Corporations
Professor Lisa M. Fairfax
Spring 2013
I.
Introduction, Choice of Entity
A. Subject in General
a. Corporations v. Unincorporated Business Association
b. Closely Held v. Publicly Held Corporations
i. Closely Held: Business with relatively few owners who interests are not
publically traded on an established market; usually smaller and have an overlap
of directors, managers and shareholders
ii. Publicly Held: Large number of owners and interests are routinely bough and
sold in the public market
B. Introduction to Business Forms
a. Concerns when forming a corporation:
i. Liability
ii. Profit
iii. Management
iv. Tax
v. Exit and transfer rights
vi. Ownership structure
b. Sole proprietorship – business owned by a single individual, unlimited personal liability
c. General proprietorship – Association of two or more persons to carry on a business for
profit
i. Liability- General partners have personal liability
ii. Profit- Each partner owns are share in the profits of the business
iii. Management- Everyone has equal rights to manage the affairs of the business
1. But have structural flexibility to determine individual responsibilities
iv. Tax- Pass through taxation
v. Exit – Exit of partner can trigger dissolution, restricted transferability of
ownership interests
d. Corporation –Separate legal entity whose identity is distinct from that of its owners
(Shareholders); Created by filing an organizational document with the state
i. Liability – Limited; directors and officers are not personally liable for the debts
and obligations of the businesses
1. But, directors and officers have corporate duties and they can be held
personally liable for failing to carry out those duties
ii. Profit- divided based on the shares of ownership
iii. Management – Directors or officers manage the corporation; Shareholders do not
have the right to participate in the management of the business
iv. Tax- Income is taxed twice – “double taxation”
1. Franchise tax is also added
v. Exit- Ownership interests may be freely and fully transferred without the consent
of others
e. Hybrid Business Organizations
i. Limited Partnership- Partnership comprised of at least two classes of partners
(general and limited) formed by filing an organizational document with the state
1. Liability- General partners have personal liability, but limited partners
have liability only if they participate in the control of the business
2. Profit- each partner owns a share in the profits of the business
3. Management- Must include at lease one “general partner” and “limited
partner”
a. Limited patterns are generally passive investors and have not
management role
4. Tax- Pass through taxation
5. Exit- Restricted transferability of ownership interests
ii. Limited Liability Partnership- General partnership that, depending on the
relevant state statute provides the partners with limited liability for the
partnership
iii. Limited Liability Limited Partnership – a limited partnership that provide
liability protection to all or some of its partners
f. Limited Liability Company- a business organization, formed by a required state filing,
that adopts many of the features of corporations and partnerships
C. Taxation of Partnerships and Corporations
a. Corporate Tax Rates
i. Difference between marginal tax rates and average tax rates
ii. Tax structure for corporations is mildly progressive
b. The Taxation of Capital Gains and Losses
i. Capital losses are available to offset capital gains
ii. Short-term capital gains and losses are separately netted from long-term capital
gains and losses then combined to determine the net gain or loss for the year
c. The Taxation of Proprietorships, Partnerships, and Corporations
i. Proprietorship
1. Separate Schedule C must be attached to the 1040 and income gain or
loss is added or subtracted from the proprietor’s other income.
