CORPORATIONS
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EXAM ANSWERS: YES/NO/MAYBE; SOURCE OF AUTHORITY; EXPLANATION.
Law is simple; fact patterns are difficult; very few bright line rules; follow best practices.
We put our money in stocks because the corporate form works
o Market will keep them smart, the law is in place to keep them faithful
 Duty of care is governed by the market
 Courts must regulate duty of loyalty
o SEC regulates the markets and ensures they are fair to all parties
 Fair, transparent, faithful fidicuaries
Best business organization for a business relationship is handled by reference to 5 questions:
Limited
Liability
Transferability
Continuity of
existence
Legal
personality
Central Mgmt
General Partnership
No, unlimited.
No, can assign
interest only.
No, ease of
dissolution
RUPA – yes, entity
UPA – no, aggregate
No, ultimate
democracy
Limited Partnership
GP: no
LP: yes
GP: no; can assign only P/L
LP: yes, all they have is interest
Somewhat better – LPs can quit
and it continues, but if solo GP
leaves it dissolves
Yes – requires a filing, all based
on RUPA
Yes, with a vengeance, if 1
general partner; dictatorship
Corporation
Yes
Yes
Yes
Entity by itself – can
sue and be sued
Yes – board of directors
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AGENCY
Definition – R3A §1
- Agency is fiduciary relationship resulting from manifestation of consent by one to another that the other
shall act on his behalf and subject to his control.
Types of Authority
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Actual Authority – R3A §2.01: A reasonably believes, in accordance with P’s manifestations, that P
wishes A so to act.
o R3A §2.02: Reasonability determined from viewpoint of reasonable person in the situation under
all circumstances of which A has notice.
o Express Authority – express manifestation by P to A
o Implied Authority – by words or actions, A reasonably believes he has authority
 Broad directions are usually given; specifics are often implied.
Apparent Authority – R3A §2.03
o A affects P’s legal relations when third-party reasonably believes that A had authority to act and
belief is traceable to manifestation’s of P.
 Power of Position: Appoint A to position that carries generally recognized duties
 No apparent authority if no contact between P and 3rd party.
Agency by Estoppel – R3A §2.05
o P carelessly, recklessly or intentionally causes 3rd party to make detrimental change of position
under belief that A had authority, and/or does not take reasonable steps to prevent that belief.
Ratification – R3A §4.01
o If P has knowledge of material facts and either 1) objectively manifests an intention to treat A’s
conduct as authorized, or 2) engages in conduct that is justifiable only if he has such an
intention, P is bound to 3rd parties even if the agent had no authority
o Morris Oil v. Rainbow Oilfield Trucking (NM 1987)
 P (Dawn) makes trucking contracts with A (Rainbow) to manage business operations,
but says they cannot take debt on. A does anyway; owes Morris money.
 P has potentially given actual authority, and certainly ratified the incurring of debt by
asking A to operate the business.
 No apparent authority because no contact b/t P and Morris.
 Does not matter that P said Rainbow was not an A in contract; actions > words.
 No claim if Morris KNEW Rainbow was not to assume agency relationship
Inherent Authority
o Not in R3A: based on how A reasonably interprets his relationship with the P
o R2A §8A: Power derived solely from the agency relation and exists for the protection of persons
harmed by or dealing with a servant or other agent. R2A §8A
Agent Liability To 3rd Parties
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Depends on whether principal is disclosed to the 3rd party…
o Principal Disclosed - R3A §6.01: A is not liable, P is.
o Partial Disclosure - R3A §6.02: A and P are liable (unidentified = partial)
o Principal Undisclosed - R3A §6.03: A and P are liable.
o P has power to terminate A’s authority.
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Agent’s Duty of Loyalty
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R3A §8.01: A has fiduciary duty to act loyally for P’s benefit in all matters connected with the agency
relationship.
R3A §8.02: A cannot take a corporate opportunity from P gained through A’s position as agent.
o Very broad duty, and is costly (monitoring/bonding).
o A can seize opportunities gained outside her position as agent.
o P can recover as damages A’s gains, not just his own losses.
o Tarnowski v. Resop (Minn. 1952)
 Π hires Δ to invest in jukeboxes. Δ takes bribe to give bad advice.
 P awarded his own losses and the ill-gotten gains of Δ.
 Court says fidelity is the issue; need to encourage agency relationships and protect Π.
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PARTNERSHIP
Definition
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UPA §6(1): Association of two or more persons to carry on as co-owners a business for profit.
RUPA §202(a): Association of two or more persons to carry on as co-owners a business for profit,
whether or not the persons intend to form a partnership.
o Some states use UPA, while others use RUPA.
o Partnerships are easily and even inadvertently formed, and easily dissolved.
o Statutes are largely enabling or default, not mandatory.
o Equality among partners.
o Partners have unlimited liability
 UPA §15:jointly & severally liable for wrongful acts of partners (UPA §13) and breach
of trust (UPA §14), or jointly liable for all other debts/obligations.
 RUPA §306: jointly & severally liable for everything
 Severally = Δ can pursue reimbursement for their non-share from other Δs
o Choice of laws for internal affairs
 No mention in UPA
 RUPA §106 – governed by the law of the state in which the partnership agreement is
filed, or otherwise where the CEO is located.
o RUPA provides more protection to third parties
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UPA
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o
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Existence of Partnership
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§7(1): Persons not partners to each other are not partners to 3rd parties.
§7(3): Sharing gross returns does not alone establish a partnership
§7(4): Sharing profits is prima facie evidence of partnership, unless profits were received..
 a) as debt
 b) as wages
 c) as an annuity to a deceased partner’s rep.
 d) as interest on a loan
 e) as other consideration for the sale of business
RUPA §202(c)
o Nearly identical to UPA §7
PARTNERSHIP VS. CORPORATION
Corporations are defined by
- Limited liability
- Free transferability of interests
- Legal personality
- Centralized management
- Good for long term projects
Partnerships are defined by
- Unlimited liability for partners
- Reduced transferability
- Less of a legal personality
- Less centralized management
- Good for short term projects
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PARTNERSHIP FORMATION
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Martin v. Peyton (NY 1927)
o KN&K owes Π money. Δ loans money to KN&K but declines to become partner. Profitsharing type plan imposed on the loans, and later it appears Δ is running some aspects of KN&K.
o Court finds Peyton was not a partner, even though certain aspects may be signs of partnership.
 Totality of the circumstances test; otherwise immaterial facts may join together to prove.
 Here, Martin only had authority to terminate projects, not initiate them.
 Statements either way are not dispositive.
Lupien v. Malsbenden (ME 1984)
o Π contracted to buy car from Cragin, but mainly interacted with Δ.
o This is found to be a partnership.
 Δ had loaned money to Cragin to finance the line from which Π purchased.
 Δ participated in day to day business and had final say on many issues.
 Unlike Martin, Δ also had ability to initiate projects. Accelerator, not just brakes.
Four Element Test
o There is an agreement to share profits
o There is an agreement to share losses
o There is a mutual right of control or management of the business
o There is a community of interest in the venture
 Test deviates from UPA §6(a) and RUPA §202(a)
LEGAL NATURE OF PARTNERSHIP
Partnership: Aggregation of Individuals or Entity
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At common law a partnership is not an entity but merely an aggregate of its members
UPA §6(1) - Aggregation Of Individuals
o Slightly unclear but intended to adopt an aggregate view
o There are a number of exceptions in UPA that treat a partnership as an entity.
o Aggregation view poses problems with dissolution/death of member – must dissolve and reform.
RUPA §201(a) – Partnership Is An Entity
o Partnership is an entity distinct from its partners
o Simplifies property (whether the partnership can buy it in its own name) and litigation matters.
o Still allows individual policy choices on many issues like partnership debts, duty of loyalty, etc.
Ongoing Partnership Operations
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UPA §18: Sets default rules governing partnerships in the absence of a partnership agreement.
o Types of Rules
 Default, Mandatory, Enabling (makes you fill in the blank)
o In UPA, “subject to any agreement between them” means you have a default rule.
RUPA §401: Does not declare itself as default, but RUPA §103 states that RUPA governs all relations
not mentioned in partnership agreement.
o Partnership is a democracy: equal voting rights/majority rules, voted upon draw, no hierarchy
 UPA §18(a)/RUPA §401(a): Partners must share in all profits and losses
 UPA §18(h)/RUPA §401(j): Changing partnership agreement requires unanimous vote.
 RUPA §101(5): “Partnership agreement” may be inferred from actions.
 UPA §18(g)/RUPA §401(i): Adding partner requires unanimous vote.
 UPA §19/RUPA §403: All partners must have access to books at all times.
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Right of Participation
 UPA 18(e): All partners must be consulted, even if minority partner is going to
be overruled by majority
 RUPA 401(f): Expands 18(e) and states that each partner has a right to
participate in the management of the firm
 UPA §20: All partners must freely share information about partnership.
 Partnership agreements can amend default rules and solve idiosyncratic issues.
 Internal affairs more often amendable; external affairs must protect third parties.
UPA §18(h)/RUPA §401(j) require any difference concerning ordinary matters to be decided by a
majority of the partners.
o Summers v. Dooley (ID 1971)
 Π and Δ in partnership; do trash collection. Π wants to hire new employee, Δ refuses. Π
hires the employee anyway, then sues for to recover salary claiming that Δ earned profit
from employee’s labor.
 The non-consenting partner does not have to reimburse expenses
 Covalt Test says that absent an enforceable agreement to resolve such matters,
dissolution, not breach of duty suit is appropriate relief.
o Sanchez v. Saylor (NM 2000)
 Π and Δ are partners. Potential creditor wants access to Sanchez’s personal financial
statements; he refuses and Saylor brings suit for breach of fiduciary obligations.
 Again, Covalt Test: Absent an enforceable contractual duty to agree, if partners cannot
do so, the remedy is dissolution not an action for breach of fiduciary duty.
 Wanted personal financials, not the partnerships.
o Indemnification and Contribution
 Although partners are all individually liable to external sources, each partner is liable
only for his share of partnership obligations to the other partners
 Indemnification: obligation of the partnership to a partner
 Contribution: obligation of partners individually to partnership
 A partner who pays/incurs a liability to third party on behalf of the partnership becomes
a creditor of the partnership, in effect subrogated to the rights of other creditors.
 If the partnership is unable to pay, all partners must contribute to make up the resulting
deficit under UPA §18(a) and RUPA §401(b).
o Capital Accounts and Draws
 Capital account shows amount of capital each partner has contributed to partnership
 Default under UPA §18(a) and RUPA §401(a)/(b) is to share equally in
profits/losses.
 Draws are cash distributions to partners
 UPA §18(h): Draws must be approved by all partners
 UPA §18(f): No guarantee of remuneration from partnership unless it is surviving
partner wrapping up business
 Sale of partnership is usually for more than value of capital accounts due to good will.
Payment Upon Termination - UPA §40(b): Assets are paid to creditors other than partners first, then
creditors who are partners, then partners in respect of capital contributions and finally partners in respect
of profits.
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AUTHORITY OF THE PARTNER
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Law of Agency Applies - UPA §4(3)
o Under UPA, apparent authority applies to “partnership business”.
o Under RUPA, this is extended to include “business of the kind”.
Limits On Partner Authority UPA §9/ RUPA §301(1): Partner’s apparent authority nullified if third
party has knowledge of the partnership agreement limitation…
o UPA §3: Constructive/Implied Knowledge - if person should have known, law attributes to him
that knowledge – the burden is on the third party.
o RUPA §102(a): Actual knowledge - provides more protection to third parties (although notice is
sufficient)
o Apparent authority applies outside the partnership – partners can bring suit against each other.
 Northmon Investment Company
 Dealings within the partnership are governed solely by the partnership
agreement.
o Statement of Partnership Authority - RUPA §303: Filing of a copy of this statement in the
real-property recording office suffices as notice to third parties of limitations on authority.
RNR Investment Limited Partnership v. Peoples First Community Bank (2002)
o A RUPA case; would come out other way under UPA
o General partner loans money in contravention of partnership agreement. Partnership says bank
acted negligently in failing to investigate extent of partner’s authority.
o Court holds that bank can recover the entire amount of loss.
 Under RUPA §301, third party must have actual knowledge of the limitation.
o RNR Test:
 1) Was the partner carrying on the partnership business in the usual way?
 2) If yes, did the third party have actual knowledge of partner’s lack of authority?
 If not, the partnership is bound.
LIABILITY FOR PARTNERSHIP OBLIGATIONS
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UPA §9, 13-15/RUPA §306-307
UPA: Partnership is merely aggregate of partners; cannot sue the entity
o UPA §13-14/15(a): joint/severally liable for wrongful acts and omissions
o UPA §15(b): jointly liable for all other debts and obligations
 Individual must sue all the partners – can’t sue them separately
RUPA §307(a): partnership may sue and be sued in its own name
o RUPA §306: Partners are jointly and severally liable
 Exhaustion Rule: Π must collect everything he can from the partnership before going
after individual partners.
 Aggregate approach to liability; entity approach to damages
 Must get a separate judgment to go after a partner’s assets.
UPA §17/RUPA §306(b): If admitted to partnership not liable for obligations from before admission
o Davis: Income partners are not partners under UPA and RUPA.
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PARTNERSHIP PROPERTY
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Must determine if property is owned by partner or partnership:
o Who can transfer property?
 Cannot transfer loaned property
 Can transfer owned property
o Creditors of the partnership v. Creditors of individual partners
o If partnership is dissolved
 Partnership property must be sold and distributed
 Property owned by a partner is returned to him
UPA- ENTITY APPROACH FOR PROPERTY cause UPA partnership is only aggregate of partners
o UPA §8 – recognizes “partnership property”
o UPA §25(1) – such property owned by the partners as “tenancy in partnership”
o UPA §25(2) – strips each partner of most ownership powers:
 No right to possess property as an individual
 Can’t individually assign rights
 Not subject to attachment or execution by a creditor in an individual capacity
 Property does not devolve to heirs or legatees
RUPA §203 Property is acquired as property of the partnership entity.
PARTNERSHIP INTEREST & TRANSFERABILITY
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UPA §24/RUPA §204:
o Partnership owns the partnership property
o Partner owns his interest in the partnership – share of profits and surplus (UPA §26)
UPA §27/RUPA §501-502: Assignment of Interests
o Can transfer property interest/distributions; cannot assign management rights/full
partnership interest (right to see books, etc.).
 RUPA §601(4)(ii): If partner assigns interest he remains a partner; assignee can be
expelled by others
 UPA §18(g): No one can become partner without approval of all partners
 UPA §31(c): Only partners who have not assigned interests can terminate partnership
 RUPA §503(d): Partner still liable; assignee has no risk.
UPA §28/RUPA §504: Partnership creditors
o Charging Order: If credit extended to partner as individual, creditor can become assignee of a
partnership interest and collect distributions
 UPA §32(2)/RUPA §801(6): Creditor can compel dissolution to get paid
o Two statutes almost exactly the same dealing with foreclosure
UPA §40(h): Dual Priorities Rule: Partnership creditors have priority as to partnership assets, but
separate creditors have priority as to individual assets of the partners
Rapoport. V. 55 Perry Co. (NY 1975)
o Issue: Had parties contracted out of the default rule under UPA § 27 (assignee has no
management rights) through partnership agreement
o Majority – reads contract to comply with §27
o Dissent – believes the contract is ambiguous and wants to send the issue to a jury
Bauer v. Blomfield
o Court allows partners to bypass assignee by funding separate entity with distributions
o Rationale is that partners have full discretion in running business, are the ones with full liability
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PARTNER’S DUTY OF LOYALTY
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UPA §21: “Every partner must account to the partnership for any benefit, and hold as trustee for it any
profits derived by him without the consent of the other partners from any transaction connected with the
formation, conduct, or liquidation of the partnership or from any use by him of its property.”
o MANDATORY RULE
RUPA §404(b)/(e) extends the scope of the duty.
o Creates an exclusive list of when a partner owes a duty of loyalty
 RUPA §103(b): THESE RIGHTS CANNOT BE WAIVED except…
 RUPA §103(b)(3)(i): Partnership may narrowly define acts that do not violate duty if
not manifestly unreasonable under § 103(b)(3)(i).
 There is a presumption that partners will act in good faith
o Rights under this section:
 (1) Accounting to partnership of any property, profit, opportunity, etc.
 (2) Refraining from dealing with the partnership in the conduct of winding up as or on
behalf of an adverse party
 (3) Refraining from competing with the partnership
RUPA §404(e) Eliminates agency rule that partner violates duty merely by furthering his own interest
A. RUPA §103: Can limit it by defining specific circumstances where it doesn’t apply
a. ANALOGOUS TO DGCL § 102(b)(7)
B. Other duties:
1. Duty of care
a. RUPA 404(c)—limited to refraining from engaging in grossly negligent or reckless
conduct, intentional misconduct, or knowing violation of a law
b. Details can be specified under §103(b)(5) so long as reasonable
2. Duty of good faith and fair dealing – BROAD AND UNSPECIFIC (defined by case law)
a. RUPA 404(d)—just says it requires “good faith and fair dealing”
b. Fills gaps between other duties
UPA §22/RUPA §305/405 - Suits by a Partner Against a Partnership
Meinhard v. Salmon (NY 1928)
o Π (operations guy) and Δ (money man) are in partnership developing land together. Δ gets offer
to develop adjacent piece of land and takes it form himself. Did he violate his duty of loyalty?
o Court says Salmon breached his duty of loyalty to Meinhard because he usurped partnership
opportunity for personal gain
 “Many forms of conduct permissible in a workaday world for those acting at arm’s
length, are forbidden to those bound by fiduciary ties.”
 Standard is the “punctilio of an honor the most sensitive.”
 Had Π given Δ notice of opportunity, could then take it himself.
o Dissent: Because they didn’t put money in together, there was no joint capital; merely a discrete
joint venture.
 Wachter says this is how case would be decided now; money/operations role split is key
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DISSOLUTION
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At Will v. For-Term Partnerships
o At will can be ended any time; just say you’re done
 Girard Bank v. Haley
 Sending a letter causes dissolution of at will partnership; does not contravene §801
o For term last for a specified time; always have power to dissolve, but not necessarily the right.
o Trivial matters will not result in dissolution; must be significant (Levy).
