CORPORATIONS OUTLINE FALL 2020
Table of Contents
Rules Sheets (DGCL, SEC, Chancery) ............................................................................................................. 3
Delaware General Corporate Laws ........................................................................................................................................ 3
SEC rules ........................................................................................................................................................................................... 7
Chancery Rules............................................................................................................................................................................... 9
Part 1. Foundations ............................................................................................................................................ 9
1.1 Corporations & Incorporation ............................................................................................................................ 9
Pizza shop exercise .................................................................................................................................................................... 11
1.2 Agency ........................................................................................................................................................................12
1.3 Investment Decisions and IPOs ........................................................................................................................13
Investment Paths ........................................................................................................................................................................ 14
Capital Structure ......................................................................................................................................................................... 15
Valuation ........................................................................................................................................................................................ 16
Essential Takeaways ....................................................................................................................................................17
Part 2: Voting..................................................................................................................................................... 17
Shareholder Voting ......................................................................................................................................................17
Director Elections .........................................................................................................................................................19
SH Proposals and Voting on Other Matters .........................................................................................................20
Federal Proxy Rules for Public Corps ....................................................................................................................21
SH Voting Disputes in Court ......................................................................................................................................21
PPI Exercise (Good DGCL Review) ..........................................................................................................................22
FedEx Exercise ...............................................................................................................................................................23
Contested Elections (Blasius and Schnell) ...........................................................................................................24
Blasius Industries, Inc. v. Atlas Corp. (1988)................................................................................................................... 24
Schnell v. Chris-Craft Industries (1971) ............................................................................................................................ 25
Hedge Fund Activism and Virtusa Pt. 1.............................................................................................................................. 26
Part 3: Fiduciary Duties & Litigation ........................................................................................................ 26
Master Fid Duties Table (w/ Mergers) ..................................................................................................................27
Main Fiduciary Duties .................................................................................................................................................27
Standards of Review ....................................................................................................................................................29
Cleansing ..........................................................................................................................................................................30
Duty of loyalty .............................................................................................................................................................................. 31
Guth v. Loft [Pepsi Case] (1939) ........................................................................................................................................... 32
Mikhail Conflict of Interest Exercises ................................................................................................................................. 32
Duty of care ................................................................................................................................................................................... 33
Smith v. Van Gorkom (1985).................................................................................................................................................. 34
In Re Walt Disney Co. Derivative Litigation (2006) ..................................................................................................... 35
Shareholder Litigation ................................................................................................................................................37
Demand Futility Test ................................................................................................................................................................. 38
Special Litigation Committees ............................................................................................................................................... 40
Common Fund Doctrine ........................................................................................................................................................... 40
Indemnification and insurance ............................................................................................................................................. 41
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Part 4: M&A ........................................................................................................................................................ 46
Introduction to M&A ....................................................................................................................................................46
Ways to Merge ................................................................................................................................................................47
Asset acquisition ......................................................................................................................................................................... 47
Acquiring shares of T, tender offers .................................................................................................................................... 48
Merging Corps .............................................................................................................................................................................. 49
Appraisal......................................................................................................................................................................................... 50
Mixing and Matching Transx Types .................................................................................................................................... 51
Controlling Shareholders in M&A ...........................................................................................................................51
Squeeze-Outs ................................................................................................................................................................................ 52
Weinberger v. UOP, Inc. (1983): ........................................................................................................................................... 53
MFW - Kahn v. #MFW (2014):............................................................................................................................................... 54
Sales of Control ............................................................................................................................................................................ 55
Hostile Mergers and Takeover Defenses ..............................................................................................................56
Unocal v. Mesa Petroleum ....................................................................................................................................................... 58
Moran v. Household (1985).................................................................................................................................................... 60
Revlon v. MacAndrews & Forbes Holdings (1986):...................................................................................................... 61
Merger Litigation and Virtusa................................................................................................................................................ 64
Consolidation (Van Gorkom and Ebay) .................................................................................................................65
Smith v. Van Gorkom ................................................................................................................................................................. 65
Ebay v. Newmark ........................................................................................................................................................................ 66
Part 5: Securities Law ..................................................................................................................................... 69
Antifraud Rules: Rule 10b-5 ......................................................................................................................................69
Basic Inc. v. Levinson (1988): ................................................................................................................................................ 71
Wells Fargo Pt. 2 and In Re Signet Jewelers..................................................................................................................... 72
Insider Trading ..............................................................................................................................................................72
Part 5: Non-Shareholder Constituencies ................................................................................................. 77
Civil and Criminal Enforcement (Wells Fargo/Cranston/Purdue Pharma) ............................................77
Debt-Equity Conflicts ...................................................................................................................................................79
Creditor Protection .................................................................................................................................................................... 79
Mechanics and Debt Overhang .............................................................................................................................................. 81
Renegotiation ............................................................................................................................................................................... 82
LBOs (Metlife) ................................................................................................................................................................83
Part 6: Structure of corporate law ............................................................................................................. 86
ESG and SH Primacy .....................................................................................................................................................86
Alternative Entities ......................................................................................................................................................86
Choice of Law ..................................................................................................................................................................88
Contractarian Theorem ............................................................................................................................................................ 89
CTS v. Dynamics (1987): .......................................................................................................................................................... 89
VantagePoint v. Examen (DE 2005): ................................................................................................................................... 90
Course Summary .............................................................................................................................................. 90
2
Rules Sheets (DGCL, SEC, Chancery)
Delaware General Corporate Laws
Charters
 101(a): every corp must have charter governed by 103
 101(b): any lawful business or purpose
 102(a): mandatory elements of charter (but very little is mandatory)
o Name of corp
o Number of authorized shares
o Names of first directors
o Name of first incorporators
 102(b)(1): general enabling clause, charter can deviate from default rules with provisions not
contrary to laws of the state (contractual freedom)
o Note this transforms all other specific enabling clauses into implicit restrictions
 102(b)(2to6): court-approve compromise, preemptive rights, supermajority, duration, prnl liablty
 102(b)(7): Allows charter to eliminate or limit director personal liability for monetary damages
for breaches of fiduciary duty by director or SHs (not officers), except
o Breaches of duty of loyalty
o Bad faith, intentional misconduct, or knowing legal violation
o Illegal dividends (DGCL 173/174)
o Any transaction where director derived improper personal benefit
 102(f): Cannot fee-shift via charter to shareholders or any other party for attorneys’
fees/expenses for DGCL 115 internal claim
 109: charter can grant bylaw adoption power to the directors (shareholders always have it).
Legally unclear if directors alone can repeal shareholder-approved bylaws
 115: forum selection — charter or bylaws can require internal corporate claims to be brought
only in DE (includes fiduciary violations). Cannot prohibit suits from being brought in DE
 141(a)(d)(k)
o A: Board manages “business and affairs”
o D: Staggered board is allowed, up to 3 classes
o K: shareholder majority can remove director without cause by vote at director election
 Unless staggered board, then removal must be for cause
 And cumulative voting rules apply, if enough vote against removal without cause
 211(a)(d)
o A: hold meeting anywhere, even remote, and can have remote communication
o D: special meetings of SH can be called by board, or others (SHs) authorized by charter
or bylaws to call special meetings
 228(a): signed consent
o Unless charter eliminates right, then SHs can act without meeting by signed consent
 242: charter amendments — to do a charter amendment, requires:
o Board resolution
o Majority of outstanding stock (not majority present)
o Majority of each stock class entitled to a class vote if
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The amendment would change the par value of such class, the number of shares
of such class, or “the powers, preferences, or special rights of the shares of such
class so as to affect them adversely”
Amendment filing
Changing rights by charter
 Rules that can be changed by charter:
o Distribution of votes
o Quorum
o Majority requirement in votes other than director elections
o Majority requirement in director elections
 Shareholder rights that CAN be changed by charter:
o Transfer shares (can also be changed by bylaws) (DGCL 202)
o Redeem shares
o Regular dividends
o Include candidates in corporation's proxy
o Equal dividends among a share class
o Default quorum of shareholders (but not below 1/3)
 But board can’t amend SH bylaw that specifies votes necessary to vote for
electors
o Majority requirement
o Shareholder ability to call special meeting (default: no)
o Shareholder ability to act by written consent i.e. do whatever they could’ve done at a
shareholder meeting (DGCL 228)
 Most charters exclude this
 Can’t do 203 via written consent
o Shareholder ability to appoint a corporate officer
 Shareholder rights that CANNOT be changed by charter:
o Power to include valid bylaw proposals in proxy
o Right of shareholders in a class are identical (DGCL 151(f))
o Rights of shareholders to amend bylaws (DGCL 109)
o Right of shareholders to elect the board
 Shareholder rights UNCLEAR if can be changed by charter:
o Assert a claim in litigation
o Inspect books and records
o Attend board meetings
 Director rules that can be changed by charter:
o Management powers of the directors
o Electorate of the directors
o Removal conditions of the directors
Bylaws
 Shareholders have power to adopt/amend/repeal bylaws, and charter can also let board do so.
Initial directors can also adopt bylaws. Bylaws can’t impose liability on a shareholder for
attorney’s fees related to derivative suits. (109)
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Access to proxy solicitation materials — can require from nominating shareholders: minimum
stock ownership, submission of specific info, indemnify for false statements. Bylaws can
preclude nomination by someone if they’ve acquired a certain percentage of shares. (112)
Bylaws can require and set limits on reimbursement for expenses incurred connected to proxy
solicitations (113)
Forum selection — charter or bylaws can require internal corporate claims to be brought only in
DE (includes fiduciary violations). Cannot prohibit suits from being brought in DE (115)
Bylaws control how many board seats of total allowable by charter are actually seated (Blasius)
o It’s a vulnerability to have fewer seated than allowable, as shown by Blasius
Stock
 151(a): types/rights of stock — corporation may issue stock as described in charter, or in board
resolution dependent on charter
o Allows corporations to set different voting rights for different classes of shares
 151(b): redemption — stock can be made redeemable at either corporation or shareholder’s
option or by triggering event
Shareholder powers
 Companies are owned by shareholders who elect the board and vote on charter amendments at
annual meetings (211(b))
 Shareholders can enact bylaw amendments (109)
 Shares are freely transferable
 Shareholders have a right of information to the books and records of the company as well as any
legally-required disclosures (220)
 A majority of shareholders can amend the bylaws by proxy (SEC § 14-8)
 Quorum at a shareholder meeting is 50% (216)
 Shareholders can vote or by written consent of a majority of outstanding shares (228)
 Shareholders elect board members and remove board members
 Shareholder resolution requires 50% to pass
Board powers
 The board controls the company’s daily affairs/primary management authority (141(a))
 Board composition is set in charter or bylaws (141(b))
 Default quorum = 1/2; charter or bylaws can change, but not down to less than 1/3 (141(b))
 Default is entire board is elected for 1-year term; but can stagger board (141(d))
 Fireable with or without cause (141(k)), unless staggered (only cause)
 Corporation can own its own stock, but can’t redeem for more than redemption price, and is
limited by 151(b) and charter (160)
 Have the power to issue all stock provided for in the charter (161)
 Have the power to declare dividends (170)
 Current directors can appoint new directors (223) and can use company funds to run their
reelection campaign
 Directors are subject to a shareholder vote (216). Can be single votes or cumulative voting
(where shareholders get a vote for each seat per share and can use them for one candidate). eBay
 Must hold an annual meeting for shareholders (211)
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Board can call a special meeting by resolution (211)
o Can by resolution give shareholders notice of a meeting 10-60 days before meeting (213)
o Board can choose date 0-10 days before resolution to determine number of shareholders
required for written consent (213)
Directors and managers owe a duty of care and a duty of loyalty to the corporation and its
shareholders
Decision-making power (defaults)
Board
Shareholders
Special meeting
X
Business decisions (141a)
X
Charter Amendment (242)
Need shareholder approval
Need board to initiate
X (if provided for in charter)
X
Bylaw amendment (109)
Stock issuance (161)
X
Dividend declaration (170)
X
X (if in charter, 211d)
Merger (251(c))
(both need to approve)
(both need to approve, unless
251(f) or 253 are satisfied)
Asset sale (271)
X
X
(both need to approve)
(both need to approve)
Dissolution
Shared powers
 Both board and shareholders approve charter amendments (242(b))
 Both approve mergers, except:
o For surviving corporation: no need for shareholder vote if charter unaffected, no more
than 20% of common stock outstanding is to be issued (251(f))
o Short form merger (253)
o Tender + squeeze out (251(h))
 Dissolution (275) — majority of board can adopt dissolution resolution for shareholder vote, and
if majority of shareholders vote for dissolution, the corporation files for certificate of dissolution
Mergers
 262(b): appraisal rights are available for shareholders of both companies merging
o Exceptions:
 262(b)(2): No appraisal rights for a publicly traded company or a merger done
under 251(f) if the merger consideration is either:
 Stock in a company (1) listed on a national securities exchange or (2) held
by more than 2,000 SH, OR
 Stock in surviving company
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262(b)(3): in a short-form merger under 251(h) or 253, appraisal rights aren’t
available for surviving corporation’s shareholders (only subsidiary)
262(d): To get appraisal, shareholder can’t vote in favor of merger, must deliver notice of
objection before the vote, and must hold the shares through the merger
262(h): Court can do appraisal
SEC rules
Proxy
 Send proxy to SEC to get approved
 Get SEC approval
 Get addresses from corporation, and send out proxies, or corporation mails out the proxies for
you (14a-7)
o If corporation mails out proxies for you, you have to reimburse them
o Have to reimburse the corporations for expenses incurred in giving you the list
 Then they send their proxy into the corporation ahead of the shareholder meeting
 NB: if it’s a written consent, you get it mailed back to you and then you deliver it to the
corporation
14a-1: Definitions
 Solicitation
o What solicitation is:
 Any request for a proxy, whether or not accompanied by or in a proxy
 Any request to execute or not to execute or to revoke a proxy
 Furnishing of a form of proxy to security holders under circumstances reasonably
calculated to result in procurement, withholding or revocation of proxy
o What solicitation is not:
 Giving someone a proxy if they make an unsolicited request for one
 Rule 14-7 required acts (corporation giving the shareholder list to the proxy
solicitor)
 A communication by someone who doesn’t make a proxy solicitation (other
than 14-2 exempt solicitations) saying how he intends to vote if:
 The speech is public (public forums, press releases, advertisements); or
 Is directed to people whom the person owes a fiduciary duty in connection
with the voting of securities that the person has; or
 Is made in response to unsolicited requests for additional information
under this paragraph
14a-2: Applicability
 Rules apply to every proxy solicitation regarding registered securities, except
o Forwarding of proxy materials, solicitation by beneficial owner, or newspaper
advertisements about where they may get a proxy and only state 1) the issuer of the
security, 2) the reason for the advertisement and 3) the proposal(s) to be acted upon
 SEC 14a-6(g), 14a-7, and 14a-9 apply to:
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o Any solicitation that does not seek the power to act as proxy on its own or another behalf,
except:
 The issuer of the security
 D/Os of the issuer when financed direct or indirectly by the issuer
 Director nominees
 Anyone proposing or intending to prose an alternative transaction in opposition to
a merger, recapitalization, sale of assets recommended or approve by the board
 Anyone required to report ownership on Schedule 13D, unless they have no intent
to contest the election of directors
o Any solicitation made on behalf of anyone except the issuer where 10 or fewer people
were solicited
14a-6: Notices of 14-2(b)(1) Exempt Solicitation
 Anyone who uses a 14-2(b)(1) exemption and owns >$5 billion in securities of the solicited class
must mail to the SEC and any national exchange where the securities are listed, a Notice of
Exempt Solicitation, unless the solicitation is an oral solicitation (other than scripts), speech in a
public forum, or advertisements
14a-7: Issuers making proxy solicitations
 14a-7(a): issuers that has made or intends to make a proxy solicitation must provide a list of all
security holders, or mail materials, for any voting security holder who request so in writing.
o Company can also decide to mail materials out for you
 14a-7(e): security holder shall reimburse expenses incurred by the registrant in mailing the proxy
information out
14a-8: Shareholder proposals on proxy card
 Can make shareholder proposals if holding at least $2000 in market value or 1% for at least one
year
 No more than one proposal per meeting
 Deadline is set by the corporation, but you have to submit your proxy statement proposal to the
company 120 days before the proxy statement is released to the corporation
 Proposals can be excluded for
o Improper under state law (e.g. binding on company if approved by shareholders)
o Violation of law
o Violation of proxy rules
o Personal grievance
o Irrelevant to company business (< 5% of assets and <5% earnings and <5% of gross
sales)
o Absence of corporate power to deal with the issue
o Ordinary business operations
o Director elections
o Conflicts with company’s proposal
 Unamendable by charter
14a-9: No false or misleading statements
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No solicitation shall contain any statement that’s false or misleading with respect to any material
fact, or which omits to state any material fact necessary in order to make the statements therein
not false or misleading.
o Examples: (1) Predictions as to specific future market values, (2) Material which directly
or indirectly impugns character, integrity or personal reputation, or directly or indirectly
makes charges concerning improper, illegal or immoral conduct or associations, without
factual foundation. (3) Failure to so identify a proxy statement, form of proxy and other
soliciting material as to clearly distinguish it from the soliciting material of any other
person or persons soliciting for the same meeting or subject matter. (4) Claims made
prior to a meeting regarding the results of a solicitation
14a-11: Proxy access for director elections
Chancery Rules
Chancery Rule 23.1 Right to sue derivatively
 (a) Must allege:
o Plaintiff was shareholder at time of transaction complained of
o Plaintiff made effort to have directors pursue the action
 Must make "demand" or allege facts that such a demand would be "futile"
 "Particularized" facts that lead to futility: facts that create reasonable doubt that
 Majority of directors are disinterested and independent AND
 The challenged transaction was otherwise the product of a valid exercise
of business judgment
 Example: Aronson v. Lewis: allegations of 47% stock ownership + selection of
board members insufficient to create reasonable doubt of futility (but plaintiffs
didn’t want to make the demand, because that would concede that the board was
independent)
o Reasons for failure of efforts
 (b) Class representative must assert that he's not receiving any fees besides
o Those expressly approved by the court
o Reimbursement for expenses by such plaintiff's attorneys
 (c) Cannot dismiss w/o court approval, and notice must be given to other shareholders
o No notice necessary if there's no prejudice or prejudice only w/r/t plaintiff + no payment
or promise of payment passed between plaintiff/defendants
Part 1. Foundations
1.1 Corporations & Incorporation
What are corps?
 Contracting technology
o Common party to contracts
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o Pool/separates assets
Not a person
Not a business
Subject to governance
By agents
What is corp law?
 Governs relationships btw diff people in corp
 Internal affairs doctrine = law of state incorporation governs affairs internal to corp (tricky line)
 Governing docs
o Charter
o By-laws
o Shareholder agreement (in private company)
Characteristics of corporations
 Grouping legal contracts (contracting tech)
o want to prevent leakage so money going into corporation comes out of it
 Indefinite life
 Limited liability (corp liability doesn’t extend to person)
o Pros:
 Shareholder liability would deter wealthy investors
 Attractive for investors b/c can realize whole upside, and no downside
o Cons:
 But distorts shareholders’ incentives because they benefit from upside, but don’t
bear downside (could have liability proportional to # of shares held?)
 Shareholders could act to prevent companies from committing torts
o Bad for tort claims, good for contract claims
 Tort claims: never consented to waiving liability, but you’re forced to agree
 Contracts claims: can specify anything in the contract
 Contracts creditors can protect self (personal guarantee), but torts creditors can’t
o Limited liability isn’t as important or impermeable as people think
 Empirically, hasn’t actually influenced investor behavior
 Companies (BP) pay for damage regardless of limited liability protections
 Entity shielding (personal liability doesn’t extend to corp)
 Relative independence from shareholders
 Freely transferrable shares
o Complements indefinite life, because reconciles corporation’s need for continuity with
SH need for liquidity
Corporation has agency problems
 Shareholders v. managers, controlling shareholder v. minority, SH v. third parties (i.e. creditors)
 Also have multiple principals (widely held companies)
o Coordination costs
o Collective action problems
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So corporate controls should increase value for everyone
Basic controls = fiduciary duties + shareholder voting + disclosure obligations
Why invest?
 Transfer value through time
o saver puts money in today to get more later
o firm expects more value later, needs financing today
 Pool resources
o Because investment needed far exceeds individual wealth
 Diversification
o Even if could avoid pooling, better to pool to avoid risk
 Amazing that this does work so well in so many parts of world
 Either debt or equity financing
o Debt = loan + interest, legal right to repayment
o Equity = buy in for stake, with possibility of dividends (no right)
Why corporations are better than partnerships
 Facilitate pooling many investors resources — limited liability in a corporation
 Minimize business frictions — no holdout problems b/c can transfer ownership
 Maximize ability to commit — hard to convince people to buy in if they know they’ll be on the
hook for your mistakes
Pizza shop exercise
Litigation view
 First, ask: it a partnership or a corporation?
 If partnership:
o Both L and K get profits, so partnership (not employer/employee relationship)
o Liabilities:
 L and K would own pizza oven themselves, and the bank would have a claim
against them directly
o Dissolution:
 K can dissolve the partnership (UPA 38 says any partner can dissolve and
liquidate the partnership)
o Lease:
 Partners are personally liable if they said “we as partners owe you X”
 If the lease and bank loan are non-recourse, then they’re not liable (contractual
form of limited liability)
 If corporation:
o Liabilities:
 Corporation has limited liability, so L and K aren’t responsible
o Dissolution:
 DGCL 275: to cause dissolution, need majority of shareholders and majority of
board to approve (probably can’t contract around rule b/c don’t want zombie
companies)
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o Lease:
 Limited liability, so not personally liable
 Usually, bank would ask for personal guarantee ahead of time
Steve:
o Liable to wholesaler b/c he had apparent authority (wholesaler thought Steve worked for
the business)
o Liable for accident b/c likely that he was acting in course of his employment (people who
were run over can sue him personally, but he’s likely insolvent)
Transactional view
 Borderline case of whether you can represent Louis and Kelly (but probably can b/c possibility
of a conflict of interest isn’t enough)
 Potential problem: 50/50 voting power, so risk of deadlock
o No real solution to this
o If K got more voting power, could replace board then fire Louis
o One solution = provision allowing one partner to buy out the other  but Louis has no
money, so he can’t bid anything
 If business isn’t profitable, K may want to dissolve; but L may want to keep it going, so
corporation inefficiently continues b/c person running it isn’t bearing any of the cost
 If corporation is losing money but on the brink of success, the bank still may want to shut down
business now; doesn’t care b/c it has a fixed claim (holdup problem)
1.2 Agency
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Can think of much of corporate law as dealing with the agency problem
o Agents having incentives to act in own interest rather than principal interest
o Management – SH
o Proxy – SH
Solutions
o Shareholder Voting (corporate democracy) to pick their agents
o Fiduciary Duties and Shareholder Lawsuits
 Duty of care and duty of loyalty
 SHs have liberal standing to enforce those duties in court
o Selling
 Useful for individual SH, but not solution to bad management
 Just locks in lower price of bad management, doesn’t compensate for damage
 But could allow buyer to amass enough control to fix management
What about board (as one set of agents) overseeing managers (as second set of agents)
o Now standard or even required for most board members to be independent
o But still, quis custodiet ipos custodes (who monitors the monitor)
Controlling SHs
o While controlling SHs help overcome collective action problems
o They can extract disproportionate share of value for selves, harmful to minority
o So DE imposes fid duties on controlling SHs
 Other jurisdictions have super-majority requirements or prohibit some transxs
o Court do factual analysis to see if SH with <50% is practically still controlling
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Agency Law
o RTA is leading source of agency law
o Agency grounded in consent of both parties
o Fiduciary relationship, duties of care, loyalty, and obedience
o Principal responsible to third parties for various acts of agent
Liability in contract
o Depends on if agent acting with authority
o Three types of authority
 Actual (agent reasonably believes based on principal’s conduct) (RTA 2.01)
 Agent reasonable belief created by principal’s actions (RTA 3.01)
 Apparent (3rd party reasonably believes from principal’s conduct) (RTA 2.03)
 3P believes actor authorized, traced principal’s manifestations (RTA 3.03)
 Inherent (exists for protection of 3rd parties harmed by agent)
o If contract without authority
 Ratification - (RTA 4.01), effects of actual authority (RTA 4.02, w/ exceptions)
 Estoppel - contract binding if principal knows third party thinks its binding and
principal causes that belief or doesn’t take steps to fix it (RTA 2.05)
Principal liability for agent’s torts
o no if independent contractor
o yes if employee
o independent contractor vs. employee
 depends on principal’s level of control over agent’s performance of task
 strict liability for employees, no matter how much care principal took
 respondeat superior, vicarious liability
o direct liability
 if principal instructs agent to commit tort, actual authority (RTA 7.03(1))
 if principal ratifies commission of tort (RTA 7.03(1))
 if principal negligent in selecting or supervising agent (RTA 7.03(1)(b))
 if delegated performance of duty to use care to agent who failed (RTA 7.03(1)(c))
o vicarious liability
 if employee in scope of employment (RTA 2.04) (RTA 7.03(2)(a))
 if agent acts with apparent authority (RTA 7.03(2)(b))
o agent personally liable for agent’s tort (RTA 7.01)
 but usually don’t have money anyway, judgment proof
When is agent party to contract
o Disclosed principal, 3P knows ID (RTA 1.04(2)(a)) = not party (RTA 6.01)
o Unidentified principal, 3P knows presence not ID (RTA 1.04(2)(b)) = party (RTA 6.02)
o Undisclosed principal, 3P doesn’t know presence (RTA 1.04(2)(c)) = party (RTA 6.03)
From Quiz
o Note Q11: If agent acting with false authority makes contract, they aren’t bound by
contract but are liable for damages
1.3 Investment Decisions and IPOs
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Investors can acquire two types of securities—debt or equity
o Debt (bonds): fixed claim, includes loans; tax-advantaged and have legal enforcement
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o Equity (stock): trending toward two classes; corporation can extinguish by buying back
Securities Market
o Primary market = corp selling own securities to investors, e.g. IPO or seasoned offerings
o Secondary market = subsequent trading from one investor to another
 Doesn’t directly impact corp finance
 but impacts investors’ wealth, provides liquidity
 and corp can anonymously sell into or buy back from secondary market
 allows paying executives in stock, to align incentives
 NB: from corp perspective buy-back = dividend
 Superficial difference is dividend = ends up with same mix cash/stock
 Only real difference is in tax treatment
Disclosure Rules
o “Securities Act” 1933 – initial disclosures mandated for primary market
 Registration statement, usually SEC form S-1
o “Exchange Act” 1934 – ongoing corp disclosures and trading, secondary market
 Applies only to “Registered securities”, so not private companies
 Requires many disclosures on EDGAR
 10K – Annual disclosure of financial situation, very comprehensive
 10Q – Quarterly disclosure of financial situation, less comprehensive
 8K – ad hoc disclosures of certain events, e.g. mergers
 Schedule 14A – proxy statements
 Schedule 14D – tender offers, proposals of other important transxs
 Schedule 13D/G – ownership interests above 5%
 Forms 4, 5, 6 – trades by corp insiders (own > 10%)
 Reg. FD – disclosure of MNPI when giving MNPI to particular parties
Investment Paths
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Retail investing
o Invest through a stock broker, as only the beneficial owner so the broker can also sell the
stocks when you want to sell more easily
Mutual Funds
o Pool investor funds and invest in pre-specified assets
o Fund managed by investment advisor, fund manager
o Funds regulated by Investment Company Act of 1940
o Managers regulated by Investment Advisors Act of 1940
Exchange-Traded Fund
o Like mutual fund, but publicly traded on exchange so anyone canbuy
Index Fund
o Passive managed, sometimes 0% management charge
Pension Plan (defined benefit plan)
o Pay in throughout life, get set amount of money out
o Predominant for public sector employers
Defined Contribution Plan (401(k))
o Special tax treatment for investments
Other institutional investors
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o Family offices (on behalf of very wealthy individuals)
o Endowments
o Sovereign wealth funds
Private Funds
o Venture Capital
 Early stage corps, before public
o Private Equity Funds
 Buy mature companies, reorganize, resell
o Hedge Funds
 Private funds that investment
o Activist Hedge Funds
 Try to profit by changing how company does business
o Merger arbitrage funds
 Specialize in buying equity of corps that have announced to merge
o All private funds have
 Management fee (around 2%)
 Incentive allocation (up to 20% of profits for manager)
Investor Stewardship
o How investors oversee their investments
o Can include engagement, meaning interacting with corp managers
o Can encourage investors to withhold votes (withhold campaign)
o Retail investors
 Basically nothing they can do
o Investment Managers
 Small fees, so small incentive, not very active
o Public pension funds
 Often lead plaintiffs in suits for breach of fiduciary duties
o Proxy advisors
 Institutional Shareholder Services (ISS) and others, sell reports to funds
 ISS report influences 20% of votes cast, so people often engage with ISS
o Activist hedge fund
 Big fees, therefore strong incentive to engage
 So more likely to cause proxy contests
o Private equity
 Big incentive to improve performance of company, engage often
o Venture capital fund
 Huge influence because company not public yet
Capital Structure
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
Boundary btw debt and equity fluid
o Debt can be convertible to equity
o Debt can come with options (warrants if issued by corp) to buy stock at certain price
o Preferred stock resembles
 Equity because no right to payment
 Debt because cash flow rights can be fixed and have priority over common shares
Free exchange between the forms
o Leveraged recapitalization – borrow money to buy back stock
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o Issue stock to pay off debt
o Refinancing – Repay one loan by taking another
Ideal mix minimizes frictions by conflict btw claimants, agency problems
o Ideally, all equity, would do this
 But even equity people have conflict, e.g. founder v. funder, management v. SH,
controlling SH v. minority, etc
 Conflict inherent to investor differentiation, claim differentiation can manage it
o Advantages of debt
 Tax advantage, interest is tax deductible, dividend aren’t
 Less info sensitive – creditors don’t have to do ton of research
 Hard legal claim
 But also cost, in that can lead to costly litigation, bankruptcy, etc
 Hence why volatile businesses and startups rely on equity
Valuation
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Courts sometimes do valuation (e.g. appraisal rights, DGCL 262(h))
Basic principle – investment appealing if value of claim > price of claim
o Positive NPV (net present value) = value – price > 0
DCF = cash flow measure that incorporates premium for risk
o Measure the expected future cash flow. Then discount for time value and risk.
o DCF = Cash Flow / (1 + r + t) ^ y, r = risk, t = time value, y = years
o Firm’s value:
 Ex: firm will either make $0, $100 or $200. Gov’t offers 1% on one-year bond.
Risk premium is 10%.
 Expected future cash flows = 1/3*0 + 1/3*100 + 1/3*200 = 100
 Firm’s value = $100/(1+1%+10%)=$90.09
o Individual claim:
 Shareholder gets whatever’s left after paying creditor
 And because SH only makes money in best possible case, risk premium is higher
 Ex: firm will either make $0, $100 or $200. Gov’t offers 1% on one-year bond.
Risk premium is 10%. Corporation has promised $100 to each creditor
 Expected cash flow for shareholder = 1/3*0 + 1/3*0 + 1/3*100 = $33.33
 Value of claim = $33.33/(1+1%+16.5%)=$28.37
Comparable Analysis = calculate EPS (profits/shares outstanding) for comparable claim
Market Price
o Only reflects public info
o Requires large number of market participants, so doesn’t work for private corp
For multiple cash flows, just do each separately and add together
Policy
 Basic problem is an agency problem  how to ensure agents (managers/directors) act in
furtherance of principals (shareholders)
o Solutions = shareholder voting and fiduciary duties
 Enforcement problems drive corporate law
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o Courts lack requisite information (don’t know what’s best for shareholders or how hard
managers worked)
o Ex: business judgment rule
Essential Takeaways
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Corporation = abstraction, “legal person”
o Key attributes
 Indefinite life but transferable shares
 the two are related, humans are mortal so need liquidity at some point
 centralized management
 related to transferable shares, don’t want management to change every
time SH sells, obstacle to liquidity
 limited liability
 entity shielding
agency problem
o arises any time someone has power to do things that affect others and doesn’t internalize
all its consequences
o inevitable, so need procedures to govern it
 incentives
 elections
 court oversight through fiduciary duties
Contractual relationship
o SH not technically in contract with corp because shares aren’t a contract, but contractual
relationship because it’s voluntarily entered into
o Descriptively: voluntary investment, US law is flexible
o Normatively: why ever intervene and restrict what people can buy or how
o Very few instances where a law is mandatory
Agency Law
o Agent can bind principal if agent has authority
o Apparent authority or estoppel count
o Vicarious liability through respondeat superior tort liability
o Note: directors aren’t legal agents, they don’t sign the contracts etc, officers are agents
Part 2: Voting
Shareholder Voting
Shareholder democracy
 Shareholder voting = shareholder democracy
 Incumbents have advantage  control voting process, and corporation pays for their campaign
Voting rules and frequency
 DGCL 216: Affirmative vote of majority of shares present is required to pass a shareholder
resolution
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DGCL 141(d): board can stagger elections
Meetings
 Types
o Annual meetings (required by DGCL 211(c))
o Special meetings
 Called by directors (DGCL 211(d))
 Called by SHs (not default rule, but can be put in charter, DGCL 211(d))
o Remote Meetings
 Directors can authorize meeting to be held online or by phone (DGCL 211(a))
 Notice
o Corp must give notice to SHs of location, date, time, record date, and purpose (if it’s
special meeting) (DGCL 222)
 Who can vote
o SHs permitted to vote at that meeting is decided by “record date”, which is a date chosen
by board between 10 and 60 days before meeting (DGCL 213)
 I.e. SHs who buy shares after record date but before meeting not eligible to vote,
and SHs who sell after record date but before meeting keep right to vote
 Notice this means that in approving merger, someone can sell out or buy in after
record date and still vote on the deal
 Proxies
o Shareholders vote in person or proxy (power of atty to vote SH’s shares) (DGCL 212(b))
o Proxy holder goes to meeting and votes in specific way (as indicated on proxy card)
 Quorum
o For meeting to be validly held, bust be certain number of shares represented by SHs
present or voting by proxy
o Default quorum in DE is majority of outstanding shares entitled to vote (DGCL 216)
 Written Consent (DGCL 228(a))
o Instead of holding a meeting, SHs send written docs agreeing to take specified action
o If SHs with enough shares send consents, action approved by SH without meeting
o Default rule is need same approval rate as meeting with all SHs (denominator large)
o Used often by small corps with few SHs
o Many corps amend charter to eliminate written consent as hostile takeover defense
 Classes
o One vote per share by default (DGCL 211(a))
o But charter can create classes, which can have different voting rights (DGCL 151(a))
 Usually have same cash flow rights (over dividends and other distributions),
though it’s possible to change that too
 e.g. Facebook’s “dual class” structure to give controlling SH control without
majority of cash flow rights
 to allow controlling SH to sell for own gain
 or to allow corp to issue new shares to raise financing for corp
 big debate over whether this is good for corps and investors
o supporters = genius founders can implement vision without SHs
who don’t understand vision and only care about cash
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o detractors = founder can use control to force decisions that benefit
founder while only bear small part of cost
Director Elections
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
Terms and Removal
o Default = elected annually for one-year terms
 Removal = default without cause removal during term (DGCL 141(k))
o Staggered = three classes (rarely two) with each class up for election every three years
(DGCL §141(d))
 Important to delay takeover attempts
 Note: language says may divide into three classes, implies cannot do more
 Removal = default only with cause removal (DGCL 141(k)(1))
 If cumulative voting, default has particular voting reqs for without cause
removal (DGCL 141(k)(2))
Votes Required for Election
o “vote” vs. “withhold”
 Vote for as many nominees as there are positions
 Or vote for fewer and withhold from the rest
o Default = plurality of “for” votes cast (DGCL 216(3))
 Don’t need majority
 And “withholds” are irrelevant
 Standard scenario = only incumbent board nominates anyone, and they only
nominate as many directors as there are open board seats to be filled
 E.g. if 100 SHs total, 51 present (for quorum), but only 1 vote for each of
three nominees for three positions, they all get elected, even though only 1
vote
 Notice that “withhold” here is actually better for nominees than abstaining from
meeting, because the “withhold” helps establish quorum
o “majority voting” (we saw in FedEx bylaws)
 Some corps have instituted it through charter
 Directors must receive more “for” votes than “withhold” votes, may be required
to resign if they don’t receive
 E.g. if all 100 shares present at meeting, each nominee needs at least 51
“for” votes
 Matters if there’s a “withhold” campaign, and even if it doesn’t break the 50%
mark, it can be a big signal to board
 NOTE: not practically that relevant
 141(b) says that directors serve until successors elected or they resign
o So if incumbent director doesn’t get majority, still on board
o Corps usually have director sign resignation letter in advance
saying they’ll resign if not elected, but for resignation to be
effective board has to accept it, and board will not accept all its
own resignation letters
o So institutional investors were very keen on this in 2000s, but
unclear it matters
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o But emotionally matters, directors care if they don’t get reelected,
looks bad for them
o Cumulative voting (DGCL 214)
 Gives SHs holding a certain minority the right to be represented by a minority of
board members
 E.g. 60 SH vs. 40 SH
 defaults rules = 60 SH wins every time
 cumulative = 60 SH gets two, but 40 SH cumulates to 120 and gets one
 so minority SH holding at least 1/3 of votes able to elect 1/3 of directors
 Formula
 X×N> X×(S-N)/X
 X = Number of board seats up for election
 N = number of shares you own
 S = total number of shares
SH Proposals and Voting on Other Matters
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Fundamental transx, first board proposal, then SH approval
o SHs cannot propose these though
 notable exception = amending bylaws (DGCL 109(a))
o mergers (DGCL 251)
o selling substantially all assets (DGCL 271)
o dissolving company (DGCL 275)
o amending charter (DGCL 242)
o Default = majority of outstanding shares (not just those present at meeting)
 But many charters require higher, often supermajority
Shareholder proposals = SH rights to request things to be put to vote
o Mandatory proposal = require the company to take certain action
o Precatory proposal = request directors take certain actions
 Federal securities law require pub companies to put to vote the precatory
proposals appropriate submitted by SHs pursuant to fed proxy rules (Rule 14a-8)
 Bylaw amdts can also be included in Rule 14a-8 proposals
 But nominations of directors cannot be given under 14a-8g
o Amend bylaws (DGCL 109(a))
o Procedures for SH proposal = in most corp bylaws, and facilitated by federal proxy rules
Required votes (federal proxy rules require corp give SH vote on)
o SHs must approve auditors of corp
o SHs must vote on non-binding proposal for executive pay (“say-on-pay” proposal)
 Every 3 yrs, vote on whether say-on-pay should be voted on every 1, 2, or 3 yrs
 Introduced in Dodd-Frank
Wachtell Memo
o SEC amended eligibility reqs for 14a-8 SH proposals
 Clearly adds hurdles, which Wachtell says is good for SH engagement
o Ownership Req
 Before was 2k or 1% for 1 yr
 Now 2k for 3yrs, 15k for 2yrs, or 25k for 1yr, removes % test
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o Availability req
 SH proposer must meet with issuer (i.e. get bullied by lawyers)
Federal Proxy Rules for Public Corps
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securities law gives rules for proxy voting under §14 of the Securities “Exchange Act” of 1934
o rules promulgated thereunder by SEC are the “proxy rules”
o e.g. reqs for form of proxy card and content of proxy statement (info about corp that SHs
receive along with proxy card) (Rule 14a-3 to 14a-5)
 recent financial results
 info about board of directors and committees of the board
 info about each director
 info about related party transxs
 details about compensation and stock holding of directors and impt managers
 e.g. CEO pay ratio (part of Dodd-Frank), saw it in FedEx
 list of SHs that hold more than 5% of stock
proxy access
o most SH votes uncontested, corp soliciting proxies, and since most SHs vote by proxy,
things need to be on proxy card to get votes, obstacle to SHs replacing directors
o proxy access therefore a big topic
o SEC has considered requiring it, and did, but overturned by courts
o Still, SH pressure has caused many corps to adopt proxy access
 So SH can nominate directors for inclusion on corp’s proxy statement
 Most bylaws require nominating SHs to have collectively held 3% of corp’s
shares for previous three years, and limit number of nominees they can nominate
 Obstacle to activist SHs, like that random dude, and we saw that
proposal in one of the exercises, fedex maybe?
Proxy contest/proxy fight
o Dissident SHs solicit own proxies, nominate own nominees, put forward own proposals
o Rare though
 Very expensive
 collective action problem, soliciting SH only gets part of benefit, bears entire cost
 hence why proxy access to corp’s proxy card is impt
Note: SEC Rules say that private corps with over 2000 shareholders must file as if public
o Was 500 shareholders until 2016, raised to promote small business
o Corp can avoid by
 Not issuing new shares
 Restricting transferability of shares
SH Voting Disputes in Court

