term, entitling him to a severance package of $130K+ (which he wouldn’t
have gotten if he was fired for good cause). Disney SH brought derivative suit saying that BOD
breached fiduciary duty when approving employment K and when firing him non-fault.
d. The requirement to act in good faith is a subsidiary element of the DOL (Stone v. Ritter). Failure to
act in good faith is not the same as DOC or DOL.
5. Usurping a Corporate Opportunity
a. A director usurps a C opportunity when the director takes for himself a business opportunity that
should have gone to the C
b. Corporate opportunity doctrine from Guth holds that a corporate officer or director may not take a
business opportunity for his own if:
● (1) The C is financially able to exploit the opportunity
● (2) The opportunity is within the Cs line of business
● (3) The C has an interest or expectancy in the opportunity, and
● (4) By taking the opportunity for his own, the corporate fiduciary will thereby be placed in a
position inimicable to his duties in the C
c. Line of business – includes activities to which it has fundamental knowledge, practical experience,
and the ability to pursue, and that are consistent with the Cs reasonable needs ans aspirations for
expansion
d. For interest or expectancy to be met, there must be some tie between the transaction at issue and
the nature of the corporate business
e. Guth corollary states that a director or officer may take a corporate opportunity if:
● (1) The opportunity is presented to the director or officer in his individual and not his
corporate capacity
● (2) The opportunity is not essential to the C
● (3) The C holds no interest or expectancy in the opportunity, and
o
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(4) The director or officer has not wrongfully employed the resources of the C in pursuing or
exploiting the opportunity
f. No one factor is dispositive
6. Duty of Disclosure
a. Whenever directors communicate with SHs, they’re required to do so honestly
b. Derived from both DOC and DOL
c. The duty obligates directors to provide the SHs with accurate and complete info material to a
transaction or other corporate event that is being presented to them for action. More generally,
whenever directors communicate with SHs, they are required to do so honestly.
7. Fiduciary Duty Litigation
a. General
● Usually C that has standing to sue (not SH), but board is unlikely to sue itself, so derivative suit
comes into play
● Derivative suit is a suit initiated by a SH on behalf of the C. Because the claim belongs to the C,
any recovery goes to the C and not the SH-P.
● For DE, prior to bringing a derivative claim, a SH must:
o (1) Make a demand on the Cs BOD to pursue the claim, or
o (2) Include in the derivative action complaint particularized facts as to why making a
demand would be futile
o Considered catch 22 because you can’t argue would be futile after bringing a demand
b. The Demand Requirement
● Demand Futility – In determining demand futility, the court must decide whether under the
particularized facts alleged, a reasonable doubt is created that:
o (1) The directors are disinterested and independent, OR
▪ Same definitions for disinterested and independent as above
▪ The question is whether a reasonable doubt exists as to the disinterestedness and
independence of a majority of the board in responding to a demand, if the P had made
one
▪ Demand will be excused if facts proved, for example, that a majority of the board has a
direct and substantial financial interest in the challenged transaction, or a majority of
the board is so beholden to an interested party that it cannot exercise independent
judgment with respect to the demand.
o (2) The challenged transaction was otherwise the product of a valid exercise of business
judgment
▪ P has to plead particularized facts creating a reasonable doubt that a majority of the
board was:
i. Adequately informed when making the challenged decision, or
ii. Honestly and in good faith believed that the challenged decision was in the best
interests of the C
o Test for Demand Futility with Respect to Failure to Provide Oversight – Whether or not the
particularized factual allegations of a derivative SH complaint creates a reasonable doubt
that, as of the time the complaint was filed, the BOD could have properly exercised its
independent and disinterested business judgment in responding to a demand
▪ If P satisfies this burden, demand will be excused as futile/useless
● Special Litigation Committees
o If court finds that making a demand was futile, board will likely respond by creating SLC,
which is a board committee composed of directors the board has determined are
disinterested and independent when it comes to the derivative suit
o The board will empower the SLC to investigate the PS allegations and determine whether
proceeding with the suit is in the Cs best interest. The SLC then decides whether the C
should pursue, attempt to settle, or move to dismiss the suit
o A decision by the SLC to move for dismissal does not receive the protection of the BJR
●
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In deciding whether to grant a motion for dismissal, the court applies the Zapata two-step
test:
▪ (1) The court should inquire into the independence and good faith of the committee and
the bases supporting its conclusions. If this is met then...
▪ (2) The court should determine, applying its own independent business judgment,
whether the motion should be granted
c. Direct v. Derivative
● Direct suit – P assert that he was directly harmed by the directors’ breach of fiduciary duty and
therefore is suing in his individual capacity for redress of this harm and not on behalf of the C. P
will usually try to bring direct because then you don’t have to follow Rule 23.1 (Court of
Chancery rule that governs derivative suits), but then D directors will argue that it should be
derivative and therefore dismissed because it’s not following 23.1.
d. To Determine Whether a SHs Claim is Derivative or Direct:
● (1) Who suffered the alleged harm, and
● (2) Who would receive the benefit of any recovery or other remedy?
