1
Business Associations
Fall 2010
Professor Steve Bradford
Office: Room 216 South
Phone: 472-1241
E-mail: sbradford1@unl.edu
Web site: http://www.unl.edu/bradford/web.htm (Follow the Business Associations link.)
BOOKS: The books for this course are:
1. David G. Epstein, et al, Business Structures (3d ed. 2010) [Thomson West
ISBN 9780314200594]. [The second edition is not acceptable.]
2. Corporations and Business Associations: Statutes, Rules, Materials and
Forms (2010 ed.) [Foundation Press ISBN 9781599418322] [You must have
the 2010 edition. Earlier editions are not acceptable.]
3. C. Steven Bradford, Basic Accounting Principles for Lawyers (2d ed. 2008)
[Lexis Nexis ISBN 978-1-4224-2398-1] [If you fully understand basic
accounting principles and the concepts of present value and expected value,
you may not need to read the assigned material in this book, but you will still
be responsible for it.]
SCHEDULE: Mon-Thurs., 1:00 p.m.-2:00 p.m. (60-minute classes). Because we are
meeting for 60 minutes, nine of the scheduled classes will be cancelled. Classes on
Thurs., Oct. 28, Mon., Nov. 22, and Tues., Nov. 23 are definitely cancelled. I will
notify you of the other cancellations later in the semester.
READING ASSIGNMENTS: A list of reading assignments is attached. For each
assignment, you should not only read the book, but also study the statutes covered
in the assignment and attempt to answer the questions and problems prior to class.
If you don’t do all of this, you are not prepared for class. For the first class, read
Assignments 1-2.
CALI LESSONS: You are required to complete two CALI lessons. That assignment
appears at Assignment 70 on the attached list of reading assignments; I will give you
instructions later in the semester about how to complete the lessons to get proper credit.
You will not receive a grade for the lessons, but your grade will be reduced by one grade
point if you do not complete them on time.
CLASS ATTENDANCE AND PARTICIPATION: I expect each of you to attend class
regularly and punctually, prepared to participate in class discussions. I will check
attendance each day. If you do not attend class regularly (and on time), you will be
dropped from the course without additional notice. Absences due to work assignments or
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job interviews are not excused. Similarly, in accordance with the policies adopted by the
Law College’s clinical instructors, absences due to clinical assignments are not excused.
Class attendance, punctuality, preparation, and participation will be considered in
determining your final grade.
PODCASTING: I will be recording each class and posting the podcast and my
PowerPoint slides to my web site after each class.
CLASS DISCUSSION LIST: I will be setting up a class e-mail discussion list. I will
use the list to inform you about things like schedule changes and reading assignments, as
well as to distribute supplemental material. Please check your e-mail on a regular basis.
You will be subscribed to the list using the e-mail address that appears on the Law
College student directory; let me know if you would prefer some other e-mail address.
CELL PHONES AND PAGERS: The use of cell phones and pagers in class is
prohibited. Any cell phones or pagers brought to class must be turned off (not just set to
vibrate or set not to ring, but with the power off) before class begins.
NOTEBOOK COMPUTERS: Computers may be used in class only for purposes
directly related to the class. Game playing, surfing the Internet, sending messages or email, or doing any work not related to this class is prohibited. Before class begins, you
must close all web browsers, e-mail programs, and messaging programs and keep
them closed during class. Don’t just minimize those programs; exit them and close the
program. Anyone violating this policy will be dropped from the class without further
warning.
AUDIO OR VIDEO RECORDING: Classes may not be recorded by any means, except
in cases of special need with my prior permission.
EXAMINATION: There will be a single exam at the end of the course. Further details
will be announced later. You will be required to take the exam using a computer. The
exam will be closed book. You will be provided a handout with the exam that includes
all the statutes and regulations you need.
OFFICE HOURS: I have no formal office hours. I will always be available in my
office immediately after class, but feel free to drop in at any time. No appointment is
needed.
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SUGGESTED REFERENCES: If you are having difficulty understanding a particular
topic or want to do further reading on that subject, please feel free to ask me for
additional references. I would be happy to suggest sources. The CALI lessons listed in
the reading assignments are also helpful. I also recommend the following books:
A. Treatises
1. James D. Cox & Thomas L. Hazen, Corporations (2d ed. 2003). An excellent
general treatise. Also available in a three-volume practitioner’s version.
2. Franklin A. Gevurtz, Corporation Law (2000). Another excellent general
treatise, although I prefer the Cox & Hazen book.
3. Stephen M. Bainbridge, Corporation Law and Economics (2002). A
corporate law treatise with an economic focus.
B. Study Aids
1. Alan R. Palmiter, Corporations: Examples and Explanations (6th ed. 2009).
Very good. Includes, in addition to the usual textual explanations, questions
and answers designed to test your understanding. [On reserve in the
library.]
2. Robert Hamilton, The Law of Corporations in a Nutshell (5th ed. 2000).
Pretty good but, at 713 pages, the word “nutshell” seems inappropriate.
3. Arthur R. Pinto and Douglas M. Branson, Understanding Corporate Law (3d
ed. 2009). Also pretty good. [On reserve in the library.]
4. Daniel S. Kleinberger, Agency, Partnerships, and LLCs: Examples and
Explanations (2d ed. 2002). Very good. Includes, in addition to the usual
textual explanations, questions and answers designed to test your
understanding. [On reserve in the library.]
5. Joseph Shade, Business Associations in a Nutshell (2d ed. 2006). Fairly good,
although I think the others are better.
6. Roberta Romano, Foundations of Corporate Law (1993). A collection of
excerpts from some of the most important scholarship in corporate law.
7. Franklin A. Gevurtz, Corporate Law Anthology (1997). Another collection of
important corporate law scholarship.
8. Jonathan R. Macey, ed., The Iconic Cases in Corporate Law (2008). A
discussion of some of the most important corporate law cases.
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C. General Business Background. I realize that some of you come to this course with
little knowledge of the business world. I try to take that into account in teaching the
class. If you have trouble understanding some of the business concepts in this course,
feel free to ask me. You might also try the following:
1. Bryan A. Garner, A Handbook of Business Law Terms (1999). A dictionary of
some of the business terms you might encounter in this and other courses.
2. Robert W. Hamilton & Richard A. Booth, Business Basics for Law Students:
Essential Concepts and Applications (4th ed. 2006). Chapters discussing
many of the business topics you might encounter in this and other business
law courses. [On reserve in the library.]
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Reading Assignments
(All assignments are in the Business Structures casebook unless otherwise indicated.
The handouts listed are attached to this syllabus.)
(I have also included references to CALI lessons that you might find helpful. The CALI
lessons are available on the CALI website: Go to www2.cali.org and follow the
appropriate links. Except for the two lessons in Assignment 70 you are not required
to do any of the CALI lessons.)
Chapter 1: What Do Businesses Do And What Do Lawyers
For Businesses Do?
1. 1-11
[CALI Lesson: The Ultra Vires Doctrine]
2. Bradford 95-98, 103-108 (Question: What does this material have to do with
Roberts’ views discussed on p. 2 of the casebook?)
3. 12-21
4. Bradford 3-13, 19-22, 43-44, 57-61
5. 21-24
6. 24-27
7. 27-30
[Correction: On p. 29, please delete the following clause at the end of the last
sentence of the first paragraph of section e (The Limited Liability Company):
“when a part of the company’s earnings is distributed to them.”]
Chapter 2: What Is A Sole Proprietorship And How Does It
Work?
8. 31-37
[CALI Lessons: (1) Introduction to Agency: Defining Agency
Relationships; (2) Liability of Agent to Third Parties: On the Contract
and Warranty of Authority; (3) Authority: Actual, Apparent, and Inherent;
(4) Ratification]
9. 37-40
[CALI Lesson: Master and Servant Relationships]
10. 40-43
11. 43-53; Handout: Restatement (2d) of Agency § 267
12. 53-61
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Chapter 3: What Is A Partnership And How Does It Work?