DE courts particularly protective attitude to SH voting rights
o have imposed general standards of behavior above statutory rules
o e.g. Schnell v. Chris-Craft Industries (DE 1971)
 board advanced date of SH meeting by amending bylaws to frustrate dissident,
refused to give dissident list of SHs as required by DGCL 220
 DE ct said this was permitted by statute but had “inequitable purpose”
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o e.g. Blasius Industries v. Atlas Corp (DE Ch. 1988)
 board actions to frustrate SH vote impermissible even though board acting in
“good faith” and not to “perpetuate itself in office”
protective attitude motivated by weaknesses of SH democracy
o one vt/share not shareholder
o incumbent advantage by controlling vote process and having corp pay for their campaign
o rational apathy and collective action problems
 individual SH has virtually on influence on outcome
PPI Exercise (Good DGCL Review)
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Facts
o S, G, and H own 1/3 each and sits on board with S as CEO
o PPI has 10 mill annual profits, traditionally pays all out annually
Can G and H under DGCL default rules (ignoring fid duties):
o Remove S from CEO and elect E (non-SH) as director and CEO?
 Yes, without cause removal standard board is ok by DGCL 141(k), 212(b), 228
 How?
 Wait until annual meeting
 Call special meeting (DGCL 211)
o can call special meeting if they first pass resolution (DGCL 213)
 By written consent (DGCL 228)
 Majority of directors can vote to install someone to fill a vacancy (223)
 CEO position appointment: 141(a), 142(b), majority decision by board 141(b)
o Issue new stock only to themselves and/or E at low price?
 Yes, board can issue new stock up to amount authorized in charter (161)
 No preemptive rights
 Note: in EU, mandatory preemption right, must offer shares to existing
SHs at same price, to avoid this
 Board’s valuation conclusive (152 and 153(a))
o Cancel S’s stock?
 Nah, even though nothing in DGCL says you can’t cancel someone’s stock
 Can specify conditions for redemption in charter, so can include it there
 Could issue to yourself the rest of authorized stock and dilute his shares
o Pay dividends only to themselves and E if she’s SH?
 No, although not explicit, still by implication in definition of rights of stock, 170
 But like last question, could just issue bunch of new stock and dilute cash flow
o Stop paying dividends, pay out profits to themselves and/or E for services renumeration?
 Yes, dividends is purely discretionary (170)
 And board has power to fix director/executive compensation (141(a), (h))
 SH vote only precatory, “say-on-pay”
 Fid duty law would prevent this
How does staggered board change answers?
o Couldn’t remove S without cause (141(k)(i))
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Would have to amend charter to change board structure back to non-staggered at
meeting or by written consent (141(b), 228, 242(b))
What if dual class stock (S owns 50 shares w/ 10 votes/share, G and H own 50 shares with 1
vote/share) does this change answers?
o Yes, anything that needed SH approval, which is removal of S
o And could get G and H off board using (DGCL 141(k) and 228)
What can G do alone (no staggered board and no dual class)
o Have E represent him at next SH meeting?
 Yes just have E as his proxy (DGCL 212(b))
o Sell all or some shares to E?
 Yes free transferability is part of board’s arrangement implicitly (DGCL 201 and
202)
o Ask that company send him proxy statement compliant with proxy rules?
 NO because corp isn’t public so not governed by Rule 14a-3
o Submit SH proposal to
 Enter market for astronomy books?
 Prepare study about social impact of business activities?
 NEITHER because no proxy statement (would have to move for it at SH meeting)
FedEx Exercise
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Domain Knowledge
o Often mutual funds are the biggest SHs
 E.g. vanguard, blackrock, etc
 They’re often the only ones who qualify for the proxy access requirements (3%
SH for 3 years), but they never make proposals or submit candidates
 They’re passive because they compete on cost
 They only vote because the SEC tells them they have to as part of SH fiduciary
duties
FedEx has majority voting in bylaws
o But doesn’t make a big practical difference (see notes above)
“if properly presented” for SH proposals
o Because we know the board will be at the meeting and make necessary motions, but for
SH proposals, they need to be at meeting and make motions accordingly
John Cheverden
o a “gatfly” who brings activist proposals
o real absurdity is that large funds sometimes vote for gatlfy proposals, but never bring
them themselves
 and they could centralize and say we like this 1 proposal, propose it everywhere
 whereas chevedden is actually flying around company by company
o he got 25% support in FedEx proposal, North Star only got 3%
o how do vanguard and blackrock feel about him
 he imposes costs on corps because they have to pay lawyers to deal with it
 but only reason it’s costly is because his proposals aren’t so terrible and worth
considering
o he’s big reason for destaggering of corps (along with HLS SH Rights Project)
North Star Asset Management
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o Also show up all the time in SH proposals
o Don’t compete on cost, but rather socially minded fund, trying to push companies to do
good
o They proposed putting employee seats on board
 Many countries have it mandated, e.g. north and western Europe
 Hard to detect in data any difference btw companies that hve it and don’t
 Funny because Elizabeth warren thinks it’ll save world and capitalists think it’ll
destroy world
o Note they always say this will increase returns to SH, because of fid duty and Dept of
Labor rules
Phrasing of proposals
o Worded as precatory usually, not mandatory, because must comply with state corp law,
so you cannot have a SH proposal that says “we hereby amend charter”, has to go
through board
o Also “ordinary business exclusion,” cannot have SH proposal demanding changing
payment of CEO, can just recommend report on how CEOs should be paid
SH Proposal fashions
o Used to be proxy access and majority voting
o Now political disclosure, lobbying, employee representation on boards
Contested Elections (Blasius and Schnell)
Blasius Industries, Inc. v. Atlas Corp. (1988)
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Facts
o
o
o
o
Blasius new stockholder of Atlas, trying to take over
Filed 13D, acquired 9% stake. Proposed leveraged recap.
At meeting, Blasius proposes specific things, Atlas refuses to do so.
Blasius then delivers written consent for
 Precatory resolution recommending board develop and implement restructuring
 Amend bylaws to expand board from 7 to 15 (max allowed by charter)
 Elect 8 named people to new positions
o Blasius sues to invalidate Atlas bylaw prohibiting written consent
o Atlas holds emergency board meeting (only one week before normal meeting)
 Board votes to amend bylaws to increase size of board from 7 to 9
 Appoints two people to fill positions
 Atlas already has staggered terms
Class questions (understanding what happened)
o Notice how it’s a vulnerability to have fewer directors seated than allowed in charter
 Lawyers specializing in sitting board defense advise against it
o Notice Blasius argues (and court agrees) that what they were doing was to protect
business (Because they didn’t like Atlas’s business ideas) rather than just perpetuate
themselves in office
Holding: Board cannot, even in good faith, interfere with a shareholder vote.
o Shareholder franchise is a special thing, and the shareholders have to decide
o Boards can’t bootstrap their own authority
Again, what board did here is legally fine
24
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o Blasius’ charter provided up to 15 directors; didn’t need to amend charter, just need to fill
vacant seats
o Board can add directors to vacant seats (DGCL 223)
Blasius had to add directors; couldn’t have just removed 9 sitting directors b/c elections are
staggered
Irony: in the end, plaintiffs lost the proxy vote
Policy:
o Disadvantage of written consent = need majority of shares outstanding (not just ones
present at meeting)
o Example of DE judges playing fast and loose with doctrine and language; not much
doctrine to support this decision
o Courts always have a door open to argue that directors interfered with shareholder vote,
but never act on it
Schnell v. Chris-Craft Industries (1971)
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Facts
o Plaintiff filed proxy materials for Jan. 11 shareholder meeting. Board of Chris-Craft
found out, and called an emergency board meeting. Changed bylaws to amend date of
meeting to make it sooner and moved its location.
Holding: Just because the board’s action is legal doesn’t mean it’s equitable.
o when it’s done for an inequitable purpose. Acting in bad faith.
o Legally, what the board did was ok
 Board was empowered in charter to change bylaws (DGCL 109(a))
o But inequitable to P, b/c needed time to clear the proxy
 Federal proxy rules say P needs to only file the proxy, but in reality all proxies
need SEC approval
 P also requested list of all shareholders, legal under DGCL 220
o “inequitable action does not become permissible simply because it is legally possible”
Policy: Decision takes 4 weeks total  DE Courts move incredibly quickly (reason why they’re
popular)
o and this works because (DE courts are good because):
 1) DE judges aren’t corrupt
 Tight knit community, don’t want to look corrupt
 2) great experience
 All experienced business litigators, know the tricks of the trade
 3) do nothing else
 Literally just US corp cases all the time, no juries
 4) speedy
 Dissent complains they came too late with injunction app, but that was
only after 4 days
o Prevents Russian mafia situations
 i.e. holding meetings in Siberia with armed guards at door
 bribing judges with tens of millions
 still, moving meetings day and time is old and tested strategy
Inequitable/legally permissible divided: Moran, Glassman, Hariton
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Hedge Fund Activism and Virtusa Pt. 1
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Background
o Activist hedge fund New Mountain trying to replace some board members at Virtusa
o Proxy contests used to be part of hostile takeover to replace directors who refused to
negotiate with potential acquirer
o Now used in campaigns by hedge fund activists
o Without this threat, activist investors would have no real way to affect corp operations
NM’s perspective
o Corp isn’t making enough profit, outsiders agree, so corp should be managed differently
and both corp and SHs will be better off
But quality of NM’s pitch?
o They’re just saying stock performance and financials are poor and need to be better
o NM complaining about an acquisition that happened in the past, yes hindsight is 20/20,
says nothing about what NM can do better, it’s not a strategy
Hedge Fund Activism goes wrong when
o Short term spike, hedge fund sells, shares tank
o Hedge fund pushes corp to do something that only benefits hedge fund
 E.g. buy things from supplier hedge fund owns
 But conflicts of interest pretty well policed in US
o Or NM gets its people on the board and board pays out tons to them
 But fid duty laws help prevent that
Short-termism
o Marty liptons of the world say this is just short-termism, bad for corps
o But doesn’t make sense, paying out dividends would affect the stock price
 Only way is if market systematically misunderstands consequences of dividend
payout, gets irrationally excited about companies that pay dividends, and hedge
fund sells at high price
 Seems implausible that there’s systematic mispricing in the market like this
o Corps take short term action all the time
 They know something but for corp but good for numbers now
 Problem probably exacerbated when it’s with insdiers, so why are activist hedge
funds the short-termism devils?
Why would director worry about activist
o Activists aren’t nice, huge pressures, letter that CEO wrote to activist that got CEO fired
shows how much activist pushes them
o Stories of sending people to stand in front of their homes, etc, or blackmail
o Fact that activists only make money when other SHs make money is good safeguard
Part 3: Fiduciary Duties & Litigation
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Background
o Statute allows powerful to do bad things  fid duties fill gaps, ensure power not abused
Three corporate fiduciaries
o Officers
o Directors
o Controlling SHs (only duty of loyalty really)
26
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To whom?
o “corporation and its SHs”
o Some conflicts can arise, where “And its SHs” favors the SHs against e.g. creditors
Master Fid Duties Table (w/ Mergers)
Main Fiduciary Duties
o Loyalty
 Act to advance principal’s interests, not own at principal’s expense
 Usually involves self-dealing
 Note, courts used to automatically void (treat as legally unenforceable)
conflicted transxs, but DGCL 144 “safe harbor” gave conditions by which
conflicted transx won’t be voided solely for reason of the conflict
 Statute doesn’t affect our normal questions, just means transx not
automatically void or voidable by virtue of conflict
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o Care
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 So “cleansing” is separate from the DGCL 144 conditions
Policed strongly, heart of fid litigation
Requires fids to exercise power competently
Standard of conduct
 “fiduciaries must exercise the prudence of an ordinary person acting under
similar circumstances in running a corp”
 Ordinary negligence standard in “due care”
 Standard of review
 Unless presumptions of BJR rebutted, just BJR and court dismisses lawsuit
 Usually involves mistakes
 Weak, largely unenforceable in court
 Exception, Smith v. Van Gorkom, aberration that later decisions rejected (e.g.
Disney)
 Liability waivable!
 Van Gorkom led to DGCL 102(b)(7), which allows corp to waive director’s
liability for violating duty of care
 Doctrine of waste
 For extraordinarily bad business decisions
 “so one sided that no business person of ordinary sound judgment could
conclude that the corp has received adequate consideration” (Glazer v.
Zapata)
 Waste is weird doctrine because it should be a useless category
o You would think you can only have waste when someone not
reasonably informed or not acting in good faith
o But reason why waste still exists is that every once in while (once
every ten years) there’s such a strange transx that DE court
entertains it’s wasteful even if they cannot identify what went
wrong
 In the end, most impt thing is does this smell fishy or not
o (oversight) (Caremark) (Wells Fargo)
 “board must make good faith effort, i.e. try, to put in place a reasonable board-level
system of monitoring and reporting”
 Have in place “information and reporting . . . reasonably designed to provie . . .
timely accurate info sufficient to allow management and the board to reach informed
judgments concerning the corp’s compliance with law” (Caremark DE Ch. 1996)
 Interestingly seems more like care, but case law anchors it in loyalty
 Early case law seemed to make it duty of care, but it’s not
 More recent cases say only violated if director violates duty of good faith,
therefore flows from duty of loyalty (since good faith part of loyalty) (Stone
DE 2006 and Marchand DE 2019)
 Traditional ambit is compliance
 Monitoring for legal violations and employee misconduct
 Not employee mistakes, bad business decisions, or excessive risk-taking (in re
citigroup DE Ch 2009)
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o
o
o
o
Though duty to monitor “operational viability, legal compliance, and financial
performance” (Marchand DE 2019)
 Standard of review
 Good faith (like 102(b)(7)) and P has burden
 “directors utterly failed to implement any reasonable rporting or information
system or controls, or consciously failed to monitor or oversee its operations”
(Stone DE 2006)
 Note on Wells Fargo probably won’t find it because of burden
(candor)
 Contained within duty of loyalty, must disclose conflicts
 Automatic violation just for not disclosing, even if price is fair
 Although doesn’t mean transx will be undone, jduges have enormous discretion for
violations of fid duties
(corporate opportunity) (Guth Pepsi)
 Contained within duty of loyalty
 Fid who takes business opp belonging to corp will violate duty of loyalty unless:
 Taking is cleansed
 Corp has disclaimed right to corp opp (DGCL §122(17))
 What’s a business opp
 “opportunity which the corporation:
o Is financially able to undertake
o Is from its nature in the line of the corp’s business
o Is of practical advantage to it
o Is one in which corp has interest or reasonable expectancy
 And which by embracing it, fid will be brought into conflict with corp’s
opportunity”
(good faith)
 Under duty of loyalty
 Actual intent to harm corp
 “intentional dereliction of duty, a conscious disregard for one’s
responsibilities” (Disney, DE 2006)
 Includes duty to obey the law no matter how profitable breaking law is
 Charter may not waive liability for knowing violation of law (DGCL
102(b)(7)(ii))
In context of hostile acquisition, corp fids can have other special duties
Standards of Review