II. MBCA Approach to Director Fiduciary Duties (codified UNLIKE the DGCL)
A. Standards of Conduct & Liability (8.30 & 8.31(a)(2))
1. Each member of the BODs, when discharging duties of a director, shall act:
a. (1) In good faith, and
b. (2) In a manner the director reasonably believes to be in the best interests of the C
2. The members of the BODs or a committee of the board, when becoming informed in connection with
their decision-making function or devoting attention to their oversight function, shall discharge their
duties with the care that a person in a like position would reasonably believe appropriate under similar
circumstances (8.31(a)(2))
3. P claiming that directors breached their fiduciary duties in approving a transaction has the initial
burden of proving the approval process was inadequate or tainted. BUT unlike DE, burden doesn’t shift
to D to show “entire fairness.” Under 8.31(b)(1), P has to prove harm to the C or SHs and that the harm
suffered was proximately caused by the director’s challenged misconduct.
B. Conflicting Interest Transactions (8.60)
1. A transaction effected or proposed to be effected by the C (or by an entity controlled by the C)
a. (1) To which, at the relevant time, the director is a party; or
b. (2) Respecting which, at the relevant time, the director had knowledge and a material financial
interest known to the director; or
c. (3) Respecting which, at the relevant time, the director knew that a related person was a party or
had a material financial interest
C. Usurping a Corporate Opportunity
1. MBCA 8.70 provides a safe harbor for a director contemplating taking a business opportunity that may
constitute a C opportunity and thus potentially give rise to a breach of DOL for usurping C opportunity
2. It shields a director from liability if, before taking the opportunity, the director brings it to the attention
of the C, and either a majority of qualified directors or qualified shares disclaim the Cs interest in the
opportunity
D. Shareholder Derivative Suits (7.42)
1. SH cannot commence a derivative suit until he has:
a. (1) Made a written demand on the C to bring the suit, and
b. (2) 90 days has run from the date of the demand, the C has rejected the demand, or waiting 90 days
would result in irreparable injury to the C
III. Fiduciary Duties of Officers
A. Officers owe the same fiduciary duties to the C as directors
B. Fiduciary dues appear to apply to officers (8.42)
1. Case law for DE
C. Under DE – does BJR apply to decisions made by officers? Fed court apply DE law said no, but DE has not
spoken on it
o
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D. Under both MBCA and DGCL, an exculpation provision can ONLY apply to DIRECTORS and NOT OFFICERS
IV. Fiduciary Duties of Controlling Shareholders
A. “Controlling SH” includes majority SH
B. Under CL, a controlling SH owes fiduciary duties to the C and its other SHs. Usually comes up with DOL
when controlling SH enters into transaction with C (like buying/selling house)
C. A SH owes fiduciary duties in two instances [Superior Vision]:
1. When it is a majority SH, owning more than 50% of the shares, or
2. When it exercises control over the business affairs of the C
a. P must prove actual exercise of control over the board in a way that it dominates the C decisionmaking process
b. A significant SH who exercises a duly obtained Kual right that somehow limits or restricts the
actions that a C otherwise would take, does not become (without more) a controlling SH
D. When a transaction involving self-dealing by a controlling SH is challenged, the applicable standard of
judicial review is entire fairness, with the Ds having the burden of persuasion. In other words, the Ds bear
the burden of proving that the transaction with the controlling SH was entirely fair to the minority SHs.
1. When entire fairness applies, Ds can shift the burden in two ways [America’s Mining Corp.]:
a. (1) They may show that the transaction was approved by a well-functioning committee of
independent directors, or
b. (2) They may show that the transaction was approved by an informed vote of a majority of the
minority SHs
E. Framework for analyzing whether a controlling SH conflicting interest transaction constitutes a breach of
the DOL:
1. Controlling SH has burden of proving the transaction was fair to the C
a. If controlling SH meets this burden no breach of DOL
b. If it doesn’t breached DOL and liable for damages
2. Controlling SH can avoid having to prove fairness by having the transaction approved by a fully
informed majority of disinterested and independent directors or SHs. This shifts the burden to the P to
prove that the transaction was unfair to the C.
a. If P meets burden controlling SH breached DOL and is liable for damages
F. Can also use committee composed of outside directors to negotiate the transaction with the controlling SH,
but:
1. Majority SH must not dictate the terms of the transaction, and
2. The special committee must have real bargaining power that it can exercise with the majority SH on an
arms length basis
V. Indemnification
A. When a C pays the litigation costs and expenses of directors and officers from suits arising out of their C
service. This is expressly allowed by statute.