UPA
Dissolution – legal end of a partnership §29
Winding Up – period of time to terminate the
partnership “as a going concern” under §30. This
affects the economic end of the partnership
Termination – absolute end
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RUPA
Disassociation under §6 – two options:
1. Mandatory buyout - §701
a. Rightful
b. Wrongful – exclusive list in
§602(b)
2. Winding up - §801/802
Termination
UPA:
o §29: dissolution is when a partner ceases to be associated in the carrying on (as distinguished
from the winding up) of the business
o §30: partnership continues until “winding up” is completed
o §31: dissolution is caused:
 (1) without violation of the agreement between the parties;
 (a) by termination of the definite term or undertaking specified in the agreement
 (b) by the express will of any partner when there is no definite term,
 (c) by the expulsion of any partner from the business
 (2) in contravention of any agreement between partners, where dissolution under any
provisions of this section is not permitted, by the express will of any partner, any time
 Death, bankruptcy, or court decree
o §38(1): when dissolution happens, partnership property may be used on liabilities, and surplus
may pay amount owing to the respective partners in cash
 §38(2)(a) – partner who contravenes agreement does NOT get good will – creates
perverse incentive to force other partners out and deny them good will (Drashner)
o § 39(2)(b) – partner can’t dissolve a term partnership before the term finishes
o § 40(b) – Rules For Distribution (Also apply under RUPA §401(h))
 1) Creditors who aren’t partners; 2) Creditors who are partners; 3) Partners in respect to
their capital contributions; 4) Non-capital partners
 Losses include capital losses under §18(a)
 Creates some inequities for non-capital partners
o Some courts consider uncompensated labor as capital
o Can contract around the provision; rule is default
RUPA
o §601 – Triggering Events
 (1) partnership having notice of partner’s express will to withdraw as a partner
 (2) event agreed to in the partnership agreement
 (3) partners expulsion as per the agreement, unanimous vote or judicial determination
 Is read to still require disassociation in good faith
o §602 – Power to Disassociate (not the right)
 Wrongful if breaches an express provision of the agreement or occurs before the
expiration of a definite term or particular undertaking
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 Wrongful dissociation makes partner liable for damages caused by dissociation
 Overrules Traynor in Page v. Page although some duty of loyalty claim may exist
o §603 – Effect of Disassociation:
 If it results in dissolution, look to §801; but if it results in continuation, look to §701
 Upon dissolution, partner’s duty of loyalty/right to participate in mgmt terminates
o §701 – if dissociation occurs without dissolution, partnership shall cause the dissociated
partner’s interest in the partnership to be purchased for a buyout price
 Judicial determination of fair value
 §701(b): disassociating partner gets fair value – higher of liquidation value or going
concern value
 RUPA eliminates incentive to push other partners to violate agreement (UPA §38(2)a)
o §801- Dissolution: partnership is dissolved and business must be wound up given certain events
 Shift to entity approach
 All default rules, except §801(4) /(5), which are mandatory.
 McCormick v. Brevig // §801(5)
o Court should have ordered dissolution in case of partner’s conversion of
assets for personal use
 Always have right to force liquidation in an at will partnership
 If liquidation will not result in FMV, a buyout by the other partners may be allowed.
o §802: partnership continues after dissolution only to wind up the business
 EXCEPTION – ALL partners must agree to waive the right to liquidation (including the
disassociating partner), unless the disassociation was wrongful.
Defining Buyout Price
o §701 – Judicial Determination of Fair Value
 No bad faith; partner gets good will
 See also §602(c)
o §38(2)(c)(II) – Buyout Price Under UPA
 No good will for bad-faith partner
Exceptions
o **Creel v. Lilly** (MD 1999)
 Creel sells NASCAR stuff. Creel dies and UPA requires winding up of business. Other
partners operate same business with same assets under new name. Creel’s wife sues.
 Rule: Partnership does not have to liquidate its assets upon dissolution
 Would not be an issue under RUPA because partnership is entity/buyout option
o MD was in process of switching
 Fire sale of assets would cause economic waste, but was previously required.
 Rejected as solution in case of non-death in McCormick.
o Page v. Page (CA 1961) – Requiring good faith in at-will dissolution (overturned by RUPA)
 Π wants to terminate at-will partnership to cut his losses and brings declaratory
judgment. Δ claims it is a term partnership and termination is in bad faith.
 Court says this is not a term partnership due to accounting methods and lack of
agreement (even implied), and Π does not exercise bad faith, but it is required.
 Π cannot terminate to gain benefits for himself unless he compensates others.
 Overturned by §602(b)(1)
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LIMITED PARTNERSHIPS (LP)
Key Features
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Cross between corporation and general partnership (GP)
o Limited liability for limited partners
o Greater formality than GP – must file a certificate of LP with the state
o Entity status like a corporation (RULPA §104)
o Centralized management
RULPA
GPs are democracies; LPs are dictatorships
§101(7) – Structure: must have at least one general partner and one limited partner
o Must be a partnership under UPA/RUPA
§201 – Filing: must file with state to be an LP
o Must state latest date upon which partnership can dissolve, but no cap (i.e. 5142 A.D.)
§303 - Liability:
o If LP participates in control of business, he is liable to persons who transact with partnership
reasonably believing LP is GP (changes old rule, see Gateway)
o §303(b): safe harbors to protect the LP
§403 – GP Rights: GP has same rights, powers and restrictions of a general partnership (UPA/RUPA)
§405 - Voting: all GPs vote, but LPs only vote if agreement allows
o §302 : LPs may have right to vote (but never do because would defeat purpose of LP structure)
§702 – Assignment of Interest
o LPs can assign entire share without dissolution; assignee cannot exercise any additional rights
 LPs have no management responsibility; only assign profits/losses
o GPs can assign subject to UPA or RUPA; cannot assign management responsibilities or liability
§801 – Dissolution:
o LPs have no right to dissolve the partnership
o GPs
 Withdrawal of solitary GP automatically causes dissolution
 If more than one, all parties must agree within 90 days to continue partnership
 If GP is corporation, requires filing of certificate of dissolution (RULPA §402(9))
RULPA §303(b)(1) – Corporation As GP
o Corporation is good GP: it never dies, requires board vote for withdrawal, and limits liability, as
creditors cannot pierce corporate veil.
o Directors of corp. are not liable for LP debts unless they fail to maintain corporate identity
(intermingling assets, insufficient corporate capitalization).
o Duty of loyalty claims follow Entire Fairness Standard
Exceptions
o Gateway Potato Sales v. G.B. Investment Co. (AZ 1991)
 Sunworth is corporate GP and Δ is LP in limited partnership. President of GP contracts
with Π. President tells Π that Δ is involved with business operations.
 Rule: LP only liable if he is also GP or takes part in control of business. If he is no LP,
only liable to those who transact business and actually know of LP’s participation
(Rejects RULPA)
 Similar to “control test” under previous ’76 RULPA regime
 Court remands over factual issue as to Δ’s control.
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CORPORATE FORM
SELECTING A STATE OF INCORPORATION
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Corporation can incorporate anywhere it wants (DGCL §101)
o Internal Affairs Doctrine: only state of incorporation has authority to regulate corp.
 Provides certainty and predictability; rooted in commerce clause
 Some challenges to IAD based on conflicts of law and con law issue of one state
discriminating against the citizens of another
o Friese(CA): Business transactions are not internal affairs; can be regulated by outside state
Vast majority of publicly traded companies in U.S. are incorporated in DE.
o Race To Bottom Theory: DE is most management friendly state
o Race To Top Theory: DE is fairest/most knowledgeable; other theory would bankrupt corps
 Specialty is undeniable; also only state to retain Chancery Court of equity.
 Suboptimal regime would lead to federal intervention.
 Intangible benefits of a “good corporate address”/networking
 Costs of incorporation seldom bankrupt corps in imperfectly competitive markets
 Costs of suboptimal regime are nominal compared to the gain managers would reap
from race to the bottom – costs are spread throughout all shareholders
o Wachter believes in Race-to-the-top
o Closed corporations usually incorporate in state of operation; if go public, reincorporate in
DE
DGCL
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§101 – Must File With Sec. Of State (COI and by-laws)
o Statute has sample certificate
o Court often requires items that MAY be in COI be there, and not elsewhere (i.e. bylaws)
§102 – Certificate of Incorporation (COI)
o §102(a) - Mandatory Terms
 Name of the corporation
 Address
 Nature of the business /purpose (“anything legal” usually)
 Total number of shares corporation shall have authority to issue, par value per share,
and if more than one class, the terms (voting rights, etc.) of each class
 DGCL §151 - Varying Classes of Stock Permitted
o §102(b) - Optional Terms
 Provision governing management/powers of corp provided not inconsistent with law
 Closed corps will often file shareholders agreements to govern many issues
 Shareholder agreements enforced under contract law
 Provision requiring the vote of larger portion of shareholders/directors than required
by DGCL for a particular corporate action.
 Limitation on the corporation’s existence (§102(b)(5))
 §102(b)(6) – Unlimited Liability
 Imposition of personal liability for the corporate debts on stockholders
 §102(b)(7) - Relief From Duty of Care; can’t hold directors personally liable
§109 – Filing By-Laws
o §109(a) – Power To Amend By-Laws: power to adopt, repeal or amend lies with
shareholders, COI may also give right to directors
o §109(b) – Content: anything that it is not inconsistent with law or COI
o Essentially governs the operating rules of the company; therefore must be easily amendable
13
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o COI trumps by-laws in event of conflict; COI earns additional protection from law
§111 – Enforcement Mechanism is Chancery Court
§121 – Corporate Powers: corporations may exercise powers/privileges granted by this statute, the
COI, and any incidental powers to conduct the business
§122 – Specific Powers of Corporation
§ 124- Ultra Vires: no act of a corp shall be invalid by reason that corp acted beyond its powers
o Protects third parties
o Classical Doctrine (overturned by §124): Corporation is fictitious person and transactions
outside that sphere are outside the entities powers and unenforceable
o Shareholders have power to enjoin yet-to-happen acts, or sue for fiduciary duty violations
§141 – Board of Directors (BOD)
o ***§141(a) – Corporation Is Managed By Board of Directors***
 Power is original and undelegated; they are not agents
 Board is elected by majority vote of shareholders
 Board votes decided by majority rules doctrine
o §141(b): only “natural persons” can be on board; number of directors set in by-laws
 Majority of directors constitutes a quorum, unless the COI requires more
o §141(c)(2) – Board Can Delegate Authority To Special Committees
o §141(d) – Board Can Stagger Elections
 Protects against hostile takeovers; requires two elections to gain control of board
o §141(e) – Board Protections: Board is protected by good faith reliance on corporations
records, experts, or information provided by corporate officers, employees, or committees
o §141(f) – board decisions can be non-face-to-face if all members consent, require minutes
o §141(h) – Board Sets Own Pay
o §141(k) – Removal: director or entire board may be removed at legitimate election of
directors with or without cause unless COI provides otherwise
 Important for proxy fights and tender offers
§142 – Officers and Duties
o Officer’s positions are governed by by-laws, or BOD decision consistent with by-laws.
o Officers hold office in manner consistent with by-laws until qualified successor is elected
§144 – Interested Transaction and Quorum (Duty of Loyalty)
§151 – Classes and Series of Stock
o §151(a) – Permits Multiple Stock Classes/Series
 Voting powers/rights may be dependent upon facts outside COI so long as manner in
which the facts shall operate upon those powers is in the COI or a separate
resolution.
 Facts – occurrence of any event, action by any person, including a corporation
o §151(b) - Redemption
§157 - BOD Must Approve All Stock Option Grants
§170 – Dividends, Payments and Waste
o Directors may pay dividends upon the shares of capital stock either:
 1) out of its surplus, or
 2) if no surplus, out of net profits for current or previous year
o BOD may pay dividends, but does not have to (contra Ford v. Dodge)
14
§ 211 – Meetings of Stockholders
o §211(a) - Location: Meetings can be anywhere, as provided in COI/by-laws
 Can be by conference call etc., or through proxy voting when not physically present
o §211(b) – Annual Meetings: Annual meeting for election of directors per by-laws
o §211(c) – Failure To Hold Meeting: Failure to hold annual meeting or elect sufficient
number of directors shall not affect otherwise valid corporate acts or work.
 30 days after designated meeting date or 13 months after last meeting, Court may
order meeting upon application of any stockholder or director.
o §211(d) – Special Meetings: Only board can call a special meeting
- § 212 – Shareholder Voting Rights, Proxies and Limitations
o §212(a) – One Share = One Vote unless COI stipulates otherwise
o §212(b) - Proxies: One can authorize another to act as stockholder by proxy; proxy
terminates 3 years from its date, unless otherwise stipulated
o Three things shareholders can vote on:
 1) amendments to certificate, 2) changes to the by-laws, 3) BOD
 §1.7 Form of By-Laws: Elections require plurality; changing to majority
o §212(e) – Proxy Must Stipulate Irrevocably otherwise revocable
- § 216 – Quorom And Required Vote For Corporation
o COI or by-laws specify votes needed, but must be more than one-third of shares so entitled.
o Default rule is that majority of shares entitled to vote constitutes a quorum
o BOD cannot amend shareholder amendment on votes required
- § 219 – Stockholders Entitled To Vote
o Officer must make ledger, stockholder number of shares, address, etc. available to all
stockholders (and no others) 10 days prior to shareholder meetings
o Proxy battles are handled through securities law because of 10 day limit.
- § 220 – Shareholders Right To Books/Records With Proper Purpose
o Chancery has exclusive jurisdiction on issue; burden to show impropriety is on corporation.
 Some states (NY) make right to books/records unqualified
- § 223 – Filling BOD Vacancies
- § 228 – Shareholders Consent In Writing In Lieu Of Meeting
- § 242 – Amendment of COI After Receipt of Payment for Stock
o §242(a) – COI may be amended in manner consistent with law
o §242(b) - Amendment Process
 1) BOD adopts a resolution
 2) Shareholder vote (requires vote of majority of holders)
 Shareholders cannot initiate changes
 Vote can be made at special meeting of shareholdres
o §241 – Amendment Before Receipt
§275 – Dissolution
o §275(a)/(b) - Board Dissolution
 1) BOD majority must adopt resolution at a meeting called for that purpose
 2) BOD then calls for shareholder meeting/vote. Requires majority vote.
 Majority of outstanding shares; not just those voting
o §275(c) - Shareholder Dissolution: Requires unanimous vote without BOD resolution.
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CORPORATE MANAGEMENT
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Traditional legal model of BOD not based on agency; BOD is a separate institution representing corp
o In past, most corporations were closed corporations; board and management are the same
In modern corps, management function is ordinarily located in the corporate executives (CEO, etc.)
o Directors cannot manage: they meet infrequently, have filtered information and are often
recruited by management.
Agency problem still exists in aligning the interests of managers/directors with the shareholder
o Shareholders monitor directors; directors bond behavior through self-regulation & disclosure
o Goal: Minimize residual disparity b/c of separation of ownership and control (stock options)
o Evidence of Race to the Top
OBJECTIVES OF THE CORPORATION
- Traditional View: what is good for the corporation is good for the shareholder.
- Alternate View: goal is to simply maximize shareholder wealth (per DCF/NPV models)
Dodge v. Ford Motor Co. (MI 1919)
A.P. Smith Mfg. Co. v. Barlow (NJ 1953)
- Δ owns majority; Π own minority. Π brings
- Co. asks for declaratory judgment after shareholders
suit after Δ lowers dividend.
question $1,500 gift to Princeton.
- Court says Ford must pay dividend
- Action authorized under common law intra vires and
o §170a – wouldn’t be forced today
b/c statute can be applied retroactively.
- Company has to be managed primarily for
- Corporation is managed BY the BOD
the shareholders, not the general public.
o §122(9) gives donation powers to corps
o Policy to reduce price of cars/employ
o Suggestion of materiality of benefits to co.
more men will produce less profits.
standard of review
o BOD chooses means to that end
o Open questions answered by Revlon
BOD Duties
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“Other Constituencies” Under DE Law
o Most states explicitly provide co. does not need to act solely in the best interests of shareholders.
o DE statutes are silent, but Supreme Court has said…
 Unocal: BOD has fiduciary duty to act in best interest of the shareholders; but the
directors can act to prevent dangers to “corporate policy” (like a tender offer)
 Revlon: Concern for other constituencies is proper in event of takeover threat, but is
limited to instances where concern is rationally related to stockholders benefit
 In event of auction, this is not so; must sell to highest bidder
 Paramount v. Time Warner: fiduciary duty to manage corporation includes selection
of a time frame to achieve certain goals; doesn’t need to be highest short term return.
 Managing in best interest of corporation doesn’t mean maximizing shareholder value.
ALI §2.01: Corporation can account for ethical considerations and devote a reasonable amount of
resources to public welfare, educational, and philanthropic purposes (less shareholder friendly)
PA §1715: corporation may be run on behalf of ALL stakeholders (employers, customers, creditors)
o Wachter thinks this creates race to bottom
Bondholders
o Katz v. Oak Indus.
 Corps not managed for bondholders (who can use contract law); managed for LT
shareholder interest, even at expense of others.
o Credit Lyonnais Bank v. Pathe Communications (1991)
 BOD has duty to entire corporate enterprise, even bondholders, in zone of insolvency
 When corp is in zone of insolvency, shareholders only have upside (residual asset claim)
o Banks/bondholders protect themselves through contract b/c shareholders get priority from BOD
16
CORPORATE STRUCTURE
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Berle & Mean’s Traditional Model
o Separation of ownership and control compounds agency-cost problem; diverse shareholders
create collective action problem.
 Rational Apathy: For shareholders with small stake, it is not cost-effective to spend time
on the corporation’s affairs; pro rata benefits after individual action.
 Proxy service firms can help fill the gap caused by rational apathy as well.
o Rise of institutional investors has made shareholder coordination easier; shareholders have
become more active in monitoring the corporation
Jensen-Mechling Agency Theory
o Agency problems solved by shareholder monitoring and bonding (i.e. independent auditor).
o Residual agency gaps filled in recent years by large institutional investors
Fama-Jensen Model
o Ownership has three attributes: control, monitoring and residual claim on assets.
o Therefore, management, BOD, and shareholders split ownership under DE model.
ALLOCATION OF POWER (MGMT v. SHAREHOLDERS)
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Shareholders vote because they are residual claimants to corporate assets.
But, shareholders have narrowly limited authority…
o §211(b) – Vote In Director Elections
o §109 – Vote On By-Law Amendments
o §242 – Vote On COI Amendments
o §251 – Vote On Mergers/Consolidations
o §271 – Vote On Sale of All Assets
o §275 – Vote On Dissolution
o Shareholder Voting
 Straight: 1 vote per share for each director
 Cumulative: # shares times # directors up for election can be cast for any director (§214)
Charlestown Boot & Shoe v. Dunsmore (NH 1880)
o Δ elected as directors. Third party is brought in by shareholders to wind up corporation, and Δ
will not work with him.
o Court says directors are not liable for damages or refusal to work with third party.
 Directors control the operations unless limited by by-laws/COI. (§141a)
People ex rel. Manice v. Powell (NY 1911)
o Director-shareholder relationship is one of trustee-beneficiary. Directors cannot be controlled in
the ordinary course of exercising their corporate duties (they are executive agents; act as owners)
 Fiduciary relationship based on estate law.
Limits On BOD Power
o SOX §404/§302 may require independent audit committee with financial experts
o Schnell: BOD cannot use corporate law (specifically §211(a)(1)) solely to entrench themselves.
Monitoring
o CEO, who is usually also Chairman of Board, manages day to day affairs; BOD monitors
o BOD stock ownership aligns their interest with that of the company/managers
o NYSE Listed Company Manual
 §303A.01 - Majority of Board Must Be Independent
 §303A.02 – Independence Test
 §303A.03 – Non-management Directors Must Meet Alone Regularly
 §303A.04 – Independent Nomination Committee Requirement
 §303A.05 – Independent Compensation Committee Requirement
 §303A.06-07 – Independent Audit Committee
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STANDARD OF REVIEW FOR SHAREHOLDER-MGMT DISPUTES
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Two Important Questions
o 1) What is the standard of review?
o 2) Who has the burden of proof?