2. Self Employment Contributions Act
ii. Unincorporated Business Forms
1. Subchapter K of the Internal Revenue Code
2. May elect to be classified for federal income tax purposes as a corporation
– “Check the box”
a. Exception for publicly traded partnerships
3. Files informational return Form 1065 – ‘Passed through’ to partners
4. Will be tax to pay on business income even though the business has not
actually distributed any of that income
5. Allocation of losses opened the door for tax avoidance on a major scale
6. SECA tax is imposed on general partners but not limited partners
iii. C-Corporations
1. 23 percent differential or bias against the C Corporation tax status at the
highest levels of income because there is no pass through taxation
iv. S-Corporations
1. Tax election and not a corporate law election
a. Not more than 100 shareholders
b. Prohibited from having non-resident aliens or non-individuals
(with some exceptions)
c. May not have issued more than one class of stock
2. Taxed on a modified pass-through basis similar to unincorporated
business forms
D. Delaware Corporate Law
a. Delaware has the dominate position in the incorporations market
i. Networking and learning externalities make it difficult for other states to
compete with Delaware
ii. Managers typically migrate to typical antitakeover statues, however states with
arguably the most severe statutes do not attract incorporation
b. Major reason for the success of Delaware General Corporation law was the
transformation to a modern judicial selection system along with modern corporation law
c. Delaware is the state of incorporation for more than 50% of all US publically traded
companies and 63% of Fortune’s 500 largest companies
d. Creating a Corporation:
i. Two Basic Documents that every corporation needs to operate
1. Article of Incorporation (‘Charter’)
a. Documents needed to incorporate a business
b. Must file with the state in order to incorporate
2. By-Laws
a. Basic operating agreement for the corporation
b. Do not need to file with the state
i. But, any company that goes public must file both the
articles of incorporation and its by-laws with the SEC
ii. Place/State of Incorporation
1. The place of incorporation matters because of the Internal Affairs
Doctrine
a. Foreign courts should apply the law of the state of incorporation
to issues related to the internal affairs of a foreign corporation
II.
Partnerships
A. Establishing Partnerships
a. Uniform Partnership Act (“UPA”) § 6 – a general partnership is formed whenever
there is an association of two or more persons to carry on as co-owners a business for
profit
i. No public filing is required
ii. A partnership can be formed if:
1. Incorrect or incomplete formation of another form of business -> default
to the partnership
2. Two people go in to business together to make a profit, even if they didn’t
have the intention to form a partnership or realize that they had done so
OR
3. UPA § 7(4) and Revised UPA (“RUPA”) § 202(c)(3) – Person who
receives a share of the profits of a business is presumed to be a partner in
the business unless the profits were received in payment of a debt, as
wages, or for other listed exceptions.
b. The Partnership Agreement
i. Default rules include:
1. Sharing of profits and losses equally
2. Every partner has the right to participate in the management of the
partnership
ii. These default rules can be altered by a partnership agreement
1. Does not need to be written, but written agreements avoid malpractice,
disputes, and statute of frauds issues
2. Partnership agreements generally include information about: partnership
construction, division of profits, ownership structure, and dissolution.
iii. Characteristics of a partnership
1. Ownership structure
a. Must have at least two people in order to create a partnership
b. All partners can share equally in the management, but the
agreement can alter this arrangement
c. Giving a loan does not establish a partnership, but managerial
authority beyond just veto power may create a partnership
2. Dissolution
a. Dissolves when one partner dies, goes bankrupt, leaves, or some
other dissolution event
b. Technically, even if the partnership continues without the leaving
member, the partnership is a new partnership
3. Governing law
a. Typically the state’s version of the UPA, but the UPA of the state
where the state has the most minimum contacts will govern
b. An agreement should include a choice of law provision
4. Liability
a. State law determines whether suit must be brought against the
partnership before suits against the individual can be brought
i. Exhaustion Clause: Under the UPA there is no exhaustion
clause available, but the RUPA allows a business to
incorporate a clause that requires a plaintiff to go after the
entity before the partners.
5. Taxes- “Pass through taxation”
B. Sharing of Profits and Losses
a. The partnership agreement governs the sharing of profits and losses, but in the absence
of such agreement
i. Default Rule or
1. Partners intend to participate equally in the profits and losses of an
enterprise
ii. California Rule: if one partner contributes the capital and another only
contributes labor and is not otherwise compensated then:
1. The contributing partner is paid back first, but
2. The party who contributed capital is not entitled to recover any part of
his losses from the partner who contributed only labor. See Kessler v.
Antinora (Supr. NJ App. 1995)
C. Management and Authority
a. Creation of the Agency Relationship
i. Agency – fiduciary relationship which results from the manifestation of consent
by one person to another that the other shall act on his behalf and subject to his
control, and consent the other to act.
ii. As long as the legal definition is met, an agency relationship is created, regardless
of whether the parties intended to create such a relationship
iii. The principal is the person for whom (or on whose behalf) the agent is action.