13. 62-65
[CALI Lesson: Are You My Partner: Is This a Partnership?]
14. 65-67
15. 67-68
16. 68-69
[CALI Lesson: Authority of Partners to Bind the Partnership]
17. 69-76
[CALI Lesson (for Assignments 14-17): Management and Financial Rights
of Partners]
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
76-78
78-79 (up to, but not including “3. Additional Owners”)
80-81 (beginning at “b. Legal Issues”)
81-83
83-84 + RUPA § 503
84-86
86-93
93-95
[CALI Lessons: (1) Partnership Dissociation; (2) Partnership: Dissolution
and the Article 7 Buyout Obligation]
95-96
96-99
[CALI Lesson (for Assignments 26-27): Partnership: Winding Up,
Partnership Accounts, and Distribution of Profits and Losses]
99-105
105-108
Chapter 4: What Is A Corporation And How Does A Business
Become A Corporation?
30.
31.
32.
33.
109-115
115-117
125-130
117-120
[CALI Lesson (for Assignments 31-33): Mechanics of Incorporation and
Defective Incorporation]
34. 120-125 [Correction: In Problem 2, p. 124, the Delaware statutory reference
should be to Delaware § 153(a).]
35. Bradford 27-32
[CALI Lesson (for Assignments 34-35): Types of Securities]
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Chapter 5: How Does A Corporation Operate?
36. 131-137
37. 137-147
[CALI Lesson (for Assignments 36-37): Piercing the Corporate Veil]
38. 147-153
39. 153-157
40. 157-162
[CALI Lesson: Shareholder Agreements Under RMBCA Section 7.32]
41. Handout: CA, Inc. v. AFSCME
42. Handout: Section 113 of the Delaware General Corporation Law
43. Handout: Shareholder Power to Control Corporate Action
44. 162-165
[CALI Lesson: Shareholder Voting: Straight vs. Cumulative]
45. 165-169
46. 169
47. Handout: Coverage of the Federal Proxy Rules
[CALI Lesson: An Introduction to the Federal Regulation of Proxy
Solicitation]
48. 170-179
49. Handout: What is a Proxy Solicitation?
50. Handout: Federal Restrictions on the Proxy Form
51. 179-185
52. Handout: Shareholder Proposal Problems
53. Handout: New Developments: Shareholder Nominees for the Board
54. 186-195
[CALI Lesson: Shareholder Inspection Rights]
55. Handout: Shareholder Inspection Problems
56. Handout: Rule 14a-7 of the Federal Proxy Rules
57. 195-200
[CALI Lesson: Voting Trusts and Voting Agreements]
58. 201-203
59. 203-208
60. 208-213 [Omit Question 3, p. 212.]
61. 213-219
62. 219-224
63. 224-229
[CALI Lesson (for Assignments 59-63): The Business Judgment Rule]
64. 233-237
65. 237-244
66. 244-248
67. Del. § 122(17)
68. RMBCA § 8.70
[CALI Lesson (for Assignments 64-68): Corporate Opportunity Doctrine]
69. 248-254
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70. Complete the following required CALI lessons (instructions to be provided):
1. Special Class Version: Judicial Review of Director’s Conflicting
Interest Transactions
2. Special Class Version: What is a Director’s Conflicting Interest
Transaction?
71. 260-270
72. Handout: The Director’s Obligation to Act in Good Faith
73. 271-272
74. 277-278
75. 278-289
[CALI Lesson: The Business Judgment Rule in Shareholder Litigation I:
Demand Upon the Board]
76. 289-294
77. 294-302
78. RMBCA § 7.44
[CALI Lesson: The Business Judgment Rule in Shareholder Derivative
Litigation II: The Special Litigation Committee]
[CALI Lesson (for Assignments 73-78): Shareholder Derivative Actions]
79. 302-303
80. 303-308
Chapter 6: How Does A Business Structured As A Corporation
Grow?
81.
82.
83.
84.
85.
86.
309-313
318-319
319-324
324-327
327-333
333-335
[CALI Lesson (for Assignments 85-86): Business Financing and the
Federal Securities Laws]
87. 335-336 (omitting the problems on pp. 336-337)
88. 337
Chapter 7: How Do The Owners Of A Corporation Make
Money?
89.
90.
91.
92.
93.
338-340
340-352
356-362
Read MBCA §§ 14.30, 14.34
362-363
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94. 363-365
[CALI Lesson: Issuance of Shares I: Basic Concepts]
95. Bradford 27-32
96. Handout: Dividend Problem
97. 373-374
[CALI Lesson (for Assignments 95-97): Corporate Distributions]
98. 365 (bottom of page)-369
99. 369 (bottom of page)-373
100.
453-463
101.
463-468
102.
403-407
103.
407-413
104.
413-420
105.
420-428
106.
428-433
107.
Handout: Insider Trading Problems
108.
434-438
109.
Handout: Additional Material on Section 16(b)
[CALI Lesson (for Assignments 108-109): Section 16(b) of the
Securities Exchange Act of 1934]
110.
438-445
111.
452-453
Chapter 9: What Is A Limited Partnership And How Does
It Work?
112.
113.
114.
115.
116.
117.
118.
119.
579-582
582-585
586-593
Read § 303 of ULPA (2001)
593-599
599-605
605-607
Read RULPA §§ 503-504, 604, 607
Chapter 10: What Is A Limited Liability Company And How
Does It Work?
120.
121.
122.
123.
124.
125.
Handout: The Revised Uniform Limited Liability Company Act
608-611
611-612
Handout: Actual and Apparent Authority to Bind an LLC
612-618
618-621
10
126.
622-634
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Business Associations
Professor Bradford
Restatement (Second) of the Law of Agency, § 267
§ 267. Reliance Upon Care or Skill of Apparent Servant or Other Agent
One who represents that another is his servant or other agent and thereby causes a third
person justifiably to rely upon the care or skill of such apparent agent is subject to
liability to the third person for harm caused by the lack of care or skill of the one
appearing to be a servant or other agent as if he were such.
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Business Associations
Professor Steve Bradford
CA, Inc.
v.
AFSCME Employees Pension Plan
953 A.2d 227
(Del. 2008)
JACOBS, Justice.
. . . On June 27, 2008, the SEC asked this Court to address two questions of Delaware
law regarding a proposed stockholder bylaw submitted by the AFSCME Employees
Pension Plan (“AFSCME”) for inclusion in the proxy materials of CA, Inc. (“CA” or the
“Company”) for CA's 2008 annual stockholders' meeting. . . .
I. FACTS
CA is a Delaware corporation whose board of directors consists of twelve persons, all of
whom sit for reelection each year. CA's annual meeting of stockholders is scheduled to be
held on September 9, 2008. CA intends to file its definitive proxy materials with the SEC
on or about July 24, 2008 in connection with that meeting.
AFSCME, a CA stockholder, is associated with the American Federation of State,
County and Municipal Employees. On March 13, 2008, AFSCME submitted a proposed
stockholder bylaw (the “Bylaw” or “proposed Bylaw”) for inclusion in the Company's
proxy materials for its 2008 annual meeting of stockholders. The Bylaw, if adopted by
CA stockholders, would amend the Company's bylaws to provide as follows:
RESOLVED, that pursuant to section 109 of the Delaware General Corporation Law
and Article IX of the bylaws of CA, Inc., stockholders of CA hereby amend the bylaws
to add the following Section 14 to Article II:
The board of directors shall cause the corporation to reimburse a stockholder or group
of stockholders (together, the “Nominator”) for reasonable expenses (“Expenses”)
incurred in connection with nominating one or more candidates in a contested election
of directors to the corporation's board of directors, including, without limitation,
printing, mailing, legal, solicitation, travel, advertising and public relations expenses, so
long as (a) the election of fewer than 50% of the directors to be elected is contested in
the election, (b) one or more candidates nominated by the Nominator are elected to the
corporation's board of directors, (c) stockholders are not permitted to cumulate their
votes for directors, and (d) the election occurred, and the Expenses were incurred, after
this bylaw's adoption. The amount paid to a Nominator under this bylaw in respect of a
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contested election shall not exceed the amount expended by the corporation in
connection with such election.