BJR= presumption that officers/directors were
o 1) informed
 In practice, courts never impose liability because fiduciary not fully informed
 Courts require “gross negligence” for BJR to be rebutted on grounds of
uninformed
 Attitude: courts loath to find liability for disinterested, good faith
directors/officers
 Hence why attacking BJR is either conflict of interest or bad faith
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o 2) disinterested
o 3) acting in good faith
o Burden on P
 Must rebut one of these, otherwise courts won’t scrutinize substance of decisions
and will dismiss lawsuit
o So if you have cleansing, need to show bad faith to overcome (very high bar)
EFR = conflicted fiduciary must show transx had:
o 1) fair dealing
 Process, e.g. revealing all material facts, negotiating with candor, avoiding
pressuring corp
o 2) fair price
 Economic substance mimicks the price of arm’s length transx btw corp and
unaffiliated third party
o Burden on D to establish both
o Avoid through cleansing = structuring the approval of conflicted transx
Standards of Conduct v. Standards of Review
o Conduct
 Defined by content of the duties
o Review
 Test court applies to evaluate if met standard of conduct
 E.g. BJR and EFR
Cleansing
Basic two step approach
o 1) is there a fid with conflict of interest?
 No = BJR
 Yes = Q2
o 2) Did corp put in cleansing techniques?
 Yes = BJR
 No = EFR
For officers and directors
o 1) approval by majority of informed disinterested SHs
o 2) approval by majority of informed disinterested directors
 If majority of directors conflicted, then need to make minority special committee
empowered with MFW
o If either (or both), BJR applies
 On theory that it substitutes to satisfy the disinterest presumption
o Note this also makes discovery unavailable (see section below after MFW)
For controlling SHs
o Type 1 and 2 above only give burden shift
 i.e. EF burden shift to P
 hence why making special committee can achieve a burden shift
o under MFW, controlling SH avoids EFR completely and gets BJR if both:
 condition transx on approval of special committee
 Special committee is independent
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
Special committee is empowered to freely select its own advisors and to
say “no” definitively
 Special committee meets duty of care in negotiating fair price
 Condition transx on approval of majority of minority SHs
 Minority is informed
 No coercion of minority
 Note: MFW (DE 2014) technically applied to controlling SH squeezeout, but
courts are likely to extend to all other controlling SH contexts
o Practically, MFW makes discovery unavailable
 To survive MTD, P must plead facts showing any/all these conditions didn’t exist
(procedurally)
 Allegations concerning sufficient price irrelevant
 So P needs facts of concrete procedural improprieties beyond conflict
Self-dealing
 Why not prohibit self-dealing altogether?
o Sometimes self-dealing can be positive (ex: if you work for a real-estate company and it’s
trying to take over a block. You own a house on the block, and would benefit from
selling it to the company.)
 Self-dealing is allowed when shareholders or directors approve it
 Self-dealing includes any money coming out of the corporation that benefits you
o Even if you do something for the company in return, can still be self-dealing
Duty of loyalty
Step 1: Is there self-dealing?
 Two tests for self-dealing:
o (1) Did the fiduciary take a corporate opportunity (permissible) or a personal opportunity
(impermissible)? (Guth)
o (2) Did the fiduciary get a benefit at the expense of other shareholders? (Sinclair)
 Note
o Courts ignore formalities, look at substance (e.g. entity owned by CEO)
o Also family relationships court will see as conflict
Step 2: Did the fiduciary get approval by fully informed disinterested shareholders or fully informed
disinterested directors?
 If approval:
o If controlling shareholder  burden shifts so plaintiff must show transaction wasn’t
entirely fair
o If director/officer  standard becomes BJR/waste
 If no approval, subject to entire fairness test
o Entire fairness = fair price + fair dealing
o Burden is on defendant to show transaction was entirely fair
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Guth v. Loft [Pepsi Case] (1939)
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Facts:
o Guth was President of Loft (which manufactured and sold candy and beverages). In 1931
Loft sold Coke at its stores, but wanted to switch to Pepsi. In 1931, Pepsi went bankrupt,
and Guth used money from Loft to personally acquire Pepsi from bankruptcy.
Holding: Guth’s holdings in Pepsi violates the duty of loyalty, because Guth took advantage of a
corporate opportunity that Loft could have.
When is a business opportunity acceptable for a fiduciary to take  when it’s a personal
opportunity and not a corporate opportunity
o Corporate opportunity test — can take a business opportunity if:
 Opportunity is presented to director in individual, not corp capacity
 Opportunity is not essential to corp
 Corp holds no interest or expectancy in opp
 Director/officer has not wrongfully employed resources of corp in
pursuing/exploiting
o Fiduciary has the burden of proof to prove it wasn’t a corporate opportunity
o But note, court isn’t specific about the middle ground; only discusses when 5 factors are
pointing in one direction or another
Here: in negotiation for syrup contract, Guth would be on both sides of the transaction. He’d
favor Pepsi because he owns more of it. Huge conflict
Remedy sought = disgorgement; Guth would have to give Pepsi to Loft
o Rationale: deterrence! Courts want to deter people from the temptation of doing this
Policy: remedy is meant as an ex ante threat  if you take a corporate opportunity, court will
annihilate you later
Note: Guth also stands for not all conflicts being immediately voidable (later codified in DGCL
144) because it develops corporate opportunity test rather than throwing out transaction just for
conflict.
Mikhail Conflict of Interest Exercises


Mikhail owns 50% of OilCo and 100% of Honeypot
Undervalued sale of oil approved by
o Just CEO
 EFR, D loses
o Special committee only
 EFR with burden shift to P, but D still loses
o Special committee and majority minority SH (and assuming MFW etc.)
 BJR
 But transx would have probably never been approved
 And probably still not safe from litigation (waste or something)
 In the end, most important question is whether something smells fishy or
not
Sinclair Oil Corp. v. Levien (1971): Sinclair owned a subsidiary called Sinven for its operations in
Venezuela. Three claims: (1) Sinven paid out $108m in dividends b/c Sinclair needed cash; (2) Sinclair
also purchased oil fields, and Sinven argues those opportunities could have been taken by Sinven and (3)
32
Sinclair International (another subsidiary) contracted with Sinven to sell its crude oil to them at specified
prices, and made payments late.
 Holding: Almost all no self-dealing because the fiduciary isn’t getting a benefit at the expense of
other shareholders. Only self-dealing with contracts.
 Three issues:
o Dividends payments — money is going out symmetrically, so no detriment to other
shareholders
o Oil fields — not to detriment of shareholders b/c none of the opportunities were brought
to Sinven directly
o Contracts — benefits Sinclair b/c they’re majority shareholders of Sinclair International.
This was self-dealing
 How you see the case depends on your story:
o One view: have little family company incorporated in Venezuela, and Sinclair buys you
up and tries to restrict your growth. Getting screwed
o Other view (more likely the case here): Sinclair set up Sinven for purpose of drilling in
Venezuela, and only have outside shareholders to satisfy domestic ownership
requirements in Venezuela. Getting what you paid for
 Policy:
o On dividends question, possible that minority and majority don’t value money the same
way, so the dividends are inequitable
 Sinven may have business opportunities they can take advantage of if more cash
is in the corporation (value of dividend to minority = low)
 For Sinclair, taking Sinven’s cash away from it is as if they’re knocking out a
competitor (value of dividend to majority = high)
o If court had ruled that dividends payment is self-dealing  would result in a ton of
litigation!
 Sinclair may try to sell Sinven; may try to squeeze out the minority shareholders;
or would have to be restructured
 If everything is self-dealing subject to entire fairness review, litigation wouldn’t
stop. So we need to draw the line somewhere
o Litigation with corporations is asymmetric warfare, since P can impose a huge cost on the
corporation through one-way discovery
RFBC hypo
 Under corporate opportunity test, is Rosalind in competition with the corporation?
o Today yes, but not after bankruptcy
o Could be conflict if they grow into same areas
 She could use DGCL 122(17) to get corporation to renounce interest in the deal
 She could get waiver for conflicts she’s allowed to take
Duty of care
Standard = business judgment rule
 Business judgment rule requires that directors are: (1) acting in good faith (2) reasonably
informed and (3) disinterested
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102(b)(7)
 Boards’ decisions are protected if they (1) act in good faith and are (2) disinterested
 Can’t disclaim liability for either (1) bad faith or (2) illegal dividends
 Doesn’t apply to managers
Smith v. Van Gorkom (1985)
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Facts
o Trans Union was exploring LBO; CFO did informal analysis and said between $50 and
$60 could work. CEO Van Gorkom met with Jay Pritzker and proposed to him an LBO
of $55; Pritzker agreed, but said deal had to get done quickly (shares were trading at
$37). Board approved merger without seeing the actual agreement. Eventually,
shareholders approved of the merger.
Class action — shareholders allege Pritzker paid too low a price
Holding: Directors breached duty of care.
o Under business judgment rule, failed to be reasonably informed
o Reasonably informed = sought out all material information that was reasonably available
o Thus, directors are held to a gross negligence standard in terms of fulfilling the duty of
care
Court’s rationale on why the directors weren’t fully informed:
o (1) Didn’t do valuation of company
o (2) Didn’t ask CFO Romans about where the $55 number came from (said a transaction
was doable at $55, not that it was a good deal)
o (3) Never read the merger agreement
o (4) Van Gorkom signed the agreement at the opera
No self-dealing because shareholders are getting the same thing as Van Gorkom; he doesn’t have
an advantage
o Counter: Van Gorkom is about to retire, and there are allegations that it’s advantageous
for him to quickly do an LBO (based on how his compensation package is structured).
But court said this wasn’t at issue
At the time, shares were trading at $37 and they got a $55 deal. That’s almost a 50% bump
o But note every CEO thinks their company is undervalued
Impacts of the opinion:
o After this opinion, people were very scared
 Ended up settling for $20m (Pritzker paid $13m)
o Board members became way more informed
o Led DE to adopt 102(b)(7)
Dissent (McNeilly): Directors were all well-informed and could make quick decisions on the
spot
Dissent (Christie): Directors are expert enough that if they thought the deal was ok, they should
be protected by business judgment rule
Policy:
o In response to this, boards would create many expensive reports and slow down
dealmaking  death by process
 Would chill dealmaking
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 Paying a very high price for court supervision
o Maybe executives would demand more pay, because they’d be taking on a bigger risk
o Today, with bigger deals, the stakes are much greater (ex: the Qualcomm deal is $100b,
so if a mistake was made that cost the shareholders 5%, then that’s $5b)
Aftermath = every company adopted a 102(b)(7) waiver as standard
o Exempting themselves from liability
o If rule ripped off the shareholders, people wouldn’t buy stock in the company
In Re Walt Disney Co. Derivative Litigation (2006)
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Facts:
o Disney wanted to hire Michael Ovitz as its new president. Made $25m/year at CAA, old
job. Under agreement, got options with different vesting schedules and if he was fired,
he’d get an NFT that amounted to $130m. Disney compensation committee met and
approved package, and then board approved it. Ovitz ended up being a poor fit, so the
company fired him w/o cause.
Holding: Disney directors were informed of all material information needed to make a decision,
so didn’t violate duty of care. Protected by business judgment rule.
Ovitz pay package
o Ovitz was making $20m before, so had to incentivize him to come to Disney
o Compensation structure guaranteed him money unless fired for cause; he had an incentive
to get himself fired (somewhat odd)
Aside on executive compensation:
o Average CEO makes $10m/year. Why so much money?
 If you want to bring in the best, you have to compete
 Hiring someone good adds value to the company (stock market perceived Ovitz
news as positive enough that it added $1b to Disney)
 Companies are worth hundreds of billions, so a difference in quality that makes
the company 5% better could amount to $5b
o Why pay cash award and stocks/options?
 Compensation moves with stock, so penalized if stock goes down (right
incentives)
Compare with Van Gorkom — the cases are very similar, but had different outcomes
o Similarities:
 Both boards agreed to deal without seeing contract
 Short meetings
 Board already made up mind they wanted to hire Ovitz before offering him a deal;
Van Gorkom approached Pritzker and offered him a price
 Similar chain of events
 Van Gorkom = initial signing  amendment w/o consulting outside
materials  shareholder vote
 Disney = initial signing  manner in which Ovitz was fired (w/o cause;
could have been fired with cause), didn’t consult outside materials
 Van Gorkom board didn’t do valuation of company; Disney board didn’t do
valuation of what Ovitz is worth to the company
 Neither looked at alternative buyers/presidents
35
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Same amount of money at stake (loss to TransUnion is $60m in 1985  $120m
today)
 Management in Disney didn’t like Ovitz, but Eisner never told the board;
management in Van Gorkom didn’t like the Pritzker deal, and he didn’t tell the
board
o Formally speaking, the law applied is the same
o Reason for different result = court showed more deference to board’s decision making
(maybe there was an expert here?)
Litigation lasted 10 years. Who bears cost?
o Corporation bore costs of defense — under DGCL 145, corporation has to cover
directors’ costs (indemnified)
o Plaintiff lawyers bore costs of plaintiffs
Discussion about waste, but logically, if the BJR isn’t violated, there’s no waste
o Waste = if there’s no possible business reason for expending resources
 Requires bad faith
o Here, court found corporation was just complying with the NFT as it was contractually
bound to do
Policy: Court wanted to send a message that even if boards aren’t protected by 102(b)(7), they
don’t need to engage in too much process (dissuading reaction after Van Gorkom).
Communicating that today’s courts don’t think like the Van Gorkom court anymore!
o Why is liability protection for boards good?
 Too much liability would mean that directors behave differently to avoid
litigation, and don’t take the right risks to grow the corporation
 Counter: could violate duty of care if they don’t take enough risks!
Liability either way
Corporate law and med mal
 Corporate law = business judgment rule. No uniform standard of care, and courts give much
deference to the corporation
 Medical malpractice = doctors are held to objective standard of care
 Difference comes from enforceability
o In medical practice, the human body is the same  we know what doctors are supposed
to do (can compare doctors to each other)
o With corporations, each business is different  hard to evaluate a business decision
(can’t compare companies to each other)
o Risk that the courts will get it wrong is high
 Another difference = compensation
o Doctors do not get compensated for success of their treatments; otherwise, they’d start
selecting patients with the lowest chance of complications
o For managers  evolved ways of compensating them for performance, and stock market
(not perfect, but decent indicator)
o Since we already have a way of incentivizing the right decisions, we don’t need liability,
and we don’t know how to apply it
 Idea that med mal deters more people b/c it’s a stricter standard (more liability) is a fallacy:
o From doctor’s perspective, can insure yourself
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#Stone v. Ritter (2006): Derivative action. In 2000, two men had engaged in a Ponzi scheme and used
AmSouth as their bank. AmSouth entered into DPA with the gov’t, and agreed to pay $40m fine for
failing to file SARs and $10m in civil penalties. Plaintiffs alleged Ds had insufficient
monitoring/reporting system.
 Holding: When directors don’t act (failure of oversight), they’re liable for breach of duty of care
if they have conscious disregard for their oversight duties, OR if they failed to implement any
reporting or information controls.
o Caremark claim = “sustained or systematic failure” of board to exercise oversight
breaches duty of care
o Conscious disregard = a variation of bad faith
o Here, court holds that board didn’t have conscious disregard, so didn’t act in bad faith
 KPMG report: AmSouth had numerous controls, had a committee and a compliance department
to address fraud. But this is just pro forma compliance, and the board could have been more pro
active in catching fraud before the regulators
 When directors aren’t protected by BJR, but they are protected by the Stone standard:
o When directors weren’t objectively informed (no requirement to be informed under
Stone)
o For practical purposes, “conscious disregard” and “reasonably informed” both involve
subjective inquiries (even though “reasonable” sounds objective)
o Note: Disney court showed how courts hesitate before making subjective evaluations
 Line between “action” and “inaction” is blurred
o Could always turn inaction into action (i.e. directors shouldn’t have voted for such a
skeletal compliance program)
o If board decides not to do something, that counts as an action
 102(b)(7) waiver doesn’t apply to failure of oversight, because doesn’t cover bad faith
 Policy:
o Court could have said—no bad faith, so no liability under 102(b)(7). But like in Disney,
wanted to take the opportunity to clean up a vague standard
o Stone doesn’t establish any level of minimum oversight the board must have. Just says it
must be “reasonable”
 Some argue that even a small company should have a compliance officer
 Having a compliance officer with 10 employees may not be reasonable
Policy — why have low BJR standard? Why not get rid of all liability?
 Liability threat emerges with bad faith. Maybe if directors slacked off too much, they’d be
considered to be acting in bad faith
 Other limits may be shaping director behavior:
o Reputational consequences
o Monetary compensation (upside motivation)  directors are very sensitive to
performance, since their money is tied up in the company
 So the liability threat is one mechanism against many, but outside of self-dealing it’s a minor one
Shareholder Litigation
Policy of enforcement
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Enforcement must incentivize substantive litigation but avoid frivolous suits
o Substantive suits = ensure actors behave correctly
o Frivolous suits = costly, make actors behave in a way we don’t want
Can’t tell where the optimum lies
Note that most suits are plaintiffs’ attorneys with a nominal plaintiff who owns one share, but
has no personal stake in the outcome
Direct vs. derivative suits
 Direct suits/class actions: happens when the shareholder’s property has been individually
affected. Big money to be made. Remedy is granted directly to the shareholder.
 Derivative suits: brought in the name of the corporation. When the shareholders stand on behalf
of the company to sue someone else. The corporation is the party that is harmed and will be
made whole in this case.
o Ex: if you hold 1 share of Apple, can name Apple as a nominal defendant and sue
Samsung
o Doesn’t matter how few shares you own (DGCL §327)
 Test for which
o 1) who suffered the alleged harm (corp or suing SH)?
o 2) who would receive the benefit of any recovery or other remedy?
 In practice
o SH can sue directly for transx that affect their status as SH
 Especially when shares exchanged or extinguished in merger
o SH must sue derivatively for things that only affect SH financially through transx’s
impact on corp’s financial position
 Advantages of direct over derivative
o 1) fewer procedural hurdles (e.g. demand futility)
o 2) damages flow direct to P, rather than to corp
 Need for derivative lawsuit
o Tension in deciding when a corp should sue
 btw DGCL 141(a), that management of a corp’s affairs vested in board
 and SHs deciding
o but board cannot always be trusted to sue, e.g. a CEO, either
 for business reason (don’t want to disturb relationship with great CEO)
 or conflict of interest reason (personal relationships)
o if board fails to sue, SHs don’t know for which reason, and so bring suit
o courts manage this tension in two ways (only apply to derivative suit):
 1) procedural hurdles (Demand futility)
 2) special litigation committees in corp that can decide to dismiss suit whenever
Demand Futility Test