The agent is the person acting for another
iv. An artificial entity, such as a corporation or a partnership, can only act through
agents
v. UPA §9 Partner Agent of a Partnership as to Partnership Business
1. (1) Every partner is an agent of the partnership for the purpose of its
business, and the act of every partner, including the execution in the
partnership name of any instrument, for apparently carrying on in the
usual way the business of the partnership of which he is a member binds
the partnership, unless the partner so acting has in fact no authority to
act for the partnership in the particular matter, and the person with
whom he is dealing has knowledge of the fact that he has no such
authority;
2. (2) An act of a partner which is not apparently for the carrying on of the
business of the partnership in the usual way does not bind the
partnership unless authorized by the other partners;
3. (3) Unless authorized by the other partners or unless they have
abandoned the business, one or more but less than all the partners have
no authority to:
a. (a) Assign the partnership property in trust for creditors or on
the assignee’s promise to pay the debts of the partnership,
b. (b) Dispose of the good-will of the business,
c. (c) Do any other act which would make it impossible to carry on
the ordinary business of the partnership,
d. (d) confess a judgment,
e. (e) Submit a partnership claim or liability to arbitration or
reference
4. (4) No act of a partner in contravention of a restriction on his authority
shall bind the partnership to persons having knowledge of the restriction
b. Actual Authority – manifestation of a principal to an agent that he has power to deal
with others as a representative of the principal
i. If the principal’s words or conduct would lead a reasonable person in the agent’s
position to believe that the agent has authority to act on the principal’s behalf, the
agent has actual authority to bind the principal
ii. A common type of implied actual authority is incidental authority- simply
authority to do incidental acts that are related to a transaction that is authorized.
iii. National Biscuit Co. v. Stroud (1959)
1. What either partner does with a third part is binding on the partnership
2. Co-partner could not restrict the power and authority for Freemen to
purchase bread because such a matter was an “ordinary matter
connected with the partnership business.”
c. Apparent Authority - arises from the manifestation of a principal to a third party that
another person is authorized to act as an agent for the principal
i. An agent cannot create apparent authority, only the principal to a third party
ii. Principal must have done or not done something that creates the impression
that broad authority exists in an agent when in fact it does not
iii. Ratification after the fact- if an action is taken and the principal acts in a way
that supports the existence of authority there is apparent authority.
D. Duties of Partners to Each Other
a. UPA §21 Partner Accountable as Fiduciary
i. (1) Every partner must account to the partnership for any benefit, and hold as
trustee for it any profits derived by him without the consent of the other partners
from any transaction connected with the formation, conduct, or liquidation of the
partnership or from any use by him of its property.
ii. (2) This section applies also the representatives of a deceased partner engaged in
the liquidation of the affairs of the partnership as the personal representatives of
the last surviving partner.
b. The Common Law –
i. Fiduciary Duty- obligation of an agent to act on behalf and in the best interest of
the business entity
1. Cannot waive, but you can carve out exceptions
ii. Meinhard v. Salmon (Ct. App. NY, 1928)
1. Partners in a partnership owe to each other a duty of the utmost good faith
and loyalty. The duty is so absolute that even if a partner does not have
the authority (either actual or apparent) to do something on behalf of the
partnership, the partner can still violate a fiduciary duty.
iii. Meinhard Factors for Determining Whether a Partner has Breached his
Fiduciary Duty
1. Notice – what constitutes “sufficient” notice? Likely very high after
Meinhard
a. Owne
2. Nexus/Nature of the Opportunity – Look at the kind of new
opportunity is being offered and the purpose of the opportunity
a. How closely does it resemble the current partnership venture
3. Role/Status of the Partners
a. Likely that the managing partner has a heightened fiduciary duty
b. A silent/capital partner is not the face of the partnership and will
likely not be approached with opportunities
4. Use of Partnership Property – including logos and indicia of
partnership
5. Geography
6. Extension of the Duty Post-Venture - Based on strong fiduciary duty
carved out in Meinhard, the duty likely extends a bit beyond the
expiration of the co-venture/partnership; HOWEVER it is unclear where
the line is drawn and when the duty would actually end
E. Partnership Dissolution
a. UPA § 29 “dissolution” is defined as “the change in the relation of the partners caused by
any partner ceasing to be associated in the carrying on of the business
i. This is different from a “winding up” or “liquidation” of the partnership, which
refer to the process of selling off the partnership’s assets, paying off creditors,
and settling profits/losses among the partners
ii. An at-will partnership is the default form of partnership
b. Was the act of dissolution “rightful?” – without violation of the agreement between the
partners: e.g.
