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Business Organizations Greenwood Fall 2015
Agency
Agency is the fiduciary relationship that arises when one person (a “principal”) manifests assent to another person (an “agent”) that
the agent shall act on the principal's behalf and subject to the principal's control, and the agent manifests assent or otherwise consents
so to act.
Restatement 2d § 1: Fiduciary Relationship exists when:
 The principal manifests consent to the agent to act on its behalf
 The Agent manifests consents; AND
 Subject to the principals is in control
To Create an Agency:
 Must be some form of agreement or understanding between the parties (not necessarily a contract).
 Facts, assertions of the parties and even silence can show a party’s consent.
 Both parties do not need compensation to establish agency.
Basic issues that arise out of an agency relationship:
 The principal is responsible for tortious acts committed by the agent within the scope of the agency.
 The agency has the ability to enter into binding agreements on the principal’s behalf, as long as the agreement may be traced
to the principal’s authority (Did the principal give permission to the agent in some form?).
 The agent’s knowledge in the subject matter of the agency is similar to the principal.
Two basic kinds of Agents
i.
Servants
1. Employee, the principal orders you on how to do your job
2. Respondent superior: is when a principal has the right to exert control over the manner and the
means by which the agent performed his duty.
ii.
General Contractors
1. Sub-contactor, Principal cannot tell you how to do your job
a. Controls own work place, work tools, methods, hours
2. Principal not liable for anything general contractors do
Agency is a fiduciary relationship:
 Agent owes duty to the principal (Binds principal).
 Agent is supposed to act for the benefit of the principal even if its not beneficial to the agent
 Agency ends when either the principal or agent says it does
Gorton v. Doty: Court held owner of car liable as a principal, for damages to TP, where owner volunteered that football coach (as
agent, according to the Court) drive her car to the game. The key fact was that owner-DEFENDANT told coach only he could drive
the car (showing coach was subject to DEFENDANT’s control and that owner consented that coach act on her behalf) –
DEFENDANT did not merely loan the car.
Gay Jenson Farms Co. v. Cargill, Inc.: An Agent is not liable for a K they entered into, only the principal is. A creditor who
assumes control of the debtor may become a principal
Factors to assess whether a principal had the right to exert enough control over the agency for the agent to be considered an
employee:
 The extent of control that the agent and the principal have agreed the principal may exercise over the details of the work.
 Whether the agent is engaged in a distinct occupation or business.
 Whether the type of work done by the agent is customarily done under a principal’s direction or without supervision.
 The skill required in the agent’s occupation.
 Whether the agent or the principal supplies the tools or other instrumentalities and decides where to perform the work.
 The length of time during which the agent is engaged by a principal.
 Whether the agent is paid by the job or by the time worked
 Whether the principal and agent believe they are creating an employment relationship.
 Whether the principal is or is not in business.
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Types of Authority
 Actual: Expressly authorized by principal: Exists when the principal communicated to the agent about the activities in
which the agent may engage in and the obligations of the agent (can be spoken, written, implied through job or silence).
o Actual expressed authority: involves examining the principals explicit instructions
o Actual implied authority: involves examining the principals explicit instructions and asking what else might be
reasonable included in those instructions.
 Apparent: Principal makes it appear as if the agent has authority: Standard: If a reasonable 3rd party might think there was
actual authority based on the principals actions (reasonable reliance). Ex. Own a theater and put the agent in a tellers booth
When a third party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to
the principal's manifestations.
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o Some action or inaction by the principal to create or to fail to dispel that reasonable belief on the part of the third
party and
o Some showing that the third party’s injury could have been avoided had the alleged principal exercised control over
the alleged agent.
Inherent agency power is a term used in the restatement to indicate the power of an agent, which is derived not from authority,
apparent authority or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with
a servant or other agent.
Mill Street Church of Christ v. Hogan: Bill hires his brother to paint a church; the brother falls. Bill had actual implied authority as
an agent to hire him, based on need and past experience in hiring helpers for work for the Church. Painter also possessed apparent
authority, based on Same’s past experience in having been hired to work with Bill.
Court: Implied authority “includes such power as are reasonably necessary to carry out the duties”
 Implied: A low level employee’s power to buy office supplies
 Inherent: Undisclosed Principal Doctrine: An agent for an undisclosed principal binds the principal when there is a tort by
the agent. Ex. Bar manager who is authorized to purchase alcohol and water. Principal can’t refuse to pay if manager decides
to buy something other like cigars.
Liability of and undisclosed principal
(1) An undisclosed principal is liable to a 3rd party who is justifiably induced to make a detrimental change by an agent
acting on the principal's behalf and without actual authority if the principal, knowing of the agent's conduct did not take
reasonable steps to notify the 3rd party.
• (2) An undisclosed principal may not rely on instructions given an agent that qualify or reduce the agent's authority to less
than what a 3rd party would reasonably believe the agent to have if the principal had been disclosed.
 Ratification: If an agent acts beyond their authority and the principal is okay with it, then it is a valid binding K. Authority
granted after the fact. To determine if there was a valid ratification:
o Did the principal through word or deed manifest his assent to affirm the agreement?
o Will the law give effect to that assent? (Accepted by law?)
o Affirmation may be expressed or implied.
o The principal must know or have reason the material facts of the transaction at the time of the ratification.
o A principal may not partially ratify a transaction- it’s all or nothing.
o If the third party manifests an intention to withdraw, prior to the ratification, the principal may not ratify the
agreement.
o Ratification will be denied to protect innocent third parties (ratification of an agreement is treated as if the agent had
actual authority at the time the agreement was originally made).
The contract liability rules for principals: disclosure and authority
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Under apparent authority, if a principal is undisclosed, an agent cannot bind the principal. Under actual authority, the agent
always binds the principal, it does not matter whether the principal is disclosed, partially disclosed or undisclosed.
Estoppel: (can not use this to enforce an agreement with a 3rd party): involves acts or omissions by the principal either intentional or
negligent, creates an apparent authority in the purported agent.
The third party reasonably and in good faith acts in reliable on that appearance of authority.
The third party changes her position in reliance upon that appearance of authority.
Duties in Agency (Of Agent to Principal): Duty of care, competence and diligence; Duty of loyalty, to act in the benefit of the
principal in all matters connected with the agency; Duty to not acquire material benefits arising out of agency; Duty not to act as or
on behalf of adverse party; Duty not to compete; Duty not to use principal’s property for own purposes or of a third party; Duty not
to use confidential information; Duty of good conduct; Duty to provide information.
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1) Unless otherwise agreed, a paid agent is subject to a duty to the principal to act with standard care and with the skill
which is standard in the locality for the kind of work which he is employed to perform and, in addition, to exercise any
special skill that he has.
An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected with the agency relationship.
(ii) discloses all material facts that the agent knows, has reason to know, or should know would reasonably affect the
principal's judgment unless the principal has manifested that such facts are already known by the principal or that the
principal does not wish to know them, and
(iii) otherwise deals fairly with the principal; and
(b) the principal's consent concerns either a specific act or transaction
Unless otherwise agreed, an agent who makes a profit in connection with transactions conducted by him on behalf of the
principal is under a duty to give such profit to the principal.
Asymmetrical power
– Principal controls; Agent obeys
Agent’s Fiduciary Duties are duty of care and loyalty.
Of Principal to Agent: Duty to indemnify: costs for agent, expenses, or damages incurred within the scope of the agency, for the
benefit of principal or in accordance with any agreement between principal and agent; Duty of good faith and fair dealing: includes
an obligation to inform agent of any risks, financial loss, has reason to know or knows the risks that are present in the agent’s work.
Tort: Basic Rule: You can sue both the agent and principal when an agent commits a tort while in the scope of agency
 A principal is vicariously liable for the tortious acts of the agent.
 Scope of employment Doctrine:
o Conduct is of the kind the servant is employed to perform, serving purpose to master
o Occurs substantially within the authorized time and space limits
Ira S. Bushey & Sons, Inc v. United States: Company is liable when the employee is acting within the scope of their employment.
(US Coast Guard sailor flooding a private dry dock)
Servant v. Independent Contractor
 Servant
o Principal liable for tort of their servants
o Control of agent (decisive issue):When to come in, what tools, what to wear
 Independent Contractor: those who perform services for others and are not employees.
o Principals not liable for torts of their independent contractor unless:
 Inherently dangerous activity: principal liable
 Non- delegable duties- i.e- Landlord
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 Negligent hiring
 The principal has exercised control over area in which tort occurred.
 Franchisor Problem: Issue is control
o How much control does the Franchisor have over the franchisee
o If there is a lot of control, there is likely agency
PARTNERSHIPS
Partnership: §202 Formation of a Partnership
o An association of two or more persons
o Carrying on as co-owners in a business for profit
o Whether or not the person intended to form a partnership. (Written agreement is not needed)
Agency relationship in which each partner is an agent for all other partners
 All partners are liable for each other
 If one partner knows something, all partners know about it as a matter of law
 Applies to contracts signed by any partner
– Each partner is an agent of partnership
• § 301. Partner Agent of Partnership.
• … Each partner is an agent of the partnership for the purpose of its business. …
– The principal is the partnership
– As an agency relationship, partnership can be ended in violation of contract
• (a) A partnership is an entity distinct from its partners.
Fenwick v. Unemployment Compensation: Court found NO partnership where: Fenwick owned barbershop, had 7 employees, and
under NJ statute, if employer had 8 employees, had to pay into unemployment fund. Clerk wanted more money, Fenwick didn’t
want to lose her but couldn’t afford to pay more unless the business was more profitable. They arranged something calling
themselves partners, but her job stayed exactly the same, he retained all the control, and she only received a percentage of profits if
the business was successful (at Fenwick’s discretion – she is just getting profits as opposed to sharing profits)
Characteristics of a partnership: Not necessary but can help indicate a partnership:
1) A partnership cannot be another entity like an (LLC)
2) Owners in a partnership make some kind of contribution, need not be monetary, could be skill, labor, or time.