Basic test (from Aronson):
o To survive MTD, derivative complaint must show that a majority of directors aren’t
impartial to assess the suit by alleging “particularized facts” that either:
 1) majority of the board conflicted in that transx (including by affiliation with a
direct beneficiary)
38
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Majority ownership doesn’t mean no independence (Aronson)
Financial beholdence probably counts (independent director financially
beholden to conflicted director)
 Family relationship could count
 Doesn’t matter if controlling SH selected those “independent” members
o “not enough to charge that a director was nominated by or elected
at the behest of those controlling the outcome of a corporate
election” (Aronson)
 2) otherwise breached duties in alleged transx (in bad faith, or if no 102(B)(7)
waiver, grossly negligently uninformed or committed waste)
Practical consequence: P must already have facts since it’s threshold to get to discovery
o Now done often through books and records request (DGCL §220)

Aronson v. Lewis (1984): Prudential owned subsidiary Meyer; then spun it off to Prudential
stockholders. Suit alleges that transactions were only approved b/c Meyer director Leo Fink (owned
47% of stock) personally selected each director and officer of Meyer. Fink had 5 years terms, was paid
hundred of thousands as a “consultant” and was given interest-free loans. Ps allege board breached
fiduciary duties by approving Fink’s employment contract.
 Holding: In applying the demand futility test, plaintiffs must plead “particularized facts” that
raise reasonable doubt that majority of the board was disinterested, independent and protected by
BJR.
o Just the abstract threat of liability b/c the P names the directors as Ds isn’t enough to
constitute partiality
o Here: just b/c Fink appointed the directors doesn’t make them impartial. Must be more
particular facts
 Demand futility test:
o Is there a majority of impartial people on the board who can bring the suit instead of the
shareholders?
 Impartial: (1) if directors are directly interested or (2) if there’s a reasonable
chance that directors will be held liable
o If so, shareholders are required to make a demand.
 In practice: shareholders never make demands, b/c if they do they give up their right to sue.
Would rather argue later that the directors were impartial
 Whether Fink’s contract is fishy depends on what’s going on
o If he’s someone like Warren Buffet, seems like a steal
o If he’s just getting a payoff for nothing, seems bad
 Under substantive law, Fink would probably lose
o Fink is self-dealing, but board approved the contract
o He’d normally be held to BJR, but since Fink is the controlling shareholder all he gets is
a burden shift for entire fairness
 Policy:
o Court requires pleading particularized facts b/c the plaintiffs could always get past the
motion to dismiss just by naming the directors as Ds (bootstrapping)
 Says: 23.1 would have no function if you could always name Ds as the defendants
and get past the demand requirement
39

Counter: 23.1 has much function beyond fiduciary suits (i.e. Apple/Samsung suit,
really want to sue Samsung)
o Misalignment: Fink would lose on the substantive standard here, but he wins on the
procedural standard
o Problem with court’s “particularized facts” holding = P can only find out if something
bad went down through discovery, so at the pleading stage they can’t do much
o 23.1 only applies to derivative suits, not direct actions. Rationale for having a higher
hurdle for derivative suits = they happen all of the time; direct actions only happen at
“end of the road” scenarios
Special Litigation Committees




Court may dismiss action at any time if special litigation committee recommends
Committee has one or more independent directors
In practice
o Formed when court has denied corp’s MTD and P passes demand futility
o Committee then investigates, decides either:
 1) claims are meritorious, settle suit
 2) move to dismiss the action
If committee moves to dismiss, court review under Zapata two-part standard:
o 1) independence and good faith of the committee and the bases supporting its conclusion
o 2) court determines, applying own business judgment, whether motion should be granted
o Usually turns on whether court thinks committee members are sufficiently independent
 E.g. In re Oracle (DE Ch. 2003), court finds question of fact as to two new directs
on litigation committee, says “question of independence turns on whether a
director is, for any substantial reason, incapable of making a decision with only
the best interests of the corporation in mind”
Zapata: Corporation can appoint an independent committee to evaluate the claim, and recommend
whether suit should be dismissed (decide whether damage was so small that it’s not worth the cost)
 Plaintiffs would rather be dismissed under Aronson than Zapata, b/c discovery is so costly
 Tradeoff: ex ante, need litigation to deter people from doing things to line pockets. But ex post,
litigation is so costly it may not be worth it
 Courts are stricter at the Zapata stage, because of the huge risk to plaintiffs of getting dismissed
 First hurdle = Aronson (demand requirement)
 Second hurdle = Zapata motion
Common Fund Doctrine


Obviously only applies in derivative suit!
Policy
o Need to incentive litigation because it’s the enforcement mechanism for fid duties
o If SHs only got pro rata share, low incentives, collective action problem
 Same collective action problem as proxy fights
o So give plaintiff lawyers the incentive with common fund doctrine
 15-25% recovery
o Problem is you also get nuisance suits and meritless settlements
40


Corps try to limit litigation, both for good and bad reasons
o They tried fee-shifting (so Ps would bear costs of loss)
 DGCL amdt prohibits fee-shifting in DGCL 102(f)
Settlements
o Require court approval
 Class actions: DE Ch. Rules 23(e)
 All derivative actions: 23.1(c)
 So only direct non-class action suits don’t need court approval
o Check on bad incentives of both nominal P and P’s lawyer
 Nominal P: only bears tiny fraction of benefit, little incentive to effectively check
lawyer
 Lawyer: quick settlement due to expensive litigation + opportunity cost
 Articulated in In re Riverbed (DE Ch. 2015)
 Particularly a problem because lawyer could forfeit entire classes of
claims on behalf of class or corp
 Hence Joel Friedlander said he took over a suit settling for disclosure and
got hundreds of millions
Indemnification and insurance




Indemnification = reimbursement of director/officer expenses/judgments by corp
Insurance = same as above but by third party
o Typically have this as supplement because corp could become insolvent
o Particularly when things go very wrong, which is when liability risk most acute
Both regulated by DGCL 145
indemnification
o If third party lawsuit (145(a))
 corp can indemnify against reasonable expenses (including atty fees) and
judgments (or settlement amounts)
 if director/officer in good faith
 if criminal, corp had no reasonable cause to believe conduct unlawful
o if plaintiff is corp itself (i.e. derivative action) (145(b))
 corp can only indemnify for reasonable expenses, not judgments/settlement
 if person acted in good faith
 if person not found liable
o corp must indemnify when (145(c))
 for reasonable expenses
 if director/officer found successful on the merits “or otherwise”
 meaning also settlements in which corp but not the fiduciary makes
payment to third party
 giving fiduciary strong incentive to steer corp into settlement in which
corp, not fiduciary, promises to pay at least part of P’s cost
o timing
 most corps have provisions for advances on indemnification for litigation costs
during litigation (permitted by DGCL 145(e))
41


Insurance
o 145(g) allows corp to give insurance to any person for any liability
 even when it can’t indemnify
 director and officer “D&O” insurance very common
o in practice
 insurance companies insist on exemptions from coverage for “Bad faith”
 mimicking “good faith” req of indemnification
 though note Michael Granston said they sometimes insist on waiving insurance
for knowing violation
 indicating some limited amount of it?
 still this is why people are encouraged to settle early, so they can still get
the insurance to pay before they’re found in bad faith, and settlements
don’t admit bad faith or knowing violation
policy: overkill?
o Demand futility + BJR + 102(b)(7) already so protective
o Some risks that still justify it
 litigation costs liability
 Third party actions (e.g. SEC enforcement, employee lawsuit even if meritless)
Policy
 Directors have strong incentive to settle and not go to trial, b/c if you go to trial and lose, it’s
probably b/c you acted in bad faith—and then insurance doesn’t cover you
o Directors would be very generous in settlement, b/c not playing with their own money
 Directors and officers still insist on insurance (despite indemnification) b/c more behavior is
insured than indemnity covers
o Also, if corporation goes bankrupt, insurance will still pay and indemnification isn’t
helpful
 Despite indemnification and insurance, the point of liability is to threaten punishment for bad
faith, particularly in cases where it’s not clear
o Maybe it’s a soft threat, but still potent
o However: not totally clear why this is the case
America’s Mining Corp. v. Theriault (2012) Southern Peru:
 Facts
o Groupo Mexico owned 50% of Southern Peru. SP buys Minero Mexico from America’s
Mining, and the money flows to America’s Mining. Minero Mexico is allegedly worth
$2.4b, but SP pays $3.76b, and SP shareholders sued, alleging that SP overpaid for the
asset b/c G Mex wanted to put cash into America’s Mining (since it owned 100% of
AM).
 Allegation = self-dealing (GMex is controlling shareholder of SP), so subject to entire fairness
review. Court holds for shareholders.
 For the judgment, SP paid AM back $2.03b, and the attorneys got $300m of that (15%).
 Holding: Attorney’s fees are permissible under common fund doctrine.
 American Mining (defendant/seller) is the one opposing the fee award — Groupo Mexico wants
more money going back to SP than in the hands of the attorneys b/c they still own 50% of SP
 Court looks to Sugarland factors:
42
(1) Benefit achieved — P got the award through the litigation led by the lawyers
(2) Difficulty and complexity — complex case involving valuation
(3) Contingent representation — lawyers took a huge risk
(4) Standing and ability of counsel — had a record for success
 (5) Time and effort of counsel — significant
In reality: through the amount of the common fund, the court finds a permissible range then the
factors determine where in the range they’re going to be (so size of recovery = biggest factor)
Policy:
o Makes sense to award such big attorneys’ fees—bigger the transaction, the higher the
stakes, the more the managers or CSH is arguably stealing from the minority. These are
the kinds of suits we want to incentivize
o Only real sanction with deterrent effect for GM is the attorney’s fee
 GM is just paying the amount later that they should have paid in the first place
 May say: if we pay the $2b extra now, if the probability of losing the
litigation is low enough (under 80%) then they’d do it because all they’re
risking is that $300m
 So all they’re losing is attorney’s fees (and half of that is paid by outside minority
SH)
o
o
o
o


In Re Trulia Inc. Stockholder Litigation (2012): Plaintiff’s attorneys in Zillow’s acquisition of Trulia
offered agreement to settle. Under settlement, Trulia agreed to supplement proxy materials with more
information and pay $100k, and plaintiffs agreed to drop case. Since settlement isn’t much money,
plaintiffs won’t get any benefit; only lawyers will get paid.
 Holding: Courts will start policing settlements for real “give and get” between parties. No more
big waivers of claims without some real give from D.
o In that case, unless the plaintiff has a real claim, the defendant won’t settle
 Case discusses skewed incentives at play:
o Suits lose all deterrence effect, b/c always settled for small amount regardless of the
merits of the claim
o Ps attorneys bear all of the cost, but only get a small % of the recovery, so often if they
go to litigation it’s not worth the cost/benefit (only small percentage of winning)
 Case is all dicta and has no precedential value; but courts follow it
43


Policy: Shows how in DE, almost every transaction is litigated immediately, and settled for a
little fee. Almost like a deal tax.
o But now plaintiffs who want settlements just go to different courts
Main takeaway: conflict btw plaintiff’s attorneys and the shareholder group, and the incentive
to sell out the class
Trados: Trados was founded in 1984 as desktop software that translated documents. Managers =
Campbell and Hummell. Wachovia invested $5m in Trados and got Series A shares with preferred
stock. Trados wasn’t doing well, so had several options of how to exit. Could sell to SDL for $40m.
Could merge with Bowne for $91m. Could also do stand-alone project like an IPO with a windfall
($2,057m).
Projects
SDL
Bowne
Stand-alone (large
Preferred
40
37
10.57
Expected payoffs
Commons
0
8.5
10
Corporation
40
45.5
20.57
probability of nothing, but
small probability of
windfall)
Expected payoff of SDL strategy:
 Preferreds: $40m
 Commons: $0
Expected payoff of Bowne strategy:
 Preferreds: .50*0 + .50*(91m - 57m)/2 = $8.5m
 Commons: .50*0 + .50*(57m + (91m - 57m)/2) = $37m
Expected payoff of windfall:
 Preferreds: .99*0 + .01*($57m + ($2,057m - $57m)/2) = $10.57m
 Commons: .99*0 + .01*($2,057m - $57m)/2 = $10m
Key takeaways
 Neither group chooses the efficient strategy (Bowne) — means we can’t entrust the decision to
either group
 Creditor’s claims are fixed, so as more money comes in, they get up to the claim amount and
then only after that are the shareholders paid
 Creditors have no incentive to take risk; shareholders have much incentive to take risk
o Creditors have zero upside
o Shareholders have zero downside, only upside
44
How can we solve this?
 Give a bonus to Campbell and Hummel when they make a deal to incentivize them to come over
to preferreds side
o Could have buyer give them money (but that means less money to us as preferreds in the
end)
 Problem: awarding a bonus would be self-dealing under Sinclair (favors us at expense of
commons)
o Board could ask for approval from unconflicted shareholders (aka the commons, but
wouldn’t approve it)
 Could prepare for entire fairness review with lawyers and bankers who would say the company
is worth less than $57m, so commons would never see any money
o Entire fairness = fair price + fair dealing
o Unclear what fair price is here; depends on what you think the corporation should
maximize (see chart above)
o Preferreds could argue we’re pricing the company according to the market, which is
$40m
 In real life:
o Board worked out a payment scheme for Hummel and Campbell, and flanked themselves
for litigation
o Sold company for $60m — $57 to preferreds, and $3m to Campbell and Hummel
o Commons sued and won
 Chancellor said: not entirely fair, b/c the directors must think about the commons
and not the preferreds!
 All they could have done in real life was buy the commons out (to pass entire
fairness)
 DE default rules say you must act on behalf of commons
o But as we just saw, this makes no sense, b/c would force the board to be constantly taking
the moonshot scenario. Would be better to maximize the value of the corporation
45
Part 4: M&A
Introduction to M&A
General notes
 Four categories
o Friendly transx
o Hostile transx
o Sale of control (controlling SH sells corp)
o Squeezeout (controlling SH buys rest of SH)
 sources of rules
o State statute
 Approval reqs
o Docs of corp
 Special approval reqs
o Judicial decisions
 Fiduciary duties in the transx
o Fed securities law
 Since requires SH approval, securities law governs public corp SH voting
 E.g. voting by proxy (Exhange Act §14)
 Tender offer rules (part of Williams Act 1968 in Exchang Act)
 And req disclosure of acquiring over 5% (warning of hostile takeover)
o Federal antitrust
 For MA of large businesses
 FTC and DoJ ensure MA won’t substantially reduce competition, can block
mergrs
 Hart-Scott-Rodino Act requires corp above certain size give advanced notice of
MA to FTC 15-30 days prior
o Sector-specific rules
 E.g. bank MA requires bank regulator approval
 Transx
o by contract (asset purchase agreement, share purchase agreement, merger agreement)
o structured to have big delay btw signing and closing
 approval
o both board and shareholders (subject to some exceptions) (DGCL 251(b)-(c))
o charter can have special approval reqs
 Appraisal (DGCL 262)
o can request to receive “fair value” of shares as appraised by Chancery court, rather than
the merger consideration/price
o Elements
 shareholders (DGCL 262(a))
 not the shares themselves
 who don’t vote for the merger (DGCL 262(a))
 not just vote against, but passively don’t vote for
 and hold the shares through the effective date of the merger (DGCL 262(a))
46

 and deliver demand to buyer before the vote (262(d))
o Exception: not available if
 you hold stock in public company or one with more than 2k SHs

 in exchange for the merger consideration you get stock in another public
company (no matter how bad) OR
 stock in the surviving corporation, you get no appraisal remedy
o Literally anything can be merger consideration
o Appraisal remedy was a compromise—allows people to get cash in exchange for losing
stock ownership if they didn’t like the deal
Hostile takeovers
o Hostile takeovers = takeovers without consent of management
o Takeover defenses are permitted
 Justified b/c the hostile takeover can be abused to disrupt target’s business
 Can be important bargaining tool to get better price for shareholders
 But board could use them to keep themselves in office
 Double edged nature = entrenchment vs. legitimate protection of corporate
interests
Ways to Merge


Three types of transxs
o Buying assets
o Buying shares
o Merging
Existing SHs
o Either stay involved by receiving stock of acquirer
o Or become uninvolved by receiving cash
Asset acquisition