1. The termination of the definite term or particular undertaking in a term
partnership
2. Express will of any partner in at at-will partnership
3. Express will of all of the partners who have not assigned their interests or
had them subject to a charging order
4. Expulsion of any partner from the business bonafide in accordance with a
power conferred by the partnership agreement.
ii. Grounds for dissolution that are not explicitly rightful or wrongful
1. Any event which makes it unlawful for the business of the partnership to
be carried on or for the members to carry it on as a partnership
2. Death of any partner
3. The bankruptcy of any partner or the partnership; and
4. A decree of court under § 32 – equity, willful, can only operate at a loss
iii. There is not such thing as an indissoluble partnership, there always exists a
power, but not always a right – Collin v. Lewis (Ct. of Civ. App. Tx. 1955)
1. Legal right to dissolution rests in equity as it does the right to relief from
the provisions on any legal contracts
2. Courts will not require to remain in a partnership that is not profitable,
but in this case the jury found that this business could be profitable
c. Dissolution Process:
i. Formal dissolution caused by some trigger event
1. Express will
2. Ending of the term
3. Bankruptcy
4. Court order- equity, willful breach, can only operate at a loss
ii. Winding up of affairs – satisfying debts and obligations
iii. Termination of partnership- splitting up of profits and losses
d. Duties during the dissolution process
i. Fiduciary duties still exist and may linger for some period after dissolution. See
Meinhardt
ii. Liability is not dissolved during windup
1. May be personally liable for things that happened while you were there if
the partnership continues after you leave
iii. Terminated authority other than what is necessary to wind-up
1. Apparent authority does not end. Need to give notice to creditors
iv. Finances and Accounting: If you continue a partnership after a dissolution even
the partner who leaves is entitles to:
1. The value of interest on the day of the dissolution event and
2. Either interest on the assets that were left (company not doing well)
or profit (company has become successful)
III.
Other Business Forms
A. Limited Liability Partnerships
a. Provides the partners with limited liability for the firm’s tort obligation or for both its
tort and contract obligations
b. General partnership law is applicable to the LLPs when it is not explicitly altered by LLPspecific provisions
c. Designed to avoid the fear by a partner that her personal assets may be at risk because of
negligence or malpractice by a partner over whom she has no control.
d. Can be found at the end of a state partnership act, does not have a separate statute
e. Formation:
i. (1) LLP must fall within the statutory definition of a partnership – an association
of two or more persons to carry on as co-owners a business for profit
1. Easy to convert from a general partnership to an LLP
2. When you convert, any contracts entered into as a general partnership
are subject to genera partnership law; all those entered into after the
conversion will be subject to LLP law
i. (2) Must file a document with the state, include LLP in official name of
partnership
ii. (3) Some jurisdictions require a specified amount of liability insurance or a pool
of segregated funds
1. If an LLP fails to comply it presumably loses its limited liability protection
B. Limited Partnerships
a. Formation:
i. Need to have at least one general partner and one limited partner and must be
designated as such
ii. Can only be formed by filing a certificate with the secretary of state
iii. The real detail of the rights and duties of partners and on the overall operation of
a limited partnership is contained in the partnership agreement – a separate,
non-public document
b. Management and Operation
i. RULPA §403(a) indicates that a general partner in a limited partnership has the
same rights and powers (and is subject to the same restrictions) as a general
partner in a general partnership
ii. RULPA does not explicitly grant or deny management rights to limited partners.