CA's current bylaws and Certificate of Incorporation have no provision that specifically
addresses the reimbursement of proxy expenses. Of more general relevance, however, is
Article SEVENTH, Section (1) of CA's Certificate of Incorporation, which tracks the
language of 8 Del. C. § 141(a) and provides that:
The management of the business and the conduct of the affairs of the corporation shall
be vested in [CA's] Board of Directors.
It is undisputed that the decision whether to reimburse election expenses is presently
vested in the discretion of CA's board of directors, subject to their fiduciary duties and
applicable Delaware law.
***
II. THE CERTIFIED QUESTIONS
The two questions certified to us by the SEC are as follows:
1. Is the AFSCME Proposal a proper subject for action by shareholders as a matter of
Delaware law?
2. Would the AFSCME Proposal, if adopted, cause CA to violate any Delaware law to
which it is subject?
***
III. THE FIRST QUESTION
A. Preliminary Comments
The first question presented is whether the Bylaw is a proper subject for shareholder
action, more precisely, whether the Bylaw may be proposed and enacted by shareholders
without the concurrence of the Company's board of directors. Before proceeding further,
we make some preliminary comments in an effort to delineate a framework within which
to begin our analysis.
First, the DGCL empowers both the board of directors and the shareholders of a
Delaware corporation to adopt, amend or repeal the corporation's bylaws. 8 Del. C. §
109(a) relevantly provides that:
After a corporation has received any payment for any of its stock, the power to adopt,
amend or repeal bylaws shall be in the stockholders entitled to vote ...; provided,
however, any corporation may, in its certificate of incorporation, confer the power to
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adopt, amend or repeal bylaws upon the directors.... The fact that such power has been
so conferred upon the directors ... shall not divest the stockholders ... of the power, nor
limit their power to adopt, amend or repeal bylaws.
Pursuant to Section 109(a), CA's Certificate of Incorporation confers the power to adopt,
amend or repeal the bylaws upon the Company's board of directors.4 Because the statute
commands that that conferral “shall not divest the stockholders ... of ... nor limit” their
power, both the board and the shareholders of CA, independently and concurrently,
possess the power to adopt, amend and repeal the bylaws.
Second, the vesting of that concurrent power in both the board and the shareholders raises
the issue of whether the stockholders' power is coextensive with that of the board, and
vice versa. As a purely theoretical matter that is possible, and were that the case, then the
first certified question would be easily answered. That is, under such a regime any
proposal to adopt, amend or repeal a bylaw would be a proper subject for either
shareholder or board action, without distinction. But the DGCL has not allocated to the
board and the shareholders the identical, coextensive power to adopt, amend and repeal
the bylaws. Therefore, how that power is allocated between those two decision-making
bodies requires an analysis that is more complex.
Moving from the theoretical to this case, by its terms Section 109(a) vests in the
shareholders a power to adopt, amend or repeal bylaws that is legally sacrosanct, i.e., the
power cannot be non-consensually eliminated or limited by anyone other than the
legislature itself. If viewed in isolation, Section 109(a) could be read to make the board's
and the shareholders' power to adopt, amend or repeal bylaws identical and coextensive,
but Section 109(a) does not exist in a vacuum. It must be read together with 8 Del. C. §
141(a), which pertinently provides that:
The business and affairs of every corporation organized under this chapter shall be
managed by or under the direction of a board of directors, except as may be otherwise
provided in this chapter or in its certificate of incorporation. . . .
Article SEVENTH Section (2) of CA's Certificate of Incorporation provides that “[t]he original By Laws
of the corporation shall be adopted by the incorporator. Thereafter, the power to make, alter, or repeal the
By Laws, and to adopt any new By Law, except a By Law classifying directors for election for staggered
terms, shall be vested in the Board of Directors.”
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No such broad management power is statutorily allocated to the shareholders. Indeed, it
is well-established that stockholders of a corporation subject to the DGCL may not
directly manage the business and affairs of the corporation, at least without specific
authorization in either the statute or the certificate of incorporation. Therefore, the
shareholders' statutory power to adopt, amend or repeal bylaws is not coextensive with
the board's concurrent power and is limited by the board's management prerogatives
under Section 141(a).
Third, it follows that, to decide whether the Bylaw proposed by AFSCME is a proper
subject for shareholder action under Delaware law, we must first determine: (1) the scope
or reach of the shareholders' power to adopt, alter or repeal the bylaws of a Delaware
corporation, and then (2) whether the Bylaw at issue here falls within that permissible
scope. Where, as here, the proposed bylaw is one that limits director authority, that is an
elusively difficult task. As one noted scholar has put it, “the efforts to distinguish by-laws
that permissibly limit director authority from by-laws that impermissibly do so have
failed to provide a coherent analytical structure, and the pertinent statutes provide no
guidelines for distinction at all.” The tools that are available to this Court to answer
those questions are other provisions of the DGCL and Delaware judicial decisions that
can be brought to bear on this question.
B. Analysis
1.
Two other provisions of the DGCL, 8 Del. C. §§ 109(b) and 102(b)(1), bear importantly
on the first question and form the basis of contentions advanced by each side. Section
109(b), which deals generally with bylaws and what they must or may contain, provides
that:
The bylaws may contain any provision, not inconsistent with law or with the certificate
of incorporation, relating to the business of the corporation, the conduct of its affairs,
and its rights or powers or the rights or powers of its stockholders, directors, officers or
employees.
And Section 102(b)(1), which is part of a broader provision that addresses what the
certificate of incorporation must or may contain, relevantly states that:
(b) In addition to the matters required to be set forth in the certificate of incorporation
by subsection (a) of this section, the certificate of incorporation may also contain any or
all of the following matters:

Because the board's managerial authority under Section 141(a) is a cardinal precept of the DGCL, we do
not construe Section 109 as an “except[ion] ... otherwise specified in th[e] [DGCL]” to Section 141(a).
Rather, the shareholders' statutory power to adopt, amend or repeal bylaws under Section 109 cannot be
“inconsistent with law,” including Section 141(a).

Lawrence A. Hamermesh, Corporate Democracy and Stockholder-Adopted By-Laws: Taking Back the
Street?, 73 TUL. L.REV.. 409, 444 (1998); . . .
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(1) Any provision for the management of the business and for the conduct of the
affairs of the corporation, and any provision creating, defining, limiting and regulating
the powers of the corporation, the directors and the stockholders, or any class of the
stockholders ....; if such provisions are not contrary to the laws of this State. Any
provision which is required or permitted by any section of this chapter to be stated in
the bylaws may instead be stated in the certificate of incorporation.
AFSCME relies heavily upon the language of Section 109(b), which permits the bylaws
of a corporation to contain “any provision ... relating to the ... rights or powers of its
stockholders [and] directors....” The Bylaw, AFSCME argues, “relates to” the right of the
stockholders meaningfully to participate in the process of electing directors, a right that
necessarily “includes the right to nominate an opposing slate.”
CA argues, in response, that Section 109(b) is not dispositive, because it cannot be read
in isolation from, and without regard to, Section 102(b)(1). CA's argument runs as
follows: the Bylaw would limit the substantive decision-making authority of CA's board
to decide whether or not to expend corporate funds for a particular purpose, here,
reimbursing director election expenses. Section 102(b)(1) contemplates that any
provision that limits the broad statutory power of the directors must be contained in the
certificate of incorporation. Therefore, the proposed Bylaw can only be in CA's
Certificate of Incorporation, as distinguished from its bylaws. Accordingly, the proposed
bylaw falls outside the universe of permissible bylaws authorized by Section 109(b).