T sells assets to A
o If substantially all, then requires approval of majority of T’s SH (DGCL 271)
o Generally need approval from both A and T board
T liquidates and gives cash/stock consideration to T’s SHs
Policy
o Disadvantages:
 Some assets can’t be transferred without affirmative approval of third party
 Inelegant and cumbersome, need to describe all assets in contract
 Different “transfer rules” for some asset types
o Advantages:
 Dissenting shareholders don’t get appraisal rights (DGCL 262)
 Acquirer doesn’t automatically assume all liabilities of the target
 But limited — some liabilities automatically transfer with ownership of
asset, and major debt Ks restrict debtor’s ability to sell off the asset
 Sometimes tax reasons to do an asset sale instead of a merger (asset can be valued
at the price you paid for it)
47
Acquiring shares of T, tender offers




If only small number of SHs at T, single contract
In public corp with tons of SHs, tender offer
o Governed by Williams Act 1968
Tender offer rules
o Disclose terms to T SH, corp, and SEC (Rule 14d-3)
o Corp respond with rec (Rule 14e-2)
o Offer open for minimum 20 days (Rule 14e-1)
o Same offer open to all SHs of same class (Rule 14d-10)
o Bidder cannot buy outside tender offer while ongoing (Rule 14e-5)
o If more SHs tender than threshold, must accept pro-rata (Rule 14d-8)
o Special rules for corp tender offer of own shares (Rule 13e-1)
o Penalties for breach of rules, materials misreps, and omissions (§14(e))
Squeezeout
o Some SHs inevitably don’t sell, so A must follow with squeezeout for full control
48
Merging Corps



Combine into surviving/resulting corp with all assets/liabilities of two corps (DGCL §259)
o Stock-for-stock merger, T’s SHs keep stock in new corp
o Cash merger, T’s SHs no longer involved
Approval
o Board of both A and T (DGCL §251(b))
o Majority SHs of both A and T (DGCL §251(c))
Exceptions to approval
o If small, cash deal (251(f)): no A shareholder approval needed if (1) surviving corp’s
charter isn’t amended and (2) surviving corp issues less than 20% of new shares in
merger.
o Short-form merger (253(a)): when corporation already owns at least 90% of voting stock,
approval of subsidiary’s board/SH never required, but approval of parent’s SH isn’t
required if parent is surviving corp, and charter isn’t changed
o Back end squeeze out (251(h)): approval by remaining target shareholders isn’t required
if (1) target is public corporation; (2) bidder acquires majority of shares in prior tender
offer and (3) price paid for merger consideration is same as tender offer
49
Appraisal

Subject to (DGCL 262)
o can request to receive “fair value” of shares as appraised by Chancery court, rather than
the merger consideration/price, using all accepted valuation techniques
 remember, it could be less than sale price, so there’s always downside, whereas
litigation would not risk going lower
o Elements
 shareholders (DGCL 262(a))
 not the shares themselves
 who don’t vote for the merger (DGCL 262(a))
 not just vote against, but passively don’t vote for
 and hold the shares through the effective date of the merger (DGCL 262(a))
 and deliver demand to corporation before the vote (262(d))
o Appraisal rights are available for shareholders of both corporations (262(b))
o Market-Out Exception: appraisal not available if
 you hold stock in (262(b)(1))
50

public company, one with more than 2k SHs, or one where SH approval
wasn’t required under 251(f) (small cash deal merger)
 and merger consideration is
 stock in surviving corp (262(b)(2)(1))
 or other public corp (or held by more than 2k SHs) (262(b)(2)(2))
o Short form merger exception
 parent’s shareholders don’t have appraisal rights (253(c)/(d), 262(b)(3))
Mixing and Matching Transx Types




in real world
o use two or three of these transx types
o create a sub specifically for transx
o mixing/matching eliminates most differences btw types
e.g. back-end squeeze-out
o start with tender offer to buy shares
o then merge target into acquirer and pay off rest of SHs (with cash or stock in acquirer)
 can be forced if acquirer got controlling majority in tender offer
 and if tender offer done in agreement that specifically intends squeeze-out, then
DGCL 251(h) says no need for target SH vote for merger
another difference is ultimate location of T’s assets
o share purchase put T assets in sub of A
 but can get other result by just merging after asset purchase
o asset purchase and merger put T assets in A
 but can get other result by just using sub to purchase (triangular merger)
choice btw
o mostly governed by tax, accounting and delay
o for hostile transx = tender offer is only real choice
 because merger and asset purchase require T board approval
 in which case would need to do proxy context and replace board first
Policy
 For firm: acquisitions affect substantive organization of the business (especially for the target)
 For social allocation: reallocate large pools of assets to different management, and possibly
different economic tasks (ex: FB and Instagram)
o Capital structure of the corporation changes
 For corporate governance: just the threat can incentivize boards to do a better job
Controlling Shareholders in M&A

Issue
o No risk of hostile acquisition since controlling SH has power to decide
o Opposite risk of controlling SH forcing MA to benefit self at expense of corp
 1) if controlling SH wishes to buy rest of corp
 2) if controlling SH wishes to sell controlling stake
51
Squeeze-Outs





“going pivate” if corp is public
Good reasons for one
o Private corps don’t need to make filings
o No more conflicts of interest to manage
o More motivation because 100% of benefit
o if we don’t allow squeezeouts, there will still be a bunch of conflicting SH action and
stealing little bits of money over time, not clear which is worse, at least we have clear
structure afterwards
o having to constantly cleanse everything is inefficient
o synergies (one marketing dept instead of two)
o if we prohibit squeezeouts, we’ll see bad pressure on minorities
 e.g. threat to sell to drug cartel who will loot (if we didn’t have looter doctrine)
o if we prohibit squeezeouts, controlling will abust corp and buy fancy jets
Merger has huge conflict of interest
o Dollar less for minority is dollar more for controlling SH
o Therefore heavily policed in duty of loyalty and through Rule 13e-3
Default SoR = EFR
o Burden shift to P with approval of board special committee or minority
o BJR with MFW
Note: EFR doesn’t apply to short-form mergers (DGCL 253)
Overview of squeeze out mergers
 Set-up = controlling shareholder who owns 100% of a holding company and less than 100% of a
subsidiary
 When two entities merge, minority shareholders get consideration (can be anything)
o Still have appraisal rights (unless public company share swap applies)
 Standard of review:
o Involves self-dealing, so for CSH would be subject to entire fairness std
 Self-dealing b/c CSH benefits by taking over the company
 Economic conflict: every dollar going to the minority shareholders is a dollar less
for the company
o Can be subject to BJR if from the outset the CSH:
 (1) Appoint an empowered special committee, and
 (2) Make offer contingent on vote by majority of minority
o For short-form squeeze outs:
 No need for a special committee
 Controlling SH is subject to BJR
 Policy: huge number of squeeze-out cases get into court b/c they’re direct actions, not derivative
actions, so no demand requirement
52
What options do courts have to deal with squeeze outs?
 (1) Prohibit squeeze outs b/c too much conflict
o Costly and bad, b/c we’d end up with many inefficient corporate structures lying around
 (2) Allow squeeze outs, but ensure full valuation hearing at trial
o Would cause expensive litigation, inefficient
o Messy, both sides would be lying to judge about
o Could also be worried the judge is biased
 (3) Glassman/MFW standard and give CSH ways to get around entire fairness
o What courts end up doing!
o Typical of DE — structured incentives for CSH to use procedure where someone wellsituated decides
o Not perfect, but best option
 (4) Allow squeeze outs as long as there’s shareholder approval (formalist)
Management buyouts
 Management buyouts = when an outside buyer wants management to stay, so they join the
buying team. This creates a conflict
 Held to same standard as squeeze outs, because management has conflict every time
Weinberger v. UOP, Inc. (1983):



Takeaways
o MFW is super useful, but it can take things out of your hands and tie you to scary results
o So maybe best thing is to have nominally “independent” people who will do what you
want
Facts
o Signal acquired majority stake in UOP, put 6 of 13 directors on the board and replaced
CEO with a Signal employee. Signal had cash on hand; did study saying they could do an
acquisition of $24, but decided to do cash-out merger with UOP for $21. Two directors of
both UOP and Signal did a report using internal UOP information, but only shared the
report with Signal. Signal wanted to acquire UOP b/c it’d cut down on conflicts of
interest and they called it an “outstanding investment opportunity,” meaning they’re
admitting they’re lowballing UOP.
Note: Signal could have just paid their extra cash out as a dividend; just acquiring for the hell of
it (not questioned here b/c was common in the 70s/80s)
53




Holding: Signal was self-dealing in the merger, so it’s held to entire fairness standard.
Transaction violated fair dealing, so Ps win.
o Even though minority shareholders approved deal, vote wasn’t an informed one b/c
material information was withheld (report)
o Court also says for fair price — court can use any valuation method accepted in finance
(more flexible approach)
o Replaces business purpose test (old std for squeeze outs) with entire fairness
Directors argued: they owed a duty of loyalty to Signal, not UOP
o Court responds: you also have a duty of loyalty to UOP! If you want to be a fiduciary to 2
corporations, that’s your problem if they conflict
Footnote 7: court says the case would be different if UOP negotiated with an independent
committee
Policy:
o Weinberger brought fiduciary duty claim (even when he could have gotten appraisal) b/c
class is bigger, so can get bigger recovery  this matters for the plaintiffs’ attorneys
 Appraisal: only those who voted against merger have claims
 Fiduciary duty: any shareholder can be in the class
 Also, in fiduciary duty claims, your downside is capped — have already gotten
merger consideration, and could potentially get more. With appraisal, you are
forgoing merger consideration, and if the court does appraisal you may get less
 Once fiduciary duty claim gets into court, get most favorable standard of review
(entire fairness)
o Case highlights the story of DE corporate law
 Started out with formalistic business purpose test, then moved to standard where
boards can get away with more (squeeze outs for barely any consideration are
permitted)
 But beefed up fiduciary duty review b/c DE judges are expert enough to handle a
more flexible standard
MFW - Kahn v. #MFW (2014):



Facts
o M&F owned 43% of its subsidiary, MFW, and wanted to acquire it. M&F took two
measures to protect the shareholders before negotiations: (1) required merger to be
negotiated by special committee of independent MFW directors and (2) merger be
approved by a majority of disinterested shareholders (non-waivable). Special committee
was empowered — had own lawyers, etc., and negotiated price up by $1 (seems marginal
but represents millions of dollars). Merger was approved by minority SH.
Holding: BJR is the applicable standard in squeeze out mergers when the deal upfront is
conditioned on (1) approval of a special committee of independent directors and (2) uncoerced,
informed minority shareholders.
What’s really new here = court makes price into a procedural inquiry
o If court applied entire fairness, M&F would have won on fair dealing
o So here, court is essentially saying “fair price” is achieved when the parties engage in a
process that replicates arms’ length mergers
 Courts don’t want to have to figure out valuations (Evercore came up with $15$45 valuation range for MFW)
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 Better for parties to adopt process that will deliver fair result
o “Fair price” determination used to be complicated battle of the experts that’d always be
litigated at trial
o This matters b/c cases will be dismissed at summary judgment instead of going to trial
(what happened here)
NB: MFW is good law generally for conflicted transactions! Not just squeeze-outs
Policy:
o Is the committee really independent?
 No — of the directors was elected to the board of another subsidiary 2 years later,
but court says it’s ok
 Court knows there are soft conflicts, but the courts are capacity constrained so
something has to give
 Could be constrained by their reputations
o However, the process will never replicate an arms’ length transaction b/c:
 (1) If the special committee fails, the parent/CSH will take them off of the board.
So they have incentive to make the deal go through
 (2) Main leverage you have as a seller = sell to someone else. But MFW can’t do
this, because M&F said they’ll never sell their stake
Sales of Control
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Issue: controlling SH has no incentive to insure that buyer will treat minority well
Mandatory bid rule
o Require buyer of controlling stake to offer to buy out minority at same price
o Used in UK, EU, Australia
Market rule
o Controlling SH has right to sell at higher price and receive control premium
o Exceptions
 1) seller liable if buyer loots corp and seller had reason to suspect and didn’t
investigate suspicion
 2) seller cannot accept payment for “sale of office”, i.e. installing individual as
officer, but can agree to do so as part of sale
 3) very rarely, if sale of control “diverts” corp or collective opportunity (Perlman)
In Re Delphi Financial Group Shareholder Litigation (2012): Robert Rosenkranz took Delphi public
and held Class B stock that had outsized voting power. Rosenkranz also owned RAM, which had
contracts with Delphi. In the company’s charter, provision said that upon the sale of the company, class
B shares would be converted to class A. TMH wanted to take over Delphi, and made offer for $46, even
though Class A was trading for $22. Rosenkranz said he wouldn’t sell unless he got separate
consideration. Delphi creates special committee, and TMH ends up offering $54 to Rosenkranz and $45
to minority. At shareholder meeting, repeal charter provision to say that Class B stock converts upon
merger.
 No statutory rule was violated  charter was amended via a shareholder and director vote
 Holding: Rosenkranz gave up his ability to get a control premium at the IPO, so repealing the
charter amendment violates the charter. But because of how far into the deal the company is,
stopping the deal would harm the minority.
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o No injunction; court will hold damages hearing later.
Even though Rosenkranz gave up control premium to raise more money at the IPO, he also gave
himself a full veto (which could be worse for minority in the end), so maybe this did merit an
extra premium
Shareholders end up winning twice:
o The deal goes through for a huge bonus over the share price
o Ex post, Rosenkranz gets millions taken away in settlement
Chancellor is convinced that the original charter provision says that Rosenkranz gave up his right
to a control premium — but all it says is that Class B converts upon transfer
o Both sides have veto right here (class A still needs to approve of the deal, so they still
have some power)
o Charter never explicitly said he’d be giving up his control premium
Policy: case highlights dilemma in sales where there’s a CSH
o CSH wanted to give minority a proportional price to raise money at the IPO, but retains
veto power
o But provision that seems helpful (conversion w/o control premium) could end up hurting
the minority (b/c CSH still has veto right)
Hostile Mergers and Takeover Defenses
Overview of law
 Unocal: Board has power and duty to oppose bids it sees as harmful. Blessed discriminatory
defensive measures
o Board can respond to a takeover threat if:
 (1) They meet the business judgment rule standard (disinterested, good faith,
reasonably informed)
 (2) The response is reasonable to the threat
 Moran: poison pill is a permissible response to any hostile takeover threat, not just a coercive
measure (making other defensive measures unnecessary)
 Revlon: poison pill is ok to adopt as a preemptive measure, but once it’s clear the company is
selling, fiduciaries can’t consider any other constituency besides getting the highest price for the
shareholders
Why would board resist
 Business reasons
o Believe offer price too low
 Personal reasons
o Want to perpetuate themselves in office
Takeover Defenses
 White knight
o Find another buyer you like better
o Buy big enough part of corp to stop initial A taking control
 Could offer them discounted price
o Or knight may be willing to buy whole corp at higher price
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Poison pill (court approved in Moran)
o Gives all SHs right to acquire shares of corp at cheap prices if tender offer launches
o Only way to avoid is proxy contest (if staggered, takes years)
o Board can decide if and when to adopt pill, no SH approval required
o Board can easily revoke pill
o Remember slight parallel to DGCL 203
 Must wait 3 years between when you buy stock and when you can acquire
 Post-takeover ratification disables 203 if 2/3 of remaining shareholders and new
board approve
 Only applies when stock is acquired against wishes of sitting board
 Policy: not as restrictive as pill, b/c leaves avenue for hostile takeover
Permissibility of Takeover Defenses
 Permissible but enhanced duty (Unocal)
o Because of “omnipresent specter” that board acting in own defense, defense has to be
reasonable in relation to threat posed
o Two steps
 1) does board have reasonable belief that takeover constitutes threat to corp
enterprise
 Very low bar now, even lower price counts as threat, “substantive
coercion” has hollowed out Unocal
 2) is defense measure reasonable in relation to threat
 Poison pill permissible (Moran)
o Specifically to a threat of substantive coercion
o All corps have a “shadow pill,” they can adopt pill formally as soon as threat emerges
 Only real limit in sale (Revlon)
o If board decides to sell or break up company, turns into auctioneer and must get highest
price, cannot use defenses to play favorites or protect non-SH constituency
o Obviously applies in cash sale
o In stock-for-stock, only applies if there’s a “change of control”
Deal Protection
 Protections in merger agreement to make it more expensive for another A to come in
o Similar to takeover defense, but protection of transx not company
 Forms
o T board limited from seeking bids
o T required to pay termination fee if accepts other transx
 Balances two concerns
o They might prohibit efficient transxs (buy scaring away other A who would pay more)
 Would violate Revlon duties
o They might incentivize efficient transxs (lower risk for initial A)
 T has to commit at some point
o To sort btw them, courts do very detailed factual analysis
Coercive 2-tier tender offers
 V1 > V2, you tender no matter what (or how big X is)
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o If others tender, you get V1
o If others don’t tender, you still get X no matter what you do’
Others
Tender
You
Tender
V1, V2
No tender
V2
No tender
X
X
Unocal v. Mesa Petroleum (1985):
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Spamann’s High-Level Summary
o Unocal: "the board ha[s] both the power and duty to [defend, i.e.,] oppose a bid it
perceive[s] to be harmful to the corporate enterprise.” However, there is an "enhanced
duty which calls for judicial examination at the threshold before the protections of the
[BJR] may be conferred. … directors must show that they had reasonable grounds for
believing that a danger to corporate policy and effectiveness existed.” “the directors may
not have acted solely or primarily out of a desire to perpetuate themselves in office.” “If a
defensive measure is to come within the ambit of the business judgment rule, it must be
reasonable in relation to the threat posed.” “However, they satisfy that burden `by
showing good faith and reasonable investigation…’ Furthermore, such proof is materially
enhanced … by the approval of a board comprised of a majority of outside independent
directors.”
o Does this mean that the courts will scrutinize if the defense is proportional? No, they will
defer to the board as long as the board "show[s] good faith and reasonable investigation."
o "Threat" has been understood very liberally by subsequent decisions -- it is enough that
the board considers the offer too low and fears that the shareholders might see it
differently (i.e., accept the offer) ...
Facts
o Mesa owned 13% of Unocal stock and initiated two-tier cash tender offer for 37% of
stock: offered $54 on “front end” until he reached 37%, and then he would offer $54
worth of securities (junk bonds) on “back end” for rest of shareholders. Unocal Board
adopted defensive measure where board launched own tender offer for $72, excluding
Mesa (costs Unocal $6b in debt). At first, would only trigger tender offer if Mesa
acquired 37%; then, after SH pressure, agreed to make offer unconditionally.
Holding: In a defensive measure, the board is held to BJR + enhanced scrutiny (reasonable
response to a threat). Here, board was disinterested, acted in good faith and gave a reasonable
response to the given threat.
o Test for defenses:
 (1) Is there a given threat to the corporation? (leaves room for board to think
about other constituencies besides shareholders)
 (2) Was the defensive response by the board reasonable?
Board flipped collective action problem to make V2 > V1
o Allowed to exclude Pickens b/c the whole point of the scheme was to exclude him
Court suggests “grossly inadequate price” is a legitimate threat that the board can protect against
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When Unocal overpays in the self-tender (bankers said the company was really worth $60), the
value of Pickens’ stake goes down
o If you eliminate shares by buying them back at the fair price, value of each stake in
company stays the same
o If you eliminate shares by giving them out for free, value of each remaining stake gets
bigger (b/c same size pie but divided into fewer pieces)
o If you eliminate shares by overpaying for them, more money is flowing out of the
company than shares left, so each remaining share is worth less
Pickens was also engaged in greenmail (permitted by DE courts):
o Greenmail = a SH goes to board and threatens to do tender offer unless board buys back
the stake for a higher price
Could argue: the court is sanctioning both 2-tier coercive offers and greenmail here! Could have
just prohibited them outright
Alternative = could have outlawed coercive tender offers altogether, or reviewed them under
entire fairness review
Policy:
o Pickens’ credibility  he may have been bluffing the whole time! He took a stake in
Unocal, and he may just want the share price to go up so he makes money on his trade
o Court calls Pickens a “raider,” said he was “coercive” — doesn’t like him. Likely
contributes to why result came out this way
o Board is actually going farther than just neutralizing Pickens’ offer, b/c they’re
fundamentally changing the structure of the company
 Also sanctioning a coercive defense against a coercive attack
o In reality, unclear how much work the “plus” is doing (if you’re exercising BJR you’re
probably ok; a reasonable response is part of BJR)
o The board is really the one who is protected here
 Shareholders are subject to 2 coercive measures, so never really deciding which
deal to take
 Even if the $54 was a great offer, shareholders could never take advantage of that
#Poison pills
 Flip-in provisions:
o (1) Company issues a “right" via a dividend to each share
 Unilateral action — board can just vote and adopt a rights agreement (via board
resolution)
 Before “acquiring person” reaches % threshold:
 Rights can’t be exercised
 Board has right to redeem them at 1 cent/right (they’re worthless)
 NOTE: “acquiring person” includes any other affiliated corporations
o (2) Buyer reaches threshold and becomes “acquiring person”  “stock acquisition date”
 Board can’t amend or redeem the rights
 Rights can’t be transferred
 Acquiring person’s rights are voided automatically
 Exchange period:
 Board can exchange each right for one share of company’s common stock
 This dilutes the shares
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 If the board doesn’t exchange rights, we go to the exercise period
 Exercise period:
 Shareholder pays “exercise price” (under market price, typically ½ of
common stock’s FMV) for each additional share of their own company’s
shares
o Extent of the ensuing mayhem depends on the ratio of the exercise
price and the FMV
o Higher the ratio, the more shares will be issued and paid for under
the rights plan
 Since underpriced, everyone will do it
 Also will dilute the acquirer
 Money exchanges hands, balance sheet balloons and it causes companies
to self-destruct b/c they aren’t equipped to handle the volume of trading
o (3) “Distribution date” — 10 days after stock acquisition date
 Rights can be separately traded
o Acquiring person can trigger threshold by:
 Tender offer
 Buying up shares
Flip-over provisions:
o Instead of the “exercise period,” we have:
 Shareholder pays “exercise price” (under market price, typically ½ of common
stock’s FMV) for each additional share of the acquiring company’s shares
o Agreement allows you to purchase acquirer’s shares so the pill won’t look too crazy! In
reality, could allow shareholders to purchase anyone’s stock
 Acquirer doesn’t have to comply with agreement, but issuer does — so could put
target in default
Only way to get around a poison pill = proxy solicitation
o Replace board, and vote to remove the pill
Pill has only been triggered once since it was invented in 1985
o Had 5% threshold, and bidder thought it was fine to be diluted to 2.5%
o Consequence was total mayhem — tons of cash flew into the corporation, violated stock
exchange rules and got suspended from trading
Real purpose of the pill = deterrence
o Nobody actually wants to trigger it, and empirically this deterrence factor has worked
Moran v. Household (1985)
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Spamann’s Takeaways
o allows the pill -- a blatantly discriminatory defense that
o is unilaterally deployed by the board (no shareholder approval necessary)
o does not change the corporation's assets or financing (it is costless in that sense)
o 35 years of experience have shown to be insurmountable except by a proxy fight to
replace the board
Facts
o In 1984, Household Board adopted a Rights Plan as a preventive measure. Plan was flipover: if 20% of shares are acquired rights are issued and are exercisable for 1/100 of a
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preferred share. If rights aren’t exercised and a merger occurs, then the rights holder can
exercise the right to purchase $200 of the common stock of the tender offeror for $100.
Moran was a director of Household and chairman of DKM, which was the Household
CSH, and wanted to take over Household.
Holding: Directors receive BJR in adopting poison pill, and they’re allowed to do this before a
threat has arisen.
Question 1: is the poison pill legal?
o DGCL 157: allows board to issue rights for the acquisition of corporate stock
 Allows corporation to issue rights to purchase this corporation’s shares, but
poison pill allows purchase of the acquirer’s shares
 Court is fudging on this a bit
o Court says it’s ok if 157 wasn’t designed as a takeover defense (opposite of Schnell)
 Compare to Glassman: there, court read 253 as eliminating entire fairness review
based on intent of the legislature, but didn’t give any evidence. Here, the court
does the opposite b/c it says P has to prove legislature never meant for 157 to
permit pills
o Also says that the rights aren’t sham rights b/c Crown Zellerbach involved issuing real
rights (but that case didn’t have self-destructive feature)
Question 2: does pill contravene allocation of power between SH and management?
o Court says there are ways shareholders can get around it
 Counter: SEC filed an amicus brief saying pill will stop all hostile bids
o In reality, court wants corporations to stop doing crazy things (that ere fundamentally
changing the structure of their businesses) to defend themselves against hostile takeover
bids. So decided to just stop hostile takeovers altogether
 Couldn’t police other defenses (if you just sell an asset that’s not market-traded,
hard for courts to know its value, so permitted under BJR). Didn’t want a Van
Gorkom situation
NOTE: no 2-tier coercive offer here. Simply a tender offer, so only potential threat could be too
low of a price.
Policy:
o Example of a decision where the court pretends it isn’t making a big change, but it ends
up being a huge change. De facto every DE corporation has a poison pill, which makes it
impossible to take over a company without a sitting board member. So the only way is
through a proxy fight
o Case is highly political — SEC intervened against the pill (3-2 vote), United Auto
Workers intervened in favor of the pill (were worried takeovers would result in
outsourced production), Moran was head of RNC
o Anti-takeover view vs. pro-takeover view:
 Anti-takeover = firms get shut down, factories close and jobs are eliminated (but
note, not empirically true)
 Pro-takeover = companies are worth more if they’re broken up (very random
conglomerates in 80s)
Revlon v. MacAndrews & Forbes Holdings (1986):
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Spamann’s Takeaways
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o "[W]hen … it became apparent to all that the break-up of the company was inevitable
[and] that the company was for sale … [t]he duty of the board … changed from the
preservation of [the] corporate entity to the maximization of the company’s value at a
sale for the stockholders’ benefit. This significantly altered the board’s responsibilities
under the Unocal standards. It no longer faced threats to corporate policy and
effectiveness, or to the stockholders’ interests, from a grossly inadequate bid. The whole
question of defensive measures became moot. The directors’ role changed from defenders
of the corporate bastion to auctioneers charged with getting the best price for the
stockholders at a sale of the company."
o Can the board still differentiate based on the acquiror's business plan, or plan for the
workers, creditors, etc.? No! Those are irrelevant for shareholders once they receive the
deal consideration.
o Is the bottom line dollar figure all that matters? No, not if the deal consideration also
differs on other dimension: (1) closing certainty (think conditions, antitrust risk, etc.), (2)
type of consideration (shares vs. stock)
o Are all deal protections prohibited (e.g., termination fees)? No, they can be used to
induce bidders to come forward in the first place.
o Does the board literally have to run an auction? No, it just needs to run some process that
it can reasonably argue maximizes the price received by shareholders.
Facts
o Ron Perelman tried to buy Revlon at $47.50, but Revlon’s CEO (Bergere) rejected him
— installed pill and launched exchange that involved exchanging shares for notes and
options. Revlon also made deal with Teddy Forstmann where he got access to Revlon’s
data, he got an asset lock-up, a no-shop as well as a cancellation fee, and the covenants
on the notes were waived (covenants = prevent notes issuer from making certain business
choices, so notes holders are protected from default). Notes holders were furious, so
board then asked Forstmann to promise to support the notes in exchange for $25m lock
up and assurance to buy part of Revlon’s business for $100m under value. Pantry then
engages in fractional bidding (agrees to always offer slightly more than highest bidder).
Board gives dubious reasons for accepting Forstmann’s offer:
o No indication financing was firm
o Price wasn’t a good reason b/c Pantry said it’d keep raising its offer
o Very uncommon for notes covenants to be waived by debtor, showing they were phony
notes from the start
o Shows problems with board changing its mind about its defense  first it issued the
exchange, then it wanted a white knight
Pantry is actually using fact that Forstmann has access to information to their advantage
o Typically, if you bid against someone with information, you only win the auction if
you’re overpaying
o But Perelman said he can pay at least the amount Forstmann came up with when he had
more information, so capitalizing on getting close enough to the optimal price
Exchange offer is actually a coercive self-tender (like Unocal)
o Offer was oversubscribed (83%) — meant it was a good for the shareholders who were
exchanging, but bad for the rest collectively
o Revlon offered to exchange 1/3 of stock against notes
o Only 1 of 3 shares are accepted  so people still held their other 2 shares in stock
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o Therefore, the two shares that weren’t exchanged had lower value as cash flowed out of
the corporation
Holding: Once it became clear the company was going to be sold, the directors had a fiduciary
duty to get the best price for the shareholders.
o Corporation can’t act to protect the note holders once it agrees to sell the company
o Initial defensive tactics (poison pill) was ok, but situation flipped when Revlon started
negotiating with Forstmann
Court was also upset about the lock-up b/c it stifles competition (when it’s clear you’re selling,
b/c deters bidders)
NOTE: Whole decision took 7 days. Court had way more time in Moran than here
When are Revlon duties triggered?
 Time-Warner (1989): Revlon duties (duty to get highest price) isn’t triggered if corporation isn’t
broken up, and was widely held both before and after the merger
 Paramount (1994): if control of corporation shifts from shareholders to one controlling
shareholder, that’s enough of a change in control to trigger Revlon duties
Liability
 Unocal and Revlon liability isn’t available to support claim for monetary damages (only
injunctive relief)
 Corwin: when a transaction isn’t subject to entire fairness (as is the case with takeover defenses)
and is approved by a fully informed vote of disinterested SH, BJR applies  only get liability,
not monetary damages
Staggered boards
 Staggered boards were a non-issue until hostile takeovers
 When a company has staggered boards + a pill, the hostile bidder needs 2 proxy fights that are
spaced out over time (ex: Airgas)
 Debate over staggered boards:
o Pro staggered boards: boards can’t respond to short-term threats all of the time
o Against staggered boards: boards are entrenched, can unlock value by holding boards
more accountable
 Over last decade, staggered boards have disappeared after Shareholder Rights Project
o Shareholder Rights Project = precatory resolutions passed by shareholders to de-stagger
the board
 To destagger the board, must change charter  requires a board resolution
 Shareholder vote standing alone can’t change anything, so has to be advisory vote
 Then SRP went to boards and asked them to destagger
o Why did boards agree to destagger?
 Board had legal ability to withstand pressure, but not the psychological ability
 Similar to Unocal (board did conditional self-tender, but after SH rebelled,
Unocal board changed course) and Revlon (board protected note holders when
they complained) — both boards didn’t have legal obligation to change course
 Shows how people don’t go all the way to the extent of their legal power
o Why did the SRP have so much impact?
 We don’t really know
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One theory: most large investors are highly diversified, and evaluated relative to
their peers, so none want to incur the cost of governance
 Counter: there are actively managed funds that could have theoretically
done this and gotten an extra 4% on destaggering the board, but they never
did
Other theory: unclear whether destaggering the board would actually result in
higher value
Institutional investors never initiated it, but once it was there they agreed to it (but
they also buy IPOs of firms that do have staggered boards)
Short-terminism
 Concern with short-terminism = if board is exposed to outside pressure all of the time (i.e.
through a hostile bid), then board caters to short-term concerns
o Ex: cut R&D today (long-term investment) to get higher cash flows. Results look good
today, but no new products in 3-5 years
 Debate also arises with shareholder activism
o Shareholder activist: hedge fund that buys a stake in a company and approaches board in
private to make changes to increase the value of their stake
o Works b/c often there’s too much pressure for board to resist
o Also use threat of proxy fight to get 1-2 people on the board
o Short-terminism problem arises b/c activists aren’t there for very long; don’t care what
happens later
 HS: short-terminism view is unfounded
o Markets aren’t short term; they price in future developments (barely profitable companies
like Amazon are very valuable)
 If activists made a company’s value go down, the share price would go down
o Maybe PE firms can snap companies up for so cheap b/c corporations are mismanaged
o Activists get board to pay out cash  means there’s fewer shares outstanding, but less
money in the corporation, so value per share says constant
o Politicians criticize corporations for paying out money to shareholders and sucking
companies dry  but this is the point of investing! Want to make money you can pay out
to investors in the future when you're growing
 Counter: to stave off shareholder activist, companies may do things like inflating sales numbers
(different kind of short terminism)
Merger Litigation and Virtusa