 Most of DE law is based on maneuvering to get favorable standard/burden
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Business Judgment Rule (BJR)
o Default rule
o Highly deferential to management
o Burden is on Π to rebut BJR by showing an abuse of discretion
o Requires:
 Decision made by disinterested directors;
 Made on an informed basis;
 Made in good faith;
 AND honest belief that action was taken in best interest of corporation
o If BJR is not rebutted, burden is on Π, standard of review is irrationality.
Entire Fairness Standard (EFS)
o Triggered if BJR is rebutted (i.e. duty of loyalty cases, or with directors on both sides)
o Heightened judicial scrutiny of BOD decision
o Burden is on corporation under EFS, standard is entire fairness
 Fair Dealing (procedural fairness): timing, initiation, structure, approval, etc.
 Fair Price (substantive fairness): economic/financial considerations
 Not bifurcated; see Weinberger.
Unocal/Unitrin Standard
o Triggered in cases of contested control transactions
 Hostile takeover if stock purchase/tender offer directly to shareholders, bypassing BOD.
o Intermediate judicial scrutiny
o Burden is on corporation to show
 Reasonable threat to the corporation; and
 Corporations defensive response was proportional (i.e. not preclusive or coercive)
 If so, standard shifts back to BJR
Blasius Standard
o Likely limited to cases where board can affect election of future boards
o Highest level of scrutiny
o Π must first allege
 Unilateral action by the BOD; AND
 A primary purpose of interfering with shareholder franchise (preclusive behavior)
o Then, board must show compelling justification via
 New, potential board members are acting wrongfully; AND
 No time to inform the stockholders
 Mercier v. Inter-Tel: Compelling just: protection of stockholder fin. interests
 Defensive measure in event of compelling justification must still be
reasonable/proportional (a la Unocal)
Four Standards of Review for Corporate Actions
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Blasius Cases
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Blasius v. Atlas Corp (DE 1988)
o B, an LBO firm, buys 9.1% stake in A. B proposes restructuring, special dividend, and sale of
certain businesses. A refuses. B makes recommendations to attempt to gain control of the board
(bylaw amendment, etc.); A’s BOD responds with defensive measure to preemptively increase
board size and prevent B’s moves.
o Court says BOD cannot increase BOD size to interfere with shareholder vote.
 Schnell does not apply b/c primary purpose is not entrenchment, but protection
o Rule: Board may take steps, like a stock purchase, to defend against threat to corporate control if
taken in good faith pursuit of corporate interest.
 Rule does not apply if board prevents shareholder vote.
 By-passing shareholders is not a “business decision”
 BJR does not apply to these actions
o Court says A has not shown a compelling justification to prevent B from electing new directors.
 B did not take any coercive actions
MM Companies v. Liquid Audio (DE 2003)
o M is threatening takeover and L expands board in act of intentional preclusion. Chancery Court
says this is okay because of shareholder approval vote.
o Supreme Court says this violate Blasius/Unocal despite shareholder vote
 Even after M shows a compelling justification, must still meet Unocal requirement of
proportional/reasonably related defensive measures.
 Chancery Court did not look for a compelling justification first; therefore overturned.
Int’l Brotherhood of Teamsters v. Fleming (OK 1999)
o Π says Δ is using company’s rights plan to entrench current board. Δ says OK law does not
require inclusion of Π’s proposal for shareholder ratification of rights’ plans in proxy statement
o Court says power is not exclusive to BOD, and shareholder’s have right to require ratification.
 Case would likely come out differently under §141(a)
PIERCING THE CORPORATE VEIL
Limited Liability
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§102(b)(6) - Shareholders Not Liable As Default Rule
o Prevents risk aversion, helps provide liquidity, and protects creditors.
o Credit Lyonnais Exception: BOD has fiduciary duty to creditors when in zone of insolvency.
o Bonholders/Creditors can protect themselves with contracts and interest rates.
Limited Liability Issues
o Contract credit justifications no longer applicable.
o Market would be less efficient and less liquid without limited liability
 Value of shares would be tied to wealth of shareholders, increase transaction costs.
o Critics say shareholders potential of having to pay is insignificant, and could purchase insurance.
Corporate veil never pierced in public corporation, only closed corporations.
19
Cases
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Fletcher v. Atex (2 Cir. 1995, DE law)
o F files suit against A. A is wholly-owned subsidiary of Kodak. P sues K too. Cash mgmt system
o Rule: To prevail on piercing claim under DE law, Π must show:
 That parent and sub operated as a single economic entity
 Sub’s solvency?
 Minton: Adequate capitalization (or liability insurance)
 Observation of corporate formalities (dividends, records, officers functions)
 Commingling of funds (cash management system not commingling)
 Siphoning of corporate funds
 If corporation is fascade for dominant shareholder
 That an overall element of injustice or unfairness existed; fraud is not necessary
 Sea-Land: Unjust enrichment constitutes injustice
 Kinney Shoe: If creditors knew what was going on, no recovery.
o Corporation can be a shell, but you can’t borrow money for a corporation existing only on paper.
Waklovsky v. Carlton (NY 1966)
o Π is hit by cab. Δ owns multiple cab companies like this one. Gets minimum liability insurance
on each small, instead of one large company. Π wants to hold shareholders personally liable.
o Court finds no liability
 Veil would have been pierced if Π brought claim for companies’ undercapitalization,
corporate boundaries being crossed, lack of formalities, etc..
 Must show that Δ had no other purpose than to limit liability; otherwise limited liability
is a prominent feature of a corporation.
 If Δ is operating multiple company’s in a way that would be legal if he had only one, he
cannot be held liable just because he has multiple ones.
Minton v. Cavaney (CA 1961)
o Π’s daughter drowns in pool, Π sues pool’s maker and gets small judgment b/c co. is broke.
Then brings suit against Δ because he acted in ownership role, although never received shares.
o Court says Δ can be held liable because company was severely undercapitalized.
 Δ must be given chance to refute claim against company b/c he was not party to first suit
Sea-Land Services v. Pepper Source (7th Cir. 1993)
o Π shipped peppers to Δ and was stiffed for bill. Π looks to pierce corporate veil and go after
owner, and then reverse pierce his other companies (alleged alter-egos) to go after those assets.
o Court allows corporate veil to be pierced.
 Van Down Test
 Corporate form not observed; blend line b/t corporation and individual
 Corporate veil being used to perpetrate fraud or injustice (“smell of fraud”)
 Corporations had no COIs, had same offices/accounts, zero-interest loans, etc.
 Owner got benefits at expense of Π, IRS, etc. and used funds to pay personal expenses
Kinney Shoe Corp v. Polan (4th Cir. 1991)
o K subleased building to Industrial, owned by P. P put no capital into Industrial; no assets,
income or bank account; no corporate formalities; no officers. I files for bankruptcy and K sues.
o Court says Kinney can collect from Polan
 If conducting investigation of corporation’s credit would be reasonable, burden is on that
party to conduct such an investigation.
 If Π is unsophisticated can overcome presumption that they knowingly assumed risk.
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Uniform Fraudulent Transfer Act
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§4(a) – Transfer/Obligation Is Fraudlent If…
o Actual intent to hinder, delay, or defraud; or
o No reasonably equivalent value was exchanged and
 Engaged in transaction with assets unreasonably small vis-a-vis the transaction
 Intended to incur debts beyond ability to payback
§4(b) – Factors Of Actual Intent
Less broad than piercing; must show specific transaction and specific fraudulent conveyance.
Doctrine Of Equitable Subordination
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When in bankruptcy, debt claims of controlling shareholder against corporation may be subordinated to
the claims of other persons, including the claims of preferred shareholders, on equitable grounds.
o Used if parent improperly managed subsidiary for parent’s benefit, or in undercapitalization
o Proof of fraud or illegality is NOT necessary because liability is less broad than in piercing
21
INFORMATIONAL RIGHTS AND PROXY VOTING
INDEPENDENT DIRECTORS
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BOD runs corporation under §141(a), but most authority is delegated to management.
ALI Corporate Governance Best Practices
o §1.34 – Definition Of Independent Director
 Not an employee of corporation in preceding two years
 Not a member of immediate family of officer/senior executive in preceding two years
 Less than $200,000 worth of business done with corporation in last two years
 Not affiliated with law firm or investment bank that is primary advisor
o §3.02 – BOD Should Monitor, But May Manage
o §3.04 – BOD Can Retain Expert Advice
o §3.05 – Audit Committee Must Be Fully Independent
 Also recommends independency for nominating and compensation committees.
34Act §10A – Independent Auditing Committee
o Cannot accept consulting, advisory or other compensatory fee from issuer
o Cannot be affiliated with issuer or any subsidiary
o At least one member must be financial expert
o Audit committee is subject to federal, not state, law
SOX §404: Requires reporting on viability of monitoring system
NYSE also requires some independent directors
INFORMATIONAL RIGHTS UNDER STATE LAW
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Shareholders may bring two types of suits…
o Direct: Acting to protect himself
o Derivative: Acting to protect the corporate entity
 Usually requires §220 suit to initiate
DGCL §219 – Access To Stockholder List
o Stockholder receives access to list 10 days before meeting, if for the purpose of the meeting
o Not very helpful b/c you usually just get the name of the four depositories (brokers)
o If the company has the NOBO list (non-objecting beneficial owners), the corp. has to turn it over
o Easier to get list under proxy rules of Exchange Act
DGCL §220 – Access To Books and Records With Proper Purpose
o Proper purpose includes mismanagement or anything related to the stock’s value
o Improper purposes include bad faith, harassing litigation, intention to sell list, or scheme to bring
pressure on third corporation.
o Proper purpose gets you…
 Information related to the purpose and NOBO list
 Records retained by corporation, not their advisors or subsidiaries
 Saito: Do not have be stockholder at time of indiscretion if relevant to suit
o Seinfeld: Steps in §220 Suit
 Technical filing requirement
 Π must show proper purpose by preponderance of the evidence
 Π must show credible basis for allegations by preponderance (not proof of wrongdoing)
 34Act §13 requires companies to report many indiscretions
 Π must show that requested books/records are essential to articulated purpose
o Pillsbury v. Honeywell: Π cannot get shareholder ledger b/c he opposes Vietnam War
 Credit Bureau Reports: No proper purpose needed simply to get stockholder list
 ALI §2.01: Mismanagement is defined more broadly, including ethical concerns.
22
Cases
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Saito v. McKesson HBOC (DE 2002)
o M merged with HBOC in 1999; H operated as wholly owned subsidiary. M later restated
financials due to irregularities with H’s accounting. Π claims M violated duty of care by failing
to discover them before the merger.
o Court dismisses claim without prejudice because Π did not file §220 suit (“tool at hand”)
 Had he gone through proper channels, purpose was proper
 Standing not limited to shareholders at time of indiscretion.
 §237: Cannot bring derivative suit if did not own, but can get list.
 Stockholder has access to H’s books if he can show need, even though prior to merger
Seinfeld v. Verizon (DE 2006)
o First limit on §220 suits.
o Π owns shares of Δ. Π recognizes no factual basis for claim, simply fishing
o Court says Π must show credible basis for suspicion of wrongdoing
 Burden is on Π to show proper purpose by preponderance of evidence
 Lowest possible burden
INFORMATION RIGHTS UNDER FEDERAL LAW
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State law does not apply to securities sales; 33 Securities Act and 34 Exchange Act regulate.
o State law handles internal management – aligning interests
o Federal law handles the securities market – fair and efficient markets
 33Act – Issuance of Securities
 34Act – Disclosure In Trading Securities
The Securities Exchange Act, which is applicable to corporations that have at least 500 record holders of
a class of equity securities and meet certain other conditions, requires the corporation to report certain
information to all shareholders without shareholder requests.
o However, a corporation with less than 500 holders may still be publicly held and not covered by
the SEA. Many states require that they still furnish annual financial statements based on GAAP
The Securities Exchange Act of 1934
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Only applies to corporations with 500+ stockholders among other conditions
o Requires periodic and event-driven disclosure to reduce agency costs
o Many states require smaller corporations file similar disclosures
§4 – Establishes SEC, Grants Powers
§6 – Provides For Registering Of Securities (National Securities Exchanges)
§10 - Insider Trading and Misrepresentations
o §10A: Gives audit committees specific powers and ability to appoint counsel – SOX-related
 SOX §302: Requires that CEO sign financial statements and vouch for accuracy.
§ 12 - Registration Requirements for Securities
o §12(a): Broker/Dealer/Member cannot transact with security unless it is registered.
o §12(g): Requires registration of public corporations (500+ owners, $1 million+ assets)
§13 – Periodical And Other Reports
o §13(a) – Continuing Disclosure and SEC Rule-Making Authority
 Reg. 13A – Biggest Mandatory Disclosure System In World (EDGAR)
 13A-1: Annual Reports (10K)
o Identify risks and competitors
 13A-11: Current Reports (8K)
o Filed upon occurrence of specific events within 4 business days
 Change in control, Acquisition/Disposition of Assets, Change of
Accountants, Termination of Agreement, Departure of Director
of Officer, Amendments To COI/Bylaws, Waiver of Ethic Code
23

o
13A-13: Quarterly Reports (10-Q)
o 13A-13(a): Midstream updates of 10Qs or 10Ks for material changes
 13A-15: SOX Requirement For Internal Controls
 13A-20: Report Must Be Simple
 SOX §404: Requires internal control report in §13(a) filings
§13(d) – Reports By Persons Acquiring 5%+ Certain Securities Classes
 §13(d)(1): Beneficial owner must notify issuer, exchange and SEC of change of
ownership within 10 days of acquisition of…
 Background, Identity, Residence, Citizenship, Nature of Ownership
 Source and amount of consideration used in making purchase
o Except for bank name in event of loan
 If purpose is to acquire control, any plans to liquidate, sell assets or merge
 Number of shares owned
 §13(d)(2): Continuing disclosure req. for material changes (increase in ownership)
 §13(d)(3): If two or more persons act as a partnership, they are considered one person
 §13(d)(6): Does not apply to purchase by the issuer
 Reg. 13D – Regulation of Tender Offers
 13D-1: Filing Schedules 13D and 13G
o 13D filer may file short-form 13G if…
 (i): Securities acquired in ordinary course of business (no plan
to control/influence the issuer)
 (ii): Such person is a broker/bank/insurance co.
 (iii): Such person has provided alternate notice
 Person is not beneficial owner of 20% or more of class
o If owner acquired security to influence/change control and has not filed..
 Cannot vote or direct voting of securities
 Can’t acquire additional beneficial ownership stake of 20%+
 13D-2: Filings Of Amendments to 13D/13G
 13D-3: Determination of Beneficial Owner
o Must have voting power
o Must have investment power, including power to sell
 Includes options, conventions, etc. exercisable within 60 days
 13D-4: Ability To Refute Beneficial Ownership
 13D-5: Can’t Avoid Requirements Through Partnership
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PROXY RULES
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Proxy Definition: written instrument authorizing vote on a shareholder’s behalf
o Proxy voting is the dominant mode of shareholder decision-making
Proxy Solicitation: Process by which shareholders are contacted and urged to execute/return proxy forms
§14 – Proxy Rules
o §14(a) - SEC Sets Proxy Rules Pursuant To §12
 §14(a)(3): The “Big” Filing Requirement
 §14(e): Untrue Statement of Material Fact Or Omission WRT Tender Offer Is Unlawful
 Any solicitation in opposition or favor of any offer
 Reg 14A – Solicitation of Proxies
 Rule 14a-3: Information to be furnished to security holders (Schedule 14A)
 Rule 14a-4: Proxy requirements
o (a) – Mandatory elements
 On whose behalf solicitation is being made
 Blank space for dating
 Clearly and impartially indentify each issue to be acted upon
o (b) – Must allow space to note approval, disapproval or
abstention/names of nominees in election
 Rule 14a-5: Presentation of information in proxy statement
o (a) – Must be clearly presented and divided in groups by subject matter
o (b) – Terms to be decided in the future must be noted and explained
 Rule 14a-6: Filing requirements (i.e. Notice of Exempt Solicitation)
PROXY FILING ANALYSIS
1. Rule 14a-1(l) – Is It A Solicitation?
a. A proxy includes (interpreted broadly):
i. Request for proxy whether accompanied by form of proxy or not
ii. Request to execute or not to execute, or to revoke, a proxy
iii. Furnishing of proxy form or other communication to holders under circumstances
reasonably calculated to result in the procurement of proxy
b. A proxy does not include (14a-1(l)(ii))
i. Furnishing of proxy form upon unsolicited request of shareholder
ii. Performance by registrant of acts required by Rule 14a-7 (providing shareholder list, etc.)
iii. Performance of ministerial acts on behalf of a person soliciting a proxy
iv. A communication by a security holder not engaged in proxy solicitation stating how he
intends to vote and the reasons therefore, provided that the communication is:
(A) a public speech, press release, published/broadcasted statement/ad, etc.
(B) directed to persons to whom the security holder owes a fiduciary duty
(C) made in response to unsolicited request for additional information by shareholder
c. Basic 14a-1(l) Rule: Saying what you’re doing is not a request; encouraging others is
2. Rule 14a-2(b) - If it is a solicitation, are they exempt from filing the Big One (14a-3)?
a. Rule 14a-2(a) – Exemption from all filing requirements
b. Rule 14a-2(b) – Exemption from big filing requirement (14a-3-15, Schedule 14A)
(1) Outlines specific “unexemptions” from the exemption (certain registrants, officers, etc.)
(2) Any solicitation made not on behalf of the registrant where total number of persons
solicited is not more than ten (testing the waters provision)
(3) Furnishing advice to someone as an advisor in a business relationship
(4) Any solicitation connected with a roll-up transaction
(5) Publication or distribution by a broker or a dealer of a research report
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c. Basically, if you have any skin in the game, then you’re un-exempt of filing the Big One.
d. If you are exempt under 14a-2(b), then you still have some requirements:
i. 14a-6(g) - for solicitations which fall under Rule 14a-2(b)(1)
ii. 14a-7 – provide a list to security holders, upon request
iii. 14a-9 – can NOT make any false or misleading statements, including in the press.
 Broad scope; covers omissions; requires disclosure if past indiscretion discovered
3. Are there any filing requirements other than the Big One (14a-6(g))?
a. Must file if you are exempt under 14a-2(b)(1) and own securities valued over $5MM
b. Oral solicitations and published/broadcasted opinions are exempt under 14a-6(g)(2)
c. Filing requirement is “Form of Notice of Exempt Solicitation”
d. Essentially, must file if you communicate to a subset of shareholders instead of everyone
- Note: 14a works in conjunction with 13d (requiring filing purpose in case of hostile takeover, 5% test)
PRIVATE ACTIONS UNDER PROXY RULES
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Rule 14a-9: Private right of action exists if any solicitation is false or misleading wrt material facts.
o Implied Cause of Action (See JI Case Co. v. Borak (US 1964), Wyandotte v. US (US 1967)
 Cort v. Ash: For implied cause of action, can be no state remedy, and must be
legislative intent
o SEC also has enforcement rights under 14a-9
o Proxy exemptions do not cover 14a-9
o Unsolicilited shareholders still have standing to bring 14a-9 claim
Elements Of a 14a-9 Claim:
o Misrepresentation of a material fact
 TSC Industries: Fact is material if reasonable investor would have found it significant
 Mills v. Auto-Lite: Materiality is the same as causation/reliance
 Virginia Bankshares: Conclusory statements can be material if they rest on
factual predicates (limits Mills)
 Fairness to and any material gain of the shareholders are not relevant.
