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1. Jesse by Reinecke v. Danforth, (1992); pg. 184, briefed 2/19/97
2. Facts: Danforth was part of a group of doctors who hired an attorney to assist them in
the creation of a corporation for the purchase of an MRI. Jesse sued Danforth for
medical malpractice unrelated to the activities of the MRI corporation.
3. Procedural Posture: Jesse hired an attorney from the same office as the one which
incorporated the MRI corporation. Danforth moved to disqualify the plaintiff’s
attorney alleging that the firm had a conflict of interest based on Danforth being a
former client of the firm.
4. Issue: Whether one of the founders of a corporation may be treated as a present or
former client of a firm for the purposes of the conflict of interest rule when the
founders’ only contact with the firm was for the purpose of incorporation, and not for
personal representation.
5. Holding: No.
6. Reasoning: The entity rule contemplates that where a lawyer represents a
corporation, the client is the corporation, and not the corporation’s constituents. Thus,
if a person who retained a lawyer for the purpose of forming a corporation were
considered a client, then there would be automatic dual-representation of the person
and the corporation once the corporation was formed. But this is the exact effect that
the entity rule is designed to avoid. Thus, the entity rule must apply retroactively to
the person who retained the lawyer, so long as the lawyer’s involvement with the
person was limited to matters of incorporation.
1. Cranson v. International Business Machines Corp., (1964); pg. 197, briefed 2/19/97
2. Facts: Cranson hired an attorney to incorporate a business. Cranson acted as
president of the corporation, and exercised corporate business observing all formalities.
Cranson contracted with IBM, on behalf of the corporation, to purchase 8 typewriters.
It was later discovered that the corporation was not formally incorporated at the time of
the making of the typewriter purchase contracts due to an oversight on the part of the
incorporating attorney.
3. Procedural Posture: IBM sued Cranson personally for the balance due on the
typewriters. The lower court granted summary judgment against Cranson holding
that the constituents of a business that fails to file articles of incorporation are
personally liable, as a matter of law, for the debts of the business.
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4. Issue: Whether an officer of a defectively incorporated association may be subjected
to personal liability for the debts of the association under these facts.
5. Holding: No.
6. Reasoning: A de-facto corporation may be formed if there is a good faith effort to
incorporate, and actual exercise of corporate powers. Furthermore, under the doctrine
of estoppel, a person seeking to hold a corporate officer personally liable may not do so
if he has dealt with the association as if it were a legally-existing corporation. IBM
dealt with the business as if it were a legitimate corporation, and relied on its credit
rather than that of Cranson. Thus, it is estopped to assert that the business was not
incorporated.
1. Dodge v. Ford Motor Co., (1919); pg. 262, briefed 2/19/97
2. Facts: Ford Motor Co. had a surplus of almost $112 million. It declared a dividend of
$1.2 million. The Dodge Bros. were major shareholders, and wished to get some
money to open a competing business. Ford’s Board of Directors refused to issue a
larger dividend, claiming that the surplus was needed for expansion and operating
cushion.
3. Procedural Posture: Dodge sued to compel Ford’s board to declare a special dividend
equal to one-half of its surplus. The lower court awarded the dividend.
4. Issue: Whether the refusal of the Ford board of directors to issue such a dividend in
this case amounted to a willful abuse of discretion.
5. Holding: Yes.
6. Reasoning: It is well recognized that the power to declare a dividend, and the
amount of the dividend, is exclusively within the discretion of the board of directors.
However, a board may be compelled to pay a dividend if the failure to do so would be a
willful abuse of their discretionary powers, or fraud, or breach of the fiduciary duty.
Here, the surplus is so large, that even if Ford were to immediately spend all of the
money it planned for expansion, there would still be an obscene surplus.
1. Kamin v. American Express, (1976); pg. 267, briefed 2/24/97
2. Facts: Amex’s board of directors decided to declare a dividend. However, rather
than distributing cash as a dividend, they distributed shares of a stock (DLJ) which had
declined in value since they had purchased it. For tax purposes, Amex would be better
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of selling the stock and taking the capital loss. However, the board knew that selling
the stock would require that they reduce their reported income for the year (hurting the
stock price), whereas distribution by dividend would only reduce the retained earnings
by the book value of the stock, and thus not be reportable against income.
3. Procedural Posture: Two shareholders sued to enjoin the board from declaring the
stock dividend.
4. Issue: Whether the declaration of the stock dividend in this case amounts to abuse of
discretion.
5. Holding: No.
6. Reasoning: Unless there is fraud or bad faith, the board of directors has the exclusive
discretion to make such a business judgment. The minority stockholders are not in a
position to question this right of the directors, unless they act in bad faith. The
director’s board room, rather than the courtroom, is the appropriate forum for arguing
these purely business (and not legal) questions.
1. Walkovsky v. Carlton, (1966); pg. 338, briefed 2/24/97
2. Facts: Carlton owns several taxicab corporations. Each corporation owns two
taxicabs. Each taxicab corporation carries the statutory minimum of $10,000 of
insurance per cab. Each corporation is also highly leveraged. Carlton observed all of
the legal formalities of operating these corporations. Walkovsky was injured by one of
the taxicabs, and the amount of insurance was not enough to pay his medical bills.
3. Procedural Posture: Walkovsky brought this action to “pierce the corporate veil” and
hold Carlton personally liable for his damages.
4. Issue: Whether a claim that does not allege that the owners are conducting business
in their personal capacities through the corporation is sufficient to state a cause of action
for owner liability.
5. Holding: No.
6. Reasoning: It is a general rule that whenever anyone uses control of the corporation
to further his own rather than the corporation’s business, he will be liable for the
corporations acts upon the principle of respondeat superior. In such a case, the
corporation is merely and “enterprise entity” for the owners’ individual business ends.
However, in the present case, there was no allegation that the owner was operating the
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corporation in his own personal capacity. Whether the insurance coverage is sufficient
is a matter for the legislature.
1. Brunswick Corp. v. Waxman, (1979); pg. 345, briefed 2/24/97
2. Facts: Waxman formed a no-asset corporation to act as a signatory on a series of sales
agreements for bowling alley equipment with Brunswick. The no-asset corporation
then leased the equipment to five separate partnerships which operated five separate
bowling alleys. The bowling alleys failed before the no-asset corporation could pay the
entire purchase price. The corporation held no directors meetings, issued no stock, and
adopted no bylaws.
3. Procedural Posture: Brunswick moved to collect against Waxman personally for the
liabilities of the no-asset corporation.
4. Issue: Whether the owners are personally liable under the “instrumentality rule” for
the liabilities of the corporation when the creditor knew that the corporation had no
assets at the time of contracting, and did not rely on the owner’s personal guarantee.