Implicit in CA's argument is the premise that any bylaw that in any respect might be
viewed as limiting or restricting the power of the board of directors automatically falls
outside the scope of permissible bylaws. That simply cannot be. That reasoning, taken to
its logical extreme, would result in eliminating altogether the shareholders' statutory right
to adopt, amend or repeal bylaws. Bylaws, by their very nature, set down rules and
procedures that bind a corporation's board and its shareholders. In that sense, most, if not
all, bylaws could be said to limit the otherwise unlimited discretionary power of the
board. Yet Section 109(a) carves out an area of shareholder power to adopt, amend or
repeal bylaws that is expressly inviolate. Therefore, to argue that the Bylaw at issue here
limits the board's power to manage the business and affairs of the Company only begins,
but cannot end, the analysis needed to decide whether the Bylaw is a proper subject for
shareholder action. The question left unanswered is what is the scope of shareholder
action that Section 109(b) permits yet does not improperly intrude upon the directors'
power to manage corporation's business and affairs under Section 141(a).
It is at this juncture that the statutory language becomes only marginally helpful in
determining what the Delaware legislature intended to be the lawful scope of the
shareholders' power to adopt, amend and repeal bylaws. To resolve that issue, the Court
must resort to different tools, namely, decisions of this Court and of the Court of

Although CA advances this argument in its Brief in connection with the second question, i.e., as a reason
why the Bylaw, if adopted, would violate Delaware law, we view the argument as also properly bearing
upon the first question, namely, whether the proposed Bylaw is a proper subject for shareholder action.
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Chancery that bear on this question. Those tools do not enable us to articulate with
doctrinal exactitude a bright line that divides those bylaws that shareholders may
unilaterally adopt under Section 109(b) from those which they may not under Section
141(a). They do, however, enable us to decide the issue presented in this specific case.
2.
It is well-established Delaware law that a proper function of bylaws is not to mandate
how the board should decide specific substantive business decisions, but rather, to define
the process and procedures by which those decisions are made. As the Court of Chancery
has noted:
Traditionally, the bylaws have been the corporate instrument used to set forth the rules
by which the corporate board conducts its business. To this end, the DGCL is replete
with specific provisions authorizing the bylaws to establish the procedures through
which board and committee action is taken.... [T]here is a general consensus that
bylaws that regulate the process by which the board acts are statutorily authorized.
Examples of the procedural, process-oriented nature of bylaws are found in both the
DGCL and the case law. For example, 8 Del. C. § 141(b) authorizes bylaws that fix the
number of directors on the board, the number of directors required for a quorum (with
certain limitations), and the vote requirements for board action. 8 Del. C. § 141(f)
authorizes bylaws that preclude board action without a meeting.17 And, almost three
decades ago this Court upheld a shareholder-enacted bylaw requiring unanimous board
attendance and board approval for any board action, and unanimous ratification of any
committee action. Such purely procedural bylaws do not improperly encroach upon the
board's managerial authority under Section 141(a).
The process-creating function of bylaws provides a starting point to address the Bylaw at
issue. It enables us to frame the issue in terms of whether the Bylaw is one that
establishes or regulates a process for substantive director decision-making, or one that
mandates the decision itself. Not surprisingly, the parties sharply divide on that question.
We conclude that the Bylaw, even though infelicitously couched as a substantivesounding mandate to expend corporate funds, has both the intent and the effect of
regulating the process for electing directors of CA. Therefore, we determine that the
Bylaw is a proper subject for shareholder action, and set forth our reasoning below.
Although CA concedes that “restrictive procedural bylaws (such as those requiring the
presence of all directors and unanimous board consent to take action) are acceptable,” it
points out that even facially procedural bylaws can unduly intrude upon board authority.
17
See also, e.g.,8 Del. C. § 211(a) & (b) (bylaws may establish the date and the place of the annual
meeting of the stockholders); § 211(d) (bylaws may specify the conditions for the calling of special
meetings of stockholders); § 216 (bylaws may establish quorum and vote requirements for meetings of
stockholders and “[a] bylaw amendment adopted by stockholders which specifies the votes that shall be
necessary for the election of directors shall not be further amended or repealed by the board of directors.”);
§ 222 (bylaws may regulate certain notice requirements regarding adjourned meetings of stockholders).
18
The Bylaw being proposed here is unduly intrusive, CA claims, because, by mandating
reimbursement of a stockholder's proxy expenses, it limits the board's broad discretionary
authority to decide whether to grant reimbursement at all. CA further claims that because
(in defined circumstances) the Bylaw mandates the expenditure of corporate funds, its
subject matter is necessarily substantive, not process-oriented, and, therefore falls outside
the scope of what Section 109(b) permits.19
Because the Bylaw is couched as a command to reimburse (“The board of directors shall
cause the corporation to reimburse a stockholder”), it lends itself to CA's criticism. But
the Bylaw's wording, although relevant, is not dispositive of whether or not it is processrelated. The Bylaw could easily have been worded differently, to emphasize its process,
as distinguished from its mandatory payment, component.20 By saying this we do not
mean to suggest that this Bylaw's reimbursement component can be ignored. What we do
suggest is that a bylaw that requires the expenditure of corporate funds does not, for that
reason alone, become automatically deprived of its process-related character. A
hypothetical example illustrates the point. Suppose that the directors of a corporation live
in different states and at a considerable distance from the corporation's headquarters.
Suppose also that the shareholders enact a bylaw that requires all meetings of directors to
take place in person at the corporation's headquarters. Such a bylaw would be clearly
process-related, yet it cannot be supposed that the shareholders would lack the power to
adopt the bylaw because it would require the corporation to expend its funds to reimburse
the directors' travel expenses. Whether or not a bylaw is process-related must necessarily
be determined in light of its context and purpose.
The context of the Bylaw at issue here is the process for electing directors-a subject in
which shareholders of Delaware corporations have a legitimate and protected interest.
The purpose of the Bylaw is to promote the integrity of that electoral process by
facilitating the nomination of director candidates by stockholders or groups of
stockholders. Generally, and under the current framework for electing directors in
contested elections, only board-sponsored nominees for election are reimbursed for their
19
CA actually conflates two separate arguments that, although facially similar, are analytically distinct. The
first argument is that the Bylaw impermissibly intrudes upon board authority because it mandates the
expenditure of corporate funds. The second is that the Bylaw impermissibly leaves no role for board
discretion and would require reimbursement of the costs of a subset of CA's stockholders, even in
circumstances where the board's fiduciary duties would counsel otherwise. Analytically, the first argument
is relevant to the issue of whether the Bylaw is a proper subject for unilateral stockholder action, whereas
the second argument more properly goes to the separate question of whether the Bylaw, if enacted, would
violate Delaware law.
For example, the Bylaw could have been phrased more benignly, to provide that “[a] stockholder or
group of stockholders (together, the ‘Nominator’) shall be entitled to reimbursement from the corporation
for reasonable expenses (‘Expenses') incurred in connection with nominating one or more candidates in a
contested election of directors to the corporation's board of directors in the following circumstances....”
Although the substance of the Bylaw would be no different, the emphasis would be upon the shareholders'
entitlement to reimbursement, rather than upon the directors' obligation to reimburse. As discussed in Part
IV, infra, of this Opinion, in order for the bylaw not to be “not inconsistent with law” as Section 109(b)
mandates, it would also need to contain a provision that reserves the directors' full power to discharge their
fiduciary duties.
