Corporations Outline
BASICS OF CORPORATIONS
I.
II.
III.
IV.
Closely held v. publicly held
a. Closely held – 5 or fewer owners (overlap w/ control), no active mkt for shares
Forming a Business Entity – Reasons:
a. Liability for protection of owners.
b. Set forth an understanding of management/rules.
c. Establish change of control/exit/succession procedures
d. Taxes & Investment/Raise Money – easier to do with an established model
e. Ownership and profit issues
Taxes – important in determining which business form to choose
a. Basics
i. Marginal rate (each add’l $ above threshold) v. average rate
ii. Capital Gains/Losses
1. Long term, taxed at 15% v. short (up to 1 year), taxed at norm rate
2. Long term and short term netted separately
3. Losses may be carried to offset gains in future years
b. Proprietorship – not a separate taxable entity from owner (Schedule C)
c. Unincorp Business Entity – at least 2 owners/partnership – Subchapter K – pass
through taxes to owners
d. C-Corp – double taxed (if distribution made, shareholders taxed)
e. S-Corp – created to deal with issue of double taxation. Req’s:
i. Less than 100 shareholders
ii. No non-resident or non-individual shareholders
iii. Only 1 class of stock
Internal Affairs Rule – foreign courts apply law of state of incorporation
GENERAL PARTNERSHIP
I.
II.
III.
Governed largely by state statute: Uniform Partnership Act; 1997 Revised UPA –
adopted by 36states, DC, VI, and PR
Formation
a. Established by default where “2 or more ppl carry on as co-owners of a business for
profit” – prima facie case if share profits.
i. UPA and RUPA provide rules for assisting in determ of if established.
ii. Estab. whether there was intent or not.
b. Creditors can give some business advice – if too involved, can be seen as partners
Partnership Agreement
a. RUPA – agreement may be written, oral, or implied – doesn’t have to be in writing
i. If not in writing won’t reflect all expectations/understandings of partners.
ii. Only reason to have in writing is for statute of frauds issues (Gano v. Jamail)
iii. No analogous UPA provision.
b. Default rules (of state statute) apply unless altered by agreement btwn partners.
c. Profits – partners share equally in profits
d. Management – each partner has equal right to participate in mngmnt.
e. Unlimited personal liability.
i. Liable for act depending on when you entered P-S in relation to when
liability-creating event occurred – later/earlier partners not subj. to liability
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ii. NOW – generally have an exhaustion requirement for partnership’s assets
before going after partners personally; prev. did not have exhaustion req.
f. Flow through taxation to partners – partnership preps statement for filing to inform
of profits.
IV.
Joint Venture – specific venture/specific undertaking – NOT general operation.
a. Generally limited time and limited purpose
b. Each must have equitable interest in profits; joint sharing of losses commonly
regarded as essential
c. Treated as “general partnership w/ limited purpose” – thus partnership laws
generally govern
V.
Kessler v. Antinora (NJ 1995) – partnership profits
a. K to provide funds to build house; A to build it – profit split, but silent on losses;
house sold for a loss.
b. Issue – what sort of entity is formed? Should A have to cover K’s losses?
c. Holding – partnership (by default); Not required to cover losses – Cali Rule.
d. General Rule – repay capital contribution first; if there is a loss, it should be split
along lines that the profits were to be split (unless agreement specifies otherwise).
i. If both parties put in capital, repayment is split into that proportion before
reverting to the profit/loss rule.
ii. Might require one partner to pay cash to the other to reach that split
e. CALIFORNIA EXCEPTION (Kovacic v. Reed) – if one party contributes only labor
(and is not compensated for it), he does not have to compensate the capital partner.
i. The labor investment is valued equally to the capital investment.
ii. Thus, labor investment is losing 100% of its value, while investing partner
only losing a small percentage.
iii. If labor partner is compensated, default rule kicks in.
VI.
Indemnification & Contribution
a. INDEMNIFICATION – UPA S.18(b) & RUPA S.401(c) – partnership must indemnify
partner for payments made and liab incurred in ordinary course of partnership’s
business (unless altered by agreement)
i. Obligation of the partnership
b. CONTRIBUTION – if insuffic funds to pay obligations on dissolution, partners must
make up the short fall.
i. Creditor may go after indiv partners, but only liable up to their share (RUPA
307(d)
VII.
AGENCY RELATIONSHIP
a. Definition
i. “Fiduc relationship which results by manifestation of consent by principal to
agent to act on principal’s behalf and subject to his control; and agent
consents to act”
1. Manifestation by principal
2. Agent’s acceptance of undertaking
3. Understanding that principal is to be in control of relationship
ii. As long as legal def. met, agency is present even if parties did not intend one.
iii. Relationship is not limited to natural persons (partners to partnership)
iv. If not within scope of the business, there is no authority.
b. Principal is liable to a 3d party when agent acts w/: actual, apparent, inherent auth.
i. May also arise through estoppel or ratification.
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ii. Cannot remove authority after the fact and invalidate liability to 3d party
iii. Except, if didn’t have authority, can quickly say “no” to avoid liab – needs to
be before there is detrimental reliance.
c. Actual Authority
i. Stems from communication btwn principal and agent – is it reasonable for
agent to believe he has authority to act?
1. Can be revoked beforehand
2. If after the fact – ratification/estoppel
3. May be express or implied (from prior acts)
4. If principals words/conduct would leave reasonable person in agent’s
position to believe agent has authority to act, agent DOES have actual
authority (hypo – principal left note on wrong desk to do act)
ii. Incidental Authority – authority for agent to engage in acts necessary to
accomplish an authorized transaction.
iii. UPA S.9 – Partner Agent of Partnership as to Partnership Business
1. Carrying on in usual way of P-S binds P-S, unless acting partner has no
such authority AND 3d party knows he has no such authority
2. If not w/in usual scope of business, BUT is within apparent course of
business of other firms in same business, than still falls under S.9
3. If not in usual business, doesn’t bind partnership unless authorized.
4. Certain acts require no authority less than all partners – (see list)
iv. National Biscuit Co. v. Stroud (1959)
1. S advised N it would not be responsible for more bread; F bought
more
2. Issue – Can acts of 1 partner bind partnership as a whole?
3. Holding – YES, each partner has actual authority for the partnership
4. Each GP has equal mngmnt authority, within scope of the partnership
5. Other partner cannot restrict such authority by notifying 3d party
a. To revoke, must dissolve partnership
6. Holds unless partnership agreement states otherwise – RUPA S.303 (if
agreement publicly filed) – no similar UPA provision.
7. Outcome would be different if F had been
a. Agent (rather than partner) – can revoke actual authority
b. F might still have apparent auth, unless S notified Nabisco
d. Apparent Authority
i. Arises from manifestation of PRINCIPAL to 3d PARTY – if Principal’s
words/conduct would lead a reasonable person in 3d party’s position to
believe agent has such authority (cannot be created by agent)
ii. May be created through agent’s position/title – if not clearly estab, what is
industry standard for such position/title.
iii. To dispel, principal must note that not authority exists to the 3d party
e. Estoppel
i. No affirmative representation made, but principal contributed to 3d party’s
belief OR failed to dispel it.
ii. 3d party must have undergone a detrimental change in position.
VIII. Fiduciary Duties
a. UPA S.21 – Partner Accountable as a Fiduciary
i. Every partner must account to P-S for any benefit
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ii. Applies to all representatives of a deceased partner as well.
b. Meinhard v. Salmon (NY 1928)
i. Lease btwn G & S, S enters separate agreement with M – S to operate, M to
pay ½ costs. Near end of lease, reversion enters into extended lease; S did
not tell M.
ii. Issue – Does S have a duty to include M in the new lease?
iii. Holding – YES, related to their nexus of opportunity
iv. Those acting as partnership have undivided loyalty to one another
v. New lease was incident of the enterprise, which S appropriated in secret,
excluding M from chance to compete from opportunity arising from
participation in partnership
vi. Should receive half of lease, with ~1share adjustment to account for S’
mngmnt interest
vii. JV/General Partnership distinction doesn’t seem to matter
viii. If G had approached capital partner instead, maybe a diff outcome – S has
greater duty b/c of mngmnt role.