5. Holding: No.
6. Reasoning: The instrumentality rule has three factors: 1) domination and control over
the corporation by those who are held liable which is so complete that the corporation
has no separate mind will or existence of its own, 2) the use of this domination and
control to commit fraud or wrong or any other dishonest or unjust act, and 3) injury or
unjust loss resulting to the plaintiff from such control and wrong. Here, there was no
fraud, no misappropriation of corporate funds, and consequently no fraud to
Brunswick. Brunswick was under no illusion than the no-asset corporation was merely
and agent for its owners. Brunswick, a sophisticated corporation, was not misled. It
had full knowledge that it was doing business with a no-asset corporation, and
proceeded anyway. It can not be heard to complain now that the corporation has
defaulted.
1. Kinney Shoe Corp. v. Polan, (1991); pg. 350, briefed 2/24/97
2. Facts: Kinney subleased a building to Industrial, Inc., a no-asset corporation set up by
Polan. Industrial, Inc. in turn subleased half of the warehouse to another of Polan’s
corporations, Polan Industries, Inc. All of the assets were placed into Polan Industries,
Inc. Industrial thereafter defaulted on the sublease to Kinney. Neither of Polan’s
corporations observed the corporate formalities required.
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3. Procedural Posture: The district court held that Kinney had assumed the risk of
Industrial’s undercapitalization and was not entitled to pierce the corporate veil.
Kinney appeals.
4. Issue: Whether there was sufficient unity of interest and other equitable factors
present to pierce the corporate veil under these facts.
5. Holding: Yes.
6. Reasoning: West Virginia has a two-pronged test: 1) is the unity of interest and
ownership such that the separate personalities of the corporation and the individual
shareholder no longer exist; and 2) would an equitable result occur if the acts are
treated as those of the corporation alone. Industrial was clearly undercapitalized, and
used solely as a shield layer to Polan Industries’ assets. Combined with the fact that
neither corporation observed any formalities such as to give the corporation a separate
existence from its owner (i.e. no stock, no meetings, no elected officers, etc.), it would be
inequitable not to pierce the corporate veil in this case.
1. American Trading and Production Corp. v. Fishbach & Moore, (1970); pg. 356,
briefed 2/24/97
2. Facts: An exposition hall was destroyed by fire. The plaintiffs are exhibitors who
lost property. Defendants are the corporate parent of a wholly owned subsidiary
electrical contractor corporation which allegedly installed faulty wiring in the
exposition hall.
3. Procedural Posture: American Trading sued to pierce the corporate veil of the
subsidiary electrical contracting corporation to get at the assets of the parent
corporation. Defendants move for summary judgment on the grounds that they are
not liable under any theory.
4. Issue: Whether the wholly owned subsidiary corporation is a mere instrumentality of
the parent corporation, thus entitling the plaintiffs to pierce the corporate veil.
5. Holding: No.
6. Reasoning: While stock control and common directors and officers are generally
prerequisites for application of the instrumentality rule, they are not themselves
sufficient to bring the rule into operation. There must also be some “direct
intervention” by the parent, and the actual exercise of control. Here, that control is
lacking. The undisputed facts clearly show that the subsidiary is a separate
corporational entity, and all formalities as to its operation have been observed. The
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separation of the parent and the subsidiary is scrupulously maintained. Furthermore,
there are no equitable considerations that would justify piercing the corporate veil here,
even if the subsidiary were the mere instrumentality of the parent.
1. Lee v. Jenkins Bros., (1959); pg. 381, briefed 2/24/97
2. Facts: Lee sued Jenkins Bros. to recover pension payments allegedly due under an
oral contract made on behalf of the corporation by the president.
3. Procedural Posture: The lower court dismissed on the grounds that there was
insufficient evidence of the oral contract to enforce it. The court of appeals affirmed,
and went on to discuss the following issue:
4. Issue: Whether, as a matter of law, a president of a corporation does not have the
authority to secure employment of badly needed personnel by granting a “life
pension”.
5. Holding: No.
6. Reasoning: The actual authority (granted either implicitly or explicitly by a
corporation) of a corporate officer is augmented by his apparent authority to third
persons. As a general rule, the president only has the authority to bind the corporation
by acts arising from the usual and regular course of business, but not for contracts of
“extraordinary” nature. It is generally settled that a president may hire and fire
employees, but it is a question of fact as to whether the granting of a life pension is so
“extraordinary” as to defeat the apparent authority of the president.
1. First Interstate Bank of Texas v. First National Bank of Jefferson, (1991); pg. 385,
briefed 2/24/97
2. Facts: FIB and FNJ entered into a contract for the purchase of certain bonds. On
behalf of FNJ, their senior vice president, Boyd, signed the contract. When the deal
later fell through, FNJ refused to honor the contract, claiming that Boyd did not have
any authority to bind FNJ in such a manner.
3. Procedural Posture: The lower court held that as a matter of law, there was
insufficient evidence to show that Boyd had sufficient authority to sign the contract,
and directed a verdict for FNJ.
4. Issue: Whether sufficient evidence existed to present an issue of fact for submission
to the jury.
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5. Holding: Yes.
6. Reasoning: There are two types of authority, actual and apparent. There are
further two types of actual authority: express and implied. A principle can confer
express actual authority by writing or orally. There was evidence that Boyd had
spoken with the board of directors, and that they had given him authority to sign this
contract. Furthermore, Boyd’s position in the company lends credence to his assertion
that he was authorized to sign. With regard to implied actual authority, an agent is
vested with the implied authority to do all of those things necessary or incidental to the
agency assignment. However, a state statute requires express agency. With regard to
apparent authority, a corporation may be bound if it 1) manifests the agent’s authority
to the third party, and 2) the third party reasonably relies on the agent’s purported
authority as a result. By the nature of Boyd’s position, the corporation holds him out
as having authority. Furthermore, the corporation sent Boyd specifically to close the
deal. Thus, there is sufficient evidence to create a jury question as to whether there
was authority to bind the corporation.
1. Hariton v. Arco Electronics, Inc., (1963); pg. 405, briefed 2/24/97
2. Facts: Plaintiff is a stockholder in the Arco corporation. Arco entered into an
exchange of stock for assets with Loral corporation whereby Arco (target) would
transfer all of its assets and liabilities to Loral (parent) in exchange for shares of Loral
common stock, pursuant to a Delaware exchange of stock for assets statute. Thereafter,
Arco was dissolved. Under the Delaware statute, such a transaction does not allow a
stockholder in the acquired corporation (the target corporation) to have dissenter’s
appraisal rights.
3. Procedural Posture: Hariton sued to have the transaction declared a de facto
merger, and therefore unlawful because the merger statute (a different statute) had not
been complied with.
4. Issue: Whether the transaction in question is a de facto merger, therefore vesting
dissenter’s appraisal rights in the plaintiff.