20
19
election expenses. Dissident candidates are not, unless they succeed in replacing the
entire board. The Bylaw would encourage the nomination of non-management board
candidates by promising reimbursement of the nominating stockholders' proxy expenses
if one or more of its candidates are elected. In that the shareholders also have a legitimate
interest, because the Bylaw would facilitate the exercise of their right to participate in
selecting the contestants. The Court of Chancery has so recognized:
[T]he unadorned right to cast a ballot in a contest for [corporate] office ... is
meaningless without the right to participate in selecting the contestants. As the
nominating process circumscribes the range of choice to be made, it is a fundamental
and outcome-determinative step in the election of officeholders. To allow for voting
while maintaining a closed selection process thus renders the former an empty
exercise.22
***
The shareholders of a Delaware corporation have the right “to participate in selecting the
contestants” for election to the board. The shareholders are entitled to facilitate the
exercise of that right by proposing a bylaw that would encourage candidates other than
board-sponsored nominees to stand for election. The Bylaw would accomplish that by
committing the corporation to reimburse the election expenses of shareholders whose
candidates are successfully elected. That the implementation of that proposal would
require the expenditure of corporate funds will not, in and of itself, make such a bylaw an
improper subject matter for shareholder action. Accordingly, we answer the first question
certified to us in the affirmative.
That, however, concludes only part of the analysis. The DGCL also requires that the
Bylaw be “not inconsistent with law.”23 Accordingly, we turn to the second certified
question, which is whether the proposed Bylaw, if adopted, would cause CA to violate
any Delaware law to which it is subject.
IV. THE SECOND QUESTION
In answering the first question, we have already determined that the Bylaw does not
facially violate any provision of the DGCL or of CA's Certificate of Incorporation. The
question thus becomes whether the Bylaw would violate any common law rule or
precept. Were this issue being presented in the course of litigation involving the
application of the Bylaw to a specific set of facts, we would start with the presumption
that the Bylaw is valid and, if possible, construe it in a manner consistent with the law.
The factual context in which the Bylaw was challenged would inform our analysis, and
we would “exercise caution [before] invalidating corporate acts based upon hypothetical
injuries....” The certified questions, however, request a determination of the validity of
the Bylaw in the abstract. Therefore, in response to the second question, we must
22
Harrah's Entm't v. JCC Holding Co., 802 A.2d 294, 311 (Del. Ch.2002) (quoting Durkin v. Nat'l Bank of
Olyphant, 772 F.2d 55, 59 (3d Cir.1985)).
23
8 Del. C. § 109(b).
20
necessarily consider any possible circumstance under which a board of directors might be
required to act. Under at least one such hypothetical, the board of directors would breach
their fiduciary duties if they complied with the Bylaw. Accordingly, we conclude that the
Bylaw, as drafted, would violate the prohibition, which our decisions have derived from
Section 141(a), against contractual arrangements that commit the board of directors to a
course of action that would preclude them from fully discharging their fiduciary duties to
the corporation and its shareholders.
This Court has previously invalidated contracts that would require a board to act or not
act in such a fashion that would limit the exercise of their fiduciary duties. . . .
[T]he internal governance contract-which here takes the form of a bylaw-is one that
would also prevent the directors from exercising their full managerial power in
circumstances where their fiduciary duties would otherwise require them to deny
reimbursement to a dissident slate. . . .
AFSCME contends that it is improper to use the doctrine articulated in QVC and
Quickturn as the measure of the validity of the Bylaw. Because the Bylaw would remove
the subject of election expense reimbursement (in circumstances as defined by the
Bylaw) entirely from the CA's board's discretion (AFSCME argues), it cannot fairly be
claimed that the directors would be precluded from discharging their fiduciary duty.
Stated differently, AFSCME argues that it is unfair to claim that the Bylaw prevents the
CA board from discharging its fiduciary duty where the effect of the Bylaw is to relieve
the board entirely of those duties in this specific area.
That response, in our view, is more semantical than substantive. No matter how artfully it
may be phrased, the argument concedes the very proposition that renders the Bylaw, as
written, invalid: the Bylaw mandates reimbursement of election expenses in
circumstances that a proper application of fiduciary principles could preclude. That such
circumstances could arise is not far fetched. Under Delaware law, a board may expend
corporate funds to reimburse proxy expenses “[w]here the controversy is concerned with
a question of policy as distinguished from personnel o[r] management.” But in a situation
where the proxy contest is motivated by personal or petty concerns, or to promote
interests that do not further, or are adverse to, those of the corporation, the board's
fiduciary duty could compel that reimbursement be denied altogether.34
It is in this respect that the proposed Bylaw, as written, would violate Delaware law if
enacted by CA's shareholders. As presently drafted, the Bylaw would afford CA's
directors full discretion to determine what amount of reimbursement is appropriate,
because the directors would be obligated to grant only the “reasonable” expenses of a
successful short slate. Unfortunately, that does not go far enough, because the Bylaw
contains no language or provision that would reserve to CA's directors their full power to
34
Such a circumstance could arise, for example, if a shareholder group affiliated with a competitor of the
company were to cause the election of a minority slate of candidates committed to using their director
positions to obtain, and then communicate, valuable proprietary strategic or product information to the
competitor.
21
exercise their fiduciary duty to decide whether or not it would be appropriate, in a
specific case, to award reimbursement at all.
***
In arriving at this conclusion, we express no view on whether the Bylaw as currently
drafted, would create a better governance scheme from a policy standpoint. We decide
only what is, and is not, legally permitted under the DGCL. That statute, as currently
drafted, is the expression of policy as decreed by the Delaware legislature. Those who
believe that CA's shareholders should be permitted to make the proposed Bylaw as
drafted part of CA's governance scheme, have two alternatives. They may seek to amend
the Certificate of Incorporation to include the substance of the Bylaw; or they may seek
recourse from the Delaware General Assembly.
Accordingly, we answer the second question certified to us in the affirmative.
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Business Associations
Professor Steve Bradford
Section 113 of the Delaware General Corporation Law
In 2009, the Delaware legislature added a new Section 113 to the Delaware
General Corporation Law. Section 113 allows a corporation’s bylaws to provide for the
reimbursement of expenses incurred by a shareholder in connection with an election of
directors.
This is precisely the kind of language the plaintiffs in CA, Inc. v. AFSCME
Employees Pension Plan, 953 A.2d 227 (Del. 2008), were seeking to add to the
corporation’s bylaws. Under section 113, a provision like that may now be included in a
Delaware corporation’s bylaws, and is thus a proper subject for shareholder action under
section 109(a). Thus, section 113 essentially overrules the narrow holding of CA, Inc.
Section 113 does not affect the broader holding of CA, Inc.—the proposition that,
in general, only the certificate of incorporation, and not the bylaws, may restrict the
managerial authority of directors. Section 113 just carves out one particular substantive
provision and says it is appropriate for the bylaws.
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Business Associations
Professor Steve Bradford
Shareholder Power to Control Corporate Action
As the book points out, shareholders ordinarily have no direct control over what their
corporation does. The board of directors, either directly or by delegating authority to
others, is responsible for the management of the corporation. Read Del. Gen. Corp. L. §
141(a) and MBCA § 8.01(b). But what if a majority of the shareholders want to restrict
the corporation’s activities? Can they amend either the articles of incorporation or the
bylaws to limit the board’s discretion?
To see how the articles of incorporation may be amended, read Del. Gen. Corp. L.
§ 242(b)(1) and MBCA § 10.03(a),(b). (Remember that Delaware calls the articles the
“certificate of incorporation.”) To see how a corporation’s bylaws may be amended, read
Del. Gen. Corp. L. § 109(a) and MBCA § 10.20. Consider how these amendment
provisions interact with the sections giving the board power to manage the corporation.
Do you see the dilemma a shareholder wanting to limit the board’s power faces?