 If statement is opinion…
 Must misrepresent the true reasons for directors actions
 Must show causation
o Negligence
 Gerstle v. Gamble (2nd 1973): Negligence, not scienter, is required mind state.
 Supreme Court hasn’t officially held this, but has commented favorably on it.
o Damages Not Necessary
 Shareholders don’t have to be hurt for a claim to succeed
 If no damages, attorneys still collect attorney fees
Cases
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Mills v. Electric Auto-Lite Co. (US 1970)
o Mergenthaler, controller of Δ, is about to merge with Δ. Π brings suit day before vote claiming
that proxy statement did not disclose BOD was controlled by Merg.
o Rule: Materiality establishes causation.
- A judicial appraisal of merger’s merits cannot be substituted for informed vote
- Protects shareholders and avoids determination of what votes were affected
- District court has flexibility in determining damages
- Attorney’s fees are granted in order to avoid collective action problem
- Private enforcement as additional gatekeeper/bounty hunter
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-
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TSC Industries v. Northway (US 1976)
o An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would
consider it important in deciding how to vote.
o Must have significantly altered the “total mix” of information made available.
Virginia Bankshares v. Sandberg (US 1991)
o VB’s parent company is merging into VB. An investment firm says that $42/share is a fair price
for minority stock. Executive committee approves price. Directors solicit proxies for voting on
proposal at annual meeting. S brings suit after non-approval for violation of 14a-9 and breach of
fiduciary duties under VA state law.
o Rule: Conclusory statements in a commercial context reasonably understood to rest on a factual
basis, the absence of which renders them misleading, are actionable under §14a.
- Must be a misstatement of what the speaker actually believes
- Π able to show that price was not fair and VB knew it, despite statements to contrary
o Rule: No recovery where shareholder vote was not required.
- Dissent disagrees
o Case also stands for the remanding of traditional state actions to that venue.
SHAREHOLDER PROPOSALS UNDER 14a-7 and 14a-8
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Reg. 14A has two mechanisms for ensuring effective shareholder access to proxy solicitation process
o Rule 14a-7: Requires corporation soliciting shareholders in conjunction with an annual or
special meeting to provide specified proxy solicitation assistance to requesting shareholders
o Rule 14a-8: A “qualifying shareholder” may require corporation to include her “shareholder
proposal” in its proxy statement
Rule 14a-7 – Registrant Must Provide Shareholder Lists To Requesting Shareholders
o 14a-7(a)(2) - Two Methods of Delivery
 Company mails soliciting material itself, OR
 Company provides a list of security holders to requesting shareholder
 Can request subset list if readily available.
o 14a-7(c)(2)(i): Solicitation has to be about upcoming meeting or relevant issue; proper purpose
o 14a-7(e): Security holder must reimburse reasonable expenses incurred by the registrant
o Does not preempt state law (i.e. §220) requiring proper purpose; only get lists related to proxy
Rule 14a-8 – Shareholder Proposals
o Shareholder has to meet the following requirements to get proposal in the proxy:
 b) Continuously hold $2000 worth/1% of company for > one year through time of meet
 c) No more than one proposal
 d) No more than 500 words
 e) If presented prior to meeting, must give corporation before the meeting to consider.
 f) Company may exclude proposal for procedural reasons, but have 14 days to correct
 g) Burden is on corporation to demonstrate exclusion is allowed
 h) Must actually present proposal at meeting
 i) Reasons company can exclude the proposal:
 See Statutes p. 1940 for reasons
 Generally if illegal, usurps §141(a) powers, personal grudge, or is irrelevant.
 14a-8(i)(8) is hot-button topic; proposed amendment gives more power to BOD
 j) Procedure to exclude (issue explanation to SEC > 80 days before filing proxy
statement)
 SEC responds with no-action letter; otherwise will take action if not included.
 m) Company can make arguments giving own point of view, even if contra proxy
statement
o Most successful proposals are on the social rather than management or operational front.
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Cases
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Lovenheim v. Iroquios Brands (DC 1985)
o Π stockholder wants to include proposal for Δ corporation to study the way French duck
suppliers treat their ducks, despite being only 1% of business
o Rule: Social issues are a proper subject for a shareholder proposal
o Less than 5% still found significant in AT&T Administrative Hearings also
Roosevelt v. E.I. DuPont de Nemours (DC Cir. 1992)
o Π proposes that Δ phase out CFC production faster than they currently are. Δ obtains no-action
letter from the SEC under 14a-8(i)(7) (ordinary business matters). Π brings suit.
o Court affirms that Π can omit the proposal.
 Rule: There is a private right of action under 14a-8 upon refusal to include.
 However, this was properly excluded
 This was an “ordinary” business judgment
 Deciding to build a nuclear power plant would be “extraordinary”; must include
 Cracker Barrel had received no-action letter on ordinary business ground for
refusing to hire gays; SEC later reversed its position.
AFSCME v. AIG (2d 2006)
o Π wants to submit proposal that Δ must make shareholder nominated BOD candidates public
along with BOD’s own candidates. SEC issues no-action letter and Δ does not include proposal.
o Court says the proposal cannot be excluded despite no-action letter b/c SEC does not get
deference given their conflicting interpretations of the rule.
 SEC amicus brief conflicts with 1976 statement clarifying the rule, permitting voting
procedure changes for future elections, but not the current election
o This was likely overturned by a recent SEC decision on 14a-8(i)(8)
CA v. AFSCME (DE 2008)
o AFSCME wants CA to reimburse reasonable expenses of any stockholder that seeks to elect less
than 50% of the board (short slate) and succeeds in electing one director.
 Rule 1: Proposal is a proper subject for stockholder by-law amendment
 Rule 2: Bylaw would violate §141(a) and can therefore be excluded under 14a-8(i)(1).
 §141(a) takes precedence over §109(b) permitting shareholder by-law changes
Additional Issues
o Proposals
 Shareholders cannot order company to something because of §141(a); any such proposal
is thus excludable under 14a9(i)(1) (violation of state law).
o By-law amendments
 Teamsters (OK 1999): Court allows amendment that company can’t adopt a
shareholder’s rights plan (i.e. poison pill) without shareholder approval
 Likely would violate §141(a) under DE law
 An amendment cannot tell directors how to manage, but can create specific duties for
managers
 Ex) Changing the number on BOD, Changing timelines for proxy contests
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PROXY FIGHTS
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Classic proxy fight is whole new slate against old directors; modern fights governed by rights plans and
shareholder proposal battles to put pressure on current board
Rules
o Existing Management: Directors have a right to make reasonable expenditures, subject to
judicial scrutiny if challenged, for purposes of persuading shareholders and soliciting support.
o New Management: Stockholders have right to reimburse successful contestants for reasonable
expenses incurred in a policy contest (Heineman)
Cases
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Rosenfeld v. Fairchild Engine and Airplane Corp. (NY 1955)
o Π owns 25 shares of Δ. Brought suit to compel return of $260,000 paid out of the corporate
treasury to reimburse both sides in a proxy contest.
o Court affirms dismissal of complaint
 Π had conceded that costs were fair and reasonable.
 Reimbursement ensures that rich people can’t wage takeover campaign
 Concurrence and dissent raise issue with broad interpretation of “fair and reasonable”
Heineman v. Datapoint (DE 1992)
o Π shareholder brings suit against Δ corporation alleging corporate waste and breach of fiduciary
duties Certain directors are on both sides of slate; reimburse insurgents in role as incumbents.
o Rule: Reimbursement of insurgent directors requires approval of disinterested shareholders.
 The earliest duty of loyalty case; applies because this is conflicted transaction with
directors on both side
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DUTY OF CARE
BACKGROUND
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Two fiduciary duties:
o 1) Duty of care
o 2) Duty of loyalty
o 2a) Duty of good faith (Merged into loyalty by Stone v. Ritter)
 Board may inherit duty of monitoring where federal law applies to corporation.
Duties apply to directors, officers, and controlling shareholders
Must bring duty of loyalty/good faith claim to survive motion to dismiss b/c can’t recover for duty of
care thanks to §102(b)(7) (Malpiede)
Duty of Care
- Requires directors show 1) no conflict of interest; 2) were informed; 3) did not act irrationally
o There are very few Duty of Care cases
 The market incentivizes directors to be faithful & careful
 More of a jurisdictional boundary; if directors follow best practices, court stays away
 Court’s lack business acumen; shouldn’t be making decisions
 Duty of Care in place to “temper” BJR and BOD’s power to manage
o Derived from trust law: trustee must “exercise such care and skill as a man of ordinary prudence
would exercise in dealing with his own property.”
 Not in DGCL – first arose in Aronson v. Lewis
 Appears in ALI §4.01 and RMBC §8.30
 Governed by a negligence standard, but more procedural in reality.
 Also, once breach is proven, burden shifts, unlike traditional negligence
o Duty of Care is to shareholders, unless in zone of insolvency, where it expands to bondholders
o Always a derivate suit
Cases
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Francis v. United Jersey Bank (NJ 1981) (Mrs. Pritchard)
o Δ is widow of corporation’s founder/shareholder. Sons siphoned off corporate funds causing
bankruptcy; Δ did not participate in control, but did nothing to help. Πs sue her for negligence.
o Court finds Δ liable for losses due to her negligence that was a proximate cause of losses
o Rule: Director must perform in good faith with the degree of diligence and care which ordinarily
prudent men would exercise under similar circumstances.
 Essentially, Δ is guilty because she can’t do nothing
 Director has duty to have some understanding of the business
 Director has continuing obligation to stay informed
 Has duty to object and maybe resign if illegal course of action is found
o This is a pseudo-piercing case as Πs want to go past directors to controlling shareholder
Aronson v. Lewis (DE 1984)
o Directors have a duty to inform themselves prior to making a business decision of all material
information readily available to them.
Trans Union
o Directors must exercise reasonable care under the circumstances.
Emerging Communications
o Director with specific expert knowledge cannot hide behind a veil of ignorance.
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BUSINESS JUDGMENT RULE (BJR)
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The BJR is an “aspirational” standard
Delaware BJR
o **Aronson v. Lewis** (1984)
 BJR is a presumption that directors of the corporation:
 Are disinterested (not on both sides of transaction, no self-dealing)
 Act on an informed basis
 Act in good faith
 Have honest belief that action was taken in best interests of the company
o BJR is a legal conclusion affecting pleading requirements and burdens of proof
 Π has burden of showing director was interested or otherwise violated 3 requirements
 If Π shows that one of conditions was violated, standard of review is entire fairness
 Here, burden is on director to show biz decision was fair and reasonable
 If Π does not, decision is judged on good faith/rationality standard with burden on Π.
 If BJR applies, requires gross negligence to incur liability.
 Hindsight bias could lead to extensive litigation.
o Always a derivate suit
ALI BJR (ALI §4.01) (No state has adopted ALI in full; DE law is corporate law)
o §4.01(a): Directors must act in good faith, in a manner reasonably believed to be in best interest
of corporation, with the care of an ordinarily prudent person in like circumstances.
o §4.02(b): Board can delegate responsibilities to committees and rely on their findings
o §4.02(c): A director acts in good faith if…
 Not interested in the transaction/judgment
 Is informed to a level reasonably believed to be appropriate.
 Belief that judgment is in best interest of corporation is not irrational
Kaim v. American Express (NY 1976)
o Minority shareholder Π wants to stop dividend claiming corporate waste. Company had bought
another company that declined in value. Δ wants to distribute shares; Π wants tax write-off.
o Court rules that the BJR applies. Case dismissed
 Cannot merely allege that directors made imprudent decision/misjudgment
 Directors have discretion making business judgment decisions
 There is no self dealing or any other element of bad faith
 Πs objections and alternate plan were carefully considered and rejected in good faith.
Smith v. Van Gorkom (DE 1985)
o Δ’s CEO wants to do an LBO of his company. Runs the deal himself, approaches the investor (a
friend of his), signs deal himself and has BOD rubber stamp it on 9/20; market tests were run
after proposal was made, but no offers stuck because of limitations in place in initial offer.
o Rule: Whether a transaction is informed turns on whether directors have acquired all material
information reasonably available to them (standard is gross negligence)
o Court says Δ was uninformed because decision making process was defective. BOD must pay
 BOD was completely uninvolved before 9/20 meeting (uninformed)
 The BOD relied entirely on CEO’s 20 minute oral presentation
 This is not a “report” under §141(e) allowing reliance on experts.
 Just because offer is above market price does not make it fair.
 Market test period was marred by a delay in issuing proxy statement
 The initial proposal by the CEO severely limited alternate courses of action by BOD
 Required definitive agreement be in place to terminate merger agreement
o This type of transaction may be cleansed by an informed shareholder vote (limited by Gantler)
o The court is concerned about procedural fairness, not necessarily substance.
o Wachter says this was likely decided wrong on the facts; the board likely was informed
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Fallout From Van Gorkom
o Once BJR is rebutted, standard of review is entire fairness scrutiny, with the burden on the
corporation (Cede v. Technicolor)
o BOD cannot be an uninformed rubber stamp; they must run the company under §141(a)
o Best Practices
 Investment banks now issue fairness opinions fulfill market test requirements
 Officers, not just CEO, must notify board of its reasoning/decisions
 Committee of independent directors should evaluate all sales
 Outside counsel and investment bank must be brought in to advise
 BOD must maintain obligation to recommend new, higher offers
 Shareholder ratification from informed shareholders
 Merger agreement must allow solicitation of other bids
 §251(d) – Fiduciary Out - Merger may allow termination by BOD prior to filing with
the Sec. of State.
o §102(b)(7)
 Allows COI to include provision eliminating/limiting personal liability of BOD for
breaches of fiduciary duty of care
 COI amendment must be rec’d by BOD and approved by shareholders
 This essentially removes duty of care liability (can still make claim)
 Π must claim bad faith or duty of loyalty violation (intent to harm) to survive
motion to dismiss though
 Nearly all corporations have adopted §102(b)(7)
 Allows BOD to take business risks without fear of negligence suit
 Also allows directors to purchase insurance and receive indemnification from corp.
 Duty of care claims now brought under umbrella of duty of good faith
o Courts are more willing to punish imperialistic CEOs (see also Disney)
o In a cash-out deal, BOD’s only duty is to get highest possible price (Revlon)
o Should also bring duty of loyalty claim; pleading requirement to survive motion to dismiss is
much lower (facts that if true raise reasonable doubt that BJR applies).
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Graham v. Allied-Chalmers (1963)
o Pre-Van Gorkom, and slightly opposed.
o Court finds no liability for directors who were ignorant of price-fixing scheme.
 In Van Gorkom, we see the BOD assigned a monitoring function.
In re Caremark Int’l Derivative Lit. (DE 1996)
o Employees of C engaged in kick-back scheme with clients. Πs claim BOD breached the duty of
good faith in allowing scheme to occur during a hearing on the fairness of a proposed settlement.
 Duty of care claims now brought under umbrella of good faith because of §102(b)(7)
o Court says settlement is fair b/c directors did not breach duty of good faith.
 BOD did have adequate corporate reporting system in place.
 Reporting system not required, but noted as a best practice
 No system is strong evidence of failure to monitor
 Liability on part of BOD would require
 Directors knew of scheme or should have known of scheme
 No steps taken to remedy
 Causation of losses
o A systematic, sustained failure to exercise oversight needed for lack of good faith liability
 Standard now is sustained inattention; still much higher than gross negligence.
Duty of Care Cases
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Emerald Partners v. Berlin (DE 1999)
o Trial burden (not pleading burden) in good faith claim is on party seeking §102(b)(7) protection
 Once Π meets prima facie case, Δ must show good faith and duty of loyalty.
o Rule: If duty of loyalty claim survives motion to dismiss, so does duty of care claim. Δ then must
show that failure to make fair transaction was exclusively attributable to a duty of care violation.
 Claims considered intertwined
Malpiede v. Townson (DE 2001)
o Fredericks is looking to sell. First makes agreement with Knightsbridge, then Veritas makes
high offer. F fears breaching agreement with K by pursuing V’s offer. K matches V’s offer, but
BOD had already accepted the lowball offer.
o Rule: Must bring duty of loyalty/good faith claim for duty of care to survive motion to dismiss
o Duty of loyalty claim is dismissed b/c disinterested directors approved the deal
 Duty of care claim is thus defeated by §102(b)(7)
 This is pleading burden, distinguishing from Emerald
 Recall board has fiduciary out under Van Gorkom/§251(b)
Steps in A Derivative Suit
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Look to publicly available information for evidence (newspaper, 10K, 10Q, 8K)
Must show proper purpose/some violation by preponderance of the evidence for a §220 suit
Use §220 suit to get access/discovery on company books and records
Δs will move for 12b-6 dismissal or failure to make damages
Burden is then on Πs to rebut the BJR presumption
o If they do not, Πs lose for failure to state a claim. No claim under BJR standard of review.
o If they rebut, proceed to trial with entire fairness standard of review (substantive and procedural
fairness). The burden also shifts to the defendant.
 At this stage, most cases settle
The steps in a duty of loyalty case are almost identical.
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DUTY OF GOOD FAITH
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Many cases brought under Duty of Good Faith since §102(b)(7) eviscerated Duty of Care
Now incorporated into Duty of Loyalty (Stone v. Ritter)
o Can’t be acting loyal if not acting in good faith.
Definition of Good Faith (In re Walt Disney)
o The conscious and intentional disregard of a director’s responsibilities
 Somewhere between gross negligence and subjective bad faith/actual intent to harm
 Can’t be as low as gross negligence because of §102(b)(7)
 Actual intent to harm more akin to duty of loyalty
 Examples
 Intentionally fails to act in the face of a known duty to act (Caremark)
 Violations of applicable positive law (AT&T)
o Duty to act lawfully is part of good faith
o §102(b)(7) notes that it does not protect against illegal acts
Cases
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In re the Walt Disney Company Derivative Litigation (DE 2006)
o WD’s BOD approves huge compensation package for Ovitz. Ovitz bombs and is fired without
cause, leading to huge golden parachute. Shareholders file a derivative action saying contract
was collusive (Eisner, imperialistic CEO, wanted Ovitz in as President).
o Survives motion to dismiss: if true, claims amount to violation of duties.
o Court says Disney is not liable
 Decision-making process not best practice, but no breach of duty of care/good faith.
 Good faith claim was based on lack of monitoring leading to care claim
o Rule 2: Recovering on corporate waste claim requires showing that deal was so one-sided that no
business person of ordinary, sound judgment could conclude compensation was adequate.
 Very high hurdle; in this case, would have to show contract was one-sided.
Stone v. Ritter (DE 2006)
o AmSouth has a wholly-owned subsidiary, AmSouth Bank. In 2004, AmSouth paid $50MM in
fines to resolve government investigations for certain filing failures and potential illegal activity.
Π brings derivative suit without making demand on AmSouth’s board of directors
o Rule: Failure to act in good faith is subsidiary piece of duty of loyalty and may cause liability
 Court says duty of good faith does not stand independent of care/loyalty.
o Court dismisses for failure to show demand would be futile
 No red flags to show that BOD was aware that internal controls were inadequate.