IX.
Dissociation and Dissolution
a. 3 stages: formal dissolution; winding down; termination
b. Fiduc duties still exist - might even be heightened to avoid looting.
c. Also continue to be personally liable during this period (unless altered by agrmnt)
i. Except if P-S continues after dissolution, leaving partner not liab for future
acts.
d. Terminates actual authority (except that needed to wind down) – problem is
apparent authority (key is to send notice to 3d parties)
e. UPA S.29 – Dissolution
i. Def – change in relation of the partners caused by any partner ceasing to be
assoc in carrying on of the business (refers to personal rel. of the partners)
f. Terminology
i. At will – agreement has no specified definite term or undertaking (default)
ii. Term Partnership – implicit/explicit agreement by all partners that P-S shall
have definite term for a particular undertaking.
1. Statement that goal of partnership is to recoup investment not suffic
to constitute a “term”
iii. Rightful Dissolution – w/o violation of the agreement
iv. Wronful – in contravention of terms of agreement
1. Dissolving partner must pay damages, for breach of contract.
g. Formal Dissolution – Step 1
i. Req’s a formal event.
1. P-S to end on set date
2. Partner walks away
3. Death/Bankruptcy
4. Court Order – Key reasons:
a. Breach of agreement/partner conducts self unreasonably
b. P-S can only carry on at a loss
c. Indiv partner capable of performing function
d. Lunatic
ii. Partnership can continue after dissolution event
1. Have to give accounting to leaving partner – either then or later
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2. If later, accounting = amount of share (valued at time of dissolution) +
(interest on capital OR returns gained from capital)
3. Partners choice – encourage P-S to make accounting when leaving
4. Equitable Rule – allows reasonable efforts to make acct’g – can’t find
partner, so put money into escrow/trust
5. Generally not made when leaving, b/c ppl for get or it isn’t much at
the time (eg: FaceBook)
h. Winding Down – Step 2
i. Close any transactions; distrib assets:
1. Creditors, partners (non capital contrib), capital contrib, profits
2. Partners personally responsible for contribution to satisfy liabilities
3. Selling assets can be piecemeal or as a going concern
ii. Authority/Agency still exists in a limited way.
i. Termination – Step 3
j. Collins v. Lewis (Texas 1955)
i. C puts up money, L operates cafeteria – goes way over cost
ii. Issue – May court dissolve partnership?
iii. Holding – NO, L hasn’t done anything wrong; but C may walk away
iv. Partners have inherent power of dissolution, but not the right
v. Court will not assist in braking of partnership where partner not fully or
fairly performed agreement – courts as a policy don’t like breaking up P-S
1. C did not perform when he stopped his payments to L (no finance cap
in agreement)
2. L could perform his role (mngmnt) but for C’s stopping payment.
vi. L not dissolving b/c no incentive
1. He has a set cash flow
2. Cali Rule won’t apply b/c receiving compensation for his labor, so
would have to repay losses.
vii. C could potentially bring suit later, arguing P-S not possible to carry on for
any profit – but that might have to be awhile to avoid appearing as if trying to
scuttle the P-S
viii. Case heard under Texas Law, but outcome largely the same under UPA
OTHER BUISINESS FORMS
I.
II.
III.
Change to a diff structure does not affect liab for acts while done under prev. structure
a. Some states may say that after certain time, that is no longer the case.
Main Partnership/Corporation trade-off is taxes v. liability.
LP
a. State statutes generally explicitly link to general partnership law.
b. Formation – req’s filing with the state
c. Real details of rights/duties/operation is in the partnership agreement (non-public)
d. Can withdraw w/o notice, triggering dissolution.
e. Statute does not explicitly grant/deny mngmnt rights to LP, but cases hold that LP
may not participate in mngmnt – agreements also tend to deny mngmnt rights.
f. LP participates in control, loses LP status: “control rule liability”
g. Generally no voting rights, except for major transactions
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Corporations Outline
IV.
LLP
a. General partnership law applicable, when not explicitly altered
b. All partners have right to participate in mngmnt w/o risking loss of limited liability
– provides “peace of mind” insurance for innocent partners
c. Supervisory liability – only liability for acts you engage in and wrongful acts of ppl
you supervise.
d. Formation – must fall w/in general def. of partnership, and meet certain formalities
(such as filing with the state and carrying specified insurance funds)
V.
LLLP
a. Allows for an LP to register as an LLLP.
VI.
The Control Rule – lmt’d partner has no liability for debts of venture beyond initial
investment, but can lose that protection if they participate in mngmnt.
a. Signif litigation on how much activity is necessary
b. Each progression of LP statute, control rule has become more protective of LP – last
version eliminated control rule
c. Gateway Potato Sales v. GB Investment Co (AZ 1991)
i. S (GP) told Gateway that GBI (LP) providing the financing and was actively
involved in the management – GBI never confirmed, and took it at face value
ii. Issue – Is GBI liable as a general partner, even though Gateway did not
directly know of GBI’s mngmnt acts?
iii. Holding – YES, can be (remanded for determination of liability)
iv. Threshold question is whether there is authority for the transaction
1. Actual authority – yes, GP’s role to manage affairs
2. Apparent authority – no – agent cannot create authority, must come
from partnership (principal)
v. Is there liability? 3 rules, under 2 statutes
1. If LP’s participation in control is not substantially the same, then must
have actual knowledge of participation in control
2. If there is no actual knowledge of participation, then LP’s control must
be substantially the same as GP’s.
3. Participate in control in substantially the same way and signal it to
creditor – saying the LP provides funding not suffic b/c that is the LP’s
role.
vi. AZ adopts rules 1 and 2.
vii. Under current law, when “substantially the same” test is met, direct contact
not req’d. If test not met, then direct contact is req’d.
VII.
LLC
a. Combines benefits of corporation and partnership – lmt’d liability and pass-thru tax
b. Large freedom to arrange internal operations of venture
i. Members can appoint managers – members don’t have authority
ii. Can also be “member-managed” – all members have authority
c. Most states allow LLC to be formed by 1 person
d. Can unilaterally disassociate at any time, but dissolution req’s a vote.
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Corporations Outline
CORPORATIONS
I.
II.
III.
Formation of a Closely Held Corporation
a. Where to Incorporate – appraisal of 2 factors: cost of incorp and law of state of
incorporation
i. Usually comes down to state conducting business w/in and Delaware
b. How to Incorporate
i. File w/ state – 4 req’s: agent, #shares, corp name, name of incorporators
ii. Permissive provisions
1. Opt-in (must be put into charter to apply) – lmt’d liab of directors
2. Opt-out – purpose of court
iii. Then must create bylaws (not publicly filed)
iv. Restated (articles redone – only need to check one copy)
v. Amended – only certain parts redone (need to check all versions)
vi. Signif issue – what to put into articles – trend toward simplification, only put
in what is req’d
MBCA provisions
a. S 2.02 – Articles of Incorp
i. Must contain – corp name, # shares, street address of office and name of
agent, name and address of each incorporater
ii. May contain – name and address of initial directors, purpose of corp, defining
powers of managers/directors/shareholders, imposition of personal liab for
shareholders, director liability and indemnification
b. S 2.03 – Incorporation: effective when docs filed (concl. proof of proper existence)
c. S 2.05 - Org of Corp
i. After incorp, initial dir must appoint managers and create bylaws
d. S 2.06 – Bylaws: may contain any provision for managing the business
Ultra Vires
a. Ashbury Railway v. Riche – beginning of doctrine
i. Corp NOT liable to contrast RR b/c it was “beyond power of corp” – which
was to “make or sell, lend, hire”
ii. Doesn’t matter that corp’s shareholders agreed
iii. Articles of Incorp are public record and should be looked at when doing trans
b. Some courts avoided ultra vires by construing purpose clauses broadly or finding
implied purposes – could also use estoppel, unjust enrichment, waiver
c. 711 Kings Highway Corp v. F.I.M.’s Marine Repair Service (NY 1996) – diminish UV
i. Casea arguing ultra vires should be dismissed for failure to state a claim
ii. People weren’t checking public record (undermines reason for UV)
iii. NY Bus Corp Law S.203 – no act of a corp shall be invaled by fact it was w/o
capacity or power to do such act
1. Except:
a. Act brought by shareholder to enjoin corp act
b. Act by corp against incumbent or former officer
c. Act brought by state AG
d. Sullivan v. Hammer (DE 1990) – Chartable Donations
i. Financial support for museum to be named after corporation’s founder –
settlement for court approval
ii. Allows settlement to go through – in making determ, Court should look at
fairness of the case, considering:
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IV.
