Corporations ~ Fall, 2004
Professor Mercer Bullard
***NOTE*** Be aware of the following underlying themes & ideas:
1. Corporate Lawyers always want to anticipate problems and ask, “which ones are worth paying for to solve
now?”
2. Keep in mind the dichotomy between:
a. Owners v. Owners –AND----------------- (“Intra-corporate battles”)
b. Owners v. Managers
3. In the really close cases, it’s not about the law, it’s about the politics
4. “Managerial Capitalism” ~ As corporations grow, you have to disperse your management
a. Involves retaining of professional managers
b. Highlights the important conflict between representation of the company/corporation and the
shareholder
c. Remember, executives are usually out for their own interests rather than the interests of the
Corporation.
I.
PRINCIPLES OF AGENCY
A) Generally:
1) Agency principals lay the foundations for Corporations
2) Goes to ideas of employer/employee relationships
3) As a principal, you assume liability for your agents! (SO, you’re UN-limiting your
liability rather than limiting it)
4) A principal’s duty to agent is often defined contractually
B) Identifying the Agency Relationship:
1) Fiduciary relationship
2) Manifestation of intent
3) Agent shall act on principal’s behalf and subject to principal’s behalf and subject to
principal’s control (and agent shall consent so to act)
C) Gay Jensen Farms v. Cargill (ACTUAL AUTHORITY)
1) Cargill financed a grain elevator that went belly up and P’s were creditors going after
Cargill
2) ISSUE – did Cargill, as a lender, actually become its debtor’s principal by its course of
dealings with it
3) HELD – An Agency Relationship was established
a. Rules:
1. A creditor who assumes control of its debtor’s business may become liable
as its principal (due to de facto control)
b. The most “Damning” facts for Cargill:
1. Active participation in operations (beyond financing)
2. Claimed right of first refusal to grain
3. Admitted “paternalistic relationship”
4. drafts and forms with Cargill’s name imprinted at the top
4) CONTRAST Agency with Buyer/Supplier Relationship:
a. Factors indicating supplier rather than agent:
1. he receives fixed price for property
2. he acts in his own name and has title to property he is to transfer
3. ***He has an independent business*** (this must be shown before it can be
concluded that Δ is not an agent)
D) Butler v. McDonalds (APPARENT AUTHORITY)
1) P’s sued McDonalds Corp. after their kid hurt himself on a glass door at a franchise
restaurant
2) Key Questions Here:
a. Is an agency relationship formed by being a franchise?
b.
How far beyond use of name do you have to go to create apparent authority of
principal/agent?
3) B.O.P. ~ Elements required for apparent agency:
a. Franchisor ran his business such that a RPP would believe the franchise employees
were actually employees of Δ Corporation?
b. The P. actually did believe such
c. P. thereby relied, to his detriment.
4) Key Facts (determining there WAS agency relationship)
a. Corporate conducted frequent inspections
b. Encouraged consistency and cooperation “with McDonalds standards”
c. Ultimately ~ the means/methods of maintaining an image of uniformity lead a RPP
to believe the franchise restaurant was an agent of Δ franchisor
1. Example: National ads, uniforms, common menus, & appearance
5) Bullard’s Practice Tip: Settle these cases!
E) Recapping Agency Pointers:
1) The KEY to determining Agency ~ Is the relationship one of CONTROL???
2) RE: Apparent Authority:
a. Can a third party “look to” one specific party as having the image of actual
authority?
b. You likely need to look for more than just the similarities between franchisees and
corporate
c. Be aware of “Public Duty Theory” here:
1. When should we hold a Co. responsible based on how it presents itself to
the public?
2. Does the nature of the agency go to the harm?
 i.e., hot coffee? YES
 Cracked glass? NO
II.
PARTNERSHIPS (“A dying breed”)
A) General Partnership ~ any association of two or more people who carry on business for profit as
co-owners
1) NOTE – important to know that you may inadvertently form a partnership
2) All partners are individually liable for the obligations of the partnership!
3) Co-Owners ~ means both have an ownership interest and a degree of control
B) Martin v. Peyton ~
1) Issue – whether a general partnership was inadvertently formed between lender and
debtor
2) Held – No Partnership
a. The K documents did not associate the two parties together as co-owners of a
business for profit
b. Δ’s Measures, taken as precautions to safeguard the loan, were ordinary caution . . .
NOT an implication of association in the business (simple Lending relationship)
1. These “measures” included:
 in exchange for a loan of liquid securities . . .
 P’s turned over its aliquot securities, which couldn’t be used as
collateral for bank loans and
 P’s were to give Δ’s a % of firm profits and an option to join the
firm.
3) Arguments/Factors for each side ~
a. Supporting the judgment
1. Securities were segregated
2. Trustees’ interest was in their OWN securities
b. Supporting partnership:
1. financial terms of the deal
2. negotiating 40% profits up front ~ looks like a profit-based relationship
2

NOTE – the Uniform Partnership Act says there’s a prima facie
argument that receipt of profits makes a partnership (but not if
it’s just interest payments)
C) Fiduciary Obligations in Partnerships
1) Meinhard v. Salmon ~
a. P & Δ were joint venturers, leasing a building for shops and offices. Δ secretly
entered into a new agreement with a third partner to purchase surrounding property
as a leasehold estate, but he never told P.
b. Held – Δ breached his K with P.
1. Important to keep in mind that:
 This deal was intrinsically enter-twined with the original lease,
in which P. WAS involved
 Thus, Δ would not have been in the rewarding position were it
not for the joint venture.
3. Δ Should have at least TOLD P. about the opportunity (i.e., disclosure)
d. General Rules working here:
1. Partners owe each other fiduciary duties of loyalty
2. That duty includes conceding and revealing any business opportunities
coming to one partner alone by virtue of his agency
3. “A trustee is held to something stricter than the morals of the marketplace”
D) Partnership Authority (conflicts between partners)
1) Summers v. Dooley ~ despite Δ’s repeated objections to P’s requests to hire a third man
to work for the partnership, P. hired a new guy, paid him out of his own pocket and
wanted Δ to reimburse him.
a. Be aware that:
1. when you take on a partner, you’re responsible for the decisions your
partner makes
2. in the absence of agreement otherwise, the Uniform Act defaults to a 50/50
split
b. Generally ~ business differences must be decided by a majority of the partners,
provided no other agreement between them addresses the problem
2) National Biscuit v. Stroud ~
a. Here, 1 of 2 general partners wanted to stop selling bread, but the other partner kept
selling. In bankruptcy, the bread supplier was owed $171 and the refusing partner
didn’t want to pay
b. Held – Δ had to pay the bread guy, plus interest
c. Rule – under N.C. statute, activities within the scope of the business of the
partnership could not be limited except by a majority decision . . . ½ of the partners
don’t equal a majority
III.
OTHER LIMITED LIABILITY ORGANIZATIONAL STRUCTURES
***Running Concepts: (1) “limited liability” is limited to your K investment; (2) in cases where you’re
trying to “pierce the veil,” the key question will be “how much control did X have?” ***
A) Limited Partnerships
1) The “essentials” ~
a. At least one general partner, with unlimited personal liability
b. Limited partners, liable only for the amount of their capital investment, if actively
participating in management, lose their limited liability
c. Created by state ~ must take affirmative step: FILING (otherwise, the “default” rules
of general partnerships are the same
d. In Bankruptcy proceedings, limited partnerships are at the end of the line . . . behind:
1. Secured creditors are first
2. followed by unsecured creditors ~ two big groups:
 lenders/banks
 trade creditors
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
NOTE – these are all in the same pool; share what’s left pro-rata
. . . UNLESS
4. Subordinated Debt ~ unsecured creditors with terms in their K’s allowing
them to “up their standing” in line before some other unsecured creditors
e. To lose limited liability protection ~ participate in running the business
2) Gateway Potato Sales v. G.B. Investment Co. ~
a. Creditor sold goods on credit to Δ, a limited partnership. After default, P. sought
recovery from the limited partner based on an affidavit from Δ’s president,
describing Δ’s active business participation
b. Held: Limited Partner held liable
c. Statutory Construction here is key:
1. Two ways to interpret loss of limited liability
 Was there actual knowledge (by the creditor) of Δ’s participation
in control of the company?
 Was there exercise of control without actual knowledge?
2. Grappling with the policy issue ~ should you be liable for control even
though the creditors have no knowledge of that?
d. Ultimately:
1. Court decided to impose liability whenever the limited partner exercised
control “Substantially the same as” the general partner UNLESS it fell
within the purview of the safe harbor provision of the state statute.
2. “Control substantially the same as” is a question of fact for the jury.
e. Advice for client:
1. it’s not just want you do, it’s what the outside world perceives you to be
doing
2. Keep an activity log day-to-day to suggest that you don’t exercise control,
despite your “functions”
B) Limited Liability Partnerships (LLP)
1) The “Essentials”
a. created by statute; requires affirmative act of FILING with the Secretary of State
b. allows participation in management without incurring liability
1. great model for law firms and service type businesses
c. Management structure is NOT a centralized, top-down structure
d. Covers basically any type of liability a partner may incur (ex: Torts OR K claims, etc
...)
e. These are now recognized in most states
2) Lewis v. Rosenfeld ~ stands for the straightforward principle that partners of an LLP
are not liable for the debts or liabilities (in Tort or K) of the partnership solely by
reason of their membership in that partnership.