5. Holding: No.
6. Reasoning: Although the doctrine of de facto merger has some equitable merit, the
fact that a separate statute exists in Delaware to allow an exchange of assets for stock
defeats that argument. It would be up to the legislature to change the statute if
desired. The various statutes of the Delaware corporation law are independent of each
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other and a given result may be accomplished under one section which is not possible,
or is even forbidden under another.
1. Terry v. Penn Central Corp., (1981); pg. 408, briefed 2/24/97
2. Facts: Penn (parent) created a wholly owned subsidiary called PCC Holdings
(subsidiary). Penn then sought to merge Colt (target) with PCC Holdings, to effect a
triangular merger, thereby bypassing the right of Penn shareholders to vote on, or
dissent from, the proposed merger. Plaintiffs are Penn shareholders.
3. Procedural Posture: Terry sought to enjoin the triangular merger on the ground
that it was a de facto merger of the parent, entitling them to dissenter’s rights.
4. Issue: Whether the merger of Colt into PCC Holdings is a de facto merger of the
parent, Penn.
5. Holding: No.
6. Reasoning: Although the doctrine of de facto merger is appealing, it is directly
contradicted by the state statute allowing triangular mergers. The parties to a merger
are only those that are actually combined into a single corporation. Thus, Penn is not a
party to the merger. Although a de facto merger might be found in the presence of
fraud, there is no evidence here of fraud. A corporation is not a static entity. When a
shareholder purchases a share, he is purchasing rights in a dynamic entity, and has
constructive knowledge, based on the existence of statute, that the corporation may
effect a triangular merger.
7. Note: The ALI forwarded a proposal that a shareholder is entitled to vote on any
“transaction in control” and is entitled to appraisal rights unless “those persons who
were shareholders of the corporation immediately before the combination own 60
percent or more of the total voting power of the surviving corporation immediately
thereafter.”
1. Gimbel v. Signal Companies, Inc. (1974); pg. 413, briefed 4/11/97
2. Facts: Signal is a large oil conglomerate which started as an oil company. At a
special meeting, the board of directors approved a sale of its oil subsidiary to another
company. The oil subsidiary accounted for 26% or Signal’s total assets, 41% of its net
worth, and 15% of its revenues and earnings.
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3. Procedural Posture: A stockholder brought an action to require shareholder approval
of the sale under Del. §271(a).
4. Issue: Whether the sale of the oil subsidiary was a sale of “all or substantially all” out
of the ordinary course of business of the assets of Signal, thus requiring a shareholder
approval.
5. Holding: No.
6. Reasoning: The critical factor in determining the character of a sale of assets is
generally considered not the amount of the property sold but whether the sale is in fact
an unusual transaction or one made in the ordinary course of business. Also, if the
unusual transaction “strike[s] at the heart of the corporate existence and purpose” then
it is beyond the power of the board of directors. Thus, the test in Delaware is both
quantitative and qualitative. Here, the sale is not quantitatively “substantially all” of
the corporate assets. Furthermore, it does not affect the existence and purpose of the
corporation, because although it used to be primarily an oil company, it is now merely a
conglomerate that ordinarily buys and sells subsidiaries as part of its business.
1. Auer v. Dressel, (1954); pg. 421, briefed 4/11/97
2. Facts: Stockholders sought to hold a special meeting as provided by bylaws. At this
meeting, the stockholders sought to 1) recommend reinstatement of the former
President, 2) amend the articles of incorporation and bylaws to grant shareholders the
power to fill vacancies caused by their removal of directors for cause, 3) to remove four
directors for cause, and 4) to amend the bylaws to reduce the quorum requirement.
The President refused to call the meeting.
3. Procedural Posture: The lower court found for the stockholders.
4. Issue: Whether the stockholders have the power to amend the bylaws to authorize
themselves to fill vacancies created by directors who have been removed.
5. Holding: Yes.
6. Reasoning: It is settled law that stockholders who have the power to elect directors
have the power to remove them. Thus, it is not inappropriate that they should use
their existing power to amend the bylaws to elect the successors of the directors that
they remove. Any director illegally removed can have his remedy in the courts.
1. Campbell v. Loew’s, Inc., (1957); pg. 423, briefed 4/11/97
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2. Facts: Four of Loew’s directors resigned. The President called a special shareholders
meeting for the purpose of filling the director vacancies of the resigned directors, to
remove two other directors, and to fill the vacancies of the removed directors.
3. Procedural Posture: The plaintiff brought an action to enjoin the special shareholder’s
meeting.
4. Issue: 1) Whether the stockholders have the power between annual meetings to elect
directors to fill newly created directorships. 2) Whether the shareholders have the
power to remove directors for cause.
5. Holding: 1) Yes. 2) Yes.
6. Reasoning: Del §223 provides that newly created directorships “may be filled by a
majority of the directors then in office...unless it is otherwise provided in the certificate
of incorporation or the by-laws.” Thus, the statute does not give the directors the
exclusive power to fill such vacancies. In Moon, the court held that the stockholders
do have the inherent right between annual meetings to fill newly created directorships.
The stockholders have the implied power to remove directors for cause. Otherwise a
director who is guilty of the worst sort of violation of his duty could remain on the
board and continue to inflict damage on the corporation. However, the directors must
be given notice and an opportunity to be heard before removal for cause.
1. Blasius Industries, Inc. v. Atlas Corp., (1988) pg. 428, briefed 4/11/97
2. Facts: Blasius acquired 9.1% of Atlas’ stock, and then delivered a written consent to
Atlas, adopting a resolution recommending that Atlas implement a certain restructuring
proposal, amending the bylaws to increase the size of the board from 7 to 15, and
electing 8 named people to fill the vacancies. In response, Atlas’ directors called an
emergency meeting to amend the bylaws to increase the board from 7 to 9 and filling
the two new directorships - thus negating the effect of the Blasius written consent’s
attempt to take control of a majority of the board.
3. Procedural Posture: Blasius sued to have the board’s actions set aside.
4. Issue: Whether Atlas’ board of directors’ action to increase the board size for the
principle purpose of defeating the shareholders from electing a new majority of
directors was valid
5. Holding: No.
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6. Reasoning: It is clear that Atlas’ directors were acting in subjective good faith to
protect their control of Atlas because they thought that it was in the corporation’s best
interest. However, the board has a fiduciary duty to the shareholders, in the nature of
an agent to a principle. As such, the board bears a heavy burden of demonstrating a
compelling justification when it acts to thwart the power of the shareholders as the
principles. Here, the board had time to present its case to the shareholders, and the
shareholders did not need a paternalistic protection of the board.
1. Lehrman v. Cohen, (1966); pg. 457, briefed 4/11/97
2. Facts: A corporation had two classes of voting stock, equally divided among two
families. To break deadlocks, they created one share of a third class of voting stock,
which had no right to dividends and a value of only $10 par, and issued it to their
corporate counsel. The corporate counsel proceeded to consistently vote against the
wishes of one of the families.