1. Probable validity of claims
2. Difficulties in enforcing claims through court
3. Collectability of judgment
4. Delay, expense, and trouble of litigation
5. Amount of compromise
6. Views of parties involved
iii. No personal benefit, lack of indep, or gross neg shown – so get BJR
iv. If this is UV depends on how purpose clause written – “any lawful purp”
v. Defense – gift contributes to goodwill of the corp – speculative at best, but
doesn’t matter b/c of BJR protection
vi. What considerations matter? – geography, entity donated to, indiv’s name in
relation to the corp
vii. State statute – allows for reasonable contrib to charity
viii. CL – reasonableness interp and ultra vires.
e. Citizens United
i. UV arg for corp making political donations didn’t work
Promoters
a. “Person who directly/indirectly takes initiative in founding/organizing” firm – could
be a promoter w/o knowing it
b. Owes signif fiduc duty to others in corp – corp may bring suit v. promoter after corp
control transfers to subsequent investors.
c. Default Rule – promoter liable for contracts made when no corp exists – unless
there is an agreement to look to some other entity for liability.
i. Where performance called for before corp existence, inference promoter
intended to be personally liable, and corp not liable on contract unless it
explicitly/implicitly adopts contract (McArthur v. Times Printing Co)
ii. Yaki v. Giles – Promoter not liab when 3d party knows corp not exist yet
d. Stanley J. Hove & Assoc. v. Boss (S.D.Iowa 1963)
i. Architect signs contract as “By: Edwin A. Boss, agent for a Minn corp to be
formed” and checks were made payable to corp name.
ii. Issue – Is Boss personally liable for contract with corp not yet formed?
iii. Holding – YES
iv. General rule is that indiv personally liable unless 3d party agreed to look
elsewhere for completion
v. 4 alternatives
1. Revocable offer on the table and corp has to accept on its own when it
comes into existence
2. Best Efforts – promise by promoter to use best effort tot form corp
and get it to accept offer
3. Novation – promoter personally liable, unless corp is formed and
steps in to assume the contract/obligation
4. Contract formed where promoter remains liable for performance,
regardless of corp’s liability (guarantor essentially)
vi. Which alternative used depends on facts of the case.
vii. Should look to intent of entire contract – did not intend corp to be solely liab
viii. Thus, Boss personally liable unless P agreed to look solely to new corp (since
no duty to P to form new corp) – no revocable offer b/c contract entered into
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V.
Defective Incorporation
a. MBCA S 2.04 – Liability for Pre-Incorporation Transactions
i. If acting as or on behalf of corp, and know that there is no corp, then jointly
and severally liable for all liabilities created.
ii. Comment – lmt’d liab should be recognized even if corp not formed when:
1. Thought docs filed but wasn’t
2. Mailed letters but state doesn’t file or refuses to file
3. Immediate execution urged and other party knows corp not filed.
b. Robertson v. Levy (DC 1964)
i. L submitted docs, but no cert issued; entered lease and began business; cert
later issued.
ii. Issue – Can he be held personally liable for obligation entered into before
cert issued?
iii. Holding – YES, personally liable.
iv. One reason for enacting modern corp statutes was to elim problems inherent
in de jure, de facto and estoppel concepts
1. De jure – conform w/ mandatory req’s: you’re a corp
2. De facto – defectively incorp but everything else is fine, usually has a
good faith req
3. Estoppel – 3d party thinks they’re dealing w/ a corp, but aren’t
v. S139 – if indiv or group assumes to act as corp before cert issued, joint and
several liability attaches – bright line rule, elims de facto and estoppel
vi. NOT ALL JURIS FOLLOW THIS BRIGHT LINE RULE.
VI.
Piercing the Corporate Veil
a. There is a legit obligation, but insuffic corp funds to cover it
b. Not all shareholders will be liable – specific shareholders, for specific transaction
i. Reason it’s a phenom for closely held corps, never done for a public company
c. Enterprise or Sibling Liability – corp has no money, but related entities do.
d. Factors – no factor necessarily determinative (although first 3 usually more import)
i. Ownership – majority rule: “substantial owner”
ii. Undercapitalized – compare assets to liabilities – “sufficient capital” to pay
expected liabilities/obligations
1. May have to change over time (expanded corp, industry changes, law)
iii. Failure to observe corp formalities (eg: lack of board mtgs, no corp records)
iv. Non-payment of dividends
v. Insolvency of debtor corp
vi. Siphoning/Co-mingling
vii. Non-functioning officers
viii. Misrepresentation
ix. Overlap of directors – can have, but need to act diff when in diff roles
e. Diff btwn tort and contract claims – tort: no voluntary dealing
f. Bartle v. Home Owners Coop (NY 1955)
i. B trustee of WB, which is in bankruptcy, and wholly owned by HOC
ii. Issue – is parent liable for debts of wholly-owned sub?
iii. Holding – NO, if conditions met
iv. Original theory – unless fraud, misrep, or illegality, will not pierce
v. While HOC controlled WB affiars, had outward indicia of sep corps
1. Creditors not misled
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2. No fraud
3. Appear to be engaging in corp formalities
4. No act causing injury to creditors of WB
5. Overlap of officers directors – happens a lot for subs though
6. POLICY – parent corp provides low cost housing for veterans
vi. Piercing generally reserved for preventing fraud/achieving equity – no
evidence of fraud, misrep, or illegality here
g. DeWitt Truck Brothers v. W. Ray Flemming Fruit Co (4th Cir 1976)
i. Pierce Corporate Veil
ii. Idea of corp is only a theory and courts decline to recognize it when it would
extend beyond reasonable and legit purposes and produce injustices.
iii. Proof of plain fraud is not necessary, but is sufficient
iv. Main concern is w/ reality and how the corp operates in rel. to D.
v. To pierce, need # of factors and an element of injustice/fund. Unfariness
1. One man corp (90% ownership)
2. Undercapitalized (5000 shares at $1 each
3. No business records/corp meetings (formalities not observed)
4. Doesn’t appear corp designed to make any profit
5. Very small “risk capital”/capital reserves
6. No dividends
7. Director a figurehead w/ no fees
vi. If do not pierce, F permitted to retain large amount from corp that doesn’t
have any real capital in the venture – also stated he would take care of
charges personally.
h. Baatz v. Aarow Bar (S.Dakota 1998)
i. DO NOT PIERCE corporate veil
ii. A corp is a separate entity unless there is suffic reason to the contrary – if
cont. recognition will “produce injustice and inequitable consequences”
iii. Args for piercing here – no piercing justified
1. Personally guaranteed oblig – suggests formalities observed and
trying to support capitalization
2. Overlapping ownership – but fails to show how owners conducting
personal business through corp
3. Undercapitalized – started w/ only $5K, but had add’l $200K put in
4. Failed to observe formalities b/c didn’t indicate it was a corporation
a. Statute req’s name indication – name incl. “inc”
b. Mere failure in corp name also will not justify piercing
5. No fraud
i. Radaszewsi v. Telecomm Corp (8th Cir 1992)
i. No piercing of corp veil to get to parent company
ii. MO law allows piercing when 3 req’s met:
1. Control – complete dominion over finances, operation, and policy
a. Prong alone not suffic – need to look at how using corp
2. Control used to commit fraud, violate a law, or unjust act violating P’s
legal rights
a. Undercapitalization has become a proxy for this
3. #1 and #2 Prox cause of injury/loss
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iii. Courts disregard undercap’d corp b/c justifies inference parent
delib/recklessly created business
iv. However, $11M in liab insurance – which satisfies fed regs is suffc
v. Further, no distinction on form of money – debt v. equity.
j. CUPCAKE HYPO – SEE NOTES, p23
CAPITAL FORMATION
I.
