EO
I. Introduction to Organization in Firms
A. Introduction
1. 6 Basic Concepts:
a. Risk v. control: As one ascends, the other descends, and vice-versa. The idea here is,
with greater risk comes greater possibility of big success. But with EO, big success can
only be had by ultimately relying on others. Hence the loss in control. On the other hand,
too much control shuts out lots of options.
b. Form over substance: There’s legal fiction, everywhere.
c. Corporations are all about people.
d. Money and markets matter (to whom is management responsible).
e. Rules re: corporate law are passed by legislatures. With that in mind, ask yourself,
“Who is supposed to benefit, and are the results of these laws optimal?”
Another important question to ask is how do people set up enterprises given the rules
under which they must operate? Rules really do matter.
A final question to ask is when (and/or if) private arrangements should give in to public
concerns.
f. Last, but certainly not least: planning by lawyers is important. Figure out the rules,
and draft wisely! You will avoid many potential pitfalls.
2.
a.
1)
2)
3)
Powers, Gain
Why read it?
It’s all about how people make companies.
There are several instances of the risk/control interplay.
It’s a good examination of the thoughts behind the corporate process.
b. The three phases:
1) The Entrepreneur: Clare.
a) Needs backers. The limitations of control.
b) Hard to find investors.
c) Could get a loan, but that’s really risky.
d) What about shareholders?
Note: When a company dissolves, all remaining assets are first used to pay off any debt.
Whatever is left then goes to shareholders. Shareholders are therefore allocating some
of the risk (but are also taking some of the control). Hmm, this looks like one situation
where a higher risk for the entrepreneur may allow for greater control.
2) The Partnership: Clare’s sons and Innis.
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a) Less control for the sons, since they allocate control to Innis. On the other hand, they
have greater control of the market.
b) At the same time, there is less risk, since the partnership controls the manufacturing,
as well as the merchandising. On the other hand, with a bigger structure, there’s more
room for trouble.
3) The Corporation: The End.
a) Continuance - Corporations are the modern transmitter.
b) Less risk #1 - protected by the government.
c) Less risk #2 - Limited liability.
d) Beware: Control problems can sneak back in here. Consider that the pursuit of profit
is overshadowed by the pursuit of steady growth. Board of directors symbolizes this loss
of freedom.
e) Another problem exists in the alienation of control from the means of production and
marketing.
c. Two final points:
1) Corporate law is only a small part of the story. Fed securities law trumps corporate
law. Don’t ignore it, just the same.
2) Freeze-outs. Common in smaller companies, this is where larger shareholders force
smaller shareholders out. To avoid this, plan carefully. Most common and statutory law
will also help, since we wish to protect investors (and investing).
B. Agency Principles
1. Cases
a. Humble Oil Refining Co. v. Martin
Facts: Car roles away, hitting P. Gas attendant was negligent. P claims that D is liable,
since attendant was an agent of D. D claims that attendant was really an independent
contract, and that D therefore isn’t liable.
Holding, Reasoning: The big question is whether D controlled the attendant. This court
finds D did. Court bases its opinion on several factors:
 D provided the equipment
 D established the hours of operation
 D managed the operating costs
 The station only sold D’s products
 Other stuff
b. Hoover v. Sun Oil
Facts: Similar to Humble, but here negligent gas pumping caused a fire
Holding, Reasoning: Court determines attendant is an independent contractor. The
attendant:
 Controls hours
 Gets advice, not comands
 Rent (?)
 Controls compensation. The attendant has “the overall risk of profit and loss.”
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No written reports between parties.
Either party may terminate @ will.
c. Question: Are these cases really that different?
1) These difference look substantial in form, only. For example, the “advice” given in
Hoover could also conceal threats which would be just as coercive as the commands in
Humble. It would seem the rule is just play the game, and make it look right.
2) Perhaps there is a policy rule here. Ask yourself, which party would best be able to
control risk? This would still lead to gray areas, but provides a nice simple question in
place of reliance on formalities.
3) Note the trade-off: greater control may be economically sound, but it may increase
liability (although it may also decrease negligent behavior). Consider which of these two
costs more: bonding costs, or insurance premiums.
d. Gay Jenson Farms Co. v. Cargill, Inc.
Facts: Warren gets line of credit from Cargill to sell grains. Hill sells grain to Cargill,
which pays off line of credit. Warren goes out of business.
Holding, Reasoning: The big question is, was there a special relationship between Cargill
and Warren that would make the former responsible for the latter’s problems? The court
decides that there is.
Note: Professor West notes two factors that should make us suspicious are the
increasing line of credit and the “strong paternal guidance.” In considering the first
factor, a good question to ask is would an independent interest really behave in this
manner. It’s a comparative question, but even with little empirical data, it would seem
Cargill’s behavior indicated too great a concern with Warren’s well-being to indicate an
arm’s length relationship. On the other hand, perhaps Cargill just has a stupid loan
officer. Even though the loan officer is definitely an agent of Cargill’s, would that
connect the two companies? As for the latter, this court list several sub-factors in
determining Cargill’s relationship. We’ll indicate the factors Professor West deems truly
important.
The court rules that Cargill assumed control of Warren’s business, using the Restatement
(Second) of Agency and a practical laundry list to draw this conclusion.
Note: The Restatement is really more about the actions of the two parties, and less about
the contract between them.
The laundry list:
1) Cargill’s constant recommendations to Warren by telephone. Too ambiguous to be
really important.
2) Cargill’s right of first refusal on grain. Not important, either. Why not?
3) Warren’s inability to enter into mortgages, to purchase stock or to pay dividends
without Cargill’s approval. Hey, isn’t this a traditional lender requirement? That it is,
but the court recognizes this, considering such a factor only “in light of all the
circumstances surrounding Cargill’s aggressive financing of Warren.” Are there any
other factors that stand on their own?
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4) Cargill’s right of entry onto Warren’s premises to carry on periodic checks and audits.
Same as #3.
5) Cargill’s correspondences and criticism regarding Warren’s finances, officers salaries
and inventory. Same as #3.
6) Cargill’s determination that Warren needed “strong paternal guidance”. This is an
observation; whether it was acted upon is another matter.
7) Provision of drafts and forms to Warren upon which Cargill’s name was imprinted.
That’s something, but not enough on its own.
8) Financing of all Warren’s purchases of grain and operating expenses. Same as #3.
9) Cargill’s power to discontinue the financing of Warren’s operations. Same as #3.
All of these factors seem pretty weak, or at least they don’t indicate how an agency
relationship is any different from a lending relationship. Certainly we don’t want to
lump them all together; that would seriously deter lending. Here are some other factors
which indicate an agency relationship:
1) Cargill contacted Warren’s customers and notified them that Warren’s checks were
good. What gives them that authority?
2) Cargill’s supervision of the elevator.
3) This was a jury trial. Was their finding of an agency relationship clearly erroneous?
Probably not. There’s enough reason to believe the jury’s finding.
2. The Five Types of Agency
a. Actual express agency.
P (the principal) authorizes A (the agent) to negotiate with third party (T). A acts
accordingly.
b. Actual implied agency.
P can’t think of everything A has to do. So, P will tell A “do what you need to get the job
done.” A is therefore acting for P, even if P wasn’t completely specific on all A must do.
However, A is limited by standards of reasonableness (like industry standards, for
instance) and legality. Is that circular? If the behavior was illegal, then P isn’t
responsible, but the only proof is the assumption that P would never implicitly require
illegal behavior of A. I guess the way out of this is asking whether P’s request really was
implicit.
c. Apparent authority.
P notifies T of A’s right to deal. Even if A doesn’t know of authority, T thinks A has it.
Unlike express and implied agency, the communication goes from principal to 3rd party.
Communication has to come directly from the principal. Manifestation of agency can
come through agent to 3rd party.
Could be actual, if P and A had actually communicated.
Can also be non-actual:
P notifies T. P also notifies A, but with provision to call P first. A contacts T without
calling P. A has apparent authority even though A breached an agent relationship with P.
What this means: Draft your authorizations carefully, or don’t tell T that you’re bound
by A.
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Note: Both P and T can enforce any apparent authority arrangements.
d. Ratification.
By enforcing contract, P ratifies it. This is true even where A arranged an unauthorized
contract.
e. Inherent Agency Power
P tells A to do x. Mistakenly, A does y.
Respondeat superior - P should pay for A’s torts. While unauthorized, A’s actions
resemble what P has authorized A to do.
3. Hypo: Paula, Amy and Tom
P tells A to hire a camera person – express authority to hire, implied authority to take care
of contract details
T wants a job as a camera person, asks P. P hates T, says, “I’d love to work with you, but
A is doing hiring.” P tells A, under no circumstances hire T. A talks with T, T convinces
A to hire him. A hires T. P fires A, but loses in court when she refuses to honor the K
because A had apparent authority.
Twist 1: Manifestation that A is doing hiring comes through agent of P. A still has
apparent authority. Manifestation can come through an agent (here, secretary).
Twist 2: A tells T that she has authority to hire. T did not hear this from P. Might have
case for apparent authority. Difficulty: A leaves out that she does not have authority to
hire T.
Twist 3: P has a good reputation for making family films. Decides to do a racier film.
Asks sleazy director Alice to do everything as if she’s the sole producer, but not to let
anyone know that it was her behind it. Only other stipulation: don’t hire T. A hires T. P
fires A. T sues P. P is liable, should be careful in choosing agents.
Twist 4: A hires T, tells P. P says, “I told you not to hire him.” A apologizes. P says,
“fine, I’ll go along with it.” K ratified by P.
4. More Cases
a. Lind v. Schenley Industries, Inc. (p. 30) [Seinfeld-esque?]
Facts: Herrfeldt (VP of Park) tells Lind that Kaufman would inform him of the details of
his compensation. Kaufman told L he would get 1% of the gross sales of the men under
him. Kaufman had no authority to set salaries – only the president did – and the president
did not authorize the compensation Kaufman offered L.
Holding, Reasoning: Park was liable under a theory of apparent authority.
Restatement defines apparent authority as “[T]he power to affect the legal relations of
another person by transactions with third persons, professedly as agent for the other,
arising from and in accordance with the other’s manifestations to such third persons.”
Court goes on to consider the manifestations:
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K’s power to set salaries. Kaufman only has authority to offer commission if it’s
close to salary company would normally offer. Apparent authority depends on 3rd
person believing it would be reasonable. The commission would have quadrupled
L’s salary. This isn’t really reasonable. If L was really concerned, why didn’t L hold
off for years before saying something.
 K was “the boss.”
Reasonableness is the big issue. The longer the contract, the greater the responsibility of
employee to determine its reasonableness.
Note: How could this have been avoided?
By L? L could have asked for the K in writing, gone to H to approve it.
By Park (the company)? Park could have had an employee manual, rule about approving
commissions or new salaries that increase your compensation by more than a particular
percent.
These do not avoid inherent agency, agency manifested by A. P’s safeguards against A
really only work if A is an honest A, or if A couldn’t claim ambiguity in P’s
communication.
b. Watteau v. Fenwick (p. 43)
Facts: Humble’s (A) beerhouse was bought out by a firm of brewers (Watteau, et al. - P).
A remains as manager, his name is over the door. P tells A to buy all his needs (except
bottled ales and mineral water) from P. A buys cigars, bovril and other articles and didn’t
pay up.
Issue: Does P owe anything to T?
What sort of agency are we considering?
No manifestation by P (principal) to T  no apparent agency.
No express authority by P to A  no actual (or implied) authority.
Holding, Reasoning: Inherent agency power applies here since the 3rd party could
perceive the sale as being within the scope of H’s duties. Doesn’t matter that principal is
undisclosed. Why should principal be responsible for agent’s acts? Principal is the best
equipped to know the agent hired and to guard against poor business practice by agent.
c. Bacroft-Whitney v. Glen (p. 58)
Facts: Glen’s “sins”:
 personally recruited B-W employees
 assisted recruitment (by supplying picture) and
strategizing
 misled LCP as to whether he would help thwart a
raid (see fn.7, p. 61)
 gives MB salary information
Holding, Reasoning: (p. 65) – Guth v. Loft:
“Corporate officers and directors are not permitted to use their positions of trust and
confidence to further their private interests. While technically not trustees, they stand in a
fiduciary relation to the corporation and its stockholders.”
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Hypo: AFoster invited by competitor law firm to open new branch office and bring some
good people with her. What can she do?
 Fellow associates? Real world answer: practice of recruiting others is very common
(more so peers than subordinates?)
 What about recruiting clients? Not allowed, but this actually happens even more
commonly than recruiting associates. Can’t recruit clients before leaving.
Underhanded stuff happens. Explicit recruiting would be a breach of fiduciary
responsibility.
 Watch out for confidentiality and conflict of interest situations.
 The Restatement allows for liability for breaking contract, but an attorney isn’t on
contract.
 Safe harbor approach – announce you’re leaving first, drop hints later
e. Town & Country House & Home Service, Inc. v. Newberry (p. 71)
Facts: T&C cleaned houses, s are their former employees. s left to open their own
home-cleaning business, enticed away clients of T&C.
Holding, Reasoning: This court treats the case as a client list which is a trade secret.
Prof. W: Case is really about implicit application of the duty of loyalty. Just because
your employment has ended doesn’t mean your duty of loyalty is over.
Different from law firm situation. Lawyers often call up old clients after leaving one firm
for another. Generally, this is not seen as breaching a duty of loyalty.
Why? Courts make distinction between legal services and cleaning services.
Should they? Both involve a degree of trust between client and service-provider.
C. Partnership
1. The Framework.
a. Distinguishing factors (Note: Form over Substance re: distinctions from
corporations).
taxes
partnership
doesn’t pay taxes
partners report gain/loss on
individual returns
liability
unlimited
transferability of non-transferable
interest
life
limited life
corporation
pays taxes twice – (1) by corporation and (2)
by shareholders on dividends
Special tax rules:
 corporation can elect to be taxed as an SCorporation. Need less than 35 shareholders with
one state of residence; shareholders then pay tax
on individual returns
 Corporations can get special expenses – lunch,
travel, etc. – treated specially.
 State taxes too – incl. franchise taxes (just to be
registered as a corporation in the state)
limited
shares may be transferred
unlimited life
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flexibility
more flexible
centralized
management
could provide for a
centralized management
structure
expenses
less flexible, standardized, have by-laws, etc.
But, can structure agreements/corporate docs
to be more flexible
has board of directors, CEO, power structure
added costs: tax returns (accountants charge
more), incorporation fees
b. Limited partnership – one partner or more is a limited partner, enjoys same status as
shareholder; other partners are general partners
Don’t need to register with any government authority in order to become a partnership.
Just start acting like one – *share profits, *share control. Can become partners whether
you want to or not. Don’t need a formal agreement.
However, to become a corporation, need to register/apply with the Secretary of State.
c. Hypo:
1) Scenario: Clinton and Yeltsin resign and decide to go into business together, open a
Stucky’s in the South. Both are wealthy and want to protect their assets. The firm is
small, don’t want to spend their own money, go for loans. But bank will probably ask
them to vouch for their loans with their personal funds.
2) Liability?
Partnership - If there are 5 investors and one wants to run the business while the others sit
back. Bank might be satisfied with only the active people securing the loans.
May be able to get insurance to cover liability.
Limited Partnership - Protects assets, and limited partners are very limited in liability.
3) Transferability - Want transferability of interest  corporation
Stock of closed (smaller) corporations are easily transferable. Can use stock repurchase
agreement to restrict movement of shares.
Partnership – new partners admitted only on vote of existing partners. Partners can
decide that the vote need not be unanimous.
4) Duration - Theoretically, a corporation has an unlimited life while a partnership does
not. In theory, whenever a partner dies, the partnership dies as well and other partners
have to reconvene and vote to re-enter the partnership. Starting 50 years ago, courts
allowed partnerships to make rules that the death of a partner doesn’t end the partnership.
5) Flexibility - Generally less with corporations (by-laws and such).
6) Overall - you can manipulate surrounding to achieve results either way.
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d. Another alternative - Limited liability corporation (LLC). Tax treatment as
partnership, everything else is like a corporation.
2. What Makes a Partnership
a. Excerpts from the Uniform Partnership Act
Section 6 - Partnership is an association of two or more persons to carry on as co-owners
a business for profit. Must conform with rest of act.
Section 7 - Sharing of property does not of itself establish a partnership. Neither does
sharing of gross revenue. Profit sharing is primie facie evidence of a partnership, unless
such profits are received in payment:
 as a debt
 as wages or rent
 as an annuity
 as interest of on a loan
 as the consideration for the sale of a good-will of a business.
Section 9 - Carrying on business as if the business was a partnership binds the
partnership, unless partner A has no such authority, and partner B knows A has no such
authority. Also, the partners’ acts must apparently be for the carrying on of business to be
binding, and mustn’t contravene a restriction established in the partnership.
Section 13 - If A fucks up, all partners are liable.
Section 14 - Clarifies partners’ liability.
Section 15 - Further clarifies partners’ liability.
Section 16 - If A claims to be a partner of B’s to X, and X acts in reliance to this claim, A
is liable to X.
b. Application
1) Scenario: Sarah, Sam’s daughter, goes to work for Sam. Sam says no to partnership,
but pays her $20/week and 20% of profits. Time goes by. Sam occasionally pays bills
addressed to “Spade and Spade”. Sam takes to drinking, gets in trouble with creditors,
promises good things for Sarah if she helps him out, and Sarah pays some bills with her
own funds. Sarah eventually leaves, but wants a share of Sam’s supposed ill-gotten gains
that should have gone to the business.
2) Is Sarah a partner?
Is Sarah a partner when she walks in the door?
 Do Sarah and Sam share both profits and control? UPA § 6. Partnership Defined
Some profit sharing.
But no sharing of control. No partnership
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See also UPA § 7(4) – sharing profits as a way of paying an employee is not even prima
facie evidence of partnership
Later Sam tells Sarah to pay off creditors and says “we’ll work together.” Once Sarah
starts paying the bills she’s entitled to profits and control.
(a) What share of profits is Sarah entitled to?
At least 20% – based on employment agreement
Maybe 50% – If Sarah and Sam are now partners without an agreement, UPA default
position is 50-50 split of profits.
UPA § 18 (p. 86):
“subject to any agreement between them… All partners have equal rights in the
management and conduct of the partnership business.”
Maybe 60% – 20% as wage plus 50% of leftover profits
(ex: total revenue = $100; $100 – $20 = $80; ½ x $80 = $40; $20 + $40 = $60)
(b) Does Sarah have to pay creditors’ bills where they were sent to Spade & Spade?
Is there apparent agency? Then, yes.(?)
Weaker case for liability for non-Spade & Spade bills.
(c) Is Sarah responsible for Sam’s liquor bills?
No. UPA § 9(1) – every partner is an agent of the partnership
If liquor is an intrinsic part of the business, then she is responsible for the liquor debts.
Sam misapplies funds – takes from client funds to buy liquor – UPA § 13: wrongful act
 partnership is liable; UPA § 14: misapplication of funds  partnership must make
good.
3. Cases
a. Fenwick v. Unemployment Compensation Commission (p. 82)
Facts: Mrs. Chesire was hired as a receptionist. After working for about a year, requests
raise. Fenwick says he can’t afford to give her a raise but offers to make her a partner,
giving her 20% of the profits at year’s end. Fenwick maintains all control, Mrs. C.
doesn’t share in losses.
Holding, Reasoning: Court finds C is an employee, using an eight-part test.
1) Intent of parties - Appears to be, but court rules intent isn’t enough.
2) Right to share in profits - Yes, but this point is not conclusive.
3) Obligation to share in losses - No. Prof.: sharing losses doesn’t matter, only sharing
profits.
4) Ownership and control of the property - Fenwick had it all.
5) “Community of power in administration” - Precluded by Fenwick’s control.
6) Language - Specifically calls it a partnership, but court looks at “substantive” factors.
7) Conduct towards third-parties - Certainly acted like employer-employee.
8) Right to dissolution - In this case, no different than terminating employment.
Note: How could Fenwick and Mrs. C. be partners but still let Fenwick maintain all
control? Possibilities:
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Make it look like she has some responsibilities (ex: Mrs. C. is in charge of reception –
may not be enough for a court)
Write in provisions for conferring and voting (ex: giving Fenwick a majority share of
votes or giving him veto power with obligation to hear her out)
Bring in more partners who are loyal to Fenwick (ex: his wife)
b. Meinhard v. Salmon (p. 106) [J. Cardozo]
Facts: Co-adventurers in the 20-year lease and renovation of a hotel (shops and
offices). At lease’s end, building owner offers new lease with new terms to Salmon.
Salmon takes offer for himself, not for partnership with Meinhard.