 Under Disney and Caremark, BOD has obligation to be reasonably informed on
corporation; an intentional dereliction of this duty is a failure to act in good faith.
 Caremark Test
 Directors failed to implement any reporting system/controls; OR
 After implementing such system, failed to monitor operations anyway
Miller v. American Telephone & Telegraph Co. (3rd Cir. 1974)
o Π brought derivative action against Δ for failing to collect outstanding debt of $1.5 million owed
by the DNC for communications services. Alleges breach of duty to exercise diligence, resulting
in “contribution” to DNC in violation of corporate campaign donation laws.
o Survives motion to dismiss
 Court looks to NY law because AT&T is incorporated there
 The alleged violation of law, if true, would be a violation of duty of good faith.
 Duty of good faith includes duty to act lawfully.
 One purpose of law was to prevent shareholder-opposed donations
 If it was a mere failure to pursue a corporate claim, BJR would apply.
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ALI
o §2.01(b): Corporation must act lawfully and within reasonable ethical boundaries
Criminal Liability
o BOD’s failure to monitor managers acting unlawfully (red flags) can create liability
o Managers though are not vicariously liable under agency theory for illegal acts of subordinates.
 Responsible Corporate Officer Doctrine
DUTY TO MONITOR SUMMARY
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Included within duty of good faith instead of duty of care due to §102(b)(7)
o Good faith itself now part of Duty of Loyalty (Stone v. Ritter)
Requires “sustained or systematic failure of the board to exercise oversight” (Caremark)
o If there is increased chance of liability, no one wants to be on the board
o Not isolated mistake; must be continuous to breach
o Best practice is to create a monitoring system
o Unlike Van Gorkom because there the board actually took action
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DUTY OF LOYALTY
BACKGROUND
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Unlike duty of care (where interests are aligned), the market does not self-police; VERY IMPORTANT
o Violating the duty of care/good faith will not make you rich; violating this one will.
o Purpose of corporate law is to make directors loyal.
Traditional remedy is restitution (Δ between contract price and fair price)
o Sanctions are usually tamer than those for Duty of Care
o However, court may invoke punitive damages or require repayment of salary for fraud (not DE)
Emerald Partners Rule: If Duty of Loyalty claim survives motion to dismiss, duty of care does as well
despite §102(b)(7). Burden is on Δ to show that the failure to make a fair transaction was attributable
exclusively to the duty of care, rather than the duty of loyalty
Often seen in closed corporations (Lewis v. SLE, Talbot)
Mechanics
Controlling shareholder
Non-controlling shareholder
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Burden Shifting in Interested Transaction
o §144 – Interested Directors & Quorom
 Initial burden is always on Π to rebut BJR (informed, disinterested, rational, good faith)
 If Π overcomes BJR presumption, burden shifts to Δ under entire fairness
 Must show procedural and substantive fairness
 Entire Fairness can be shown by…
 Showing that BOD was independent and disinterested
 By having a fully informed, uncoerced shareholder vote
 That deal was both substantively and procedurally fair (price and dealing)
 Contract between management and corporation not void simply due to financial conflict
 Best Practice: Disclose; Get price from market test; Delegate decision to disinterested
committee; do not have to pay your top price, but must beat second best.
Decision by full BOD
1. BJR presumption
2. Π can rebut by
alleging facts with
particularity
3. If so, SoR switches to
entire fairness
4. Burden on Δ
5. Substance and
Procedure
Disinterested/Independent committee approval
1. Π pleads particularized facts that comm was
interested/deal wasn’t fair to rebut BJR
a. P gets info from §220 suit
2. At SumJ, Δ must show committee was
disinterested (best practices/arms-length)
a. If Δ does, switches back to BJR
3. If Π makes it to trial, 2 things may happen:
a. Π may rebut BJR as factual issue
b. If Π succeeds entire fairness SoR
Shareholder approval
1. Π must rebut BJR
2. If Π succeed, entire fairness SoR
3. Δ can rebut: a) majority of
disinterested SH approved, b)
informed, c) not coerced.
4. If Δ does, waste standard applies
5. No reasonable person can consider it
fair (no consideration)
6. Gantler
1. BJR presumption, and 1. Burden rebutted b/c BoD always interested
P can rebut.
w/ a controller
2. Entire fairness, with
2. Δ has burden of showing that the
the burden on the
independent committee actually was
defendant to show it
a. If it does, burden shifts to the Π, but
was fair.
still under entire fairness
3. Interested does not
b. If not, burden remains on Δ
necessarily mean
3. Kahn v. Lynch
unfair
- This is all on the motion to dismiss; at trial, we start all over.
1. Same as rule for controlling
shareholders with disinterested
committee approval.
2. Disinterested shareholders must offer
informed approval
3. If so, burden shifts back to Π, but
still under EF
4. Kahn v. Lynch
36
Duty Of Loyalty Cases
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Types
o
o
o
o
Basic Self-Dealing (one party on both sides of transaction)
Excessive Executive Compensation (directors set own pay under §141(h))
Diversion of Corporate Opportunity
Controlling Shareholders Selling Control
Basic Self-Dealing
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Where director/officer is on both sides of the transaction (§144)
o Interested transaction not per se void so long as it was fair (procedural or substantive)
Entire Fairness Standard requires…
o Procedural
 §144(a)(1)-(2): Must disclose conflict to the board/shareholders
 Doesn’t have to disclose everything (arms-length)
 Don’t have to disclose personal gain
 Have to disclose only what fiduciary duties require
 Can cleanse transaction with disinterested director approval
 Must show disinterested directors and arms length dealing
o Should have own counsel/i-bankers
o Mechanisms to preserve independence
o Substantive
 §144(a)(3): Was transaction economically fair to corporation
ALI §5.02
o Two step inquiry
 Mandatory disclosure
 Show fairness, authorization by disinterested directors, or shareholder ratification
o If both were not done, burden on Δ to show fairness.
 If they don’t, burden stays on Δ under entire fairness scrutiny.
 If they do, SoR shifts back to BJR (or a waste standard if shareholder approval).
 Fairness in both price and dealing (would shareholders have approved?)
o Who is interested?
 Few bright line rules under §1.23 (self, family, employees, pecuniary interest)
 §10A(m)(3) also includes those receiving compensation for advisory service
 Fact heavy inquiry
Lewis v. SL&E (2nd 1980)
o 6 siblings own SLE. Only 3 own LGT. LGT leases land from SLE at below market rate. SLEonly kids refuse to sell shares as mandated by agreement claiming waste of assets in lease.
o Court says burden of proof is on Δ because the transaction had a conflict of interest
 Δ must show transactions were fair and reasonable.
 Δ failed to meet burden and damages awarded for difference b/t market and actual price.
 No market test/appraisals done by Δ
 LGT’s lack of profits are not evidence; can balance P/L with higher salaries
Talbot v. James (SC 1972)
o Π owns land. Forms corporation with Δ who wants to build apartment on it. Δ hires himself as
builder, doesn’t tell Π.
o Rule: Officers/Directors have fiduciary duty of full disclosure when entering into contract with
corporation.
o Court says Δ did not disclose and therefore must return ill-gotten gains
 Lack of disclosure impedes inquiry, implies procedural unfairness
 Dissent disagrees: says Π knew of conflict and that price was fair and reasonable
37
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Cookies Food Products v. Lake Warehouse (IW 1988)
o Controlling shareholder Δ, receives payments for services provided to the company.
Shareholders bring suit saying high fees led to lower profits, lack of dividend.
o Court determines that the transaction was fair
 Controller owes fiduciary duty as director/officer, and as controller, owes duty of loyalty
prohibiting self-dealing
 Burden is on Δ to show good faith and fairness under statute analogous to §144
 Court is not persuaded that profits would be more with outside contractors
 Controller’s compensation was fair and reasonable and he disclosed interest
 Dissent says court only looked at net profits, not a market test
Executive Compensation
-
-
-
-
Statutory Base
o §141(h) – BOD Sets Own Pay (unless restricted by COI or bylaws)
o §157 - BOD Must Approve All Stock Option Grants
 b) In absence of fraud, issuance is conclusive as to sufficiency of consideration
 c) Board can delegate power to officer, but officer cannot grant to himself
o NYSE §312.03(a) – Shareholders Must Approve Equity Compensation Plans
o IRC §162(m) – Can’t Deduct More Than $1M in Executive Compensation
 Perform based pay/Options are exempt with shareholder approval (26 CFR §1.162-27)
 However, shareholder say on pay creates tension with §141(a)
o Best Practice: Appoint independent committee; hire outside compensation consultant (Disney)
o Exempt from “ordinary business exception” under 14a-8
Compensation Claims
o Types
 Self-dealing
 Retroactive payments (invalid b/c no consideration)
 Corporate waste through excessive compensation
o Not much you can do about executive compensation under DE law; mainly IRS enforcement
 Executives are unique; what they should be paid is a business decision
o These claims are more common in closed corporations
 Executive comp is typically a higher % of corporate income
 In public companies, must have compensation approved by shareholders
o Wilderman v. Wilderman (DE 1974)
 Factors to consider in excessive compensation claim under Entire Fairness
 What similarly situated executives receive (market comp)
 Ability of the executive (performance)
 Reasonability of payment
o Full IRS deduction? Corporation successful? Previous year salary?
Options
o Companies do not have to issue addt’l stock, and leverages increase in stock price for execs
 Note: Most execs exercise options through a stockless sale
o FASB requires be accounted for based on fair (Black-Scholes) value
o SEC regulates options through Regulation SK , Item 402
o Are exempt from IRC §162(m) tax rules with shareholder approval
In re Tyson Foods Inc. Consolidated Shareholder Litigation (DE 2007)
o T is closed corporation. Family-run LLC owns controlling share. Π alleges that BOD comp
sub-committee violated duty of loyalty by using deception to approve spring loaded options for
execs. Comp committee was interested, but plan approved by majority of non-interested BOD.
 Non-interested committee’s approval cleanses transaction; BJR applies
 Spring loading options (issue before good news) close to intentional harm; still got BJR.
38
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Gantler v. Stephens (DE 2009)
o Special ratification v. Classical/Required ratification
o First Nile Bank is in bad shape. Other banks make friendly takeover offers, but BOD decides to
go private by changing capital structure. This requires a COI amendment. Three of the BOD
interested in transaction (financial/power). Πs claim breach of loyalty in abandoning sale and
reclassification and breach of disclosure through proxy misstatement and .
o Court says dismissal was improper because the shareholder ratification was ineffective
 Essentially, the required vote on the COI amendment is tarnishes the cleansing power
with respect to the reclassification.
 Best practice: Bifurcate the vote so that it is clear that directors were disinterested, and
vote was informed.
Corporate Opportunity Doctrine & Corporate Assets
-
-
-
-
Similar to Tarnowski (agency/jukeboxes) and Meinhard (Manhattan real estate partners)
Delaware Approach
o 1) Is it a corporate opportunity? (emphasis here)
o 2) If so, was the transaction fair?
 Approval of disinterested directors cleanses transaction under §144(c)(2)
 Disclosure by BOD shifts burden back to Π
o Guth Line of Business Test (Coke v. Pepsi) (DE)
 Rule: Opportunity so closely associated with existing business that it would put
purchaser into competition with the company. Factors include…
 Corporation’s financial ability to exploit opportunity
 Is opportunity in corps line of business?
 Does corp have interest/expectancy in opportunity?
 Would purchased put himself in conflict with his corporate duties
 Determination by court
o DE disallows contracting around corporate opportunity doctrine (can say specific activity isn’t)
ALI §5.05(a)
o (a)(1): Mandatory disclosure by BOD
o (a)(2): Corporation must reject opportunity, AND EITHER
 1) Rejection is fair to the corporation
 2) Opportunity is rejected by disinterested directors
 3) Rejection is authorized in advance or ratified by shareholders
 A) Rejection must be fair to corporation
 B) Lower-level employee need only go to his superior
o ALI §5.05(b)
 Broad definition: Any activity closely related to corporation’s business
 Ties in to the mandatory disclosure under §5.05(a)(1)
 Determination by board
o (c): Burden is on Π to show taking, but if done, burden shifts to Δ to show fairness
 Again, disclosure and offering opportunity to corporation is mandatory.
o (d): A good faith but defective disclosure can be cleansed by new, proper ratification
Fairness and Expectancy Doctrine (Lagarde / Ballantine)
o Does corporation have an interest expectation in the opportunity?
 Does the corporation think they have a right to it?
 Is it fair?
o More relevant in closed corporation setting
 To many factors in public corporation
Best Practice: Disclose everything
39
-
-
-
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Hawaiian International Finances v. Pablo (HI 1971)
o HIF is buying property; Δ, director of HIF, receives commission from seller. Δ had used some of
his own funds in arranging deal, but does not disclose commission to corporation.
o Rule: Corporate officer cannot receive commission absent full disclosure
 Violation exists even absent harm to corporation
 Corporation’s lack of a real estate broker license is irrelevant; could have reduced price
o Δ forced to pay for restitution
Northeast Harbor Golf Club v. Harris (ME 1995)
o Δ was president of Π. Δ began buying land around golf course in own name without fully
disclosing. Later said club did not have sufficient funds anyway, but approached as President.
o ME Court accepts ALI §5.05 approach
 Δ did not disclose opportunity; per se violation under ALI approach
 Must disclose to full board in official capacity.
Broz v. Cellular Information Systems (DE 1996)
o B owns a cell company, but is also on the board of a competitor, CIS. B’s own company
approached with offer to buy FCC license; tells some BOD members, does not formally disclose.
CIS is bought out later and sues B by new owners.
o Rule: Full, formal disclosure is best practice, but is not required
o Court finds for B.
 CIS was not financially capable of exploiting the opportunity.
 While opportunity was in line of business, CIS was divesting its holdings
 B need not consider subsequent events in making his decision (like the sale of CIS)
 DE test more akin to ALI §5.05(b) / Guth
In re eBay Shareholders Litigation (DE 2004)
o eBays i-bank allocated thousands of IPO shares to officer/founder Δs, huge profits for Δ.
Allegation is that i-bank did so to carry favor for future business.
o Court finds that facts as alleged are a violation of the duty of loyalty.
 Even if not a corporate opportunity, agent has duty to account for personal profits
obtained from transactions with his/her company.
Obligations In Sale Of Control By Controlling Shareholder
-
-
Rights Of Minority Shareholders
o When directors are controllers, their duty continues to the residual shareholders
 Zahn: BOD duty to alert SH of rights, and make sure they use them in informed way
 Directors do not have duty to maximize benefit to each class of stock, only residual
 Still must disclose everything to other classes
 Distributing benefits pro-rata is proof of fairness
o If independent committee is appointed, entire fairness is SoR.
 If there is evidence of unfair dealing, the court will look to fair price.
 Burden shift, but not per se liability.
o ALI §5.10-§5.12
Zahn v. Transamerica Corporation (3d 1947)
o Δ redeems Class A shares of subsidiary, through proper channels and above FMV, but at steep
discount from actual value due to tobacco price controls. Then liquidates company. Π brings
suit alleging they should be able to participate in liquidation, not just redemption.
o Rule: Full disclosure to SH required; SH must exercise right in informed manner
o Court determines that controller cannot use control of BOD to gain at expense of minority SH
 Burden is on Δ to show that transaction was entirely fair and in good faith
 COI would have permitted redemption had BOD been disinterested
 Controller need not subordinate his interests, but must disclose to fellow shareholders
40
o
-
-
-
-
Controllers Duty To Disclose
 Lynch v. Vickers Energy Corp. (DE 1977)
 Complete candor of all facts and circumstances regarding tender offer
 Rosenblatt v. Getty (DE 1985)
 Controller must disclose all material facts
 Shell Petroleum v. Smith (DE 1992)
 Omission/Distortion of fact must be relevant to an investor to be material
 Echoes TSC Industrie v. Northway
Sinclair Oil Corp v. Levien (DE 1971)
o Sinclair is holding company/controller of Sinven, dominates board; L owns the rest. L alleges
that Sinven payed excessive dividends, ignored opportunities to expand and breached a contract
through another of its subsidiaries.
o Rule: Entire fairness is the standard for transactions between a parent and its subsidiary that
harm the interests of minority shareholders.
 BJR proper standard for dividends because benefits were pro-rata, conforms with §170
 BJR applies to expansion claim because Sinclair did not usurp any opportunity
 Entire fairness for breach of K claim. One party on both sides is classic self-dealing
 Burden on Sinclair to show deal was entirely fair to L.
Greene v. Dunhill Int’l (DE 1968)
o Δ is controller of Spalding; toy division account for 4% of sales. Δ acquires toy company.
Minority SH of Spalding allege taking of a corporate opportunity.
o Court finds for Π; corporate opportunity existed
 Court says toy company was in same line of business as Spalding
**Kahn v. Lynch Communications Systems** (DE 1994)
o Alcatel is de facto (<50%) controller of Δ. Wants Δ to purchase company, Δ refuses. Alcatel
looks to squeeze out minority shareholders and create wholly-owned sub to make purchase.
Independent committee is appointed to approve, but Alcatel makes threats if deal isn’t done.
o Rule: When independent committee cleanses a transaction by a controlling/dominating
shareholder, burden of persuasion/proof shifts to Π, but SoR remains entire fairness.
 Rosenblatt v. Getty Oil, Weinberger v. UOP
 Additional protections needed due to additional powers of controllers
 Artificially reduces market price; tougher to gauge “fairness”
 Arms-length bargaining is evidence of fairness
 Controller cannot dictate terms of merger
 Committee must have real bargaining power to negotiate with controller
o Court finds that Alcatel’s domination/threats neutralized the committee, was not arms-length
 “Take it or leave it” approach is not arms length
 Committee could have adopted poison pill, or some other defensive measure
o “Running dogs of capitalism” – disinterested directors who allow stealing of opportunities
Levco Alternative Fund v. Reader’s Digest (DE 2002)
o Δ has two classes of stock: class A votes, B does not. Recapitalization is proposed to eliminate
A shares. Π alleges that the independent committee which approved the deal did not adequately
consider their non-voting interests (they would gain voting rights but lose value).
o Rule: When transaction involves conflicting interests among SH classes, there must be a fairness
evaluation for each class of shares
o Court finds that Π may succeed
 Burden does not shift to Π because Δ cannot show that committee was disinterested
 Committee did not consider harm to A shareholders; there job was to balance
 Differs from Zahn because there was no contractual right to recapitalize; therefore must
consider rights of all shareholders.
41
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Jones v. HF Ahmanson (CA 1969)
o Minority Π of an S&L brings action against controller Δ. Δ had transferred its shares to a
holding company, creating a public market for the shares. Shares selling for more than book
value while dividends for Π are declining.
o CA Rule: Controller has duty of good faith and inherent fairness to the minority SH in any
transaction where control of the corporation is material, even if not self-dealing.
o Court finds that Δ has breached this duty.
 Controller had other options which would have allowed minority access to gains
experienced only by controller under chosen avenue.
 Narrow reading: Δ seized a corporate opportunity by using corporate assets
 Broad reading: All shareholder have equal opportunity to take shares public
Sales of Control
-
-
-
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Zetlin Rule (US rule)
o Majority shareholder may sell at a premium and minority does not need to share in the benefit.