3) Generally, share profits- they do not get wages, default rule, unless its changed.
4) Jointly share management, equal control is not necessary
5) Sharing risk of financial loss
6) Other individuals can be hired that are not partners like associates.
7) Don’t need to actually make a profit, just attempt to
8) Profits and loses are equally divided among the partners (default)
9) Ex. If one partner puts in $1 million and other partner puts in $100, profits split 50/50
10) Need all partners (unanimous) to vote same way to admit a partner
– Separation from partners:
• Legal Personality: Makes contracts, holds property, commits torts in its own name
• Continuity: It continues even if partners change
• Property separation:
– § 203. Partnership Property.
– Property acquired by a partnership is property of the partnership and not of the partners
individually.
• Pass-through income tax:
• Each partner pays taxes as if s/he received a proportional share of entity income and expenses.
What a partner cannot do: A partner cannot treat partnership property as their own; Cannot Possess; Control; Dispose; Assign;
Pass by will
What a partner can do: Partner may vote to use or distribute partner property; Partner may spend, assign, encumber, demise his/
her interests in partnership distributions; Partner may not transfer vote or partnership rights.
A Partnership is not created by
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1) Joint ownership/ Co- Owners unless they agree to share profits
2) Sharing gross returns or giving capital to an enterprise independently
Sharing profits in a business is prima facie evidence that a partnership exists EXCEPT where those profits are received as a debt
services, wages, rent, annuity, percentage of revenue/ percentage of profits. Commission (sales men) is the percentage of the
sales price and profit is after all $ has been paid off.
(Is the intent of the parties to carry on as co-owners of a definite business?)
Partnership Attributes:
1) Liabilities: Each partner is jointly and severally liable for the debts of the partnership; If partnership assets are not sufficient
to cover debt, the partners would become personally liable.
Unlimited” personal liability
Each partner (individually) guarantees all partnership liabilities if (and only if) the partnership is unable to
meet them.
2) In tort actions, the whole partnership is also liable.
3) Control: Each partner has the ability to participate and manage the partnership. Only entitled to one vote each, regardless of
how much capital is invested by the partner.
4) Returns: When a partnership is dissolved, profits are equally shared, and divided up among the partners; exception is when
partners agree to allocate profits based on amount contributed by each.
5) Tax treatment: Tax Benefit; IRS does not tax the partnership, just individual partner; Each partner pays a tax on their
individual share of the profit in their personal income tax; All money made (profits) is taxable: Ex. If you make a profit of
100k and only take 80k, and put back 20k into the business, you get taxed on the 100k
6) Partners owe fiduciary duties to one another.
General Partnerships
Partner Control Rights
(a) All partners have equal rights to participate in management, not protected by limited liability
(b) All have informational rights (right to inspect books/records and demand information)
(c) But all of these rights can be modified by K in partnership agreement
(d) Here partners have equal rights and can’t satisfy the “solely from efforts of others” prong – hard to qualify as
a security UNLESS it is modified by contract if it virtually eliminated the control right
1. Partners unlikely to be passive investors who profit solely on efforts of others
Limited Partnerships
Limited partners generally have no control rights and they have limited liability but become liable as general partners if they
take part in the control of the business (passive investors)
(e) Membership interests of limited partners can be securities
(i) But some limited partners do have de facto control or exercise substantial control over management 
limited partner has not profited solely from efforts of others and is not a security
(f) General partners have all the powers and duties of general partners in general partnerships
In determining if it a employee- employer relationship or a partnership examine:
1) Intent of parties
2) Language of the agreement, if any
3) Conduct of the parties; with third parties too
4) Treatment of returns from the business; i.e sharing profits, sharing losses, wages is an indication of an employee-employer
relationship.
According to Revised Uniform Partnership Act, a partnership may NOT:
(In the absence of a partnership agreement):
1) Unreasonably restrict a partner’s access to books and records of partnership
2) Eliminate general duty of loyalty (specific exceptions may be approved)
3) Unreasonably reduce the duty of care
4) Eliminate the obligation of good faith and fair dealing
5) Vary the power of a partner to dissociate
6) Vary the right of a court to expel a partner under specific circumstances
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7) Vary the requirement to wind up the partnership
8) Restrict the rights of third parties
Partnership by Estoppel: Even when someone is not a partner, he or she still might be responsible for the debts of the partnership.
This requires:
1 Actual reliance, partner claiming estoppel must actually rely
2 Reliance must have been reasonable
3 Some manifestation of the alleged is required (the alleged partner must act or fail to act in some way as a partner).
Fiduciary Obligations of Partners: During the enterprise you owe a fiduciary duty
1) The duty of loyalty for each partner
a. To account for partnership profits, property or benefits from the conduct (or winding up) of partnership business or
the use of the partnership property
b. Refrain from acting as or on behalf of a party with an adverse interest
c. Refrain from competing with partnership
d. Performing all duties to the partnership consistent with the obligation of good faith and fair dealing.
e. It must be within the scope of the partnership in time and in space
If a new opportunity arises partner must:
- Disclose the business opportunity to the other partners
- Decide whether or not to act on behalf of the partnership and take the opportunities, in good faith.
2) The duty of care: the standard of which the partner must evaluate and make partnership decisions; a partner must not engage
in:
a. Gross negligence
b. Reckless conduct
c. Intentional misconduct or
d. A knowing violation of the law
Fiduciary Duty of Partners: A partner has a duty to inform other partners about any material information not known to the other
partners (UPA)
Meinhard v. Salmon: 20 yrs, leasing a property. New LL wants to find someone to sell property to, but after not finding anyone, he
decides to go to Salmon to see if he would rent the place (4 months left on lease). Gerry might not even know Meinhard exists.
Meinhard wants the money Salmon is making from the new lease to put into a trust. Court held Salmon liable for profits on leased
building where: Salmon and Meinhard were “coadventurers” NOTE: Cardozo’s standard was very high: He thought that Salmon
owed Meinhard the opportunity to buy in, but today he would really only be required to disclose the opportunity
General Standards of Partner’s Conduct (not enacted at time): A partner’s duty of loyalty to the partnership and the other partners is
limited to the following:
- To account to the partnership for any benefit derived by partner in the conduct/winding up of partnership OR derived from a
use by the partner of partnership property, including the appropriation of a partnership opportunity
- To refrain from acting on behalf of a party having an interest adverse to the partnership; and
- To refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the
partnership
(c) The duty of care of a partner in the conduct or winding up of the partnership business is to refrain from engaging in grossly
negligent or reckless conduct, willful or intentional misconduct, or a knowing violation of law.
Nabisco v. Stroud: Stroud and Freeman formed a partnership to run a grocery store. Stroud told National Biscuit that he would not
be personally liable for any more bread it sold to the store. Freeman ordered more bread, National Biscuit delivered it, and National
Biscuit sued Stroud for payment.
- Partners have full personal liability for debts of the partnership. If the partnership is liable on the contract, so is Stroud
Nature of partnership interests:
1) Economic rights: right to receive money which is distributed from the partnership to the holder of economic right
2) Management rights- to vote, participate in management of the partnership, making decisions for day to day operations.
Economic rights are transferable, management rights are not, unless the other partner’s consent.
- When a partner transfers economic rights to the recipient, the transferee has the right to obtain money.
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Transferees obtain economic interest in the following ways:
1) By voluntary transfer by transferor partner
2) By involuntary transfer by the transferor partner due to a judgment against him or
3) By death of transferor partner
Partnership Dissolution and Disassociation:
When a partnership ends it goes through three phases:
1) Dissolution: is the change in the relation of the partners by any partner.
2) Winding up: where partners conclude its business, sell its assets, pay its creditors, and make distributions to its partners.
3) Termination
A dissociated partner is entitled to receive:
1) The value of the partnership interest (measured as the greater of their share of the going concern value or of the liquidation
value of the partnership); minus;
2) The dissociated partner’s share of any liabilities: plus
3) Interest paid from the date of dissociation to the date of payment
4) Payable within 120 days provided the partnership is at-will or at the end of the term or undertaking, unless payment would
not create hardship for the partnership.
5) Can sue for damages if damages occur (breach of K).
 To be an entity for tort and contract- If you are an entity for income tax, you pay tax on your income. A corporation pays taxes on its income. The rates are
Terminating Partnership:
o If you dissolve the partnership wrongfully, you are liable for damages
Meehan v. Shaughnessy: A partner breaches his fiduciary duty of good faith and loyalty to his partners by inducing the
partnership’s clients to withdraw their business from the partnership without ample time for the partnership to compete to retain the
business, where the partner delayed in providing information after being asked for it, and where the partner sent the letter to clients
on the partnership letterhead.
Violation of UPA § 20: On demand, a partner must give true and full information of all things affecting the partnership to any
partner or the legal representative of any deceased partner or partner under legal disability
- Partnership ends whenever one partner wants it to
o Can take out money from partnership
- When a partner withdraws the partnership goes into dissolution
o Can continue with partnership if agreed to by the rest of the partners
Owen v. Cohen: Owen and Cohen became partners in a bowling alley. Owen put up $6,986, which was to be repaid out of the profits
of the business; treated as a loan. Owen sues for dissolution. Dissolution of a firm prior to termination is wrongful and subject to
damages
Liabilities for departing:
o Once partner who dissociates walks away he is no longer liable for debts of the partnership following dissociation.
Exception: If a third party enters the transaction relying on the fact that the disassociated partner is a party. Thus, a
disassociated partner must give notice to 3rd parties.