Holding, Reasoning: Cardozo finds for Meinhard. Does it make a difference that in the
course of the lease property values have skyrocketed (Grand Central was built a few
blocks away)? Meinhard has profited substantially from Salmon’s deal. Why should
Salmon be allowed to take this opportunity and the additional profit for himself?
“Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard
of behavior” (p. 107)
“Salmon put himself in a position in which thought of self was to be renounced, however
hard the abnegation.” (p. 109)
What would have satisfied Cardozo?
Maybe just informing Meinhard of the opportunity. West hates this case, but I like it
because it seems likely that the chilling effects of withholding information between
partners would overshadow any benefits of allowing such behavior (like maybe
efficiency). Cardozo’s a windbag, but a clever windbag.
4. Raising additional capital (pp. 128-30)
a. Context: Restructuring companies going bad, doing M&A, creating companies.
Applies to both partnerships and corporations.
Ex: 40 people in a partnership
40 x $25,000 = $1,000,000
$9,000,000
$10,000,000
equity collected for business
bank loans = debt
total collected for project
When the $ runs out, the property is worth $9,000,000.
If we sell now, just pay debt, partners get no return on investment.
If we finish the project, need to raise $500,000. Then property is worth $10,000,000
people get at least some of their investment back.
Point system – analogous to shares of stock
40 partners x 25 pts. = 1,000 pts.
b. How to raise capital:
1) Ask for it from everyone. Problem: no one is obligated to put $ in  free-riding
classic prisoner’s dillema:
I lend
I don’t lend
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my equity
my loan
$12.5k
$12.5k
equity
cash
$12.5k
$12.5k
2) Pro rata dilution
Partnership issues more points. If you don’t pay, you’re share will be reduced.
500 pts. x $1,000 = $500,000
1,000 pts. [old] + 500 pts. [new] = 1,500 pts.
Property value = $1,000,000
Pt. value = $1,000,000/1,500 pts = $666.66/pt.
buy new points
don’t buy new points
equity
equity
25 [old] +25 [new]
25 pts. at $666
= 50 pts. at $666
= $16,666 + $25k in cash
=$33,333
= $41,666
3) Penalty dilution
Sell new points: $250/pt. x 2,000 pts. = $500,000
1,000 pts. [old] + 2,000 pts. [new] = 3,000 pts.
$1,000,000/3,000 pts. = $333/pt.
Advantage: You spend $250 to get $333.
If you don’t buy, someone else can buy your points and your share of the
partnership ends up getting diluted. This can be abused by partners doing this
only when they know you don’t have cash
4) Managing partner can sell new partnership shares to anyone at whatever price
can be obtained.
5) Recap
a) Loans (of $12.5k each) – free-riding problems
b) Pro rata dilution (sell 500 new points for $1,000 each to get shares worth $667) (not a
good deal, don’t buy, hope others do… on the other hand, value can rise)
c) General partner pays/guarantees
d) Penalty dilution (sell 2,000 new shares at a discount for $250 each, get shares worth
$333) (good deal, buy) – some may not agree to this in advance since they fear that new
shares will be sold when they can’t afford to buy them
e) Pro rata loans (cap/no cap)
f) Additional points to new investors (similar to corporate solution of selling shares)
5. Breach of fiduciary duty
a. Bohatch v. Butler & Binion (Supp. pp. 3-14)
Facts: Bohatch is an attorney and partner in B&B who reports that McDonald, a
managing partner is overcharging a client. She reports him but no overcharging is found.
In fact, the firm and client find that Bohatch’s work was unsatisfactory. The firm
suggests that Bohatch leave and pays her in the meantime. She leaves and the firm expels
her as a partner.
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Holding, Reasoning: Court finds for D. No whistleblower exception exists for severing a
partnership, even a good faith whistleblower. Partnerships exist by the agreement of the
partners; partners have no duty to remain partners.
Dissent: We should not discourage whistleblower activity
b. What is fiduciary duty?
Stems from agency – agent of a principal, agent of a corporation you’re an officer or
director of, agent of a partnership you’re a partner of
 duty to play nice, do what you’re told
 duty of trust – comply with wishes of principal
 See Day v. Sidley & Austin
c. Cases
1) Day v. Sidley & Austin (p. 135)
Facts: Day ran the Washington, D.C. office of S&A. S&A merged with another law
firm, the Liebman firm. Day approved of the merger along with the other S&A partners,
but then got his ego severely bruised when he found out he would no longer be the “sole
partner” at the Washington office, but rather co-chair. Day resigned and sued for breach
of fiduciary duty.
Background info: There was a culture clash between firms. Day got the job through his
father-in-law, Burgess who was on the executive committee. By the time the merger
occurred, Burgess was dead.
Holding, Reasoning:
Issue one: was the termination all right? Answer: yes. For this partnership, a unanimous
vote wasn’t necessary. Fn.8 (p. 138) – executive committee will make major decisions,
some subject to partners approval/ratification; majority is according to percentage of
partnership interest, not of partners.
Issue two: what are the fiduciary duties in this case?
Fiduciary duties (pp. 139-40)
The essence of fiduciary duty - a partner must not advantage himself at the expense of
the firm
 Curtails reach of Meinhard v. Salmon.
Basic fiduciary duties
(1) account for profit acquired in a manner injurious to the interests of the partnership
(2) not to acquire a partnership asset or use a partnership opportunity without consent of
other partners
(3) not to compete with the partnership in the scope of business
Problems (p. 142)
#2 Did S&A have a sensible system of control? Where you have a lot of partners, it
makes sense to have an executive committee.
#3 What should Day have done to protect himself? Sign a contract naming him the sole
Washington office chairman; amend partnership agreement; get named to executive
13
committee; get buyout agreement to benefit him if pushed out of the chairmanship or
voluntarily leaves (unlikely to get). What you can get depends highly on how much
power the particular partner has.
Note: Technically, when a partner leaves a firm, the partnership dissolves. The partner
can then “cash out” her draw and whatever interest she may have. In real life,
partnerships like law firms automatically renew.
2) Page v. Page (p. 155)
Facts: Dissolution. -H.B Page and -George Page are brothers and partners.
’s corporation has a loan out to the partnership. Partnership hasn’t been doing well,
now starting to show profit.  wants out.  claims bad faith/violation of fiduciary duty.
Holding, Reasoning: Court finds none. If no specific term mentioned in partnership
agreement, partnership is at-will.
Problems
#1 If  wants to buy assets of partnership and continue business with new partner, what
does he have to do?  should inform  of opportunity (Meinhard v. Salmon), have an
auction, have assets appraised and offer half to . If it’s in good faith, it’s OK.
#2 Suppose  wants to liquidate business and pick up its better accounts through his
corporation. How should he go about doing so? Set up a buy-sell agreement. (?)
3) Lawlis v. Kightlinger & Gray (p. 168)
Facts: Alcoholic attorney admits problem to firm and is given opportunity to get better
and would then be returned to full partnership. After one setback and another
opportunity, Lawlis is better. After working for a while, requests to have his partnership
share increased. The next day, Lawlis is told that he will be expelled from the
partnership.
Holding, Reasoning:
Issue #1: Lawlis claims that he was let go in order to achieve the partners’ goal of
improving the partner-associate ratio. Court does not find this claim to have merit.
Issue #2: Lawlis claims he was wrongfully expelled, since he should be expelled by a 2/3
vote, not announcement of one partner. He says he was still a voting member afterwards.
Court says that the partner informing him was not a unilateral act, but just a warning.
Note: Did the firm do the right thing?
The firm owes a duty to its clients, but what about its duty to Lawlis?
Could have booted Lawlis after he relapsed the first time. That condition was not met, so
they had no responsibility to restore him to his previous position. The rule to be learned
from all this is that fiduciary duties may be specified in a contract.
Problems
#1 What result if fired when they first discovered his alcoholism?
#2 What result if fired in August ’84?
14
Answer to both: These are trick questions. It really doesn’t matter. They’re being very
generous.
#3 What would a client have wanted the firm to do?
Keep him, but not on my case.
Questions:
 Should the bar have a flat rule ordering alcoholics to be expelled from firms?
ordering firms to disclose attorney’s alcoholism to clients?
 Privacy issues. Does it impact on how the job is done?
 Does this create a chilling effect on alcoholics who are considering disclosure and
seeking help?
6. Providing for a Break-up: Buy-Out/ Buy-Sell Agreements (p. 175)
a. Prof: When structuring deals, lawyers should always advise clients to have a buyout agreement. Not having them is almost legal malpractice..
b. 2 types:
1) Right to sell to others of your choosing
2) Right to force partnership to buy your share. This one is good for getting out without
having to find a new person.
c. Hypo
1) David Silver and Valerie Mallone decide to start a chain of Peach Pit nightclubs, want
to start a company called Peach Pit, Inc.
2) Obligation to buy – If Valerie is concerned that David may sell stock to someone she
doesn’t trust  right of first refusal.
3) Veto right - Can also handle the problem in #2. It may also be too harsh, leaving both
parties with unsellable stock.
4) Valerie may want the right to force David or Peach Pit, Inc. to buy her stock. Might
use it to extort interests, hold out for concessions. Securities laws and closed
corporations statutes may require certain types of stock transfers.
5) Advancing estate planning – upon death of investor, remaining investors want to
make sure that stock doesn’t pass on to unwanted investors; want to reduce taxes on own
estate
6) Price – market value is easier to know where the stock is commonly traded; for
closely-held investments, it’s more difficult to tell what each side’s investment is worth.
Most common way to determine price is to hire an appraiser. There’s still an issue of
who to hire, so often there are provisions for that (ex: each side hires their own appraiser,
if they don’t agree, take average). Can also use formulas (ex: cash flow figures and
multiplier), book value (doesn’t change even though outside investors may be more or
less attracted to invest), set price (the other party can chose to sell his share or buy yours,
15
so you have an incentive to pick a number close to market price; only useful where both
sides have sufficient funds), or propose a buy-out agreement.
7. Limited Partnerships
a. Holzman v. De Escamilla (p. 186)
Facts: 1 general partner and 2 limited partners.
General partner = manager, limited for partnership debts
Limited partner = not liable for partnership debts
Holding, Reasoning: The court finds that the 2 limited partners are in effect general
partners (so that a creditor can get debts repaid by them)? The 2 had control over the
partnership’s money, forced the g.p. to resign and selected his successor, actively dictated
which crops to plant and overruled g.p.’s choice of crops
Rule: If you share profits and control, you are a general partner.
b. RULPA* § 303(a): A limited partner who participates in control is liable “only to
persons who transact business with the limited partnership reasonably believing, based
upon the limited partner’s conduct, that the limited partner is a general partner.”
c. More notes:
 Limited partnership is a liability device for the limited partner, control device for the
general partner.
 Need at least one general partner who is liable for the firms debts. Note that the
general partner can be a corporation (whose shareholders have limited liability) or
other entity.
A. Corporations
1.
a.
1)
2)
3)
4)
The Players
Shareholders
Shareholders get percentage of profits (or loss) via share value.
Shareholders also get a residual (after buying creditors off if company closes down).
Shareholders also get dividends.
The number of shareholders changes the amount of risk and control.
b. Officers
1) Can sign for the company, thus binding it.
2) Handle the day-to-day operations of the company.
c.
1)
2)
3)
4)
*
Directors
Elected by shareholders.
Vote on major decisions.
Liable for failing duties.
Officers will put forth slate of directors for shareholders to vote on.
Revised Uniform Limited Partnership Act
16
d. Note: Regarding agency, none of these three groups necessarily entails one is always
either an agent or a player.
2. Incorporation
a. Starting Up - De jure
1) articles of incorporation – name, address, purpose of corporation (sometimes any
legal purpose), type(s) of stock.
2) bylaws (procedural items on how to run the company) – supermajority votes needed
for certain decisions, notice of meeting (what kind, how often), how amended (by
directors or shareholders).
3) You’re a partnership so long as you act like one. But, to be a corporation, you need a
certificate of incorporation from a particular state. To certify, complete 1) and call up CT
Corp = a company that files your articles of incorporation, can receive process in the
jurisdiction you incorporate in.
4) CT sends forms.
5) Fill out forms, and send in with 1).
6) While waiting for certification, draft by-laws.
7) When you get the certificate of incorporation, you have a meeting of incorporators
(even just one person) to elect directors who will appoint officers and sell stock
8) Some other processes that may be required in order to incorporate:
 clear the corporation name
 register with Securities and Exchange Commission – if you want to issue your stock
to a large number of persons, sell it on the stock exchange or just have a lot of money
involved
b. Delaware
1) Most incorporation happens in Delaware. Probably 90% of Fortune 500 companies
register there. Why?
 better corporation code, e.g., favorable tax treatment
 every else is doing it (don’t let competitors get marginal advantage, no loss of
prestige)
 rules are clear, already in place, clear legal precedents, courts and attorneys are
experts in corporate law, state dedicated to helping corporations
 changes to DE code require 2/3 vote of legislature – rules won’t be changed easily
2) Is this good or bad?
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Bad – creates race to the bottom as states lower their requirements for incorporation,
lowering liability to unconscionable levels, erosion of corporate duty
Good – creates race to the top, enticement to managers to run companies to their fullest,
unconcerned about unnecessary restraints of corporate law
= Ongoing concern in an era of international incorporation.
c. p. 189 – Old Dominion Hypos
1) Promoter = Any person who sets up a commercial venture [not an exam question
promoters and pre-incorporation liability  much of a focus in this course]
A promoter falls under the general principles of agency law, end up incurring fiduciary
liability.
2) Case 1
Ann buys land for $125k, sells to Sean for $200k. Does Ann get to keep $75k profit?
Sure, unless she committed fraud or misrepresentation. She doesn’t have to volunteer the
information (even if asked), just can’t lie about it.
3) Case 2
Paula asks Art to represent her in purchase of land. Art owns land already, purchased for
$125k. Art sells it to Paula for $200k without revealing his interest in the transaction. He
could have sold it to someone else for $195k. Art must disgorge the $75k profit.
No disclosure to or ratification by principal, agent can’t keep profit.
REST. § 388:
“Unless otherwise agreed, an agent who makes a profit in connection with
transactions conducted by him on behalf of the principal is under a duty to give
such profit to the principal.”
4) Case 3
No difference between this case and Case 2, except a corporation is the principal and P is
the president of the principal. Paula doesn’t have an action in her individual capacity
against Art.
5) Case 4
Promoter sales
P and A decide that there will be a checklist of points that must happen in order to
complete the transaction.
a) A forms corporation, C Corp.
A sells C stock to P.
A sells property to C for $200k.
 A must disgorge profit because as a promoter, he owes a fiduciary obligation to
the corporation, like that of an agent to a principal (like in case 2).
Same result:
P has all
shares of C,
C owns
property, A
has the $
b) A sells property to P for $200k.
P forms C Corp.
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P sells/invests property to C.
 A has no duty to disgorge – no agency, no fiduciary duty.
c) A forms C Corp.
A sells property into his own corporation.
A sells stock to P.
?
= Form over substance. Same practical results, but different mechanisms yield different
protection for parties.
d. 2 additional ways to become a corporation besides properly filing forms
1) Corporation de facto – found by court where organizers
a) try in good faith to incorporate
b) had a legal right to do so
c) acted as a corporation
2) Corporation by estoppel – found by court where person dealing with firm
a) though it was a corporation all along
b) would get a windfall if firm was not a corporation
3. Limited Liability - Piercing the Corporate Veil
a. General Rule
Corporation is liable for its own debts. A corporation is a person with a capital “P”
(definition usually includes artificial persons). General principle of limited liability is
that you can only lose as much as you put in. Can’t normally go after directors,
shareholders and officers.
b. When we pierce: Observe these 3 general rules:
1) If you observe the formalities of corporate life, you’re generally safe.
Respect the separate existence of the corporation (separate bank accounts, records, etc.),
avoid unity of interest.
2) If the formalities have been observed, shareholders and directors may be liable
for fraudulent conveyance or improper dividends, but the liability is only for the
amount paid out and not the full amount.
If a corporation doesn’t have enough money to issue dividends, it shouldn’t be
distributing dividends.
Ex: Corporation A has $1,000 in the bank and 100 shareholders
A spends $950 on office equipment, decides to authorize $1@shareholder in dividends.
If the creditor says, you can’t issue that since you owe us money, you hand over what you
have. If you already paid out, you are only liable up to the $100.
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3) If the separate existence of the corporation has not been respected, the law is
murky.
a) Most commentators say need to also prove an element of injustice or wrong.
b) Others say disrespecting separate existence of corporation is sufficient to pierce the
corporate veil.
c) Theory: if the shareholder doesn’t respect the unity of interest issue, we don’t make
the creditors respect it either.
d) Some require more in the way of proof of actual injustice, e.g., Texas requires proof
of actual fraud.
e) Often it doesn’t matter if plaintiff was aware of defendant’s disregard, just that there
was disregard.
f) Old-fashioned fraud is a separate cause of action, but requires proof of reliance.
c. Cases
1) Walkovsky v. Carlton (p. 196)
a) The case
Facts: W struck by cab owned by Seon Corp. Seon, along with 9 other corporations is
solely owned by Cartlon. Each corporation owns 2 taxis and is undercapitalized.
C drains the money out of his enterprises, leaving only minimum insurance policies on
the vehicles.
Holding, Reasoning: Court finds for Carlton. Confusing case!
Court starts with 2 theories for piercing the corporate veil: fraud and agency
2 agency situations described:
(1) company is part of a bigger corporation that actually conducts the business
(2) company is a dummy for an individual stockholder who actually runs the business
Here, C didn’t run operation in his personal capacity  no agency. Fuld’s reasoning
seems pretty sparse, although he considers the deleterious affects that the opposite ruling
would have on the city’s cabbies. Plaintiff didn’t bother to consider other agency
situation, so the court needn’t consider it. In fact, plaintiff’s case is more like fraud, but
neither C’s nor S’s behavior is fraudulent. Inadequate capital isn’t sufficient for piercing
the corporate veil.
Dissent: When corporation is run irresponsibly, shareholders lose privilege of limited
liability.
b) Three legal doctrines that could be invoked:
 enterprise liability - treat all 10 corporations as a single entity
 respondeat superior (agency) - liability depends on C’s control of S to make it an
agent.
 disregard of the corporate entity (piercing the corporate veil) - All roads lead to C.
 Note: The court in this case tends to weave agency and piercing together.
c) What if the court did pierce the corporate veil? All the shareholders would be liable as
partners.
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d) What if each of the 10 corporations is a large public corporation with many
shareholders? All shareholders can be held jointly and severally liable as partners. Each
could be liable for the entire amount.
Other options?
pro rata system – would require either legislative authorization or a very inventive court
just officers and directors – would need adequate insurance in place or people wouldn’t
want to be officers and directors.
e)



Policy options:
Require higher minimum insurance or bond
Pierce the corporate veil – may lead to some bad consequences
Let the loss fall on the victim – does the victim have insurance?
2) Sea-Land Services v. Pepper Source (p. 202)
Facts: Marchese owned several businesses incl. PS, ran them out of the same office,
played with assets, used assets for personal expenses. PS owed S-L a lot of $,
Marchese dissolved it.
Issue: Can S-L “reverse pierce” Marchese’s other companies to get paid?
Holding, Reasoning: Court establishes a 2-prong test for piercing the corporate veil:
1. unity of interest and ownership  can’t separate corporation and
individual/corporation
2. inequitable result otherwise = adhering to fiction of separate corporate existence
would work a fraud or injustice
Court rules in this case that #1 certainly holds. Court considers these four factors, and
finds they all apply to Marchese:
1. failure to maintain adequate corporate records/comply with corporate
formalities
2. commingling of funds/assets
3. undercapitalization
4. one corporation treats assets of another as its own
#2 is allot trickier, since fraud and injustice are shifty concepts. The court here defines
injustice as D skirting its responsibilities. P didn’t prove this, so the case is remanded.
3) Kinney Shoe v. Polan (p. 208)
Facts: D formed two corporations. Very informal. P sub-leased building to D. D subleased part of building from corp #1 to corp #2. Sublease was #1’s only assets. D only
made one payment, and P sued #1 for unpaid rent. Succeeded, but since #1 had no
assets, P wanted to pierce corporate veil and go after D.
Holding, Reasoning: Court rules that piercing the corporate veil = equitable remedy.
Court uses two-prong test, and also applies third (optional) prong: it would not have been
reasonable for creditor to conduct a reasonable credit investigation which would reveal
gross undercapitalization.
4) Perpetual Real Estate Services v. Michaelson Properties (p. 211)
21
Facts: D started company to go into two joint ventures with P to convert apartments to
condos. When purchasers sued one partnership for breach of warranty, P settled with
them. P now wants indemnification from D’s company and from D.