Consider the following problems:
1. Coyote is a shareholder of Acme Corporation, a manufacturer of firearms.
Coyote is concerned about the possible use of Acme’s products by terrorists,
particularly in Saudi Arabia. At the next annual meeting, Coyote wants Coyote’s
shareholders to vote on a resolution to add the following sentence to Acme’s
bylaws: “Acme shall not sell any products in Saudi Arabia.” If Acme is a
Delaware corporation, is this resolution effective? What if Acme is incorporated
in a state that has adopted the MBCA?
2. What if Coyote presents a resolution to add the same language to Acme’s articles
of incorporation? Would that be effective under Delaware law? Under the
MBCA?
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Business Associations
Professor Steve Bradford
Coverage of the Federal Proxy Rules
The federal proxy rules do not apply to all companies. Read section 14(a) of the
Securities Exchange Act of 1934. This is the statutory provision that authorizes the SEC
to regulate proxies.
Note the language at the end of section 14(a): “in respect of any security (other
than an exempted security) registered pursuant to section 12 of this title.” If a security is
not registered pursuant to section 12 of the Securities Exchange Act, the proxy
solicitation rules do not apply. In essence, registration under section 12 triggers the
application of the proxy rules (and many other requirements in the Exchange Act).
Section 12 covers primarily two categories of securities:
(1) securities traded on a national securities exchange, such as the New York
Stock Exchange [Exchange Act § 12(a)]; or
(2) any class of equity securities having more than 500 hundred record owners
issued by a company with total assets of more than $10 million [Exchange Act §
12(g)(1)(B), as modified by Exchange Act Rule 12g-1].
Because of the section 12 trigger, your typical Mom-and-Pop small corporation is not
subject to the proxy rules, only public companies.
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Business Associations
Professor Steve Bradford
What is a Proxy Solicitation?
The federal proxy rules apply only to proxy solicitations. Read Rule 14a-1(l). If
a communication is not a “solicitation” within this definition, it need not comply with the
proxy rules. In addition, Rule 14a-2(b) exempts certain solicitations from most, but not
all, of the proxy rules. In other words, even though a communication is within the
definition of “solicitation,” it still doesn’t have to comply with most of the rules. Read
Rule 14a-2(b)(1),(2). Note one very important rule that Rule 14a-2(b) does not exempt
solicitations from: Rule 14a-9, the antifraud rule.
Problems
Assume that Curly is a shareholder of Stooge Corporation and Stooge is subject to the
proxy rules. Is each of the following communications a proxy solicitation? If so, is it
exempted by Rule 14a-2(b)?
1. Curly mails a proxy form to Mo, along with a letter asking Mo to sign the form.
2. Curly sends a letter to Mo asking Mo to give Curly his proxy, but Curly does not
include a proxy form for Mo to sign.
3. Would it matter in the prior problem if Curly sent the same letter to all 5,000
Stooge shareholders? What if Curly called all 5,000 shareholders on the phone?
4. Curly publishes an ad in the Wall Street Journal announcing that he intends to
vote against the existing directors of Stooge Corporation because he thinks
they’re incompetent.
5. Would it matter in the prior problem if Curly planned, after the ad appeared, to
send a mailing to all of Stooge’s shareholders asking them to give Curly their
proxies?
6. Curly sends a letter to all 5,000 Stooge shareholders asking them to vote against
the current Stooge directors. Curly is not himself seeking, and will not accept,
proxies from any of the shareholders.
7. Would it matter in the prior problem if, before sending the letter, Curly discussed
it with Larry, who is soliciting proxies from the Stooge shareholders to vote
against the current directors?
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Business Associations
Professor Steve Bradford
Federal Restrictions on the Proxy Form
Look at the proxy form on p. 168 of the casebook. Note that it specifically
identifies matters to be considered at the meeting, including the election of directors, and
gives the shareholder the opportunity to direct the proxy holder how to vote on those
matters. This is required by the SEC’s proxy rules.
A proxy form must “identify clearly and impartially each separate matter intended
to be acted upon.” Rule 14a-4(a)(3). Read subsection (a) of Rule 14a-4. And the
shareholder must be afforded means for specifying a choice on those matters. Read
subsection (b) of Rule 14a-4. What happens under subsection (b) if the shareholder fails
to make a choice?
What happens if a shareholder raises a matter at the meeting that the proxy holder
did not anticipate when it mailed its proxy forms? That matter would not be identified on
the proxy form and the shareholder would not have been given a choice to specify how
the proxy should be voted. Does that make the proxy invalid for voting on the
unanticipated issue? Not necessarily. Read subsection (c)(1) of Rule 14a-4, which
allows the proxy holder to exercise discretionary authority in such cases.
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Business Associations
Professor Steve Bradford
Shareholder Proposal Problems
Would a corporation be able to exclude the following proposals under subsection
(i) of Rule 14a-8? (Assume that the shareholder otherwise qualifies to use Rule 14a-8.)
1. Resolved: The board of directors shall cease all business operations in Iran.
[The supporting statement indicates a concern that the negative publicity
associated with operations in Iran, and the possible loss of corporate property if
the present government is overthrown, could cost the corporation money in the
long run. Assume that the company’s Iranian operations are a miniscule part of
the company’s business.]
2. Resolved: The shareholders recommend that the board adopt a policy not to hire
women.
3. Resolved: The shareholders recommend that the board choose IBM as its
computer supplier.
4. Resolved: The shareholders express their contempt for John J. Smith [a director
of the company], who has done a poor job of leading the corporation’s board of
directors.
5. Resolved: The shareholders recommend that the board adopt a policy prohibiting
discrimination against homosexuals in hiring.
[The board has already adopted such a policy and the corporation is vigorously
enforcing it.]
6. Resolved: The shareholders recommend that the board quit allowing Beverly
Howard [the CEO of the company] to steal $4 million from the corporate treasury
each year.
[There is no evidence that Howard has “stolen” any money from the company.
However, her annual salary is $4 million.]
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Business Associations
Professor Steve Bradford
New Developments: Shareholder Nominees for the
Board
The SEC recently proposed to amend the proxy rules to require a company, in
certain circumstances, to include shareholders’ nominees for directors in the company’s
own proxy materials. See SEC, Facilitating Shareholder Director Nominations,
Securities Act Release No. 9046, 74 F.R. 29024 (June 18, 2009). Proposed Rule 14a-11
would only be available to shareholders, or groups of shareholders, who have owned a
specified amount of the company’s securities for at least one year. The actual percentage
required varies from 1% to 5%, depending on the size of the company. The rule would
not be available to a shareholder or group of shareholders seeking to change control of
the company or to gain more than a limited number of seats on the board (the greater of
one nominee or 25% of the number of directors on the board).
State law is also changing to accommodate shareholder nominees in the
corporation’s proxy materials. In 2009, the Delaware legislature added a new Section
112 to the Delaware General Corporation Law. Section 112 allows a corporation’s
bylaws to include a requirement that the corporation include in its proxy materials, in
addition to the company’s own nominees for the board of directors, shareholder
nominees.
In December 2009, the ABA Committee on Corporate Laws amended section
2.06 of the Model Business Corporation Act. New subsection 2.06(c) allows a
corporation’s bylaws to include requirements that (1) the corporation’s proxy materials
include shareholder nominees for the board or (2) the corporation reimburse shareholders
for expenses of proxy solicitation related to elections.
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Business Associations
Professor Steve Bradford
Shareholder Inspection Problems
What would the result be in each of the following problems if the corporation is a
Delaware corporation? What if the corporation is incorporated in a state that has adopted
the MBCA?
1. A shareholder seeks to obtain a copy of the list of shareholders so he can
communicate with other shareholders about the corporation’s contracts with
North Korea. He seeks support from the other shareholders to replace the current
board members with directors who oppose doing business with North Korea. He
believes the North Korean contracts should be terminated because North Korea is
an oppressive Communist dictatorship and terminating the contracts will help
topple the North Korean government. He admits that the contracts are highly
profitable to the company, but thinks the company should “do what’s right.” Is
this a proper purpose? Who has the burden of proof on that issue?