C) Limited Liability Companies (LLC)
1) The “Essentials”
a. neither a corporation or a partnership . . . but it has aspects of each
b. similar, in principle, to an LLP; made of “members”
c. Focus is on allowing K-based rules govern the Co., while keeping certain default
rules
2) “Advantages”
a. limited liability
b. taxed as a partnership
c. flexibility in operations
3) Disadvantages
a. Complexity in formation ~ requires an “operating agreement”
b. Veil Piercing ~ potentially more of a threat b/c LLC’s are a new form of business
entity, without an extensive body of law
c. State taxes, where they exist
4) Jaffari Case ~
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a.
b.
IV.
Here, P’s were bringing a derivative suit on behalf of an LLC, but there was a Q. of
whether the LLC was bound by its Operating Agreement (and provisions therein),
which it did not itself sign
Held – Yes, the company was bound.
1. In deciding these cases, courts tend to look for anything showing the intent
of the parties
2. The Delaware Statute governing LLC’s was intended to foster flexibility
with LLC formation and nothing in the Act prohibited the creation and
binding nature of forum selection clauses contained in the operating
agreement.
CORPORATIONS ~ FORMATION AND FINANCES
A) Practical Rules for the Corporate Lawyer:
1) Don’t do anything you wouldn’t want published on the front page of a national
newspaper
2) If you can’t afford to lose a client, you can’t afford to keep the client.
3) If it’s too good to be true, it’s too good to be true.
B) Mechanics of Incorporation:
1) Preparatory Steps ~ handle in pre-incorporation shareholder agreement
a. make sure client developed a business plan describing the capitalization of the
business
b. allocate ownership interests
c. How will the company be managed/hired/fired/compensated?
d. What happens if the owner dies?
2) Select a corporate name (lawyer does a copyright check)
3) Maintain an office in the state of incorporation and pick a registered agent for service
of process (in that state)
4) Preparation and filing of the Corporate Charter (“Articles of Incorp’n”)
a. Simple form setting forth:
1. Name of business
2. address
3. number of shares of stock to be issued
4. names and addresses of incorporators
b. Re: Additional provisions:
1. You can have them, but be wary . . . they may “curb the scope of the
company’s business and affect the rights of shareholders.”
2. May address power to adopt and amend by-laws (rules governing the
operations of the corporation)
 General Default – MBCA provides that the board of directors
and the shareholders share power to adopt/amend by-laws unless
the articles of incorporation provide otherwise
5) To operate in other states, qualify for doing business by filing with the Secretaries of
State in each respective location
6) Conduct an organizational meeting
a. Used to (1) issue stock to owners and (2) appoint initial directors, who will appoint
officers
b. Minutes must be maintained
C) Pre-Incorporation Liability
1) Three major issues at work:
a. personal liability of promoters for their acts
b. determining when corporate liability attaches to pre-incorporation activities
c. corporate liability to investors for fraudulent promoters’ activities
2) 5 Theories of how the liability of a corporation can arise off of the promoters’ contracts
a. Adoption ~ Corp. takes the K rights and obligations of the promoter and makes them
its own
b. Ratification ~ only properly applied in post-incorporation K’s
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Acceptance of a Continuing Offer ~ i.e., the Corp. simply accepts the promoter’s
original K when it comes into existence
d. Formation of a new K ~ adoption is nothing more than formation of a new K for new
consideration
e. Novation ~ All parties anticipate that the formed corporation will accept the
promoters’ K’s, upon which time the corporation is substituted for the promoter
(after assenting)
3) O’Rorke v. Geary: (responsibility accompanying the pre-corporate life of a firm)
a. P. and Δ contract to build a bridge and Δ is a promoter for “the bridge company to be
formed . . .”
b. Issue – who is liable for the K breach? Δ can’t be an agent to a not-yet-existing
corporation, so who is bound by the K?
c. 3-Prong approach/rule here: A promoter cannot bind the proposed corporation to preincorporation contracts, BUT he may:
1. take on its behalf an offer to be accepted upon formation
 Drawback – this is very hot/cold. Great for the promoter but
inefficient for the company
3. Enter into a K binding himself with the understanding that the corporation
will take his place upon formation
 Drawback – competing interest of promoters and corporations
- i.e., promoters: don’t want to be bound at all
- corporation: wants everybody “on the hook”
4. Personally bind himself and look to the corporation, when formed, for
indemnity
4) Old Dominion v. Lewisohn ~ (The “Watered Stock” Case)
a. This case addresses the question: To what extent can the shareholders of a
corporation complain of promoters’ fraud in the reincorporation stage?
b. Ultimately ~ (because this case is pre-securities law)
1. Holmes is trying to preserve the corporation as a legal entity
2. he says there is no fiduciary duty between promoters and future
shareholders
c. “Watered Stock” ~ selling assets to corporations at inflated prices in exchange for
stock with a par value that was set at the inflated price . . . Then, stock is sold to
unsuspecting investors who thought the corporation’s assets were properly valued
1. Note ~ diluted stock becomes an issue when a corporation liquidates
because shareholders end up getting screwed.
d. NOTE ~ other cases have held there IS a fiduciary a fiduciary duty by the promoter
to the corporation . . . (for argument purposes)
c.
D) Defective Incorporation
1) De Facto Corporation
a. applies where elements show:
1. existence of law authorizing corporation
2. effort in good faith to incorporate under that law
3. actual use or exercise of corporate records
b. 5 Classes of cases where this issue may arise (MBCA):
1. honest, reasonable belief that articles were filed (but they in fact weren’t)
2. delay or error in mailing articles to the secretary of state
3. passive investor gives $$$ w/ instruction not to do business until articles are
filed, but business commences anyway
4. third party agrees to K w/ a company in its corporate name even though
third party knows the articles haven’t been filed and the other K party deals
with the corporation (not the individual Δ)
2) Incorporation by Estoppel ~ Generally employed where:
a. person seeking to hold officer personally liable:
1. has contracted/dealt with the association
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2.
in such a manner as to recognize/effectively admit its existence as a
corporate body
b. Thus, it’s a reliance argument
3) Consequences of Defective Incorporation:
a. If your company is not a de jure or de facto corporation . . .
1. The default is likely a General Partnership
2. Thus, exposure to unlimited joint and several liability
4) Cranson v. I.B.M. ~ (officer for corporation personally sued for debts due on electric
typewriters purchased by the corporation)
a. Important: this was not a de Facto Corporation because the Company
failed/neglected to make a good faith effort to incorporate
b. Doctrine of Estoppel Applied
1. based on the inequity of allowing people to deny a corporation’s existence
after they’ve dealt with it as such
c. The incorporation problem here ~
1. wasn’t really a Pre-Incorporation issue . . .
2. The corporation had legal existence, it just failed to comply with a condition
subsequent
3. ALSO – P’s are dealing with the corporation AS a corporation . . . NOT a
promoter of the corporation!
 Be able to distinguish this from true pre-incorporation issues
E) Corporate Structure:
1) Bonds/Bondholders:
a. Bond – a certificate with a corporate promise to repay the lender the principle, plus
interest, at a future date
b. Usually first in line in bankruptcy proceedings
1. Secured Debt ~ goes very first . . . you’re subject to less risk but you get a
lower interest rate
2. Unsecured Debt ~ goes next . . . may be subordinated to other debt; more
risk but higher interest rate/level of return
 If subordinated – the credit agreement would provide for it;
higher risk and higher return
c. Trust Agreement – will contain terms to protect the creditors
2) Stocks/Stockholders: Piece of corporate ownership interest
a. Inherently more volatility, but also a possibility for a bigger “up-side.”
b. Two Broad Categories:
1. Common Stocks – an aliquot ownership position in the corporation
 rights may be varied by the corporate charter
 generally (1) can vote and (2) share dividends pro-rate, but they
may be divided into (example) dual class categories.
2. Preferred Stock: includes basic preferences over common stockholders
 ahead in line in liquidation proceedings (to get their guaranteed
% and then step back . . . join the common stockholders)
 Get dividends before C/S holders
- Cumulative Dividends ~ each year, the % of preferred
stock dividends accumulates and P/S holders have to be
paid before any common stockholders
- Non-cumulative Dividends ~ right to dividends dies at the
end of the year, but earnings are building up and P/S
holders are first in line
3) Leverage – (think of a mortgage)
a. gained by borrowing capital; avoid dilution
b. But note – leverage works both ways, depending on increase or decrease of
stock/property value
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V.
MANAGEMENT OF CORPORATIONS
A) Board of Directors:
1) Role ~
a. exclusive authority to manage the corporation; appoint officers, who have day-to-day
control of the corporation
b. independent obligation to run the business and act in its best interest (but note, this is
not an agency relationship)
c. Shareholders have only limited ability to interfere with directors’ rights and
obligations
2) Dunsmore Case ~ (i.e., shareholders can’t give orders)
a. stockholders appointed a man to a self-made committee to go in and oversee the
work of the directors
b. Power of shareholders – (no power to initiate decision-making)
1. They cannot order the board to take any specific action
2. Control is limited to (1) removal of directors and (2)
approving/disapproving certain major actions of the board
c. Power of Directors –
1. manage the business of the corporation
2. formulate policy; initiate decision-making (which can be approved or
disapproved of by the shareholders)
B) Shareholder Approval/Disapproval
1) Especially allowed for major decisions/activities:
a. liquidation
b. merger
c. consolidation
d. sale of all assets
2) Changes to corporate charter ~ shareholders can ONLY approve or disapprove changes
initiated by the board
3) Changes to By-Laws:
a. There is concurrent authority here.
b. Can be initiated by either the board OR shareholders.
4) Shareholders generally may remove any director for cause.
C) Staggered Boards of Directors:
1) Here, only a portion of the board members are elected each year.
2) General purpose ~ assure continuity of management and make takeovers (of the board)
more difficult/less likely.