Holding, Reasoning:
What  must prove to pierce the corporate veil
1. corporation was alter ego of  Court looks at existence of corporate records, history
of dividends paid, observed formalities, and existence of offcers and directors.
2. corporation was device or sham used to disguise wrongs, obscure fraud, or conceal
crime
Court finds that #1 is satisfied, but that #2 isn’t. P went into arrangement with D
knowing full-well what was going on. D did nothing to violate any contractual
obligation.
5) Theoretical difference between torts and contracts cases
It makes more sense for court to pierce the corporate veil in a torts case than in a contracts
case. In the latter, the parties should be aware of how corporate structure and assets affect
parties’ rights.
RESTATEMENT (SECOND) OF TORTS § 324(A):
One who undertakes… to render services to another which he should recognize as
necessary for the protection of a third person or his things, is subject to liability to
the third person for physical harm resulting from his failure to exercise reasonable
care… if
(a) his failure to exercise reasonable care increases the risk of harm, or
(b) he has undertaken to perform a duty owed by the other to the third person,
or
(c) the harm is suffered because of a reliance of the other or the third person
upon the undertaking
d. Due diligence
1) Definition: No court-enunciated definition. Before any mergers/combinations of
corporations, the buying party does due diligence review. Usually done by buyers’ law
firm, sometimes with [forensic] accountants. Client wants a detailed list of what they’re
buying.
Ex: See if company’s lease on office space says that it loses its lease if there’s a change in
ownership.
2) In re Silicone Gel Breast Implants Products Liability Litigation (p. 215)
Facts: Bristol-Meyers Squibb Co. (Bristol) bought all stock/is parent and sole
shareholder of Medical Engineering Corporation (MEC) after due diligence review.
MEC had a “paper” board of directors, and made periodic reports to Bristol. Bristol
controlled all of MEC’s assets. Bristol and MEC were interrelated in a number of other
ways; most notably, Bristol performed safety reviews for MEC.
Issue: If MEC gets sued, should Bristol also be liable.
Holding, Reasoning: Court finds corporate control by looking at the following factors:
 the parent and the subsidiary have common directors or officers
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









the parent and the subsidiary have common business departments
the parent and the subsidiary file consolidated financial statements and tax returns
the parent finances the subsidiary
the parent causes the incorporation of the subsidiary
the subsidiary operates with grossly inadequate capital
the parent pays the salaries and other expenses of the subsidiary
the subsidiary receives no business except that given to it by the parent
the parent uses the subsidiary’s property as its own
the daily operations of the two corporations are not kept separate
the subsidiary does not observe the basic corporate formalities, such as keeping
separate books and records and holding shareholder and board meetings
Court makes a contract-tort distinction, holding that the latter doesn’t require fraud,
injustice or inequity. In other words, torts actions only require a one-prong test. The
logic behind this is that the plaintiffs never entered into an agreement with Bristol, only
MEC.
Prof: Corporate veil analysis by court is not very good. Isn’t this a contract claim?
There are understandings and agreements with distributors, suppliers, doctors, and
patients. Since the patients didn’t request any guarantees from Bristol, maybe they
shouldn’t be allowed to succeed on a suit.
There are better theories under which Bristol could be held liable.
 More sympathy for patients where case viewed as a contract case
ex: name and logo used  apparent agency claim (if Bristol wants to use its name to
sell a product, should accept consequences)
 “There ought to be a law.”
On the other hand, if there should be complete corporation responsibility, what sort of
investors will get involved?
Study: Never been a successful piercing claim against a publicly-traded corporation.
Probably courts don’t see it as equitable.
4. Financing the Corporation: Debt and Equity
a. Debt
1) Definition: Fixed claim, unconditional obligation to interest and principal paid by the
debtor to lender over time
2) How gotten?
a) From bank
 put in document called:
Loan agreement
b) From individuals, institutions (insurance companies, mutual funds…)
 put in documents called:
Bond has security interest
} put in documents called
23
Debenture is an unsecured obligation
Notes used for either
} indentures
3) Tools for giving sense of security to persons holding unsecured interests:
a) Maintenance of property covenant – lender had to maintain property so that not
devalued so that bondholder will have something to take
b) Negative pledge clause – lender will not pledge any of his assets to another debtor
c) Restrictions on dividends (note: there are legal limits on when they can be issued)
d) Debt becomes due upon change of control – protection against takeovers
e) Additional debt covenants, e.g., subordination agreements
f) Risky projects limitation (difficult to draft, say that the lender gets to approve certain
kinds of projects)
4) Some terms in the agreement:
a) duration
b) callable at option of issuer before due date
b. Equity
1) Definition: share of stock, holder has residual claim, can control firm through,
generally no control over company except through election of directors. Shareholder has
a piece of the corporation.
2) Risk and return
On average one is more highly compensated for taking a greater risk in the stock market.
To reduce risk, develop portfolio of stocks. Diversification of risk may not offer
protection from systemic problems.
Beta = measure of stock volatility
Beta = 1 – stock tends to move exactly with the market
Beta > 1 – stock tends to go higher than market when market goes up
3) Efficient Capital Markets Hypothesis (ECMH)
Stock prices incorporate all publicly available information.
4) Dividends
a) Pro: Money in your hand, increases pressure on company to find new sources of
capital ( discipline, innovation)
b) Drawback: Doesn’t change value of stock, just how much money is available to
company,
c. Mixes of Debt and Equity
1) Convertible debt – converts into common stock on certain conditions (event, time)
2) Warrants – options issued by corporation that allow shareholders to profit based on
future firm earnings, “sweetener”, often issued to management as part of their
compensation packages
24
d. Debt/Equity Ratio
1) Borrowing is good, some of your money should be from debt, some say have a lot of
debt  more disciplined management
2) Don’t have complete debt or complete equity.
e. Par Value
Articles of incorporation indicate how many shares issued, par value of each share, and
legal capital.
ex: issue 1,000 shares, par value $1/share, legal capital = $1,000. Means you have to
have $1,000 in your coffers.
For the most part, this is a dead concept. Most restrictions on when to issue dividend are
not tied to a legal capital test.
=The written value of the share. Some meaning for accounting purposes.
f. Options and Derivatives
1) Used to be that the only way for an investor to make money was from debt or equity.
2) Now, have options – 2 types: call or put – issued by third party outside the company.
a) Call option – right to buy company’s stock in the future at a specified price
b) Put option – right to sell company’s stock in the future at a specified price
Shorting a stock – expect the price will go down, borrow shares sell them back later
Derivatives – instruments that attach to underlying stock or stock index, has no value in
and of
5. The Role and Purpose of the Corporations
a. Business judgment rule: If management of a corporation makes an informed business
judgment, courts will defer to management. From time to time courts have to reel in
managers who stray their bounds, set limits.
b.
1)



Cases
Questions to consider
When can a corporation contribute to a public charity?
When must a corporation issue dividends?
To what extent can a person controlling a corporation use it to indulge private ends?
2) A.P. Smith Mfg. Co. v. Barlow (p. 264)
Stockholders sue after corporation directors decide to give donation to Princeton.
Their argument was that
(1) ’s certificate of incorporation didn’t expressly authorize the contribution and under
common-law principles and company had no implied power to make it, and
(2) state statute that would so authorize the company was inapplicable because enacted
after company’s incorporation.
25
Court: Corporations control lots of wealth that individuals used to give away. Good
citizenship requires contributions by corporations. State enacted doctrine prior to
incorporation of this company reserving the right to alter the state-corporation contract in
the public interest.
Standard: Donations bad if made indiscriminately or in furtherance of personal ends.
Holding: As long as corporate ends are met (there must be some benefit to corporation –
however tenuous), directors may make reasonable donations to charities.
Most courts uphold charitable gifts.
Shareholders are often working class with pension funds that hold stocks. CEOs tend to
give to upper-crust charities. Moral high ground to take from workers and give to opera?
Arguments in favor of corporate philanthropy
1. Good for America
2. Good P.R.
Problem, p. 270 and statutes pp. 268-69
CEO wants to give $100,000 to charity. Corporation’s before-tax earnings are $20M.
CEO wants gift to be anonymous.
Issues raised:
Pet charity? May be violative of fiduciary duty, but CEO could present to board with
full disclosure for legitimizing approval
Anonymous nature?
Size of gift?
3) Dodge v. Ford Motor Co. (p. 270)
Ford had issued large dividends in the past. Henry Ford announces that there will be no
dividends and that profits will be rolled back into company to support pro-social
corporate goals. Court decides that Dodge Bros. (who have a 10% interest in the
company) get a dividend.
Court: Ford’s business is to maximize shareholders’ profits. Ford must issue dividends.
Why this doesn’t make sense:
1. It doesn’t make a difference whether dividends are issued.
2. Case is an aberration in law of dividends. Issue should be: Does the corporation have
sufficient legal capital to issue dividends?
3. What’s the court thinking when they distinguish between dividends (court forces) and
new plant construction (court ignores)? Court chickened out probably.
Is Ford running company as a charity?
No. Court misses the point.
Ford didn’t want to be seen as a robber baron, wanted to help people and make a
reasonable profit.
26
Court also missed conflict between Dodges and Ford. Didn’t want him to build plant that
would enable Ford to decrease prices further. Dodges wanted extra capital for their own
car business, didn’t want prices to go down so they could compete with Ford. Also, Ford
would have had to pay 73% tax on them
4) Shlensky v. Wrigley (The Chicago Cubs Case) (p. 275)
a) Case
Stockholder brings suit to get lights installed at Wrigley Field, alleging that the lack of
night games adversely affected the profitability of the ball club.
Wrigley, the majority shareholder, was personally opposed to night games.
Courts defer to directors’ judgment, presuming good faith effort to promote corporate
interests, unless there’s fraud.
Here  didn’t prove that the lights would make the corporation more profitable.  didn’t
want to bother the neighbors and didn’t want night games. Court defers to directors’
decision.
b) Analysis questions (p. 279)
1. If Shlensky wasn’t happy, why didn’t he sell his shares?
It doesn’t cost much to sue. If he tries to sell, price will reflect lower profits.
2. Does the decision in this case leave open the possibility that Shlensky might have
prevailed? Under what theory?
 Prove that corporation would have profited from night games.
 Claim that directors and management failed to investigate the possibility that
night games would improve profitability.
3. If you represented Shlenksy, what strategy would you take with Wrigley?
Get Wrigley to say what his motivations are – not profits, but personal distaste of night
games; no research, just personal distaste of night-games.
c) Problem 1. (pp. 279-80)
Ann and Bill’s salami
If no fraud…
It depends on how Bill presents his reasoning. If Bill says, “I don’t care about profits, I
care about my employees” he’s screwed. We set up corporations to be profitable [in the
short run]. Unless we have a constituency statute like in PA that allows directors to
consider other benefits.
Alternatives: incorporate as not-for-profit, include agreement/definition in corporation
papers (ex: “…incorporated to play the great game of baseball which is played only in the
daytime”).
27
Question to ask: What is objective reality, is this an objective decision to maximize
profits?
A fully-informed fraud-less business decision may be sufficient in some courts, not in
others.
c. Derivative suit = action by stockholders against directors of corporation where
directors are alleged to have done something bad. Instead of the corporation suing the
board, the stockholders sue on behalf of the corporation. Right to sue is derivative of
their being stockholders in the corporation (stockholders don’t sue in their personal
capacities).
If the stockholders win, the directors pay $ to the corporation (not the
stockholders) out of their own pockets ( corporations may take out liability insurance
for their directors). Since there’s limited profit to minority shareholders, often
shareholders bring derivative suits for the principle of it (and attorney’s for the fees).
Most jurisdictions say there’s no minimum shareholder requirement for suing.
II. Fiduciary Duties and Shareholder Litigation
A. The Business Judgment Rule
1. Introduction
a. Aside: Formal model of organization is inaccurate at describing real distribution of
powers in corporations.
 First work on this subject: Burley and Means The Modern Corporation and Private
Property – separation of ownership and control. Shareholders can’t control
corporation – dispersed, can’t get together to make decisions. Normally, you want
ownership and control by the same people.
 Prof. Heller article The Tragedy of the Anti-Commons (Harv. L. Rev.): we always
look at tragedy of the commons problems – how common owners can use common
property most efficiently. Look at the anti-commons – entity whose ownership is
divided up among too many people, where everyone has a tiny interest in the
firm/project, can’t have effective governance. Ex: In the 50’s. Quaker Oats
Corporation issued 1” squares of property to people. Can’t do anything with the
property because owners are dispersed and own too little to do anything with it.
How do we solve the anti-commons problem in corporation so that the managers and
controllers of corporations are lined up?
b. 4 ways to align management and shareholder interests:
 Shareholder voting – shareholder vote for managers reflecting their interests
problem: shareholder who owns very little doesn’t care enough to vote
 Contract – write a K that tries to align interests
ex: give directors stock options, conditions, bonuses tied to profits
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 Market – leave it to the market for corporate control, i.e., M&A market (raiders or
other managers who think they can do it better will take over)
 Legal Rules – take care of two big problems:
(1) duty of care combats sloth
(2) duty of loyalty combats greed
2. Definition of the BJR - Courts will defer to the business judgment of the actors
within the private sector. Apparently unwise decisions aren’t criminal; the court assumes
that market participants are still the best representatives of their interests.
Court grants immunity only if director’s judgment comports with:
1. no fraud, illegality [duty of good faith?]
2. duty of care – no negligence, sloth
3. duty of loyalty – no conflict of interest, greed
B. The Obligation of Control: Duty of Care
1. Introduction
Duty of care started as common law doctrine, now many modern statutes codify it.
Negligence here is closer to gross negligence (egregious conduct).
2. Cases
a. Kamin v. American Express Co. (p. 281)
Facts: Stockholders seek remedy for ‘bad’ business decision to distribute depreciated
stocks as in-kind dividend instead of selling them at a loss (which would have resulted in
tax savings). Corporate directors chose to distribute the stocks to avoid bad net income
figures on financial statement.
Holding, Reasoning: Don’t sue unless you allege a clear case of fraud, deceit, oppression,
arbitrary action, or breach of trust. This is a business question; it’s not our job to judge it.
Boards can make bad decisions in good faith with impunity.
“A complaint which alleges merely that some course of action other than that
pursued by the Board of Directors would have been more advantageous gives rise
to no cognizable cause of action.” (p. 282)
Applying the BJR test:
1. No fraud or illegality.
2. No negligence.
3. No conflict of interest – well, maybe “hint of self-interest.”
Financial theory: The market should know that AmEx’s stock has declined by $26M
because of the devaluation ($30M  $4M) of the stocks it holds. If AmEx’s stock price
already incorporated the loss (under ECMH), then reporting it in the financial statement
should be superfluous. It shouldn’t matter. Then again, the market doesn’t always work
the way that Nobel laureates theorize it will.
Moral: BJR protects directors from liability for dumb decisions. A decision doesn’t have
to be smartest or best, just can’t be the product of fraud, illegality, negligence or conflict
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of interests. If the decision is really horrible, will probably be able to show some sort of
breach of duty.
b. Joy v. North (p. 284)
Facts: Citytrust makes bad investment. CEO dominated Citytrust. CEO supported
investment in his son’s employer’s project. Board agrees. Shareholders sue directors
(derivative suit). Corporation sets up Special Litigation Committee* which recommends
to court that “outsider” directors not be liable and “insider” directors might be.
*When a shareholder wants to sue directors, s/he serves notice on corporation and asks them to sue
its own directors. Corporation will usually set up a Special Litigation Committee so that company
can decide whether it will sue. If it decides not to, shareholder goes ahead and brings derivative
suit against corporation (corporation loses control over case). If demand would be futile (because
of the make-up of the board/committee), shareholder need not go to them.
Court: The court acknowledges the BJR, but takes exception where a corporate decision
lacks a business purpose. Here, North’s control over this matter, the lack of
communication with the other directors, and the apparent negligence in the loan’s
handling indicate North lacked a business purpose. “Outsiders” won’t be protected if
found to be ostriches (breachers of duty of care). That “insiders” might be liable is an
understatement.
Note: Joy v. North cites Litwin v. Allen (famous case, see Clark hornbook) and seems to
be saying that you can make a duty of care case if the decision creates a no-win situation.
But according to what we’ve been saying, it shouldn’t matter how egregious a decision
is.
This is not what it appears to be.  couldn’t prove conflict of interests so judge crafted a
poorly-reasoned duty of care decision.
A bad decision alone, not matter how bad, doesn’t prove that BJR shouldn’t apply.
There’s no duty of intelligence. But where there’s smoke, there’s fire – will likely find a
breach of duty of care or of loyalty.
Question 4, p. 290
How do you suppose the court that decided Joy would have decided Kamin?
Kamin – no neglect (heard and considered shareholders’ preference)
Joy – neglect (didn’t seem to be asking the right questions)
c. Francis v. United Jersey Bank (p. 290)
Facts: Two sons inherit and then bankrupt a reinsurance broker business (by ‘loaning’
money to themselves). Mother/widow is largest single shareholder and the third director.
Trustee in bankruptcy sues widow’s estate.
Holding, Reasoning: Court finds her liable for breaching duty of care and that the breach
was the proximate cause of the bankruptcy.
Standard of liability:
 breach of duty
 breach is proximate cause of loss
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Laundry list – bare minimum of directors’ duties:
(1) understanding the business of the corporation
(2) keeping informed of corporation’s activities
(3) not ignoring corporate misconduct (no ostriches)
(4) generally monitoring corporate affairs and policies
(5) regularly reviewing financial statements
(6)  duty to inquire further
(7)  if illegal conduct found, duty to object
(8)  if no correction of conduct, duty to resign
(9) sometimes: seeking advice of counsel
(10) maybe taking reasonable steps to prevent illegal conduct, e.g., by threatening suit
What could she have done? She could have read the financial statements and then she
would have seen the decreasing funds in conjunction with corresponding loans. Then she
could have protested, resigned, sued….
Problem, p. 295
Main points:
 obligations to creditors – no clear fiduciary duty, though some academics think you
should; may have ethical obligations to other constituencies. [No fiduciary duty to
creditors. Duties prescribed by K. Some say that creditors stand in same position as
shareholders. Generally that doesn’t happen, though.]
 Can’t resign just because of a duty issue that arises during your tenure – first, do
everything you can to prevent, stop or remedy it.
 Can’t distribute money to shareholders when you have outstanding obligations to
creditors. Source: rules on payments of dividends, law of fraudulent conveyances,
bankruptcy law.
3. The BJR and Mergers
a. Usual situation:
1) Idea among management, hint of offer by inquirer. Becomes common knowledge,
price may be driven up if buyer is well-known. Want a suitable buyer who will pay a
high price for stock, other needs of company being acquired.
2) Hire merger assistants. Merger assistants make search public, look for suitable “fits”,
and in some instances bargain with these parties.
3) Due Dilligence Phase: Lawyers set up data room – full of Ks, outstanding
obligations, leases, potential lawsuit documents. Whoever is interested in buying is
invited to check out the data room to do due diligence.
4) Agreement Phase: Letter of intent drafted by lawyers, states inquirer, inquiree,
offer, sometimes lock-up agreement (locks inquiree into agreement subject to certain
conditions).
 Merger agreement – indicates agreement to merge.
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 Closing – last step, all documents on table, sign, transfer stocks/assets, have a big
party.
b. LBO – Leveraged Buy-Out = purchase of a company financed by a relatively small
amount of equity (common stock) and a large amount of debt (which provides the
leverage). Often assets of the company are sold to pay of part of the debt.
analogy: purchase of house that costs $1M.
purchase price: $1,000,000
cash payment: $100,000
bank loan:
$800,000
loan from friend: $100,000 at 21% interest.
90% of sale is financed by debt. If price of house goes up, can sell later and
make profit. Or could lose everything.
Business example: add lots of zeros, change buyer to corporation (ex: KKR),
change friend to corporation holding junk bond for 21% interest (junk debt) –
high interest, potentially high yield, high risk of default.
A lot of 80’s LBOs ended in bankruptcy.
c. MBO – Management Buy-Out
When incumbent managers of target have equity involvement in buy-out.
d. Smith v. Van Gorkom (p. 301)
1) The Case
Facts:
Part one: Trans Union’s cash-flow situation was excellent, but had difficulty in
generating income sufficient to make use of investment tax credits.
Available options:
(1) issue dividends,
(2) repurchase its own stock (to raise price of stock, since there are fewer stocks
available)
(3) acquire other businesses
(4) sell corporation, let buyer deal with it
Part two: Van Gorkem approaches retirement, has stocks. Likes idea of leveraged
buyout (at about $55 per share), but vetoes managed buyout. Meets with takeover
specialist Pritzker w/o consulting directors or management.