 Does not have right to make arbitrary decisions as a controller
o Exceptions
 Reynolds: Cannot receive premium to allow buyer to loot corporate assets
 Perlman: Can’t sell for a premium in return for sale of corporate opportunity
 Brecher/Essex: Can’t sell management control without selling full shares
 Mgmt control must equal voting control
o US rules grants benefits of control premium to a controller because of benefits they bring
 Single vision, monitoring function, etc.
 Belief that market/SEC/law can police controllers so they don’t abuse power
Zetlin v. Hanson Holdings (NY 1979)
o Δ sells controlling shares at double FMV. Πs bring suit b/c they received none of premium.
o Rule: Absent fraud, looting, conversion of a corporate opportunity or other bad faith, a controller
is free to sell his interest at a premium price.
 Minority receives protection from abuse, but not an equal opportunity
 Instead, fiduciary rules in place to make BOD maximize value
 If you invest capital necessary to acquire dominant position have right to reap benefits
 Controller Duties: 1) treat common stock equally, 2) inform other classes, 3) no
delegation.
Gerdes v. Reynolds (NY 1941)
o Δ was officer/director/controller of mutual fund. FMV is 6 cents because of liabilities. Sell for
$2/share. Buyers steal corporate assets, resulting in bankruptcy. Π is trustee in bankruptcy filing.
o Rule: Controller can sell his shares for a premium, but inherits fiduciary duty if he knows or
should know that it will result in corporate looting.
 Extreme premium offered should have been red flag to seller.
 Court will look to see if price paid is justifiable
 Nature of assets (more liquid = more suspicious)
 Method by which transaction is consummated (pay in advance or after?)
 Relation of price to stock value
Perlman v. Feldman (2d 1955)
o Δ is controller/chair of board of steel company. Wilport buys to acquire more steady supply of
steel during war. Π alleges that consideration paid for controlling shares include corporate
opportunity to exploit and allocate during steel shortage.
o Court finds that Δ violated his duty of care/loyalty by selling a corporate opportunity
 Δ was on both sides of transaction, there burden on Δ
 “The Feldman Plan” is deemed a corporate asset (exploiting steel shortage)
 No fraud, but Δ was not entitled to profit that belonged to corporation as whole
42
INSIDER TRADING
-
-
-
Two Views
o Extension of the fiduciary duties of good faith and loyalty
 Directors owe duty to disclose dealings with corporation
 ALI §5.04: Directors can’t use corporate property for corporate gain
o It is separate, concerning the functioning of markets and protection of securities traders.
 Regulation of insider trading promotes liquidity/transparency in markets
 Why bring capital to market if it is a rigged game?
 More protection of minority shareholders; others handled at state level
Policy Basis
o For: Cheating is wrong, Non-public information is corporate asset, Need fair/liquid markets
o Against: Market will self regulate; stifles research and initiative; “compensation option” to make
officers want to increase company value.
§10(b) and Rule 10b-5
o Regulates all non-proxy disclosures, scienter mindstate; 14a-9 handles proxies (negligence)
o Two purposes
 Prevent insider trading by those with material non-public information
 Prevent defective disclosure by the corporation
 Bad conduct
 Material misrepresentation
o §10(b) – Manipulative and Deceptive Devices
 Unlawful to use any such device in the purchase or sale of a registered security.
 SEC has rule-making authority under §10(b).
 10b-5 – unlawful in connection with purchase/sale to…
 a) employ any device, scheme or artifice to defraud
 b) make any untrue statement of fact or omit a fact necessary to make sense of
other statements; OR
 C) engage in any practice which defrauds or deceives any person
o Private action right is implied rather than explicit
 SEC enforcement actions, DOJ criminal liability and exchange enforcement also in place
o Wharf/Deutschmen v. Beneficial: Options and oral contracts are securities
o Zlotnick: Short sellers have standing, but with tougher reliance requirement
Elements of a 10b-5 Case
-
Generally
o Rule 10b-5(1) – Trading On Basis Of Material Nonpublic Information
 “Use test”
 b) Cannot trade on basis of material nonpublic information if you were aware of it
 If you know about the information, you are assumed to use it
 c) Affirmative defense
 Technical or Strategy trading in place before gaining knowledge are okay
o Rule 10b-5(2) – Duties Of Trust Under Misappropriation Theory
 Codifies O’Hagan
 Fiduciary duty inherited on promise, history of confidence, family member & more
o Elements: Material Misrepresentation, Connected, Reliance, Scienter, Transaction/Loss Cause
43
Private Causes Of Action Under The Act
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-
-
-
-
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Requires Jurisdictional nexus and Transactional nexus
o Jurisdictional: “instrumentality of interstate commerce”
o Transactional: “in connection with the purchase or sale”
Elements
o Material misrepresentation (or omission) (TSC Industries, Basic)
o In connection with the purchase or sale of a security – (Blue Chip Stamps)
o Reliance (fraud-on-the-market) – often referred to as “transaction causation” (Basic)
o Loss causation – causal connection b/t material misrepresentation and loss (Dura Pharma)
o Economic loss
o Scienter (intent or recklessness) – (Ernst & Ernst)
Private Securities Litigation Reform Act - §21(D)-(E)
o Imposes specific requirements for class actions under the ’34 Act
 Π cannot accept payments for being named Π, or be a professional Π
o Pleading
 §21D(b)(2): Plead with particularity facts that give rise to strong inference that Δ acted
with required state of mind.
 Scienter is still state of mind
 §21E – Forward Looking Statements
 Includes statements about projections of revenue, earnings, etc.
 21E(c)(1) – Safe Harbors
o Contains meaningful cautionary statements (Bespeaks Caution
Doctrine)
o Π must be able to show actual knowledge of misleading
 No duty to update
Aiding/Abetting
o Stoneridge Investment Partners: Aiding and abetting is not enough to trigger liability; if Δ has
not made statement upon which Π has relief, Δ cannot be held responsible (no reliance)
Remedies/Damages
o Closed corporations
 If insider later flips stock, original seller is awarded difference between two prices.
o Public Corporations - Misrepresentation
 Conventional: Damages measured by FMV at time of disclosure of correct information
 Rescissory damages are rare
o Public Corporations – Non-Disclosure
 §20A(a): Insider liable to anyone who contemporaneously sells/purchases securities
 Rarely enforced; limited to gains/losses
Forum
o §10(b) allows many traditional state claims a federal venue
 Limited by Santa Fe
o Fedreal venue requires showing of misrepresentation, heightened pleading under §21D.
To Whom Does 10b-5 Apply
-
Who is “any person”
o Insiders: Officers, directors, controlling shareholders
o Cady Roberts factors
 1) Information intended to be available only for corporate purpose is regularly available
 2) Fairness of the transaction vis a vis those without the inside knowledge
 Limited to those with a fiduciary duty to disclose in Chiarella and Dirks
o Disclose or Abstain Rule: If disclosure prior to purchase/sale would be improper or unrealistic,
the alternative is to forego the transaction. (Cady Roberts)
44
-
-
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Assigning Liability
o Classical Theory
 Cady Roberts: Look to whether a person is an insider/receives confidential info
 Chiarella: Silence in connection with purchase/sale is only actionable when
there is a duty to disclose arising from the relationship.
o Partially overturned by Cady Roberts factors
 Dirks: Tippee’s inherits derivative duty to disclose/abstain from insider.
o Tippee only in violation if the insider would be
o Insider also must receive material gain for giving tip
o Misappropriation Theory
 O’Hagan: Person commits fraud “in connection with” transaction when
misappropriating confidential information in breach of duty owed to source
 Exception: There is no “deceptive device” if fiduciary discloses to source that he
intends to trade on the info.
o Still may violate duty of loyalty
o Rocklage: Previous scheme or device taints subsequent transactions
 Codified by 10b5-2
 Fills gap when fiduciary duty breaks under Dirks
o Rule 14e-3
 Reverses Chiarella with respect to tender offers
 If you have any relevant info with respect to tender offer, cannot trade
 Chestman: Cannot pass on info if there is reasonable chance person will trade.
 Upheld in O’Hagan.
In the Matter of Cady, Roberts & Co. (SEC 1961)
o Cady insider received info on dividend reduction. Wants to sell stock. Put in market value order
for opening, assuming info would be public. Release delayed, order processed before release.
o Rule: Fiduciary duty of officers, directors and controllers extends to those with a “special
relationship” to the company making them privy to its internal affairs.
 1) Existence of relationship giving access to info intended solely for corporate purpose
 2) Inherent unfairness is involved where party takes advantage of information knowing it
is unavailable to the counterparty
 Any person
o Court says insider had duty to disclose his knowledge or abstain from trading.
o Limited severely by Chiarella and Dirks
Chiarella v. United States (US 1980)
o C is printer who prints documents on corporate takeover bids. Doesn’t disclose knowledge and
buys stock of target companies for profit. SEC brings 10b-5 charge.
o Rule: Silence in connection with purchase/sale is only fraud if party had duty to disclose arising
from relationship of trust between parties.
o Court says Δ was not insider and info did not concern earning power/operations of the company
 Unfairness does not mean fraudulent
 Mere possession of nonpublic information does not bring on duty to disclose
 Fiduciary chain was broken
 Does not address whether C breached duty to acquiring corporation, who hired his
printing company. (Refined by Dirks)
 SEC could have pursued claim of misappropriation
o Dissent argues for broader reading akin to Cady Roberts Misappropriation Theory
o Overturned with respect to tender offers by 14e-3 (Cady Roberts applies there)
45
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Dirks v. SEC (US 1983)
o Δ was broker at investment analysis firm. Secrist, former employee of Equity Funding, informs
Δ that EF’s assets were fraudulently overstated. Δ is ignored by SEC and papers. Discusses
claims with select group of clients, who traded. EF collapses, and SEC brings 10b-5 action.
o Court says duty to disclose is product of relationship b/t parties.
 Tippee only inherits duty to disclose/refrain when the insider will receive a direct or
indirect personal benefit from the tip
 If he doesn’t gain personally, no duty to shareholder has been breached.
 “Any person” only refers to those who have used a deceptive device; not Cady Roberts
o Tipper did not receive personal benefit, there no duty passed.
 Encourages collection of information.
o SEC v. Yun (11th 2003)
 Interprets Dirks broadly: Existence of tit for tat business relationship is enough.
United States v. O’Hagan (US 1997)
o Δ is lawyer at firm hired by Grand Met to advise in tender offer for Pillsbury. GM and P keep it
secret. Δ isn’t working on deal, but buys P stock. SEC brings charges under §10(b) and §14(e)
o Court finds Δ violated §10(b) by breaching fiduciary duty to source of information
 Misappropriation Theory: Person commits fraud “in connection with” transaction when
it misappropriates confidential information for trading purpose, in breach of duty owed
to the source of the information (as opposed to the company whose shares were traded).
 Protects against abuses by those with access to material nonpublic info.
 Fills gap
o SEC did not overstep rulemaking authority in adopting Rule 14e-3
 14e-3: Cannot trade if you have any info in case of tender offer
 SEC can prohibit non-fraudulent activities if it is reasonably design to prevent fraud
SEC v. Rocklage (1st 2006)
o Δ’s husband told her non-public information with reasonable expectation she would not disclose
it. However, she tells brother who trades after receiving negative info. SEC brings §10(b) suit.
o Court finds a violation of 10b-5
 Δ’s acquisition of info was deceptive; did not correct reasonable belief of secrecy
 Doesn’t matter that wife told her husband she was going to disclose this instance
 Δ’s use of info may fall under O’Hagan, but her deceptive acquisition was not disclosed.
 Brazen misappropriation cannot escape liability.
Transactional Requirement: “In connection with the purchase or sale”
-
Generally
o Zandford/Dabit: Fraud alleged must simply coincide with a securities transaction
 Broad interpretation – any statement reasonably calculated to affect the investment
decision of a reasonable investor
 Δ does not need to be a buyer/seller
o Blue Chip Stamps: Limits standing to those who purchased/sold stock before misrepresentation
was disclosed.
o Broad definition of “sale”
 Blue Chip Stamps: Includes options and other rights to purchase/sell
 Wharf: Includes oral contracts to purchase/sell
 Zandford: Includes traditional areas of state law fraud claims
o Semerenko: Where alleged fraud involves public dissemination through medium upon which an
investor would presumably rely, “in connection with” is established by proof of materiality.
 Does not need to be made for purpose of influencing decision
46
-
-
-
-
Blue Chip Stamps v. Manor Drug Stores (US 1975)
o BC is forced to break-up monopoly. Makes “gloomy” prospectus so they can sell as few
securities as possible. Πs say they would have bought the securities if they had known value.
o Rule: Only a person who purchased/sold stock before misrepresentation disclosed has standing
under Rule 10b-5.
o Πs don’t have a cause of action.
 Narrow to avoid abusive litigation in hopes of settlement
 Avoids issues with “would have sold my stock” claims
 Limits expansive definition of sale for traditional area of state law
Wharf Holdings v. United Int’l Holdings (US 2001)
o Wharf offers 10% stake in company for United’s services. Later refuses to pay
o Rule: Options and oral contracts are securities for purposes of 10b-5
o Wharf’s intention not to pay is a violation of 10b-5.
 Also evidence of implied private right of action
 Wharf’s intention not to honor affects value of option (it is worthless)
SEC v. Zandford (US 2002)
o Δ stockbroker has client open account and give Δ power of attorney. Δ transfers money to his
own account. SEC brings 10b-5 suit for misappropriation of funds.
o Rule: When the fraud coincides with the sale or purchase of securities, satisfies “in connection”
o Court determines that a cause of action exists
 SEC has always interpreted “in connection with” broadly (Chevron, Mead)
 Includes broker who never intends to deliver securities
 Scheme to defraud is enough; doesn’t need to make misrepresentation about value
 Δ wrote checks to himself knowing it require the sale of securities from client account
Merrill Lynch v. Dabit (US 2006)
o Court rejects narrow construction of “in connection with’ from Zandford.
o Rule: It is enough that fraud coincides with a securities transaction, whether by the Π or
someone else; does not need to be an identifiable purchaser for the SEC to bring suit.
Transactional Causation / Reliance
-
Generally
o Must be causal connection between Δ’s violation of 10b-5 and Π’s purchase or sale
 But for cause
 SEC does not have reliance requirement for enforcement actions
o Materiality
 Texas Gulf Sulphur: If fact is material, reliance is presumed
 No reliance requirement for failure to disclose
 TSC Industries: Fact is material if reasonable investor would attach importance
 Basic/Texas Gulf Sulphur - Test for Pendings Events (i.e. merger)
 Probability events will occur
 Magnitude of event if it occurs
 If Π shows materiality, burden shifts to Δ to show Π would have made sale anyway
 Don’t need to disclose, but if you don’t must abstain (Cady Roberts/Texas Gulf)
o Fraud On The Market Theory (Basic/In re Verifone)
 If market is efficient, there is a presumption of materiality/reliance because the market
price incorporates the fraud and party relied on market price in transaction.
 Δ can rebut presumption by showing the investor did not rely
 Truth on the Market Principle: If the market knows of the misrepresentation,
fraud on the market is rebuffed
 If market is inefficient or illiquid, fraud on the market doesn’t apply.
47
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-
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SEC v. Texas Gulf Sulphur (2d 1968)
o Officers discover valuable mineral site. Buys surrounding land and loads up on stock options
without disclosing value to BOD, even denying rumors about them striking gold. A few days
later, information is released. SEC brings 10b-5 action for insider trading.
o Rule: Broad interpretation of Cady, Roberts Disclose or Abstain Rule
 1) Information must be material – substantial impact on market and affect a reasonable
person in making a choice of action
 Material: Balance of probability of event and anticipated magnitude (TSC)
 2) Information must be non-public
 Insider need not disclose his expertise, but simply the basic facts, can’t lie
o Court determines that results of initial drilling were material and actions violated 10b-5
 Knowledge of a huge strike like this would be relevant to investor
 Insiders themselves made outsize investments during time period
 Only insiders knew true risk profile of their investment (no downside)
o Insiders cannot act until they can reasonably believe that information is public disseminated
 Minor officers need only report to their superiors
Basic Inc. v. Levinson (US 1988)
o Combustion makes offer to Basic. Basic denies talks repeatedly to keep price low. Later BOD
endorses Combustion’s offer. Π’s bring suit claiming they sold after Basic’s initial statement.
o Rule: Omission is material if substantial likelihood that a reasonable shareholder would consider
it important in deciding how to proceed. (TSC Industries)
 Materiality: Look at probability of event and magnitude if it happens
 The issue is that Basic lied; could simply have said nothing
o Rule 2: Fraud on the market theory creates a rebuttable presumption of reliance where
materiality can be shown.
 In re Verifone: Δ can rebut by showing a break in the causal connection
 E.g.) Market makers knew of merger, newspaper, Π doesn’t believe denials
o Court remands issue of materiality after noting new standard
o Dissent rejects fraud on the market theory – no way to know true value
o Best Practice: “No comment”
Efficient Market Hypothesis
o Three forms
 Weak Form: Prices reflect information contained in past prices
 Semi-Strong Form: Prices reflect all published information
 Only insiders have advantage
 Premise for Fraud on the Market
 Strong Form: Prices reflect all info that can be acquired through analysis of company
 Even for insiders
o Based on belief that market prices are correct and investors are rational
o Two Types of Efficiency
 Informational: Price immediately contains all possible info; doesn’t mean price is right
 Fundamental: Prices only reflect info relating to the NPV of its DCFs
o Lessons of Market Efficiency
 1) Markets have no memory; past prices are irrelevant to future changes’
 2) Market price contains all available information
 3) No financial illusions; discounted cash flows are all that matter
 4) Investors will diversify, companies don’t have to
 5) Stocks are unique; investors simply want the most return for the risk
48
Loss Causation
-
-
General
o Analogous to proximate cause
 Wrongful act must cause purchase/sale and the resulting loss
 Causal link – must be foreseeable
 If loss is result of investment risk, no recovery
 Π must show that it was eventual disclosure of truth that caused price drop
 Court can look to market-wide trends to see what caused decline
Dura Pharma v. Broudo (U.S. 2005)
o Π claims Δ made false statements concerning profits and future FDA approvals. Alleges that Π
paid artificially inflated price in reliance on market price.
o Court says fraud on the market resulting in inflated prices does not itself constitute a proximate
cause of economic loss.
 AUSA Life Test: Must show relationship between the fraud and the loss
 Lentell v. Merrill: Must allege misrepresentation directly cause the loss
 Π has not pleaded with particularity facts that show connection
 Value of share at time of purchase was true to FMV; no loss at that time.