DE case law makes it difficult to challenge mergers approved by majority of SHs
Virtusa Baring Merger with New Mountain Activist
 Facts
o Virtusa agreed to sell to Baring in lieu of NM proxy fight
 Common for companies under activist pressure to sell
o NM initially opposes deal claiming undervalue
o Parties settle
 NM agreed to withdraw all proxy nominees
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Virtusa promises NM one new board seat, reimbursement of $2.5 million, and
price guarantee for NM to sell Virtusa shares before merger closes
o Virtusa candidates win with 1/3 vote (because 2/3 vote just disappears when NM
candidates withdrawn)
Is this actionable self-dealing
o They paid $2.5 million to get rival directors out of picture
o We have a unocal duty of loyalty self-perpetuation issue
Procedurally actionable?
o You DO pass demand futility
 Whole board self-perpetuating
o But for derivative suit, P must own stock from time of violation through end of suit
 Here merger will extinguish derivate claimants stock ownership before end of suit
o Not financially viable
 Only 2.5 million, common fund (15%) of that won’t be enough for lawyers
Understanding structure of deal
o Notice role of declaations, sellers reps and warranties
 They don’t trigger indemnification later
 But they’re conditions to closing of sale
o Also couldn’t trigger indeminification because who would you sue?
 Baring would now own virtusa
 Would you go after millions of individual SHs? Contract with each one of them
beforehand?
 You could just have a holdback, put some money in escrow and say not paid to
SHs immediately, wait a couple years
o Hence in public deals, no indemnification post-closing, whereas in private deals you do
Consolidation (Van Gorkom and Ebay)
Smith v. Van Gorkom
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Facts
o Things moving very quickly, board makes decision to sell without fairness report (Based
on their experience and knowledge with business), CEO signing deals at the opera, etc
 Note you could swing “opera” fact other way and say it shows dedication
o Because they want to get the tax credits to count, they had tax credits they couldn’t use
o Note: directors were doing M&As for 10 yrs before this, they have tons of exposure to
the process
o There was a SH vote approving it but P says vote wasn’t fully informed because they
didn’t know Van Gorkom came up with the $55 sale price
Holding
o Merger fails BJR
 Board members were not informed (should have taken more time and gotten
fairness opinion)
 Their legal advice that they didn’t need fairness opinion, and that they
could get sued for refusing deal, doesn’t matter
 Note: damned if you do, damned if you don’t
 Cleansing methods adopted not effectual
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 “market test” totally ineffectual because of restrictions put on bids
o SH vote doesn’t matter because uninformed
 Board violated duty of candor by not disclosing basis for van gorkom proposed
initial price (even though it actually DID disclose that van gorkom proposed it)
 Note: there will always be something not in the proxy statement, so this comes
down to what court wants to make issue with
o Now seen as aberration, Disney shows step back
 Investment banker employment doctrine
 “pimp the deal” add fairness opinions to everything
Dissent
o All these board members are extremely experienced we can trust them
Policy
o Huge waste in fairness opinions
 Just takes money out of corp, so from SHs
o DE law is actually still in a good spot
 Today 102(b)(7) would get you out of liability just for not having fairness opinion
(no bad faith)
 And revlon demands good auctioning process
o Why not have liability for mistakes
 There are other control mechanisms
 Elections, compensation, etc
 Law may not be best because courts don’t have good standard to judge on
(vs. medical practice we have better standard for what good care is)
Ebay v. Newmark
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
Facts
o Three actions:
o 1) staggered board amdt (keep ebay off board)
 Effect is to limit ebay’s ability to place a director on the board because cumulative
voting won’t work anymore in any single election
o 2) rights plan (keep ebay from selling to third party)
 Prevents any of craig, friend, or ebay from selling entire block, would have to sell
in chunks less than 15%, so restricts liquidity of ebay
o 3) rights of first refusal (keep ebay off board)
 Condition that anyone who accepts the rights gets issued more stock
 Effect was to dilute ebay down to under 25%, because then even without a
staggered board ebay doesn’t have enough for cumulative voting
Holding
o Staggered board – survives normal BJR
 Court reviewed under BJR (not unocal) because it wasn’t conflicted transx and no
defense possible
 Note: usually a staggered board is a defensive measure with poison pill,
but here jim and craig had majority and ebay would have never been able
to execute hostile takeover, so no self-perpetuation possible
 To win, P must show interest, info, or bad faith
 Ebay argued interest and bad faith
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Court denies, says good faith because ebay stealing info with it’s board
seat, and no interest for reasons discussed above
o Right of first refusal – fails EFR
 Why EFR
 Jim and craig are on both sides (diluting ebay gives them more)
 Fails entire fairness because not fair price
 Ebay would have to encumber unencumbered shares
 Jim and craig shares already encumbered by their agreement
o Rights plan – fails BJR
 Why unocal BJR
 Court considers it defensive measure (even though they said staggered
board wasn’t)
 But poison pills so crazy they have no purpose except defense, will always
get unocal
 Fails BJR because
 Wasn’t grounded in effort to promote SH value, was just to preserve
“corporate culture”
 And would only matter after jim and craig die
Note: practical takeaways
o Ebay won litigation, but didn’t win the war
 1) ebay is off the board
 2) craigslist gets slap on the hand about SH primacy, but ultimately unenforceable
under BJR
 Court said “inc.” has to mean something
Old Outline for Ebay
Ebay v. Newmark (2010): Craig, Jim and Knowlton founded eBay. Knowlton wanted to monetize, so he
sold his stake to eBay, and eBay also compensated Jim and Craig. (Note: Knowlton was probably a
roommate/there at the founding).
 Jim and Craig invited their problems with eBay  Knowlton was just a minority shareholder, so
he couldn’t have really done anything (nor could have the person he sold to)
o All the minority shareholder can do is sue them left and right (costly)
o But Jim and Craig also didn’t have to give eBay a board seat (unclear why they did this)
 Why didn’t Jim and Craig just squeeze out Knowlton?
o Under MFW, wouldn’t have gotten BJR b/c Knowlton (the minority SH) wouldn’t have
approved the deal
o Would get entire fairness
 Could show fair dealing
 Couldn’t show fair price b/c too risky
 Very different subjective valuation methods — if they think that the stake
is worth $1m, but after litigation the judge says it’s $1b, that means that
Jim and Craig will have to monetize to cover the judgment
 So Jim and Craig let eBay be a shareholder and amended charter to give it certain rights
(cumulative voting to guarantee eBay a board member, and veto right for charter amendments)
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o Cumulative voting (DGCL 214) = for every board seat open at a given time, every share
gets 1 vote. You can cumulate your votes and put all of them on one candidate.
 Here, board has 3 members — so any SH with over 25% of shares is guaranteed
one candidate
 De facto proportional representation
 Without cumulative voting, the minority is outvoted every time
After a few years, clear that eBay can’t take over Craigslist, so they launch Kijiji. Jim and Craig
are mad that eBay isn’t playing fair (linking to their own site on Google, and taking information
from Craigslist). They send a letter to eBay CEO Meg Whitman, who tells them to go pound
sand.
On Jan. 3, 2008, Jim and Craig go nuclear — adopt a staggered board, a pill and a “dilution
plan” under which every shareholder who grants 1 extra share to each shareholder that gives
Craiglist right of first refusal
o Approved pill — board can unilaterally adopt, and eBay gave up its veto right when it
launched the competitor Kijiji (part of K)
 Purpose: prevents eBay from selling their stake (b/c 15% trigger threshold);
would make it expensive to sell
o Approved staggered board via charter amendment — board ratified, then as SH they
launched written consent to approve the amendment
 Purpose: takes away cumulative voting power, so takes eBay’s board seat away
o Dilution/ROFR — issuing new stock was disallowed under agreement at first, but eBay
gave up right when they competed. Board can issue new stock anytime via board
resolution
 Purpose: to also take eBay’s board seat away (backup plan)
 Corporation always has right to buy stock back. For Jim and Craig, this is
costless b/c shares are already encumbered (each other has ROFR already)
and they have no desire to sell. As a result, J + C get more stock and eBay
is diluted below 25%, so cumulative voting plan won’t work
o Altogether, the point was to remove eBay’s board seat and prevent eBay from finding a
way out (encumbers eBay’s negotiating position if it tries to sell)
Poison pill  held to Unocal standard
o Court says: anytime the pill is used, that is considered a takeover defense, so held to
Unocal standard
o Outcome: Craiglist loses
 Could have ended the case here by saying: pill = anti-takeover device; no threat of
takeover; so can’t use pill (narrower grounds)
 But Chancellor says action wasn’t reasonable, b/c a threat to corporate culture
(where you make no money) isn’t a legitimate threat
 You’re a DE corporation, so you have to be for profit
 NB: no language in DE statute mandating this; but it’s implied that
corporations exist to profit (otherwise why would you set this up)
Staggered board  subject to BJR
o Counter: this is clearly self-dealing! J+C wanted to get eBay off the board to give them
an advantage
o Court says that J+C got no special advantage b/c no financial benefit
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Said didn’t actually change the power J+C already had, since they already had 2
board seats, so weren’t trying to perpetuate themselves (except not true, b/c they
were effectively taking away eBay’s cumulative voting and thus its board seat)
 Said had a legitimate business purpose to keep eBay away from trade secrets
o Outcome: Craiglist wins; no breach of fiduciary duty
Dilution plan  entire fairness
o Why different than staggered board? Both seem equally like self-dealing
 Court says: asymmetric implication b/c J+C can accept at no cost, and eBay can
only accept at a higher cost. Therefore J+C are getting a benefit that eBay isn’t
 Maybe the difference is the financial benefit
o Compare with Sinclair: could argue some more abstract benefits in the dividend
payments
o Outcome: Craiglist loses; breach of fiduciary duty
So who won the litigation?
o Craigslist achieved goal of getting eBay off of the board (could keep staggered board;
backup plan of dilutive issue got struck down)
o Craigslist also won the war, since it’s still functioning
 Even after Chancellor said it had to monetize, continued to operate without one
b/c eBay never sued on that issue
 eBay knew it’d lose, b/c it’d have to sue for breach in duty of care, and that’s a
BJR standard
o In the end, eBay settled the CA suit (over the breach of K) and eBay sold its stake back to
Craigslist
Policy:
o Somewhat odd result, b/c the rationale for the fiduciary duties protecting the shareholders
is that shareholders don’t have other protections. But here, eBay is sophisticated and
could have contracted around some of these issues. Maybe shouldn’t have gotten
fiduciary duty protection
o Why doesn’t the court decide the pill issue on narrower grounds?
 Risk that once management argues its defending its broader culture, it’ll just be
acting to benefit itself
Part 5: Securities Law
Antifraud Rules: Rule 10b-5
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
Based on §10(b) of the Exchange Act
o Unlawful for any person to use in connection with purchase or sale of any security any
manipulate device in contravention of rules the SEC may prescribe
Rule 10b-5
o Unlawful for any person using instrumentality of IC, mail, or securities exchange to:
 1) employ any device, scheme, or artifice to defraud
 2) make untrue statement of material fact or omit that material if necessary to not
make statements misleading
 3) engage in anything which would operate as a fraud or deceit
o In connection with purchase or sale of any security
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 NOTE: any security, not just registered security, so it applies to private companies
Elements (paralleling common law fraud):
o 1) false or misleading statement
o 2) material fact
 “substantial likelihood that the disclosure would have been viewed by the
reasonable investor as having significantly altered the total mix of information
made available” (Basic 1988)
o 3) scienter
o 4) reasonable reliance on the statement
o 5) caused injury
o Prereq 6) in connection with purchase or sale of security (not decision not to transact)
Private rights of action
o Not mentioned, but courts implied one, allowing citizen suits and gov enforcement
Fraud on the Market (Basic 1988)
o SCOTUS interprets “reliance” req in broad way to allow class actions
 “a person who traded a corp’s shares on a securities exchange after the issuance
of a materially misleading statement by the corp may invoke a rebuttable
presumption that in trading he relied on the integrity of the price set by the
market”
 b/c any individual loss too small to incentivize litigation
 now “Rebuttable” presumption that, in trading, he relied on the integrity of the
price set by the market” after a misleading statement
o controversial
 congress tried to reign it in with PSLRA’s strict pleading reqs
 theoretically weak
 most people trade because they think the market price is not right, i.e. sell
high, buy low
General Policy
 Advantages of securities fraud class actions:
o More enforcement means people disclose more — information is more accurate, we
lower information asymmetry and markets are more liquid
 Accurate disclosure helps use stock prices for executive compensation
o Benefit from private litigation’s extra deterrent effect
o Maybe everyone benefits because deterrence improves the info environment and better
targeted executive compensation
o We don’t always want to respond to fear of side effects
 we know prohibiting drugs creates drug violence, we know hospitals do too many
C-sections, should we pile on punishment and keep trying to weed it out?