B. Mandatory
1. C is required to indemnify a director or officer who is sued in such capacity and wins the suit on the
merits (145(c), 8.52 & 8.56(c))
C. Permissive
1. C is permitted, but not required to indemnify a director or officer who was unsuccessful on the merits,
provided the person acted in good faith and in a manner he reasonably believed to be in the best
interests of the C (145(a), 8.51(a) & 8.56))
a. For criminal proceeding, person must also have no reasonable cause to believe that his conduct was
unlawful
D. Derivative Suits
1. Permissive indemnification is limited to the payment of expenses (ex: attorney’s fees) and in some
states (including DE), doing so requires court approval (145(b), 8.51(d)(1))
E. Advance Litigation Expenses
1. Corporate law statues allow a C to advance litigation expenses to directors/officers (145(c), 8.53 &
8.56(a))
33
a. BUT director/officer must repay if it’s determined he was not entitled to indemnification
VI. Directors & Officers (D&O) Liability Insurance
A. Corporate law statutes expressly allow Cs to purchase insurance to protect directors and officers against
liabilities arising out of their C service (145(g), 8.57)); usually included in indemnification agreement
1. Side A – coverage that provides directors/officers with insurance protection when indemnification is
not available, either because indemnification by C not legally permitted or C is financially unable to
meet its indemnification obligations
2. Side B – reimburses a C for amounts it pays out fulfilling its indemnification obligations
B. D&O policies typically exclude:
1. Fraudulent or criminal misconduct, and
2. Profits or compensation to which the director/officer was not legally entitled
DOC
DOL
Conflict of
Interest
DOL
Duty to Monitor
DOL
Duty of Good
Faith
DOL
Usurping C Opportunity
DOL
Duty of
Disclosure
Directors must
act with:
1. Care
2. Competence,
and
3. Diligence
-Requires BOD
to be
adequately
informed when
making
decisions
Analysis:
1. BJR
2. Cleansing
Device
-Disinterested
-Independent
-Fully Informed
-Maj. or
SHs/directors
3. Entire Fairness
-Fair Dealing
-Fair Price
4. If D shows 2 or
3, P will try “but
waste”
Stone:
1. Director must
have known either:
2. That they utterly
failed to implement
any reporting or
info
system/control OR
3. Having
implemented such
system/control,
consciously failed
to
monitor/oversee
its operations thus
disabling
themselves from
being informed of
risks or problems
requiring their
attention
Three categories:
1. Subjective bad
faith
2. Lack of care
3. Intentional
dereliction of
duties
Guth:
Directors/officers can’t
take an opp. for C if:
1. C is financially able to
exploit
2. Opp. is within Cs line of
business
3. C has an
interest/expectancy in the
opp.
4. By taking the opp., the
fiduciary is placed in a
position inimicable to his
C duties
Obligates
directors to
provide SHs
with all
material
info
regarding a
corporate
event
presented
to them for
action
Analysis:
1. 8.01(c)
2. Stone (see
above)
Analysis:
1. 8.31(a) or 8.42
– director/officer
must act in good
faith,
respectively
2. Then
supplement with
CL (see above)
(exculpation OK for
directors ONLY)
DGCL
-Same analysis for
controlling SH,
except no BJR
MBCA -8.30(d) – care
of a reasonable
person in the
same
circumstances
Analysis:
1. 8.60 – Is there a
COI transaction?
2. 8.31 – BJR
3. 8.62 & 8.63 –
Cleansing device
(1.43 defines
qualified director)
4. 8.61(b)(3) –
Was transaction
otherwise fair?
5. Waste
argument is based
in CL
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Guth Corollary:
Director/officer can take
opp. if:
1. It’s presented in his
individual capacity
2. It’s not essential to the C
3. C doesn’t hold
interest/expectancy
4. Director/officer doesn’t
use C resources in
pursuing the opp.
Analysis:
1. 8.70 and safe harbor in
8.70(a)(1)
2. Guth (see above)
-8.30(c)
35
MINORITY SHAREHOLDER PROTECTIONS
I. Negotiated Protections
A. General Rules
1. C default laws provide little protection to minority SHs. Among other things, they:
a. Have no right to be employed by the C or participate in management
b. Cannot compel the C to pay dividends or buy back shares, and
c. Have insufficient voting power to elect even a single director
2. Rights are even worse in privately held Cs
B. Cumulative Voting & Other Board-Related Provisions
1. Default C law rule – directors are elected by straight voting, which means a majority SH will be able to
elect the entire board, regardless of how minority SHs vote
2. BUT C law statutes provide for CUMULATIVE voting as well, so C can opt in to cumulative voting by
including a statement to that effect in its charter
3. Cumulative voting provides some protection to a minority SH, because it may result in him being able
to elect one or more directors, a possibility not afforded by straight voting
4. Default – directors are elected by a plurality voting standard, meaning the candidates receiving the
most votes win
5. Can K around this for minority SH and have condition that says minority SH gets to select one or more
members of the BOD (Kally agree)
6. Voting agreement is an agreement between two or more SHs as to the voting of shares
a. Voting agreement aka pooling agreement
C. Preemptive Rights
1. Preemptive rights give an existing SH the opportunity to purchase a proportionate part of to be issued
shares before they are offered to other persons. This enables a SH to avoid having his ownership %
diluted by new issuances.