 No strong, logical link between inflated price and later economic loss
 Market price may have been affected by other economic circumstances in meantime
 Court says price went down b/c of bad business, not the misrepresentations
 Goal is not to insure investors from economic loss
Scienter Requirement
-
Ernst & Ernst v. Hochfelder (US 1976)
o Δ auditors did not discover that President was engaging in fraud (refused to let anyone else open
the mail). Financial statements were thus inaccurate. Δ says it is not their job to uncover fraud
o Rule: State of mind required for fed securities fraud is scienter
 More than negligence required by 14a-9
 FN12 says that recklessness may be enough
 “extreme departure from standards of ordinary care”
o Actual knowledge of fraud required for forward-looking statements under PSLRA §21E(c)
Manipulative/Deceptive Device Requirement
-
-
Definition
o Misstatements
o Omissions, if and only if, you have a duty to disclose, and must be material under Texas Gulf
Sulphur (reasonable investor would have attached importance)
o Must be actual deception or misrepresentation; unfairness is not enough (Santa Fe)
 Prevents usurping of many state-law claims
 If state remedy is foregone, Π can bring suit under §10(b) (Goldberg)
Santa Fe Industries v. Green (US 1977)
o SF is controller of Kirby and engages in §253 short form merger. Minority shareholders object
to terms under §10(b), arguing that i-banks appraisal was fraudulent, price unfair.
o Court says that no cause of action was state.
 Narrow interpretation of §10(b) language
 No deceptive act b/c information statement complied with §253
 SF gave rationale for their offer price
 Breach of fiduciary duty dealing with internal corporate management is not §10(b)
 Appraisal remedy available under state law; limits similar to Blue Chip Stamps
49
-
Goldberg v. Meridor (2d 1977)
o Duty of loyalty case. Π alleges that controller Δ forced corporation to sell him shares with
inadequate compensation.
o Court permits a 10b-5 claim despite traditional state area.
o Rule: Suit survives Santa Fe if –
 1) Transaction involves stock; AND
 2) Material facts concerning transaction not disclosed to SH, which caused a loss to all
shareholders
 In Santa Fe, there was full disclosure; minority voted.
 If the controller did not need approval by the minority to effectuate transaction, Π must
establish that state remedy is foregone by lack of full disclosure
 Π must also show likelihood of success (rejected by 7th Circuit though)
 DE has duty of complete candor when shareholder action required
Obligations Of A Non-Trading Corporation Under 10b-5
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-
-
Texas Gulf Sulphur: Timing of disclosure of material facts is matter of business judgment, except:
o Must immediately correct misleading or inaccurate statements made by mistake
o Must correct errors in analysts reports
o Duty to correct erroneous rumors resulting from leaks from corporation
o Duty to update forward-looking statement that was correct, but turns out to be materially
misleading (but not projections under PSLRA §21e(d))
Regulation FD
o If a corporation makes a voluntary disclosure, it cannot do so on a selective basis.
 Must disclose to public as a whole if intentional
 Must disclose promptly when non-intentional
SEC Release No. 33-7881
o FD does not create new duty; seeks to forbid using corporate information as way to curry favor
with select group of analysts.
Filing Requirements And Short Swing Trading
-
-
§13(d) and §16(a) stipulate required disclosures by large stockholders; NYSE regulations too.
o §13(d) requires reporting by persons acquiring 5%+
o §16(a) requires filing of a statement of ownership for owners of 10%+
 Must file within 10 days if you are the beneficial owner
 Enforced by SEC
 Follow by Wall St. as a signal of insider sentiment
o §16(b) requires reimbursement of all short-swing profits from trading by 10%+ owner
 Cannot flip securities within 6 months of original purchase (strict liability)
 Enforced by shareholders not the SEC; request corporation bring suit, then wait 60 days
 No contemporaneous owner requirement; can buy stock after and still bring suit
 §16(b)-6 governs options
o §16(c) regulates sales by said owners, directors or officers
o Results in situations where people buy 4.9%, then jump to 9.9%.
Colan v. Mesa Petroleum (9th 1991)
o Δ buys 13.6% of Unocal for $45. Makes tender offer at $54. U makes self-tender at $72. Deal
later struck that allows Δ to participate. U shareholder brings suit for violation of §16(b)
o Court finds that Mesa is liable under §16(b).
 Exchange does not receive protection of “unorthodox transaction” exception
 Exception only applies to automatic/involuntary transactions
 “Economic coercion” not enough to trigger the eception
50
COMMON LAW AND MISREPRESENTATIONS
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Malone v. Brincat (DE 1998)
o Π SH alleges that director Δ forced dissemination of overstated earnings and financials in
violation of fiduciary duty. Also brings suit against KPMG for confirming figures in audit.
Chancery court dismisses b/c disclosure require exclusive federal remedy.
o Rule: Director who knowingly disseminates false information that results in damages to SH and
corporation violates fiduciary duty and may be liable under state law.
 There is no federal remedy here because there was no transactional nexus
 Federal law requires there to actually be a purchase/sale; not simply holding
 Lynch v. Vickers: Directors owe a duty of complete candor to SH
 Stone v. Ritter: Lying to shareholders may be loyalty/good faith claim
 However, case was properly dismissed because should have been brought as derivative
suit, not direct.
 Could resubmit pleadings alleging personal injuries for direct suit.
 Allows SH to get around PSLRA pleading requirements for certain statements
51
SHAREHOLDER SUITS
Derivative Suits
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-
-
-
Generally
o Definition: Suit brought on behalf of the corporation by SH to enforce a corporate cause of
action, usually against directors, officers or third parties
 Corporation must be joined as an indispensable party
 Provides additional bounty hunter against corrupt directors
o Requirements (Chancery Rule 23.1)
 Valid claim on which corporation can sue
 Additional procedural requirements
 Pleading with particularity
 Contemporaneous ownership
 Demand requirement – required to get around §141(a) per Rales
 SH must first approach corporation about indiscretion or show it is futile
 By sending a letter you would admit that BJR applies
 Also in place b/c of additional rights available after demand (special litigation
committee)
 Obtain court approval of any settlement
o Dual nature of claim: SH right to sue and Merits of corporation’s claim
o Cases usually settle if they survive the motion to dismiss
 Case must be settled quickly; mainly in place for deterrence purposes
 SH usually made worse off because payments often made from treasury
Standing
o Π must be SH at time action is begun through the pendency of the action
 SH loses standing in event of merger unless:
 Merger was perpetrated merely to deprive SH of right to bring derivative suit
o Usually results in pro rata settlement (Perlman)
 Merger is a reorganization that doesn’t affect ownership
o Creditors do not have standing, unless they have convertible debentures, in which case they may.
o Personal Defense: SH is barred from bringing suit if…
 Participated in the alleged wrong
 Consented to the wrong or explicitly ratified it
 Guilty of laches
 Tainted Share Rule – transferee of barred SH’s share is also barred
Attorneys Fees
o Π’s bar works as bounty hunter role similar to the one played in Federal Securities Law
o Attorney’s usually find the claim and then look for a nominal Π; usually get huge fees
ALI Approach
o §7.02 – Standing
 Acquired before disclosure and hold through time of judgment; fairly represents SHs
o §7.03 – Demand
 Universal demand required.
52
Direct v. Derivative Suits
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-
Derivative suits are brought by SH on behalf of the corporation; recovery paid to corporation.
Direct suits are brought by SH on behalf of themselves, looking to recover personal losses
o Duty of Loyalty cases (Cookies Foods, Lewis v. SLE, Malone v. Brincat, Disney) are almost
always derivative; those about voting rights, etc. are direct (Blasius, Kahn, Van Gorkom)
o Proxy rule violations and other hybrid claims can be brought as either
Tooley v. DLJ (DE 2004)
o Minority Π bring direct suit against Δ for delaying merger with Credit Suisse, harming
shareholders through time value of money.
o Tooley Test
 1) Who suffered the alleged harm: the corporation or the individual stockholder?
 2) Who would receive the benefit of the remedy?
 Does not require showing of special injury from all other shareholders
o Court dismisses claim for failure to show a harm to the corporate entity itself
 There is no individual direct claim because Πs have not been injured
Contemporaneous Ownership Rule
-
-
SH bringing action must hold shares at time of wrongful transaction and time of trial to have standing
o DGCL §327, ALI §7.02(a), NY BCL §626, FRCP 23.1)
o More important in closed corporation where wrongdoing more often priced in.
Exceptions
o Purchase price does not reflect damages
o Π receives shares through merger/inheritance from owner at time of alleged wrong
o Continuing Wrong Theory (alleged wrong still going on)
o §16(b) short-swing profits
Demand Requirement
-
-
-
Delaware
o SH must bring claim to BOD’s attention and ask them to rectify it before bringing a derivative
suit; otherwise, dismissed for failure to make demand
 Balances §141(a) and relieves court from internal corporate governance matters
 Discourages frivolous litigation
o However, making demand on the BOD is an admission that BJR applies
o Therefore must show that demand is excused by pleading with particularity facts that show
 Directors are interested/dependent
 Independence governed by SOX/exchange rules
 Disinterested product of no financial interest
 Directors are uninformed or acted in bad faith
 Directors failed to exercise sound business judgment and transaction is egregious on face
 Aronson Factors: Majority of directors interested; not sound biz judgment
o Burden is on the Π
New York
o Must actually rebut BJR (Marx)
 Less forward-looking and higher standard than DE
ALI (Pennsylvania)
o §7.03 - Requires universal demand
o §7.04 – Must plead facts with particularity
 If BOD rejects demand, Π can still bring suit if reply raises significant doubt that…
 Statements in reply aren’t true
 BJR wasn’t met
 SoR would not be BJR
53
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-
-
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Futile Demand
o If demand is found to be futile, Board has three options
 Settle (most common)
 Trial on the merits
 Make its own investigation with a Special Litigation Committee (Auerbach / §141(c))
 Committee can cleanse transaction and recommend settlement or dismissal
 Must be composed of directors not on board at time of transaction
 Zapata Test
o Corporation has burden of proving committee’s independence, goof
faith and reasonable investigation
o If burden is met, corporation applies its own business judgment
In re Tyson Foods (DE 2007)
o Π makes written demand for §220 documents and files suit alleging that compensation
committee spring-loaded options for directors.
o Rule: Director who intentionally uses inside knowledge not available to SH to enrich employees
in avoidance of SH imposed requirements cannot be said to be acting loyally and in good faith
o Court denies Δ’s motion to dismiss under the BJR
 Analogizes spring-loading to backdating; material, factual misrepresentation to SH
 Provides bite to second prong of Aronson
Ryan v. Gifford (DE 2007)
o Π shareholder files suit against directors of company including CEO. Shareholder-approved
stock option plan required exercise price be no less than FMV of common stock. Π alleges
back-dating and brings derivative suit.
o Court says Π did plead with particularity; denies Δ’s motion to dismiss
 Under Aronson
 3/6 directors took back dated options  Reasonable doubt of disinterest
o 3/6 is not a majority
 Knowing violation of plan  Reasonable doubt of business judgment
o Stone v. Ritter: Fiduciary bad faith when intentionally self-interested
 Π pleads facts that show highly suspicious timing; egregious on face
Stone v. Ritter (DE 2006)
o AmSouth has a wholly-owned subsidiary, AmSouth Bank. In 2004, AmSouth paid $50MM in
fines to resolve government investigations for certain filing failures and potential illegal activity.
Π brings derivative suit without making demand on AmSouth’s board of directors
o Court dismisses for failure to show demand would be futile
 No red flags to show that BOD was aware that internal controls were inadequate.
 Under Disney and Caremark, BOD has obligation to be reasonably informed on
corporation; an intentional dereliction of this duty is a failure to act in good faith.
 Caremark Test
 Directors failed to implement any reporting system/controls; OR
 After implementing such system, failed to monitor operations anyway
o Rule: Failure to act in good faith is subsidiary piece of duty of loyalty and may cause liability
 Court says duty of good faith does not stand independent of care/loyalty.
54
-
-
-
Zapata v. Maldonado (DE 1981)
o Πs do not make demand in derivative suit claiming it would be futile. Board forms litigation
committee anyway.
o Court says that under §141(a)/(c) BOD still has power to delegate authority to committee.
 Standard of review for committee’s decision is not BJR
 Corporation has burden of showing independence, good faith and a reasonable
investigation under entire fairness
o Best practice is to hire outside counsel and negotiate at arms-length
 Assuming this is done, the court will review the decision of BJR
o Here, demand was futile and suit was improperly dismissed
Auerbach v. Bennett (NY 1979)
o Company launches internal investigation of bribery. Audit committee finds wrong did occur.
Derivative suit brought. BOD creates independent special litigation committee of members not
on board at time of transgression. SLC says not in corps interest to proceed.
o Rule: The business judgment of directors will not be scrutinized by the court so long as directors
are disinterested and investigation leading to business decision was not a sham.
o Court finds that a derivative suit cannot be brought
 BJR still applies when interested directors are excluded from decision-making.
 Nothing in record suggests that committee was not disinterested
 Substantive aspect is inherently product of BJR
 So long as the procedural aspect is fair/disinterested, it passes
Marx v. Akers (NY 1996)
o Π brings derivative suit against IBM, alleging waste of corporate assets through excessive
compensation. Π did not make demand on the board to initiate the suit. Δ seeks dismissal for
failure to state a claim.
o NY Rule: Demand futile if 1) majority of directors are interested, 2) not informed; 3) decision so
egregious cannot be product of sound business judgment. Cannot make conclusory statement.
o Court says Π did not show demand was futile
 Did not show that BOD did not deliberate or were not disinterested
 Demand was futile on excessive compensation claim due to self-dealing, but still did not
plead with particularity.
o Other approaches
 DE: Must show reasonable doubt of BJR (Aronson v. Lewis, Chancery 23.1)
 1) Show majority of directors are interested in transaction
 2) Not valid business judgment (not informed, not rational, best interest of corp)
 ALI §7.03 requires universal demand be made
55
CORPORATE COMBINATIONS
Merger Type
Asset Sale - §271
Classical Merger - §251
Small-Scale Merger - § 251(f)
Triangular Merger - § 251(b)(5)
Short-Form Merger - § 253
Tender Offer - §203
-
Voting Rights
Shareholders of seller vote
Shareholders of both parties vote
(majority of outstanding stock)
Shareholders of smaller co. vote
No vote
No Vote
No Vote
Appraisal Rights
Closed corp or cash merger (for
both sides)
Closed corp or cash merger
No appraisal
Full appraisal
None
Why Merge?
o Economies of scale/scope
o Strategic acquisition
o Excess cash flow
o “Can’t say no” offer
o Owner’s retirement
o Take firm private
ASSET SALES
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-
-
One company sells all or substantially all of its assets to another
o Bought out company still exists; not technically a merger, even if stock purchase
 May dissolve with shareholder vote
o Licenses, rights, and obligations won’t pass on as in true merger
o Old company exists as a holding company
§271 – Sale, Lease or Exchange Of Assets; Consideration; Procedure
o a) BOD can sell, lease or exchange assets when authorized by majority of SH entitled to vote
 Required when selling all or substantially all of the assets
 Gimbel Standard
o Assets are quantitatively vital to corporation (51%+); AND
 Bidding value, revenues, EBITDA
o Substantially affects the existence and purpose of the corp (qualitative)
 If small company buys part of large one, for example
o Hollinger: Not the “coolest” asset, but the one that is most profitable.
 Only the selling company gets to vote, not the buying company, with some exceptions
 Acquiring Company’s Shareholder Rights
o Under §271, have some remedies depending on how paid for:
 Bonds: BOD approval all that is required
 New Stock: Look to §242(a)(3) for amendments b/c new shares
need to comply with COI under §102(a)(4)
 Two-step process to issue new shares
o 1) BOD adopt resolution on forth amendment
o 2) Shareholders must vote for it
 Unissued Stock: BOD approval all that is required
 If >20% of voting power, SH vote required (NYSE
312.03(c))
o b) BOD can abandon sale without approval by the SH
 Fiduciary out.
o c) BOD does not need approval to sell, lease or exchange with subsidiary
No appraisal rights for asset sale under §262
56
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Hollinger v. Hollinger Int’l (DE 2004)
o Subsidiary is suing parent company b/c parent is trying to sell the Telegraph subsidiary without a
§271 vote. SH argue that it is “substantially all” of the corps assets.
o Court uses Gimbel standard (51%+) and says this is not substantially all
 Telegraph might be “coolest asset” but still is profitable company.
 Not quantitatively vital: offer less than 60% of co. value, generates half of profits
 “Substantially all” means “essentially everything”
 51% is not dispositive, but guiding reference.
APPRAISAL RIGHTS - §262
-
-
-
-
-
-
Eligible stockholders who dissent in certain mergers are entitled to fair value of shares
Eligibility - §262(a)
o Must be a continuing shareholder through the effective date of the merger
o Cannot have voted for the merger
Qualifying Mergers - §262(b)
o §251, §252, §254, §257
o Classical mergers of closed corporations
 Market Out Exception (§262(b)(1)(i)): No appraisal for publicly traded companies
o Cash mergers
 §262(b)(2): Appraisal rights in all stock-for-cash deals
 Extra protection because no upside to cash; it is what it is
o Short-form mergers
 §262(b)(3): All short-form mergers get appraisal rights
o When COI stipulates
 §262(c)
Appraisal Notice - § 262(d)
o Corporation has to notify you that you have appraisal rights, then you must demand in writing
o Shareholders must pay for it—costs shared pro rata amongst shareholders
Fair Value - § 262(h)
o Exclusive of value arising from merger itself court considers “all relevant factors.”
o Definition: Best price single buyer could reasonably be expected to pay for the firm as a whole.
 NPV of discounted future cash flows
 Must be fair price and fair dealing, analyzed under entire fairness
Quasi-Appraisal
o Court will sometimes grant both fair value and recissory damages (Weinberger)
 Recissory damages seen as compensation for violation of fiduciary duties
o No quasi-appraisal in short-form managers because no fiduciary claim (Glassman)
 Expedited measures alleviate entire fairness requirement
Other Remedies
o Availability of appraisal rights does not preclude other remedies (Rabkin)
Damages Under Appraisal v. Fiduciary Duty
o Appraisal: Right to going concern (fair price)
o Fiduciary Duty: Entire fairness is fair price (in appraisal) and fair dealing
 Must go through trial only for this
 If you win, receive reasonable expenses
57
MERGERS
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-
-
-
Classical Mergers - § 251
o §251(a): Any two or more corps may merge into one.
 New company can keep name of one ones, or make a new one.
 Licensing, rights, obligations, etc. must continue
o Merger Process
 §251(b): BOD adopt a resolution approving the merger
 §251(c): Shareholders of each corporation vote
 Abstention is a no vote; proxies may be used
 §251(e): Shareholder vote on merger ratifies new COI (no second vote)
o Consideration for merger at discretion of parties (§251(b)(5))
o Fiduciary Out - §251(d)
 Agreement should include provision allowing renege for better deal
 Better offer must also compensate for termination fee of old deal
 Allows for satisfaction of fiduciary duties per Van Gorkom
o Parent-Subsidiary Merger - §251(g)
o Consolidation: Same as merger, but one constituent is absorbed into another
Small-Scale/Pipsqueak Merger - §251(f)
o Big company buys small company
 Merger agreement cannot amend big company’s COI
 SH in surviving corporation must have identical value to former
 No new shares may be issued
 Authorized, unissued shares used cannot exceed 20%+ of Big’s total common stock
o Only SH of small company get vote
 This is a relatively small transaction for Big; business judgment
o §262(b)(1): No appraisal rights for publicly traded companies
Short-Form Merger - §253
o If parent owns at least 90% of sub, can buy remainder without SH vote of either corporation and
without the approval of sub’s board
o Glassman: Expedited merger, so don’t have to establish entire fairness (independent committee)
 Simply go to secretary of state and file forms, essentially.
o §262(b)(3): Appraisal is the only remedy for minority shareholders
o Occasionally used to issue cash rather than stock to minority shareholders
Triangular Mergers
o §251(b)(5): Designed to give management for form of a merger without necessarily
incorporating the liabilities of the disappearing corporation, and without voting or appraisal
rights (§262(b)(2)(b)) from the survivor’s shareholders.