Types of Equity Securities
a. Basics
i. Board empowers corp to authorize/issue shares
1. Authorized – the ceiling, listed in article of incorp
2. Issued & Outstanding – amount sold/being publicly held
ii. Share – unit into which proprietary interest in copr is deivided
1. May be diff classes w/ diff distinctions, preferences, rights
2. Each share within a class has to have identical rights
iii. 2 fundamental rights – voting and entitled to net assets of corp
1. May be in diff classes, so long as both rights authorized and at least
one 1 share of each class is outstanding
iv. Distributions
1. Dividend – distrib from current/retained earnings
2. Liqidation – distrib at dissolution
v. Voting rights
1. Categories: transaction, governance, dissolution
2. Fundamental right b/c protects interest vis-à-vis debt holders
b. Common Shares
i. Have both rights, but may be divided into diff classes
ii. Non financial rights – inspect books, sue on corp behalf, right to financial info
iii. Characteristics (as stated by SCT) – right to receive dividends, negotiability,
ability to serve as collateral for debt, confer voting rights, capacity to inc. in
value.
c. Preferred Shares
i. Entitled to specific distribution before anything paid to common shares –
“amount of preference”
1. Typically a capped value – even when share value increased, amount
of preference may not
ii. Special rights (varies based on contract)
1. Cumulative Dividends – accumulates year to year and full amount
must be paid before anything to common
a. Partially Cumulative – cumulates to extent corp has earnings,
and non-cum to extent there is excess dividend preference
2. Voting – preferred usually non-voting
a. For protection, usually get to vote on certain things if no
dividend issued
b. Can also give large voting power to ensure person stays in
control (FB example)
3. Liquidation Preference
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4. Redemption Right (Call Option) – option of corp to recall shares at
fixed price set in articles of incorp.
5. Put Option – shareholder option to force corp to buy back shares at
fixed ratio.
6. Conversion Rights – into common shares at fixed ration
a. Reason – amount of preferred dividend no longer greater than
that being received by common.
b. Could be “upstream” as well, but very uncommon.
7. Protective Provisions
a. Sinking Fund – req’s corp to set aside funds each year to buy
back portion of preferred – protects conversion priv from
dilution
8. Participating Preferred – after specified preference, also get to
participate in dividends as a common share
9. Anti-Dilution – in event more shares issued, must first give current
holders right to purchase amount that would not dilute their
ownership %
a. Right to buy at lower value if priced less than your shares
b. Protection that shares w/ better pref can’t be issued w/o
consent
iii. MBCA S 6.30 – Pre-emptive rights and dissolution.
d. Distributions
i. Gottfried v. Gottfried (NY 1947)
1. Action to req Board of closely held corp to pay dividends
2. Issue – Has withholding dividends been in bad faith, entitling common
holders to a dividend?
3. Holding – NO, need a finding of bad faith and a surplus suffic to pay
dividends
4. Dividends generally paid at Board’s discretion, so need court to say
failure to pay was a breach of fiduc duty.
a. Mere existence of adequate surplus not suffic to invoke
payment of dividends – need bad faith
b. Relevant to bad faith
i. Intense hostility, against minority shareholders
ii. Exclusion of minority, from employement
iii. High bonuses, salaries, loans to officers
iv. Majority holders subject to high taxes if div paid
v. Desire by majority to acquire minority interest.
c. Essential test is if decision dictated by personal interest
5. Factors here:
a. Advance made to majority – has been made to directors and sh.
for years’ no evidence loans made w/ div policy in mind
b. No weight to 1 dir statement that goal is to freeze minority out
c. Recent expenditures of $165K, to retire preferred – essentially
a dividend
d. Capital retained to pay down outstanding mortgage
e. Dividend paid a few years ago
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ii. Dodge v. Ford Motor Co (MI 1919)
1. Prev policy of paying large dividends; highest profits in history this yr
2. Issue – should FMC be compelled to distrib dividends?
3. Holding – YES
4. Uses Gottfried Rule – surplus + bad faith.
5. Clearly had a surplus
6. Appears thus to be an arbitrary refusal – req’s justifications –
duplication of plant
a. Goal was lower cost of cars for consumers – leads to less profit
b. Ford – profits should be shared w/ public – 58% owner
c. Is this really bad faith?
7. Had policy of paying dividends – diff outcome if no such policy?
FIDUCIARY DUTY
I.
II.
Board of Director Basics
a. Usually 10-12 ppl that operates by committee – compensation, audit, nominating
(req’d committees if a public company)
b. Inside director v. outside director (preferred b/c of independence/loyalty issues)
c. No req directors must be shareholders
d. Personal Liability Protection for directors – director insur, indemnification clauses
Statutes
a. Del Gen Corp Law S.102(b)(7)
i. Art of Incorp MAY contain provisions limiting or eliminating personal liab of
directors for money damages for breach of fiduc duty
ii. Doesn’t apply to suits in equity
iii. 4 exceptions
1. Breach of duty of loyalty
2. Act not in good faith or is intentional misconduct/illegal
3. Act where director derives personal benefit
4. Act violates S.174 – deals w/ unlawful dividends and repurchases
iv. Opt-in provision; came as a response to VG.
b. Del Gen Corp Law S.144
i. No contract/transaction is void solely b/c of conflict of interest IF:
1. Material facts disclosed and board authorizes it by majority of
disinterested directors; OR
2. Material facts disclosed/known to shareholders, and they vote; OR
3. It is fair as to corp at time it is authorized
ii. Common/interested dir present may count toward quorum
iii. S144 only gives BJR presumption – may still have been found to breach
c. MBCA 8.30 – Standards of Conduct for Directors
i. Shall act in good faith and in manner reasonably believes to be in best
interest of corp
ii. When becoming informed, such manner as person in like position would
reasonably believe approp under circumstance
iii. Shall disclose info material to discharge of duties – unless violates some law
iv. Entitled to rely on performance, info, opinions, reports of ppl listed in sub (f)
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d. Some states have “other constituency” statutes. – permit not shareholder
considerations.
III.
Shlensky v. Wrigley (IL 1968)
a. No breach of fiduciary duty (failing to install lights at stadium)
b. To prove breach must overcome BJR – can be done it 2 ways:
i. Decision was wholly uniformed – process
ii. So irrational, it was wasteful, and no rational person would do it.
c. Not proven that installing lights would benefit corp
i. Not following others lead is not negligence
ii. No allegations other teams turned profit on lights
d. Court says Dodge is irrelevant
IV.
DUTY OF CARE
a. Smith v. Van Gorkon (DE 1985)
i. Does BJR isolate Board from liability (for breach of duty of care)?
ii. NOT HERE
iii. Board must make decision w/ all info reasonably available – if not, then no
BJR protection – has to do w/ decision-making process and substance
iv. DE proper standard for BJR is predicated on negligence.
v. Here, not an informed decision b/c
1. No study of intrinsic value of corp – no determ if $55 was “fair”
2. No director asked CFO for details or why no fairness study done
3. Accepted $55 as fair w/o scrutiny
a. Should have gotten other opinion
b. Price was in relation to cost of transaction, not stock price
c. Wasn’t fairly put to mkt
4. No questions on tax implications
5. Board didn’t know purpose of mtg til got there and only got docs there
6. Lasted only 2hr – if couldn’t extend, what could they have done with
that time?
7. Why is reliance on CEO a problem?
a. Best person would have been the finance person – CFO
b. Person relying on needs to be reliable – “lawyer told us”
insuffic
c. Could/should have consulted w/o outside experts.
vi. Rejects arg that Board’s collective experience/sophistication is suffi for
finding of reasonable decision.
vii. Outcome of case was shocking b/c DE usually pro-corp and pro-mngmnt
b. Brehm v. Eisner (DE 2000)
i. No breach of fiduc duty – employment contract w/ umbrella payment
ii. First Q – check for (Eisner) independence: nothing alleged he would
personally benefit and had several million options of his own to protect
iii. Second step – PROCESS
1. Doesn’t matter it was negotiated outside of Board b/c employment
contracts common/standard thing.