3) Consequence ~ It means that certain directors are entrenched for a period of at least 2
years.
D) Auer v. Dressel ~
1) Here, the shareholders (following a provision in the by-laws) ordered the corp.
president to call a special meeting, at which the president was going to get the boot.
The pres. refused to call the meeting.
2) Court found for the Shareholders.
a. Concurrent authority exists when dealing with by-laws
b. Shareholders can always remove a director for cause and courts will lean toward
supporting that right.
3) The lesson here ~ make sure your charter and by-laws give you the power to deal with
renegading directors
E) Campbell v. Loew’s (how do you remove a director for cause?)
1) 2 Factions are fighting for control of MGM (6 vs. 4 directors); President sends
shareholders a letter, calling a meeting, and soliciting proxies (by laying out the
“wrongs” of the director to be ousted)
2) Power to call the meeting granted by-laws
3) Rule – Bad directors can always be ousted for cause, but there is a procedural
requirement:
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notice of the proxy solicitation must be given to directors before it’s sent out
directors get opportunity to defend the charges before the stockholders vote
4) Quorum Issues ~ (The # of people required to be at a meeting to take action; set by the
by-laws)
a. Here, 4 directors consistently refused to show up, leaving only 6 present and the
quorum was 7
b. Understand ~ intentional absences from meetings may be held a breach of duty,
especially where it’s done to specifically prevent a corporation from being able to
take action.
5) Consequence of power to remove directors for cause
a. B/C shareholders have a right to replace removed directors between annual meetings
(absent strong language to the contrary in the corporate by-laws).
b. Cumulative voting concepts are disrupted/undermined.
F) Cumulative Voting
1) First, “Straight Line Voting” ~ each share has one vote
a. because directors are voted by a plurality, the minority will NEVER get
representation on the board.
2) But . . . Cumulative Voting:
a. allows for one shareholder to cumulate/aggregate his votes in favor of fewer
candidates than there are slots available
b. makes minority representation on the board possible
c. Ex: 100 shares; 5 director positions ~ up to 500 shares to vote for one director.
3) The KEY ~ Do not divide up your # of votes evenly; rather, the question is how to
divide it up to get the most you can.
4) The effect of a “Tie” ~
a. As a minority, you never want this because you’ll always lose in a run-off (which
goes back to straight-line voting)
5) The effect of creating new directorships and immediately filling them:
a. strips/undermines cumulative voting because you’re always going to get into a runoff situation, so the majority always wins.
b. The balance, according to the courts:
1. Oust the bad directors vs. ensuring minority rights in cumulative voting
2. You’ve GOT to be able to get rid of bad directors!
6) Hypo: S/H-1 = 40 shares ; S/H-2 = 60 shares; 5 directors to elect
a.
b.
SH-1
SH-2
A
67
B
67
C
66
D
0
E
0
F
G
H
I
J
2
75
75
75
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G) Board Meetings:
1) Process is key!
a. Lawyers concerned with this and courts will be deferential of anything short of
outrageous conduct where the process has been properly followed
b. Requirements (to minimize the risks)
1. Meetings must be “in person”; i.e. – participatory discussion
 Exception: unanimous decisions (where authorized by statute)
2. Notice of when and where meeting will be
 Required only for special meetings (not regular meetings)
3. Quorum
 set in the by-laws; law requires it to be at least 1/3 of the total
number of directors
5. Number of Votes needed to take action (separate from quorum)
 Often a “majority of the quorum”
 You can provide for a higher number, but balance that decision
with the likelihood of deadlock.
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2) Challenging corporate actions for failure to follow formalities:
a. detail oriented; arising from “the most esoteric grounds”
b. more likely to have a challenge when the dispute is internal b/c the protection of the
formalities are designed for insiders
H) Committees:
1) General things to remember –
a. typically made up of directors who can act on behalf of the board
b. major decisions cannot be delegated to committees
c. Advisory Committees – can be made up of anyone but can take no action
themselves; purely advisory
2) Most Common Committees –
a. Executive ~ reviews and approves much of the corporate business
b. Compensation ~ pass on salaries and bonuses of officers
c. Audit ~ assures the corporation’s books and records are accurate
d. Special Litigation ~ review issues re: derivative suits; evaluate whether or not to
pursue the litigation
e. Nominating ~ selects candidates for board of directors and reviews the performance
of existing directors (for reelection, etc.)
3) Inside v. Outside Directors:
a. “Inside” ~ Directors who also hold a management position with the company (also
large shareholders, etc . . . )
b. “Outside” ~ not employees, representatives of large shareholders, or otherwise
affiliated with the corporation
1. Understand, outside directors likely don’t have the same conflict from
desire for personal gain that inside directors have
I) Officers’ Powers:
1) These are often defined in the Corporate By-laws
2) Corporations act through officers with delegated actual authority or apparent/implied
authority.
a. Understand, questions arise regarding whether and when these officers’ actions can
bind the corporation.
1. Apparent authority issues are a question of fact; Usually, you just have to
certify that you ARE the president or CEO or whatever, and the Secretary
of State can verify that.
2. Principles of Agency Law govern these situations.
VI.
THE DUTY OF CARE
A) Defined ~ Directors and officers must behave with the level of care that a reasonable person in
similar circumstances would use.
1) Judged by an objective standard
B) Passive Negligence ~ circumstances exist which the board ought to notice and do something
about, but they instead do nothing . . .
1) Generally, directors have no duty to actively detect wrongdoing.
2) BUT – if the directors are on notice of facts that would make a RPP suspicious, they
must act.
3) Additionally, reasonable controls must be put in place to detect wrongdoing, even
without prior reason to suspect that wrongdoing is in fact occurring.
C) Bates v. Dresser ~
1) Bank employee embezzled LOTS of $$$ from the bank; shareholders sued directors
and bank president for the losses under a breach of duty of care theory.
2) The Directors – let off the hook because they had reasons for their “confidence” in the
employee; also, they had no face-to-face notice and all the bank examinations were
checking out
3) The President – held liable because he had actual grounds for suspicion
a. The TEST: Would the facts make a RPP suspicious that wrongdoing was taking
place? If so, the director must act.
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b.
D)
E)
F)
G)
Generally: Dresser had warnings that should have led him to take steps to make
fraud impossible, even though the exact type of fraud may not have been foreseen.
Barnes v. Andrews ~ (“Cause would have happened anyway”)
1) Director was sued when “his” start-up factory ran out of money before it ever made it
to full production
2) Issue – Did Δ’s negligence constitute breach of duty of care?
3) Rules:
a. Directors DO have a duty to keep themselves informed . . . but . . .
b. CAUSATION is required – i.e., for liability to attach, the breach must be the legal
cause of damage to the corporation.
c. TEST: if the director had not breached his duty, would the loss have been avoided?
1. NOTE – P. must also show what sum of $$$ performance would have saved
the co.
4) Here ~ No proximate cause = No liability
a. Most of the delay could be attributed to incompetent workers
b. No way to know if a more attentive set of directors, taking other actions, could have
avoided the loss
c. NOTE – Bullard says this is an extreme illustration of the causal requirement.
The Business Judgment Rule ~
1) Defined:
a. Courts will not find absence of due care merely because a decision was unwise.
b. There is a PRESUMPTION that the director acted:
1. on an informed basis (ordinary prudence of RPP)
2. in good faith
3. with the belief that the decision was in the best interest of the corporation
c. The presumption is not available in cases of:
1. Fraud, illegality, misleading, etc . . .
d. As long as the board shows a rational basis for its decision, P’s will never win these
cases.
2) Schlensky v. Wrigley ~
a. Derivative suit brought by a minority shareholder against majority shareholder for
refusing to install lights at Wrigley Field and hold night games
b. Held ~ Business judgment rule protected Δ from liability
3) Problems with overcoming the “Good Faith” prong:
a. Good faith is often a subjective belief
b. If there’s not good faith, you’re into self interests, etc . . .
MBCA Approach to the Duty of Care:
1) It eliminated the “ordinary person” standard because:
a. it prompts risk averment
b. but a truly subjective approach is dangerous, so
c. NOT judging CONTENT of the board decision . . .
Smith v. Van Gorkem ( Re: Informed Decision Requirement)
1) Keep in mind: This is a takeover case! All the directors are concerned with is – “Is this
the best price I can get for this transaction?”
2) Re: the nature of the deal:
a. really, it’s a takeover, but it’s voted on as a merger.
b. The $55.00 per share offer ~ A Dilution issue
1. Remember that when you take on large amounts of debt the focus turns to
generating large CASH FLOW in order to make the interest payments on
the debt.
2. Understand ~ share price is driven by the amount of cash flow in a
corporation at a given time (i.e., you need at least enough cash flow to
survive/make the payments on the debt!)
c. This is, in some ways, a leveraged buy-out in which a company is using all of its
own assets to do the transaction
11
the nature of leverage – the more debt you take on, the more cash you have
to generate to pay on the interest-bearing debt.
3) Three Categories of Facts and Corresponding Corporate Theories: REMEMBER,
we’re not looking at the merits of the deal; the focus is on whether the deal was
informed.
a. Sept. Meeting and Press Release ~ Market price was $38.00 per share and Pritsker
was offering $55.00 per share
1. Explain these discrepancies with theory:
 Control Premiums ~ carry with them additional company value
not reflected in the market price (i.e., if you’re selling a
“controlling block” of stock)
 Treasury Stock ~ the issuance of treasury stock dilutes the value
of the company
2. Helps to explain why directors must actively seek information when
negotiating major deals; don’t just jump at something that looks good on its
face!