 S and T want to merger. S will be survivor; T will end up with shares of S.
 In a normal merger, S would issue X shares of its own stock
 In a triangular merger, S creates new subsidiary (Z). Transfers X shares of S stock to Z.
 Permitted by §251(b)(4)
 Z and T engage in a statutory merger, where Z transfers S stock to T.
 T is now, in effect, a wholly own subsidiary of S. S is insulated from T’s liabilities.
o Unfortunately allows for subversion of voting rights
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Terminology
o Freeze Out: Transaction whose purpose is to reconstitute corporate ownership by involuntarily
eliminating the equity interest of minority shareholders
 Cashout Merger: Survivor of merger issues cash instead of stock
 Freezeout possibilities from §253 extend to additional transactions
 Reverse Stock Split Freezeout: When minority shares become fractional, they must
surrender.
o Lock-up: Protects white knight from outside bids by giving option to acquire at favorable price
o Fair Price Provisions: Requires supermajority (80%+) of voting shares approve any merger when
acquirer owns a certain percentage of the corporation (20%+)
o No-Shop Clauses: Merger agreement may require BOD to recommend merger to SH, or not shop
around.
Weinberger v. UOP, Inc. (DE 1983) (Identifies Best Practices)
o Direct class action challenging value received for shares. Signal has a lot of cash and buys some
of UOP, looking to buy it all. Board of UOP has five directors of Signal. Market price is $14,
but artificially reduced by controlling shareholder.
 Company hired Lehman Brothers to determine whether $20-21 is a fair price, but did
NOT ask them to independently come up with a fair price. (Not best practice)
 Company rushed the process – only 4 days (Not best practice)
 Dual officers of two companies doing negotiations (Not best practice – not arms-length)
 Did not disclose that initial report concluded a fair price would be between $21-24
o Rules
 Π first must show interested transaction. Then burden on Δ unless majority of minority
SH make fully informed vote in favor of the transaction. Burden then shifts to Π.
 Requires fact pleading for direct suit
 Appraisal is the exclusive remedy in a cash-out merger
 Unflinching duty of entire fairness owed by self-dealing fiduciaries
 Fair dealing: timing, how deal was initiated, structure, negotiated, disclosed, etc.
 Fair price (§262(h)): economic/financial considerations, including assets, FMV
 Same duty not owed in §253 short-form mergers
o Holding
 Minority SH not fully informed; Δ did not meet burden of showing merger was fair:
 Minority did not show basis for invoking entire fairness standard
 But, Signal violated fiduciary duty by not disclosing the feasibility study
 No fair dealing because of best practice violations above
 Δ has not shown a fair price – must use modern valuation techniques
o Footnote 7: If it’s an arms-length negotiations, the court will say its fair.
 Π must provide some basis for invoking fair test; showing interest in transaction is okay.
Glassman v. Unocal Exploration Co.
o Unocal owns 96% of UXC. Uses special committee to consider short-form merger. Π minority
files a class action alleging breach of fiduciary duty of entire fairness and full disclosure.
o Rule: In Short Form §253 merger, controlling fiduciaries of parent corporation do not owe a duty
of entire fairness to the sub. Absent fraud or illegality, appraisal is exclusive remedy.
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TENDER OFFERS
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Generally
o Differs from a merger in that you go directly to target corps SH
 Origins are hostile takeovers, but can be friendly
 Voluntary and non-coercive, therefore there is no fiduciary duty implicated
 If you don’t want to tender, don’t tender; no claim for unfairness (Solomon)
 No negotiation with board, so no concerns of arms-length, etc.
 Exception: Two-tiered tender offers are coercive
 Not discussed in DGCL; only protection is §203
o Two Stages
 1) Get control
 Take ad in WSJ or something saying you’re trying to buy controlling %.
 2) Acquire the whole-company through a squeeze out
 If 90%+ holder, can do short-form merger under §253
 If 51%+ holder, but less than 90%, takes longer, must use §251
o Target can delay even longer if board is staggered
 Minority SH have right of appraisal, but is not exclusive remedy unless §253
o Minority protected by complete disclosure, lack of coercion and potential defensive measures
§203 – Business Combinations With Interested Stockholders
o Puts BOD in place to force raider to negotiate with BOD
o a) Prohibits interested SH from collecting other shares on back-end (“engage in business
combination”) for 3 years following tender offer, unless…
 BOD approves combination
 Upon consummation if SH gets at least 85% of the voting stock
o b) Other exceptions (see p. 622)
Solomon v. Pathe (DE 1996)
o Π argues that tender offer was unfair to all SH. Asserts breach of duty of fair dealing b/c
directors did not oppose the tender offer.
o Court says tender offer is voluntary, and there is no cause of action.
 Sell your stock if you don’t like the offer
 Tender offer is not voluntary in event of coercion of misleading/fraudulent disclosures.
Pure Resources Shareholders Litigation (DE 2002)
o Rule: Entire fairness standard of Kahn v. Lynch is not applicable to a tender offer by a
controlling shareholder. Only protection is that it can’t be coercive, determined by…
 Minority SH that are independent and disinterested from acquiring corp vote to approve
 Controller promises to consummate a prompt §253 merger upon owning 90% of shares.
 AND; Controller has made no threats of hostile action should tender fail
o Rule presents dilemma for shareholders who don’t want to sell, but may be subjected to §253
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DEFENSIVE MEASURES
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When faced with hostile tender, BOD has the authority to take defensive measures
o §141(a): BOD has duty to manage in the best interests of the shareholders
o §160(a): Board has authority to manage the company stock
Defensive measures judged under the Unocal/Unitrtin Standard—if standard is met, BJR applies
o 1) Must be reasonable grounds for perceiving a threat to the corporation
 Unitrin: Process based inquiry; types of threats are…
 Opportunity Loss (deprives SH chance to select superior alternative)
 Structural Coercion (risk of disparate treatment of non-tendering SH might
distort decision making)
 Substantive Coercion: Risk SH will accept low offer b/c of disbelief in
management’s intrinsic valuations
 Threat to Corporate Policy: Directors do not have to sacrifice long-term strategic
vision for short-term value (Time-Warner)
 Cannot be acting to perpetuate directors in office
o 2) Reasonable response that’s proportional to the threat
 Unitrin: Proportional means it cannot be draconian
 Preclusive: Bidder has no way to achieve takeover appealing directly to SH
 Coercive: SH have no other choice
o Termination fees, stock option agreements, etc. may be coercive
 BOD must inspect process: inadequacy of price, timing/nature of offer, illegality, effects
on creditors/employees/customers, quality of securities being offered.
 Best Practice: Get approval by independent directors
 Dead-Hand Poison Pills and Delayed Redemption Provisions are invalid because they
deprive the new board of its ability to manage (§141(a) and Quickturn)
 Board cannot entrench itself
o Standard is negligence; board’s decision to enact must be informed and disinterested
o Decision to take, and to maintain a defensive measure is subject to scrutiny.
 Time Warner: Can leave defensive measure in place, but may eventually violate duty.
Board has duty to act in face of coercive tender offer
o Breach of fiduciary duty for gross negligence
o Securities laws under the Williams Act
Unocal v. Mesa Petroleum (DE 1985)
o M makes two-tier “front-loaded” tender offer for U at what U believes is a low price financed by
junk bonds. U’s disinterested board gets outside opinions, then makes a self-tender for a much
higher price and excludes M from terms. M files for injunction
o Court: Corporation’s board has right to oppose takeover threat and exclude raider-shareholder
 Board has inherent authority to issue stock and manage under §141(a)/§160(a)
 Majority of independent directors found that M’s threat was classic coercion
 Board’s exclusion is reasonable and proportional
 Therefore, to proceed, M must rebut the BJR
 Directors duty to Mesa is superseded by duty to the corporation.
o Note: Discriminatory self-tender now impermissible under Rule 13e-4(f)(8)(i)
Unitrin v. American General Corp (DE 1995)
o Puts a “gloss” on Unocal
 1) Was there a threat to the company?
 2) Was the response reasonable and proportional?
 These first two are the same as Unocal
 3) Proportional means not draconian (coercive or preclusive)
 Threat, Opportunity Loss, Structured/Substantive Coercion
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Moran v. Household International (DE 1985)
o Δ’s board adopts poison pill that allows SH to purchase stock at half-price. Π brought suit to
invalidate.
o Rule: Poison pill provision is not per se legal. Response to reasonable fear of hostile takeover.
 §157 – Rights and Options Respect Stock
 §141(a) also
 Board cannot arbitrarily reject tender offers, and SH can still entertain offers
o Court allows poison pill to stand
 Δ meets initial burden under Unocal/Unitrin by showing that decision was informed
and made by independent directors
 There was a good faith and reasonable investigation with outside counsel
o Best practice
 It was reasonable in proportion to threat of increasing “bust-up” takeovers
 Therefore, burden shifts to Π under BJR
 Board was informed and had good faith belief poison pill was necessary
Carmody v. Toll Brothers (DE 1998)
o Rule: Dead hand poison pill that can only be redeemed by BOD that adopts it is invalid.
 Impermissibly creates voting-power distinction among BOD without COI authorization
 Also interferes with §141(a) rights
 Unlawful under Blasius because it interferes with SH voting franchise without a
compelling justification
 It is disproportionate under Unocal/Unitrin because it precludes SH rights to take offer
Quickturn Design Systems v. Shapiro (DE 1998)
o Q initiates two defensives measures: 1) amends SH rights plan with a delayed redemption
provision; 2) amends by-laws to delay holding of any special SH meeting by 90 days.
 Combined effect would be to delay any acquisition by at least nine months.
o Delayed Redemption Provision would prevent newly elected board from completely discharging
its management duties, and is therefore invalid.
 §141(a): an “unremitting obligation” to manage in best interest of corporation
 Any limitation on BOD power must be in COI
 Paramount v. QVC: Provision is invalid if it limits ability to fill fiduciary duties
DUTIES IN SALE OF COMPANY/CONTROL – REVLON LAND
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Triggering Revlon Land
o Revlon: All cash-out deal automatically triggers it
o Time-Warner: Corp initiates active bidding process seeking to sell or reorganize involving a
clear break-up of the company
o Time-Warner: Target company abandons LT strategy and seeks alternative transaction
involving break-up of company, even if coerced
o QVC: Sale by a group of individuals to someone who will become controller
 Future of company at stake with controller coming into being
Duties In Revlon Land
o Must act neutrally, cannot favor one bidder
o Only interest is to maximize shareholder value
o Best Practices
 Board must be adequately informed; Must analyze entire situation (risk, bidder’s
identity, etc.); Conduct an auction; Canvas the market; Independent directors
 Barkan: No single way to sell off the company
Unocal v. Revlon
o Unocal deals with defensive measures in response to coervice, inadequate threats, no BOD sale
o Revlon does not deal with a coercive threat, but an all cash deal, and BOD later puts up for sale
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Revlon v. MacAndrews & Forbes Holdings (DE 1995)
o Pantry Pride tells Revlon they want to buy it. R thinks price is to law and refuses to negotiate;
sets up some legal defensive measures. PP keeps increasing price. R solicits white knight bid
from Forstmann and seeks to sell to F at a lower price through an LBO.
 The defensive measures comported with Unocal/Unitrin (reasonable response)
 Defensive measures legal so long as they don’t interfere with auction.
 Lock-up provision/Termination fee prevented PP’s higher bids
 The hiring of F is evidence that company is up for sale
 PP says it will top any bid by F
 The LBO will result in the cash-out of R shareholders
 This triggers Revlon land and R has duty to get highest price.
 R tries to argue they are looking at other constituencies, but they cannot
o ALI §2.01(b)(2): Only requires enhancement of shareholder value, not maximization
o Barkan v. Amsted Industries (DE 1989)
 Do not have to conduct active market survey but must run auction in neutral manner
 Directors must have reliable evidence that price is fair
o Fully informed, Outside valuation, etc.
o Lyondell v. Ryan (DE 2008)
 Not in Revlon land until board recognizes it has to do the deal. Up until then, BOD can
always say they are not interested in doing the deal.
Paramount v. Time
o Time and Warner want to have merger of equals. P decides it wants in on auction. P goes after
T and T enacts defensive measures. T says merger with W is better because it creates more
synergies; market likes P deal. Board is clearly informed.
o Court says that Revlon land does not apply
 Company is not obliged to abandon a long-term plan for short-term gain
 Threat to corporate policy
 Market is not king; BOD still has authority to make decisions
 There is no substantial evidence that dissolution/breakup of company was inevitable
 T’s response was informed and reasonable/proportional under Unocal
o Stands for proposition that corporation can “just say no” so long as they are informed
Paramount v. QVC
o P finds partner for merger in Viacom. Q tries to make its own offer but P won’t listen.
Defensive measures are instituted.
o Court says that Revlon land occurs when a corporation initiates reorganizations or breakup; OR
when active bidding is initiated, such that the long-term goals of the company are abandoned.
 Importance of change of control; when a majority of voting power is acquired by a
single person there is a dimunition in voting power for the new minority
 Selling to a controller will put you in Revlon land
 Therefore the burden is on the BOD to show the adequacy of the threat to the
corporation and the reasonableness of their response (Unocal/Unitrin)
o P found to have violated duties to shareholders by favoring Viacom deal arbitrarily
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AGENCY ............................................................................................................................................. 2
Types of Authority ......................................................................................................................................2
Agent Liability To 3rd Parties .......................................................................................................................2
Agent’s Duty of Loyalty ...............................................................................................................................3
PARTNERSHIP ................................................................................................................................... 4
Definition ....................................................................................................................................................4
Existence of Partnership .............................................................................................................................4
PARTNERSHIP VS. CORPORATION ..................................................................................................................4
PARTNERSHIP FORMATION ............................................................................................................................5
LEGAL NATURE OF PARTNERSHIP ...................................................................................................................5
Partnership: Aggregation of Individuals or Entity ......................................................................................5
Ongoing Partnership Operations ................................................................................................................5
AUTHORITY OF THE PARTNER ........................................................................................................................7
LIABILITY FOR PARTNERSHIP OBLIGATIONS ...................................................................................................7
PARTNERSHIP PROPERTY ................................................................................................................................8
PARTNERSHIP INTEREST & TRANSFERABILITY ................................................................................................8
PARTNER’S DUTY OF LOYALTY ........................................................................................................................9
DISSOLUTION ................................................................................................................................................10
LIMITED PARTNERSHIPS (LP) ..................................................................................................... 12
Key Features .............................................................................................................................................12
RULPA .......................................................................................................................................................12
CORPORATE FORM ........................................................................................................................ 13
SELECTING A STATE OF INCORPORATION ....................................................................................................13
DGCL .............................................................................................................................................................13
CORPORATE MANAGEMENT ........................................................................................................................16
OBJECTIVES OF THE CORPORATION .............................................................................................................16
BOD Duties................................................................................................................................................16
CORPORATE STRUCTURE ............................................................................................................ 17
ALLOCATION OF POWER (MGMT v. SHAREHOLDERS) .................................................................................17
STANDARD OF REVIEW FOR SHAREHOLDER-MGMT DISPUTES ...................................................................18
Four Standards of Review for Corporate Actions .....................................................................................18
Blasius Cases .............................................................................................................................................19
PIERCING THE CORPORATE VEIL ...................................................................................................................19
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Limited Liability.........................................................................................................................................19
Cases .........................................................................................................................................................20
Uniform Fraudulent Transfer Act .............................................................................................................21
Doctrine Of Equitable Subordination .......................................................................................................21
INFORMATIONAL RIGHTS AND PROXY VOTING ................................................................... 22
INDEPENDENT DIRECTORS ...........................................................................................................................22
INFORMATIONAL RIGHTS UNDER STATE LAW .............................................................................................22
Cases .........................................................................................................................................................23
INFORMATION RIGHTS UNDER FEDERAL LAW .............................................................................................23
The Securities Exchange Act of 1934 ........................................................................................................23
PROXY RULES ................................................................................................................................. 25
PROXY FILING ANALYSIS ...............................................................................................................................25
PRIVATE ACTIONS UNDER PROXY RULES......................................................................................................26
Cases .........................................................................................................................................................26
SHAREHOLDER PROPOSALS UNDER 14a-7 and 14a-8 ..................................................................................27
Cases .........................................................................................................................................................28
PROXY FIGHTS...............................................................................................................................................29
Cases .........................................................................................................................................................29
DUTY OF CARE ............................................................................................................................... 30
BACKGROUND ..............................................................................................................................................30
Cases .........................................................................................................................................................30
BUSINESS JUDGMENT RULE (BJR).................................................................................................................31
Duty of Care Cases ....................................................................................................................................32
Steps in A Derivative Suit..............................................................................................................................33
DUTY OF GOOD FAITH ................................................................................................................. 34
Cases .........................................................................................................................................................34
DUTY TO MONITOR SUMMARY ................................................................................................................35
DUTY OF LOYALTY ....................................................................................................................... 36
BACKGROUND ..............................................................................................................................................36
Mechanics .................................................................................................................................................36
Duty Of Loyalty Cases ...................................................................................................................................37
Basic Self-Dealing......................................................................................................................................37
Executive Compensation ..........................................................................................................................38
Corporate Opportunity Doctrine & Corporate Assets ..............................................................................39
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Obligations In Sale Of Control By Controlling Shareholder ......................................................................40
Sales of Control .........................................................................................................................................42
INSIDER TRADING ......................................................................................................................... 43
Elements of a 10b-5 Case .............................................................................................................................43
Private Causes Of Action Under The Act ..................................................................................................44
To Whom Does 10b-5 Apply .....................................................................................................................44
Transactional Requirement: “In connection with the purchase or sale” .................................................46
Transactional Causation / Reliance ..........................................................................................................47
Loss Causation ..........................................................................................................................................49
Scienter Requirement ...............................................................................................................................49
Manipulative/Deceptive Device Requirement .........................................................................................49
Obligations Of A Non-Trading Corporation Under 10b-5 .........................................................................50
Filing Requirements And Short Swing Trading .........................................................................................50
COMMON LAW AND MISREPRESENTATIONS ........................................................................ 51
SHAREHOLDER SUITS .................................................................................................................. 52
Derivative Suits .........................................................................................................................................52
Direct v. Derivative Suits...........................................................................................................................53
Contemporaneous Ownership Rule .........................................................................................................53
Demand Requirement ..............................................................................................................................53
CORPORATE COMBINATIONS .................................................................................................... 56
ASSET SALES ..................................................................................................................................................56
APPRAISAL RIGHTS - §262 ............................................................................................................................57
MERGERS ......................................................................................................................................................58
TENDER OFFERS ............................................................................................................................................60
DEFENSIVE MEASURES .................................................................................................................................61
DUTIES IN SALE OF COMPANY/CONTROL – REVLON LAND..........................................................................62
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