2. Default – SHs have NO PREEMPTIVE rights, so that statutes say they have to be included in the charter
if they’re going to be offered (6.30(h), 102(b)(3))
3. Sometimes preemptive rights are offered in a K instead of within the charter because:
a. There are fewer formalities associated with entering into a K as compared to amending its charter,
and
b. It only needs to grant the rights to select SHs
4. Reverse preemptive rights – takes advantage of the “controlling premium” by forcing the sale of the
minority’s shares at the price of the majority’s, which are inherently worth more as a group
D. Veto Rights
1. Veto rights give the SH the right to prevent a C from taking a specified action. Two types:
a. Explicit
b. Implicit – result from higher quorum or voting requirements
E. Employment Rights
1. Common for minority investor in closely held C to expect C to employ him
2. Stock ownership does not become with employment rights
3. K should include position, duties, compensation, fringe benefits, circumstances under which
employment may be terminated
F. Buyout Obligations
1. Under statutory default rules, neither the C nor its SHs have any obligation to buy out a SH who wants
to exit his investment
2. Minority investor in private company can negotiate for a provision that requires the C or other SHs to
buy out the minority investors upon the happening of certain events
G. Dividend Policy
1. Default – payment of dividends is left to the discretion of the BOD
2. Thus, minority SH cannot force the board to declare a dividend, so it’s helpful to have a provision to
negotiate a dividend policy in connection with his investment
H. Documenting Minority Shareholder Protections
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1. Minority SH protections usually documented via:
a. Charter provision
b. Bylaws provision
c. SHs agreement provision
2. Usually dictated by statute; however, absent specific statutory requirement, there is a lot of flexibility
as to in which document a particular provision can be located
a. Cs preference is usually in SH agreement (because not public and cheaper to amend)
3. SH agreement – K between two or more of the Cs SHs and oftentimes the C as well (validated by 7.32)
4. For SH agreement to fall within 7.32, it must be set forth in:
a. The Cs charter or bylaws and approved by all persons who are SHs at the time of the agreement, OR
b. In a written agreement that is signed by all persons who are SHs at the time of the agreement and is
made know to the C
5. SH does not have to comply with 7.32 to be enforceable! It is a safe harbor for SH agreements that
contain provision that conflict or may conflict with the governing statute. A SH agreement that does not
comply with 7.32 is not necessarily invalid.
a. DGCL – 350 (comparable)
II. Immutable Statutory Protections
A. Inspection Rights
1. MBCA and DGCL afford SHs rights to inspect a Cs books and records
2. MBCA 16.02(a) entitles a SH to inspect and copy, among other things, the Cs charter, bylaws, SH
meeting minutes from the last three years, written communications the C to its SHs from the last three
years, and a list of current directors/officers. Additionally, under 16.02(c), a SH can inspect and copy
excerpts from board meeting minutes, accounting records, and the SH list provided the SH seeks to do
so in good faith and for a proper purpose and the records the SH wants to inspect are connected to that
purpose.
a. Proper purpose – reasonably relevant to the demanding SHs interest as a SH
3. DGCL 220 is analogous – SHs have the right to inspect and copy for any proper purpose the Cs stock
ledger, a list of its stockholders, and its other books and records
a. Proper purpose – a purpose reasonably related to such person’s interest as a stockholder
4. MBCA has separate provision under 16.20, which requires a C to deliver annual financial statements to
its SHs within 120 days after the close of each fiscal year
a. DGCL doesn’t have this
5. MBCA and DGCL allow a director to examine the Cs books and records for a purpose reasonably related
to his duties as a director
6. Burden on SH to show by a preponderance of the evidence (look to intent):
a. Demand made under oath
b. Demand states proper purpose
c. Docs are essential and sufficient for stated purpose
B. Judicial Dissolution for Oppression
1. MBCA 14.30(a)(2) – provides for dissolution of a C in a proceeding by a SH if it is established that the
directors or those in control of the C have acted, are acting, or will act in a manner that is illegal,
oppressive, or fraudulent. Thus, a minority SH who believes he is being mistreated by a majority SH can
bring suit for dissolution and argue the mistreatment amounts to oppression.