3. Re: Sourch of the $55.00 figure:
 Can from Van Gorkem, with no explanation
 Directors had a duty to seek an honest valuation of the company,
simply to inform themselves of “WHY X amount?” (if that’s
even an ok price)
4. Experience of the Board
 You can’t just go by your gut! Need objective backup.
 Experience suggests they should KNOW that.
6. Reliance on Advice (for information)
 To be reasonable, advice should be broken down, providing
options on both sides.
 There needs to be some reason/basis for the opinion.
 The point where reliance on an opinion becomes reasonable is
the point where directors will escape liability
7. Market Tests
 may be reasonable to rely on them when results align with the
sales figures
 BUT, in Van Gorkem, this was merely illusory
 Big difference between soliciting offers (affirmative action by
the board) and considering offers (passively sitting back and
waiting for others to “inform” them).
b. October Period ~ meet and amend agreement; add market test
1. The proxies needed to be sent out earlier
2. In reality, the deal was becoming more and more definite so the new
provision was basically illusory
c. January 26th Meeting ~ acquisition of new information
1. This shows the TIMING issue/problem:
 The information came too late; you have to be informed before
you make the decision (i.e., when you can still do something
WITH the information)
 This marked the “shit or get off the pot” point and the decision
had really already been made.
4) Consequence of losing the presumption: (of the business judgment rule)
a. Corporation has to prove that the $55.00 amount was the best deal.
H) Brehm v. Eisner ~ When can you rely on an expert???
1) Delaware Statute had an “opt-in” provision:
a. No personal liability for directors UNLESS
b. Breach of duty of loyalty, bad faith, fraud, or malfeasance
1.
12
I)
VII.
2) Board relied on information from an expert who later said, “woops, I forgot to tell them
that . . .”
3) Rule – Reliance on an expert is sufficient to meet the informed decision requirement of
the business judgment rule UNLESS
a. The directors didn’t really rely on the expert;
b. The reliance wasn’t in good faith;
c. They didn’t really believe the advice was in the expert’s professional competence
d. They were negligent/reckless in selecting an expert
e. The material subject matter reasonably available was so obvious that failure to
consider it constituted gross negligence regardless of the expert’s advice (or lack
thereof)
f. The board decision was unconscionable waste or fraud.
Emerald Partners v. Berlin ~
1) Deals with the same Delaware statute as in Brehm; shareholder derivative suit
challenging a merger in which the controlling stockholder had an interest in both
parties to the merger
2) Rules ~
a. Directors have three fiduciary duties: good faith, loyalty, care
b. To demonstrate entire fairness, the board must present evidence of how it discharged
all of its duties
c. There must be a finding of unfairness before the exculpatory nature of the Delaware
statute is examined.
THE DUTY OF LOYALTY
A) Self-Dealing Transactions ~
1) Look for circumstances where three conditions are met:
a. key player and corporation are on opposite sides (also think of key player as sitting
on both sides)
b. key player helped influence the corporation decide to enter the transaction
c. key player’s financial interests potentially conflict with the financial interests of the
corporation
2) Globe Woolen v. Utica Gas & Electric ~ (C/L Rule)
a. Understand the nature of this suit: The executive committee and Maynard (P’s) are at
the crux of this duty of loyalty suit, but it’s the electric company that’s getting sued.
Their DEFENSE is breach of duty of loyalty in formation of the K
b. Rule ~ Duty of Loyalty
1. Trustees must seek no harsh advantage to the detriment of their trust, but
must protest and renounce, if through the blindness of those who deal with
him, he gains what is unfair.
 Thus, Maynard had a duty to disclose: (to Δ’s)
- That Δ’s MAY incur greater losses than anticipated due to
market flux and miscalculation
- The HE was guaranteed a flat savings every month under
the deal.
- Enough to keep the directors “informed” and specific
risks and the possible future actions and how they will
affect the business
2. NOTE – even though Maynard doesn’t have a financial stake in Δ’s Co., he
has a duty of loyalty b/c he is on their board of directors.
c. Maynard’s Options:
1. Go to the meeting and don’t vote
2. Don’t go to the meeting at all
3. Resign from the board b/c the conflict is too strong
4. He MUST PURSUE AGGRESSIVE DISCLOSURE
d. Other issues working in this case (for exam purposes)
1. Van Gorkem issues ~ the rest of the board didn’t seek to be fully informed
13
2. The rest of the business judgment rule issues
3) Statutory Codification of these standards (MBCA):
a. Three ways to protect decisions from voidability
1. impartial director approval
2. impartial shareholder approval
 note, the above two options require full disclosure of transaction
details
3. proof that the transaction is substantively fair
 This is the least attractive method because there is a higher,
much more subjective B.O.P.
 The MOST attractive/efficient ~ director approval
B) Conflicts of Interest ~
1) Gilder v. PGA Tour, Inc. (steps required for adequate board approval)
a. The PGA board voted to change the by-laws so that three non-interested directors,
alone, could pass a new regulation banning U-groove golf clubs from professional
play
b. On its face, this seems ok, but the PROBLEM IS:
1. The Loophole/payoff ~ they HAD to change the by-laws because the
players/directors each had a financial stake in seeing the new regulation
pass.
2. The Player/Directors KNEW about the controversy:
 Ordinarily, amending by-laws is a neutral act , BUT
 When it’s done specifically to be able to pass a controversial
rule, it’s become a conflict of interest deal.
c. The Lesson ~ A good lawyer would have anticipated this because there’s ALWAYS
going to be a situation where directors can’t vote because of conflicts
d. A possible solution would have been to create a special committee of outsiders (who
can put forth independent recommendations to the board)
2) Marciano v. Nakash
a. This shows Delaware’s approach
b. None of the three “buffer” approaches of the MBCA were taken regarding the
specific contracts at issue . . . are they automatically voidable?
c. NO – The court found the transaction to be fundamentally fair and OK’d it
(“intrinsic fairness test”).
C) Corporate Opportunities ~
1) The running question: What can and can’t you do that won’t violate your fiduciary
duty to the company?
2) Guth v. Loft ~ (acquisition of the Pepsi Syrup Formula)
a. Key facts in this case:
1. Guth buys the formula as an individual without offering it to Loft -BUT2. He borrows Loft $$$ to do this, creates a new corporation, and runs it out of
Loft offices!
b. Threshold question for corporate opportunity cases:
1. Is the business opportunity closely related to the existing or prospective
activity of the corporation?
c. TWO-PRONG TEST ~ (Consider both)
1. Line of Business Test: Is the opportunity something to which the
corporation has:
 Fundamental knowledge, practical experience, and the ability to
pursue?
 Is it logically and naturally adapted to corporate business?
 Could it seriously allow for company expansion?
2. Fundamental Fairness Test: considers the overall equity of permitting the
transaction
d. Key Factors to Look at (for corporate opportunities)
14
Was the offer presented to Δ in his official or individual capacity?
Nature of officer’s relationship to management and control of the
corporation
3. Prior disclosure of the opportunity to the board? Their response?
4. Use or exploitation of corporate assets during acquisition of the opportunity
5. Did the acquisition harm or benefit the corp.?
6. All facts bearing on the officer’s good faith
e. Doctrinal Rule ~ A corporate fiduciary may not appropriate to himself an
opportunity that rightfully belongs to the company.
3) Meiselman v. Meiselman ~
a. Three types of business opportunities a corporate fiduciary can try to take advantage
of:
1. entirely extraneous
2. in the same or direct line
3. complementary
b. Three accompanying tests:
1. Corporate interest/expectancy in the opportunity
2. “Line of Business” test
3. Does “fairness” suggest the opportunity rightfully belongs to the
Corporation?
4) ALI – “Disclosure Approach”
a. Generally ~ prohibits directors from taking advantage of a corporate opportunity
without first disclosing both the opportunity and its conflict of interest (and the board
must first reject the opportunity OR the company doesn’t have the funds TO pursue
the opportunity)
b. “Corporate Opportunity” ~ defined in terms of the director’s business position when
he becomes aware of the business opportunity
1. Applies the “line of business” test
5) Director who sits on the board of many corporations and takes an opportunity in his
individual capacity:
a. The Director has the OPTION to:
1. keep the opportunity as an individual -OR2. Present the offer to whomever he wants
 not fair or practical to require disclosure to every corporation
whose board he sits on
 also not fair to mandate disclosure preferring one company over
another.
D) Competition and the Duty of Loyalty:
1) Lincoln Stores v. Grant ~
a. former directors set plans in motion to compete with the corporation; lawsuit by
corporation sought imposition of a constructive trust
b. Competition Rules
1. Post-employment ~ compete however you want (as long as there are no
enforceable non-compete clauses)
2. During employment ~ potential fiduciary duty conflicts:
 look for any interest, express or implied, existing or potential, on
the part of the corporation in the acquisition/deal/opportunity
 Otherwise: fiduciary duty does not preclude directors from
entering into an independent business in competition with the
corporation, but in so doing the directors must act in good faith!
2) Duane Jones Co., Inc. ~ (Law Firm type scenario)
a. 10 Δ directors end up “putting a gun to the head” of P’s Sr. partner/shareholder and
end up taking employees and clients to form a new business/firm
b. Held – Duty of loyalty breached!
1.
2.
15
c.
d.
VIII.
Rule – It’s no defense (to a breach of loyalty) to say you didn’t avail yourself of the
benefit of personnel and clients diverted from P. until after making your decision to
leave known.
1. Rationale – Δ’s cannot be relieved of liability for advantages secured by
them post-termination where those opportunities were initially gained
because of that first job!