3. Procedural Posture: The minority family brought this action to declare the
deadlock-breaking class of stock invalid as a voting trust. The lower court found that
the stock was valid.
4. Issue: Whether the third class of voting stock created here was valid.
5. Holding: Yes.
6. Reasoning: There are three tests that must be satisfied to establish that an
arrangement is a voting trust: 1) the voting rights are separated from the beneficial
ownership of the stock, 2) the voting rights are irrevocable, and 3) the principle purpose
is to acquire voting control of the corporation. Here, the voting rights were not
separated from the beneficial ownership. Although the creation of the third class of
stock diluted the voting power of the other two classes, the other two classes still
retained complete control of the voting power of their own stock. Furthermore, since
even non-voting stock is allowed by Del §151(a), it is not against public policy to
separate voting rights from beneficial stock ownership.
1. Triggs v. Triggs, (1978); pg. 467, briefed 4/11/97
2. Facts: A father and three sons were shareholders in a closely held corporation. The
father and one of the sons agreed to vote their shares together to maintain control and
employment at a guaranteed salary in the corporation. They also entered into an
agreement that the first son had an option to purchase the father’s stock when he died.
However, the father and son had a falling out, and the father executed a codicil to his
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will that bequeathed his shares to the other two sons, and declared the agreement with
the first son to be null and void. At the father’s death, the first son sought to have the
estate sell him the father’s shares under the option agreement, and the estate refused.
3. Procedural Posture: The defendant argued that the agreement was illegal as an
attempt to misappropriate the discretion of the board to manage the company. The
lower court granted specific performance of the stock option purchase.
4. Issue: Whether the stock option agreement, in combination with the share pooling
agreement is valid.
5. Holding: Yes.
6. Reasoning: If the agreement was in any way illegal, it would only be to the extent
that it restricted the freedom of the board of directors to manage corporate affairs.
However, the evidence shows that the agreement did not fetter the board of directors
power. The other directors, which constituted a majority of the board were unaware of
the share pooling agreement or the option agreement. Nevertheless, they voted to
approve the salaries of the father and the first son freely. Since the lower court only
upheld the stock option agreement, and not the agreement to guarantee each other’s
salaries, it is affirmed.
7. Dissent Reasoning: The agreement to secure the appointment of the father and the
son at a specific position other than director at a guaranteed annual salary are illegal.
As such, although a share pooling agreement is not per se invalid, it is not valid where
there is the danger of harm to the general public or to other shareholders. Here, the
danger of harm, even if there was no actual harm, is evident. The share pooling
agreement can not be severed from the option agreement, and thus both should be
struck down.
1. Wilkes v. Springside Nursing Home, Inc., (1976); pg. 493, briefed 4/11/97
2. Facts: A minority stockholder was “frozen out” of the corporation by being voted out
as an officer and director, and having his salary terminated. However, he was
performing his duties well. He just didn’t agree with the other directors.
3. Procedural Posture: The frozen out stockholder brought an action to recover the
salary he would have received had he continued to be an officer and director. The
action was dismissed.
4. Issue: Whether the majority stockholders breached their fiduciary duty to him as a
minority stockholder by freezing him out of the corporation.
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5. Holding: Yes.
6. Reasoning: The stockholders in a close corporation owe one another substantially the
same fiduciary duty in the operation of the corporation as partners owe to one another
in a partnership. This is a duty of the “utmost good faith and loyalty.” A guarantee
of employment with the corporation was one of the “basic reasons why a minority
owner has invested capital in the firm.” The majority stockholders must demonstrate a
legitimate business purpose for frustrating the expectations of the minority, and also
show that there was no less harmful alternative. Here, mere disagreement is not a
legitimate business purpose for freezing out a minority stockholder.
1. Smith v. Atlantic Properties, Inc., (1981); pg. 510, briefed 4/11/97
2. Facts: Several investors formed a corporation for the purpose of buying some land.
One of the minority shareholders pushed for, and obtained, a clause in the bylaws and
the articles of incorporation requiring an 80% supermajority vote of the directors for an
action to be valid. This created the need for a unanimous vote in order to declare a
dividend, and the minority shareholder consistently refused to vote for a dividend so as
to avoid personal tax liability, even after severe tax penalties were repeatedly levied on
the corporation.
3. Procedural Posture: The corporation brought an action against the minority
shareholder to recover the tax liability from him personally. The lower court held that
the minority shareholder had breached a fiduciary duty.
4. Issue: Whether a minority shareholder may exercise or withhold his vote to any
extent which results in harm to the corporation without violating a fiduciary duty.
5. Holding: No.
6. Reasoning: There must be a weighing of the legitimate business interests advanced
by the majority against those of the minority shareholder. Here, it is clear that the
primary purpose of the minority shareholder withholding his vote to declare a
dividend was for personal tax avoidance. As such, he ran reckless and serious risks
which were inconsistent with any reasonable interpretation of the duty of “utmost good
faith and loyalty” owed by the shareholders of a close corporation to one another.
1. Matter of Kemp & Beatley, Inc., (1984); pg. 519, briefed 4/11/97
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2. Facts: Two long-time employees of the corporation were minority shareholders.
One resigned and the other was fired. After they were no longer employees, the
corporation made no further distributions of dividends to them on their stock.
3. Procedural Posture: The former employee stockholders brought an action for
involuntary dissolution of the corporation as the only way to recover the value of their
stock since they had been effectively “frozen out.” The lower court granted the
dissolution based on “oppressive conduct” by the majority.
4. Issue: Whether involuntary dissolution of the corporation was appropriate under
these circumstances.
5. Holding: Yes.
6. Reasoning: The involuntary dissolution statute permits dissolution when a
corporation’s controlling faction is found guilty of “oppressive action” toward the
complaining shareholders. Oppression occurs when those in power have acted in such
a manner as to defeat the “reasonable expectations” of the minority shareholders which
formed the basis of their participation in the venture. The majority here is not able to
demonstrate the existence of an alternate remedy. However, the order should be
conditioned upon permitting the other shareholders having an option to buy the
oppressed person’s share at fair market value. This will prevent the minority from
using the threat of dissolution as a coercive tool.
1. Long Island Lighting Co. v. Barbash, (1985); pg. 582, briefed 4/11/97
2. Facts: A shareholder of a local utility acquired enough shares to call a special
shareholder’s meeting to consider his proposal to make the corporation public. Prior
to the meeting, the shareholder took out a newspaper advertisement accusing the
corporation of mismanagement and attempting to pass on unnecessary costs to their
consumers.
3. Procedural Posture: The utility company sued to have the ad declared an unlawful
proxy solicitation. The district court found for the shareholder on the basis that the ad
appeared only in a general circulation publication and could only indirectly affect the
proxy voting.