Liabilities for new partners:
o A new partner only personally liable for the new debts that are incurred upon joining the firm.
o Liable to any creditors for your business; Personal assets can be touched by creditors; Cannot sue other partners for a
tort; Each partner owes a fiduciary duty to the partnership
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Outside of bankruptcy,
– Partnership creditors look to partnership assets
– Personal creditors look to personal assets (including the partner’s claim to partnership distributions, if declared)
UPA: Jingle Rule
– Partnership creditors have priority re partnership assets
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– Personal creditors have priority re personal assets
Chapter 7 & RUPA:
– Partnership creditors have priority re partnership assets
– Parity re personal assets
• but personal estate has a claim against partnership for subrogation
The rights and duties of the partners in relation to the partnership shall be determined, subject to any agreement between them, by
the following rules:
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(e) All partners have equal rights in the management and conduct of the partnership business
• At least one GP (with the rights and responsibilities of a GP)
• LPs contribute capital but may NOT have control rights
• LPs are not liable for partnership obligations
– Entity liability (=“limited” liability)
• Entity is not recognized for tax purposes
– Pass-through taxation
• Standard form for Hedge Funds
• LPs have no contractual rights to returns (that’d be debt)
• LPs have no control (that’d make them GPs)
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CORPORATIONS
Corporation: A group of people organized to act as a single entity.
Organized so that very few people decide and not everybody knows the information needed for a decision.
ii) Theory of corporate mergers: always someone who doesn’t want to merge
iii) Purpose: Maximize the wealth of shareholders
Characters: Directors, Shareholders, Officers (employees), Community
Classifications (2 main types): Public v. Closely Held Corporations
(1) Public Corporation
 Large number of shareholders, widely distributed
 Controlled by professional managers
 “Separation of ownership and control”
 Shares are traded on a public exchange like the NYSE
 Must accept entity taxation
(2) Closely Held Corporations (or Incorporated Partnership)
 Small/limited number of shareholders
 Managers and directors are also majority shareholders
 May have transfer restrictions in Articles
 May elect “pass through” taxation.
Corporate Law: Legal personality: Exists separately from people in the law: It can own property, it has certain rights.
Business Corporation Basics:
1. Legal Personality
2. Entity liability
3. Indefinite Life
4. “Centralized Management”
5. Shares vote for Directors
6. Freely Transferable (Saleable Shares)
Citizens United v. Federal Election Commission
Facts/Issue: In a dispute over whether the non-profit corporation Citizens United could air a film critical of
Hillary Clinton, and whether the group could advertise the film in broadcast ads featuring Clinton's image,
in apparent violation of the 2002 Bipartisan Campaign Reform Act, commonly known as the McCain–
Feingold Act, the court held:
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Rule: Corporate funding of independent political broadcasts in candidate elections cannot be limited
— because of the First Amendment (overturned Austin)
1. Legal Personality
a) Corporation is a legal actor, independent of its participants or investors, independent of the people working for it.
b) May vary from area to area
i) Property, contract, tort, criminal
ii) But Tax- Some can opt out
iii) Constitutional law
(1) Due process, speech, and seizure
(2) But not self-incrimination
(3) It can sue and be sued, owns assets.
2) Entity Liability:
a) Corporation is fully liable for its obligations
b) Shareholders have NO liability for corporate obligations
c) Consequences of entity liability; anonymous stock market, equality of investor dollars, share value based on business, not
investor.
Allocating risks; contract; convenient default rule; Tort; inefficient subsidy
o Shareholders cannot lose more than the amount they invest.
o MBCA 6.22 Liability of Shareholders:
 (a) a purchaser from a corporation of its own shares is not liable to the corporation or its credits with respect
to the shares except to pay the consideration for which the shares were authorized to be issued (section 6.21)
or specified in the agreement (section 6.20).
 (b) unless otherwise provided in the articles of incorporation, a shareholder is not personally liable for the
acts or debts of the corporation except that he may become personally liable by reason of his own acts or
conduct.
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The Lenders Nightmare:
o Lenders extend credit based on risk of non-payment
o Low risk -> low interest
o Debtors may be tempted to change the odds after taking out the loan.
Exploiting Creditors:
o Spend transfer assets
o Add risk: Heads, debtor wins; Tails, creditor loses
o Add senior debt: It gets paid first
Protecting Creditors:
o Minimum Capitalization- Abandoned
o Limited on distributions (dividends)- Only in vicinity of insolvency, Closely related to Fraudulent Conveyance Acts
o Limits on business plans, risk, changes-Abandoned
o Disclosure- No corporate law requirement for public financials or audits
o Fiduciary Duty- Usually no duty to arms length creditors. Corporation has no obligation to pay a dividend; Elect a new
board of directors
o Reputation- (make enough money to buy yourself a new one)
 Limited by “end game problem”
o Clarity:
 Personal assets v. corporate assets
 Personal decisions v. corporate decisions
 Personal role v. (various) corporate roles
3) Indefinite Life: Corporations with no expiration date
4) Centralized Management: The principal is the legal entity (the corporation). Shareholders choose the board of directors:
a) Board of Directors: they hire the employees that run it.
i) Directors control the agenda.
b) Shareholders cannot run the company: (i) Board appoints the officers who are the operational managers: (ii) Board
member’s monitors and approves: (iii) Operational managers initiate and execute (iv) The separation serves as a check
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o Charter: sets forth the structure of the board in very general terms.
o All members of the board are selected annually
5) Shares vote for Directors: One share, One vote: But—
i) Non-business corporations may have “membership voting”
ii) Self-perpetuating boards
Voting rights can be varied in Articles
6) Freely Transferable Shares:
a) Shares (and therefore votes) can be bought and sold.
b) Default rule only
Owned by shareholders: are entitled to the residual value of the corporation after it has paid its creditors; they do not participate in
the management of the corporation; they merely elect the Board of Directors; the Board of Directors then appoint officers, such as
president, treasure, and secretary of the corporation.
The Rights of Shareholders
1. Right to receive dividend if declared
2. Right to receive pro rata share of “residual” if corporation is sold or dissolved
3. Right to vote
4. Right to sell (or transfer)
5. Right to sue for breach of fiduciary duty
• Only at duly called shareholder meeting
• Ordinarily, one vote per share
• To elect directors for a term
• To approve amendments to charter (=Articles of Incorporation)
• To approve sale (or equivalent) of company
• Ordinarily, directors control agenda
Shareholders:
- Basic obligations are to pay what you agree to pay.
o Is it a formality? It can be when there is one shareholder that owns the whole corporation It still can be considered a formality even when someone owns less than 51% of the vote.
- Right to vote on certain fundamental corporate transactions (pp. 153).
 Proportionality: 1 Shareholder -> owns whole corp.
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100, 000 Shareholders -> Owns whole corp.
*** The latter is less likely to be affected by one vote****
*** The larger a shareholder’s proportionate share; the more stake in the outcome***
- Shareholders do not manage but they have the right to vote on certain matters
• Shareholder may appoint an agent (“proxy”) to vote in shareholder’s place.
• With or without binding instructions.
• Ordinary agency rules apply.
Can typically vote on: The election of Board Directors authorizes the Securities and Exchange Commission to create Mechanisms
through which shareholders may nominate and solicit votes for directors
o Electing Directors:
 Mandatory Rules:
 Must have a class of voting stick (in business corporations)
 Annual Elections (but “classified board” is permitted”
 Default rules (one vote per share)
 Bonds don’t vote
 Default Rules
 “First past the post” plurality voting
 Recall
 Common law rule abandoned
 At any shareholders meeting
 By majority vote
 Shareholders may replace a director
 Classified or staggered Board
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 Only if specified in Articles
 Board divided into three classes- Each class serves for three years
Amendments to the Articles of Incorporation and the Bylaws.
Fundamental transactions such as mergers and acquisitions and
Miscellaneous matters such as the approval of independent auditors and non- binding resolutions
A director is entitled to certain due process rights when he or she is removed “for cause” (this is unclear). Fraud and unfair selfdealing is good cause.
Shareholder Meetings:
- Proxy vote: Shareholder may appoint an agent to vote in shareholder’s place.
Not who but how they are going to run the company: Then you can use company money when it is in the interest of the
corporation.
Rights of Shareholders: One Shareholder One Vote;
Shareholders that disapprove of management’s actions, they are likely to sell the shares.
- Right to inspect the company’s books and records for proper purpose.
o Plaintiff has the burden of showing proper purpose including some expected wrongdoing.
o New York gives shareholders the right to inspect key financial statements, balance sheets, and the income statements.
Stock lists (information about each owner of the company stock)and meeting minutes, unless company can show that a
shareholder lacks a proper purpose.
- Right to receive dividend if declared
- Right to receive pro rata share of residual if corporation is sold or dissolved
- Right to elect directors and remove directors for cause.
- They cannot initiate a transaction or approve sale of a company;
- Board can only send it to shareholders after they approve it; then the shareholders can obtain it and then ratify it.
- Right to sell (or transfer)
- Right to sue for breach of fiduciary duty.
- Special meetings are where shareholders can:
o Amend by laws, Remove directors, vote on transactions, vote at least once a year to elect directors, and ratify board
actions.
o Put in the bylaws or the holder of at least 10% can cast the demand in writing (Delaware?)
- Special meetings are costly, for public companies, and are costly due to lost time from the senior executives.
Alternative to special meetings is to have a written consensus.
 Class voting: majority blocks will always advance their private interests; Minority needs structure against
the exploitation of the majority.
 Class voting requirement- a majority of the votes in every class that is entitled to a separate class vote must
approve the transaction.
Minority Shareholders:
- Those who have less shares in a company
- Cumulative voting (only if specified in Articles) is taking the # of directors she is entitled to vote X the number of shares she
owns.
- Each share receives one vote per candidate
- May cast all votes for one candidate
Class Voting: The Bi- National Solution:
Articles may designate multiple classes of stock
o Class A elects 6 directors
o Class B elects 5 directors
- This prevents a shareholder coalition from excluding class B from the Board.
Board of Directors: (Every Corporation must have a B.O.D)
- Responsible to the shareholders for managing the corporation’s assets.
The directors of the corporation are:
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Elected by the shareholders, Serve by a set term, and typically make the major decisions relating to the operation of the
corporation.
The Officers of the corporation are:
- Selected by the board of directors and manage the day to day operations of the corporation are the president also sometimes
called the Chief executive officer, the chief financial officer and the secretary, or the Chief Operating Officer.