Lawyer Advice - A better way to do this:
1. Go out, get an office, and incorporate a new business . . .
2. Then, as soon as you leave, get on the phone with clients.
LIMITED LIABILITY AND ULTRA VIRES
A) Piercing the Corporate Veil
1) Minton v. Cavaney ~
a. Δ was the attorney and a director for Δ corporation; P’s sought to hold him
personally liable to satisfy a former judgment against the corporation (P’s daughter
drowned in corporation’s pool)
b. Generally, Equitable owners may be held personally liable when:
1. They treat corporate assets as their own – i.e., add/withdraw capital from
the corporation at will
2. They hold themselves out as being personally liable for the Corporation’s
debt.
3. Active participation in corporate affairs but failure to provide adequate
capitalization
c. Alter-Ego Doctrine: (exists to pierce the corporate veil when):
1. unity of interest and ownership (separate personalities of the corporation
and the individual no longer exist)
2. treating acts as the corporation’s alone would lead to an inequitable result
d. Thin Capitalization:
1. Minton shows the minority view (this alone = sufficient to pierce the veil)
2. Usually – this is just a factor to be considered by the T.C.
3. Where it results from losses or growth:
 Usually no liability UNLESS owners removed capital from the
company, undermining its ability to continue
2) Instrumentality Doctrine ~ Piercing justified where:
a. control
b. used by the Δ
c. proximately causing the injury
3) Walkovsky v. Carlton ~ (Taxi cab crazy structure case)
a. structure of the “corporation” here:
1. Δ was stockholder of 10 corps, each with 2 cabs registered in its name, but
all of the small corporations operated under the guise of one corporation
with unity of ownership
2. This structure was a deliberate attempt to limit liability
3. Each mini-corp. carried minimum liability insurance
b. Broad rule re: Piercing the corporate veil here ~
1. Allowed whenever necessary to prevent fraud or inequity
2. the equity question is determined by rules of agency
c. Key Question ~ Was Δ conducting business in his individual capacity?
1. Remember, distinguish between the following situations:
 Corp. is a fragment of larger corporation, which actually
conducts the business
- here, if the veil is pierced, only the larger corporate entity
is liable
 Corp. is a “dummy” for its individual shareholders, who are
really conducting business in their individual capacities, for
personal rather than corporate ends
16
-
here, if veil is pierced, stockholder can be personally
liable
4) Factors to consider for piercing the corporate veil:
a. commingling of corporate funds/assets with those of individual shareholders
b. diversion of corporate funds/assets for non-corporate uses
c. individual shareholder representing to others that he/she is personally responsible for
corporate debt
d. failure to adequately capitalize for reasonable risks the business is taking
e. share use of office by corporation and shareholders
f. employment of same attorney for corporation and shareholders
g. absence of separately held corporate assets
h. the formation and use of a corporation to assume existing liabilities of another
person/entity
i. failure to properly issue stock/comply with such formalities
j. failure to maintain adequate corporate records
k. sole ownership of all stock by one person or a family
l. concealment or misrepresentation of corporate information
5) Equitable Subordination:
a. Costello v. Fazio ~ 2 Δ’s (directors of corporation) withdrew large amounts of
capital already committed to the corporation in the face of bad financial news,
leaving the business grossly undercapitalized
b. “Equitable Subordination”
1. arises in bankruptcy circumstances
2. where a claim is found to be inequitable, it may be subordinated to the
claims of other creditors
3. The Question ~ within the bounds of reason and fairness, can the plan be
justified?
4. The Test if the claim is by fiduciaries ~ Under the circumstances, did the
transaction carry the earmarks of an arms length transaction?
 Fraud is NOT an essential element; it is to be examined along
with all facts otherwise inequitable
5. Justified when inequitable conduct affects:
 creditors currently known -AND/OR present/future creditors, unknown
c. “Turnover” concepts ~ recall: hot dog stand hypo
1. Generally speaking, the higher the turnover, the less capital you need
B) Ultra Vires (“Beyond the Scope”)
***THINK: what risks were shareholders expecting and is it appropriate to expose them to the
risk? (lawyering advice)***
1) C/L Doctrine ~ Corporation can be restrained from doing any act which is not
embraced within the scope and purpose for which the corporation was created and
which would violate the corporate charter
a. Corporate Charters ~ traditionally, corp. purpose had to be stated with
particularity/specificity in the charter
1. Implied Powers – sometimes courts implied powers to engage in conduct
furthering the stated purpose of the corporation
2) Modern Approach (MBCA) ~ “Any lawful purpose”
a. Consequences:
1. Shareholders have less control in governing K’s the corporation actually
enters into
2. Thus, more risks with investing
3. Conversely, under C/L ultra vires, shareholders were better protected
because there are les risks associated with the doctrine (b/c if the K is not
authorized in the charter, they could just void it).
17
4.
Third parties, however, are better protected under the modern approach
(don’t have to double-check charters to make sure their K’s are going to be
enforceable).
3) Corporate Opportunity v. Ultra Vires issues:
a. At C/L ~ not only could it not be a corporate opportunity (if considered ultra vires),
the corporation couldn’t even engage in the opportunity at all
b. Modern Court ~ would be a determination of whether the thing was a closely-related
business opportunity, based on:
1. Practical considerations -AND2. equitable concerns
C) Corporate Responsibility
***THINK: business morality of making equitable/charitable contributions***
1) A.P. Smith v. Barlow ~ Co. made a charitable donation to Princeton and shareholders
brought a dec-action re: legality
a. Held: Corporations can make donations where the activities being promoted by the
gift promote the “goodwill” of the corporate business
1. Here, the Co. argued that there was an INDIRECT PROFIT MOTIVE of
increasing and encouraging education in the local community
2. Public policy favors charitable donations
3. Limits:
 Corporation cannot make contributions “above its means”
 Corporation can make donations, but it can’t “increase its
earnings to take care thereof”
2) MBCA ~
a. codifies corporate ability to make charitable contributions (unless the articles of
incorporation provide otherwise), “consistent with the law”
b. Allows contributions for political purposes
3) Today ~ Ultra Vires doesn’t carry much weight in charitable contribution cases; rather,
it’ll likely come down to issues re: duty of loyalty and/or business judgment rule
4) Dodge v. Ford Motor Co. ~
a. Re: Henry Ford’s decision to quit paying special dividends to lower production costs
and sell cheaper cars “to help the little guys”
1. Inherent problem – they were lowering prices but not increasing the volume
of cars being produced, THUS, the value of the company was decreasing
b. Held: the company was forced to pay dividends
c. Understand:
1. A corporation is organized for the benefit of stockholders, not for charitable
purposes!
2. There was NO PROFIT MOTIVE connected to this business decision
5) Adams v. Smith ~ Corporation agreed to pay $$$ to the widows of the corp. president
and comptroller; minority shareholder objected.
a. Rule – Neither the board of directors nor the majority shareholders can, over the
protest of a minority shareholder, give away corporate property.
IX.
CORPORATE DEMOCRACY ~ STATE LAW
***KEEP IN MIND: “Democracy” in the corporate context is sort of a misnomer; not a direct decision
making device, but it IS a good monitoring device (indirect effect on decisions)***
A) Degrees of Management Control:
1) Majority Control ~ 1 stockholder owns 35% or more of the stock
2) Minority Control ~ 1 stockholder owns 10 – 35% stock
3) Management Control ~ single-held stock blocks max out at 5-10%
B) The Voting Process:
1) Note – Votes really “matter” the most in closely-held corporations
2) Management controls the voting process
a. It typically owns a large block of stock
18
1.
Remember, the more disperse the shareholders, the less % of stock is
needed to effectively control the corporation.
b. It controls the proxy machinery
1. content and scheduling of shareholder meetings are chosen by management,
so things stack in favor of management’s choices
2. HOWEVER, You can’t show bad motives/purpose in rescheduling and get
away with it (Rule from Schnell case)
 Example: re-scheduling annual meeting to prevent dissident
shareholders from filing proxy challenges
3) Reversed Cumulative Voting (codified in MBCA § 8.08)
a. Generally – shareholders cannot vote to remove a director elected by cumulative
voting UNLESS the number of votes cast against removal are less then the amount
that was sufficient to originally have him elected
b. Thus, it’s a minimum ~ if the number of votes cast against removal would have been
enough to elect X, he won’t be removed.
4) The Role of the SEC ~
a. State law has unlimited control over regulating the proxy process
b. BUT – the SEC does govern disclosure regulations
1. The Q. arises: when is the regulation of disclosure the regulation of
substance? (Thus exceeding SEC authority?)
C) Varying Shareholder Rights:
1) Various stock voting rights:
a. Weighted voting ~ e.g., one class of shares has multiple voting rights
b. Class voting ~ established in the articles of incorporation
c. Contingent voting ~ voting rights contingent on some event happening
d. Disparate voting ~ similar to weighted voting . . .
2) Lacos Land Co. v. Arden Group ~
a. Co. attempted to create a new class of stock with substantially more voting power to
keep power in the hands of CEO/majority shareholder and help prevent possible
takeovers
b. Two potential “motivations” working here:
1. Selfish desire ~ CEO wants to protect his job
2. Selfless motivation ~ activate powerful anti-takeover devices
c. The Problem here:
1. CEO threatened to act adversely to the best interests of the corp. if the
shareholders refused to vote for the recapitalization
2. Thus, breach of duty of loyalty if he was acting in position of CEO when
threat was made
d. Today ~ you cannot create a new class of stock that disenfranchises existing
stockholders!