2. MBCA 14.34 – allows the C or one or more of its SHs to purchase at fair value all of the shares of a SHS
petitioning for judicial dissolution
a. DGCL doesn’t have this
3. “Freeze out” – actions taken by the controlling SHs to deprive a minority SH of her interest in the
business or a fair return on her investment
a. Ex: withholding dividends, discharge from employment, removal from BOD
b. Usually occurs in closed Cs
c. Can resolve by “put” option, way to exit, BOD
37
4. Oppression should be deemed to arise only when the majority conduct substantially defeats
expectations that, objectively viewed, were both reasonable under the circumstances and were central
to the minority SHs decision to join the venture [Balvik].
a. Court considering oppressive conduct must investigate what the majority SHs knew, or should have
known, to be the minority SHs expectations in entering the particular enterprise.
b. Court says we don’t really know what oppression is, but we know it when we see it
C. Judicial Dissolution for Deadlock
1. Deadlock occurs when a Cs board is evenly divided on an issue and is therefore unable to make
decisions (usually occurs when there’s an even amount of directors)
a. SHs can break a board deadlock by amending the Cs bylaws to add/remove a director
2. MBCA remedy for deadlock is judicial dissolution (14.30(a)(2)). Acceptable when:
a. (1) The directors area deadlocked in the management of C affairs, the SHs are unable to break the
deadlock, and irreparable injury to the C is threatened or being suffered, or the business and affairs
of the C can no longer be conducted to the advantage of the SHs generally, because of the deadlock,
OR
b. (2) The SHs are deadlocked in voting power and have failed, for a period that includes at least two
consecutive annual meeting dates, to elect successors to directors whose terms have expired
3. In order to prevent deadlock, SHs usually include shotgun provision in SHs agreement that says an
initiator can offer to buy out a recipient at a fair price, and recipient can decline to be bought out and
instead buy out the initiator. Basically, one of the parties is going to be taken out, which ends the
deadlock.
III. Heightened Fiduciary Duties
A. Heightened duty of utmost good faith and loyalty is more rigorous than fiduciary duties owed by
controlling SHs to minority SHs and only applies to SHs of a close C.
1. DE DOES NOT APPLY THIS RULE TO SHs IN CLOSELY HELD Cs (it can, but it has not)
B. Close C is typified by [Donahue]:
1. A small number of SHs
2. No ready market for the corporate stock, and
3. Substantial majority SH participation in the management, direction, and operations of the C
C. When minority SHs in a close C bring suit against the majority for breach of strict good faith duty, courts
asks [Wilkes]:
1. (1) Whether the controlling group can demonstrate a legit business purpose for its action, and if they
can then...
2. (2) Can minority show that same legit objective could have been achieved through an alternative
course of action less harmful to the minority’s interest?
IV. Buy-Sell Agreements
A. General
1. Buy-sell agreements are standard among closely held Cs where all SHs participate in the business.
They:
a. (1) Restrict an owner’s rights to transfer shares, and
b. (2) Specify how shares are to be transferred following a SHs death, disability, etc.
2. Customary with closely held Cs because they allow SHs to control who they co-own with
3. SHs usually enter into buy-sell agreement at the same time or shortly after the C is incorporated;
usually fair because SH doesn’t know if he will be the buyer or seller at the time of agreement
B. Blanket Prohibition on Transfers
1. “No SH may transfer any shares except as permitted under this Agreement. Any purported transfer of
shares in violation of this Agreement is void.”
C. Right of First Refusal or First Offer
1. Buy-sell agreement usually allows for transfers in compliance with a right of first refusal or first offer in
the C or its SHs
2. Right of first refusal requires a SH who has found a 3d party to buy some or all of his shares to the C or
its other SHs on the same terms the 3d party has agreed to
38
3. Right of first offer allows a selling SH to offer his shares to the C or other SHs on terms determined by
the selling SH. If the offer is not accepted, the selling SH may then sell the shares to a 3d party on terms
no better than those offered to the right holders.