4. Issue: Whether the newspaper ad was an unlawful unfiled proxy solicitation.
5. Holding: Yes.
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6. Reasoning: The proxy filing rules apply even to indirect communications which are
designed ultimately to influence a shareholder’s vote. The question is whether the
challenged communication, in the totality of the circumstances, is “reasonably
calculated” to influence the shareholders’ votes. It would permit easy avoidance of the
proxy filing rules to exempt all general and indirect communications to shareholders,
even if they are addressed to matters of general “public interest.”
7. Dissent Reasoning: In order to avoid a serious first amendment issue, the solicitation
of proxies rules should not be applicable to general newspaper advertisements.
1. Amalgamated Clothing and Textile Workers Union v. Wal-Mart Stores, Inc., (1993);
pg. 616, briefed 4/11/97
2. Facts: A group of shareholders sought to require a shareholder proposal to be added
to the Wal Mart proxy solicitation materials. The proposal would require the
corporation to report on various equal opportunity policies and statistics. Wal Mart
sought to omit the proposal.
3. Procedural Posture: The shareholders brought this action to enjoin Wal Mart from
omitting the proposal. Wal Mart moved to dismiss on the basis that the proposal deals
with “ordinary business operations”.
4. Issue: Whether the proposal sought by the shareholder group is omittable under SEC
Rule 14a-8 as dealing with the conduct of “ordinary business operations.”
5. Holding: No.
6. Reasoning: A shareholder may offer a proposal as long as the proposal relates to a
proper subject matter on which the shareholders may vote. Most relevant is SEC rule
14a-8 which must be interpreted in accordance with the SEC’s own interpretations. In
a 1976 Interpretive Release, the SEC stated that where proposals involve a substantial
policy matter, they are not omittable under 14a-8(c)(7). There have been contradictory
rulings by the SEC since that time, but these have been in the form of No-Action Letters,
which are not subject to the same critical analysis as an Interpretive Release. Thus,
since equal opportunity issues are substantial policy matters, they do not fall within the
omission exception for “ordinary business operations.”
1. Lovenheim v. Iroquois Brands, Ltd., (1985); pg. 627, briefed 4/11/97
2. Facts: A shareholder sought to have a proposal concerning the corporation’s
purchasing of force-fed geese products into the proxy materials. The corporation’s
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sales of pate products derived from these force-fed geese amounted to far less than 5%
of the total assets or sales of the corporation. The corporation wanted to omit the
proposal.
3. Procedural Posture: The shareholder brought this action to enjoin the corporation
from omitting his proposal. The corporation argues that the proposal is excludable
under 14a-8(c)(5) for being relevant to less than 5% of the assets and not otherwise
significantly related to the corporation’s business.
4. Issue: Whether the proposal is excludable under 14a-8(c)(5) for being relevant to less
than 5% of the assets and not otherwise significantly related to the corporation’s
business.
5. Holding: No.
6. Reasoning: Rule 14a-8(c)(5) was interpreted in a 1976 Interpretive Release by the SEC
as not being “hinged solely on the economic relativity of a proposal.” The SEC
required inclusion when the economic significance was very small, but the proposal
raised substantial policy considerations important enough to be considered
“significantly related” to the corporation’s business.
Thus, the meaning of
“significantly related” in the rule is not limited to economic significance.
1. Francis v. United Jersey Bank, (1981); pg. 675, briefed 4/11/97
2. Facts: The directors of a reinsurance brokerage corporation were a husband, wife and
their two sons. When the husband died, the sons took over control of the corporation
and began to divert assets to their personal use. The wife never took any action to
exercise even the slightest inquiry into the operation of the corporation, even though
she was a director. The corporation went bankrupt as a result of the embezzlement.
3. Procedural Posture: The customers (now creditors) of the corporation brought this
action against the mother for breach of her directoral duties.
4. Issue: Whether the mother is liable for breach of her duties as director for her failure
to inquire into the operations of the corporation.
5. Holding: Yes.
6. Reasoning: Directors are under a duty to exercise reasonable care in the performance
of their directoral duties. This includes the duty to keep informed about the activities
of the corporation. This does not require a detailed inspection of the day-to-day
activities, but rather a general monitoring of corporate affairs and policies.
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1. Graham v. Allis-Chalmers Manufacturing Co., (1963); pg. 682, briefed 4/13/97
2. Facts: Several employees of the corporation were indicted for anti-trust violations
surrounding price-fixing activities. The operating structure of the corporation makes
the individual divisions fairly autonomous, and the directors do not exercise direct
supervision over the divisions' activities.
3. Procedural Posture: Shareholders sought to obtain damages as a result of these
anti-trust violations.
4. Issue: Whether the directors were liable for a breach of the duty of care for failure to
inquire more closely into the activities of the divisions.
5. Holding: No.
6. Reasoning: The directors had no actual notice of the illegal activities. Prior illegal
activities that were 30 years prior did not put the directors on notice. Directors are
entitled to rely on the honesty and integrity of their subordinates until something
occurs to put them on suspicion that something is wrong. Del section 141(f) protects a
director who reasonably relies on his employees. There is no requirement for a
director, absent some triggering event, to make inquiry into the activities of the
corporations' employees without some justification.
1. Smith v. VanGorkam, (1985); pg. 698, briefed 4/13/97
2. Facts: The CEO of the corporation negotiated a leveraged buy-out plan with an
investor. The deal was made outside of the knowledge of the other directors, and was
proposed to them in a summary fashion in a relatively short board meeting with no
supporting data or figures. The buy-out plan was approved by the board without
significant investigation, and the price was approved at $55 per share which was far
above the stock market price.
3. Procedural Posture: Shareholders opposed to the sale commenced a lawsuit to
prevent the buy-out.
4. Issue: Whether the board's decision to approve the buy-out was protected by the
business judgment rule under these facts.
5. Holding: No.
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6. Reasoning: The business judgment rule is based on the presumption that 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 company. The determination of whether
the directors were sufficiently informed turns on whether they have informed
themselves "of all material information reasonably available to them." Here, the
directors were grossly uniformed, and took no action to inform themselves prior to
approval of the sale. There was no crisis or emergency justification. The board
merely relied upon an oral 20 minute presentation without any facts or figures or
studies or reports on the actual value of the company. Even though the sale was for a
substantial premium over the market price of $38, in the absence of other sound
valuation information, this is not an adequate basis for assessing the fairness of an
offering price. There was no study of cash flow valuation. Also, there was no
effective "public auction" of the company to determine the market value to a potential
buyer.
1. Shlensky v. South Parkway Building Corp., (1960); pg. 759, briefed 4/13/97
2. Facts: A corporation which owned and operated commercial property had directors
that also sat as directors of some of the businesses that rented from the corporation.