D) Shareholder Inspection Rights:
1) Pillsbury v. Honeywell ~
a. Issue – when can a shareholder demand shareholder lists and other corporate
records?
b. Here – P. was a Vietnam War protestor who bought 1 share of stock specifically to
try and sway the corp. board in his favor, to stop creating weapons used overseas in
war efforts.
c. Rules –
1. A shareholder must have a “proper purpose” for seeking inspection of
corporate records
2. Good faith is not determinative, but bad faith is indicative of an improper
motive
3. A mere statement in a petition alleging a proper purpose is insufficient;
facts in the case will be examined.
E) Proxy Contests:
1) Campbell v. Loew’s ~
19
Typically – the CEO tells the board what to do, so the CEO and the board are having
a proxy fight with shareholders, etc . . .
b. Here, however – the CEO and the majority of the board are dividing into to “camps”
c. Re: Use of Corporate Funds/Assets in proxy contests:
1. Generally, it’s ok to use corporate funds to defend the current/existing
status quo
 Here, the Vogel group could use Corporate $$$ to solicit proxies
because his camp symbolized existing policy
2. Not Ok to use corporate facilities and employees in soliciting proxies
2) Rosenfeld v. Fairchild Engine and Airplane Corp. ~
a. General Rule – management may have the corporation reimburse them for
reasonable expenses of soliciting proxies to defend its position in a bona fide policy
contest.
b. Expenses of Successful Insurgents – reimbursed when:
1. The contest involved “policy” rather than power struggle
2. The stockholders approve the reimbursement
c. Limitations on Reimbursement
1. If $$$ is spent for personal power or individual gain and not in the best
interests of the corporation
2. Amount of $$$ spent may be duly challenged on fairness and
reasonableness grounds
d. Rationale for reimbursement:
1. The directors are defending existing policies of the corporation; to best
protect them from random takeovers, they need the monetary support of the
corporation.
2. Proxy contests are expensive!
3) Hewlett v. H.P. Co. ~ (Vote Buying)
a. P’s alleged that H.P. CEO improperly coerced a large institutional investor to
support a merger by “dangling the carrot of potential future business”
1. Deutsche Bank had 17 million shares to vote
2. It got $1 million up front and another million if the merger closed
b. B.O.P. in a vote buying claim:
1. Usually turns on circumstantial evidence
2. Plaintiffs must show:
 Actual Coercion – NOT independent business reasons
3. The “KEY” to coercion – Plaintiffs must show Δ’s used a business
relationship “as a weapon to coerce”
c. HERE ~ Plaintiffs failed to meet their burden of proof
1. The CEO acted “like a reasonable executive faced with unexpected adverse
information.”
2. All Q’s from the proxy committee went to the merits of the transaction.
a.
X.
SEC PROXY REGULATIONS
***REMEMBER: state law determines basic governance rules while federal securities laws impose
disclosure requirements over and above state law requirements***
A) Sadler v. NCR ~
1) Board of directors at NCR created a poison pill in opposition to a merger, sought by
AT&T
2) AT&T’s strategy after creation of the poison pill:
a. state law allowed special meeting of stockholders upon request of 25% of voting
shares
b. Corporate Charter allowed directors to be replaced at that meeting upon a vote of
80% of all outstanding shares
c. To get that 80% - a very thorough campaign is required.
1. They need stockholder lists: CEDE & NOBO
20

CEDE lists – shares bought by broker dealers and held “in street
name” by depositary firms (no individual names listed)
 NOBO lists – “non-objecting beneficial owners” (actual names
listed)
d. SEC Rule required compilation of NOBO lists at the Corporation’s request.
3) Re: Access to shareholder lists
a. AT&T recruited the Sadlers to access the lists “for AT&T”
b. Held – The Courts allowed access to the lists and demanded that NOBO lists be
produced
1. Many courts say you can’t get a list not already in existence
2. Here, the Court’s Goal – FACILITATE COMMUNICATION among
shareholders on issues respecting corporate affairs
 NOBO lists were important for achieving this
B) LILCO v. Barbash ~
1) Conflict involved here:
a. SEC jurisdiction over proxies vs. First Amendment
b. Corp. lawyers always combat SEC overreaching
2) During opposition/fight over the building of a nuclear power plant, 1 faction of
corporation took out ads opposing the plant and saying “people ought to vote against
it.”
a. The Problem – If the ads constitute proxy solicitations, SEC jurisdiction applies and
you have to comply with all of its disclosure rules
3) Rule(s):
a. Applied by the Majority – “Whether the challenged communication, seen in t.o.c., is
reasonably calculated to influence the shareholders’ votes.” (Court said this was a
solicitation and enjoined the ads for disclosure . . .)
b. Today – As long as you don’t mention proxies, you can go out and advertise/politick
all you want
4) Understand – the crux of this case revolved around the SEC’s ability to constitutionally
regulate political speech
a. Main points on dissent:
1. The content of the ad was addressed to the public at large, about matters of
public political interest
2. It’s not specifically purposed to solicit proxies
C) Overview: SEC Proxy Rules ~
1) Generally, the SEC regulates:
a. Content of proxies -ANDb. Process of soliciting proxies
2) Based on a DISCLOSURE REGIME (designed to monitor agency conflict)
a. you must register securities with the SEC when making any public offerings
1. Any kind of investment K is likely a “security” if it is an investment of
money with the expectation of profit from business
b. Companies also have to register with the SEC
1. This regulation of companies has given the SEC the power to regulate
proxies
c. Exemptions: private investments
3) SEC Regulations also govern:
a. exchanges
b. brokers and broker-dealers
c. investment advisors
d. mutual funds (most pervasive Federal Regulation here)
XI.
SECTION 16 OF THE SECURITIES EXCHANGE ACT OF 1934
A) Two Types of Registration (generally)
1) Registration for the sale of securities (“1 shot deal”)
a. Company going public for the first time -OR-
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B)
C)
D)
E)
b. Company raising more capital by selling more securities
2) Registration of Companies
a. This triggers ongoing legal obligations to be reporting information to the public
marketplace
1. example: annual reports, updates of all significant events (Form 4)
b. Triggered by:
1. 500 shareholders and $10 million in assets
2. offering shares for sale on an exchange
c. Brings you under:
1. SEC proxy regulations
2. Section 16 requirements re: holdings of company D&O’s
Section 16 Requires:
1) officers, directors, and major shareholders to report to the SEC any purchase or sale of
securities of the company
2) Purpose: prophylactic provision imposing strict liability to deter insider trading
3) Who brings the suit?
a. The statute allows for suits on behalf of shareholders or the corporation
b. Law Firms / “Private Attorneys General” – typically buy shares specifically TO
bring the suit and collect attorneys fees
c. Procedurally:
1. The law firms must make demand on the Corporation
2. Wait 60 days and then bring suit
d. The SEC cannot sue; they can only require companies to report
Key elements in a § 16-b C.O.A.
1) You must be a shareholder by the time suit’s brought
a. Contrast – ordinarily you must hold stock when the harm occurs
2) Must have a continuing ownership interest throughout the course of the litigation
3) Must make demand and wait 60 days
a. Exception – if the people you’re suing are the directors
4) Strict Liability Rule (be aware of)
a. 6 months, 1 day – SAFE
b. 5 months, 30 days – SUED
5) Trade was done by a 10% holder
6) SOL – 2 years from the date of sale (not purchase)
7) Understand:
a. you don’t have to prove the person acted on the inside information
b. you just have to show he/she had access to inside information
Effect of Sarbanes-Oxley Act:
1) Now have to report all significant trades
2) Shortened filing time for “change of holdings” form from 10 days to 4 days
a. This is much more burdensome
b. Consequence – executives have/keep schedules by which they’ll sell stcok
1. This insulates them from § 16-b liability and makes reporting requirements
less “crazy”
2. This is also an insulation from § 10-b liability
Persons Subject to § 16-b:
1) C.R.A. Realty v. Crotty ~ ( an exception-type case)
a. Δ was a Corporate V.P. of a film company who allegedly took part in a short swing
trade within the purview of § 16.
b. Who is an “officer” for § 16-b liability?
1. It is the duties of an employee rather than corporate title that determine
whether he is an officer under § 16-b.
2. The TEST – Is it more likely than not that the employee’s duties gave him
access to inside information?
 “Inside Information” – information that would aid someone
engaged in personal market transactions
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Rationale – many corporate “officers” only bear their titles honorarily and
don’t really have access to inside information.
 Remember, the purpose of § 16-b liability is deterrence.
c. Way to play it safe (Judgment call counsel should make):
1. Have all V.P.’s file § 16-a reports
2. Easier to do this than face litigation down the road . . .
 the media doesn’t distinguish between § 16 strict liability and §
10-b fraudulent insider trading!
2) “Automatic” officers for 16-b purposes: (listed in 1st phrase of Rule 3b-2)
a. president
b. vice president (if not honorary)
c. secretary
d. treasurer
e. comptroller
3) Institutional Investors with Board Representation:
a. Generally – it is permissible to bring a § 16-b suit against an entire institutional
investor where that company is represented on the board of the P. corporation.
b. Rationale – “Deputization Theory”
4) Winston v. Fed-Ex ~
a. Director resigned in August; resignation was not effective until late September;
exercises stock options in between those dates, before the passage of 6 months
b. Rule – (taken by most courts) There is a rebuttable presumption that an officer,
although recently resigned, still has access to inside information
1. To overcome the presumption ~ former officer must present evidence
showing he DIDN’T have access
F) Disgorgement of Short Swing Profits:
1) Generally ~ you cannot recover more than the total # of shares actually sold.