2. What if, in the prior problem, the shareholder expresses concern that the North
Korean contracts will reduce the corporation’s profits? He believes the negative
publicity associated with dealing with North Korea will drive away other
customers, resulting in a net loss to the corporation. Does that change anything?
3. In addition to the list of shareholders, the shareholder in the preceding problems
wants to obtain copies of the following records:
1) All contracts between the corporation and the North Korean government;
2) All documents reflecting profits or losses on those North Korean
contracts;
3) All correspondence from consumers expressing disapproval of the
company’s dealings with North Korea.
4) All documents relating to the North Korean government’s use of the
materials sold by the corporation.
Assuming the shareholder has a proper purpose, can he obtain these documents?
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Professor Steve Bradford
Rule 14a-7 of the Federal Proxy Rules
One of the books and records that a shareholder may obtain under state
corporation law is a list of the corporation’s shareholders. See MBCA § 16.02(b)(3);
Del. Gen. Corp. L. § 220(b). A shareholder might want to obtain this list to communicate
with other shareholders about corporate affairs, such as whether to reelect the existing
directors, how to vote on a resolution to be considered at the next annual meeting, and so
on.
A shareholder might obtain the shareholder list under state law, but there is
another option. If the proxy rules apply to the company, the shareholder may use Rule
14a-7, one of the SEC’s proxy rules. Read Rule 14a-7(a). Note especially subsection
(a)(2), which specifies two possible alternatives. What are the two alternatives under
Rule 14a-7? Read section (b) of Rule 14a-7, which tells you who gets to choose between
those two alternatives. When the company’s management has the choice, it almost
always chooses the option specified in subsection (a)(2)(i). Why do you think the
company’s management would consider that the better choice?
Finally, note that the requesting shareholder bears all the expense of compliance
with Rule 14a-7. Read Rule 14a-7(e). Because of that, small shareholders wishing to
raise an issue would rather use the shareholder proposal rule, Rule 14a-8, if they can.
Why? Why would a shareholder ever use Rule 14a-7 instead of Rule 14a-8?
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Business Associations
Professor Steve Bradford
The Director’s Obligation to Act in Good Faith
Two subsequent Delaware Supreme Court cases have discussed the director’s
obligation of good faith.
In Stone v. Ritter, 911 A.2d 362 (Del. 2006), the Delaware Supreme Court
concluded that good faith is not a separate duty in addition to the duties of care and
loyalty, but part of the duty of loyalty. The court wrote:
. . . [A] failure to act in good faith is not conduct that results, ipso facto, in the
direct imposition of fiduciary liability. The failure to act in good faith may result
in liability because the requirement to act in good faith “is a subsidiary
element[,]” i.e., a condition, “of the fundamental duty of loyalty.” It follows that
because a showing of bad faith conduct, in the sense described in Disney and
Caremark, is essential to establish director oversight liability, the fiduciary duty
violated by that conduct is the duty of loyalty.
This view of a failure to act in good faith results in two additional doctrinal
consequences. First, although good faith may be described colloquially as part of
a “triad” of fiduciary duties that includes the duties of care and loyalty, the
obligation to act in good faith does not establish an independent fiduciary duty
that stands on the same footing as the duties of care and loyalty. Only the latter
two duties, where violated, may directly result in liability, whereas a failure to act
in good faith may do so, but indirectly. The second doctrinal consequence is that
the fiduciary duty of loyalty is not limited to cases involving a financial or other
cognizable fiduciary conflict of interest. It also encompasses cases where the
fiduciary fails to act in good faith. As the Court of Chancery aptly put it in
Guttman, “[a] director cannot act loyally towards the corporation unless she acts
in the good faith belief that her actions are in the corporation's best interest.”
The final major Supreme Court case discussing the obligation of good faith was
Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (Del. 2009), where the court wrote:
The Stone Court . . . clarified any possible ambiguity about the directors' mental
state, holding that “imposition of liability requires a showing that the directors
knew that they were not discharging their fiduciary obligations.”
***
[B]ad faith will be found if a “fiduciary intentionally fails to act in the face of a
known duty to act, demonstrating a conscious disregard for his duties.” . . .
[T]here is a vast difference between an inadequate or flawed effort to carry out
fiduciary duties and a conscious disregard for those duties.
32
***
Directors' decisions must be reasonable, not perfect. “In the transactional context,
[an] extreme set of facts [is] required to sustain a disloyalty claim premised on the
notion that disinterested directors were intentionally disregarding their duties.”
The trial court denied summary judgment because the Lyondell directors'
“unexplained inaction” prevented the court from determining that they had acted
in good faith. But, if the directors failed to do all that they should have under the
circumstances, they breached their duty of care. Only if they knowingly and
completely failed to undertake their responsibilities would they breach their duty
of loyalty.
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Business Associations
Professor Steve Bradford
Dividend Problem
1. On the next page is a balance sheet for Acme Corporation. As of the date of
this balance sheet, what is the maximum amount of dividends Acme could pay to its
common shareholders under MBCA § 6.40(c)? Under Del. Gen. Corp. L. § 170? (See
also Del. Gen. Corp. L. § 154.)
The following additional information may or may not be helpful:
1. The short-term indebtedness shown on the balance sheet is due 30 to 60 days from
the date of the balance sheet.
2. The long-term indebtedness shown on the balance sheet is due 15 months from
the date of the balance sheet.
3. Acme had a net loss in 2008 of $50,000. It has had a net profit in 2009 of $5,000.
34
Acme Corporation
Balance Sheet
As of December 1, 2009
Assets
Cash
Accounts Receivable
Inventory
Equipment
$80,000
10,000
30,000
25,000
Total Assets
$145,000
Liabilities and Shareholders’ Equity
Liabilities
Accounts Payable
Short-Term Indebtedness
Long-Term Indebtedness
Total Liabilities
Shareholders' Equity
Common Stock
(50,000 shares issued and outstanding; $0.50/share par value)
Preferred Stock
(10,000 shares issued and outstanding; $0.50/share par value;
$1.00/share liquidation preference)
Additional Paid-in Capital
Retained Earnings
Total Shareholders' Equity
Total Liabilities and Shareholders’ Equity
$20,000
20,000
65,000
$105,000
$25,000
5,000
20,000
(10,000)
$40,000
$145,000
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Professor Steve Bradford
Insider Trading Problems
1. What if O’Hagan, when he found out about Grand Met’s tender offer for
Pillsbury, told both Grand Met and his superiors at the law firm that he was going
to buy Pillsbury stock? Would he still be liable under Rule 10b-5?
2. Smith is an officer of Grand Met. Her husband is angry when she comes home
extremely late one night. He accuses her of having an affair. To alleviate his
concerns, she responds, “No, we’re doing a tender offer for Pillsbury and things
have been really hectic.” The next day, the husband buys Pillsbury stock. Is the
husband liable under Rule 10b-5? (Does Rule 10b5-2 help you answer this
question?)
3.
Smith is talking on an airplane to an officer of Pillsbury about the upcoming
tender offer. Washington, a flight attendant, overhears enough of the
conversation to figure out what’s going on. As soon as the plane lands,
Washington purchases Pillsbury shares.
4.
Jones is an officer of Texas Gulf Sulphur. Jones learns about the mineral
discoveries and tells Coach Snyder, the coach of Jones’ favorite college football
team. In return for the tip, Snyder gives Jones season tickets on the 50-yard-line.
Snyder immediately buys Texas Gulf Sulphur stock. Snyder also tells his
daughter, Roe, that he’s heard Texas Gulf Sulphur stock is going up in value.