The property corporation entered into several transactions that were very favorable to
the businesses that had dual-directors, including low-rent leases, and favorable asset
purchases.
3. Procedural Posture: Minority shareholders of the property corporation sued to
require the defendant directors to personally account for damages suffered by the
property corporation as a result of the favorable transactions with the dual-director
businesses.
4. Issue: Whether the defendant directors of the property corporation are liable for
damages from a breach of a duty of loyalty to the property corporation.
5. Holding: Yes.
6. Reasoning: The directors of a corporation are subject to the same duty of loyalty as
trustees with respect to their corporation. They have the duty to exercise the best care,
skill and judgment solely in the interest of the corporation. When one directors sits on
the board of two corporations, transactions between the two corporations will be subject
to the closest scrutiny of fairness. The burden is on the directors to show the fairness
of the transactions, and they have not done so. The factors of fairness include whether
the corporation received full value for the transactions, the financial position of the
corporation, whether the corporation could have obtained a better bargain elsewhere,
and whether there was full disclosure. None of the transactions in issue satisfy these
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fairness factors. None of the transactions was approved by a disinterested majority of
the other directors. Thus, the transactions defendant directors are liable for damages.
1. Remillard Brick Co. v. Remillard Dandini Co., (1952); pg. 765, briefed 4/13/97
2. Facts: Two majority shareholders and directors of a manufacturing corporation were
also majority shareholders and directors of a sales corporation. The manufacturing
corporation's board voted, against the wishes of the minority shareholders, to have the
sales corporation perform the sales function for the manufacturing corporation.
3. Procedural Posture: The minority shareholders brought this action to have the sales
contracts invalidated on the ground that they unfairly stripped the manufacturing
corporation out of the opportunity to gain profits that otherwise went to the sales
corporation.
4. Issue: Whether the contracts are valid based on their approval by the board of
directors.
5. Holding: No.
6. Reasoning: The business judgment rule does not automatically validate a transaction
simply because it was approved by a majority of the stockholders. It does not permit
an officer or director, by an abuse of his power, to obtain an unfair advantage or profit
for himself at the expense of the corporation. In this type of situation, the dual-director
is precluded from receiving any personal advantage without full disclosure and consent
of all persons affected.
1. Marciano v. Nakash, (1987)pg. 768, briefed 4/13/97
2. Facts: A jeans-manufacturing corporation had two principle shareholder families.
When the corporation fell into financial problems, the shareholders deadlocked on the
issue of how to proceed. One of the families, without consulting the other, loaned the
corporation $2.3 million of their personal funds at an interest rate of 1% over prime. The
loan was an interested transaction, and was not approved by a disinterested majority of
the directors or shareholders.
3. Procedural Posture: The other family brought an action to have the debt declared
void.
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4. Issue: Whether the loan, although an interested transaction not approved by a
disinterested majority of the directors or shareholders, was nonetheless fair and
therefore valid.
5. Holding: Yes.
6. Reasoning: Del. Section 144(a) provides a basis for immunizing self-interested
transactions. Its tests were not satisfied. However, section 144(a) merely removes an
"interested director" cloud, preventing invalidation "solely" because an interested
director was involved. Thus, the proper analysis is a two-tiered analysis: first apply
144(a), then apply a fairness test. Here, the loans compared favorably with what was
available from market lenders. Thus, they were objectively fair. Furthermore, the
loans were made in the good faith effort to keep the corporation alive. On the other
hand, approval by fully informed disinterested directors under section 144(a)(1) or
disinterested stockholders under section 144(a)(2) permits invocation of the business
judgment rule and limits judicial review to issues of waste with the burden of proof
upon the party attacking the transaction.
1. Farber v. Servan Land Company, (1981); pg. 794, briefed 4/22/97
2. Facts: A golf course was owned by the corporation. Some adjoining land was
available for sale, which, if acquired by the corporation, would increase the value of the
golf course and the adjoining land if they could be sold together. The corporation was
informed of the opportunity to buy the land, and expressed an interest in it, but did not
take any immediate action to buy it. Two of the directors of the corporation bought the
land in their individual capacities. The land parcels were then sold together at a large
profit, with a large share of the profit going to the two individual directors.
3. Procedural Posture: The corporation brought an action for taking of a corporate
opportunity. The district court found that it was not a corporate opportunity because
real estate development bore no substantial relationship to the corporation’s activities,
and that the transaction actually increased the value of the golf course and so benefitted
the corporation. It also found that the purchase was not antagonistic to the
corporation.
4. Issue: Whether the purchase of the adjoining land by the two directors was the taking
of a corporate opportunity.
5. Holding: Yes.
6. Reasoning: The directors occupy a fiduciary relationship to the corporation, and have
the duty not to acquire property in which the corporation has “an interest or a tangible
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expectancy” and which fits into the present activities or established corporate policy
which the opportunity would forward. Here, there was interest by the corporation,
and it was an advantageous opportunity to the corporation that would have furthered
the corporate interests. The taking of a corporate opportunity can not be ratified by a
vote of interested directors. Also, the fact that the transaction increased the value of
the corporation’s remaining property does not make the corporate opportunity doctrine
inapplicable. The corporation is entitled to all profits from the sales of both parcels of
land.
1. Burg v. Horn, (1967); pg. 802, briefed 4/22/97
2. Facts: The Burg’s and the Horn’s formed a real estate investment corporation for the
purpose of buying low rent housing in the city. The Horns already had a corporation
of their own that had the same purpose. The Burgs, who were new to this kind of
business, believed that the Horns would offer the joint corporation any properties it
came across, but there was no agreement to that effect. The Horns’ separate
corporations purchased several buildings that were of interest to the joint corporation.
The Burgs and the Horns later had a falling out.
3. Procedural Posture: The Burgs brought this action for a constructive trust on the
properties purchased by the Horns. The trial judge held that the Horns did not have
any obligation to offer the properties to the joint corporation, and thus had taken no
corporate opportunities.
4. Issue: Whether there was a taking of a corporate opportunity when the Horns
already had a preexsiting and competing corporation.
5. Holding: No.
6. Reasoning: Not all opportunities within a corporation’s “line of business” are
corporate opportunities per se. It is a factual determination based on all of the
circumstances of the case. Since the Burgs spent most of their time in unrelated
businesses, and the Horns already owned a real estate investment corporation, there
was no duty to offer all buildings to the joint corporation without some further
evidence of an agreement to that effect.
1. Northeast Harbor Golf Club, Inc. v. Harris, (1995); pg. 40 supp., briefed 4/22/97
2. Facts: Harris was the president of the Golf Club corporation. Harris, in her capacity
as president, was approached by a real estate agent with an opportunity to purchase
surrounding land. Without disclosing the offer to the corporation, Harris purchased
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the land with her own funds. Later, Harris informed the board, but they took no
action, apparently in reliance on her statement that she would not develop the land.