2) Ways to Calculate:
a. First in, first out
b. Average in, average out
c. First in , last out (or vice versa)
d. The Smolowe Approach ~ Lowest In Highest Out
1. This allows recovery of the highest possible amount of damages
2. Under this approach, however:
 Although, over time, the Co. may have only broken even…
 They will STILL have to pay damages under this method
(without ever actually having made a profit)
3) Policy Implications of Disgorging Short Swing Profits:
a. strict liability + Smolowe = Deterrence
b. The focus in on leveling the playing field.
1. It doesn’t matter how the Δ does overall.
2. The point is: the access to inside information potentially enhanced Δ’s
position in an unfair way over “outsiders”
G) What is a “Sale?”
1) Kern Co. Land Co. v. Occidental Petroleum Corp. ~
a. Co. entered into a K with option to sell all of its shares
1. Option to buy 105 share; $10 per share paid up front
2. To exercise the option, have to pay $95 per share
 Sidebar ~ What determines whether you exercise the option?
- The Market!
- Are the shares selling for more than $95
3. Option was granted within the 6 month period
b. TWO-PART TEST: Determining § 16-b short swing “Sale” (Pragmatic Approach)
1. The transaction was voluntary
2. The transaction was the type in which Δ likely had access to inside
information
3.
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
Here ~ exercise of an option is an involuntary act on the part of
the seller; options generally aren’t “sales”; and the adversarial
nature of the transaction suggested to access to inside
information – SO – No Sale.
2) Similarly, FORCED MERGERS (and trades within) have been defined as
INVOLUNTARY under the Pragmatic Approach of Kern.
XII.
INSIDER TRADING AT COMMON LAW
***THINK: insider trading is a clear illustration of courts taking on an area of common law and applying it
federally***
A) Duty to Disclose (at Common Law)
1) Treated under K law and tort law
2) Why should we NOT want a duty?
a. Theory ~ Market efficiency
b. You want to reward market participants for seeking out information regarding the
highest valued use of a resource.
3) Market Efficiency Theory in the Corporate Scenario
a. There is a conflict re: the perks and drawbacks of Insider Trading:
1. Insider trading brings information to the marketplace efficiently ----BUT2. The worry: disincentivizing market participants
 affects shareholders’ willingness to invest in stocks; they would
rather engage in less risk (i.e., buy bonds)
 less inclined to seek informational advantages because insiders
have a head start (get information first and for free)
4) Black Letter Law ~
a. As long as there’s been no fraud or misrepresentation, a seller doesn’t have to
disclose anything that may affect the value of his property.
1. No responsibility to disclose or even answer -BUT2. If you answer, you have to tell the truth
5) The Assumption ~ Equal access to information
B) The Dividing Line:
1) Information is accessible for free to everyone and one uber-zealous person goes out
and gets it first (C/L assumption) -VS2) Someone gets information only by virtue of his position with a company
a. this carries with it TWO APPROACHES (early state law)
1. “Information held in trust” ~
 Based on the fiduciary relationship of the trade
 Thus, there is a duty to disclose prior to trading
2. No duty rule set aside in “Special Circumstances” ~
 Seller conceals his identity (disrupts privity notions)
 Fraudulent misrepresentation
C) Goodwin v. Agassiz (Silent Trading; Early State law approach) ~
1) Directors go into open market and buy shares based on a geologist’s theory of copper
there . . . meanwhile, P’s sold their shares based on a newspaper article.
2) Court’s Analysis: NO DUTY to disclose the information
a. The Open Market Problem ~
1. Where there is direct privity, disclosure makes sense because parties in a
face to face transaction owe a duty to not misrepresent . . . (fiduciary if
between a director and a shareholder)
2. BUT – in an open market, potential buyers are unidentifiable
 Who do you have a duty to disclose information to?
 No causal relationship because you can’t connect the gain to any
particular sale (beforehand)
D) Diamond v. Oreamuno (The “New York” approach) ~
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1) As a general principle – “Profit” means just as much in terms of avoiding a loss as it
does actual profit/gain from an initial trade
a. HERE – insiders sold large amounts of stock upon receiving tips that stock value
was going to plummet
2) Rule – The nature of the fiduciary relationship prohibits a trustee from extracting secret
profits from its position of trust
a. Note, however – here, the only “damage” to the corporation was having a “cloud cast
upon it.”
b. Further Rationale (for this Court) ~ derivative claims make for the “best plaintiff”
because that’s “the only effective remedy for preventing this type of corporate
abuse.”
XIII.
INSIDER TRADING AS FRAUD ~ SEC RULE 10b-5
A) Section 10-b, generally:
1) Not originally intended to address insider trading
2) Not self-executing
a. Thus, Rule 10b-5 was promulgated to effectuate section 10b
1. Still, no original intent to address inside trading or private claims
3) Generally prohibits fraud and/or misrepresentation in connection with the purchase or
sale of any security
B) Three reasons justifying the insider trading prohibition: (in addition to the free market approach)
1) Knowledge of an executive’s compensation sources helps to understand his/her
discretionary behavior
2) Difficult to assess CEO’s performance without full awareness of trading activity
3) Shareholders expect the executive to concentrate on their welfare rather than his private
investment goals.
C) Recall: Evolution of Insider Trading Law:
1) C/L ~ Laidlaw: No duty to disclose absent fraud/misrepresentation
a. market efficiency theory
2) Early 20th Century Split:
a. Corporate fiduciaries hold information in trust
b. Duty to disclose under special circumstances
3) Goodwin rationale / prevailing early state law:
a. Recognized “duty” when: (Must meet all three)
1. face to face transaction
2. trading with a shareholder
3. To whom fiduciary duty is owed (by the insider)
D) The Disclosure or Abstain Rule:
1) Generally, understand:
a. There’s no “duty to actually disclose” in a literal sense
b. Because it’s confidential corporate information, actual disclosure will often
constitute a breach of fiduciary duty itself.
c. It’s really a duty to abstain from the trade
2) Cady, Roberts ~
a. This case shows the prevailing state law re: insider trading being replaced by the
SEC’s “Federal C/L Approach” to § 10b-5
b. NEW TWO-PART TEST for insider trading / 10b-5 liability
1. Special relationship granting access to information intended for corporate
purposes, not for personal benefit (non-public)
2. Inherent unfairness of taking advantage of such info (materiality)
c. The Effect of Cady, Roberts:
1. You no longer have to be a fiduciary
2. You don’t have to be trading with existing shareholders
3. You can be trading on the market (instead of face-to-face)
d. Rationale:
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It doesn’t matter how you got the information, the point is that you got it,
and from a special relationship
2. Potential shareholders should have some protection too
3. Encourage even playing field for all market participants
3) Texas Gulf Sulfur ~
a. Further defining the standard for liability: ‘
1. Anyone in possession of
2. nonpublic
3. material information
4. must disclose -OR5. abstain from trading (without disclosure)
b. Defining “Non-public”
1. Look for reasonable availability to the public
 initial public announcement is not enough
 look for actual proof of dissemination in the marketplace
2. May be a good approach to – wait until the moment you see some trading
happen and then trade
c. TEST for Materiality ~ whether a RPP would attach importance to the information in
determining his choice of action in the transaction in question:
1. NOTE – this is NOT a result-oriented test; it focuses on the process of
determining what to do.
2. Magnitude/Probability Standard – (helps determine materiality)
 indicated probability that the event will occur ---------------BALANCED WITH Anticipated magnitude of that event in light of the totality of the
company activity
3. The Key – Substantial likelihood of importance . . .
 On a Spectrum:
1.
(Maybe important) ----------------------------------------(material)------------------------------(decision changer)
E) Misappropriation:
1) Chiarella v. U.S. – Criminal prosecution of a guy who got “inside information” from
the printing press where he worked
a. Held:
1. Duty has to run between the person doing the trade and the person on the
other side of the transaction
 NOTE – this flatly rejects Cady, Roberts & Texas Gulf
2. Mere possession of non-public information about the market does not give
rise to a duty to disclose
3. There is no general “duty to the marketplace”
b. Rationale:
1. Rule 10b-5 covers fraud
2. The element required to make silence fraudulent is a duty to disclose
3. You can’t separate fairness from duty . . . it’s only unfair to trade if you owe
the other partner to the trade a duty (and breach it)
c. Response by the SEC ~ (very unhappy after Chiarella)
1. Immediately start working on theories of misappropriation
2. Note also, the lower courts immediately start adopting those theories (thus
contradicting Chiarella)
2) The Theory of Misappropriation
a. Outlaws trading based on nonpublic information, by a corporate outsider in breach of
a duty owed not to the trading partner, but to the source of the information.
b. The point is ~ you’ve stolen information and used it to your advantage
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1.
The fact that you stole the information from someone to whom you owe a
duty is itself inherently unfair and, thus, a violation.
c. Principle Case: O’Hagan ~ suggests:
1. All you need is a special relationship where you owe a duty
2. If you gain information from that relationship and use it to your advantage,
it’s insider trading/misappropriation.
3) What kinds of “Duties” are covered?
a. U.S. v. Kim ~ Can misappropriation theory apply to a club-type situation?
1. TEST (“fiduciary relationship or its functional equivalent”) – Similar
relationship of trust and confidence?
2. Primary characteristic of fiduciary relationship ~ some measure of
superiority, dominance, or control
3. “Fiduciary-like Dominance” arises from a combination of:
 disparate knowledge and expertise
 persuasive need to share confidential information
 legal duty to render competent aid
4. Club/Member situations ~ no legal duty or functional equivalent of a
fiduciary relationship because:
 Club members are essentially equals!