Part three: V.G. didn’t really know what he’s doing – didn’t ask Pritzker what he thinks
it’s worth, came up with an uninformed figure, didn’t consult with the experts on his
board of directors. Pritzker decided on cash-out merger offer for $38 per share. V.G.
helps establish financing. Handshake deal between VG and Pritzker on Thursday.
Pritzker wants approval by Sunday night. Pritzker is interested in (1) cash on hand and (2)
get benefit of ITC’s by combining taxable income with other corporations.
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Part four: V.G. finally got around to telling management, although he failed to supply all
pertinent information. Pritzker did agree to pay $55/share. Even so, management hated
it, especially since the merger involved a 90-day bidding period where Trans Union could
receive, but not solicit competing offers. Legal Counsel says that if they don’t take the
offer, they could get sued. Hard to say no.
Note: But, they could have easily gotten a fairness decision – investment bank comes in
and generates a fair price for the firm. (But prof says they probably would have found
the number to be fine.) [Interview for job at Salomon Bros.: Interviewer: What’s 2 + 2? Interviewee:
4. The interviewee who gets the job is the one who says, “What kind of figure did you have in mind?”]
Part five: Board approved merger agreement, with supposed conditions of right to accept
better offers and right to share proprietary info with potential bidders. Instead of letter of
intent, merger agreement isn’t read by anyone, signed by VG, handed over at Opera
house.
Dissent among management led to VG and Pritzker modifying agreement. VG got
directors to agree amendments - sight unseen! This blew up when the actual
modifications were found to be very different from what VG told the directors they were.
Part six: Two companies expressed interest. The first wanted the merger agreement
rescinded, but Pritzker wouldn’t allow that, so it gave up. The second gave up, too.
Part seven: Merger between Trans Union and Pritzker.
Holding, Reasoning: Business judgment rule’s presumption of good faith rebutted where
directors breached fiduciary duty by:
(1) Not informing themselves of available/relevant info. Price is $17 above stock price
on market. Salomon Bros. looked for other purchasers. Maybe Pritzker would have
walked if he wasn’t locked-in.
Isn’t this a good deal?
BJR isn’t about the best decision, it’s about the process.
What should have been done differently?
Amendments voted on sight-unseen, Salomon Bros. called in too late. No one
understood how the $55 figure was really generated (not as an end product, but
investigated as a (random) starting point).
The directors (1) did not adequately inform themselves as to VG’s role in
forcing the ‘sale’ of the Company and in establishing the per share
purchase price; (2) were uninformed as to the intrinsic value of the
company; and (3) given these circumstances, at a minimum, were grossly
negligent in approving the ‘sale’ of the Company upon two hours’
consideration, without prior notice, and without the exigency of a crisis or
emergency. (308).
(2) Continuing to act stupid. Salomon Bros. tried to find alternative suitors for company.
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If directors didn’t act stupid, Pritzker and VG couldn’t have nixed the other potential
deals as successfully as they did, ruling out the possibility of a better price (in other
words, the auction never really happened).
(3) Not disclosing material info to stockholders re. merger.
Dissent: “Outside” directors were all experienced and knew better
2) Notes:
a) Options for acquisition:
(1) Creation of subsidiary – quicker, less paperwork than direct acquisition by public
corporation.
How can we get everything owned by Trans Union Corp. to be owned by Marmon
Group.? Marmon creates “New T” which buys all assets of TU. To merge companies –
need majority vote by board and shareholders of acquired company. Shareholders are
sheep, do whatever board tells them.
(2) Tender offer (common in hostile takeover situation) = direct appeal (through
newspapers, mass mailings) to stockholders to sell their shares for a certain price ($,
stocks of newly created company, purchaser).
Drawback: need to get 50% of stocks, may have holdouts and not get enough.1
b) If the market knows best, why is Pritzker offering $55 for a stock that sells for $38?
Why not offer 38¼, 39?
 Avoid bidding war
 $55 may be value as a merged company (can use ITC’s better than existing company)
 Shareholders less likely to pass it up
 1 share is worth $38 (judged at market value to minority shareholder), but many
shares may be worth more. After a certain point, there’s a control premium for each
additional share.
Stock
value
Increasing # of shares
c) Lock-up option
(1) gives original bidder a benefit even if outbid
(2) gives successful new bidder an obligation to sell shares to original bidder at a given
price
d) Financing contingency
Cumulative voting – percentage shareholding is represented on the board, i.e., if you
have a third of stocks, you can elect 1/3 of board. So you may gain control with less than
50%.
1
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If bidder can’t get $ from banks to pay for deal, has an out.
Here, if contingency met or waived (gets $ otherwise), TU required to sell 1 million
shares at $38/share.
e) Board voted on agreement, why is there now dissent among the officers?
Maybe some officers (who  the directors who voted for this) are concerned about
keeping their jobs or are interested in doing an MBO.
Why did Pritzker agree to modifications?
Maybe realized that VG didn’t have the backing of his people, might get sued, might lose
good officers.
f) Outrage followed the case.
What should boards do about seemingly good offers now?
Correctives:
1. Insurance industry: Boom in directors/officers liability insurance
2. DE Legislature: enacted Del.Gen.Corp.Law § 102(b)(7) – can limit liability for
director’s breach of loyalty, non-good faith acts by directors, personal benefit
impelled transaction by inserting a clause in certificate of incorporation.
= Protects directors (not officers) from suits for damages (no injunction) from
shareholders only
g) Are there just madcaps running businesses?
These people are on the hook for a lot of money. Liability can be substantially more than
salaries. Outside directors generally don’t have packages that cover liability.
Analogy: Truck driver for GM with family, equity of $100,000, savings of $50,000.
These assets are exposed to risk of loss where driver negligently drives and causes an
accident. Personal assets are at risk, person will be more careful.
Same thing with officers/directors.
4. In re Caremark International Inc. Derivative Litigation (Supp. p. 30)
Facts: Anti-referral payments law means you can’t pay doctors to advise patients to use
certain drugs. Since Caremark employed doctors in consulting matters, gov’t claimed
there were kickbacks, and Caremark got fined. Shareholders filed a derivative suit, and
Caremark responded with a settlement.
Holding, Reasoning: Court holds settlement reasonable.
BJR: Directors who act in good faith with proper procedures will not be liable, no matter
how stupid their decisions. Here, the directors didn’t originally know of the illegal
activity, and took good faith steps to remedy the situation once they discovered it.
 Old rule: Directors don’t have to monitor employees as long as not on notice of
misconduct.
 New rule: Duty of care does require monitoring of more important aspects of firm –
via good faith effort to assure that adequate reporting system exists.
Rule1: Whether a judge or jury considering the matter after the fact believes a decision
substantively wrong, or degrees or wrong extending through “stupid” to “egregious” or
35
“irrational” provides no ground for director liability so long as the court determines that
the process employed was either rational or employed in a good faith effort to advance
corporate interests.
BJR is process-oriented and informed by a deep respect for all good faith board of
directors.
Rule2: Absent grounds to suspect deception, neither corporate boards nor senior officers
can be charged with wrongdoing simply for assuming the integrity of employers and the
honesty of their dealings on the company’s behalf.
Standard for being held liable:
 directors knew/should have known that violations of law were occurring
 took no steps in good faith to prevent/remedy situation
 this failure was proximate cause of loss.
C. The Duty of Loyalty
1. General - Conflicts of Interest
a. BJR yields to rule of undivided loyalty – designed to avoid (1) possibility of fraud and
(2) temptation of self-interest.
General rule: directors acting separately and not collectively as a board cannot bind
corporation.
Reasoning: (1) collective procedure is necessary to take deliberate action
(2) directors are agents of shareholders, can only act as a board by law
Failure to observe procedures is not fatal.
b. Bayer v. Beran (p. 323)
Facts: Celanese corporation wanted to differentiate their rayon-like product, went into
radio advertising. In spending $1M on classy radio show, hired CEO’s wife to sing on it.
She’s qualified, was fairly hired, didn’t have a lead role or make much money.
Holding, Reasoning: Court finds no violation. Advertising “served a legitimate and a
useful purpose and the company received the full benefit thereof.” P claims that
decisions were made informally, without a meeting of the board of directors, and that this
fails the general rule (see above). Court decides the rule isn’t applicable, since
communication between the members of the board is sufficient in an informal way.
Note: What should an attorney advise CEO Dreyfus?
Go to board, fully disclose the fact that it’s your wife, seek approval of non-interested
directors.
To be really safe, the board could remove Dreyfus from this particular decision-making
process.
Court here says it will look at the actions of all directors (unusual).
2. Burdens of Proof - Lewis v. SL&E (p. 328)
Facts: SLE = lessor (land)
LGT = lessee (tire dealership)
R, A, L Jr., L Sr., Etsberger = common directors of both corporations
36
Lewis gave his shares of SLE to his 6 kids. Kids agree that non-LGT shareholders will
sell their shares to the kids who are LGT shareholders in 10 years.
Conflict of interest present because of overlap of two boards: LGT shareholders are all
SLE shareholders, but not all SLE shareholders are LGT shareholders. SLE artificially
holds down rent for LGT. LGT shareholders and directors don’t care since they’re on
both sides. SLE shareholders believe the book value of their stocks is lower than it
should be because of the low rent charged LGT. They therefore refuse to sell to LGT
shareholders at that book value as previously agreed.
Board doesn’t acknowledge conflict = Unratified conflict of interest
Holding, Reasoning: Court finds for non-LGT shareholders.
If no conflict of interest   has burden of proof, BJR applies  usually director wins
If unratified conflict of interest   has burden of proving that transaction is fair and
reasonable
If ratified conflict of interest (disinterested directors or shareholders approve transaction)
  has burden of proof
To ratify: see 3. (“Statutory Approaches” below)
Note: This case and Celanese case are aberrations. Modern cases look at substantial
financial interest, not just seat on board.
Question on Compensation (p. 332)
How can directors set their own salaries if they’re supposed to be avoiding conflict of
interests?
1. Committee of outside directors set salaries
2. Hire consulting firms to set salaries
Problem (p. 332)
Singer who wants to break into opera circuit, marries wealthy Kane CEO and majority
shareholder of magazine. Shares of magazine are worth $100M.
1. OK for magazine to give $20M donation to create opera (where Singer doesn’t sing)?
Seems like a pet charity problem. Also, too much $$$. And, unlikely to get the value
back in goodwill.
2. Can Singer sing for free in opera? If paid in line with others, would look more
legitimate. If more objectively determined to be good, would look better.
3. What if Kane owns 100% of the stock? Then like privately owned, can ratify without
opposition, no one has a right to sue.
4. What if Singer is a genuine star, hired after audition? Doesn’t look great, probably
sufficiently sanitized. “Penumbra of conflict.”
3. Statutory Approaches to Immunizing Duty of Loyalty Issues
a. NY BCL § 713 – maintain transaction’s validity by
(1) disclosing in good faith to board (unless they already know) and board approves
without counting interested director’s vote
(2) disclosing in good faith to shareholders (unless they already know) and they approve
Note: no disinterested requirement for shareholders.
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b. ALI Principles of Corporate Governance
See Supp. Pp 52. Unlike NY, ALI holds shareholders should also be disinterested.
4. Corporate Opportunities
a. Definition
1) What is a corporate opportunity?
Corporate opportunity doctrine is a subset of duty of loyalty.
A corporate opportunity is an interest, expectancy, or necessity.
interest – something to which firm has a contractual right
expectancy – something which, in the ordinary course of things, the corporation could
expect to receive
ex: renewal of lease (reminiscent of Meinhard v. Salmon – partnership analog to
corporate opportunity)
necessity – right to goods and services that the corporation vitally needs
Some define it as “anything in the company’s line of business” – can be too vague.
2) Energy Resources Corp., Inc. v. Porter (p. 333)
Facts: ERCO hires Porter from MIT to direct a project on staged fluidized bed
combustion of coal. Porter (on behalf of ERCO) and 2 profs from Howard go for DOE
grant together with advantage of minority ties. One prof later decides he can’t work with
ERCO as subcontractor because he’d feel like they were fronting for a non-minority
institution. Offers Porter a way to stay in the deal by creating his own company (EEE)
once they get the grant. Profs substitute EEE for ERCO on application. When asked by
superior executives about how the grant was coming along, Porter told them that they
weren’t going to get it (no elaboration). When profs get grant, Porter resigns allegedly to
start a computerized car company.
 Holding: Porter can’t rely on Prof. Jackson’s refusal to deal with ERCO. Firmness of
refusal to deal is not a defense to breach of fiduciary duty not to divert a corporate
opportunity unless person has unambiguously disclosed the refusal to the corporation,
together with a fair statement of the reasons for that refusal.
 Reasoning: can’t be tested by corporate executive alone, without full disclosure to
corporation, can’t verify unwillingness to deal, corporation doesn’t have opportunity
to test resolve of non-dealer
 “[A] fiduciary’s silence is equivalent to a stranger’s lie.” (Brown’s concurrence)
Prof. Jackson’s reasoning is ambiguous – doesn’t want to be a minority front for a white
subcontractor but also wants more money in the long run.
Notes:
Trial court judge found this defense adequate. Appeals court said no, it’s not a defense as
a matter of law (since fact-finding occurs at trial court level).
38
KK: Or is it just that the facts before the court didn’t support the exception for using this
defense, i.e., unambiguous disclosure of the refusal to the corporation, together with a fair
statement of the reasons for that refusal.]
If application had not originally mentioned ERCO, it would still be within line of
business of ERCO. But why? Expectancy? The whole thing started on a summer
vaction. Necessity? Maybe. The corporation may the right to goods it vitally needs (?)
(Prof. West: maybe the guy has a better idea of whether his colleague is willing to deal)
Racial implications - consider them. Any affirmative action defense possible? Perhaps
not with high scrutiny.
b. The Process
1)
Director/officer offers
Director/officer can take
Is it a corporate
opportunity to
Corporation rejects?
opportunity as his own
corporation’s disinterested
opportunity?
directors/shareholders
Test:
 interest? (contractual right)
 line of business?
 expectancy?
 necessity?
2) Broz v. Cellular Information Systems, Inc. (Supp. p. 46)
The players: Broz (RFBC), CIS, Mackinac, PriCellular
Facts: Broz is the president and sole shareholder of RFBC a small cellular provider
(license for Mich-4). Broz also sits on the board of a larger competitor, CIS. Mackinac is
a cellular provider looking to divest itself of a license for Mich-2 an area adjacent to
Broz’s area (Mich-4). Mackinac approaches Broz as a potential buyer, but not CIS which
is in no financial shape to buy it and which has no licenses in the area. Broz mentions
deal to a board member and executives at CIS. All say, go ahead, we’re not interested.
Broz does not present to the board, goes ahead and buys it by upping the purchase price
of a competitor, PriCellular. PriCellular at that time was in negotiations to buy CIS but
had not consummated the deal yet.
Holding, Reasoning: Court held that Broz was under no obligation to let PriCellular get
the deal. PriCellular had no interest or expectancy in the Michigan-2 opportunity (it
couldn’t handle it, anyway). A formal presentation is not necessary without a corporate
opportunity.
KK: Broz has two different obligations – to his own company and to CIS – how far does
he have to go for each? Not to the point where he was “required to consider every
potential, future occurrence in determining whether a particular business strategy would
implicate fiduciary duty concerns. Parallel to Salmon v. Meinhard – have to inform
corporation of opportunity, but can still compete. Otherwise, it would make no sense for
competitors to sit on each other’s boards.
Notes:
Financial capacity defense (p. 336)
39
Usually not a defense accepted unless executive has explicitly offered the opportunity to
the corporation.
Reasoning: too convenient, gives incentive to executives to fail to use their best
efforts to help firm raise necessary funds
Presentation of corporate opportunity to the board is a “safe harbor,” but not required.
Values promoted: certainty, predictability, no undue restrictions on officers and directors.
(See also ALI def of corporate opportunity - “Shareholders are sheep, they’ll follow
whatever scraggly shepherd is leading them.” – Supp. p. 53)
KK: this kind of fiduciary duty doesn’t seem intuitive to me… a guy helps a corporation
and in return can’t conduct his own business as usual? Why would a little guy (which it
turns out that Broz isn’t) want to be on a competitor’s board then? Why don’t all
corporations use this as a strategy to take opportunities from their competitors?
 Individual director opinions don’t count – have to go to board formally. However, do
directors Broz spoke to have an obligation to inform board of opportunity?
 Resignation of interested director? May not be best option (or allowed)
Why didn’t PriCellular outbid Broz?
Not want to get into a bidding war
Thought they might win in court (at lower bid price) after losing on market
Problems, p. 337
The barber shop hypo
Suppose Louis invests his savings to form a new
corporation that will take over the lease for Phabio’s
salon, has he taken a corporate opportunity?
1. not in line of business
2. not a director or officer, just main employee – but maybe considered officer
3. no interest or expectancy
4. found out about opportunity in casual conversation
5. didn’t use corporate info or property to learn of opportunity
If a firm makes employment Ks requiring employees to inform corporation of every
opportunity – might not get all potential employees (too restrictive), shareholders might
not want to deal with each opportunity that comes up
5. Dominant Shareholders
a. Directors and Shareholders
Directors have fiduciary duty, shareholders don’t. Shareholders don’t buy stock to look
out for others’ interests, just to make $.
ex: IBM enters merger agreement with Apple, submits agreement to shareholder vote.
Directors with conflict of interest must disclose these. But we don’t expect a
shareholders to say, “I should be disqualified from voting because I hold two
shares of Apple.”
40
Sometimes courts impose fiduciary duties on shareholders because controlling
shareholders can control board:
A controlling shareholder can be:
 majority shareholder (> 50%)
 voting schemes under which less than 50% can control board
 have minority share but large enough to beat out other fractured interests
Some corporate actions require shareholder vote – shareholder shouldn’t vote “unfairly”
b. Sinclair Oil v. Levien (p. 338)
Facts: Sinclair (parent) owns 97% of Sinven (subsidiary) stock. Parent causes subsidiary
to pay out large dividends. Subsidiary able to survive, but not expand. Derivative suit
claiming improper motive (parent’s need for cash).
3 claims:
1. Excessive dividends – Sinclair causes Sinven to issue large dividends (of which they
receive 97%) – take cash out of company
Court: no self-dealing because dividend issuance is equal to all shareholders
2. Corporate opportunity taken by Sinven for itself or other subsidiaries
Court: BJR
3. Breach of K by parent’s wholly-owned subsidiary
Test for parent-subsidiary dealing applied where there is (1) fiduciary duty and (2) selfdealing:
Standard of intrinsic fairness
= parent has burden of proving that its transactions with subsidiary were objectively fair
basic situation: parent receives benefit to the exclusion and at expense of
subsidiary
Fiduciary duty?
Y
Self-dealing?
Y
Intrinsic
fairness test
N
Business
judgment rule
c. Pepper v. Litton (cited at p. 342)
A dominant or controlling group of stockholders = fiduciary  actions held to standard
of proving inherent fairness
(Sounds a lot like intrinsic fairness standard)
41
Analysis questions (p. 342)
How might one have resolved the case using only the law regarding the duty of loyalty of
directors?
In this situation, Sinven’s directors are the agents of Sinclair (principal) so Sinclair could
be liable under agency principles.
D. Relationships: The Shareholder Derivative Suit
1. General
a. Definition
Derivative suit
 = a suit in equity against a corporation to compel it to sue a third party
 brought by shareholder(s) on behalf of corporation to redress injury to corporation
 usually goes after director, directors decide whether to sue (protected by BJR)
b. Derivative v. Direct
Injury to corporation  derivative action
ex: manager runs off with company funds, corporation doesn’t go after him
Injury to person  direct action (personal suit, class action)
ex: directors reconfigure shareholder rights to give more power to preferred class of
shareholders over non-preferred class
c. Incentives
Management considers derivative suits to be nuisances.
 gets nothing – it’s the corporation that’s given a remedy.
Cases probably only pursued because of attorney’s fees – win fee awards in 90% of
settled suits (and most derivative suits settle for a third of the claimed damages)
d. Eisenberg v. Flying Tiger Line, Inc. (p. 230)
Shareholder sues to enjoin reorganization of company that will deprive him of right to
vote on operations. Suit is representative/personal, not derivative (so shareholder doesn’t
have to post security).
Corporate maneuvers:
(Rem: Eisenberg has shares of FT.)
FT organizes FTC (wholly owned subsidiary)
FTC organizes FTL (wholly owned subsidiary)
3 companies reorganize: FT merges with FTL. [shareholders approve]
FTC renames itself FT.
Shareholders end up with shares of FTC (calling itself FT and holding FTL, the real
operating FT)
Before:
After:
FT
FTC holding FT
( has shares of FT)
( has shares of FTC)
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Note: Why reorganize into a holding company (just holds shares of FT)?
 tax advantages
 get around regulatory requirements about diversification of businesses (ex: banks
can’t hold stock)
“Form over
Holding, Reasoning: Not a derivative suit because doesn’t allege injury to corporationsubstance”
Injury is to shareholder.