Disadvantages
o weak deterrence
 damages and litigation paid by corp, not officers/directors
o misplaces damages
 victims of fraud are those who traded, at expense of the innocent (those who
didn’t trade)
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 this is just a “subsidy for trading SHs”
 e.g. mutual funds who just hold on to stuff and don’t actively trade
o not info forcing
 they usually follow public enforcement actions that have already uncovered and
punished wrongdoing
o deters efficient law breaking
 E.g. uber, and that was socially beneficial
 But it’s scary if there’s an org that perfects evading law because it doesn’t just
mean evading good laws
o All corps break the law
 Company that had a designated signature forger
 You can never fully weed out organizational law breaking, like you can with an
individual and incapacitate them
 So comes down to big prosecutorial discretion, want people like DoJ Michael
Granston if we trust them
what’s ideal remedy?
o Calculate social harm, then have the penalty be greater than the harm (so that it’s not just
equilibrium, since not all misconduct gets caught)
o So that it’s not just “cost of doing business”
Basic Inc. v. Levinson (1988):
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

Facts
o Combustion wanted to acquire Basic Inc. From 1977 to 1978, Basic made three public
statements denying it was in merger negotiations. On Dec. 18, 1978, Basic said it’d been
approached for a merger, and on Dec. 19, Board endorsed Combustion’s $46 offer.
Respondents—former Basic shareholders who sold stock after the first statement (Oct.
1977) and before trading suspension in Dec. 1978—alleged they sold their stocks at
depressed prices b/c of misleading statements.
Holding:
o (1) Fraud on the market theory is acceptable to show reliance for class certification.
Fraud on the market = rebuttable presumption that petitioners relied on material
misrepresentation.
 Can rebut by showing others knew or there was another reason for the sale
o (2) Can show materiality in merger context if a reasonable shareholder would consider
the fact important in deciding how to vote. (TSC Industries std)
Rationale for fraud on the market theory:
o If market is efficient and the stock price reflects all public information, then if the
corporation lies, the price is wrong. So anyone who buys or sells relying on that price is
misled
 Makes reliance into a common issue
 It’d be impossible to show reliance for every single class member (couldn’t
physically ask them if they read and relied on the disclosure, and would create
individual, not common, issues)
o Idea = people who trade rely on the information
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Counter: people buy b/c they expect the price to increase, and they think the
company is undervalued! If the price is correct, you're not getting a good deal
(White’s dissent)
 Maybe people who invest for retirement are happy to buy at an efficient price (b/c
expect the whole market to go up over time)
 Counter: these people trade only once a month  when they get their
paychecks. Most trading volume comes from people who don’t think price
is correct
o In reality, court holds this b/c it wants to allow private securities class actions to exist
Materiality standard:
o Test = if there’s a substantial likelihood that a reasonable shareholder would consider the
information important in deciding how to vote; aka would it alter the total mix of
information made available
o Based on: (1) what’s the probability a merger will succeed? Court looks at “indicia of
interest” and how invested in the merger the company is; and (2) how big is the merger?
Policy: The court’s rationale makes no sense, so we end up with highly paid experts making
technical arguments that follow from the precedent but don’t make sense
o The real point of the case is to allow plaintiffs to bring securities fraud class actions
Wells Fargo Pt. 2 and In Re Signet Jewelers.

Takeaways
o Court can just ignore reliance, injury, and causation now with fraud on the market
presumption
o Lead P chosen by whoever has biggest financial stake, and deference to their choice of
lawyer
o Once you pass MTD, get settlement because discovery is huge burden
o Notice mismatch of penalizing “Fraud” when mad about the underlying harm
 E.g. you commit war crimes but sued because you lied to investors about it
 Hence ugly facts are useful even though the fraud isn’t necessarily greater
 So some try to bring social action as fraud, e.g. Facebook says they value
diversity but are lying to market and don’t
o Puffery
 In In Re Signet, what crossed the line from puffery was denying the seriousness
of thigns
Insider Trading
Background
 Trading on the basis of MNPI (material nonpublic information)
o Most countries have blanket prohibition, US more complex
Main Rules

Rule 10b-5: main rule for criminal prosecutions for insider trading
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o Prohibits trading on MNPI if its use violated a duty to disclose
 meaning in violation of relationships of trust and confidence
 doctrinal concession to fact that 10b-5 is fraud and it’s not obvious that insider
trader always defrauded someone
o since it’s criminal, don’t need reliance, injury, causation for public enforcement
 private litigation plays virtually no role in enforcing 10b-5
o so requires only misrepresentation of a material fact committed with scienter
 and prosecutors avoid when materiality of fact isn’t obvious
 so only need to prove
 misrepresentation
 scienter
o safe harbor provision for trading plans (Rule 10b5-1(c))
Wire Fraud (18 USC §1343) and Securities Fraud 18 USC (§1348)
o Much broader, to avoid hurdles of personal benefit test
o Blaszczak (2nd Cir. 2019) held that these provisions cover insider trading and don’t
require Dirk’s personal benefit test
Rule 14e-3 for tender offers
o Prohibits trading while in possession of MNPI about a tender offer
o Not directly based on fraud, broader than Rule 10b-5
Exchange Act §16
o 1) corp directors/officers/over 10% SHs must within 10 days disclose every transx of
corp’s securities on Form 4
o 2) gives corp right of action to recover short swing trading profits from
officers/directors/principal SHs
 Any profit realized by purchase or sale of any security within 6 months
Elements of insider trading under 10b-5:
 (1) trading in any “security”
o Security = any security or securities-based swap – not only publicly traded! (SEA
§3(a)(10))
o Can be a family fund, partnership interest, anything
 (2) “on the basis of”
o On the basis of = while aware of. If you have the info, presumed to be trading on it
o Exception: executive’s pre-committed trading plan (SEA rule 10b5-1)
 (3) material …
o Material = significantly affecting total mix of information available in eyes of reasonable
investor (Basic)
o Cannot be puffery (in re signet wasn’t because continued denying seriousness of things)
 (4) … nonpublic information (MNPI)
o Nonpublic information = not broadly disseminated
 (5) which is being used, or has been obtained, in breach of a duty
o Mere trading while in possession of MNPI (= “equal access theory” of insider trading) is
not enough. Rather, the information must have been obtained, or be used, in breach of a
duty (Chiarella)
o Must breach either of these fiduciary duties:
 Classical theory: duty to the company whose stock is traded
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Actual employees of the corp, or those who owe corp fiduciary duty
(lawyers or accountaints)
 Tipper must have derived some personal benefit under Dirks
o Makes no sense, should have been a whistleblower exception
o Even requires scienter, that tippee KNEW tipper would derive
benefit
o + burden of proof on prosecutor
Misappropriation theory: duty to the source of the information (e.g., O’Hagan,
cf. SEA rule 10b5-2)
 Where duty was procured in violation of a relationship of trust (not just to
company)
o info received pursuant to confidentiality agreement (Rule 10b52(b)(1))
 E.g. gov employee gets info about corp in role as employee
for gov, employee violates their employee agreement
o Between family members (Rule 10b5-2(b)(3))
 E.g. spouse violates duty to spouse who leaves info about
corp around
Hypos on Fraud and Insider Trading
 Classical always misappropriation, misappropriation not always classical
o Unless insider discloses to corp that he’s trading, because then disclosure cures the duty
of trust issue for misappropriation, but still liable under classical
 Finding something lying around
o Random person finds something on the street
 No liability, not even under 1343 and 1348
 But if it has tender offer info, liable under 14e-3
o You find something in your house
 If roommate
 Maybe  on norms established w/ roommate (Rule 10b5-2(b)(2))
 If established practice of duty of confidentiality, then yes
 If spouse/family
 yes because presumed (Rule 10b5-2(b)(3))
 Private exchanges
o SEC can prosecute still
o But you don’t get “fraud on the market” presumption
 If X and Y working on a deal
o If employee of X buys in Y, only misappropriation, because no duty directly to Y
 Hedge fund trading on own info about upcoming transx
o Not illegal, not violating duty to itself
o And it’s IMPT they be able to profit from this, they generate positive externalities for
others, otherwise they wouldn’t have incentive to do this
o But this is where people make the short termism critique if they don’t like hedge funds
coming in and doing this
 Private meetings and SH engagement?
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o Facial expressions are nonmaterial, that’s what all the hedge fund lawyers are saying
o Ironic though, because material is what a reasonable investor cares about, and clearly
they care enough about this to pay for access by transacting a lot with specific banks
o Notice though the hedge fund employee would be getting info straight from the issuer of
securities
 They’d have a duty directly to them through an NDA or something and therefore
potential classical liability theory if there was MNPI
Congressman?
o Nah not enough, and they passed statute saying no
Trading plans
o Note that if timing is fixed, directors can just change the flow of information to favor
their pre-planned transxs
o But you could say information flow harder to control
What’s still legal?
 As a non-fiduciary, trading on material, nonpublic information after disclosing to the principal
the intent of the trade
 Insider trading with MNPI that someone intends to make open market share acquisitions (as long
as the target doesn’t know about the intention, so no apparent misappropriation)
o For liability, MUST breach the duty owed to the target. Nobody owes a duty to the target
here, so no liability
 Overhear something inadvertently from someone and trade on it (unless tender offer)
 Trade on debt securities (no fid duty)
Enforcement
 One judge said (Gupta SDNY 2012)
o Insider trading is easy to commit but hard to catch. Violators therefore have to understand
that when they get caught they’ll go to jail.
 Hard to catch also a reason why you need public enforcement
o Private suits don’t have the resources and tools to get the info, e.g. wire-tapping
o Public enforcement also takes advantages of stock exchange monitoring reported to SEC
 Lack of incentive for private plaintiff lawyers
o Individual defendants have small amounts at stake (damages limited to gain derived by
defendant, Exchange Act §20A(b)(1))
Policy
 Why not implement equal access theory:
o Might reduce trading on leaks
o But might impede trading generally, and there’d be huge evidentiary problems
 Argument that insider trading should be legal:
o Reveals information to the market, so it moves the price closer to the fundamental value,
and makes the price more informationally efficient
o Saves resources of providing information (i.e. hedge funds would spend $ getting the info
through public sources)
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o Insider trading doesn’t create value, there are always winners and losers
 And there’s no “Fair” playing field with microtrading and hedge funds and stuff
 We just care if it helps investment
Argument against insider trading:
o Governance
 Temptation to make money insider trading would overwhelm incentives for good
business decisions
 Directors would just create volatility and exploit it
 At minimum distracting if they’re always thinking about how to capitalize
o Crowds out informed trading
 Some say insider trading actually gets the information into the market more
efficiently, after all it’s free and the insiders have it, don’t need to do research
 But it crowds out other kinds of information, more macro and systemic stuff,
agglomeration
o One gain is another’s loss, so shifts value to the insider, which could deter investment
 But losing against informed trader is normal part of trading?
o But then hedge funds or others won’t enter the market if they can’t compete with better
formed insiders
 Therefore, stock prices would reflect less information
o Better arguments:
 Insiders would be more reluctant to disclose information
 Insiders would intentionally increase riskiness of corporations’ business if they
could use info about risk realization to trade
 Ability to trade would divert insiders’ attention and warp incentives
Could have a system like Europe, where no trading on any MNPI  but ex ante, very hard to
figure out what’s material. So fiduciary duties draws a finer line
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Part 5: Non-Shareholder Constituencies
Civil and Criminal Enforcement (Wells Fargo/Cranston/Purdue Pharma)
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Enforcement a different animal, not about protecting SHs but about public and others
For Wells Fargo
o Real purpose is to protect customers
o Civil liability not enough because if there aren’t enough enforcement actions then
consumer fraud becomes profitable
o And you want penalty to be greater than social harm because you cannot catch every case
o Remember Cranston arguments above
For Purdue
o Three claims
 Direct liability under false claims act
 Don’t have smoking gun but believe you can prove Sacklers had scienter
of Purdue’s marketing
 Civil forfeiture claim, indirect liability
 Allows one to recoup proceeds of crime if can trace it back
 Fraudulent transfer claim, derivative suit
 Show Purdue alienated assets with intent to obstruct government’s ability
to recover from Purdue
o Unique remedy of public benefit corporation
 Argument between letting Purdue go bankrupt or turning it into PBC
 Bankruptcy runs risk that because opioid industry so toxic, wouldn’t find good
buyers that would avoid social harm in the future
 PBC route allows them to retool Purdue to not only maximize creditor returns but
combat crisis
 Make them produce opioid treatment drugs
Policy
 Why is criminal prosecution better than civil enforcement?
o Prosecutors can get wiretaps (SEC can’t)
o Prosecutors have more negotiating leverage (since harsher sanctions), so they can extract
more concessions from companies
 Plea vs. DPA
o Difference = whether company is admitting guilt (which can be important for PR and
follow-on civil suits)
 Prosecutors have deputized law firms to perform investigative function
 Goals of corporate prosecution:
o (1) Deterrence
 More aggressive enforcement tools are only available in criminal prosecution,
such as wiretaps
 Government can act as central enforcer on behalf of dispersed class of injured
parties who won’t have incentive to sue (collective action problem)
 Better to punish individual, but often corporate crime isn’t committed by one
person, so we deter by punishing organization
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Give management incentives to install preventative procedures ex ante
Pressure corporation (through threat of criminal liability) to produce information
that allows for individual prosecution
o (2) Incapacitation
 some organizations are so bad, it’s better to shut them down
 Only want to incapacitate (bankrupt) companies that have pervasively bad
corporate culture (ex: Arthur Andersen, Uber?)
 Otherwise, want to keep company operating
Tradeoffs
o (1) Calibrating deterrence so it’s neither over- nor under-deterrent
 Must account for probability of detection
 Corporations may be so sensitive to wrongdoing that even a mention of
investigation can cause harm, which blunts actual deterrence
o (2) Deterring bad behavior from happening, but incentivizing the corporation to
investigate once it’s happened
 Solved by giving a lot of benefit for self-reporting
Sentencing guidelines
 Purpose = “just punishment,” “adequate deterrence” and incentives to create internal
mechanisms (similar to director control liability in Stone)
 Adequate level of deterrence in corporate context is more complicated than in typical crimes
o If punishment was too harsh  company would have to close
o Those who would bear the consequences of the corporation shutting down (shareholders,
etc.) have nothing to do with the crime, and the employee who commits the crime doesn’t
pay the consequences
o Usual deterrence method may apply to the extent that you think decision-makers have the
power to commit the crime
 But hard to carve out the individual’s role in something like an environmental
crime
 For the high-level decision-makers, corporate crime is most like negligence
o In torts, negligence starts where the benefits < cost to society (risk of harm)
 But the rule in corporate crime is more like strict liability
o Hold actor responsible for whatever negative social consequences happen
o Actor can decide whether the benefit > cost to society
o Act if:
 Social: benefit > harm (social harm)
 Private (tort feasor): individual benefit > E[d] (expected damages)
o We set damages = harm so that the private activity level is socially optimal
 Works if punishment is certain. But often punishment isn’t certain (i.e. with
pollution) so we must inflate the punishment by the inverse probability of being
caught
 d = h/p (b/c E[d] = p*d)
 Where d = damages, h = social harm and p = probability of getting caught
o In other words, if the cost of the action perceived by the individual = social cost, we get
the optimal level
 Individual must internalize their actions (how to solve externality)
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Problem = sentencing guidelines don’t adjust for the probability of getting caught
o On net hard to say where we land  overdeter by adding punishment on top of damages
(b/c punishing twice), but underdeter b/c don’t make adjustments for getting caught
o Even though the goal is deterrence, this is an amateurish implementation of deterrence
B/c the punishment for corporations is diffuse, hitting many individuals who had nothing to do
with crime
o Raises problem of overdeterrence, b/c people who were indirectly hit with punishment
will implement safeguards, and that’s costly
o Society may be overall worse off: punishment > harm to society, and organization
spending more $ than they need to address the harm
Debt-Equity Conflicts
Creditor Protection
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Direct conflict
o SH’s want to take money out of corp even at expense of creditors
Subtle conflict
o Creditor upside and SH downside are capped
o Creditor = risk-averse, SH = risk-prone
Creditor claims
o Fixed
o Priority over SH
 In bankruptcy, SH get nothing unless creditors paid in full (DGCL §281)
o Enforceable in court
But NO governance rights
o Hence corp can do something right before bankruptcy to eliminate creditor claim
o Note: DGCL §221 actually permits creditor governance rights, but they’re very rare
(suggesting there’s value in financiers only having either governance or contractual rights
but not both)
Creditor protection = mostly contractual
o Covenants – restrict corps right to pay dividends, sell certain assets, or change business
o security interests – in particular assets
o guarantees – from SHs or parent company
o Note “involuntary creditors”, e.g. tort victims and tax authorities, protected by statutory
rules and equitable principles
Minimal statutory protection
o Fraudulent transfer
 Creditor can sue to void transfer of asset from debtor to transferee to return asset
to estate
 E.g. transfer from indebted person to spouse
 But also transfers in which transferor didn’t act with purpose of frustrating
creditor
 And in which transferee paid insufficient consideration
 Definitions
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Transfer made or obligation incurred: UFTA §4(a)
o 1) with actual intent to hinder or defraud creditor, OR
o 2) without reasonable value in exchange, and debtor
 Left with remaining assets unreasonably small, OR
 Intended to incur debts beyond ability to pay as they
became due
 If debtor insolvent or becomes insolvent because of transfer: (UFTA §5)
o 1) transfer given without reasonably equivalent consideration
o 2) payment of antecedent debt to insider
o Distribution constraints and capital
 Limit dividends (DGCL 173 and 170) and share repurchase (DGCL 160(a)(1))
 can only be paid out of surplus, or if none, net profits for last two years
 directors J&S liability even for negligent violations (DGCL §174)
 BUT only really matters in insolvency
 Surplus defined as net assets minus capital (DGCL §154)
o Net assets = total assets minus total liability (equity)
o Capital = what board wants, over aggregate par value (DGCL 154)
o Par value defined by charter, or even board (DGCL 151(a))
o Par value low, hence corp could pay entire equity as dividends
o Equitable remedies
 Piercing corporate veil
 1) unity of interest and ownership
o Disregard of corp formalities
o Commingling of funds, and/or
o Undercapitalization
 2) inequitable conduct
 i.e. just respect corp formalities and you’re fine
 agency
 controlling SH could be liable for debt corp incurred as SH’s agent
 Q: did sub act on behalf and subject to control of parent (RTA §1.01)
o Not mere ownership
o Concrete directives should be enough
 Very underdeveloped theory
 Equitable subordination
 Prevent SH from getting paid funds that will otherwise be available to
creditors, usually if SH also a creditor
o Court may treat loans from SH to corp as equity, subordinate them
o Mere undercapitalization not enough
o but exchange of equity for debt at critical moment is enough
 two conditions
o 1) SH must be powerful insider in corp, like officer
o 2) SH must have engaged in inequitable conduct toward corp
 Fiduciary duties (NACEPF)
 Creditors have standing to assert fid duty claims, but content defined
purely with respect to interests of corp and its SHs, not creditors
 So when SH and creditor interest conflict, fid duties actively favor SHs
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i.e. could FORCE the board to gamble money in risky way
Mechanics and Debt Overhang
Ways for the juniors to screw the seniors:
 1) take out assets
o SH take money off table that would have gone to creditors if project failed
o If project succeeds SH would have gotten that money anyway
o Liable to fraudulent transfer clawbacks
 2) substitute riskier assets
o Lowers the total EV, but creditors bear all that cost, higher return in success
o Classic gamble in casino scenario
 3) recapitalize with senior claims
o Immediately take on a secured loan, and pay that straight out to the shareholders (via a
dividend)
o Nothing changes on the asset side, but there are more liabilities
o Old creditors now have to share some firm money with new creditors if company
succeeds (lower pro rata share) but nothing more if success
Debt overhang
 Debt overhang = where existing debt impedes new investment
o If shareholders finance a project, given the risk of the investment, they’ll have to split the
benefit with creditors and it’s not worth it to them
o Here is when existing creditors will want new senior debt because they could benefit
from its added value
 Will even allow senior lending and waive some covenants
 Example: Imagine LECo can invest $12 today, and get $20 for certain in the future.
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o Will LECo’s SH be willing to finance this opportunity with new equity? No!
 If existing project fails (50% prob), all benefit from new project goes to creditors
 $50 old project + $20 cash + $20 new project = $90, still less than loan
 So shareholders only get the $20 if the risky project is successful  their EV of
the project is then .50*$0 + .50*20 = $10, less than $12 investment
o this debt overhang will “tax” new investment
Solution = financing project with senior debt
o New super senior lenders will get $12 back for sure
o Old lenders will get $8 generated by new project if old project fails ($20 - $12 = $8)
o Shareholders also get more:
 When risky project is successful, they are the ones who get the $8
Example: banks and financial crisis
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o Banks have high leverage (only hold 2-10% equity, instead of around 50% standard)
 so SH controlled banks have high incentives for risk-taking
 there bank regulators regulate bank rsik
o In a crisis, banks even less capitalized than before
 E.g. 1980s Savings and Loans bank, gambled in risky junk bonds, needed bailout
o Deal with problem by recapitalizing large banks with fresh new equity
o But resisted by SH b/c of debt overhang (would prefer to wait and hope for the best)
 New investment just shores up existing bank debt and goes to creditors, and new
investors have to be compensated with large percent of equity
 So old SHs give up lots, lock in the bank losses for them, lost chance of upside
 Old SHs are bailing out the old creditors or the gov
o Bank regulators must force banks to accept new equity investment
 Banks don’t recap by themselves, and not due to lack of available capital
Renegotiation
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Pros:
o
o
o
Cons:
o
o
o
o
Existing claimants can forgive some claim to solve debt overhang problem
Juniors (SHs) can be bribed into not taking excessive risk
Ex post fix negative consequences of bad incentives
Costly (lawyers fees, but also social costs in general)
Distributional consequences remain (whoever allows renegotiation wants compensation)
Collective action problems [see below]
Can always fail
(1) Free rider problems
 Ex: failed debt exchange — firm has liabilities of 1k bonds with face-value of $1 each, due
tomorrow. Has $600 in assets that’d drop to $400 in bankruptcy
o If nothing is done  each bondholder gets $400 (assets)/1000 (claims) = $0.40
o Exchange offer = swap your $1 bond claim for $0.50 claim of same seniority
o If everyone exchanges, everyone will be better off
 Reduces total debt to $1000 x .50 = $500 < $600 assets (so no bankruptcy)
 Every bondholder gets $0.50 > $0.40
o But individually, each bondholder is better off not accepting, so exchange fails
 If every other bondholder exchanges, the holdout gets $1  more than 0.50 from
exchanging, and bankruptcy is avoided
 If no other bondholder exchanges, holdout gets 0.40 vs. 0.20 if they had
exchanged (company goes into bankruptcy, so regular claim worth 0.40, and the
claim of people who exchanged is halved)
o Example is atypical for corporate debt (b/c bankruptcy isn’t that expensive), but it’s
typical for sovereign debt b/c no bankruptcy procedure
o Intuition: positive externality created by compromise means we get too little exchange
o IMF solution
 Sovereign bond debt clause that allows creditors to group vote to reduce debt
 But this could just make countries worse creditors, raise prices
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(2) “Self-cannibalization”
 Ex: coercive debt exchange — firm has liabilities of 1k bonds with FV $1 each, and assets have
50/50 chance of either $1200 or $400.
o If nothing is done, each bondholder expects to get: .50*$1 + .50*($400/1000) = $0.70
o Exchange offer: swap $1 bond for $0.80 senior bond
o If everyone exchanges, everyone will be worse off
 Each bondholder gets 50%*0.80 + 50%*0.40 = 0.60
o But individually, every bondholder is better of exchanging, so the exchange happens
 If you exchange and others don’t, exchanger gets 0.80 > 0.70 (b/c senior)
 If you don’t exchange and others do, you get 50%*1 + 50%*0 = 0.50 > 0.60
 (0 b/c it’s junior debt, so others are paid out first)
o Intuition: negative externality imposed on others so we get too much exchange
 Ex: forced subscription — firm has no liabilities (1000 SH with 1 share each), and 1000 assets.
Imagine firm has a bad manager who turns any extra $1 into 0.50.
o If nothing is done, each shareholder expects to get $1000/1000 = $1
o Management issues rights and offers each SH to buy 1 extra share for $0.10
 Collectively bad (b/c value is halved), but individually good (b/c getting a cheap
share)
o If every share subscribes to the offer, every shareholder will be worse off
 Each share: ($1000 + 1000*1/2*$0.10)/2,000 = $0.525
 If every shareholder subscribes, we’ll have 2000 shares outstanding, so
value per share goes down
 Each shareholder will have 2 * $0.525 – $0.10 = $0.95 < 1
o But individually, every shareholder is better off subscribing, so the manager wins
 If no other shareholder subscribes, subscriber gets 2*$1,000.5/1,001 - $0.10 =
$1.90 > 1
 If every other shareholder subscribes, non-subscriber gets $1,049.95 / 1,999 =
$0.53 < $0.95
 When every other SH subscribes, the value of the company goes up, then the
value of your share is halved
o Intuition: negative externality b/c we get too much
LBOs (Metlife)
Background
 “Leveraged buy-out” = an acquisition where the buyer uses a lot of debt to finance the price
MetLife v. RJR Nabisco: Does the implied duty of good faith and fair dealing restrict companies from
taking on more debt?
 Holding: No, no express covenant restricting incurrence of new debt; won’t read implied
covenant of good faith to read in terms.
 Usually creditors are sophisticated and make a K limiting new debt to ensure they get paid out in
full. MetLife’s bonds didn’t contain covenants like this that prevented the deal from happening
o Metlife negotiated out of these, they had them before, so particularly don’t deserve.
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o Metlife says this completely unexpected, but they’re an LBO lender and are doing it on
the lender side all the time, pretty rich.
o So Metlife just miscalculated, then financial market grew quick to make these scale
LBOs possible.
o General K doctrines didn’t protect them
Main protection of creditors comes from contractual covenants
Who can MetLife sue?
o Can’t sue selling shareholders, b/c highly dispersed and remedy would have to be
enforced one by one
Note
o This is same era as unocal, moran, Revlon
o Fascinating court stretches to give SH many protections but says tough luck to creditors
 Never told SH you should have gotten something better into the charter, but here
they’re telling creditors you should have gotten something better into the contract.
o But creditors much more able to protect themselves? Contracts more tailored
o Everyone needs creditors so it’s not like SHs want to always screw them over
Why protect SHs more
o 1) they take bigger risk putting something upfront without contractual protection
 Fid duties are only so ambiguous because equity financing is so ambiguous
 Creditors can say if money falls below certain level we take over
o 2) maximizing equity value while not harming others = maximizing enterprise value
 Whereas if you only maximize creditor return you sacrifice all upside
Other remedies for MetLife?:
 Minimum legal capital — not used in the US
o Minimum legal capital is the amount of assets that shareholders are required to contribute
to a corporation by law
o Also, remedy would just be that the SH (now KKR) would contribute the minimum
capital, which isn’t much of a recovery
 Fiduciary duties — won’t worked b/c fiduciary duties are owed to the SH, and not clear the
board did anything wrong
 Illegal dividends — probably not
o Threshold issue = was there a dividend issued? Not here
o Even if we argued that the share repurchase was like a dividend, a dividend is only illegal
if its paid out of something besides surplus (meaning RJR would have to have been
insolvent at the time, and they weren’t)
o Surplus = net assets – capital
 Capital must be at least “aggregate par value of corporation”
 Par value = number that was printed on stock certificate (set by the board when
they issue new stock)
 In practice, board says par value is either 0 or very close to it. So surplus is
basically net assets
o Also, recipients are old shareholders, who aren’t suitable defendants
 Fraudulent transfer — maybe, most viable claim
o Fraud: when transaction is entered into with purpose of not paying creditors
o Constructive fraud:
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(1) Payment is made without getting a reasonable value in return
 One view = LBO lenders incurred obligation w/o getting something in
exchange (b/c RJR didn’t get any of the cash; it was paid out to old SH)
 (2) Business must be insolvent or rendered insolvent by the transaction, or
remaining assets are so small relative to the transaction company engages in
 In real life, may be unclear if this happened
o Application depends on how you look at the transaction
 One way is to look at overall structure: cash goes in and out of RJR, so all they
get is a new $16b obligation without any value in return
 Other way to look at it in pieces: RJR didn’t actually incur any obligation; they
just merged, and in a merger, you get both assets and liabilities. Merger sub
incurred obligation, but also got company in return
 Boils down to whether the remaining assets are small enough relative to the
transaction
o Remedy: new debt would be disallowed in a bankruptcy proceeding
o TO AVOID CLAIM: just get a fairness opinion saying that after the transfer, the
company is solvent, then there’s no valid fraudulent transfer claim
 “solvency opinion”
Equitable subordination — maybe
o In bankruptcy, courts may subordinate some creditors on equitable grounds
 May treat loans from shareholders to the corporation as corporate equity, meaning
they will rank these loans after all other creditor claims
 Mere undercapitalization is generally not sufficient grounds for equitable
subordination. But the exchange of capital (equity) for debt at a critical moment
probably would be
 Supposed to catch when you hit bankruptcy and SH initiate recapitalization to add
debt and take equity out, and then the assets are shared between old and new
creditors
 So requires insolvency or insufficiency of assets (same with fraudulent transfer)
o The remedy here would be that the new lenders would be subordinated to the old ones in
bankruptcy, i.e., the old lenders would get paid first before the new ones get anything
 Usually applies to recapitalizations
o Application here too depends on how you look at it
 If you look at individual components, doesn’t work
 Still have problem of sharing assets by adding a creditor and changing
who the shareholders are
 If you look at overall structure, does work
Piercing the corporate veil — likely no
o So many lawyers here that all formalities are likely addressed
o Usually applies if corporation doesn’t keep its books well, where the Court will say we
should disregard the corporate structure since we don’t know who owns what
o Always closely held corporation, and its when they comingle funds and can’t keep trakc
of who owes what
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Part 6: Structure of corporate law
ESG and SH Primacy
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Addressing the Bad Arguments
o Do corps do bad things? Yes but individuals, governments, private companies, all do too
 “corporate” greed is just greed
o SH primacy just means only care about the bottom line?
 We have regulation
 And business reasons are also constraining
 E.g. mistreat customers/employees and you won’t have any
 And SH primacy isn’t even enforceable
 And many corps do bad things without SH primacy
 Pre-WWII German corps had strong constituency orientation and that
didn’t stop them
o Corps should have worker or state ownership/governance
 Government corps are huge enviro polluters
 Family ownership does just as bad, e.g. Purdue Pharma, Facebook, etc
o Financial markets are to blame
 Short termism is a myth
 Short term SH value is an oxymoron, SHs invest for time delayed benefit
SH Primacy v. Stakeholder Model
o Normative question – whose interests matter
o Business question – whether it is advantageous to prioritize other interests
Does it matter since it’s not enforceable?
o Norms can influence behavior, e.g. if lawyers are advising board that’s what they need to
do
Notice normative and business question have to differ for this to make a difference
o Milton Friedman says must prioritize SH value
 Boards are not government regulators
o Larry Fink Memo tries to pretend they’re aligned by calling it sustainable value
o Cliff Asness says obviously have to be different and that’s how ESG makes difference
DoL Rules strongly mandate that funds cannot have ESG funds
Alternative Entities
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First, note link to choice of law
o Gets to difference between regulation and contracting
o i.e. when you just escape regulation (by choosing a different entity or a different state)
 e.g. DE corp cannot waive duty of loyalty, but LLC and LP can
o so what are real mandatory rules?
Three dimensions of comparison
o Taxation
 Want “pass through” status
o Limited liability
o Contractual freedom
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E.g. duty of loyalty mandatory for corporations, but only default rule for LLCs
and LPs in DE
LP
o Modified partnership
o LL to partners who were completely passive and had no control
o Must have one “general partner” with personal liability
 Usually another legal entity that has LL
o Private investment funds often LPs
o Advantages
 LP can go public (LLPs and LLCs cannot)
o Disadvantages
 Tax is very complicated for public LP, therefore they’re rare
LLP
o All partners, even active, have LL for various kinds of claims
 E.g. specific torts (usually those relevant to law and accounting firms)
LLC
o LL to all equity investors
o Pass-through taxation
o Many small businesses are LLCS
o S-Corp has same tax treatment, but LLC has less formalities
Trust
o Certain investment funds and securitization vehicles
 Entities that exist only to hold certain assets on behalf of investors
Mutual
o Entities that don’t have investors, organized for their customers or suppliers
 e.g. agricultural mutual cooperatives owned by farmers who produce the goods
the cooperative is selling
 mutual banks and insurance companies
 metlife, vanguard also
o technically depositers in mutual banks elect the board, but few ever vote
o so practically, self-perpetuating board subject to state reg
o Advantages:
 Not for profit, so not set up to screw anybody
 Creates trust, so people may prefer doing business with them
 Can organize business locally and operate that way
o Disadvantages:
 No way to scale up and can’t take on capital that needs a return
 Only works well for companies that scale naturally (like insurance companies)
o Track record = some are well-run, but most don’t make it
 Depositors don’t vote, so you have to hope for the best with managers
 Nobody has an incentive to intervene when things go wrong (corrective
mechanism built into corporate structure that mutual don’t have)
o Whether it made sense for Friendly Savings Bank to convert:
 Accountant would say: went from a bank with $50m in capital, then put $50m in,
and got $100m out  not much different
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Economist would say: what comes out of the mutual is services to employees and
consumers. If whoever buys the organization maintains those services, that’s the
same entity, so if they make money on top of it that’s a good thing.
 But if people who buy the bank change the bank itself, then hard to say if
they’re “stealing” the $50m or taking a badly run organization and both
changing its output and making more money on top of it
Choice of Law
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Internal affairs doctrine = applicable law from state of incorporation, not business
o Odd no federal choice of law statute in U.S.  instead we have internal affairs doctrine
o Departs from contract law, where courts generally refuse to apply law of state chosen by
parties if no substantial relation to parties/transx or reasonable basis (RSCoL 187(2)(a))
Why DE?
o NY, then NJ, tried to combat “trusts” i.e. cartels, by prohibiting holding corps
Regulatory competition
o Will generate negative externalities for third parties, requiring federal intervention
o Significance of externalities depends on
 scope of internal affairs doctrine
 if third parties need protection of those rules specifically
 i.e. tort victims already have tort law, enviro has enviro statutes
 but laws are imperfect, rest of society depends on non-legal norms in
human interactions, but corps aren’t human and therefore suppress
internalized norms or diffuse responsibility (“sociopathic” corp behavior)
Internal affairs doctrine constitutionally mandated?
o VantagePoint (DE) tries to say CTS (SCOTUS 1987) means yes
o But SCOTUS just said “Indiana has no interest in protecting nonresident SHs of
nonresident corps”
 What about resident SHs? Or what about resident consumers?
o And SCOTUS said “so long as each state regulates voting rights only in the corporations
it has created, each corporation will be subject to the law of only one state. No principle
of corp law is more firmly established than a State’s authority to regulate domestic corps”
 Only says that there’s no problem so long as every state regulates own corp
 In context of discussion that IN by regulating own corps is infringing on IC
 Not saying anything about a different corp law rule
o Hence DE in VantagePoint just creatively tiptoes
Also in VantagePoint, note declarative relief remedy issue
o DE did this fast to beat CA’s parallel litigation and take advantage of “full faith and
credit” clause, make finding that internal affairs applied
States have mostly accepted internal affairs doctrine
o CA has pushed back with §2115 “quasi-CA corporations”
o and now these two new bills about board diversity
 SB 826 – women, AB 979 – minorities
o But still pretty half-hearted
So what’s a good rationale for a mandatory state corp law rule?
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o Pre-req = when it’s hard for corp to escape state
o Protect those setting up corp who don’t have good info and good be getting screwed
 This is paternalistic though
o But basically, as long as internal affairs doctrine exists, no state can regulate through
corporate law
o E.g. DE sometimes passes something, Wachtell writes memo saying interesting choice
maybe I’ll advise my clients to incorporate elsewhere, DE scrambles and fixes it
Should you be able to regulate through corp law?
o Now, DE is just a service provider
 Works well for most things, we like competition
 But failures in the externalities
Contractarian Theorem
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If those who contract with corp
o Do so voluntarily (i.e. no externalities)
o And are able to think through implications of interaction (i.e. no contracting failures)
THEN privately negotiated terms will be best for all involved
If assumptions hold
o Distributional concerns can be addressed by taxation
o Mandatory rules only make things worse
Failure #1 = externalities
o Is corp law the tool to fix them?
o Have other legal tools, norms, etc
Failure #2 = limits of thought
o Small family firm then ya, but hard to think VCs would fall in this
Even if either failure applies
o Question still is it sufficient rationale for regulation
o Regulation imperfect too, which is less imperfect
o There’s lots of bad legislation
 Very sticky
 Corruption
 incompetence
CTS v. Dynamics (1987): Indiana implemented anti-takeover statute that said it applied if company
was incorporated in Indiana. Law said when an entity acquires more than 20%, 33% or 50%, it’ll only
receive voting power if a majority of disinterested shareholders approve.
 First question: does the Williams Act preempt this Act?
o Holding: Williams Act doesn’t preempt Indiana law.
 Argument that it doesn’t preempt:
 Point of Williams Act is to require disclosures and regulate takeovers, and
that’s consistent with the purpose of the Indiana law. A company can
comply with both laws
 Argument that it preempts:
 Williams Act imposes some restrictions on takeovers, but it reflects a
compromise and wasn’t meant to unidirectionally make things harder.
Preempts laws that are more restrictive.
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Second question: does the act violate the Dormant Commerce Clause?
o Holding: Indiana law doesn’t violate DCC.
 DCC: law can’t impose a burden on interstate commerce that isn’t justified
 Internal affairs doctrine mandates that the company must follow the laws of its
state of incorporation. Indiana law doesn’t impose a burden on interstate
commerce, since all companies in Indiana know they’re following the internal
affairs doctrine
 If a state imposed a law that violated the internal affairs doctrine, it would
be a violation of the DCC
Policy: case arguably constitutionalizes the internal affairs doctrine
VantagePoint v. Examen (DE 2005):
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VantagePoint, preferred shareholder in Examen, doesn’t want merger to go through. Under CA
law (2115), VantagePoint can have class vote and veto the deal. But under DE law, there’s no
class vote and they can’t block the merger. CA 2115 applies when ½ of voting securities are
owned by someone based in CA, and the corporation conducts ½ of its business in CA (Examen
is a Silicon Valley start up, so would have applied here).
Holding: CA law violates internal affairs doctrine.
o Court says that SCOTUS said IAD is an “accepted part of the business landscape” (note,
this is misquoting CTS)
o DE court could have just said: we’re not applying 2115 under choice of law rule (DE
courts don’t have to apply CA law)
o Chooses not to do this b/c in corporate context, choice of law would cause the doctrine to
become a mess (if DE courts were to sometimes apply CA law, sometimes DE law)
o Also, DE would lose incorporation! Only reason Examen, a CA company, is incorporated
in DE is because of the internal affairs doctrine
Policy: VantagePoint is really just acting self-interested here  sophisticated VC fund that just
wants to go back on the deal they struck in the charter.
Course Summary