Roe, who does not know where the information came from, also buys Texas Gulf
Sulphur shares. Is Snyder or Roe liable under Rule 10b-5?
5.
Johnson is the chief executive officer of Acme Corporation. Johnson has set up a
program with his broker pursuant to which the broker buys 100 Acme shares for
Johnson on the first of every month. Johnson and the broker have been doing this
for over a year. On July 25, Johnson finds out that Acme has reached terms with
a buyer on a major new contract. Assume the contract is material. Johnson’s
broker buys the usual 100 shares on August 1. The contract is announced
publicly on August 3. Is Johnson liable under Rule 10b-5? (Does Rule 10b5-1
help you answer this question?)
6.
On August 26, Johnson finds out that Gates, the creative genius behind many of
Acme’s products, is leaving Acme. Johnson calls his broker and tells him not to
make the usual purchase on September 1. Gates’ resignation is announced on
September 2. Is Johnson liable under Rule 10b-5?
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Professor Steve Bradford
Additional Material on Section 16(b)
Who Brings Section 16(b) Actions and Why. The second sentence of section 16(b)
indicates who may bring an action to enforce it:
Suit to recover such profit may be instituted at law or in equity in any court of
competent jurisdiction by the issuer, or by the owner of any security of the issuer
in the name and in behalf of the issuer if the issuer shall fail or refuse to bring
such suit within sixty days after request or shall fail diligently to prosecute the
same thereafter; but no such suit shall be brought more than two years after the
date such profit was realized.
The company itself may sue to enforce section 16(b) or, more commonly, if the company
won’t sue, any owner of the company’s securities may sue. Courts have held that a
plaintiff need not have been a security owner at the time of the violation, as long as he
owns the company’s securities at the time the section 16(b) action is filed. In other
words, if I determine that someone violated section 16(b), I could then buy some of the
company’s securities and sue.
But note that the first sentence of section 16(b) says any recovery “shall inure to
and be recoverable by the issuer.” Why would a shareholder want to sue if the
shareholder himself gets no money? A shareholder would have an indirect interest in the
corporation’s recovery but, given the small percentages owned by many shareholders in
public companies, the value of that interest could be miniscule.
The answer lies in another procedural aspect of section 16(b): a successful
security owner can recover attorneys' fees. Section 16(b) actions are motivated primarily
by the attorneys' fees. The real party in interest here is the plaintiff's attorney, not the
plaintiff. A few attorneys specialize in section 16(b) actions, and the plaintiffs tend to be
the same people in case after case. The attorneys discover violations by perusing section
16(a) reports, the plaintiff buys a small amount of the company's securities, a demand is
made, and the action is filed. Because of this diligent plaintiffs' bar, section 16(b) is very
well enforced.
Who Are “Directors” and “Officers”? Section 16(b) covers, in addition to 10%
beneficial owners, directors and officers. The meaning of “director” is fairly
straightforward—a member of the corporation’s board of directors. However, not all
companies covered by section 16(b) are corporations, so section 3(a)(7) of the Exchange
Act expands the definition of “director” to include “any person performing similar
functions with respect to any organization, whether incorporated or unincorporated.”
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The definition of “officer” is not as straightforward. The problem is that some
companies, such as banks and brokers, traditionally have literally dozens of “vice
presidents,” some of whom really aren’t executive officers in any meaningful sense. The
SEC has no interest in including all those people within the coverage of section 16(b). It
has adopted a definition of “officer that excludes most of these people. Rule 16a-1(f)
provides:
(f) The term "officer" shall mean an issuer's president, principal financial officer,
principal accounting officer (or, if there is not such accounting officer, the
controller), any vice-president of the issuer in charge of a principal business unit,
division or function (such as sales, administration or finance), any other officer
who performs a policy-making function, or any other person who performs
similar policy-making functions for the issuer. . . .
Note: "Policy-making function" is not intended to include policy-making
functions that are not significant. . . .
Calculation of Section 16(b) Damages. Section 16(b) makes persons covered liable for
“any profit realized” in the covered trading. Calculating the amount of profit can get
difficult when the person has engaged in multiple purchases and sales, all at different
prices. To facilitate the calculation of profit and to ensure that people covered by section
16(b) don’t keep any gain, the courts have adopted a simple rule that sometimes produces
what some might consider unjust results. To determine if a person has profits, you match
the purchase at the lowest price in the six-month period with the sale at the highest price.
You keep doing that matching until you can’t produce any further profit. (You don’t
offset the “profits” with any matches that might produce a loss.) We will discuss the
application of this rule in connection with the problems in the book.
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Business Associations
Professor Steve Bradford
The Revised Uniform Limited Liability Company Act
The National Conference of Commissioners on Uniform State Law issued a
revised version of the Uniform Limited Liability Company Act in 2006. The casebook
cites to the 1996 version, but the statute book contains the revised version and we will be
using the revised version. The following chart shows the sections in the 2006 Act that
correlate to the sections of the 1996 Act cited by the authors.
ULLCA (1996)
ULLCA (2006)
103
105
201
202(b)
203
203(c)
301
303
404
405
409
502
601
602
603
701
702
902
110
108
104(a)
201(d)(1)
201(b)
112(d)
301. See also 407.
304
407(c)(5)
404
409
502
602
601
603
*
*
1006-1009
*There is no equivalent. RULLCA § 603
covers the issues formally dealt with in
these sections.
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Business Associations
Professor Steve Bradford
Actual and Apparent Authority to Bind an LLC
To what extent may a member (or a manager in a manager-managed LLC) bind
the company?
The 1996 version of the Uniform Limited Liability Company Act closely
followed section 301 of the Uniform Partnership Act, although the ULLCA distinguished
between member-managed and manager-managed companies. In a member-managed
LLC, all members had essentially the same authority to bind the business as partners in a
general partnership:
(1) Each member is an agent of the limited liability company for the purpose of its
business, and an act of a member, including the signing of an instrument in the
company’s name, for apparently carrying on in the ordinary course the company’s
business or business of the kind carried on by the company binds the company,
unless the member had no authority to act for the company in the particular matter
and the person with whom the member was dealing knew or had notice that the
member lacked authority.
(2) An act of a member which is not apparently for carrying on in the ordinary
course the company’s business or business of the kind carried on by the company
binds the company only if the act was authorized by the other members.
ULLCA (1996) § 301(a).
In a manager-managed LLC, ordinary members did not have the authority to bind
the partnership. The statute provided that a mere member in a manager-managed LLC
“is not an agent of the company for the purpose of its business solely by reason of being a
member.” ULLCA (1996) § 301(b)(1). The manager, however, had essentially the same
authority as a partner in a general partnership:
(1) . . . Each manager is an agent of the limited liability company for the purpose
of its business, and an act of a manager, including the signing of an instrument in
the company’s name, for apparently carrying on in the ordinary course the
company’s business or business of the kind carried on by the company binds the
company, unless the manager had no authority to act for the company in the
particular matter and the person with whom the manager was dealing knew or had
notice that the manager lacked authority.
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(2) An act of a manager which is not apparently for carrying on in the ordinary
course the company’s business or business of the kind carried on by the company
binds the company only if the act was authorized under Section 404.
ULLCA (1996) § 301(b) (emphasis added).
The 2006 version of the ULLCA eliminates all of this language, and with it the
whole idea of statutory apparent authority. Section 301 of the revised Act provides that
“A member is not an agent of a limited liability company solely by reason of being a
member.” ULLCA (2006) § 301(a). According to the Official Comment, “other law—
most especially the law of agency—will handle power-to-bind questions.” ULLCA
(2006) § 301, Official Comment. Section 301(b) now provides that “A person’s status as
a member does not prevent or restrict law other than this [act] from imposing liability on
a limited liability company because of the person’s conduct.”
Delaware’s approach is different. See Del. § 18-402, last sentence.