Forming a Corporation:
- Created under state law
- Articles of Incorporation must be filed with the Secretary of State in the State where it has been selected for formation
- Articles of Incorporation Typically Include:
o The name of the corporation
o Stock Structure
o The purpose of the corporation which may be as broad as “any lawful purpose”
o The number of shares, which are authorized for each class of stock of the corporation; and the name and address of the
agent for service of process.
- The person who signs the Articles of Organization is known as the Incorporator:
o Once the articles have been properly filed a corporation is established
o The incorporator will appoint initial directors who will hold an organizational meeting to adopt bylaws.
o Bylaws: are the rules, which govern the basic internal operations of the corporation and its relations with its shareholders,
officers, and directors.
- At the organizational meeting the directors will also appoint officers, issue stock, and establish the basic framework for the
organization.
- If the Articles of Incorporation is properly filed the corporation is known as a “de jure” corporation.
Duty of Loyalty: Directors set aside interests for the benefit of the corporation
1) In good faith
2) In a manner that advances the corporations purposes
**Bars the corporate officers/directors from competition with the corporation; from appropriating its property, information, or
business opportunities; and especially from transacting business with it on unfair terms. ***
Bayer v. Beran: Derivative: Corporation undertakes a radio advertising campaign costing $1M to promote Celanese, an alternative
to rayon. The directors wanted consumers to know that Celanese was different, perhaps better, than rayon. The company produced
“The Celanese Hour,” a musical variety show, to promote the product line. The president of the company spoke with his wife, and
she offered to perform. Holding: Although there was a conflict of interest, the burden of proof is on the defendants and they
demonstrated that the hiring was fair because wife was paid fairly.
Ratification: If a challenged transaction involves a deal between (burden shifted to plaintiffs to show breach): the corporation and
one of the directors or the corporation and a controlling shareholder
An interested transaction is not void if there is: Full disclosure and disinterested directors ratify it
§ 144(a): “No contract or transaction between a corporation and 1 or more of its directors or officers ... shall be void or voidable
solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee
which authorizes the contract or transaction, or solely because any such director’s or officer’s votes are counted for such purpose, if:
(a)(1): approved by a majority of the disinterested directors: Disinterested = being related or having a financial interest
(a)(2): approved by a majority of the shareholders
Fliegler v. Lawrence: Directors made business decision and had shareholders vote for approval. After approval was won and the
options were executed and the CEO gains 800,000 shares. This derivative suit was brought to recover the optioned shares.
In order for ratification by the directors to be valid: 1) Give full disclosure 2) Disclose all terms of the transaction
In order for ratification by the shareholder to be valid: 1) Full disclosure; 2) Majority vote of the shares
In order for director ratification to be ratified by the shareholders 1) Full disclosure 2) Majority vote of disinterested shares
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Sinclair Oil Corp v. Levein: Derivative: Sinclair owns 97% of SinVen and controlled its board of directors. Over six years, SinVen
paid out excessive dividends and began to dissolve. Plaintiffs argue that Sinclair took business opportunities away from SinVen, but
SinVen’s minority shareholders could not produce evidence of such. Holding: Stockholder can compete with company because there
is NO fiduciary duty. When you are a majority stock holder you owe some sort of fiduciary duty to the minority shareholders
(exception to holding).
Zahn v. Transamaerica Corp.: Derivative: Zahn owned stock in a tobacco company and complains that he should have got
$280/share instead of $80. There were two classes of stock, A getting first dibs, B getting seconds, and any remainder getting split
evenly between them. B had voting rights, A was callable by the corporation. TC owned the majority, and called in the shares when
the price of tobacco increased suddenly from $6m to $20m, liquidating the company to the benefit of TC shareholders. Holding: TC
can be held liable for self-dealing. When a director votes he must act upon the interest of the shareholders and not of his own.
(Fiduciary Duty)
AP Smith v. Barlow: The Company wants to donate $1,500 to Princeton University. Shareholders argue that, as surplus, they have a
future interest in the money and Board should be prevented from giving it away. If the company were to close, after all debts and
contracts are paid (which must be true because the money is a surplus) then any remaining money goes to the stockholders. They
have a fiduciary responsibility to the stockholders and giving the money to charity was improper. The company said that they
thought it would be good publicity to give to the school, because future engineers might consider working for them as a result of the
goodwill. Holding: You can make donations for the public welfare, scientific purposes or educational purposes. Business judgment
rule.
Quasi-Charitable contributions: Shlensky v. Wrigley: Stockholders want Cubs to play night games at home. Cubs are 1/20 teams that
do not. Managers say it is bad business putting lights up that bother the neighbors. Holding: Business judgment rule. No evidence
that having night games would increase profits: Board gets to decide how a corporation operates, what their goal is and how they are
going to achieve that goal.
Parent-Subsidiary Context: Generally a parent corporation is entitled to the benefits of limited liability (let subsidiary take the
brunt of it). However, if it can be shown that the parent so dominates the subsidiary that the two can be taken to act as one single
entity, and treating the parent and subsidiary as separate entities would lead to injustice a court will PCV to hold the parent liable for
claims made against the subsidiary
Paramount Comm v. Time: Time was in the process of merging with Warner when Paramount made a competing offer. Time said
that the offer was not large enough. Paramount increased the offer, but Time refused again. Paramount sues in Chancery to force
Time to accept offer. Holding: Company is allowed to profit maximize and choose the means by which they profit maximize;
Bell v. Maryland: lacks hold sit-in protest in restaurant that refused to serve blacks. Owner did not want to serve blacks because he
said then he would lose customers. Holding: If the manager thinks it is in the best decision of the business to segregate, then it can
segregate: Segregation at the time was OPTIONAL: At a time before civil rights laws
Rule 10b-5: 5 elements of a fraud tort:
1. Intentional: sometimes reckless can be enough
2. Misrepresentation: has to be false: can be omission
3. Material fact: caused the plaintiff to change their decision (common law): Strategic silence works
o TSC standard:
 A substantial likelihood that a reasonable shareholder would consider the information in deciding to vote
 Only need the potential to influence
 Objective, reasonable person standard
4. On which the P relied: Means it was material: Is it important to a reasonable person : Alters the total mix of information
5. To its detriment; Still have to prove damages: Usually the price difference of the stock before and after
Privity is also a requirement: Can’t rely on a rumor: If you buy stock on the second hand market, you are not in privity with the
company: 1) You do not know who you bought from 2) Reliance will be impossible to prove 3) No breach of fiduciary duty
10b-5: Unlawful to use or employ in connection with a security any manipulative or deceptive device
- To make any untrue statement of a material fact or to omit to state a fact
- To engage in any course of business that deceives or frauds a person
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Private right of action
Makes it possible to bring a fraud action
Basic v. Levinson: CIP wanted to acquire Basic, so they had meetings with Basic directors and discussed a merger. Basic made
public statements that it was not in merger negotiations. Later, Basic asked NYSE to suspend trading on their stock and announce
that they had been approached regarding merger. Class Action suit claiming directors misled to artificially depress prices. Holding:
Basic’s statement that it was not engaged in a merger were material because of the likelihood a reasonable shareholder would have
considered such information important before deciding how to vote.
Fraud on the market theory: Every piece of information is incorporated into the stock price: When a plaintiff relies on the price of
a stock, he or she has relied on a material misstatement or omission
Santa Fe Industries v. Green: SFI slowly bought up shares of Kirby until it owned 95%. It then sought a short-form merger because
they had more than 90%. Stock prices ranged from $65–93. Fair market value for shares was $125. Green (et al) argued that it
should be $772, moved to have merger declared invalid. Green is dismissed for failure to state a claim for which relief could be
granted (short-form merger is done by statute.) Holding: No federal fiduciary principal Breach of fiduciary duty without fraud is not
a violation of 10b-5.
Inside Information: Trading on non-public information by someone with a duty not to trade: Current test for when inside trading is
actionable: Has to breach fiduciary duty: If no fiduciary duty, no inside trading: If you are in possession of inside information:
Disclose the secret and trade: Abstain from trading.
Goodwin v. Agassiz: Goodwin accuses mining company of buying shares with inside information derived from a geology study.
Agassiz bought the shares through a broker, therefore Goodwin did not know they were buying (which might have tipped him off to
the value of the stock.) Holding: When Directors buy from existing shareholders, they have a fiduciary duty to negotiate a fair price.
Do not owe duty to non-shareholders.
Chiarella v. US: A financial printing company worker was able to figure out what company was about to get a tender offer, so he
bought stock in the undervalued company and was caught. Holding: Printer did not owe fiduciary duty to the company even though
he caused the company to breach their fiduciary duty. Need to locate fiduciary duty in the chain.
Dirks v. SEC: Dirks was investigating a fraud and as a result received inside information and released it to investors who then traded
on it. Holding: Dirks had no duty to abstain from use of inside information because he was not a fiduciary of the company In order to
charge for inside trading, you must locate the fiduciary duty; Mere possession of non-public information does not give rise to a duty
to disclose
Principals of Corporate Governance/ Duty of Care:
1) In good faith
2) Advances the best interest of the corporation and
3) With the care that an ordinarily prudent person in the same circumstance.
**Corporate directors invest other peoples money so liability falls on them, their negligence in corporate governance is much greater
than a tort.****
***This could discourage other people/ directors/ officers from undertaking valuable risky projects.
***The law protects shareholders un-economic consequences but relation to the economy shareholders are left alone
***If corporate directors are found liable then they are jointly and severable liable
Business Judgment Rule: Creates a zone of autonomy for the primary decision-maker, not subject to judicial review.
- Compare: international law, federalism: comity, Due process: “rational basis test” Admin, Procedure Act: Chevron
Deference, Family, property law: “privacy.”
- No liability unless you can establish gross negligence, breach of duty of loyalty or conflict of interest.
- If plaintiff can establish any above, then the business judgment rule goes away.
- Mistakes/ mere damage cannot establish liability- not evidence of lack of due care.