Note: Is shareholder really hurt?
Before: voted on FT operations matters
After: elects directors who hold 100% of FT stock
Could make duty argument that directors of FT still have fiduciary duty. But, could say
that because shareholder’s power is now less direct, FT directors are more likely to shirk
their responsibilities.
2. Demand Futility
a. Definition
1) What’s a demand? Well, a demand is what the shareholder must first do before
filing a suit against the board of directors. In other words, the shareholder must first
demand that the board of directors bring the shareholder’s action. There are some
situations where such a requirement would be unjust.
2) Marx v. Akers (Supp. p. 17)
Facts:  allege that directors approves excessive compensation for themselves and
executives.  claim failure to make demand or state a cause of action.
Holding, Reasoning:
Part one: Court acknowledges the intrusiveness of derivative actions, and its subsequent
reluctance to permit such suits. The demand requirement is established to deal with this
problem.
Purposes of demand requirement (Supp. p. 18)
1. relieve courts from deciding matters of internal corporate governance by
providing corporate directors with opportunities to correct alleged abuses
2. provide corporate boards with reasonable protection from harassment by litigation
on matters clearly within directors’ discretion
3. weed out unnecessary or illegitimate suits/discourage “strike suits” commenced
by shareholders for personal gain rather than for the benefit of the corporation
Part two: Court next considers different methods of determining when demand would
be futile.
1. Delaware approach (p. 236-37)
Demand futile where:
under particularized facts alleged
there’s a reasonable doubt that
43
(1) directors are disinterested and independent, and
(2) challenged transaction was entitled to BJR protection
2. Universal demand approach (Supp. p. 20)
Demand required in all cases, can proceed in 90 days if not rejected earlier
3. New York approach (Supp. p. 21)
Demand futile where:
complaint alleges with particularity that
(1) majority of directors are interested
(2) directors failed to inform themselves by a degree reasonably necessary,
or
(3) directors failed to exercise business judgment
Part three: Court picks the third approach (although both Del and NY approaches are
quite similar). Court holds that demand requirement is still necessary, since “only three
directors are alleged to have received the benefit of the executive compensation scheme.”
The fact that the majority of shareholders acted out of personal interest might have been a
factor, but P’s claim fails to state a cause of action.
Note: DE’s and NY’s rules are both collapsible into the business judgment rule.
b. Procedural Rules
1) Alford v. Shaw (p. 259)
Issue: Whether a special litigation committee’s decision to terminate
shareholders’ derivative suit is binding on court.
3 approaches to role of special litigation committee
1. Auerbach
BJR applies. Court defers. Judicial review limited to committee’s independence, good
faith, and sufficiency of investigation.
2. Miller
Court defers to committee only if directors implicated don’t help select committee
members.
3. Zapata
Two steps:
(1) Judicial review of committee’s independence, good faith, and investigative techniques
(basically same as Auerbach)
(2) Court can exercise its own “independent business judgment” – has wide discretion to
reverse committee’s decision
Court adopts a modified-Zapata test:
Judicial review of substantive recommendation, may rely on it but not bound by it.
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= substantive
due care
= procedural
due care
How are independent board members selected?
CEO finds them, directors approve them.
Note: Likely difference in practical effect of various rules? Not much.
Delaware Law
Futile demand?
Particularized factual allegations
of reasonable doubt that:
 majority disinterested
 BJR (broad leeway)
Aronson
Y
N
Demand excused
Demand required
Board sets up Special
Litigation Committee?
Demand made
BJR governs
Y
Board can regain
control of litigation
N
Shareholder-
controls
(No further board
action)
Demand accepted
Demand rejected
Corporation initiates
and controls case
Litigation may not initially
proceed unless shareholder shows wrongful refusal
BJR/Zapata
Who is allowed to do this?
Shareholders
Which ones?
Those holding shares at the time of the alleged injury. Some jurisdictions require holding
for 6 mos. prior to demand.
If board appoints special litigation committee,  usually loses. Why?
If they have enough confidence to set up special litigation committee, usually because 
was wrong to begin with.
Ultimate end: settlement, very very few will make it to court.
Why? Pretty good idea of allegations  settlement easier
45
Parallel process in not-for-profits?
Can have suit brought by company or public institutions (Attorney General).
III. Shareholder Issues
A. Shareholder Voting
1. Procedure
a. FAQ
When do shareholders vote?
Shareholders meetings.
Not technically required in every state.
If number of shareholders is small enough can have telephone meeting.
If shares are publicly traded, exchange will require actual shareholders’ meeting
Sometimes called by officers/directors.
Who votes?
Only shareholders holding stock on record date can vote.
Why?
Elect directors.
Approve director compensation.
Vote on mergers or major asset sales.
Why would people come together from across the country to vote?
They don’t. Most don’t show up because most don’t care. Many shares are held by
mutual funds (larger ones do care). Activism by larger institutional investors, especially
when you have a lot of votes.
What if people don’t show?
For those interested enough, can vote by proxy.
Appoint someone to vote on his behalf at shareholders meeting.
Public corporations institutionalize the process because people don’t vote anyway.
Technically speaking, shareholders are sheep.
When enough large proxy votes come in, you can forego the meeting.
West’s stump speech on shareholders’ meetings:
Shareholders’ meetings are, by and large, meaningless farces... All they are is one of the
directors standing up and talking about how they’ll do better next year and their
accountants will guarantee it. Disney and Sony can have big multimedia presentations. If
you’re McDonald’s you can have fries with it…Shareholders can come and protest about
important social justice issues… I don’t think shareholders meetings advance the cause
of democracy at all… If you don’t like what management is doing, dump your shares, get
out and invest in a company you do like.
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b. Cumulative voting
= a method of allowing minority shareholders to elect a proportionate minority of the
board members.
# of shares owned x number of seats
Ex: A and B are shareholders. A has 199 shares, B has 101 shares (total = 300). There
are 6 candidates going for 3 director slots. B would have no say in any election if they
used straight majority voting. B should have 1 of the 3 seats.
The way cumulative voting works: multiply number of shares x number of director slots.
Now all votes are spread over the 3 candidates you want. So B can put all 303 for one
candidate and A picks the other 2.
A = 199 x 3 = 597
B = 101 x 3 = 303
(Note: It’s possible for A and B to be stupid and mess this up. Generally, though,
cumulative voting ends up with proportional minority representation on the board.)
Why multiply them in the first place?
 Make sure there are no partial shares (since they usually can’t be voted).
 Works better in formula.
If you have 11 directors, all you need is 8.5% to get a seat. The smaller the board, the
greater the percentage of shares needed to put one person on the board. To get more
control, majority shareholders, might suggest staggered terms. This decreases the number
of seats elected at a given time, thereby increasing the number of shares you need to but
someone on the board in a given year.
c. Alternatives to reach the same result
1) Stagger the board.
2) Disproportionate voting
Shareholders do not always want voting control to correlate with their investment
interests. (Facially flies in the face of risk = control.)
Ex: Struggling technology company recruits star technician George. He’ll invest
firm-specific capital, learn firm-specific skills. In return, George may demand
significant voting power. Firm is willing to give him more control than the value of
the money he puts in (since he adds so much more).
d. Indemnification (pp. 475-78)
Insurance stuff arose after Smith v. Van Gorkem.
Companies are likely to indemnify their directors. Del. General. Corp. Law allows
indemnification of directors, officers, employees, and agents.
D&O policies resolve issue of deciding whether or not to indemnify a person in an ad hoc
decision.
2. Shareholder Voting Control
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a. Stroh v. Blackhawk Holding Corp. (p. 541)
Class A 87,868 x $3.40  initial sale at $4  stock split
Class B 500,000 x .0025
Class B stock doesn’t have the “economic incidents” of shares of stock – no dividends, no
residual rights. Just voting rights. This is reflected in price of share.
Why do this? Management wants to retain control of firm.
Stock split = dividend equal to the value of the stock you currently hold given to you in
the form of stock, not $.
Why do this? Some companies think their stock price is too high, use this to keep stock
price reasonable.
Share is a unit of proprietary interest in a corporation.
Court: Proprietary right = right to participate in control or surplus/profits or distribution
of assets. Class B stock has right to vote. That’s all that’s needed.
To retain control, management could also issue non-voting stock to the public. But, the
IL constitution at the time (but no longer) didn’t allow the issuance of non-voting stock.
1988 SEC adopted 19c-4 – barred NYSE from listing shares of corporation that dilute the
minority with dual class shares as they did here. Rule vacated for exceeding the authority
of the SEC. But the NYSE and AmEx decided to adopt the rule anyway, putting limits on
disproportionate control/ownership.
b. Ways for management to maintain voting control without having it correlate with
investment:
Ex: 3 participants in an industrial endeavor
Investor
Cartman
Stan
Kenny
total
Investment Voting interest
$10M
20%
$6M
30%
$5M
50%
$21M
Voting interest is
disproportionate to
investment
How do we get this structure?
1. Issue multiple classes of stock with different incidents of ownership. Stroh v.
Blackhawk
2. Allocate one class of regular stock in proportion to desired voting interest. Then
invest additional funds in other instruments, e.g., non-voting stock, preferred
stock (get dividends first, guaranteed dividends), or debt to others. (Investors
probably won’t want non-voting common stock (for tax purposes inter alia).)
48
Investor
Cartman
Stan
Kenny
total
Investment Voting interest
$10M
20%
$6M
30%
$5M
50%
$21M
Purchase Price of Stock
$2M
$3M
$5M
3. Have class-specific board members and issue different classes of stock. Define
stock classes by how many board members they are entitled to elect in accordance
with desired split.
4. Voting trust. Cartman places some of his stock in trust, giving Stan and Kenny the
right to direct its vote as trustees (= transfers legal title, remains equitable owner –
retains incidents of ownership, e.g., gets dividends).
5. Vote pooling arrangements.
6. Irrevocable proxies. May be conditioned on something like the holder of the proxy
working at the firm, their loan remaining outstanding, their being alive, etc.)
Analysis (p. 544)
What’s the public policy behind banning non-voting shares?
 At formation, don’t want promoters to take unfair advantage of other shareholders.
Midstream, board may be taking unfair advantage of investors.
 Power without accountability. Directors could elect themselves through gaining
cheaper shares.
 Investors won’t want the power without economic benefits. Don’t put product on
market that people don’t want.
 Risk that manager will buy B shares and deliberately mismanage corporation and
drive down value of A shares (without transgressing BJR or opening to derivative
liability), but A shares, bring company back up, make profit.
 [KK: Shareholders with control but no financial interest in company may not make
efficient decisions. No, because economic interest is still tied to stock price which
reflect value, regardless of dividend sharing. Well, maybe still since they have less
economic interest.]
In Stroh, after shares initially sold, Class A stock fell in value, Class B stock rose in
value. Why? How do you know what the value of B shares is? Were Class A shares
treated unfairly?
 Don’t know how value of B shares is set. Market does it.
 [KK: maybe it indicates that shareholders don’t see the value of shares to be that
disparate – try to bring them closer together in value.]
 Hard to argue that A shares were treated unfairly. They knew what they were buying.
As long as B shares aren’t deliberately acting to drive down price of A shares, no
problem.
49
Would you be willing to buy shares in a corporation where the people in control will
use that control to give above-market rate salaries to themselves and their children?
If you have the info going in and believe that investment is worth your while, then invest.
Maybe, at a lower price here.
Problem (p. 545-46)
Investor
All
Management
You
# shares
1,000,000A
300,000A
1,000A
Price1
$4
Price2
$6
You think that an outside investor will buy all shares for $9.
Management offers new shares of A at $5 for each share held or 5 new non-voting B
shares at 1 cent each.
What to do?
First simplify problem:
Investor
Outstanding
Me
You
# shares
150
100
50
Price1
$6
Total value
$900
$600
$300
Me puts in $500 more for 100 new shares at $5@.
Me
$1400
You
200
$1120 out of a corporation worth
= 4/5 of stocks
= 4/5 of corporate value
50
$ 280
= 1/5 of stock
= 1/5 of corporate value
So, by doing nothing, you lose $20 of value while retaining the same number of stocks.
Though you’ve done nothing, you now have a smaller slice of the aggregate pie. You’re
better off buying some additional shares.
Should the board be able to put you to the choice of buying one more voting stock or 5
more non-voting stocks that are really cheap?
No. If you don’t come up with the money, the effect is that you lose. Unfair for
management to thrust it upon you.
(If the exchange is fair to shareholders there’s no problem letting them consider it.)
B. Proxy Fights
Battle for control carried on specifically by proxy. Cards collected, votes counted.
1. Levin v. Metro-Goldwyn-Mayer, Inc. (p. 485)
50
Conflict for control between two groups in company. Outsiders claimed that incumbents
spent money on PR and proxy firms at corporate expense unfairly.
Issue: Is it illegal or unfair for incumbent directors to use corporate funds to defend
themselves?
Holding: No.
Background concern: Is this being done for the firm, or to protect management’s jobs?
Here, groups are advancing differing business policies.
Problem (p. 488)
Management has conflict of interest.
2. Rosenfeld v. Fairchild Engine & Airplane Corp. (p. 488)
Shareholders ratify reimbursement of both sides in control contest.
Court finds that management and successful contestants may be reimbursed for
reasonable expenses in a proxy fight over policy.
Rules:
1. Corporation can’t reimburse either party unless dispute concerns questions of policy
(as opposed to personnel). (Rosenfeld)
2. Corporation can reimburse only reasonable and proper expenses. (Rosenfeld)
3. Corporation may reimburse incumbents whether they win or lose (Levin)
4. Corporation may reimburse insurgents only if they win and shareholders ratify
payment. (Rosenfeld)
Critiques:
 Policy/personnel distinction is difficult. Disputes are often personnel decisions
framed as policy issues.
 Asymmetry in letting management be reimbursed whether they win or lose, but
insurgents only if they win.
 Personnel dispute could have onerous consequences for the incumbent. Fictional
distinction between policy and personnel.
Reviewed rules for reimbursing parties in a proxy fight.
Problem (p. 494)
Citizen Kane is a rich EIC of NY Inquirer and CEO and 33% owner of its parent
company. Geddes owns 10% and thinks he’d be a better CEO and EIC than Kane.
Kane throws lavish party at country estate for shareholders and gives shpiel about why he
should stay in control. Geddes throws a lean-and-mean party for shareholders on his
yacht where he tells them why he should be in charge.
Can either be reimbursed?
51



is policy at issue? Or personnel? – will probably find a policy rationale 
reimbursable
are expenses reasonable? – only reasonable expenses reimbursable
who won? – incumbent always reimbursed, contestant reimbursed only if wins
Virginia Bankshares, Inc. v. Sandberg (p. 495)
Confusing opinion.
FABI owns 100% of VBI. VBI owns 85% of Bank. (s own 15%.) FABI does a freezeout merger of Bank into VBI, pays cash to stockholders. Stock value offered was $42.
Directors described it as a high value. But it was not as good a value as they could get –
stock was probably worth $60.
[KK’s] Take-aways:
 A statement of reason by directors on a proxy is actionable under SEA § 14(a) if
 disbelieved by directors and
 false and misleading w.r.t. the subject matter.
 There was no causation of damages to a minority shareholder whose vote was
irrelevant to the outcome.
Why did they go to the shareholders if they didn’t have to? (p. 499)
1. Good PR
2. Ratify resolution of conflict of interest under VA law
Question: Did the board misstate the underlying facts?
D. Shareholder Proposals
1. Federal Rules
a. SEC Rule 14a-9 (17 C.F.R. § 240.14a-9)
Prior to this rule, had only state law fraud action. This federalized these categories of
fraud through the hook of proxies (figured out how to get people for all securities fraud
later). Rule 14a-9 gives a private cause of action for breach of § 14(a), i.e., soliciting
proxies by means of materially false and misleading statements.
Court gets cute (p. 500): Only get immunization from state law conflict of interest issue
if you get ratification after full disclosure… Don’t have good ratification if you lied in
your proxy materials… If no ratification, company went ahead with merger without good
ratification (which it was allowed to do) so there’s no causal link. Had you not lied,
you’d have ratification, but no claim.
Take-aways:
1. There are private actions (not just SEC, state law fraud claims) for (federal) proxy
rule violations.
2. Need causation (what’s meant is somewhat unclear).
52
3. There is a materiality element. Here, was statement of board that $42 was a good
price a material one or not? (“material” = sufficient to change the vote of a prudent
investor)
b. Rule 14a-8
New rule – Q&A format – easier for lay people to understand
Institutional shareholders = large shareholding blocs that use their power to influence
management.
Some popular shareholder proposals in last few years:
1. remove poison pills –defensive takeover tactic
gives existing (non-raiding) shareholders right to buy additional shares at a
discount upon certain trigger events
ex: outside investor purchases a specified percentage of firm
“flip-in-flip-over” pill (flip-in gives common shareholder right to buy
common shares of stock, flip-over gives shareholder right to buy stick in
bidder at time of merger at a substantial discount = substantial deterrent
to hostile takeovers). In no case has a raider swallowed a poison pill.
Rather, raider goes in and talks to board which then faces a BJ decision
on whether to remove poison pill.
2. require annual re-election of directors
3. require secret balloting
4. require directors to hold a specified minimum amount of corporate shares (make them
sensitive to stock price, align interests with shareholders)
5. adopt cumulative voting
6. prevent same person from being CEO and Chairman of the Board
7. prohibit green-mail
(once-popular takeover tactic: someone would buy 30% of shares in firm, tell
management that he’s ready to takeover, agrees not to if bought off at high
stock price)
8. make all board committees headed by outside directors (?)
9. management’s slate should have more nominees than seats for elections – gives
shareholders a choice
10. link director pay to corporate performance
11. require the compensation committee (that sets the salaries of directors) be composed
entirely of independent directors and have its own compensation consultant
12. create a committee of shareholders who advise the directors
Some of these are nuisance proposals, some backed by big investors. Most proposals
now focus on corporate governance.
2. Cases
a. ACTWU v. Wal-Mart Stores (p. 507)
1) The Case
53
Proposal: Corporation will prepare and distribute of reports re. its affirmative action and
EEO policies, programs, and data plus a description of the company’s efforts to
publicize its EEO policies to suppliers and purchase goods and services from
women- and minority-owned suppliers
Issue: Can  exclude ’s proposal under the “ordinary business operations” exception
(R.14a-8(c)(7))?
Holding: Proposal concerns a significant policy consideration and therefore does not fall
within exception (though some stuff is day-to-day stuff and should be excluded).
Rule: The “ordinary business operations” exception applies to “proposals that are
mundane in nature and do not involve any substantial policy or other
considerations.” (italics in original)
How do you know if it’s mundane or involves substantial policy?
 “[T]he line between includable and excludable employment-related proposals based
on social policy considerations has become increasingly difficult to draw.”
 Examples of day-to-day employment matters:
 employee health benefits
 general compensation issues not focused on senior executives
 management of the workplace
 employee supervision
 labor-management relations
 employee hiring and firing
 conditions of employment and employee training and motivation
Other reasons for legitimately excluding proposals:
see below: (7), (1), (3), (2), (4), (6), (12)
2) Notes:
Case-by-case analysis
Overturning Cracker Barrel position (that employment-related social policy proposal may
be excluded from a company’s proxy materials).
This proposal concerned only preparing reports. Deadlines concerning these can be
excluded under (1) or (6).
Does J. Wood miss the point? The Proposal’s phrasing allows management to refuse to
comply with “request” while insulating them from the BJR.
Why is it such a big deal if the proposal lost miserably anyway?
Good PR, management doesn’t want to be perceived as not being in control.
3) SEC Rule 14a-8 governs shareholder proposals
a)Bases for the Board excluding a shareholder proposal
Note:
Under the old 14a-8, the following 13 subsections appeared under 14a-8(c).
Under the new 14a-8, the following 13 subsections appeared under 14a-8(i).