Nevertheless, several cases have state that limited partners cannot take part in
the management of the business and partnership agreements tend to explicitly
deny management rights.
iii. RULPA does not speak to the issue of whether a limited partner is an agent of the
limited partnership who can bind the venture, via apparent authority, to
transactions in the ordinary course of business
1. There is some case law stating that limited partners have no agency
authority
iv. Absent provisions in a partnership agreement, a limited partner has no voting
rights under the RULPA (1985)
c. The Control Rule - Gateway Potato Sales v. G.B. Investment Co. (Ct. of App. Az. 1991)
i. Arizona Rule (Old Partnership Act)
1. If the limited partner’s participation is substantially the same as if you
were a general partner, even if the third party had no actual knowledge of
your engagement, you are liable to the (No Knowledge or contact
needed)
2. If the limited partner’s participation is not substantially the same as the
general partner, then the third party must have actual knowledge of the
control (Actual knowledge must come from direct contact)
ii. Revised Rule
1. Even if the limited partner participates in the control of the business, the
limited partner is only liable to third parties engaging with the limited
partner if they have actual knowledge of the limited partner’s control
(Direct contact)
iii. Final version of Uniform Partnership Rules removed the direct control piece
entirely and states that a limited partner cannot be held liable – not adopted by
many jurisdictions
C. Limited Liability Companies
a. LLC is a noncorporate business structure that provides its owners, known as members
with a number of benefits:
i. Limited liability for the obligations of the venture, even if a member participates
in control of the business
ii. Pass-through tax treatment
iii. Tremendous freedom to contractually arrange the internal operations of the
venture
b. Offers an entity that combines the tax advantages of a partnership with the limited
liability protection for all members, an advantage commonly associated with
corporations
c. Truly unique and new business entity that cannot be described with either forms
d. “Check the Box” rule took the lid off the growth of LLC’s
e. Remember that any public entity is taxed at a corporate rate regardless of whether it is a
partnership
IV.
Formation of a Corporation
A. The Process of Incorporation
a. Where to incorporate?
i. Involves a an appraisal of two factors:
1. An analysis of the relative cost of incorporation, or qualifying as a foreign
corporation, under the states under consideration
2. Consideration of the advantages and disadvantages of the substantive
corporation laws of these states
ii. As a practical matter, the choice usually comes down to the jurisdiction where
the business is to be conducted or Delaware.
1. Cost of forming a Delaware incorporation and qualifying it to transact
business in another state will be greater than just incorporating it in that
state
2. Although foreign and domestic corps pay relatively the same amount in
income and franchise taxes, Delaware franchise taxes were raised in 1991
3. Possibility of having to defend against suits in far away Delaware
4. The Delaware statute may offer some flexibility not available to other
states by allowing corporations with less than 30 shareholders to be
managed directly by the shareholders
b. How to incorporate
i. Significant issues that attorney’s must address:
1. What substantive provisions should be reduced to writing and whether
these provisions should be reduced to writing and whether these
provisions should be placed in the articles of incorporation, the bylaws,
or a shareholders’ agreement.
a. The modern trend is to limit the articles of incorporation to
provisions required by law
2. Always a danger of overlooking some obvious matter or using
“boilerplate” language
3. The formal requirements are sent forth in MBCA §§1.20-1.26
ii. Articles of Incorporation
1. Model Business Corporation Act (“MBCA”) §2.02 Articles of
Incorporation
a. The articles of incorporation must set forth:
i. (1) a corporate name for the corporation that satisfies the
requirements of §4.01;
ii. (2) the number of shares the corporation is authorized to
issue;
iii. (3) the street address of the corporation’s initial
registered office and the name of its initial registered
agent at the office; and
iv. (4) the name and address of each incorporator.