• “The Business Judgment Rule is a presumption that in making a business decision the directors acted on an informed
basis, in good faith and in the honest belief that the action taken was in the best interests of the corporation”
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Duty of Care:
Director or officer must (1) perform duties in good faith, (2) in a manner that he or she reasonably believes to be in the best
interests of the corporation, and (3) with the care that an ordinarily prudent person would reasonably be expected to exercise
in a like position.
Kamin v. American Express Company: “Mere errors of judgment are not sufficient grounds for equity interference, for the powers
of those entrusted with corporate management are largely discretionary.” “The Court will not interfere unless a clear case is made
out of fraud, oppression, arbitrary action, or breach of trust.” Amex acquired stock in DLJ, which decreased in value. Amex decided
to disburse the stock to Amex stockholder in the form of a dividend. Kamin wants them to sell DLJ and take the tax write-off for the
loss, which would result in less loss. Kamin argues that it is breach of duty of care to dispose of stock as a dividend. Amex argues
they were aware of the tax deductions, but selected the dividend option based on their prudent judgment.
Holding: The court will presume the director was not negligent under the Business Judgment Rule. Reason: The plaintiff must show
a breach of duty to overcome the BJR.
Smith v. Van Gorkum: Holding company had large cash flow, but low taxable income. Van Gorkum was close to retirement and
wanted to sell his 75,000 shared at $55 each. The going rate was $30-40. The stock would be made public for 90 days to allow the
market to evaluate the value of the stock, to show management that $55 was a fair price. Holding: Business Judgment Rule does not
apply because directors did not make an informed decision. They did not know: (1) Van Gorkum’s role in the forced buyout, (2) the
intrinsic value of the company, and (3) were negligent in approving the sale on short notice.
*To get protection from BJR, Director’s need to be informed of all material information reasonably available in good faith
DEL Corp Law § 102-b7: LEGISLATIVE RESPONSE TO VAN GORKOM (Limiting Monetary Remedy): Allows any
corporation to include in its articles of incorporation a provision eliminating or limiting the personal liability of a director to the
corporation, or its SHs, for monetary damages for a breach of fiduciary duty…
Francis v. United Jersey Bank: Two shareholding sons, who were also directors, took out $12M in loans from the company before
it filed for bankruptcy. The misappropriated money was supposed to fund a trust held by the company. Court found that mother
made no effort to discharge her duty as a director, even though she was largely incapacitated. Holding: If you are not actually
exercising business judgment (sitting home in bed) then you cannot claim protection under the Business Judgment
“Directors … are not insurers of corporate activities”
BUT
“Director should acquire at least a rudimentary understanding of the business”
“Keep informed about activities … and financial status”
Duty to object, resign, and perhaps more
In re Caremark: The shareholders of Caremark International, Inc. brought a derivative action, alleging that directors breached their
duty of care by failing to put in place adequate internal control systems. This was said to enable the company’s employees to commit
criminal offences, resulting in substantial fines and civil penalties. Directors have a duty to attempt in good faith to provide adequate
recording systems to protect against misconduct. If reasonably adequate system was in place, business judgment rule protect board
decisions:
Test to show breach: (i) Directors knew or should have known about violations occurring (ii) Directors took no steps in good
faith to prevent or remedy the situation (iii) Resulted in losses.
Statutory techniques for limiting director and officer Risk exposure:
Indemnification: If you are found to be acting in bad faith then the corp. does not need to pay.
Del. G. Corp. L 145 (a) A corporation shall have the power to indemnify any person made or threatened to be made a party … (in
an action other than a derivative action) by reason of the fact that the person is or was a director, officer, employee or agent of the
corporation.
…. If the person acted in good faith and in a manner the person believe to be in or not opposed to be the best interests of the
corporation…
Duty of Legality;
Miller v. AT&T: AT&T failed to collect 1.5 million telephone bills, allegedly an illegal campaign contribution.
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Does NY corporate law impose a duty on directors to cause AT&T to obey federal law? Yes, because shareholders were within the
protected class.
Duty of Loyalty: Requires that fiduciaries (such as directors and officers) put the interests of the corporation ahead of their own
interests. The Duty of Loyalty is implicated when a director is involved in a situation in which there is a conflict of interest, meaning
that is there some aspect of the situation that creates a personal benefit for the fiduciary.
•
•
•
Old TRUST rule: self-dealing transactions are void
– (Now, somewhat liberalized)
Self-dealing is often criminal in the public sector
– Nepotism, graft
Corporate directors are not trustees
– (Even in non-profits, where they may be called “trustees”)
The conflict of interest exists when the director knows that at the time he is asked to take action with regard to a potential
transaction, he or a person related to him (1) is a party to the transaction, or (2) has a beneficial financial interest then exercises his
influence to the detriment of the corporation.
• A transaction is never voidable SOLELY because directors with a conflict of interest approved it.
• Full disclosure and entire fairness are still required.
• Burden of proof is on conflicted parties to show that the transaction is fair to the corporation.
In evaluating if a duty of loyalty situation, one can ask a series of questions:
- Is there a conflict of interest (Can be direct or indirect)- then there is a duty of loyalty issue
- Was the transaction “cleansed”?
- If cleansed, then the transaction is protected and may proceed. (if the transaction is cleansed by vote of the disinterested
directors, it will be subject to scrutiny, but typically protected by the BJR).
- If not “cleansed” then transaction is “voidable” by the corporation and directors who violated duty of loyalty may be subject
to damages.
Typical situations that create conflicts of interest:
- Self- dealing- a fiduciary enters into a transaction with herself or an entity (or family member) with a substantial financial
interest.
- Taking a “corporate opportunity”- fiduciary misappropriates an opportunity that belongs to the corporation.
- Stealing: a fiduciary of the corporation takes assets for herself.
- Executive compensation: when the executive is also on the Board of Directors and votes to determine compensation.
- Disclose of information to shareholders (disclosure might impact the liability of all or some of the Board of Directors)
- Entrenchment: directors take steps to prevent others from removing them
- Key players personal financial interests are potentially in conflict with interests of the corporation.
Cleansing:
- The transaction is approved by vote of a majority of the fully informed, disinterested directors.
- The transaction is shown to have been “intrinsically fair” relating to the price and terms of the deal.
Duty of Loyalty to Whom?
- Corporation- agency law
- Consumers competitive market theory
- Shareholders- voting/“membership”
- Employees- team
- Public – democratic republicanism
Economic Surplus you’re doing something useful- you’re able to produce something that people want for less than you charge
-What can you do with the surplus? - pay taxes, pay increase; dividend; lower prices.
Shareholder Actions: When a shareholder has a complaint regarding a corporation in which she holds stock, there are two
kinds of actions that she may bring:
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Direct Action: the shareholder makes a claim in her own name against the corporation or against a director or officer of the
corporation or against for a wrong that was directly to her. Individual COA; Loss to shareholder.
i. Direct actions are often brought as class actions if the wrong affects many shareholders.
ii. In such instances the shareholder sues as a representative of a class of similarly situated shareholders who
have suffered from the same wrong.
b. Examples of Direct Action:
i. compel the payment of dividends;
ii. enjoin an activity that is ultra vires;
iii. security fraud;
iv. protect shareholder rights such as the right to vote on matter;
v. denied rights and;
vi. shareholder seeks to recover job and/ or stock upon being fired
Derivative Action: The complained of wrong has damaged the corporation and, as a result, negatively impacts the shareholder.
If the corporation has failed to act, the shareholder might be able to bring a suit compelling the corporation to force the corporation
to take action against the perpetrator. The shareholder sues the corporation and the third party (2 suits) in an effort to force the
corporation to take action to address the harm.
1) In Short: Derivative (i) Shareholder brings suit on behalf of corporation (ii) Cause of action: Corporation as an entity (iii)
Injury: Loss to the corporation
a. Examples of Derivative Action:
i. A claim that a director has violated his duty of care by making a bad deal with third party;
ii. A claim that an officer has misappropriated a corporate opportunity (or committed some duty of loyalty
violation), and corporation has failed to take action against her;
iii. A claim that a 3rd party who has a contract with the corporation has breached and the board has failed to take
action against 3rd party;
iv. A claim that senior managements salaries are excessive; and;
v. Prevent management practices calculated to prevent challenges (to current management).
Requires demand by shareholder before bringing suit
o Shareholder should not be allowed to waste assets of other shareholders
o Allow corporation to take over the cause of action or resist it, according to judgment of directors
o Gives corporation time to investigate the claims
Differences in the posture of Derivative and Direct Actions:
o Only shareholders can bring derivative suits not creditors
o Derivative actions- remedy goes to the corporation- not the shareholder.
o Direct actions- remedy goes to the shareholder.
o In a derivative suit, the corporation is required to pay for the shareholder’s attorney fees, if shareholder is successful
 Additional Requirements in a derivative law suit are as follows:
o Contemporaneous Ownership: must have been a shareholder at the time of the injury
o The demand requirement: most states require that the shareholder demand board pursue suit
o If board determines not to bring suit, then decision is often protected by BJR.
o Demand is excused when bringing suit is “futile”- one must show that there is reasonable
doubt that the majority of the directors are disinterested and independent. Director is not
disinterested bc he has material financial interest in the suit.
Demand Requirement:
Jurisdictions
 DE Law – demand can be excused sometimes if you can plead the case
 NY Law – demand can be excused if you can show certain things
 MBCA – demand is never excused – requires universal demand
Plaintiff must allege facts with particularity that create “reasonable doubt” that board is capable of making good faith decision and
SHOW:
 Majority of the board has a material interest in the challenged transaction; OR
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Majority of the board is dominated or controlled by the alleged wrongdoer (can’t act independently); OR
o Must be egregious – extremely outrageous, but this is hard to show
Difference between NY and DE Standard?
- There is no reasonable doubt language in NY
- If plaintiff cannot prove futility, then must make demand
Derivative lawsuit Summary:
o Corporation ABC does something allegedly wrong and a shareholder or group of shareholders wants to sue the directors
for their breach of fiduciary duty to the corporation.
o Since the directors are not going to sue themselves the shareholders have to bring a derivative lawsuit.