The corporation:
o Purpose is to pool resources
 You could theoretically not like pooling and be all Jeffersonian, we should be
farmers and craftspeople with no pooling, and so prohibit corp, otherwise want it
o Two sub-goals
 Commitment – ensure promise to repay is meaningful, to get more than charity
 Minimize friction – good ways to use resources in efficient manner
 E.g. not just post armed guard over the money all the time
o Sometimes the two sub-goals can be intension
 If nobody put money in, there wouldn’t be any money wasted
 Ex: fiduciary duties
 Want them to prevent management from taking money for their own
consumption, but if you crack down too hard managers/board spends all
their time fending off lawsuits
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o Sometimes goals are self-enforcing  see this through insider trading
 Prevents managers from stealing money and information
 Focuses managers on the business and not taking profits
o In the US, we’re concerned that if our rules are too rigid it’d be bad for running a
business well
 So we shifted anything with bite into the fiduciary duty standards
Voting
o Rational apathy = SHs get little of benefit and cost, therefore often passive
o Entrenchment = managers like being on board forever
 And they can achieve entrenchment through agenda power, DGCL means many
things can only be initiated by board
 Board can get anything on agenda, SHs only very limited set of things on the
agenda
 So even if SH overcome rational empathy, board very empowered
Court policing with fiduciary duties
o Duty of loyalty = most important because it has real bite, but we don’t want to prohibit it
altogether b/c we want the good transactions
 Issues: what is self-dealing so much is self-interested, so how do we figure out
what gets higher scrutiny
o Duty of care = not about managers making mistakes, because there’d be no way to police
this well
 Functional litigation system is essential to fiduciary duties
o Court structural limitations (reject Smith v. Van Gorkom)
o Incentives of P’s bar for enforcement
o Bad incentive on both sides when in litigation
 P lawyer gets a fraction of the recovery
 Defendant only pays a small fraction of the defense
 Incentives on both sides to strike background deals and quick settlement
o Main tool used to balance out the litigation = demand requirement
 Hard to say if this is the right line to draw
 Sometimes a CSH can get away with egregious self-dealing but be protected b/c
of the demand requirement (Aronson)
M&A
o Big picture: it’s about efficient organization and structuring of industry
 Not all of that internalized by actors involved
 E.g. vaccine development, small group develops vaccine, big pharma buys the
company after
o Imperfect deal v. no deal
 Wiling to accept imperfections of particular deal or not
 E.g. controlling SH squeezeouts
 Massive risk that the squeezeout is unfair, therefore imperfect
 And we may want to prohibit it so there’s no squeezeout
 But a controlled corp also has frictions, so maybe imperfect squeezeout
superior to none
 E.g. sale of control by controlling SH
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Could say it’s bad if controller can sell without sharing control premium
But if you force them to share premium, then maybe they don’t sell at all,
etc
 E.g. deal protections for court
 Could say deal protections not nice, better they’re not there
 But then what, stop deal altogether? Maybe deal falls through
o Coercion
 Of minority SHs when exploiting collective action problem
o Entrenchment
 Management’s takeover defense tools
 Also balance of offensive and defensive measures in takeover measures
 Once ou allow aggressive offensive tools, e.g. coercive takeover bids, then
you need to allow aggressive defensive tools, e.g. poison pill
Securities trading
o Trading is zero sum
 Anyone’s loss is someone else’s game
o But generates info externalities
 Btw disclosure also does, because when coca cola discloses, pepsi also learns,
possible reason for mandatory disclosure
o Incentives of insider traders
 1) incentive of what makes humans tick
 Why rajat gupta calling friend with no personal benefit
 2) if legal, what incentives would it create for people inside corps
 In book, mention that you make icnentives to maximize volatility not
value, so you can just keep trading back and forth over arbitrage
 Also incentives to keep info private, because bigger info advantage = more
gains
Shareholders and directors
o Not true that SH are owners of the corporation (business is owned by the entity, and
shareholders own rights to dividends, vote and sue in the corporation)
o Are shareholders different?
 Have nothing but fiduciary duty protections
 If SH didn’t elect the board, then nobody would invest, since the board wouldn’t
return the profits to shareholders
 Creditors have a right to payment, so can’t be abused as much as SH
 Employees get paycheck each month, and if they didn’t they’d quit
o eBay & Gheewalla: only people who get fiduciary duty protection are the shareholders,
but it doesn’t matter b/c of the BJR
 One exception = Revlon
 But since shareholders elect the board, won’t stray that far from shareholder
primacy
Other stakeholders
o Optimal deterrence
 How high should penalties be, criminal and civil and stuff, for violations
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 Social cost vs. corp gain, etc
o Creditor context
 Debt overhang, junior/senior conflict, colelective action problem, contractual
protections (guarantees, etc)
o Legal relevance or irrelevance of SH primacy
 This is more doctrinal
 Ebay, BJR shields SH primacy from being more than nominal
o Need and legitimacy of CSR
 Limits in doing this
 Legitimacy issues when you devolve these responsibilities on corp boards, who
are not tax or gov
What is corporate law about?
o Contractarian theorem
 If no externalities and everyone perfect info, then fine
 Obviouslys trong assumptions
 But we make strong assumptions about regulation too
 So tradeoff of imperfection of diff ways of doing things
o Consistency in regulation
 Federalism in US, internal affairs doctrine
 Could think of it as issue of consistency
 If all states had same substantive rules, wouldn’t matter where to incorporate
 Problem is when 49 states want to regulate an issue and 1 state doesn’t
 If that alternative imposes externality on others, everyone chooses that alternative
and undermines everyone else
 And intra-state, if corps have binding duty of loyalty, why not LLCs? People
could just undermine protection by choosing LLC instead
o Health of the ecosystem
 Investor ecosystem
 Spamann personally believes that lot of what we see around us in corp law isn’t
explainable or driven by individual actors, but just interaction by many diff actors
 And if you take one species away, entire system collapses
 Because there are interactions btw them all
 E.g. way that US corp governance works
 If just focus on majority of SHs and managers, miss lots of big picture
 Big picture
o smaller but very activist SHs kicking up storm at many corps,
generating change
o takeover buyers that take over badly managed firms
o press for reputational concerns
 so many things not captured by just SHs to fund managers to corp
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