b. The articles of incorporation may set forth:
i. (1) the names and addresses of the individuals who are to
serve as the initial directors;
ii. (2) provisions not inconsistent with law regarding:
1. (i) the purpose or purposes for which the
corporation is organized;
2. (ii) managing the business and regulating the
affairs of the corporation;
3. (iii) defining, limiting, and regulating the powers
of the corporation, its board of directors, and SHs
4. (iv) a par value for authorized shares or classes of
shares;
5. (v) the imposition of personal liability on SHs for
the debts of the corporation to a specified extent
and upon specified conditions
iii. (3) any provision that under this Act is required or
permitted to be set forth in the bylaws;
iv. (4) a provision eliminating or limiting the liability of a
director to the corporation or its SHs for money damages
for any action taken, or any failure to take any action, as a
director, except liability for (A) the amount of a financial
benefit received by a director to which he is not entitled;
(B) an intentional infliction of harm on the corporation or
the SHs; (C) a violation of section 8.33; or (D) an
intentional violation of criminal law
c. (c) The articles of incorporation need not set forth any of the
corporate powers enumerated in this Act
d. (d) Provisions of the articles of incorporation may be made
dependent upon facts objectively ascertainable outside the
articles of incorporation in accordance with section 1.20(k).
2. Articles of incorporation can be restated or amended
a. Restated Articles of Incorporation
i. Once a corporation restates the certificate and other
documents making up the articles of incorporation, any
other past amendments will be rolled into the restatement
ii. In other words, once it is restated, the corporation only
has to reference the one, restated document
b. Amended Articles of Incorporation
i. Corporation must keep the original articles AND the
amendments
ii. Every time a corporation changes its charter, it must pay a
fee and get the consent of SHs
c. Day that articles of incorporation are filed = day corporation
exists
i. MBCA §2.03 Incorporation
1. (a) Unless a delayed effective date is specified, the
corporate existence begins when the articles of
incorporation are filed
2. (b) The secretary of state’s filing of the articles of
incorporation is conclusive proof that the
incorporators satisfied all conditions precedent to
incorporation except in a proceeding by the state
to cancel or revoke the incorporation or
involuntarily dissolve the corporation
iii. Steps in forming a Corporation:
1. Decide where to incorporate
2. Create and file articles of incorporation
3. Name the corporation
4. Identify the registered agents
5. Authorized shares of stock [and classes of stock will be issued and what
the rights of each will be]
a. Gives the total amount of shares that the corporation can
ultimately issue
b. The authorized amount is usually different than the amount of
issued shares so that you do not have to amend and pay more in
fees for the filing
6. Sometimes includes the names of the incorporators or directors.
7. Most of everything else is not required (i.e. purpose)
8. Opt in provisions can be added, but if they are not included or its
equivalent in the charter then they do not apply to you
a. One important example – Art. VII in Facebook – Allows liability of
directors to be limited
9. Opt-out provisions will apply unless explicitly excluded in the charter
10. If you do business in another state you have to register as a foreign
corporation in any state it does business in
11. Initial meeting
a. Bylaws are adopted
b. Seal issued for the corporation
c. File with the IRS
d. Issue shares of stock
e. See standard set of minutes
f. Can also do this by written consent instead of meeting or virtual
shareholder meetings
12. Bylaws
a. Not a matter of public record
b. MBCA §2.06 Bylaws of a corporation may contain any provision
for managing the business and regulating the affairs of the
corporation that is not inconsistent with law or the articles of
incorporation
c. Charter will control if there is a conflict
B. The Ultra Vires Doctrine
a. Old Common Law Doctrine
i. See Ashbury Ry. Carriage & Iron Co. v. Riche (1875)
ii. The argument that corporations simply are unable to commit ultra vires acts
threatens to be very unsettling
iii. Once you have a charter that designates a purpose, the purpose cannot be
changed unless the charter is amended – requires approval of Bd. of Directors
and a certain number of shareholders
iv. Some courts avoided the doctrine by construing purposes clauses broadly and
finding implied purposes from the language used
v. One superficially-plausible justification arises from the fact that the articles of
incorporation on public file
b. The New Ultra Vires Doctrine
i. 711 Kings Highway v. F.I.M.’s Marine Repair Service, Inc. – Modern Doctrine
1. No act of a corporation and no transfer of property to or by a corporation,
otherwise lawful shall be invalid by reason of the fact that the corporation
was without capacity or power to do such lack of capacity or power may be
asserted:
a. In an action brought by a shareholder to enjoin a corporate act, or
b. In an action by or in the right of a corporation against an
incumbent or former officer or director of the corporation
c. In an action or special proceeding brought by the Attorney General
c. The New Ultra Vires Doctrine in the Context of Charitable Contributions
i. If one of the proper groups challenges a corporate action on ultra vires grounds,
corporation must prove that the action was not ultra vires (i.e. – was not beyond
the scope of the power of the corp.)