 First, the shareholder must post a bond to cover costs in the event of loss.
 Second, the shareholder must make a demand on the Board of Directors to pursue suit or show that a
demand is excused, by showing a majority of the board has an interest in the transaction in question or that
the board is controlled by someone with an interest in the transaction or that a reasonable doubt exists about
the exercise of sound business judgment.
 Third, if there is special litigation committee, they have to agree with the shareholder and allow the
shareholder to bring this case or dismiss the lawsuit, then the shareholder argues that the decision invalid,
because the process for investigating the claim was flawed, the members of the committee were not
disinterested or the committees decision itself violated the BJR.
Dismissal – Derivative suits are dismissed when
o Failure to demand
o Rejection by board
Financing
o If substantial benefit to corporation, corporation must pay plaintiff’s reasonable expenses (including counsel fees)
o If proceeding was commenced or maintained without reasonable cause or improper purpose plaintiff must pay any
defendant’s reasonable expenses (including counsel fees)
o If filing of pleading, motion was not well grounded in fact, after reasonable inquiry or warranted by existing law
or good faith argument for the extension, a party must pay opposing party’s reasonable expenses (including counsel
fees)
o Corporation will pay for settlement
Law
i)
The law of the state of incorporation governs
Marx v. Akers: Plaintiff brings suit against IBM without first demanding that board file a lawsuit. His claim is dismissed as a result,
along with failing to state a cause of action. Holding: Demand dismissed because Directors have an interest in their own
compensation (NY); Show conflict in demand
Delaware: Have to be eligible shareholder: Have to make demand then board decides whether to go through with the suit (business
judgment rule protected)
Grimes v. Donald: Agreement makes Donald CEO and takes some control away from board of directors. Grimes wants the
agreement invalidated. Grimes sent a letter to the board requesting they abrogate the contract, they refused. Derivative suit. Holding:
If you make a demand, you waive your right to say the demand should have been excused and subject yourself to the business
judgment rule (Delaware rule)
De Facto Corporations: Instances when the corporations are not properly formed, the-would-be shareholders act as though
the corporation was properly formed.
- Shareholders have corporate protection under an equitable doctrine known as “de facto” corporation status.
Requirements to assert De Facto corporate protection:
 A good faith, substantial effort to comply with the states incorporation statute;
 legal right to incorporate; and
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
o
good faith belief that they formed a corporation.
principals will have limited liability from the debts of the corporation as though the corporation has been properly formed.
Corporation by Estoppel (arises in contracts mostly): If a third party trans an organization as though it were a corporation, then
that third party may be estopped from denying the organizations corporate existence, if the denial would cause an unjust harm to the
principals.
Promoters: are the people who organize the corporation before it is formed:
Piercing the Corporate Veil Contract:
o When a court says we are going to ignore corporate law, and without statutory explanation we are going to hold the
shareholders liable.
- Language:
o “Playthings”
o “Alter Ego”
o “Mere agent”
o “total control”
o “Unity of interest and ownership”
o “Undercapitalized”
o “Promote injustice”

Deceit
o “Corporate Formalities”
1. Failure to keep proper records
2. Failure to separate corporate and personal assets
3. Failure to document transfers
4. Failure to respect corporate role
5. Failure to have meetings
o “Fraud” (not really)
Allocating risk of business failure:
- A creditor of the corporation must have a court rule that the veil may be pierced.
- It must be showed that the separate existence between the shareholder and the corporation has not been respected.
Test for Piercing the Corporate Veil:
o First, there Must be a unity of interest and ownership that the separate personalities of the corporation and the
shareholder(s) no longer exists AND:
o adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice
Sea Land Services, Inc. v. Pepper Source: Under Illinois law [the Van Dorn test], to pierce the corporate veil, a court must find a
unity of interest and ownership between corporation and shareholder, (no distinction between owner and corporation) AND a
situation where failing to PCV would either: sanction fraud [don’t need proof of intent to defraud creditors]; or promote
injustice. Van Dorn Test- Illinois law: To determine whether (a) exists, courts look at four factors: (1) the lack of corporate
formalities, (2) the commingling of funds and assets, (3) under-capitalization, and (4) the use by one corporation of assets of
another [which sounds to me a lot like commingling
Test for Unity of Interests:
- Failure to follow the corporate formalities; such as a failure to take minutes, conduct meetings, elect officers, adopt bylaws,
issue stock, create a board of directors and have the corporation take proper procedures
- Failure to maintain separate accounts “co-mingling”
- Failure to adequately capitalize, place sufficient funds to operate as a viable business, taking into account the type of
business and the market, provide the minimum insurance (if required)
Test for sanction, fraud or promote injustice; improper behavior such as;
- Unfair business practices, intentional misrepresentations, deception, criminal or sanctioned civil behavior
- Attempt to eliminate liability and lacking a true “business operation” or purpose
- Unjust enrichment (leaving business undercapitalized)
In order to prevent piercing:
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Keep the corporation’s business separate (separate bank accounts, property, records) from personal assets.
Keep minutes, hold meetings, elect board members, issue stock, adequately capitalize corporation, and carry minimum
insurance required.
Reverse Piercing:
- Where a claim against an individual shareholder is found to be enforceable directly against the corporation in which the
individual is a shareholder.
o Reverse piercing makes the individual shareholders personal creditor, a creditor directly against the corporation, which
outs them higher in line to be paid than if they just had a claim against the shareholder
Enterprise Liability: a creditor claims there are several related corporations and all or some are really part of the same corporation.
It is an effort to enforce a claim against one corporation against the other, related corporations.
- Usually claimed when there is a common ownership among two or more coporations. Typically known as “sister
corporations”
In order to avoid enterprise liability:
- Maintain separate book, avoid sharing assets, supplies and other resources.
- Engage in careful accounting practices, which reflect that supplies and or resources are paid by unconnected independent
business.
• Speech: Anti-censorship position - activist courts seek to maintain space for debate about political values
• Economic activity: – deferential courts allow political determination of the rules of the marketplace
• Speech: laissez-faire – existing distribution of power is “natural” and government may not take action to change it (except
via the usual rules to distribute economic and other power).
• Economic activity: Lochner & laissez-faire rejected; economics is inherently political. Rules change and rules matter.
Bottom line:
• Corporations are under intense legal and market pressure to profit-maximize.
Federal Law:
In 1934 Securities Exchange Act §14 (A) – 14(c):
§14 (A):
o Unlawful to solicit proxy to vote a security in violation of SEC rules
o Proxy solicitation must be accompanied by an SEC- approved “proxy statement”
o Send out your own materials
o Have your proposal included with management’s.
o Corporate governance
 Make mergers easier, by eliminate staggered boards and redeem poison pills
 Limit executive privilege
- Procedure limits and Substantive limits.
Securities Regulation
Federal Securities Law
Primary Market: issuer of securities sells them to investors (IPO)
Secondary Market: investors trade securities among themselves without any significant participation by the original issuer
SEC (Securities and Exchange Commission): Independent agency; Enforce securities laws; Promulgate laws and regulations to
implement them more effectively.
Full disclosure- investors have all information they need to make informed decisions; Prevent fraud
Statutes – 2 most important:
Securities Act of 1933:
Regulates the offering and sale of new securities – primary market
Follows transactional disclosure model – registration statement must be filed with SEC, prospectus distributed
to investors (§ 5)
Required in connection with any public sale
Securities Exchange Act of 1934:
Regulates secondary market activity, such as insider trading
Periodic
(i) Form 10 (once) – contains exhaustive disclosures regarding the companies
(ii) 10-K (annual) – audited financial statements and management’s report of the previous year’s activities, and
annual report
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(iii) 10-Q (quarterly) – unaudited financial statements and management’s report on material recent developments
(iv) 8-K (episodic) – file within 15 days after certain important events affecting the company’s operations or
financial condition
(v) 14-A (proxy)
Securities Act § 2(1) – The term “security” means any stock, note…bond, debenture, investment contract…or in general, any
interest or instrument commonly known as a “security.”
When trying to identify if a scheme, contract or instrument qualifies as a security:
o The right to receive dividends contingent upon an apportionment of profits;
o Negotiability;
o The ability to be pledged or hypothecated;
o Voting rights which accompany an instrument and correspond to the number of shares owned; and/or
o The ability to appreciate in value.
Some securities are per se securities:
Stock : Always a security, except if not a stock it might still be a security if it’s an investment contract (look at 4 factors) f not a
stock, look at economic realities
Investment Contract
SEC v. Howey – a contract, transaction or scheme whereby a person invests money in a common enterprise, and is led to expect
profits, solely from the efforts of others of the promoter or a 3rd party
Four factors:
- A contract, transaction or scheme whereby person invests money
- In a common enterprise
- And is led to expect profits
- Solely from the efforts of others of the promoter or 3rd party
- Investment of money prong
Expectation of profit- Usually not very important. Even in tax shelter arrangements, investors expect to benefit
through shielding of some of their income from taxes
Common Enterprise (requires 1 of 2 kinds)
Horizontal Commonality:
1. Looks to the relationship between the individual investor and other investors who put money into the
scheme
2. Pooling of investors’ contributions and distribution of profits and losses on a pro-rata basis among
investors
Vertical Commonality:
3. Looks to the relationship between the investor and promoter of the scheme
a. Promoter is the one organizing business
b. Problem – often promoters don’t put their own money in
4. Requires that investor and promoter be engaged in a common enterprise, with the fortunes of the
investors linked with those of the promoters
i. If fortunes of promoter is not linked with investor then not vertical commonality
(2) Solely from the efforts of others
(i) Virtually no court reads that literally – particularly no court has taken “solely” seriously
(ii) Test – how much effort does the promoter put into the project, as opposed to the investor’s efforts in order
for expectation of profits test to be met? (essentially how much control?)