D. Obligations to Sell & Buy
1. Obligations to buy and sell are set off by a particular triggering event
2. Triggering events usually include death, disability, or termination of employment with the C
3. Three most common ways to handle price:
a. Appraised price – agreement provides that the price will be determined by an appraiser
b. Stipulated price – agreement requires the SHs to periodically agree on a value for the Cs shares
c. Formula price – agreement specifies a formula to be used to determine the price
4. If C obligated to buy out a SH upon his death or disability, it will often purchase life and disability
insurance on each SH to fund the obligation
PUBLIC COMPANY REGULATION
I. Disclosure Requirements
A. General
1. A public company is subject to additional regulation under federal securities laws, primarily Securities
Exchange Act of 1934
2. Three most prominent set of rules:
a. Disclosure requirements
b. Proxy voting regulations
c. Corporate governance listing standards
3. A company is required to register securities under the Exchange Act if:
a. The securities are listed on a national securities exchange
b. The company has $10M or more in total assets and a class of equity securities held of record by:
● 2,000 or more persons, or
● 500 or more persons who are not accredited investors
B. Annual Report
1. Contents of the annual report is dictated by the 10-K form
2. 10-K must include company’s business, risk factors, audited financial statements for the fiscal year,
management’s discussion and analysis (MD&A) of the issuer’s financial condition and results of
operation for the fiscal year, and info concerning executive compensation
3. The due date for a company’s 10-K depends on the company’s “filer” status
a. “Large accelerated filer” is due 60 days after fiscal year end
b. “Accelerated filer” is due 75 days after fiscal year end
c. All other companies due 90 days after fiscal year end
4. Large accelerated filer – company with an aggregate worldwide market value of voting and non-voting
common equity held to by its non-affiliates of $700M or more
5. Accelerated filer – company with an aggregate worldwide market value of voting and non-voting
common equity held by its non-affiliates of $75M or more, but less than $700M
6. Non-accelerated filer – everyone else
C. Quarterly Report
1. A public company is required to file quarterly reports after the end of each of its first three quarters of
every fiscal year
2. Contents are dictated by the 10-Q and includes or incorporates by reference unaudited quarterly
financial statements and MD&A with respect to quarterly results
3. 10-Q due date is 40 days after fiscal quarter end for large accelerated/accelerated filers, and 45 days
for all others
D. Current Reports
1. A public company is required to file a current report generally within four business days after the
occurrence of various events
2. Triggering events, which prompt a company to file current reports, are dictated by the 8-K and include:
39
a.
b.
c.
d.
Entering into or terminating a material definitive agreement
Entering into bankruptcy or receivership
Completing an acquisition or disposition of assets
Creating a direct financial obligation or an obligation under an off-balance sheet arrangement of a
company
e. Receiving of notice of delisting or failure to satisfy continued listing standards
f. Selling equity securities in a transaction not registered under the Securities Act, etc.
E. SOX Act of 2002
1. Purpose: protect investors by improving the accuracy and reliability of corporate disclosures made
pursuant to the securities laws
2. Most infamous provision is 404 because compliance is costly ($1.66 per accelerated filer). As a result,
Dodd-Frank exempted non-accelerated filers from compliance
3. 404(a) – directed the SEC to adopt rules requiring firms’ 10-Ks to include an internal control report
that states the responsibility of management for establishing and maintaining an adequate internal
control structure and procedures for financial reporting and contains an assessment of the
effectiveness of the internal control structure and procedures of the issuer for financial reporting.
4. 404(b) – requires firms’ auditors to attest to, and report on, the assessment made by the management
of the issuer
5. 409 – discusses timing of disclosure for public companies
6. 302 – requires senior officers to verify they’ve reviewed the report and that it is accurate
7. 906 – requires CFO and CEO to certify reports are accurate; imposes $1M fine and up to 10 years jail
time for false certification; $10M fine and up to 20 years jail time for willfully and knowingly false
certification
F. Section 10(b) and Rule 10b-5
1. General
a. A company faces potential liability under 10(b)/10b-5 if its Exchange Act reports or other info it
releases to the marketplace are not accurate and complete
b. This applies to reports and any public statements made by company (tweets, blogs, press releases,
etc.)
c. Applies to misstatements and omission by both public and private companies
d. Government and private actors can bring COA under these provisions; private actors usually class
actions
e. Establishes COA that includes:
● (1) A material misrepresentation (or omission)
o A fact is material if there is a substantial likelihood that a reasonable investor would
consider it important in making an investment decision
o An omitted fact is material if there is a substantial likelihood that the disclosure of the
omitted fact would have been viewed by the reasonable investor as having significantly
altered the total mix of info made available
o For speculative info/events, materiality will depend 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 activity. Fact finder will need to look to
indicia of interest in the transaction at the highest corporate levels [Basic].
▪ Ex for indicated probability – board resolutions, instructions to investment bankers,
actual negotiations between principals or their intermediaries
▪ Ex for anticipated magnitude – size of the two corporate entities, potential premiums
over market value
o Silence, absent a duty to disclose, is not necessarily misleading. “No comment” = silence.
● (2) Scienter, that is, a wrongful state of mind
o P must prove that D made the misstatement or omission with scienter
o Scienter – mental state embracing intent to deceive, manipulate, or defraud
o Lower courts include recklessness, but SC hasn’t confirmed.