Later, Harris began to develop the land.
3. Procedural Posture: The corporation brought an action to enjoin the development,
and to put a constructive trust on the property in favor of the corporation. The trial
court found that Harris had not taken a corporate opportunity because the real estate
investment was not in the “line of business” of the corporation, and also that it did not
have the financial ability to purchase the land.
4. Issue: What is the proper test for determining whether a corporate opportunity
existed.
5. Holding: According to the ALI Principle of Corporate Governance Seciton 5.05, a
corporate opportunity is one which a director 1) becomes aware of in his corporate
capacity, or 2) uses corporate information or property to acquire, or 3) is closely related
to a business in which the corporation is engaged or expects to engage.
6. Reasoning: The ALI defines corporate opportunity broadly. There is evidence that
the property was offered to her in her capacity as president - making it a corporate
opportunity. If it is a corporate opportunity, then Harris must offer it to the
corporation first and have the board reject it after full disclosure, AND either 1) have
the rejection ratified by a disinterested majority of the directors, or 2) a disinterested
majority of the shareholders. If these tests are met, then the burden of proof is on the
challenger to show that the transaction was unfair to the corporation. However, if
Harris failed to offer the opportunity, then she loses outright. Also, if Harris offered
the opportunity, but it was not ratified by a majority of disinterested directors or
shareholders, then the burden of proof is on her to prove that it was fair to the
corporation. The case must be remanded for application of these standards of law.
1. Perlman v. Feldman, (1955); pg. 1158, briefed 4/22/97
2. Facts: Newport Steel is a mid-sized steel company trying to expand its market during
the steel shortages of the Korean war. Feldmann is the chairman and controlling
stockholder of Newport. Feldman sold his controlling interest in Newport for $20 per
share to a customer company, Wilport, who needed to secure a stable source of steel
during the shortage. This enabled Wilport to allocate more steel to itself by placing
several people on Newport’s board. The book value of the stock was $17 per share and
the market value was $12 per share.
3. Procedural Posture: A derivative action brought by minority shareholders against
Feldmann for an accounting and restitution of the profits that Feldmann personally
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realized from the sale of his controlling interest. The trial judge found that the $20 per
share price was fair and was not the sale of a corporate asset.
4. Issue: Whether the sale of control under these facts was the sale of a corporate asset
which would entitle the corporation to the profit realized by Feldmann.
5. Holding: Yes.
6. Reasoning: A fiduciary has the fresponsibility to dedicate his uncorrupted business
judgment for the sole benefit of the corporation in any dealings which may adversely
affect it. The possibility that the corporation would have benefitted is all that is
required, not a showing of absolute certainty. Feldmann’s actions prevented the
corporation from obtaining interest-free advances from prospective purchasers to
expand production. It also prevented the corporation from building up its customer
base. The defendant must show that there was no possibility of any gain by the
corporation and he has not met that burden of proof. In a time of a market shortage,
where the power to allocate a corporation’s product commands an unusually large
premium, a fiduciary may not appropriate to himself the value of that premium.
1. Jones v. H.F. Ahmanson & Co., (1969); pg. 1164, briefed 4/22/97
2. Facts: A savings and loan corporation’s majority stockholders transferred their shares
to a holding company. The majority stockholders then issued stock to themselves in
the holding company at a ratio of a 250 shares of the holding company for every 1 share
of the savings and loan they owned. They did not offer the share exchange to the
minority stockholders of the S&L. The holding company then had a public offering,
thereby destroying any potential market for the remaining shares of the S&L.
Thereafter, they caused the S&L to reduce their dividend from about $50 per share to $4
per share.
3. Procedural Posture: A class action by the minority shareholders of the S&L for
damages, alleging that defendants had breached a fiduciary duty as controlling
shareholders by rendering the S&L stock unmarketable and locking plaintiffs out of the
share exchange.
4. Issue: Whether the majority stockholders breached a fiduciary duty to the minority
stockholders.
5. Holding: Yes.
6. Reasoning: Majority shareholders may not use their power to control corporate
activities to benefit themselves alone or in a manner detrimental to the minority. Any
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use to which they put the corporation must benefit the shareholders proportionally.
Good faith and inherent fairness to the minority is required in any transaction involving
control of the corporation by the majority shareholders. The majority shareholders
could have accomplished the same result by effecting a stock split of the S&L to make
its stock more marketable without breaching their fiduciary duty.
1. Weinberger v. UOP, Inc., (1983); pg. 1273, briefed 4/22/97
2. Facts: Signal Co. owned a majority of UOP stock, and wished to acquire the rest of the
stock by a tender offer, and then merge with UOP. Using UOP resources, two of the
UOP directors, who were also Signal directors, completed a valuation study that
indicated that a fair price for the tender offer would be up to $24 per share. Signal then
made a $21 per share offer, and obtained a fairness opinion from their banker, Lehman
Brothers.
However, the $24 per share study was never disclosed to UOP’s
shareholders when they voted to approve the merger at $21 per share.
3. Procedural Posture: A class action by the minority shareholders challenging the
fairness of the merger. The lower court found for the defendants.
4. Issue: Whether the burden of proof shifts to the plaintiff to prove the unfairness of an
action when it has been approved by a majority of disinterested but not adequately
informed shareholders.
5. Holding: No.
6. Reasoning: The burden always remains on the interested shareholders to show that
they made a full disclosure to the disinterested shareholders. The proxy statement to
the disinterested shareholders did not reveal the study assesing a fair price at $24 per
share. This was a matter of material significance, and the interested shareholder’s
(Signal’s) failure to disclose it prevented the minority shareholders’ vote from being a
valid ratification of the transaction, thus requiring that it be subject to the intrinsic
fairness standard. Fairness has two aspects: 1) fair dealing, and 2) fair price. Here it
was not fair dealing to use UOP’s resources to generate a report, and then fail to
disclose that favorable report. It was a breach of fiduciary duty for the dual directors
to withhold this information from the minority shareholders. Also, the price was not
fair because it was less than the amount indicated by the report, and the fairness
opinion was too hastily prepared to be relied on.
1. Unitrin, Inc. v. American General Corp., (1995); pg. 67 supp., briefed 4/22/97
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2. Facts: American General wanted to initiate a tender offer for a sufficient proportion
of Unitrin’s stock to be able to take the second step of merging with Unitrin. Unitrin’s
board felt that the tender offer price was too low, and initiated two defensive measures
to prevent the takeover: 1) a poison pill shareholder’s rights program, and 2) an
open-market stock repurchase program.
3. Procedural Posture: American General and some of Unitrin’s stockholders brought
suit to enjoin Unitrin from instituting these defensive measures, alleging that they were
a disproportionate response to the threat posed by American General. The lower court
found for the plaintiffs.