54
(1) improper under state law
(2) violation of state, federal, foreign law
(3) violation of commission’s proxy rules (false/misleading statement)
(4) personal grievance, special interest (convey private benefit, not shared by shareholders
at large) ........................................................................................................... Austin v. ConEd
(5) irrelevant ........................................................................................................ NYCERS v. Dole
old: pertains to less than 5% total assets + 5% net earnings and gross sales + is
not significantly related to business
new:
pertains to $10M or less gross revenues or total costs; or 3% gross revenue
or total assets if that # is less than $10M
[no “significantly related to business” language  more objective]
(6) absence of power/authority to effectuate/implement ..................................... NYCERS v. Dole
(7) ordinary business operations ......... ACTWU v. Wal-Mart, NYCERS v. Dole, Austin v. ConEd
(8) election to board
(9) conflicts with company’s proposal at same meeting
(10) moot/substantially implemented
(11) duplication (substantially duplicative of proposal previously submitted by another
proponent which will be included)
(12) substantially the same as a prior proposal submitted within previous 3 years (of a 5
year period?) provided that
old: if submitted 1x, got < 3% of votes cast
if submitted 2x, got < 6% of votes cast 2nd time
if submitted 3x, got < 10% of votes cast 3rd time
new:
if submitted 1x, got < 6% of votes cast
if submitted 2x, got < 15% of votes cast 2nd time
if submitted 3x, got < 30% of votes cast 3rd time
(13) specific amounts of cash or stock dividends
b) Revisions:
Eligibility
old:
new:
1% or $1,000 for at least a year and on day of meeting R.14a-8(1)
1% or $2,000 for at least a year and on day of meeting R.14a-8(b)
Old version: 14a(c)(7)
New version: (i) Question 9 (7) “specific business decisions normally left to the
discretion of management”
55
b. NYCERS v. Dole Food Co., Inc. (p. 518)
Proposal:  should set up a committee to study and report on various health care plan
alternatives being considered by Congress.
Issue: Can  exclude ’s proposal under any of these exceptions:
a. “ordinary business operations” R.14a-8(c)(7)
b. “insignificant relationship” R.14a-8(c)(5) [not part of new R.14a-8(i)]
c. “beyond power to effectuate” R.14a-8(c)(6) ?
Holding: No, no, and no.
a. It’s hard to argue that national health care is part of Dole’s ordinary business.
b. This would involve a substantial weight on Dole.
c. NYCERS seems disingenuous w.r.t. the third prong. Dole would only have to
study health care reform. But that’s what’s fishy about this: what does “study”
mean, anyway, and why should a study be enforced at the expense of the
corporation? The truth is, the petitioners probably wanted Dole to lobby for health
care reform, backed off and said just to study it. The overall goal of the proposal is
policy-based; real corporate goals should be about money-making.
OTOH, shareholders own the company, should be able to do whatever they like.
[KK: court overlooked the fact that the health care plans being studies were not even
viable options yet – none of them might be approved by Congress. What’s the point of
investigating them if not to get involved in advocating for the one that’s best for the
corporation?]
Take-aways:
 Even if a proposal concerns ordinary business conduct, it can still involve significant
strategic decisions that will significantly alter the way a company does business.
 Considering the court costs and ’s attorneys’ fees (at least in ACTWU v. Wal-Mart)
in the foregoing two cases and the fact that both proposals at issue lost miserably
when put to a shareholder vote, maybe it makes more financial sense to put lame
proposals in the proxy materials.
c. Austin v. Con Ed (p. 522)
Proposal: non-binding endorsement of a retirement planning allowing employees to retire
after 30 years of service, regardless of age Issue: Can  exclude ’s proposal
under any of these exceptions:
“ordinary business operations” R.14a-8(c)(7)
“confer a personal benefit on proponent” R.14a-8(c)(4)
Holding: Excludable based on “ordinary business operations” exception.
Worker issues are generally going to be thought inappropriate.
Take-aways:
 An “audacious” proposal on a mundane topic is still mundane.
 The availability of other fora (e.g., collective bargaining) can be an indicator that a
proposal is not extraordinary enough to be voted on by shareholders.
d. Disingenuous aspects of these cases
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Wal-Mart – the proponents didn’t want to publicize affirmative action policies, rather to
promote them
NYCERS – didn’t want research into health care plans, rather wanted lobbying for one
Austin – employees wanted terms they couldn’t obtain through labor bargaining process
Problems (p. 525)
1. Firm X makes 3 models of cars: 2 popular luxury sedans, 1 souped-up sportscar that
always loses money. Firm keeps souped-up car because it helps their market for the
other cars.
Which shareholder proposals to stop producing the sportscar are excludable?
Proposal A: company shall discontinue
Proposal B: shareholders recommend that company shall discontinue
Proposal C: amend by-laws to limit production to sedans
A – is it “ordinary business operations” or not? (probably not since it involves a major
strategic decision)
B – may be proper, although the same question as above applies
C – by-law amendments are things that shareholders can validly concern themselves, can
probably limit business operations in this way. (How much shareholders can use by-laws
or articles to affect ordinary business operations is an open question in the law.)
Problems with measuring 14a-8(I) exceptions:
Exception #7: How do you determine magnitude (ordinary v. extraordinary)? This is a
question of fact to be decided by the jury.
Exception #4: Conveying a private benefit to the proponent
Union cases are extreme, although there may be specific benefits for anyone who would
bother to bring a proposal. Generally, private benefit isn’t ambiguous.
[KK: Thinking about shareholder loyalty:
Controlling # of votes  fiduciary responsibility
Non-controlling # of votes  can’t convey too personal a benefit through proposals you
make – although someone else could make the proposal.]
D. Shareholder Inspection Rights
1. General
Shareholders who want to get involved in a proxy fight need to be able to contact, inform,
and lobby other shareholders.
Governed by SEA of 1934 § 14:
Proxy rules provide for some kind of communication – either:
(1) mail materials for proponent (can charge insurgent for expenses) or
(2) give a copy of the shareholder list so you can do it yourself.
Insufficiencies in §14:
 Not all firms are under § 14 since they may not be registered under the Act.
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

Insurgents may want to communicate directly, don’t want companies to mail material
for them.
Insurgents may want other information in addition to shareholder lists.
2. Crane v. Anaconda (p. 527)
Facts: Crane announces tender offer for Anaconda stock. Anaconda refuses.
Underlying strategic reason: If Crane has the list, it can send out all kinds of propaganda
against management and in his favor.
Stated reason: Crane has an improper purpose (i.e., has a purpose other than the business
of the corporation)
Issue: Whether a qualified shareholder (Crane) may inspect the corporation’s stock
register to ascertain the identity of fellow shareholders for the avowed purpose of
informing them directly of its exchange offer and soliciting tenders of stock.
Holding: Anaconda must let Crane inspect the register.
Rule: A shareholder desiring to discuss a tender offer with other shareholders should be
granted access to the shareholder list unless the list is sought for a purpose adverse
to the corporation or its shareholders.
NY Statute in Crane (p. 527) – qualifying shareholder (“qualifying shareholder” =
shareholder of record for preceding 6 mos. or 5% of shares) has right to see shareholder
list and other corporate records
DE Statute in Pillsbury (p. 529) – no shareholder qualifications, constrains shareholder
by differentiating between shareholder lists and other business documents (more closely
protected)
Tender offer buyer (a.k.a. “raider”) instead of going to management to work out a
merger, goes directly to shareholders and make them an offer for their
stock. A good offer will be above market price. The offer is publicized in
newspapers, by banks, etc. Shareholders tender their stock to the raider,
well actually to a depository bank that holds shares in escrow until
conditions set forth by person making the tender offer are met.
Crane is an IL corporation. Anaconda is a MT corporation. Suit brought in NY where
Crane is a foreign corporation doing business.
Why sue in NY? Favorable law.
KK’s Take-aways:
 Liberal construction of a statute in favor of stockholder whose welfare as a
stockholder/welfare of corporation may be affected. (Sadler v. NCR too)
 Right to inspect stockholder list derives from property right of the stockholder and
right to protect that interest. (In Sadler, court also notes NY statute’s intent to place
shareholders and management on equal footing w.r.t. access to shareholders)
3. State Ex Rel. Pillsbury v. Honeywell (p. 529)
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Pillsbury buys stocks because he cares about the morality of Honeywell’s work. Requests
corporate records on bombs because he wants to stop them.
Court denies him access because he doesn’t say anything about concern with return on
investment.
“Power to inspect may be the power to destroy”
Options for “socially responsible” shareholders?
 invest in politically correct mutual funds
 do your thing more easily in a closed corporation
 If Pillsbury said that he was interested in financial effects of the anti-social policy, he
could have had a case. Morality alone doesn’t cut it.
The reason you have your shares publicly traded is to get capital. The people buying
stock are making an economic investment (at least the court presumes and recognizes
only economic interest) and want a good return on investment. If you want to maintain
control over your company and your primary goal is morality, don’t issue stock.
DE statute distinguishes between demand for shareholder list and corporate records.
Burden of proof:
shareholder list – company must prove the shareholder has an improper purpose
corporate records – shareholder must prove that s/he has a proper purpose
Shareholders may be embarrassed to have it known that they have stock in certain
companies. Ex: Universities
Can hold stock in street name – broker doesn’t write down beneficial owner’s identity.
So it looks like Merrill-Lynch owns 15% of the company and Merrill-Lynch is not going
to give you the names of the beneficial owners.
You can get a NOBO list – Non-Objecting Beneficial Owners. Most shareholders are
included.
Shareholder lists
List of record owners (CEDE list) – includes brokers holding shares in street name
NOBO list – company calls brokers and asks them to compile list of beneficial owners
listed (actual owners who gain the benefit of the shares) who don’t object to being
4. Sadler v. NCR (p. 533)
AT&T launches tender offer for NCR (MD corporation doing business in NY)
AT&T has no right under NY or MD law to get shareholders list.
Under NY law, AT&T’s ally, Sadler has the right to get the shareholders list.
Request both CEDE list (a.k.a. street list) and NOBO list.
Court disagrees with Chancellor Allen, finds that NOBO lists aren’t all that different from
CEDE lists.
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Court notes the statutory purpose of “seeking ‘to the extent possible, to place
shareholders on an equal footing with management in obtaining access to shareholders.”
Problems (p. 540)
proper purpose: promoting stock split
improper purpose: provide service to shareholders (through upscale junk mail)
E. Insider Trading
1. Introduction: Hypos
#1:
X wants to buy 51% of company. Current value is $100/share but X planson increasing
value through cost-cutting measures. X purchases for $120/share, and folks starting
selling for more than $100.
That’s ok.
Arbitrage = trading in two separate markets in the same commodity/stock
Decreases ability to get huge gain, should get some on margin
Arbitrageurs = traders who trade based on information (e.g., rumors of tender offers),
not interested in long haul or improving long-term value of company.
ex: Boesky – cheated by buying information about tender offers from loan officer
Exxon prices are down due to outstanding environmental claims.
#2:
X gets loan from Y (loans officer) to buy company. Y calls Z and Z buys stock, knowing
it will go up in value.
This is inside information. It’s also insider information to know whether tender offer will
succeed or fail.
Who’s hurt by insider trading?
1. target shareholders – sell stock to insider instead of holding onto it and making more
money [KK: but don’t they have to decide to sell on their own before they find out if
there’s a buyer?]
2. other arbitrageurs
3. other issuers – public loses confidence in other issuers, makes it more difficult for
them to issue stock and sell it (BUT no empirical support for this)
4. acquirer – more stock bought by acquirer  more likely news of offer will leak;
target managers put on notice, take defensive measures
Arguments that insider trading isn’t a bad thing
 compensate/reward managers (investors can always watch and see what managers do
and then do the same)
more arguments from text:
 Most insider trading escapes detection  banning it officially gives investors the
mistaken impression that it doesn’t happen
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
There are no victims in need of protection – does anyone suffer a loss? should that
person be owed any duty by the insider?
2. “Rule 10b-5”
a. History
Common law action for deceit
 False representation
 Of material fact
 With knowledge of falsity (or reckless disregard)
 With intention of causing reliance
 Justified reliance
 Damages
b. The Statute
17 CFR § 240.10b-5 Employment of manipulative and deceptive devices.
It shall be unlawful for any person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce, or of the mails or of any facility of any national
securities exchange,
(1) To employ any device, scheme, or artifice to defraud,
(2) To make any untrue statement of a material fact or to omit to state a material
fact necessary in order to make the statements made, in the light of the
circumstances under which they were made, not misleading, or
(3) To engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person, in connection with the purchase or
sale of any security
Common law action for deceit
Statutory action
1. Rule 10b-5
1. false representation
a. materiality
2. of material fact
b. scienter
3. with knowledge of falsity (reckless
c. causation
disregard)
d. reliance
e. duty to person harmed (Dirks)
4. with intention of reliance by 
2.
New-fangled
10b-5 Misappropriation/
5. justifiable reliance by 
Fraud on the source (O’Hagan)
6. damages
3. Mail/Wire fraud
4. Rule 14e-3 (1980) – get around duty
requirement
goal: protect market
goal: protect individual investors
{
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c. SEC v. Texas Gulf Sulphur (1968, p. 364)
Facts: Mining firm makes big find, tries to keep it quiet. Employees and their tippees
buy stock before public is fully informed of magnitude of find. Company releases
statement to quell rumors and speculative newspaper articles.
Issue1: Did employees and tippees engage in illegal insider trading?
Materiality
1. Test of materiality: Whether a reasonable person would attach importance in
determining his choice of action in the transaction in question.
 info disclosing earnings and distributions of a company
 facts which affect the probable future of the company + which may affect the
desire of investors to buy/sell/hold securities
2. The fact that an insider traded on it is evidence of it being material.
Holding1: Yes. Can’t act on info until it is available to the public in a manner readily
translatable into investment action.
Issue2: Was the press release misleading (conveyed a false impression of the situation)?
Disclose or abstain
1. Duty of abstinence ceases when info is incorporated into stock price/reaches
investors
2. Current studies say that info is incorporated into stock prices in 15 minutes
Holding2: Remand. The press release wasn’t quite false, but probably misleading to
investors because it’s gloomy.
To be liable under R.10b-5, the press release must have been released in connection with
the purchase or sale of a security. The company itself isn’t buying or selling. Court:
doesn’t matter so long as it meets the materiality standards and a reasonable investor
would rely on it in a decision to buy or sell stocks. The reasonable investor’s decision to
buy or sell meets the “in connection with” requirement.
d. Notes
Purpose of SEA ’34: prevent unfair practices, insure fairness in securities transactions
Policy goal: protect justified expectations that all investors trading on impersonal
exchanges have relatively equal access to material information
Essence of insider trading rule: (Matter of Cady, Roberts & Co.(1961))
Anyone who has direct or indirect access to information intended to be available only for
a corporate purpose and not for anyone’s personal benefit may not take advantage of the
information, knowing it is unavailable to the investing public.
So, you don’t have to be an actual insider, just have inside information (*not according to
Chiarella (1980), though, see p. 378) see Dirks! (p. 378)
If you have inside information, you have two options:
 disclose
 abstain from trading/tipping
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State of mind required for liability for false/misleading statement: recklessness
Private Securities Litigation Reform Act of 1995
Created “safe harbor” for forward-looking statements that are hedged by meaningful
cautionary statements identifying important factors that could cause actual results to
differ materially from those predicted.
Blue Chip Stamps v. Manor Drug Stores (p. 377)
Buyers and sellers are protected by R.10b-5, not would-be buyers and sellers who
conducted no securities transactions.
Problems (p. 374)
1. a. Martha inherits a farm, hires a geologist, discovers oil under George’s land, buys
his land without telling him. Is George entitled to recover profit? No.
No cousin-cousin fiduciary duty. Martha may/should profit from her investigation.
b. What if Martha gives him misleading info – “How would I know any more than
you?”
Duty not to lie. Liable for lying, misleading.
c. What if the leasing agent buys George’s land?
In order to be liable, need duty. If no duty to purchase and sell, then no duty. If
general agent whose role extends to purchase, may have duty.
No duty  no liability, except where there’s fraud.
2. Juan and Betty are partners. Partners owe each other a fiduciary duty. Juan
breaches his fiduciary duty by investigating ore and buying land from Betty without
telling her there’s ore. If he only has a tenuous theory on the presence of ore, result is
uncertain, can’t be sure if it’s material info.
3. Eve is a shareholder who overhears a company geologist say that the company found
a new ore deposit. Eve buys Bob’s shares. Eve is not liable.
No co-shareholder duty/liability.
4. Federal law and state law differ. (all you need to know)
3. Dirks
Facts: Dirks, an investment analyst, received info about alleged fraudulent practices at
Equity Funding from Secrist (former officer of EF). Dirks investigated, believed
there was fraud, advised clients and other investors, and urged the WSJ to write story
on it (declined). While Dirks investigated and spread the word, stock price fell from
$26 to <$15. Fraud was then found by authorities.
Issue: Did Dirks aid and abet violations of § 17(a) of the Securities Act ’33, § 10b of the
SEA ’34, and SEC Rule 10b-5 by repeating allegations of fraud to members of the
investment community?
SEC approach: there should be equal info among all traders
Court: no criminal liability – Tipper didn’t violate any fiduciary duty by tipping Dirks 
Dirks has no derivative duty to breach
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3 Take-aways
1. Whether tippee violates 10b-5 depends on:
 whether tipper violates fiduciary duty to firm’s shareholders in giving tip and
 whether tippee knew/should have known of the breach
2. Definition of duty (for purposes of insider trading only):
Fiduciary duty breach occurs only where a tipper earns a personal benefit from the tip
Duty of care violations don’t matter, just duty of loyalty violations.
3. Lawyers and accountants are temporary insiders for the purposes of insider
trading.
 can’t trade on client’s info, have same duty not to disclose. (fn.14)
Precedent:
In re Cady, Roberts & Co.
 corporate insiders have common law affirmative duty of disclosure
 non-insiders could by obligated to disclose or abstain
 basic principle: there should be equal info among all traders
Two-part test for Rule 10b-5 violation (Cady, Roberts & Co and Chiarella)
1. existence of relationship affording access to inside info intended to be available
for corporate purposes only
2. unfairness of allowing a corporate insider to take advantage of that info by trading
without disclosure
Chiarella
 No general duty to disclose – duty arises only from a specific fiduciary relationship
(trumps 2nd bullet above)
 Duty is breached only where there is manipulation or deception, secret profits
 basic principle: only some people, in some circumstances, will be barred from trading
while possessing material nonpublic info.
Analysts often ferret out and analyze info by talking with corporate insiders. This info
can’t be made simultaneously available to the corporation’s shareholders or the public
generally.
Rules:
1. Insiders can’t give info to an outsider for the improper purpose of exploiting it for
personal gain.
2. Tippee derives duty to disclose or abstain where he knows or should know that the
insider breached his duty.
Questions to ask (Dirks):
 Is the info material?
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 Is the info nonpublic?
 Is disclosure of the info a breach of duty?
 Will an insider directly or indirectly benefit from disclosure? (no personal gain no
breach)
 If so, is tippee under a derivative duty to disclose or abstain?
 Does the tippee know or should he know that there’s been an insider breach?
4. O’Hagan
a. Background:
Carpenter - the news rumor case. Rumors do affect pricing, so the column is material
information. Under Dirks - Nothing wrong. No fiduciary duty relationship. But court in
this casehas duty to Wall Street Journal. “Contents of columns. . . were journal’s private
property prior to publication.”
What this means: duty turns on whether tipper has internal rule against taking the
information.
Problem: should we have criminal charges based on civil arrangement? Courts say
“sure”.
The Skinny: Assuming Carpenter is good law, would publishing statistics too early in
error mean breach of fiduciary duty? No, because that isn’t intentional. What the court is
concerned about here is misappropriation.
b. The Case:
Facts: O’Hagan was a partner at a law firm, but not the principal attorney in this project.
(Question: Does liability extend to entire firm?) O’Hagan used knowledge acquired to
make big money via trading. O’Hagan is indicted.
Holding, Reasoning:
Part One: Misappropriation
Under the “new” reading of 10b-5 and 10(b), a fiduciary’s undisclosed use of information
belonging to his principal for personal gain constitutes fraud in connection with purchase
or sales of security.
Court finds misappropriation, even though O’Hagan bought shares of target, but he owes
duty to acquiror. It’s not a traditional violation, since he had no fiduciary duty to the
target. The Dirks test would fail.
Part Two: Rule 14(e)(3)
Introduced in 1980, this rule applies only to tender offer, but applies to all third parties
who use information for personal gain via trading these securities. This includes agents
of tender offerors (no back-door action there).
Although O’Hagan feels this is too broad of an extension, the court defers to the SEC in
interpreting and administering 10b-5 (within reason).
Part Three: Mail Fraud. Just know it’s out there.
c. Notes
1) Problem: Court doesn’t clarify fiduciary relationship between lawyer and client.
ABA rule only covers attorneys who act in a manner disadvantageous to the client after
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disclosure to and consent by client. What is the disadvantage in O’Hagan’s case. None,
really.
2) Hypos:
a) Bud Fox gets law firm associate to pass insider information. Buys target stocks.
Gains. Shares profits with associates.
Dirks: Violation for target associate only.
O’Hagan: Yes.
b) Fox’s dad is an officer for airlines. Dad learns FAA has formed airline liable.
Trouble?