40
Recklessness – a highly unreasonable misstatement or omission, involving not merely
simple, or even inexcusable negligence, but an extreme departure from the standards of
ordinary care, and which presents a danger of misleading buyers or sellers that is either
known to the D or is so obvious that the actor must have been aware of it
o P has to plead with particularity facts giving rise to a strong inference that the D acted with
the required state of mind that is scienter
▪ Strong inference – inference of scienter must be more than merely plausible or
reasonable, it must be cogent and at least as compelling as any opposing inference of
non-fraudulent intent
● (3) A connection with the purchase or sale of a security
o “In connection with” includes misleading statements that were made in a manner
reasonably calculated to influence the investing public
o Statements don’t have to be made directly to investors as long as they were disseminated in
a medium upon which a reasonable investor would rely
o Applies to reports and public statements
● (4) Reliance, often referred to in cases involving public securities markets (fraud on the
market causes) as transaction causation
o P must prove reliance, which requires that the material misstatement or omission of D was
a substantial factor in causing Ps purchase or sale of a security
o In 10(b)/10b-5 suit against public company, reliance often presumed under fraud on the
market theory
▪ Fraud on the market theory – in an open and developed securities market, the price of a
company’s stock is determined by the available material info regarding the company
and its business. Misleading statements will therefore defraud purchasers of stock even
if the purchasers do not directly rely on the misstatements...the causal connection
between the Ds’ fraud and the Ps’ purchase of stock in such a case is no less significant
than in a case of direct reliance on misrepresentations [Basic].
▪ Ask: did fraud influence the market price?
i. If yes presumption of reliance
ii. If no no reliance
● (5) Economic loss, and
o P has to prove actual economic loss as a result of the fraud
● (6) Loss causation, that is, a causal connection between the material misrepresentation
and the loss
o P must prove loss causation, meaning that the economic harm that it suffered occurred as a
result of the alleged misrepresentations and that the damage suffered was a foreseeable
consequence of the misrepresentation
II. Shareholder Proposals
A. SEC rules require public companies to include in their proxy materials those SH proposals that meet certain
qualifications. This is under rule 14a-8, and includes both procedural and substantive requirements.
B. To be eligible to submit a proposal, the proponent must have continually held a minimum of $2K or 1% of
the Cs stock during the preceding year. Proposal is limited to 500 words, and usually must be submitted at
least 4 months prior to the anniversary of the mailing date of the previous year’s proxy materials.
C. If SH submits a proposal in accordance with rules, company must include the proposal in its proxy
materials unless it is properly excludable for the substantive reasons listed in 14a-8(i). Before excluding,
company must file reason no later than 80 calendar days before it files proxy statement.
1. 14a-8(i)(7) permits exclusion of a proposal if it deals with a matter relating to the company’s ordinary
business operations, which includes certain matters which have significant policy, economic, or other
implications inherent in them.
III. Say-on-Pay
A. Imposed by Dodd-Frank
B. This section requires all companies subject to SEC proxy rules to hold a SH advisory vote on:
▪
41
1. The compensation of the companies’ most highly compensated exec officers (“say on pay” vote)
2. Frequency of say on pay votes (annual/bi/tri), and
3. Certain golden parachute compensation arrangements
IV. Public Company Director Elections
A. General
1. Generally not possible for a SH to use the Cs proxy card to instruct the proxy to vote for someone other
than a nominee listed on the card
2. Plurality standard – candidates that receive largest number of votes wins
3. SEC proxy regs require that the proxy card contain a box SH can check to withhold authority to vote for
a particular nominee, or, if given the effect under applicable state laws, to vote against a particular
nominee. This communicates dissatisfaction.
4. Proxy contest very rare because it costs insurgent $5-10M out of own pocket
5. Incumbent v. insurgent (READ PG. 609–11)
6. Two proposals to make director elections more meaningful: majority voting and allowing SHs to
include nominees to Cs proxy materials
B. Majority Voting
1. Many companies have adopted majority voting via bylaw provisions
2. Holdover rule – provides that a director remains in office until his successor is elected. Practical effect
is that an incumbent director who does not receive the requisite majority vote in an uncontested
election would nonetheless remain on the board since no successor will have been elected. Some
companies, like Yahoo!, have each director provide letter of resignation that takes effect if there’s a
failure for an incumbent to get a vote (141(b), 8.07(b))
C. Proxy Access
1. Shorthand for allowing SHs to include direct nominees in Cs proxy materials
2. Rule 14a-11
a. Required public companies to include board candidates nominated by SHs BUT this was vacated
because it violated Admin Procedure Act
3. Access Bylaws
a. SHs have the power to unilaterally amend a Cs bylaws, so they try to use this power to implement
proxy access bylaw provisions via 14a-8 SH proposals (109(a), 10.20(a))
V. Corporate Governance Listing Standards
A. NYSE Requirements
1. Independent directors – meaning board must affirmatively determine that the director has no material
relationship with the listed company (either directly or as a partner, SH, or officer of an organization
that has a relationship with the company).
2. Director is NOT independent if:
a. Director is, or has been in the past 3 years, employee of the listed company or if immediate family
member is or has been exec officer of company within past 3 years
b. Director or immediate family member received more than $120K in direct compensation, other
than director/committee fees and pension or other deferred compensation
c. Director is current partner/employee of firm that is company’s internal/external auditor; same but
immediate family members; same but director/immediate family member is, or has been within the
past 3 years
d. Director/immediate family member is, or has been within the past 3 years, employed as an exec
officer of another company where any of the listed company’s present exec officers at the same time
serves/d on that company’s compensation committee
e. Director is current employee, or immediate family member is current exec officer, of a company
that has made payments to, or received payments from, the listed company for property or services
in an amount which, in any of the last 3 fiscal years, exceeds the greater of $1M or 2% of such other
company’s gross revenue
42
3. Executive Sessions – board must hold regular exec sessions of its non-management directors without
management present. Should also hold at least one exec session/year limited solely to independent
directors.