2. Board responsible for considering only material facts reasonably
available
3. Reliance – consulted w/ compensation expert
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V.
VI.
a. At time was reasonable to rely on expert – may be diff if expert
has bad track record.
iv. WASTE claim – look at creation of contract, b/c obligated to pay.
1. Must prove that contract so one-sided no one of ord, sound business
judgment could conclude corp received adequate consideration.
2. Board’s decision should receive great deference – if substantial
consideration, then contract is worthwhile/not wasteful.
v. Case not immed dismissed under S.102(b)(7) b/c argued as bad faith
exception
c. Brehm v. Eisner (DE 2006)
i. Amended complaint and argues not properly informed of material facts and
grossly negligent
ii. Holding – compensation committee approp informed of material
facs/potential exposure
iii. Info for Board’s decision derived from 2 sources
1. Benchmarked to options prev. granted to Eisner
2. Amount of “downside protection” needed to incentive Ovitz – was
leaving a $150-$200M guarantee at other company
iv. Thus had rational business purpose – induce Ovitz to join
v. There are at least 3 categories of behavior that are candidates for “bad faith”
1. Subjective bad faith – motivated by actual intent to do harm
2. Lack of due care – action taken w/ gross negligence
3. Conscious disregard for one’s duties – lower court used this standard
DUTY OF LOYALTY
a. Marciano v. Nakash (DE 1987) – self-dealing
i. What is the standard for voiding a self-interested transaction?
ii. Holding – S.144 (deal was fair, under CL test)
iii. Q1 – is there an “interested transaction” – YES: N getting interest back from
loan, benefit to them and not everyone
iv. Rule was prev. per se voidability – but that overstates CL rule – self-interest
transactions have some benefits, so should be subject to fairness eval vis-àvis not interested members
1. S.144 not exclusive – can always eval under CL intrinsic fairness test
v. Q2 – Does S.144 apply? – remove taint of self-dealing and get BJR protection
1. If satisfy S.144(b)
a. If majority of disinterested shareholders approve – BJR
b. If majority of disinterested shareholders disapprove/reject:
i. Some courts – BJR
ii. Others – IFT
2. If (a) and (b) fail, eval under (c) – intrinsic fairness test
a. No set factors – court looks at terms of deal and decides what
they would do – could they have gone elsewhere for loan?
How much did they charge? Fair amount?
DUTY OF OVERSIGHT – part of duty of loyalty.
a. In re Carmark International Inc Derivative Litigation (DE 1996)
i. No breach of duty of oversight
ii. Director liability for breach to exercise apporp attn. may arise in 2 ways:
1. Ill-advised: no system or ineffective system (process issue) – BJR eval
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a. “Reasonable info system exists” – indicates some lapse okay –
how much is a problem (sustained failure)
b. Who has to know? Is 1 of 10 dir okay? (Bates v. Dresser – Pres
had info on likely culprit but did nothing – liable, but rest of
Board is not)
2. Unconsidered failure to act – know or should know of problem/ignore
system (monitoring issue)
a. Legally, Board only req’d to authorize the most signif corporate
acts – most corp decisions not subject to director attn.
b. Overrides Allis-Chalmers “red flag” requirement – still exists,
but is supplemented
c. Court cites to VG – wants board to have more responsibility
iii. Must also show failure prox cause of losses complained of.
iv. Here
1. Nothing supports view directors knew of violation
2. No evidence of sustained failure to exercise oversight function
3. Fact losses resulted from the violations doesn’t alone create breach
b. Stone v. Ritter (DE 2006)
i. Issue – is there a breach of duty of oversight? Good faith?
ii. Holding
1. No separate duty of good faith
2. Oversight is a breach of duty of loyalty (means it avoids 102(b)(7))
3. Caremark is the standard for duty of oversight
iii. Since showing of bad faith conduct is essential to oversight liability, the duty
violated is that of loyalty – results in 2 add’l consequences
1. “Good Faith” is not a separate fiduc duty
2. Duty of loyalty is not lmt’d to cases involving conflict of interest
iv. Caremark articulated the necessary conditions for oversight liability
1. Failed to implement any reporting or info system
2. Consciously failed to monitor/oversee operation, thus not informed
v. Here,
1. No red flags
2. Report showed subst resources dedicated to compliance program and
that there was an overall high degree of compliance.
DEMAND AND DISMISSAL
I.
Aronson v. Lewis (DE 1984)
a. Issue – when is demand excused as futile?
b. Holding – when facts ALLEGED W/ PARTICULARITY create a REASONABLE DOUBT
director’s actions are entitled to BJR.
c. Demand req’d b/c derivative suit inherently impedes on managerial freedom of dir
d. Court must apply a 2 step test
i. Are directors interested or non-independent TODAY (at time dismissal
would be made); OR
1. Need majority of directors to be interested/not independent
2. Must allege reasonable doubt directors disinterested/independent
a. Mere fact named in lawsuit not sufficient
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II.
III.
b. Some courts – if dir is to be be held personally liable, would be
suffic
c. Just b/c dir appt’d to Board doesn’t remove presumption of
indep. – might be diff if they’re “beholden” (eg: inside director)
d. Orchestrated trans may not be suffic – depends on type
ii. Underlying transaction is otherwise valid use of business judgment
1. Get to trial if can show it MIGHT be wasteful – only need to make it
“sound odd” – will get to eval more fully at trail (eg: defenses)
2. Looks at substantial nature of transaction
e. If determinant were “reasonable interference” conclusory allegations of futility
would be come automatic
f. Burden is on shareholder (on corporation in Zapata)
g. Duty of care req’s: good faith, best interest of co; informed basis.
Zapata Corp v. Maldonado (DE 1981)
a. Issue – Can stockholder continue suit over Board’s dismissal
b. Holding – YES, if certain steps satisfied.
c. Consideration can be broken down into 3 parts
i. Continuing right of stockholder to bring derivative suit – cannot be allowed
to invade discretion of Board, but dismissal not determinative if:
1. Dismissal was wrongful (Zapata)
2. Making such demand on Board would be futile (Aronson)
ii. When should committee be able to dismiss suit? – Q is one of member
disqualification.
iii. Role of Court in resolving conflict
1. BJR not the proper standard
2. Req’s balancing of many factors – ethical, promotional, PR, employee
relations, fiscal, legal.
d. If motion to dismiss derivative suit made (already determ that demand is req’d),
court applies 2 step test
i. Independence and good faith of SLC and bases supporting conclusion, AND
1. Burden on corporation to show good process
ii. Whether to grant motion, relying on court’s own independent business
judgment.
1. Have already proven demand futility and lack of independence – thus
likely to err on side of shareholder
2. Court considers full circum of suit – though deemed indep in prong 1,
may not be indep in prong 2 – eg: why did you pick her, of all ppl?
In re Oracle Corp Derivative Litigation (DE 2003) – deals with Zapata
a. Issue – how should director independence be analyzed?
b. Holding – not only by financial interest, but also by social interests/concerns
c. Economics is not the only consideration that effects personal behavior
d. Corp directors normally the sort of ppl enmeshed in social institutions.
i. Such inst have norms that influence behavior – some things “just aren’t done”
e. Here,
i. G-M & G were considering serious accusations against fellow board members
and professor who they have constant interaction with – tenure probably
matters (factors to eval at tenure), any exec position matters (fundraising
responsibilities), similar relation at school
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ii. Board contends unaware of Elision’s relationship – ignorance is unavailing:
should have determined that when forming SLC, esp considering the publicit
f. Fact new Board members hired by Board not determinative b/c of presumption of
independence (and b/c all appointments made through some prev knowledge)
IV.
Beam v. Stewart (DE 2004) – deals with Aronson
a. Issue – was demand futile?
b. Holding – NO, demand should have been made.
c. Directors are entitled to a presumption of good faith, and shareholder must plead
particularized facts.
d. To show that demand is futile, shareholder must provide reasonable doubt Board
members disinterested
i. Interest may be shown by demonstrating potential personal benefit or
detriment to director as result of decision.
ii. Variety of motivations (incl. friendship) may influence independence, but it
must be of a bias producing nature – most friendships do not rise to that
level.
iii. Oracle takes that to an extreme – ppl naturally and always look out for
friends
e. Here,
i. Martinez – several yrs business rel. and single affirmation of friendship no
raise reasonable doubt about M’s ability to eval demand – maybe if they were
“best friends”
ii. Moore -bare social rel do not raise doubt of independence – might be diff if
both participated in wedding
iii. Seligman – might have fel obliged by fiduc duty to call publisher and express
concern about book b/c of impact on company.