Dirks: Did dad breach duty? As an officer, looks like dad received personal benefit.
O’Hagan: What is the airline’s internal rule?
c) Mitsubishi develops new home video camera. With press release, M stock will go up,
and Sony will go down.
 Your Mitsubishi’s outside patent lawyer. You buy stock. Liable? Under fn. 14, yes.
 You sell Sony stock. No duty via Dirks, but you do as an attorney under O’Hagan.
Harris dilemma: no harm done! Think of it more in terms of equality of information.
 Patent lawyer for government buys stock. No Dirks, but what about O’Hagan? Does
an internal rule exist?
IV. Mergers, Acquisitions, and Takeovers (p. 670)
A. Mergers and Acquisitions
1. Merger Mechanics
a. [Statutory] merger – separate legal entity is formed of two legal entities with the
former ceasing to exist and the latter existing as owner subject to the liabilities of both.
Merger agreement made between two boards of directors. Shareholder approval under
provisions DE General Corporation Law §§ 251, 262.
Exceptions to shareholder approval:
(a) short-form merger – typically done when one company owns 90% of the other;
remaining shareholders have appraisal rights (= right of opponents to merger to
be paid off in cash for the fair value of their shares)
(b) disparate size and number of outstanding shares (outstanding shares will only
increase by 20% after acquiring the target)
b. [Practical mergers]
1) Stock swap – exchange of shares by acquirer issuing shares to target in return for
target shares. Target becomes subsidiary, can be dissolved or use a short-form merger.
Problem may arise if a minority of shareholders don’t want to go along.
Partial solution: minority has to accept a share exchange approved by majority of target
shareholders. (DE)
Variation: Acquirer pays cash for shares
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2) Asset purchase – acquirer purchases assets of target for stock in acquirer; target
ordinarily liquidates and distributes acquirer stocks to its shareholders
Variation: Acquirer pays cash for assets
 acquirer doesn’t deal with shareholders
 no(?) unforeseen liabilities
 takes a lot of paperwork – what the inventory is, who has title to it…
State laws vary w.r.t. need for:
 shareholder approval – most require approval for sale of assets, acquirer may
not have to vote on asset acquisition
 appraisal rights – most grant ‘em, not DE though if the majority went along
with it (they aren’t getting a raw deal, should be no difference in value)
c. Triangular combination – acquirer creates subsidiary, shares of target go to
subsidiary, acquirer merges target into subsidiary, target shareholders get shares of parent
 ensures that there’s no minority interest remaining
Why do a triangular merger?
 tax benefits
 dissenters/appraisal rights – rights that corporate statutes give to target’s
shareholders to sell their stock to the corporation at its “fair value”
Notes:
 Rights only apply where shareholder dissents to specified corporate
transactions
 Fair value = appraised value of stock immediately before the transaction
Why these rights exist:
 State may want to protect shareholders rights in investment – firm shouldn’t
be able to transform investment into something else (another firm entirely,
substantially changed nature of firm)
 Mergers, etc. impose higher risk of economic loss. This would not be a
problem if the shareholder could just sell his stock easily. DE recognizes that
in a fluid market, shareholders can sell their shares. See Del. Gen. Corp. Law
§ 262(b) (Supp. p. 81):
No appraisal rights if
(i) stock is listed on a national stock exchange or
(ii) held of record by more than 2,000 holders.
2. De Facto Mergers
Farris v. Glen Alden (p. 673)
Facts: List owns 38.5% of GA, wants to merge the two companies.
(Statutory) merger
Sale of assets
Glen Alden (PA law)
appraisal rights
appraisal rights
List (DE law)
appraisal rights
no appraisal rights
(with majority approval)
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How to avoid appraisal rights?
Have List (a larger company) sell its assets to (the smaller) Glen Alden. GA purchases
Lists’ assets for stock. List liquidates and distributes GA stock to its shareholders. List
shareholders end up with 76.5% of GA shares. List worked this by executing notice and
proxy statement and mailing these to GA’s shareholders prior to annual meeting. Along
with this notice were recommendations of amendments to articles of incorporation. This
would allow authorization of more shares to cement deal.
 claims dissenters’ rights.
Court: “When a corporation combines with another so as to lose its essential nature and
alter the original fundamental relationships of the shareholders among themselves and to
the corporation, a shareholder who does not wish to continue his membership therein may
treat his membership in the original corporation as terminated and have the value of his
shares paid to him.”
To determine whether the change is fundamental, the court looks at several factors,
including:
 type of corporate interests
 size of assets and liabilities
 management structure and personnel
 shareholders’ level of interest, and
 financial loss.
In this case, all of the factors point to fundamental change, and that means a merger.
There is an exception for sales, but the exception is really only one of form, and not of
substance. It’s a de facto merger. Can’t avoid appraisal rights under our (PA) state law.
The plaintiff therefore gets dissenters’ rights. This is a rare example of substance over
form.
Analysis questions
1. To keep the committee’s intent, the law could have been drafted as “no right to dissent
even if the transaction has all the attributes of a merger… and we mean it!”
3. Freezeout Mergers
a. Coggins v. New England Patriots Football Club (p. 692)
Facts:
Sullivan buys AFL franchise for $25,000.
10 investors, $25,000 for 10,000 shares each.
120,000 shares of non-voting common stock sold, $5 each.
Sullivan ousted from control.
Sullivan borrows money to buy voting shares for $102/share. To buy back the firm,
Sullivan has to buy out shareholders. This is because Sullivan must offer assets, since he
needs security for personal loans to buy stock (fiduciary duty). Sullivan can’t do this
unless either shareholders approve or there are no minority shareholders to approve.
Sullivan must freeze out shareholders. To do this, Sullivan creates a new firm, with the
hopes of merging the two firms. Since Sullivan is the 100% owner of the new firm, it
certainly approves of the merger. Under Massachusetts law, a majority of old firm
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shareholders must also approve the merger. Sullivan offers $15/share to the non-voting
shareholders, but what about voting members? It doesn’t matter, they approve!
Coggins bought 10 shares for $50. (p. 694)
Holding, Reasoning: Merger impermissible because need a business purpose.
Mass. court gets this from Del. case: Singer v. Magnavox (acquirer bought 60% of
Magnavox, then bought 16% through cash-out merger) – business purpose test
Burden of proof:
s must prove (1) legitimate business purpose, then (2) fairness to the minority.
[goal: balance right to “selfish ownership” vs. fiduciary responsibility to minority owners]
Can’t force a minority to submit their shares.
Can buy shares on open market or through tender offer – but may have hold-out problems
Remedy for an illegal freeze-out merger: rescission of the merger.
Exception: too much 3rd-party good faith reliance on merger (for too long – 10 yrs.).
 Damages = present value of stock (what shareholders would have had if the
merger was rescinded)
Court finds value is $80/share. (Note, p. 698)
Weird outcome since:
1. Del. courts under Singer might have allowed this merger. In the later Tanzer case, the
court held that business purpose relating to majority shareholder suffices (might be
enough that majority shareholder wanted to pay off his debts.). In other words,
business purpose doesn’t necessarily imply a corporate business purpose.
2. If Sullivan wanted to show business purpose, could have shown one.
3. Singer was rejected in Del. by the time Coggins was decided. New test: fairness
(Weinberger) – controlling shareholders owe a fiduciary duty to minority
shareholders. Fairness - fair dealing + fair price
One way to look at fairness is “was a majority of shareholders happy?” The fact that a
majority of shareholders approved of a $15/share price should conclusively prove that
they considered it fair.
Is there a sheep problem here? These are Patriot fans are buying the shares, not
professional stockholders. Probably were sheep. Maybe, thought it was better to get 3x
the initial puchase price than to be owners of the team.
Suspicious that it wasn’t offered as a tender offer?
Analysis (p. 698)
1. Legitimate business purpose?
Reminiscent of Schlensky v. Wrigley (baseball field lights), Dodge v. Ford (dividend
investment), shareholder proposals.
Probably, having a winning team is a legitimate business purpose.
3. What if funds were used for another business venture of Sullivan’s?
69
See Sinclair Oil Corporation (p. 338).
Mass. applies business purpose test, relying on the DE case, Singer. DE rule is the
fairness test as shown in Rabkin….
b. Rabkin v. Hunt Chemical (p. 699) [DE]
Facts: Olin buys majority of Hunt stock from Turner & Newell with an agreement that if
it buys any additional stock within a year (from other stockholders), it will do so at the
same price ($25). Olin had always intended to buy the remaining stock, but waited until
the year was up so it could get a better price ($20) through a cash-out merger.
Prof: When was it clear that they always intended to own 100%? Not clear from case.
Olin charged with bad faith.
JB: It seemed pretty clear to me, since Olin purchased the remainder within weeks after
the expiration date.
Holding, Reasoning: Court held that facts support a claim of unfair dealing sufficient to
defeat dismissal (looks like fairness test mentioned in last case). In addition, the
stockholders’ remedies aren’t confined to appraisal, when fraud, misrepresentation, selfdealing, and other nasty stuff is going on (Weinberger). In this particular case, it would
seem that D would have to have acted in good faith to ensure P received the contracted
(?) price of $25/share.
Test: fairness
 fair price
 fair dealing
What did Olin do wrong here? Prof. sees nothing wrong with lying about when they
would buy the stock.
Nothing inherently illegal in what Olin did. What precisely Olin did wrong is unclear.
Aftermath: judgment for s on remand.
[KK: I don’t get it – they made no commitment to buy within the year or to buy as soon as
they were interested in purchasing the remaining shares. What does this mean:
“[I]nequitable conduct will not be protected merely because it is legal.” (p. 704)]
Analysis (p. 705)
What do s gain by blocking merger?
Why would s reject appraisal in favor of other remedies?
1. A dissenting shareholder can get a risk-free investment – if company grows by more
than market return, can elect to be treated as if he had held stock all along, free-ride
on improvements.
2. A dissenting shareholder with a right to rescind/enjoin merger can hold things up and
get a better price. Extortion
3. Attorney’s fees; Class action possibility (more attorney’s fees)
Recap:
DE rule: entire fairness
70
MA rule: business purpose
Doesn’t make a huge difference which test is applied. Except in weird cases (usually
occurring in mini-series and prime time soaps), can make a record of business reasons (a
little perjury goes a long way, contort reasons a little).
B. Takeovers
1. Hostile vs. friendly deals
Depends on management’s approach. When management acquiesces, offer is friendly.
Why does management acquiesce?
Often, they get $$$ – indirectly or directly (ex: 5-yr employee Ks with high liquidated
damages clause, golden parachutes, severance pay, consulting Ks)
What does this mean to shareholders?
Company value remains the same – so pay-offs to management are in lieu of $ going to
shareholders  Conflict of interest for management, though not often recognized.
Heightened level of scrutiny for takeover defense cases.
Romano reading
1. Market for corporate control theory: management will behave properly because if
not, the company will be taken over. Raiders look for badly-managed companies to
takeover and manage better.
2. Backlash against excessive takeovers. Not just about management and shareholders,
there’s also workers to be concerned about.
3. Empirical studies of how companies did before and after takeovers by tender offers:
 Successful takeover targets have positive returns (stock price does better than the
market).
 Unsuccessful tender offers initially have positive returns, but they are lost if there
are no offers within next two years.
 Unsuccessful mergers result in neither positive nor negative net returns.
2. Williams Act Problem (handout)
§§ 13(d), 14(e), Rule 13e-4(f) of the Securities Exchange Act of 1934
No definition of “tender offer” in Williams Act. Usually people know when they’re
making one, but it’s not always clear.
Schedule 13(d) is what you file when you reach the 5% threshold.
14(d)1 usually filed at the same time.
1. Can J secretly buy 20%?
Obligation to file kicks in at 5% but has 10 days in which to file 13(d) and in those 10
days can get the other 15%. After 10 days, it’s no longer a secret.
§ 13(d)(1)
2. Can J and 3 pals agree to each buy 4.99%?
Pals = associates, have to file 13(d)
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§ 13(d)(3)
– aggregate purchases
3. Does J have to disclose his unconventional plans?
Probably.
§ 13(d)(1)(c) – major change in business or corporate structure must be disclosed
§ 14(e) – untrue statement of material fact or omission of fact with respect to tender offer
4. Can J pull a “Saturday Night Special,” i.e., announce the tender offer on Friday
afternoon and hold it open only until next Monday?
No. Offer must stay open for at least 21 days.
Rule 13e-4(f)(1)
5. J only wants 51% of stock, can he accept stock on a first-come-first-serve basis?
No, must take on pro rata basis.
§ 14(d)(6)
6. J wants to start with a low price and raise it only if insufficient people tender. Can
he?
Yes, but the increased consideration applies to the early tenders as well.
§ 14(d)(7)
Other points about rule – words are not always what they seem
Who has to comply with 13(d)?
Text
What it means
Any person who…
person = groups too
after acquiring directly or indirectly…
If you’re a group, have to file when you
form group, not just actually acquire
beneficial ownership of any equity security…
equity security = ownership interest in
the company with residual rights
registered pursuant section 12 of the SEA…
company has to be big enough
is directly or indirectly the beneficial owner… beneficial owner = person who has
power to invest/divest
of more than 5% of such class…
Have to declare options to buy more
later
Do these rules mean anything?
Do they increase shareholder value or help management? What are they designed to do?
 May facilitate auction for stock – prices may go up for shareholders.
 May impede tender offers – less options for shareholders, negative returns according
to study in Romano
3. Cheff v. Mathis
a. The Case
Facts: Policy at stake – Cheff had their own retail sales force (would go door-to-door and
“inspect” furnaces, deconstruct them, say there are missing parts and not reassemble it);
72
Maremont thought that sales could be taken care of with a handful of salesman in a
wholesale way.
Maremont starts buying stock, demands seat on board, refused. Employees start get
worried. Holland Furnace bought its own stock on the market. Ultimately, Maremont is
bought out above market – greenmail.
Shareholders object to the stocks being bought with corporate funds.
Holding: Corporate funds were properly used to buy corporation’s shares from would-be
raider (Maremont) in order to protect against a change in policy/liquidation. Actual
purpose was not just to perpetuate control.
b. Note on stock prices:
When selling big chunks of stock, selling price may include a “control premium.”
4. Director accountability re: takeovers
DE court has been somewhat reactionary – originally think takeovers are a good thing,
then back off in the late 80s.
a. Ways of finding System order:
1) One way:
Accountability of directors – virtual immunity for incumbents. (Cheff v. Mathes)
 More realistic scrutiny – (Unical and Revlon)
 Back to virtual immunity
 Back to accountability (QBC)
Another way of looking at the cases:
POSITIONS IN DEFENSE TACTICS
(getting rid of raiders)
Passivity
Do nothing
Auction
What management does:
Management should do
nothing in response to a
takeover bid. Management
should lie down, where it’s in
the best interests of the
shareholders, let the
shareholders vote.
What management does:
Management runs an auction.
Give in to the idea that the
company will be taken over,
but have some discretion as to
who takes over (since the
offers are structured
complexly)
Theory: Takeovers are
efficient, good. Ineffective
management deserves to be
taken over.
Theory: Management should
try to get the best price for the
shareholders,
Full Discretion
Interposition
What management does:
Managers interposes itself
between raider and
shareholder.
Theory: Stop short-termism.
Interests of company to stick
around for a while, broaden its
market share, shareholders are
in it for the quick buck and
shouldn’t have a say in what
happens.
Constituency protection –
groups within the firm deserve
protection as much as
73
shareholders (e.g., employees,
suppliers, lenders).
Burden of proof
Inside directors – direct conflict  burden to justify purchase by showing (1) good faith
and (2) reasonable investigation (a lot like duty of care)
Outside directors – no such conflict (although do receive a small salary)  lesser burden,
just justify their actions
Application of law to facts suggests extreme deference to BJR.
Directors may have legitimate responsibility to employees. Should a company be allowed
to hold itself up for ransom and its employees to be fired?
If allow raider to come in, employees might be fired
Company may go downhill anyway, with employees losing their jobs.
So maybe it would have made more sense to let Maremont come in. In a perfectly
competitive market, the employees can find other fraudulent door-to-door sales work.
Greenmail - “An unfriendly suitor’s act of buying enough stock in a company to threaten
a hostile takeover, and of then agreeing to sell the stock back to the corporation at an
inflated price.”
Generally causes a loss to a firm’s other shareholders. Buy stock at price above market
value causes other stocks to fall, plus the stock is bought with corporate funds with a
premium going to the raider.
Analysis (p. 719)
1. Should the shareholders be asked about the change in policy?
Should shareholders have a say in this? Is it an ordinary business operation?
5. What more could board members have done to protect themselves?
They did a pretty good job – see list on p. 717: got professional advice, investigated…
5. Unocal v. Mesa Petroleum (p. 722)
a. The Case
Facts: Case got media attention because of the acquirer – Boone Pickens (
autobiography cleverly titled “Boone”) not such a nice guy
Pickens (Mesa) gets 13% of Unocal and then makes a two-tiered front-loaded tender
offer for the rest of the stock.
First 37% get $54 cash/share, remainder get $54 junk bonds/share.
Junk bonds are less desirable than cash.
This is a coercive offer since people are more likely to tender early to get the cash.
Unocal hires an expert who determines Pickens’ price is low. Unocal decides on a selftender offer – kicks in only when Mesa gets >50%, (Unocal would buy remaining
49+%). Mesa is excluded from this offer. Unocal will use assets from the original shares
to purchase the stockets, lowering the value of the company. This is a scorched-earth
tactic.
74
Is Unocal’s tender offer a two-tier offer too? Notes are allegedly worth $72 but may be
tied to market price.
Going through the numbers:
Assume the company is worth $55/share, with 1,000 shares outstanding. Total value at
takeover would be $55,000.
Pickens buys 100 shares (10%) for $35/share. (= $3,500)
Pickens needs 400 shares to reach 50%. Buys 400 shares at $55/share. (= $22,000)
Company then starts self-tender offer – buys remaining shares in market at $70/share
[$72 in actual case] for a cost of $35,000.
Recap: Company starts out with a value of $55,000  Drained of $35,000 in self-tender
offer  worth $20,000.
Company must be worth more than that to buy Pickens out for $25,500 ($3,500 +
$22,000)
To buy out Pickens and for Pickens to break even, company’s true value must be $60,500
($60.50/share): $60,500 – $35,000 = $25,500
If the company buys all of its stock, the outstanding shares are all owned by Pickens, but
company can still vote their shares (unless they retire the shares).
Pickens as a result of shares being bought back by company is forced to pay a higher
price.
Shareholders complain about the 50% tactic – don’t wait that long. Unocal agrees to
waive this condition – will take 50,000,000 shares no matter what.
To finance the deal, borrow money (raises financial risk of transaction).
Pickens’ complaint: Unfair for directors to give special deal to other shareholders and not
to us
Issue: Whether a corporation’s self-tender which excludes from participation a
stockholder making a hostile tender offer is valid.
Holding: Court finds for Unocal
Two prongs:
1. Directors must show that they had reasonable grounds to believe that a danger to
corporate policy and effectiveness existed due to another’s stock ownership,
burden of proof satisfied by showing good faith and reasonable investigation. Cheff
v. Mathes (prove duty of loyalty by proving duty of care)
2. Balancing – proportionality test: to be covered by BJR, actions of directors have to
constitute a reasonable response to a threat reasonably believed to be posed.
Court finds first part easily satisfied (nobody liked that scoundrel Pickens), and that the
coercive/greenmail aspects of the proposed takeover indicate a severe enough threat to
justify Unocal’s drastic measures.
b. Defense tactics with “exotic, but apt, names” (p. 730)
Crown jewel – profitable part of a large conglomerate
White knight – friendly party to a corporate transaction that saves you from a hostile
raider
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Pacman defense – turn around and gobble up the raider, launch a takeover bid for them
Golden parachute – lucrative severance/retirement package
c. Ulterior motives?
1) Appraisal rights - Unocal directors don’t think much of appraisal rights, but
shareholders could still this to avoid merger. Unocal directors were really more
concerned with keeping their jobs.
2)This was when people had negative views of junk bonds. (Maybe they shouldn’t – high
yield, high risk/control). Just ask yourself what weighs more: a pound of feathers, or a
pound of junk bonds?
Analysis questions
Unocal standard is like BJR+. Unocal adds balancing/proportionality test: reasonable
response to a threat posed.
Is Pickens’ reputation as a greenmailer relevant? Board doesn’t have to pay him off. If
he succeeds in taking over, he’s going to own 100% anyway. Junk bonds holders may
end up holding debt obligations for Pickens’ own companies – may not be good
investments since he’s an unsavory character.
Would it be relevant if Pickens had a reputation for liquidating companies or would
change company’s practices?