 Not characterized by superiority, dominance, or control
4) SEC RULE 10b-5-2 (Promulgated during Kim litigation) ~
a. Purpose: try and clarify ambiguities re: where there is a “duty” under
misappropriation theory
b. NOTE – These 3 categories are often applied today as PER SE situations of “duty”
under Misappropriation theory.
1. Whenever a person agrees to maintain information in confidence
2. Whenever the person communicating the material nonpublic information
and the person to who it is communicated have a history, pattern, or practice
of sharing confidences . . . OR . . .
3. Whenever a person receives or obtains material nonpublic information from
his/her spouse, parent, child, or sibling.
F) Tippee Liability and Use v. Possession
1) Generally, differentiate between:
a. Substantive liability for insider trading FOR/BY insiders -ANDb. Tipper/Tippee liability ~ derivative liability for outsiders
2) Dirks v. SEC:
a. When will a tippee be liable?
1. Understand, factually in Dirks – We’re not dealing with an insider giving
the information! Dirks was a market analyst.
2. Dirks TEST ~ tippee liability will attach where two elements / categories
are met:
 Where the tipper has misappropriated the information (i.e.
violated a duty to the source of the information)
- KEY HERE: tipper owed a duty to the source of the
information and breached it!
 The tippee MUST KNOW that there’s a breach
- i.e. knowledge that tipper may have something to
personally gain
- think: tippee liability is a derivative liability, but it only
derives if the tippee KNEW
3. Proving Tippee’s Knowledge of Breach:
 Typically, the burden is on the tippee to show that he actually
thought the information came from an OK source and really
didn’t know (or have reason to know) that there was any breach
by the tipper
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

Objective, RPP test
Remember – 10b-5 goes to deceptive, deliberate fraud . . . NOT
sloppiness!
 Re: the tipper’s “personal benefit” ~
- Broadly construed
- Can be direct or indirect
- There are a lot of ways to argue that someone has derived
a benefit from something!
4. Remember ~ it is the tipper’s disclosure + benefit that constitutes the
necessary “breach” under Dirks
3) SEC Rule 10b-5-1 (codifying use v. possession issue)
a. Generally, this rule codifies knowing possession AS USE
b. Provides:
1. If a purchase is made on the basis of material, non-public information
(knowingly possessed by the trader)
2. There is a presumption that the sale went through BECAUSE OF the
knowing possession!
c. BUT, there are Safe Harbor Provisions:
1. Preexisting investment plan -OR2. Decision by blind trustees
 Either of these will get you out of knowing possession and
insulate you from 10b-5 actionable insider trading!
 These help to prove that an insider really didn’t act on the inside
information (i.e. the safe harbor provisions)
d. Understand - this test / rule refers to everybody.
4) Recapping: Tipper/Tippee Liability ~
a. You’re looking for:
1. Somewhere in the chain, was there a breach of duty? -AND2. Was there knowledge of the breach by the tippee?
XIV.
DERIVATIVE ACTIONS
A) “Derivative Suit,” defined:
1) A suit in which a shareholder sues “on behalf of the corporation . . .”
2) Based on the theory that the corporation has been injured by the wrongdoing of a third
person (typically an insider)
B) Derivative v. Individual Claims:
1) Generally:
a. Suits for duty of care and duty of loyalty are usually derivative suits
b. Suits by a minority shareholder alleging that a majority shareholder has unfairly
affected P are typically direct/individual suits
c. The KEY determinative question ~ Who has been injured???
1. injury to the corporation ~ derivative action
2. injury only to shareholders ~ direct action
2) General Examples to be Aware of:
a. Derivative Suits:
1. due care
2. self dealing
3. excessive compensation
4. corporate opportunity
 NOTE – shareholders are also injured in each of these cases
because the corporation has been injured
 LOOK FOR – Pro-rata share of the harm AND an objectively
quantifiable reduction in the value of their shares!
b. Direct Actions
1. voting
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2.
3.
dividends
anti-takeover defenses (example: seeking an injunction against a poison
pill)
4. compelled inspection rights
5. protection of minority shareholders
3) Shareholders’ Preference ~ Individual/Direct Suits . . . WHY???
a. full and direct recovery of damages
b. less stringent procedural rules and loops to jump through
4) Class hypotheticals ~
HYPO – shareholder of IBM signs a K to buy 10 computers from IBM; IBM breaches the K. Derivative Claim???
 NO – because there’s no harm to the corporation and the harm is personal only to that one shareholder
 You don’t get to bring a derivative claim where IBM has just breached one contract
NEW HYPO – IBM Director buys 1000 computers from the company and doesn’t pay for them. Derivative
Claim???
 YES – because the harm here is actually to the corporation and every shareholder suffers a pro-rata share
of the harm and an objectively quantifiable reduction in the value of their shares
 It’s ok that the shareholder still has a personal benefit
 Because the shareholder is STANDING IN THE SHOES OF ALL OTHER GENERIC SHAREHOLDERS
WHO ARE EQUALLY HARMED BY THE FAILURE OF THIS DIRECTOR TO PAY FOR THESE
COMPUTERS
HYPO 3 – State law requires corporation to allow inspection of corporate documents and the directors refuse.
Derivative action? (LOOK FOR SOMETHING LIKE THIS ON THE EXAM)
 Why would it be?
- Equal benefit of shareholders by the state law
- Being deprived of this right equally harms all shareholders (really)
- NOTE – a shareholder here might NOT want this case to be a derivative suit because they want
(1) less hoops to jump through and (2) full recovery that would accompany an individual cause of
action
 Why wouldn’t it be?
- the harm is specific to that one shareholder who is deprived access to inspect the documents
- What’s the harm that you could describe as being pro-rata across all shareholders in a case like
this?
1. NO, none of the other shareholders were actually denied the documents
2. There ISN’T a pro-rata share of harm or any objectively quantifiable
C) Requirements for Maintaining a Derivative Suit
1) The Contemporaneous Ownership Rule
a. Plaintiff must have been a shareholder at the time of the acts complained of, AND
plaintiff must still be a shareholder at the time of the suit
b. NOTE – this differs from § 16b procedural requirements
c. EXCEPTION – “OPERATION OF LAW”
1. if plaintiff acquires the shares “by operation of law,” he will be allowed to
sue even though HE acquired the shares after the wrongdoing . . . SO
LONG AS his predecessor in interest owned them before the wrongdoing
2. Examples:
 X owns shares and dies, leaving them to P. P can sue as long as
X owned the shares when the wrongdoing took place
- Understand – the estate is the continuing owner of the
shares by operation of law, even though it’s technically
not a contemporaneous shareholder
 BUT – a merger-induced, forced acquisition of shares is NOT a
continuous or contemporaneous ownership by operation of law
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2) The Plaintiff Shareholder must be a fair and adequate representative of similarlysituated shareholders
a. THINK: “Joe Shareholder”
b. Plaintiff can’t be motivated by some personal vendetta or political drive
1. Consequence of allowing such plaintiffs:
 arguably not fair representations for shareholders
 shareholders may want to settle at X amount of $$$
 BUT – a politically-driven plaintiff may keep on pushing the
litigation to try and recover everything he can, despite skyrocketing attorneys’ fees and litigation expenses (which the
corporation is paying for)
3) Demand Requirement ~
a. “Demand” – literally a letter written to the board, demanding that it bring suit
1. Example, “Sue the director and make him pay for the computers.”
b. FRCP 23.1 ~ The Complaint must include a description of the demand as follows:
1. What was the demand?
2. What was the response?
3. Why didn’t they bring the claim?
c. Demand is NOT required when?
1. “Futility Doctrine” – basically, the demand requirement is excused where it
would clearly be futile
 Example – everybody on the board is “conflicted” (i.e.
personally benefited from the challenged transaction)
D) Special Litigation Committees ~
****often formed in response to receipt of a demand letter from a shareholder****
1) “Heads-Uppers” ~
a. when you do this, be sure you have a whole new set of independent standards from
which the committee can operate
b. Ideal Approach ~ totally independent special litigation committee
1. NOTE – results here are twofold:
 more independent = more likely to encourage suit -VS if these people want to “serve” on more special litigation
committees, they’ll arguably “find” the way the board wants
them to.
2) Three Approaches: How a Court Treats the Findings of a Special Litigation Committee
a. Deference to the Committee’s Decisions ~
1. Basically, apply the business judgment rule!
2. Judicial review of committee decisions, limited to:
 bad faith, breaches of duty of loyalty, care, etc . . .
 really only looks for self dealing
b. Intermediate Approach ~
1. Basically, gives the committee deference UNLESS it was chosen and
influenced by interested parties, suggesting self dealing
2. This considers: who appointed and took part in the special litigation
committee. For Example:
 Vote: 8-1 ~ deference may still be given to the decision because
the presence of interested party likely doesn’t have much effect
- 8 votes would alone be enough to choose the committee,
and here they were independent / uninfluenced
 Vote: 5-4 ~ likely gets no deference because clearly the
interested party’s presence played a decisive role in the vote
 NOTE ~ for exam purposes, talk about whether one
person/interested party could have made the demand futile
c. Strict Scrutiny of the decision for substantive purposes . . .
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1.
Basically says that the fact of futility means that the special litigation report
gets no deference!
2. Two Step Judicial Inquiry:
 independence, good faith, and investigative techniques of the
committee
 additional, discretionary level of scrutiny; looks at the merits of
the case and allows the trial court to use its own “business
judgment rule” with regards to dismissing/keeping actions . . .
E) Remember ~ Derivative Actions are a MONITORING DEVICE!
1) Allowed because ~
a. board members don’t want to sue themselves!
2) The problem is finding a balance between efficiency and shareholders’ rights
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