ii. In order to show that an action was not ultra vires, party must:
1. First, must overcome the presumption of the Business Judgement Rule
a. A presumption that in making a business decision the directors of
the corporation acted on an informed basis, in good faith, and in
the honest belief that the action taken was in the best interests of
the company
b. The presumption can be overturned only if the plaintiff can show
that the majority of the directors
i. Expected to derive a personal financial benefit from the
transaction
ii. They lacked independence
iii. They were grossly negligent in failing to inform
themselves OR
iv. The decision was so irrational that it could not have been
the reasonable exercise of the business judgment of the
board
2. Then, must determine whether the charitable gift was reasonable. Good
will test – does it provide some level of good will to the company
iii. Current Law: Every state has a statute allowing corporations to make charitable
donations under the ultra vires doctrine. Must show:
1. The donation was reasonable and
a. Reasonable in light of the nature of the endeavor and the money
expended
2. Somehow linked to the company or business
a. Was it anonymous gift? Without giving specifics it can say that
they give to charity and receive good will
iv. Remember: Fiduciary duty of self-dealing – cannot engage in something that
benefits you individually.
C. Premature Commencement of Business
a. Ways that you can lose your protection of limited liability
i. Promoters
1. A promoter is a person who acting alone or in conjunction with one or
more other persons, directly or indirectly takes initiative in founding and
organizing the business or enterprise of an issuer.
2. Promoters are required to exercise the utmost good faith in their
relations with the corporation and the members including fully advising
the corporation and the members and persons who it was to anticipated
would become members, of any interest which the defendants had that
would in any way affect the corporation, the members and anticipated
members.
a. Must faithfully make known all facts which might have influenced
prospective members in deciding whether or not to purchase
memberships.
b. This full disclosure would include the duty to refrain from
misrepresenting any material facts, as well as the duty to make
known any personal interests
3. Default rule – Promoter is personally liable to the contracts that he signs
unless there is an agreement to the contrary
4. Other Options - Restatement of Agency – § 326
a. When promoters make an agreement with another on behalf of a
corporation to be formed the following alternatives may
represent the intent of the partiers
i. Revocable Offer - They may understand that the other
party is making a revocable offer to the nonexistent
corporation which will result in a contract if the
corporation is formed
ii. Best Efforts - They may understand that the other party is
making an irrevocable offer for a limited time.
Consideration is found in a promise by the organizer to
corporation and cause it to accept the offer.
iii. Novation -They may agree to present contract by which
the promoter is bound, but with an agreement that his
liability terminates if the corporation is formed and
manifests its willingness to become a party.
1. May be implicit- notification or visible to the
directors
iv. Surety- They may agree to present a contract on which,
even though the corporation becomes a party, the
promoter remains liable either primarily or as surety for
the performance of the corporation’s obligation
ii. Defective Incorporation
1. Historical common law:
a. De jure corporation results when there has been conformity with
the mandatory conditions precedent established by the statute
i. Not subject to direct or collateral attack either by the state
in quo warranto proceeding or by any other person
b. De facto corporation is one that has been defectively incorporated
and thus is not dejure
i. Requisites for a corporation de facto are:
1. A valid law under which such a corporation can be
lawfully organized
2. An attempt to organize thereunder;
3. Actual user of the corporate franchise
4. Good faith in claiming to be and in doing business
as a corporation is often added as a further
condition
c. “Corporation by estoppel”
i. Unjust enrichment
2. Modern Law:
a. MBCA §139 has put to rest the historical common law and if an
individual or group of individual assumes to act as a corporation
before the certificate of incorporation has been issued, joint
and several liability attaches
b. The certificate of incorporation provides the cut off point; before
it is issued, the individuals, and not the corporation, are liable
V.