(3) Howey test – 2 prongs of common enterprise AND solely from efforts of others are most elusive
Registration Process and Selling Securities Under the Securities Act of 1933
- Cannot sell securities until issuer has registered them with the SEC
- Registration process is very expensive
- No selling activity for a period of time before registration statement filed with SEC
- After you file the statement, you can go out and market the company
(4) Offers permitted but no sales
(5) SEC review – adequacy of disclosure, not merits
SEC allows registration
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(6) Sales permitted, prospectus must be delivered (most important) – principal disclosure document issuers are required
to give
Registration Exemptions for Private placements
An exempt security need never be registered
An exempt transaction are one-time exemptions (private placements)
(a) When you do a particular kind of transaction so you’re exempt from most securities laws
(b) Securities Act § 4(2) – does not apply to transactions by an issuer not involving any public offering
Private Placement Exemption (not public offering) – Securities Act § 4(2)
An offering to those who are shown to be able to fend for themselves is a transaction “not involving any public offering”
Purpose of Act was to protect investors by promoting full disclosure thought necessary to informed investment
decisions – so exemption turns on the knowledge of offerees
Test: 4 Factors
Number of offerees and relationship to issuer
Presumption that they don’t need much protection if there is a relationship
Number of (all) offerees – not purchasers (ascertain magnitude)
(i) General rule of thumb is 25 – if you have more than 25 people it is the danger zone where it may not be a
private placement
1. Typically a public offering is to hundreds and thousands of investors
Relationship to issuer
Offeree’s knowledge and sophistication
2. Evidence of high degree of sophistication on part of all offerees does not automatically make it private
placement exemption
3. There must be sufficient basis of accurate information upon which the sophisticated investor may
exercise his skills
i. Investor must have the required data for judgment
ii. SEC isn’t worried about protecting rich people
Offeree’s access to information
4. The information a registration statement would have provided (disclosure OR effective access)
a. Private memorandum
b. Access to files and records
5. This showing is not independently sufficient to establish that the offering qualified for the private
placement exemption
Number of units offered
Small number of units
Size of the offering
Relatively modest financial stakes
Manner of offering
No general advertising or solicitation
Perhaps offering characterized by personal contact free of advertising
Number of Offerees:
How many people are offered the deal? Not how many people actually invest but how many people actually have
the opportunity to invest.
Rule 10b-5 – Implied Civil Liabilities in Secondary Market for Non-exemption
Exchange Act Rule 10b-5: It shall be unlawful for any person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(7) To employ any device, scheme, or artifice to defraud,
(8) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make
the statements made, in the light of the circumstances under which they were made, not misleading, or
(9) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any
person,
ii) In connection with the purchase or sale of any security
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Elements For Cause of Action
Jurisdictional nexus
(1) Not everybody can sue- Only purchasers or sellers have standing to sue
Transactional nexus- Applies to any security – including close corporations securities
Material misrepresentation or omission
(a) Key is material misrepresentation or omission
(b) Material – anything that would impact on selling or buying decision (standard below)
Reliance (see more below)
(c) Can be proven by breach of duty to disclose material information
Causation
(i) Transaction causation and Loss causation
(2) State of mind
(a) Intent to defraud (Supreme Court)
(b) Reckless disregard of falsity of statement (all circuits)
General Standard of Materiality
Whether there is a substantial likelihood that a reasonable shareholder would consider the fact important
However when faced with uncertain and contingent facts
(c) Highly fact-dependent probability/magnitude balancing approach
(i) Probability that the event will occur
a. Look at the indicia of interest in the transaction
(ii) Anticipated magnitude of the event in light of the totality of the company activity
a. A merger can become material at earlier stage than other transactions because can bring a small
corporation’s death
Hypo: ABC is a small struggling pharmaceutical working on a cure for baldness. Research shows cure works on monkeys but no
human tests yet, so ABC hasn’t applied for ADA approval yet
Magnitude – if it works has huge magnitude
Probability – pretty low
Reliance
Presumed in omission cases
Efficient Capital Market Hypothesis
Moments after information is out about something bad about the company, in seconds people will start selling the stock and price
drops immediately
Fraud on the Market Theory
Can be used to prove reliance
Presumption that investor relied on integrity of market price – so investor need not have seen misrepresentation
(d) Price of company’s stock is determined by the available material information regarding company and its
business
(e) Misleading statements will therefore defraud purchasers of stock even if purchasers do not directly rely on
misstatements
(i) Market is performing a substantial part of valuation process
(3) Court will presume they relied on the fraud because it was on the market
(4) Invoked when material public misrepresentation or efficient market
(5) Rebuttal
(a) Defendant can rebut by showing
(i) Market not deceived
1. Market price would not have been affected by misrepresentation
2. Market makers were privy to the truth about merger discussion (Basic case)
(ii) Corrective statements
(iii) Specific plaintiffs would have sold anyway
1. A plaintiff who believed statements were false and was going to sell anyway (political pressure, antitrust
reasons, etc. Basic)
Causation (2 types)
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1) Transaction Causation
(b) Closely related to reliance
(c) But for the fraud, plaintiff would not have invested (or sold…)
(d) Pretty easy to show, just need to establish fraud on the market theory presumption and you can almost
always show transaction causation
(e) Presumption of transaction causation
(i) Courts will assume transaction causation where reliance is presumed
1. Omissions
2. Fraud on the market
2) Loss Causation
(a) Akin to proximate cause
(b) Fraud caused the loss
(i) E.g. market doesn’t believe the misrepresentation, stock tanked due to market decline
(c) Expert witness hired to show that losses caused by particular misrepresentation
(d) No presumption of loss causation – even if you have reliance
Insider Trading
Market Information v. Inside Information
Inside Information
(2) Originates from within the firm and relates to the firm’s earning power or assets
(a) Earnings, products, assets, plans and the like
Market information
(3) Everything else
Insider Trading
State law fraud action:
1. D made a false statement
1. of material fact
2. With intent to deceive
3. On which P reasonably relied in purchase or sale from/to D
4. Causing injury
State law fraud action:
1. D made a false statement
 Non-disclosure usually permitted
2. of material fact
 Puffery, opinions, predictions permitted
3. With intent to deceive
 D must know P will rely
4. On which P reasonably relied in buying or selling from/to D
 So no action possible in anonymous market
5. Causing P injury
 -- Identifiable victim necessary
Corporate insiders and other individuals with access to inside information must disclose or abstain from trading in
company stock
Rationale?
(a) Level playing field – equal access to information
(b) Enforcement of fiduciary duties
Insider trading liability is premised on an omission of material fact
(4) But liability for omission can only be imposed where defendant had a duty to disclose
(i) Silence is NOT fraudulent absent duty to speak
(5) There must be a relationship of trust and confidence between insider and company
(a) Chiarella case – not insider trading because he had no duty to shareholders and thus no relationship of trust and
confidence
Liability under Rule 10b-5(b)
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(6) One must have a duty to the person before required to disclose  prohibition under 10b-5 turns on whether person
had a duty
(7) Omitting to state a material fact from the duty to disclose, arising from relationship of trust and confidence
It shall be unlawful
1. To employ any device, scheme or artifice to defraud
2. To make any untrue statement of a material fact or omit to state a material fact necessary to make the statements made …
not misleading
3. To engage in any act, practice, or course of business which operates … as a fraud or deceit … in connection with the
purchase or sale of any security.
Based on 5 fingers of common law fraud:
1. False or misleading statement (or omission)
2. That is material
3. D acted with intent (or gross negligence)
4. P relied
5. To its detriment (damages)
Duty to Disclose
ii) Does not arise from mere possession of nonpublic market information
(1) Only from existence of fiduciary relationship (agent, fiduciary, trust & confidence)
iii) Rule 10b-5 liability for insider trading premised on duty to disclose arising from a relationship of trust and
confidence between 2 parties to the transaction
(1) Duty arises when there is a relationship of trust and confidence
Insider Trading – Tippee and Insiders And Liability
iv) Is someone an insider?
(1) Insider may be just one who tips, then go to tipper/tippee analysis
v) Is someone a tippee?
(1) If so, did tippee acquire information from breach by Tipper that benefited Tipper?
vi) Is there misappropriation?
Ban Insider Trading
1. Incentives: Insiders profit from creating tradeable information instead of, e.g., innovation or efficiency
2. Conflict of interest: Like a coach betting against his team, easiest way to profit is to throw the game
3. Democracy/equality: Wall St should work for all, not just privileged
4. Attracting capital: Outside investors may refuse to play if they suspect bad incentives (#1), cheating (#2) or rigged
game (#3)
5. Allocating capital: Wall St can’t funnel capital to most valuable projects if insiders are busy distorting its
information
b) Insiders
i) Officers, Directors, controlling shareholders
ii) Individuals with access to material, nonpublic information who also owe fiduciary duties to both the corporation and its
shareholders (relationship of trust and confidence) – gives rise to duty to disclose or abstain from trading
(a) Insider may be just someone who doesn’t trade for himself but tips
(i) Then go to tipper/tippee analysis
iii) Constructive Insider (where corporation info revealed legitimately to an underwriter, accountant, lawyer or consultant –
they may become fiduciaries to shareholders)
(1) One becomes a constructive insider when they
(i) Obtain material nonpublic information from the issuer with
(ii) An expectation on the part of the corporation that the outsider will keep the disclosed information
confidential and
(iii) Relationship at least implies such a duty
(2) Constructive insiders have fiduciary duties  tipper must breach – must be an insider and breach duty by tipping
iv) Duties and Failed Negotiations
(1) You only have a duty to your own shareholders
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(a) i.e. Merger negotiations, material nonpublic information about Acme disclosed to XYZ. Mergers talks fail.
XYZ buys stock in anticipation of hostile takeover bid.
(i) XYZ has no duty to Acme shareholders anymore since merger talk failed – you only have a duty to your
own shareholders, and if you are no longer part of merger negotiations you no longer have a duty to them
(2) Remedy?