List of other concerns directors can respond to include impact on other constituencies
(e.g., employees) (p. 728), duty to preserve corporation enterprise
Aftermath
Unocal did well after Pickens left them alone, tightened their belts and made better
decisions, cash flow improved.
6. Revlon v. MacAndrews & Forbes Holdings (p. 733)
Background:
Oral decision announced 5/85, written decision cam out 6/85. A few days later,
Perelman2 (Pantry Pride) approached Revlon about acquiring stock for $40-45. Revlon
didn’t like.
Directors should be happy, since Unocal opinion says there’s a threat of shareholders
getting lower price, allows them to justify rejection of offer. Firm is worth more in pieces
than it is under their management.
Defensive measures:
2
Perelman moved to NY at age of 35, borrowed $1.5M to buy jewelry stores, paid back loans and made
$15M. Bought candy company, used it to buy other companies (e.g., Marvel). Paul, Weiss handled it,
Prof. said “nice to meet you” to Perelman. Bought back remaining stock, bought Pantry Pride. Issue $75M
in junk bonds. Had lots of money to go after Revlon. Lipton (Wachtel, Lipton) and Flom (Skadden, Arps,
Slate, Meagher & Flom) were involved. Mild ethical questions – clients kept these guys on retainer since
they didn’t want ‘em on the other side. Flom to this day owes Prof. a nickel because when Prof. spent
summer at Skadden he gave him a nickel to buy a paper.
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Company repurchase up to 5M of outstanding shares – (1) get rid of extra cash, (2) get
more control, (3) make it more expensive for M&F/PP/Perelman.
Notes Purchase Rights Plan – if someone gets 20% of stock, shareholders can exchange
stocks for $60/share. Poison pill. Rights redeemable by action of Revlon board.
The Battle
Round
1
2
3
4
Final
M&F/Perelman
approach Bergerac (Revlon CEO), make
offer
tender offer for $47.50/share contingent
on financing and on NPRP rights being
redeemed by board
offers $42/share3 contingent on getting
90%
offers $50… $53… offers $56.25 Annie
Oakley clause (“Anything you can do I
can do better”)
$58 + lawsuit
Revlon
1. Stock buyback
2. NPRP
self-tender offer for 1/3 of stock for
$100/share, incur additional debt
Board looks for white knight
White knight = Forstmann4 
Management buy-out (MBO), golden
parachutes, shareholders complain: to do
MBO, you need to take on more debt, that
would lower the price of the notes you
gave us (lessens the chances that if they go
bankrupt shareholders will be able to get
anything out of the company)
$57.25 + (1) lock-up option on crown
jewels, (2) cancellation fee of $25M
(too much debt to do MBO, Forstmann comes
up with money/risk  wants control)
Holding, Reasoning: divides fight into 2 sections: 1. Before Revlon was definitely going
to sold (Rounds 1-3), management’s actions met Unocal proportionality test. Round 1
goes to Revlon, but round 4 goes to M&F/Perelman.
Why are these defensive tactics different?
Board’s duty changes once break-up is inevitable. At that point, management has duty to
get best price for shareholders. = “Revlon duties”
Note: If Revlon duties are the rule, then all a white knight immediately implies Revlon
duties. After all, looking for a purchaser seems to indicate a sale and/or merger is
inevitable. The white knight strategy really seems to hog-tie the directors.
Questions (p. 744)
1. Lock-up option gives White Knight ability to buy selected target assets in return for a
particular price.
2. Board’s duty to act as auctioneer when sale or break-up of company become
inevitable. Still lot of confusion as to when that happens.
3
Goes down because of debt, cash has flown out the window. Reflects declining value of shares.
Shareholders who didn’t tender to Revlon were hurt.
4
Pseudo-hero of “Barbarians at the Gate.”
77
3. Board’s consideration of other constituencies must be rationally related to benefits for
stockholders. Board’s has contractual and good faith duties to creditors. (p. 740)
Aside: Who is Michael Milken?
Believed that could finance saving the world through high-yield junk bonds (risky
companies)
Guiliani went after prominent insider trading and questionable transactions, targeted Ivan
Boesky. Boesky implicated Milken. Parking violations (parking stock in excess of 5% so
don’t have to file it = 13(d) violation).
7. Paramount Communications, Inc. v. Time Inc. (p. 744)
Facts:
Warner Bros.
CEO = Steve Ross
Not efficiently managed, loose corporate culture, didn’t treat shareholders well.
Time, Inc.
CEO = N.J. Nicholas
Old stoic company, strong ethical position, supported shareholder rights.
Ross doesn’t want to sign on to his resignation in 5 years.
What’s really going on: Steve Ross knows he’s dying of cancer, wants to ensure that
someone will take his place (which is hard because he thinks he’s irreplaceable).
Original merger plan: Stock deal
Stock prices:
Time
Warner
T1 $105
$36
T2 $110
$42
T3 $109
$45
Exchange rate = .465 $51.15
Warner shareholders would have most control (62%).
Time offers $51.15 for $45 shares (later, Time shareholders are offered $175 then $200
for their $109 stock.
Triangular merger structure, use subsidiary, no shareholder vote required. But, NYSE
requires vote because Time will issue 20% more shares (that go to Warner shareholders)
than those they have in the market already in order to accomplish deal.
Since this is a good deal, other companies may jump in.
 Defensive tactics:
1. “Confidential letters” - Go to big banks, pay small sum for them to agree not to
finance a rival offer for Warner.
2. No shop clause (promise to reject other offers)
3. Automatic share exchange (can buy each other’s stock to keep it from raiders’ hands)
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Time is proud to be doing it all for cash. (Debt, junk bonds unpopular)
Enter Paramount…
Paramount makes a ‘fully negotiable offer’ for Time stock.
Offer based on three conditions:
 Terminate merger
 Cable franchises
 Judicial determination that Delaware anti-takeover statute doesn’t apply.
Shareholder should be excited about Paramount deal – lots o’ $$$.
Warner deal is only for $51.15/share, Paramount puts $175/share offer on the table.
Note: Investment bankers who haven’t signed no-shop agreements are clued into
possible windfall and have a better chance with getting a piece of the action.
Warner deal goes up to $70/share in cash and securities. Borrow $10M to finance it. (So
much for debt-less merger.)
Time shareholders no longer get to vote under NYSE rules (because this is a tender
offer). Warner stockholders don’t vote, just tender shares.
Board approves deal. Shareholders don’t have opportunity to look at Paramount $175
deal offer.
Paramount raises the cash offer for Time to $200/shares, negotiable, contingent on
canceling Time-Warner deal.
One key to case is that Time’s culture is important and unique, worth preserving.
But Warner is as much of a change as Paramount is.
At least they want to be able to dictate change in their culture and who it will change
with.
Paramount and some Time shareholders sue Time shareholders.
Claims that they aren’t being allowed access to shareholders.
Time shareholders are upset that they can’t even consider the $200 offer.
Holding, Reasoning: Court goes with Time.
Let’s consider what tests should get applied:
Corporate conduct
original merger deal and defensive tactics (e.g.,
no-shop)
defensive tactics against Paramount
Standard
BJR
proportionality test – was the response
proportional to perceived threat? (Unocal)
Revlon triggers:
1. company initiates active bidding process to sell itself, reorganize, or break-up
company
2. company, in response to bid, abandons long-term policy and looks for friendly bidder
(White Knight)
79
But is there ever really anything to satisfy any of these tests? Nope. What was the threat
to the shareholders of a stock purchase for a good price? No threat. Look at corporate
enterprise, not just short-term shareholders. And if a sale was definitely going to happen,
the Paramount bid was by far the better bid for shareholder value.
This is an awful lot of deference to the board of directors (back to Cheff). This could
mean a number of things:
(1) This is where Delaware is going.
(2) Delaware doesn’t really know where it’s going with this.
(3) Delaware really cares about preserving the corporate culture.
(4) Delaware thinks that takeover bids that come too late in the game can have
deleterious effects. (JB - maybe there are reliance issues here? Perhaps settling for
damages would be a better solution).
(5) Probably 2 and 4, with 1 and 3 also meaning something.
.
Aftermath:
Time executives were uncomfortable as Warner culture prevails.
Why distinguish pre-paramount offer tactics from post-paramount offer tactics?
No real difference. Defensive tactics are defensive tactics.
[KK: Maybe once there’s another offer on the table, there’s a likelihood that the board
will entrench itself in its previous decision at the expense of choosing a better option for
the shareholders?]
Analysis (p. 752)
1. No good justification for denying shareholders opportunity to choose between offers.
Maybe: (1) shareholders would have lurched at money, directors were interested in
long-term benefit of the company. [But maybe shareholders are interested in longterm gains in the market. But, want fluid markets.] (2) Merger here was practically
done. There would be reliance costs if it got busted up.
2. Shareholders screwed, but then again shareholders are sheep.
Broader reading of proportionality test: back to BJR, deferential regime – court accepts
board’s analysis of threat and response.
But this reading may be further than the court intended. The court doesn’t rubber stamp
the Time board’s decision, go through this whole Revlon, Unocal analysis.
What is a company worth? What’s the value of each share?
When you’re looking to get control, some shares are more valuable than others.
 control premiums, lower value for stocks over the target number
8. Paramount v. QVC (p. 753)
Facts:
(a) 5 years later.
80
(b) Viacom - run by one dude.
c) Diller (QVC) and Davis (Paramount) hate eachother.
(d) Viacom and Paramount make deal. Kinda puny (8.2 billion). The deal has the
following defensive conditions:
1. No-shop provision
unless:
(a) 3rd party shows they the $ and
(b) fiduciary duties require discussion with 3rd party
2. Termination fee ($100M). That’s coercive!
3. Stock Option Agreement – gives Viacom option to purchase 20% of Paramount’s
outstanding stock at a certain price or get the cash they would have gotten as profit if
they bought and sold the shares. (Where do the shares come from? Not from
shareholders. Paramount can’t force a sale by shareholders to Viacom at a particular
price. Paramount probably has to get them on the market and sell them to Viacom.)
(e) QVC’s two-tiered tender offer:
$80 for first 51%, common stock conversion on the back end.
(f) Bidding war begins:
Viacom’s tender offer: $85
QVC: $90
QVC sues.  Live on CourTV
Holding, Reasoning:
Court uses test of enhanced scrutiny.
Two triggers for enhanced scrutiny (instead of BJR):
1. approval of a transaction resulting in a sale of control or break-up of company
2. adoption of defensive measures in response to a threat to corporate control
Note: Unclear how this is any different from Unocal/Revlon standards.
If there’s a change in control or break-up of corporation
 directors have duty to get best value reasonably available to shareholders.
Reasoning: current stockholders will become minority after merger, entitled to a control
premium and/or valuable protective devices. If not, directors have primary objective/duty
to get best value reasonably available to shareholders.
Court finds deal to be bad.
Distinguish Revlon and Time-Warner. This is not a break-up of the company.
Didn’t overturn Time-Warner, pretend it’s still good law, make meaningless distinctions.
Not clear how the “enhanced judicial scrutiny” test fits in with Revlon and Unocal.
81
Principles
1. Intermediate standard: when a board resists a takeover there’s a conflict of interest, not full-blown
though (usually involves their jobs) so BJR doesn’t apply, but board doesn’t have to prove entire
fairness. (QVC, hint in Cheff v. Mathes)
2. Two-part test for enhanced scrutiny: board’s actions in resisting a takeover are judged under a
modified Unocal test:
a. decisions made with adequate process, full information
b. decisions that are in a “range of reasonableness,” (covers some proportionality test) not made
to further personal interests, not draconian (Unitrin)
3. Maximization duty in the sale of control or breakup (Revlon duties): when it’s clear that corporation
will be sold or broken up or control transferred and shareholders no longer able to command control
premium, board must hold an auction. (QVC: Where there’s one person assuming control/concern
over control premium  stronger duty to hold auction.)
4. Unenforceable contractual obligations: if a board enters into an agreement with an acquirer and that
agreement has provisions that are inconsistent with the above rules, then those provisions are
unenforceable.
5. emeDon’t put too much stock in these principles… just where it seems like the court is going.
6.
Aftermath: Redstone gets level playing field (no defensive tactics), auction starts,
7. nt has
provisions
that are
inconsistent
the above
provisions
are unenforceable.
Paramount
doesn’t
drop
poison pill.with
Bidding
goesrules,
up to then
105,those
Viacom
goes to 107
in cash
and adds contingent value right (CVR) – cash + securities (Viacom shares +
compensation if stock doesn’t reach price targets over next three years.)
9. Hilton Hotels v. ITT (Supp. p. 90)
Facts: Hilton launches hostile tender offer for ITT of $55/share, a.k.a. “Bear hug” =
hostile offer used as an inducement to a negotiated transaction. $55 is a low offer
(intended to get them to the table), later raises to $70. ITT rejects offer, sells some
assets, announces comprehensive plan: (1) split ITT into 3 new entities the largest
being ITT Destinations, (2) ITT Destinations would have classified/staggered board
whose members can be replaced only by 80% shareholder vote (and 80% vote needed
to eliminate these provisions), (3) a poison pill that would incur $1.4B in tax liability.
ITT plans to implement plan prior to its annual meeting and without shareholder
approval.
Action: Hilton seeks mandatory injunctive relief.
Standard: heightened scrutiny – Hilton must show irreparable injury, succeed on the
merits
Issue: Whether target of a hostile takeover can entrench itself by removing the right of
shareholders to vote on board members.
Holding, Reasoning:
Ignores QVC. Why? Probably because it makes no sense to them either. QVC may
(hopefully) be an aberration. Instead, court relies on Unocal/Blasius standard.
Unocal – trigger: exercise of corporate power over corporate assets
test: proportionality (BJR+)
1. Are there reasonable grounds for believing a danger to
corporate policy and effectiveness exists?
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2. Is the response reasonable in relation to the threat?
Blasius – trigger: exercise of corporate power of power relationship between
board and shareholders – defensive measure that touches on an
issue of control, purposefully disenfranchises shareholders
test: compelling justification
3. Did the board purposefully disenfranchise its shareholders?
4. Is there a compelling justification for this?
In this case, the only threat is price inadequacy. The response looked more like
entrechment  not a compelling justification. Proportionality test fails - Classification
and 80% votes to remove board officers has no purpose other than entrenchment 
disproportionate response
Note:
3. See p. 94 – NV has a constituency statute. If the legislation allows consideration of
groups like employees then maybe Revlon shouldn’t apply because company
shouldn’t be focusing only of shareholder value through auction, there are other
constituencies who may have other interests.
Overall structure of DE law:
After Unitrin, NE Hilton opinion (treated like commentary)
Some element of unfairness – just because another bidder comes along, K can be
scrapped. When defensive measures are put into place, e.g., lockup, usually put in place
by both parties.
As for QVC:
Clear: When heightened Revlon standard come into play (triggers) – single dominant
shareholder, shareholders will lose ability to sell control premium.
Unclear: Range of reasonableness over proportionality.
Overall: Enhanced business judgment rule.
Poison pill resulting in tax liability – how does that work? Untraditional. Dunno.
10. CTS v. Dynamics (p. 767)
State regulation of tender offers.
Why would a state enact its own statute when the Williams Act is already out there?
 Protect local economic interests
 Management threatens to leave state (and take taxes with them)
Facts:
Part One:
IN statute:
What it does: Any entity acquiring “control shares” bringing its voting power above one
of three thresholds (20%, 33-1/3%, 50%) gets voting rights only when shareholders vote
to give them. Acquiror can require a special meeting to be held within 50 days of
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submitting “acquiring person statement.” If shareholders decide not to restore voting
rights, management may redeem shares at market value.
What it means: Skews incentive for potential raiders
 increased risk that takeover attempt will fail for lack of voting power
 need majority behind offer to begin with
To whom does it apply: New corporations provided they don’t opt out. Corporations
must have either been incorporated in Indiana, have a business presence in Indiana, or
have shareholders in Indiana. The corporation must also have at least 100 shareholders.
Part Two:Dynamics owns 9.6% of CTS. Makes tender offer to raise interest to 27.5% (=
probably what they need to gain control). CTS counters by invoking the IN anti-takeover
statute.
Dynamics sues on two grounds:
1. IN’s statute is preempted by the Williams Act?
2. IN’s statute violates the Commerce Clause?
Holding2: no violation
Reasoning2:
(1) no discrimination against non-residents
(2) not inconsistent with Williams Act
(3) designed to protect IN shareholders (= acceptable purpose).
Holding1: no preemption
Reasoning1:
(1) not impossible to comply with both
(2) IN law doesn’t frustrate purpose of the Williams Act – to put shareholders on equal
par with acquirer (really? Isn’t it more to help incumbent managers maintain power?)
Note: This statute may actually help acquirers, by enforcing shareholder rules.
(3) (less delays? Compare with Illinois statute in MITE)
Possible Rules/Take-aways:
 No internal affairs takeover law is preempted unless compliance with both the statute
and Williams act is impossible
 How substantially does it impede hostile tender offers
 Every takeover law preempted unless it mirrors the IN law
Many states simply mirror IN.
10. DE Moratorium statute § 203 (p. 778)
If a bidder acquires  15% of target’s stock, can’t engage in business combination with
target for 3 yrs.
3 exceptions:
1. bidder acquires  85% or more of target stock
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2. target board approves tender offer or business combination prior to acquisition of
15%
3. board approves merger after bidder acquires 15% and 2/3 of shares not owned by
acquirer approve merger.
Precedent:
Edgar v. MITE – Williams Act preempts state statutes that upset the balance between
target management and a tender offeror.
Takeover wrap-up
$1.4B tax liability “poison pill” (p. 91)
Facts not in case – second element of comprehensive plan: spin-off ITT Destinations with
complicated structure that would be tax free to shareholders, but if Hilton tried to buy ITT
Destinations, they’d incur liability because they weren’t subject to initial transaction. So,
not really a poison pill.
Analysis (p. 777)
1. Choice of law rule: state of incorporation governs a corporation’s internal affairs
If Congress wanted to enforce a uniform federal law to govern corporations’ internal
affairs they could. Most industrialized nations do.
Does it make sense that DE law covers about ½ the corporations in the US?
More consistency/uniformity means better expectations
BUT maybe Mom & Pop’s grocery store shouldn’t be incorporated under the same
laws as the big corporations.
BUT race to the bottom (states see how low they can go, minimum protections for
shareholders to get taxes from managers) BUT rules do help shareholders, they look
for DE incorporation, race to the top.
2. If IN statute is intended to protect shareholders from 2-tier coercive offers, is this the
best approach?
Overinclusive – covers all offers, not just two-tiered ones; could just say that the price
should be the same on both ends
political economy factors (pp. 778-79) – legislative motive is to keep companies in
their state, taxes in their state, and workers employed
“Management rejected the tender offer” = manager didn’t recommend the tender offer to
shareholders (tender offer actually goes straight to shareholders) – if they had approved
the tender offer, shareholders (sheep) would go along with it.
V. Federal Securities Law
A. Historical Perspective
1929 - Crash. Great Depression begins.
1933 - Securities regulations established to calm people down.
1933 Act - Disclosure ratings.
1934 Act - “Hodgepodge” of regulation.
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Note: Before 1933, companies generally disclosed anyway, and only a fool would buy
securities from a company that didn’t. But there are plenty of fools out there, and
speculation may have been allot worse, and there were certainly enough crooks.
One other thing: Blue Sky State Statutes - primarily to regulate qualify of securities.
Good for the occasional headaches.
B. Registering Securities
1. Exemptions
Registration would be nice to avoid, but avoidance can lead to civil and/or criminal
liabilities.
Possible loopholes - claim its not a security. This is pretty hard, given the expansive
definition of a security (see page 444).
 Exempted securities: include exclusive in-state securities and transactions (don’t get
cute).
 Exempted transactions: Transactions by any person other than an issuer, underwriter,
or dealer, and any transactions by issuers not involving any public offering (a private
memo still required).
2. Reves v. Ernst & Young
Facts: Business issues promissory notes paid on demand. It’s a way to raise money.
Business then goes bankrupt. P goes after accounting firm for overvaluing firm, leading
people to buy notes.
Note: Is this aiding and abetting or direct involvement? There is no private cause of
action for the former.
Holding, Reasoning:
Court looks at several tests:
SEC definition: Unclear
Landreth test: If it’s called a stock, it’s a stock.
Howey test: What makes a note a security?
Family resemblance test: Presume it’s a security, but rebut if it resembles a family of
non-securities.
Court then decides on a souped-up Howey test:
 Did the firm borrow money for general use or for minor asset?
 Did it distribute note broadly?
 Did investors think it’s a security?
 Does any regulatory scheme reduce the risk involved?
Court finds loan was for general use, disbruted broadly, and folks thought it was a
security (West: that’s weak). There’s also no regulatory scheme.
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