4. Issue: Whether Unitrin’s poison pill and stock repurchase programs were
disproportionate responses to the takeover bid by American General.
5. Holding: No.
6. Reasoning: The Unocal standard applies in this case because the board’s actions
were “defensive” reaction to a threat. The first aspect of the Unocal test is
“reasonableness”, requiring that the board demonstrate that it made a reasonable
investigation of the threat in good faith. The Unitrin board passes the reasonableness
prong because it perceived two dangers: inadequate price, and antitrust complications.
The second aspect of the test is “proportionality.” Unitrin may not use “draconian”
means to prevent takeover. Here, the response was not draconian because the share
repurchase program was not a mathematically significant deterrent to takeover. It was
neither “preclusive” nor “coercive.” Thus, the proper test for judging the board’s
action is the “range of reasonableness” of its actions. The case must be remanded for
determination of whether Unitrin’s board acted within the “range of reasonableness.”
1. Paramount Communications, Inc. v. QVC Newtork, Inc., (1994); pg. 1247, briefed
4/23/97
2. Facts: Viacom proposed a tender offer acquisition of Paramount, followed by a
second-step merger in an Original Merger Agreement which had several unusual
contractual provisions imposing extremely high penalties on Paramount if it accepted a
competing offer, and prohibited Paramount from soliciting competing offers. QVC
made a significantly higher per share tender offer, to which Viacom counter offered in
an Amended Merger Agreement. The Amended Merger Agreement, although it
increased the purchase price, did not eliminate the penalty provisions. QVC then
made a significantly higher final offer, and commenced this action.
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3. Procedural Posture: QVC seeks to prevent Paramount from merging into Viacom,
alleging that Paramount’s board acted improperly by refusing to negotiate with QVC
even though its offer was much more valuable on its face.
4. Issue: Whether the Paramount board of directors breached a fiduciary duty to its
shareholders in refusing to pursue the better offer from QVC.
5. Holding: Yes.
6. Reasoning: Where there is the approval of a transaction resulting in the sale of
control, or the adoption of defensive measures in response to a threat to corporate
control, the court must subject the directors’ conduct to enhanced scrutiny to ensure
that it is reasonable. Here, a sale of control to Viacom is involved, placing a fiduciary
duty on the directors that they pursue the transaction offering the best value reasonably
available to the stockholders. The key features of the enhanced scrutiny test are: 1) the
adequacy of the decision making process, and 2) the reasonableness of the directors’
actions. Here, the decision making process was inadequate because the Paramount
board gave insufficient attention to the consequences of the defensive measures
demanded by Viacom. To the extent that these measures were contrary to the board’s
fiduciary duty to get the best offer for the shareholders, they were invalid and
unenforceable. Also, the decision was unreasonable and unjustifiable in light of the $1
billion difference between the two competing offers.
1. Chiarella v. United States, (1980); pg. 958, briefed 4/28/97
2. Facts: A printer, in the course of his job, prints press releases from different
corporations. Several press releases from acquiring companies which announced
mergers passed through his hands, and from their information, he was able to deduce
the parties, and purchased the stock of the target company before the information
became public.
3. Procedural Posture: The printer was convicted of insider trading under SEC Rule
10(b) for failing to disclose this non-public information, and trading on it. The court of
appeals affirmed stating that no person, whether or not a corporate insider may trade
on any illegally obtained non-public information.
4. Issue: Whether a person who learns from the confidential documents of one
corporation that it is planning to attempt to secure control of a second corporation
violates SEC rule 10(b) if he fails to disclose the impending takeover before trading the
in the target company stock.
5. Holding: No.
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6. Reasoning: A corporate insider must refrain from insider trading without disclosure
because the insider owes a duty to the corporation based on his position. Specifically,
the insider should not be allowed to profit personally from his access to confidential
information by virtue of his position. However, a purchaser of stock who is neither an
insider or a fiduciary has no duty to the prospective seller to disclose non-public
information because he does not stand in a position of trust and confidence to the seller
which would make the transaction unfair. The jury instructions here were too broad,
and thus the conviction must be reversed. The court makes no opinion as to whether
the printer breached a duty to the acquiring corporation who hired him.
1. Securities and Exchange Commission v. Clark, (1990); pg. 966, briefed 4/28/97
2. Facts: The president of a subsidiary found out due to his position that his parent
company was planning on acquiring a target company. The president then purchased
stock in the target company, and sold it for a profit after the announcement of the
merger.
3. Procedural Posture: The lower court found the president guilty of violation of rule
10b-5 under a “misappropriation theory” and ordered him to disgorge his profits.
4. Issue: Whether when a person 1) misappropriates material non-public information 2)
by breaching a duty arising out of a relationship of trust and confidence, and 3) uses
that information in a securities transaction, 4) regardless of whether he owed any duties
to the shareholders of the traded stock, violates Rule 10b-5 under a misappropriation
theory.
5. Holding: Yes.
6. Reasoning: The classical theory of insider trading is based on a fiduciary or other
relationship between a company and an insider trading on the company’s stock based
on non-public information. The classical theory does not apply here because the
president is an “outsider” with respect to the target company. However, the
misappropriation theory applies to a person who receives confidential information from
another and misappropriates it for his own personal benefit. Rule 10b-5 is a “catchall”
provision which applies to “any” purchase or sale by “any” person of “any” security.
The legislative history shows Congress’ intent to have Rule 10b-5 include the
misappropriation theory.
1. United States v. Bryan, (1995); pg. 50, briefed 4/28/97
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2. Facts: The director of the West Virginia state lottery was notified by the Governor
that he intended to award a video lottery company a “single source” contract for the
provision of statewide lottery machines. However, due to the political unpopularity of
such a move, the announcement was postponed until after the Governer’s re-election.
The director then purchased a block of the stock of the video lottery company.
3. Procedural Posture: The lower court convicted the director of a securities violation of
Rule 10b-5 under the misappropriation theory.
4. Issue: Whether, in the 4th circuit, criminal liability under Rule 10b-5 may be
predicated upon the mere misappropriation of information in breach of a fiduciary duty
owned to one who is neither a purchaser nor a seller of securities, or in any other way
connected with or financially interested in, an actual or proposed sale of securities, even
when the breach is followed by a purchase of the securities.
5. Holding: No.
6. Reasoning: The language of the statute, although broad, does not support the
misappropriation theory. The statute prohibits deception in the form of material
misrepresentations or omissions, to induce action or inaction by purchasers or sellers.
The misappropriation theory bases criminal conviction on simple breach of fiduciary
duty, without requiring deception. Therefore, the statute does not include the
misappropriation theory. Even if the misappropriation theory reqired deception, it
still does not require deception which violates a duty of fair representation or disclosure
owed to a market participant. Thus, the language of Rule 10b-5 is not broad enough to
cover this case, and the misappopriation theory is not recognized in the 4th circuit.
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