(a) When companies start negotiations, sign confidentiality agreement so all information is held confidential (even
if just hint of talks)
(b) This then creates a duty not to use that information and prevents insider trading
c) Tipper/Tippee
i) Tipper
(a) Insider who tips to tippee
ii) Tippee
(a) Person who gets the information
(b) Not considered an insider
(c) Has no duty to the investor
(i) i.e. family member
iii) A tip itself is NOT the only thing required
(a) Looking at objective criteria courts must determine whether the insider will personally benefit, directly or
indirectly, from disclosure
(i) Pecuniary gain – enhanced reputation will translate into profits or gifts
iv) In general, tippee’s liability is derivative of the tipper’s, arising from his role as a participant after the fact in the
insider’s breach of duty
(a) Tippee must know that tipper is breaching his duty to invoke liability
v) Tipper Liability
(a) Must breach the fiduciary duty of constructive insider by being an insider and tipping – and have personal gain
(i) Absent personal gain there has been no breach of duty to stockholders
vi) Tippee Liability
(1) Tipper breached fiduciary duty by disclosing information to the tippee, AND
(2) Tippee knows or has reason to know of breach of duty
d) Misappropriation (deception through nondisclosure)
i) Insider trading liability – designed to protect against abuses by outsiders who have access to confidential information
(1) One misappropriated confidential information from employer for securities trading purposes (sell or buy) even
though he does not breach a fiduciary duty but breaches duty owed to source of information
(i) Fiduciary’s undisclosed, self-serving use of principal’s information to purchase/sell securities, in breach of
duty of loyalty and confidentiality, defrauds principal of exclusive use of information
(2) Violation of fiduciary duty to the source of the information
(a) i.e. Chiarella – he misappropriated information from his employer and client which is a violation and
misappropriation
ii) Full disclosure forecloses liability
(1) Since deception involves feigning loyalty to the source of information
(2) If fiduciary discloses to source that he plans to trade on the nonpublic information there is no deceptive device (no
violation)
(a) Perhaps breach of duty of loyalty however
iii) Rule: A fiduciary’s undisclosed, self-serving use of a principal’s information (nonpublic material) to purchase or sell
securities, in breach of duty of loyalty and confidentiality to source of information, defrauds the principal of the
exclusive use of that information and is fraud  violates Rule 10b-5
(a) A fiduciary who pretends loyalty to principal while secretly converting the principal’s information for personal
gain
iv) Outlaws trading on basis of nonpublic information by a corporate outsider in breach of a duty owed to the source of
the information
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v) Rule 10b5-2 – Duty of trust and confidence exists when…
(1) Whenever a person agrees to maintain info in confidence
(a) History, pattern or practice of sharing confidences, such that…the person communicating the info expects
the recipient to maintain confidentiality; OR
(b) Receives or obtains from his…spouse, parent, child or sibling, unless recipient shows that history, pattern, or
practice indicates no expectation of confidentiality
Takeovers
•
“Friendly” takeover, merger or sale: Incumbent directors agree to sell the company or merge it with another one
•
“Hostile” takeover: An “insurgent” seeks to replace incumbent directors, or a “shark” seeks to purchase the company or
cause it to merge with another.
•
The difference between “friendly” and “hostile” takeover is whether the incumbent board supports the proposal
•
Wall St Walk: shareholders rarely vote against incumbents; instead they sell.
•
Stock is freely transferable without permission of the incumbent corporate managers.
•
So corporate elections are potentially for sale.
•
–
Solicit votes
–
Hard, because shareholders who think managers are doing a bad job should sell, and then they can’t vote
Tender Offer
–
Purchase shares
–
Hard, because who wants to be a large shareholder of a company with bad managers?
Proxy Fights: Shareholders have to vote, most shareholders vote through agents (proxys): Before management can solicit
proxy’s they have to issue a proxy statement:
Burden of proof:
Negligently failed to create a proxy statement
Material misleading statement
The missing or wrong information doesn’t have to change votes, just make a reliance
If proxy statement is a false or misleading, judge can issue an injunction to post pone vote until information is corrected
a. Rule 14a-9
i. Prohibits misrepresentations or omissions of a material fact in proxy materials
Lovenheim v. Iroquois Brands: L wants proxy information included in proxy material about force-feeding geese in the production
of pâté. L wants the company to stop (if they do it) and his proposal is to have the company commission his committee to determine
how the company produces its pâté. Holding: Shareholders have no right to involvement in normal business decisions: Its managers
fiduciary duty to make business decisions; If they don’t its breach of fiduciary duty. A controversial act is proper under the 5% rule.
Shareholders are not owners of the company
Pillsbury v. Honeywell: P finds out that H is making munitions for Vietnam, wants to lobby the company to stop supporting the war.
P buys shares to gain vote and persuade other owners to petition the company. H argues that P was not really a shareholder, but was
an activist. Holding: Corporations purpose is to make a profit, if you do not like to make a profit you are not a shareholder. Delaware
says this isn’t correct
b. Inspection rights
i. Shareholder’s right to inspect for any proper purpose, the corporations
1. Stock ledger
2. List of stockholders
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3. Other books and records
ii. Must make a written demand setting forth a proper purpose (one that is reasonably
related to such persons interest as a stockholder)
iii. In NY
1. Voting disclosure applies
2. Shareholders just have to say they are using the list for a proper purpose and
they get the list
p. Takeovers, Mergers and Acquisitions
a. 3 ways to combine 2 companies
i. Statutory Merger
1. One company disappears and the other has all the assets and liability of both
a. Every contract A used to have is now B’s
b. B is free to change its name to A
c. Merger agreement has to specify
i. What company is going to survive
ii. What happens to the shareholders of the vanished company
1. Usually get paid out or made shareholders of new
company
iii. Has to be sent to both boards and ratified by both boards
1. Have to deicide its within the best interest of their
company
2. Shareholders vote on it
ii. Acquisitions
1. A and B still exist
2. Advantage because B doesn’t have to go to shareholders
a. Have to go to shareholders to change the articles of incorporation
3. A needs shareholders to vote
4. Creditors of A get paid out first by B and B takes assets
iii. Takeover
1. B purchase stock of A
2. B management is the sole voter for board of A
3. B is going to have to payout A shareholders or offer them stock in new
company
4. Only going to have to persuade the shareholders of A
a. Mergers and Acquisitions you have to persuade board of A
•
Going public: Shareholders, who control board, seek to profit by selling company at the stock price.
•
Friendly takeover/acquisition: Board seeks to sell the company in the company market and may or may not fear that
shareholders won’t want to sell.
•
Hostile takeover: “Shark” believes the company is worth more in the company market, but the board doesn’t want to sell.
ON TRIGGER
1. Rights can be bought and sold separately
2. Each right entitles holder to buy a share of stock from the company at a discount price (flip-in)
3. If the company merges, holder may buy shares of acquirer at a discount price (flip-over)
4. Triggering person’s rights are void
•
Corporations can be sold in two markets: the market for entire companies and the stock market (for individual shares).
•
The two markets are quite different.
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•
–
Mutual funds and pensions can’t buy companies, only stock.
–
Most companies will only buy companies, not stock
Most prefer diversification over control
–
–
Seeking efficiency
•
Eliminate duplication (supermarket problem)
•
Achieve scale (mass production, computers)
•
Use expertise in a new context (we do it better)
Seeking monopoly/monopsony power
•
–
Seeking regulatory influence
•
•
Larger size gives more bargaining power
Size makes governments listen
Financial buyers (hedge funds, “sharks”, LBO firms, private equity firms)
–
Arbitrage- See mispricing in stock or company market and hope to buy low, sell high
–
Wealth transfer from other corporate participants
•
Replace dividends (stock) with deductible interest (bonds) to reduce income taxes
•
Use debt to motivate/intimidate employees
•
Fees and high pay to insiders (fund principals, CEO)
•
If the share price is higher, company owners can profit by “making the company public” or selling additional shares.
•
If the company price is higher, stockholders can profit by “making the company private” (borrowing money to buy the
shares) or selling all the shares at once to a buyer of companies.
Cheff v. Mathes: Maremont approached Holland about a merger, it was declined. There were 883,585 outstanding shares. Maremont
acquired 55,000 (6.2%) before company knew it. Maremont then disclosed that Motor Products (he was CEO) had acquired 100,000
(11.3%) and wanted to be put on the board. Maremont had a reputation for liquidating companies. Maremont wanted to change the
business model, selling wholesale to plumbers, rather than door-to-door. Maremont goes to the major shareholder (Cheff, the family)
and gives him an ultimatum. Run the company in a better way, or buy me out of my shares. Cheff was not confident about the future
of the stock, so he suggested the company buy it instead. The Holland directors (Cheff family) decided to buy Maremont’s shares.
Shareholders derivative claims misuse of corporate assets to increase the voting power of the majority shareholders. Holding:
Burden of proof is on Defendant, Has to prove good faith, believed that buying Holland was a good practice
Unocal Corp v. Mesa: Unocal was approached by Mesa with a tender offer, which it refused. To avoid a hostile takeover, Unocal
wanted to buy back shares from stockholders, but excluded Mesa from the offer. Pickens wanted to buy 51% of the stock for
$54/share, then vote in a new board of directors and vote for a plan to have the company merge into a new company, which had the
sole purpose of liquidating the oil assets of Unocal. Holding: The corporation is allowed to decide that the price offered is not in the
best interest of the shareholders as a wholeBoard is permitted to protect shares
iv. Revlon v. MacAndrews & Forbes:
1. If board decides to put company up for sale it must max shareholders shares
and nothing else
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v. Time:
1. No fiduciary duty for board to be obligated to put company up for sale
b. Poison Pills
i. Special dividend that issues a right that is not activated until it is triggered by some
event (prevents takeovers)
1. Event is when a group or person buys 10% of shares without prior consent of
the board
a. After the event, the right becomes separated from the stock
b. Right gives you right to buy stock at discounted price from the
company
i. Value of stock should drop, but each shareholders have more
shares