4. Nominating/Corporate Governance Committee – must be comprised entirely of independent directors
5. Compensation Committee – must have a compensation committee comprised entirely of independent
directors
6. Audit Committee – must have an audit committee comprised entirely of directors that meet the
definition of independence according to the NYSE and Exchange Act Rule
7. Corporate Governance Guidelines – must adopt and disclose corporate guidelines that address:
a. Director qualifications
b. Director responsibilities
c. Director access to management and independent advisors
d. Director compensation
e. Director orientation and continuing education
f. Management succession
g. Annual board performance evaluation
8. Code of Business Conduct & Ethics – must adopt and disclose code of business conduct and ethics for
directors, officers, and employees, and promptly disclose any waivers of the code for directors/exec
officers. Code should include:
a. Conflicts of interest
b. Corporate opportunities
c. Confidentiality
d. Fair dealing
e. Protection and proper use of listed company assets
f. Compliance with laws, rules, and regulation
g. Encouraging the reporting of any illegal or unethical
VI. Insider Trading – “uniquely in the know before it becomes publicly disseminated”
A. Classical Theory
1. Prohibits trading on the basis of:
a. Material
b. Nonpublic info
c. In violation of a duty to disclose arising from a relationship of trust and confidence
● Relationship of trust and confidence exists between the SHs of a C and those insiders who have
obtained info by reason of their positions with that C
d. Between the trader and those with whom he traded
2. Actual insider
a. Person whom obtains nonpublic info concerning a company as a result of his position as an
officer/director/employee/agent of the company
3. Constructive insider
a. Person whom obtains nonpublic info concerning a company as a result of a temporary association
with the company with an expectation by the company that the person will keep the disclosed info
confidential
B. Misappropriation Theory
1. Prohibits trading on the basis of [Hagan]:
a. Material
b. Nonpublic info
c. Obtained in breach of a duty of trust or confidence
d. Owed by the trader to the info source
2. Key issue in applying the misappropriation theory is determining the circumstances that give rise to a
duty of trust or confidence
3. Rule 10b5-2 provides that a duty of trust or confidence exists under the following circumstances:
a. When a person agrees to maintain info in confidence
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b. When parties have a history, pattern, or practice of sharing confidences, or
c. When a person receives material nonpublic info from a spouse, parent, child, or sibling
C. Rule 14e-3
1. Prohibits a person from trading while in possession of:
a. Material
b. Nonpublic info
c. Concerning a tender offer
2. Tender offer
a. One of several methods by which a bidder can acquire a publicly traded company (the target)
3. How It Works
a. A bidder offers to buy out target’s SHs, typically at premium. Someone who knows about those
plans before they are publicly disclosed can buy at a low price and then turn around and sell at a
higher price.
b. Unlike classical and misappropriation, 14e-3 applies even if the trader did not breach a fiduciary
duty or other relationship of trust or confidence when trading. However, the rule only applies if
TENDER offer was involved.
● So, if structured as merger or asset purchase, TENDER DOESN’T APPLY
D. Tipper/Tippee Liability
1. Tipper – person who DISCLOSES material, nonpublic info to another individual
2. Tippee – person who TRADES on the basis of the tip
3. Both may be liable under classical, misappropriation, or 14e-3
4. Under Classical, both are liable if:
a. Tipper passed material nonpublic info concerning a company in which tipper is an insider in breach
of fiduciary duty owed by tipper to the company, and
b. Tippee knew or had reason to know of tippers breach of duty
● Breach of duty exists only if tipper personally benefited, directly or indirectly, from disclosing
the info to tippee
o Personal benefit can be feeling good, boost of confidence
5. Under Misappropriation, both are liable if:
a. Tipper passes material nonpublic info concerning a company in breach of a fiduciary duty owed by
tipper to the info source, and
b. Tippee knew or had reason to know of tipper’s breach of duty
● Most courts require personal benefit, but some don’t
6. NEW (applies to Classical & Misappropriation) – Newman (2d Cir. case) says that tippee must
know of the personal benefit received by tipper and must be of some consequence (not just
reputation); some type of quid pro quo
7. Rule 14e-3 expressly prohibits a person from passing a tip relating to a tender offer under
circumstances in which it is reasonably foreseeable that the person receiving the tip will trade on the
info. Hence:
a. Tippee will be liable under 14e-3(a) for trading while in possession of material nonpublic info
concerning a tender offer, and
b. Tipper will be liable under (c) for passing the tip
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