MANAGEMENT AND CONTROL OF THE CORPORATION
I.
II.
III.
Officers
a. MBCA S 8.40
b. Officers appointed by Board – DE and MBCA only req that someone take minutes
c. Roles of officers must be incl. in the bylaws
Function of Officers – MBCA S 8.41
Lee v. Jenkins Brothers (2d Cir 1959)
a. Y enters into pension contract with Lee
b. Issue – does Yardley have authority for this contract?
c. Holding – NO
d. General rule is that Pres has authority to bind the company by acts arising in usual
and regular course of business, but NOT for contracts of extraord. nature.
i. Lifetime employment contracts generally met w/ hostility
ii. BUT pension contracts usually eval’d by a different standard b/c
1. Board control not impeded
2. Agreement is beneficial, necessary, and reasonable
3. Common fringe benefit
iii. Whether there is apparent authority for the transaction is a question of fact –
depends on nature of contract, officer negotiating contract, corp’s usual
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IV.
manner of conducting business, size of the corp, circum giving rise to the
contract, reasonableness, amount involved, & who the 3d party is.
iv. In certain cases, contract may be so important that outsider would normally
supposed only Board could authorize it.
e. Here,
i. Actual auth – nothing shows there is express authority or any reasonable
belief that Y can enter the contract
ii. Apparent – employment decisions tend to eminate from Pres office – look at
size, too large to be normal.
iii. Courts generally more concerned about tenure – pension diff b/c about
money.
f. Could have become valid with ratification after creation of contract.
Relations between shareholder and director – SHAREHOLDER AGREEMENTS
a. Shareholder agreements disting from pooling agreement b/c involve things not
central right of Board, and thus not presumptively valid.
b. 4 spheres of shareholder rights
i. Electing/removing board members – majority vote movement & “holdover
rule”
ii. Amend articles/bylaws
iii. Fundamental changes – JV, merger (usually up or down vote, not details)
iv. Conflict of interest transactions (S.144)
c. Everything else left to discretion of Board
d. MBCA S 7.32 – Shareholder Agreements
i. Agreement shall be set forth in articles of incorp/bylaws and approved by
ALL shareholders at tme of agreement OR in written agreement signed by
ALL shareholders and made known to corporation
ii. Subject to amendment only by all shareholders at time of amendment.
iii. Valid for 10 years unless agreement states otherwise
iv. Existence of agreement shall be conspicuously noted on front/back of each
certificate for outstanding shares. – if made after issued, recall all shares to
include note.
1. Failure to note agreement will not invalidate it.
2. Purchaser who didn’t now of agreement at purchase, shall be entitled
to rescission right – knowledge assumed if on shares though (either
90d after discovery or 2yr after purchase)
v. Agreement ceases to be effective when corp becomes public.
vi. Agreement that limites discretion of Board als relieve Board of related liab
vii. Shall not be usedto impose personal liab on any shareholder.
e. McQuade v. Stoneham (NY 1934) – traditional theory
i. Failure to keep promise to use best efforts to keep McQuade as Treas.
ii. Issue – was replacing McQuade illegal? Can shareholders make an agreement
to vote for particular persons as director?
iii. Holding – replacing McQuade not illegal; can make contract – if can do it as
an individual shareholder, then can do it as a group.
iv. Shareholder agreements should be eval’d provision-by-provision, based on
the normal rights of the shareholders.
v. Stockholders may thus combine to elect directors.
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1. Here, the minority shareholders M claims to be protecting are not
complaining of his discharege.
2. Stoneham & McGraw’s duty was to corp and shareholders – they’re
under no legal oblig to deal righteously w/ McQuade.
3. A contract that precludes board members from changing officers,
salaries, policies, or retaining indiv except by consent on contacting
parties is illegal
4. **Norm shareholder right is for election of Board members, NOT
execs or officers.
f. Galler v. Galler (IL 1964)
i. Case is a signif development in closed corporation law and special legislative
treatment
ii. Had shareholder agreement to ensure financial security of dependents ant
that if either brother died, their wife would take their place on the Board –
suit for shares repurchased in violation of agreement
iii. Issue – is agreement void by public policy?
iv. Holding – NO, enforce agreement (accounting should be made)
v. Shareholder agreements often necessary for protection of those financially
interested in closely-held corporation – protection from majority can often
only be achieved w/ a detailed shareholder agreement.
vi. Shareholder agreements for closely held corps have prev been upheld when:
1. There is no apparent public injury
2. Absence of complaining minority
3. No apparent prejudice to creditors.
vii. Since parties to the action (when a closely held corp) are complete coowners, no reason why exercise of power and discretion of director canot be
controlled by valid agreement.
viii. Here, objections to the agreement
1. Duration – although lifetime is not exactly ascertainable, there is no
statutory or public policy which would invalidate agreement on such
grounds
2. Election of certain persons – similar agreements have been upheld
before, assuming no complaining minority; silence on removal
assumes that Board still has that power.
3. Purpose (provide maintenance for immed family) – no inherent evil in
purpose and minimum earned surplus req protects corp and 3d party
4. Salary Continuation Agreement – limited for corp/3d party
protection; usually a UV issue, but no complaining minority.
g. Shareholder Agreement Analysis
i. S 7.32 – okay if everyone signs and follows other guidelines
ii. McQuade – 4 spheres of shareholder rights
iii. Galler – if have certain pre-conditions it’s okay (closely held corps)
VOTING
I.
MBCA S. 7.28 – Voting for Directors, Cumulative Voting
a. Unless otherwise noted, directors elected by PLURALITY
b. Have right to cumulative voting only if provided for in the Articles of Incorp
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c. May not be voted cumulatively at meeting unless:
i. Mtg notice conspicuously states that such voting is authorized; OR
ii. Shareholder gives notice of intent less than 48hr before mtg
II.
MBCA S 7.30 – Voting Trusts
a. May confer trustee the right to vote or totherwise to act for them by signingin
agreement setting out provisions; effective on date first shares conferred – valid for
10 years unless extended by written consent and sent to corp office (binds only the
signing/renewing parties)
III.
MBCA S 7.31 – Voting Agreements (Pooling Agreements)
a. Open ended agreement to vote together – not specifics.
b. Presumptively valid
IV.
Ringling Bros (DE 1947)
a. Issue – should voting agreement be followed?
b. Holding – YES
c. Nothing in agreement allows one party to exercise the voting rights of another
i. Arbitrator has no right to enforce decision, but is only enforceable if one of
the parties wills it
ii. Thus, the actual voting of Haley’s shares frustrates the agreement and should
not be treated as partial performance
d. No specific enforcement for pooling agreements unless agreement gives a roadmap
or has its own enforcement mechanism – b/c agreement open-ended that parties
will vote together.
PUBLIC OFFERINGS
I.
II.
Statutes
a. ’33 Act – deals w/ registration, offer and sales (based on disclosure)
b. ’34 Act – regulates all other aspects of public trading
c. Blue Sky Laws – state statutes
IPO Process
a. Statutory Reqs
i. Registration w/ SEC, req’d by ’33 ct
1. S.5 – disclosure docs (incl. prospectus, R424)
2. Info does not have to go to investors (get some info when purchase)
ii. If something wrong w/ disclosure, firm has STRICT LIABILITY
1. Other ppl on agreement (underwriters) have liability capped at share
allotment
2. They can defend based on due diligence (varies by expert/nonexpert)
iii. After disclosure, subject to ’34 Act – periodic reporting, req’s to register on
an exchange
b. Offering – “firm underwritten public offering” – sell to underwriter, who sells to
investors (may have multiple underwriters)
c. Stages of Registration
i. Pre-filing: 30d prior to filing
1. File prelim registration (red herring) – used until final registration at
effective date
2. Problem of “conditioning the mkt” – construed broadly.
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III.
a. Prohib against selling efforts; can’t do anything differently
b. IPO more likely to be seen as conditioning b/c of large lack of
public info
c. “Tombstone ad” – cannot editorialize
d. If violate “gun jumping” then everyone deemed to have
rescission right.
e. Statute of lim – 2 yr after discovery, 5yr total
ii. Waiting: filing until it is declared effective
1. Registration may be changed
2. Selling Activities – “testing the mkt”, go on “road show” – investor
meetings with potential buyers, but can’t actually sell
a. Can be made binding as soon as company goes public though.
iii. Post-effective
1. If purchase shares, get final prospectus
2. Liab for misstatements in filings (have back-and-forth w/ SEC in
‘waiting period’ but they aren’t req’d to comment)
SEC v. Ralston Purina Co (SCT 1953)
a. S4(2) of ’33 Act exempts transactions by issuer not involving any public offering
from the registration req’s of S.5
b. D made authorized but unissued common shares avail to “key employees”
c. Issue – is class of employees considered “public”?
d. Holding – YES, private offering is one made to ppl considered able to fend for self
i. To be public, an offer need not be made available to the whole world
e. Design of ’33 Act is to protect investors by promoting full disclosure
i. Thus, exempt transactions are those which ther is no need for disclosure
since those ppl have the same info that would be made avail to public.
ii. Since it depends on info, any motive is irrelevant
iii. Regulation D helps define who is deemed to be sophisticated enough
1. Usually depends on money though, not age or position.
2. Also need to think about resale – quicker resale a problem.
SECURITIES FRAUD
I.
II.
III.
Definition – material misstatement in connection w/ security – doe not apply to
decision not to purchase.
Materiality Tests
a. TSC – Material if person would consider it important, that would alter total mix of
information. (wouldn’t necessarily affect action taken)
b. Basic – probability/magnitude for contingent event
Rule 10b-5
a. By use of interstate commerce, mails, or any facility of a national security exchange,
illegal to
i. Employ any device, scheme, artifice to defraud
ii. Untrue statement of material fact or to omit to state a material fact necessary
in order to makd statements not misleading.
iii. Act/practice/course of business which operates or would operate as fraud
deceit
b. In connection with purchase or sale of security.
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IV.
Materiality
a. Basic v. Levinson (SCT 1988)
i. 3 public statements denying merger, then announces it later
ii. Issue – what is the standard of materiality (for prelim negotiations)?
iii. Holding – probability/magnitude, in light of totality of company activity
iv. Info is material if “substantial likelihood that reasonable shareholder would
consider the info important in making a decision”
1. A lie alone is not suffic and silence alone is not actionable – info is not
made material by virtue of a public statement denying it.
2. There is no req to disclose ongoing negotiations w/ another company.
v. Probability – look at indicia of interest in transaction at highest corporate
level (Board resolutions, instructions to I-Bankers, actual negotiations)
vi. Magnitude – size of corp entities, potential premium over mkt value,
significance of transaction to securities issuer
b. SEC v. Texas Gulf Sulphur Co (2d Cir 1968)
i. Drilling discovery, keep quiet to facilitate acquisition of land area; some stock
purchases made and coll options issued; during time, corp denied finding
ii. Issue – what constitutes insider trading?
iii. Holding – material, non-disclosed facts.
1. Judged at the time the order is placed.
iv. Trading alone not enough – has to be material as well
1. Size of transaction can be indicative of materialness
2. Can safely trade when public fully digests info – may take longer for
more technical info
v. R10b-5 req’s same access to same info for everyone
1. Rule applicable to anyone possessing info, even if not an isider
2. If someone cannot disclose the info, then they are banned from
trading on it.
3. Restrained only if the info is MATERIAL – “essentially extraord in
nature and which is reasonably certain to have a subst effect on mkt
price.
vi. Disclosure of info is only effective when it has been fully absorbed – news
release merely the first step.
vii. Here, major indication of materialness is importance attached to the results
viii. Issuance of stock options –ppl receiving the shares have a duty to inform the
issuing committee of their find/that shares are too low.
V.
Breach of Duty
a. Chiarella v. US (SCT 1980) – TRADITIONAL THEORY
i. Worked at printer, was able to deduce names from blank docs
ii. Issue – does person who learned from confidential docs of corp takeover
violate S10b if he fails to disclose before trading?
iii. Holding – NO, trading must be in violation of some duty
1. Duty can extend beyond fiduciary duty and cover employees
2. “Constructive insider” - attorney, accountant, consultant.
iv. Obligation to disclose info is held by virtue of position, arising from existence
of relationship of trust and confidence
v. Not every instance of financial unfairness constitutes a violation of S.10b – it
requires a prior relationship to make the activity fraudulent.
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vi. Here, Chiarella owns a duty to the printer and the acquirer, but not the target
firm that he acquired shares in – no rel. of trust and confidence with the
target firm.
b. US v. O’Hagan (SCT 1997) – MISAPPROPRIATION THEORY
i. Issue – is someone who trades using confidential info misappropriated in
breach of their fiduc duty to the source of the info?
ii. Holding – YES, have a relationship of trust and confidence w/ the source
establishing a fiduciary duty to that source.
iii. S10b reaches any deceptive device in connection w/ purchase/sale
iv. Trading on non-public info qualifies as a deceptive advice
v. If you misapprop confidential info for trading purposes, you are in breach of
duty owed to the source of the info.
vi. Full disclosure to source of the info of an intent to trade forecloses liability
under the misapprop theory b/c disclosure removes the deception.
VI.
TIPPEE LIABILITY
a. Dirks v. SEC (SCT 1983)
i. Issue – Did Dirks violate anti-fraud provision by not disclosing info? How do
you breach by passing info?
ii. Holding – NO
iii. Can only be held derivatively liable – someone else must breach their duty to
hold you liable – because tippee has no relationship to shareholders
iv. First, must use TSC/Basic to check if info is material.
v. Only person w/ fiduc duty to shareolders is Secrist
1. Didn’t trade – so not directly liable
2. Mere passing not enough – must have:
a. Established duty (relationship of trust and confidence) to corp
(trad) or source (misapprop)
b. Pass was in violation of that duty.
c. Pass was for personal benefit – can be reputational, kickback
for more business, as a gift – inherently incl. expectation that
tippee will trade on the info.
vi. Once there is a violation, everyone downstream is liable – by not checking
upstream that the tip is clean, you assume liability
vii. Here, there is no actional be violation
1. Dirks has no fiduc duty to shareholders, so not directly liable for trade
2. Took no action to induce shareholders to place confidence in him
3. No expectation from source that info would be kept confident, so not
liable through misapprop theory.
4. No violation by Secrist, so not dervi liable – no pass for personal
benefit
b. US v. Chestman (2d Cir 1991)
i. Issue – do family links create fiduc relationship of trust and confidence?
ii. Holding – NO, rel. req’s independent relationship of trust and confidence
iii. First step is to determine if info is material – it is.
iv. Chestman dos not have a fiduc relationship with the shareholders so cannot
be held directly liable, and no expectation from source he would keep it quiet
so no misapprop theory
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Corporations Outline
v. Can only be held derivatively liable. – if can get one person liable for a pass,
then can get Chestman b/c he knows of family relationship and thus that the
info was prob wrongfully attained
1. Start with Ira – duty to corp, but not passed for benefit, no breach
2. Shirley – duty to Ira (they usually discuss such matters), and maybe to
corp, but not pass for benefit.
3. Breach in pass btwn Susan and Keith
a. Is there a rel. of trust and confidence btwn Susan and mother –
might have been, but pass was not for personal benefit.
4. Pass to Chestman
a. Keith and Susan usually don’t discuss such matters – marriage
is only a general confidence, and insider trading req’s specific
consequences.
b. Was she trying to get an agreement for Keith? – maybe, but to
be sufficient the agreement has to go both ways, not unilateral
c. Rules post-Chestman
i. Rule 10b-5-1 – knowing possession of info while trading is suffic, not req’d
that it be shown they actuallyused the info
ii. Rule 10b-5-2 – non-exclusive list of 3 situations in which person has duty of
trust and confidence
1. Mutual agreement to maintain info in confidence – can’t be unilateral
2. History, pattern, practice of sharing confidences, such that recipient
knows or should reasonably know that person expects confidence
a. Nature of exchange not relevant
b. But if can show that don’t discuss this info, then rebuts rule
3. Bright line rule for presumption of trust and confidence if receive
from spouse, parent, child, sibling.
a. Can rebut if show don’t discuss such things.
d. SEC v. Cuban (NDTex 2009)
i. Issue – did Cuban have a duty to corp to keep info quiet? Can duty be created
by agreement?
ii. Holding – No duty to keep the info quiet; can be created by agreement, but
Cuban didn’t have one.
iii. No reason why duty cannot arise by contract – would prob form an even
stronger duty
1. But req’s 2 agreements ; non-disclosure and non-use (otherwise no
duty not to use/trade on the info)
2. Reason by R10b-5-2 does not create the req’d duty – deals only w/
confidentiality (related to tipper/passer liability)
iv. No agreement was created here
1. “Can’t sell” statements only indicate a misbelief that he cannot trade,
not an agreement not to trade
2. The expectation cannot be unilateral: no contention that CEO
expected Cuban not to trade on the info
v. Circuit Split
1. 5th cir – need non-disclosure AND non-use agreements
2. Other courts – only need agreement “not to tell”
e. See HYPO in notes.
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Corporations Outline
TAKEOVER MOVEMENT
I.
II.
III.
IV.
Cash Tender Offer
a. Buy shares of target company either on open mkt or by making offer to
shareholders – public invitation to “tender” shares to bidder, usually at 15-20%
premium; usually mailed or posted as ad
b. Usually comes w/ conditions that not req’d to purchase unless necessary amount is
tendered
c. Signif modified by 1968 Williams Act
i. Req’s disclosure by bidder if acquiring 5% or more, but need not be made in
advance (no later than time announce tender offer
ii. Set bidding urles
1. Must remain open for minimum of 20 business days
2. Shareholder can w/draw during that windo
3. All shareholders must receive highest price paid
4. If oversubscribed, all shareholders have shares purchased pro-rata
iii. Target company cannot be passive: 3 options to shareholder on which offer
to take
1. Recommend option
2. No opinion/remain neutral – maybe a suggestion they’re all good
3. Unable to take a position (harsher than #2)
iv. Goals of Act
1. Slow down process to give shareholder full info and target time to
respond
2. Assure all shareholders treated equally.
Rule 14e-3 – cannot purchase/sell if you have material, non-public info about a tender
offer
a. No duty requirement
b. Trader and tipper liability
Leveraged Buyout
a. Aggressor (mngmnt, other corp, raider) purchases all or most of the outstanding
stock for a premium (enough to get a controlling stake)
b. Financed through loans, and structured such that the debt usually ultimately
becomes the target’s obligation.
c. Proceeds of the debt used to purchase the target’s shares.
d. Generally not possible to get 100% of shares, so might engage in secondary merger
Takeover Defenses
a. Generally accepted justifications
i. Offered price too low and doesn’t reflect true value
ii. Aggressor has reputation for unsound fiscal policy
iii. Cannot meet debt w/o using target’s assets
iv. In shareholder’s best interest to remain independent
v. Mngmnt already embarked on long-term plan to improve profits/stock price
vi. Violates some law
vii. Unfair to shareholders by coercing them
b. Panter (7th Cir 1981) – cause DE courts to reject simplistic application of BR for a
“more balanced analysis” (b/c board seen as inherently interested
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Corporations Outline
V.
Unocal Corp v. Mesa Petroleum Co (DE 1985)
a. Mesa seeks to purchase 51% of shares, and then issue “highly subordinated
securities for th rest
b. Unocal defense by issuing “exchange offer” – If Mesa gets 51%, rest of shares can be
exchanged for $72/share – would result in Mesa owning 100% of a debt-awashed
corp
c. Holding – Reasons for exchange offer valid and reasonably related to threats posed
d. Can’t analyze breach under normal BJR b/c managers generally inherently biased
b/c jobs on the line – econ motivation could overcome normal judgment
e. Thus, need heightened rule for Board’s fiduciary duty when Board is responding to a
takeover
f. 2 part test
i. Reasonable ground to believe threat to corp policy or effectiveness
(something the court will recognize)
ii. Response reasonable to perceived threat (usually about proportionality)
g. Generally as long as doesn’t completely preclude takeover, court says its okay.
h. Dir’s duty not unbridled authority – must analyze nature and effect, including:
i. Inadequacy of price offered
ii. Nature and timing of offer
iii. Legality
iv. Impact on non-shareholder constituencies
v. Risk of non-consummation
vi. Quality of securities offered
vii. Basic stockholder interest
i. Here, objective was to make sure remaining stockholders get fair value if takeover
goes through, and excluding Mesa necessary to definition of defense
VI.
Revlon Inc. v. McAndrews & Forbes Holding (DE 1986)
a. Holding – actions to fight off initial low bid value was okay; but ultimately choosing
lower offer was a breach – estab a new principle
b. Once in Revlon, Board cannot consider other constituencies.
c. Once break-up become apparent/inevitable, duty of Board changes from
preservation of corp entity to maximizing corp’s value at sale for shareholder
benefit
i. R’s arg that it took lower offer in consid of other corp constituencies has
limits in that it must be “rationally related” to corp
ii. However, such concern inapprop in action among active bidders.
d. When does Revlon zone commence?
i. Board’s response (10M share repurchase) – NO, b/c takeover not inevitable
ii. Deal w/ FL (lock-up) – YES
iii. If entire posture is a defense, can probably manage to stay in Unocal.
VII.
Paramount v. Time-Warner
a. Paramount offering larger amount for tender offer than Warner, arguing for Revlon
b. Court – not in Revlon b/c company (Time) is going to continue
c. Case is important in determining when Revlon is triggered.
VIII. Paramount v. QVC
a. Paramount agrees not to shop around for other buyers
b. Court finds Revlon duties were triggered
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Corporations Outline
IX.
Barbarians at the Gate
a. Once company targeted, escalation happens really quickly – why need to test the
mkt (VG)
b. Defenses to takeover
i. Lock-up – lock company or part out s that its not part of transaction: keeps
ppl in the transaction, stalls the transaction, and makes it more expensive.
ii. Scorched Earth – sign agreements w/ others that if takeover happens,
company parts get sold off
iii. Management Buyout (what Ross tries)
iv. Shark repellants (in charter to make takeover harder to do)
1. Staggered Board terms
2. Supermajority for mergers
3. Fair price provisions – any 2d step merger needs a “fair price”
v. Green Mail – says will do a takeover (to cause price to go up), but doesn’t and
instead sells for profit
vi. Poison Pill
1. Can be triggered by diff types of takeovers, depending on how written
2. At time of takeover, convertible securities go to common stock at a
high ration, with a right to repurchase at a vey low price
3. Makes takeover impossible – higher price and lot more shares
4. Can only be de-activated by pre-takeover mngmnt
a. Bidder goes to Board and offers incentive to remove pill
b. Lawsuit against Board that not removing pill is a breach of
duty b/c in shareholders best interest for transaction
c. Why would company get involved at all? – becomes subject to fiduc duty attack
i. Doing what they think in best interest of shareholder
ii. Req’d to act under the Williams Act
1. Freedom to deal with who they want
2. Can’t make false public statements, but not req’d to give everyone the
same info
iii. Changing bids elongates the 20 business day period.
d. Is Board in movie in Unocal or Revlon?
i. Eval at the time Board makes defensive move – diff defensive moves might
require diff analysis.
ii. Seems like Board is in Revlon – never trying to repel takeover
iii. Is starting to entertain offers acknowledging a takeover’s inevitability?
1. If issue is to protect corp, then in Unocal
2. If no restriction on what buyers can do, then in Revlon
iv. Important distinction b/c if still in Unocal, can consider other constituencies.
e. Board ultimately took lower offer – is that a breach?
i. Fear that Ross could not consummate.
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