Piercing the Corporate Veil
A. General Doctrine
a. The power to pierce the corporate veil is to be exercised reluctantly and cautiously and
the burden of establishing a basis for the disregard of the corporate fiction rests on the
party asserting the claim
b. The piercing does not change the nature of the corporation
c. If the defendant pierces the corporate veil they are generally able to reach the
shareholders and keep them liable
d. Piercing cases are successful with closely held corporations they are overwhelming not
successful against public corporations
e. Outside of a context where there is fraud, misrepresentation, or illegality, the corporate
veil can still be pierced
i. Generally speaking the doctrine of “piercing the corporate veil” is invoked “to
prevent fraud or achieve equity”
f. Instrumentality or alter ego doctrine factors: - DeWitt Truck Brokers v. W. Ray Fleming
Fruit Co (4th Cir. 1976)
1. Whether the corporation was undercapitalized for the purposes of the
corporate undertaking
2.
3.
4.
5.
6.
7.
8.
Failure to observe corporate formalities
Non-payment of dividends
The insolvency of the debtor corporation at the time
Siphoning of funds of the corporation by the dominant stockholder
Non-functioning of other officers or directors
Absence of corporate records
The fact that the corporation is merely a façade for the operations of the
dominant stockholder or stockholders
ii. In addition, must present an element of injustice or fundamental fairness
g. Factors Courts Consider When Deciding Whether to Pierce:
i. Ownership
1. Look to see whether the corporation is closely held (i.e. – one or only a
few people hold all of the shares
2. In the parent-sub context, look to see whether the subsidiary is a “whollyowned” subsidiary (i.e. – the parent corporation holds most or all of the
sub’s shares)
ii. Undercapitalization
1. Look to see whether or not the corporation has the funds necessary to
continue its operations
2. Must know about the other capital and assets of the corporation, as well
as its debts and obligation
3. Look at whether the corporation can pay dividends to its shareholders
4. Determine if there is comingling of funds
iii. Overlap of Directors/Officers and Managers
1. Is there a director/officer overlap with management between two
companies
2. Raises the possibility that the corporation is a façade for the operations of
the dominant stockholders
iv. Focus on the Plaintiff
1. Was the contractor a creditor (voluntary) or a tort victim (involuntary)
2. Courts are less sympathetic to contractors/creditors because they should
have done due diligence before entering into an agreement with the
corporation
3. Also consider who would be affected by allowing the veil to be pierced –
See e.g. Bartle v. Home Owners Co-op (1955) (piercing veil would have
exposed veterans homes to being seized as assets)
v. Corporate Formalities
1. Did the corporation hold regular meetings and observe formalities
associated with a corporation
vi. Siphoning of Funds
1. Draining money out of the corporation so that there is only enough
money to satisfy debts and carry out day-to-day business
h. Ways to Pierce the Corporate Veil
i. Parent -> Shareholders – Pierce the parent company to get to the shareholders
ii. Parent -> Subsidiary – Pierce the subsidiary to get to the parent
1. Can “double pierce” – pierce the subsidiary to get to the parent and then
pierce the parent to get to the shareholders
iii. “Enterprise Liability” - Situation where a parent corporation has a bunch of
subsidiaries
1. “Sideways piercing” – piercing one subsidiary to get to the other
subsidiaries
B. Tort Cases
a. Generally: Policy-wise, courts are slightly more willing to pierce in the context of tort
violations b/c the victim at issue is usually involuntary (i.e. – didn’t willingly enter into a
relationship w/ the corporation via a contract). Nonetheless, the nature of the suit on its
own is not enough to automatically trigger piercing. Getting the court to pierce remains
an uphill battle.
b. See Baatz v. Arrow Bar (S.D. 1990)
c. See Radaszewski v. Telecom Corp. (8th Cir. 1992)
i. District Court held that Contrux was undercapitalized in the accounting sense,
Most of the money contributed to its operation by Telecom was in the form of
loans, not equity
ii. Court says that this doesn’t matter, because Contruz had $110,000,000 worth of
liability insurance available to pay judgments like the one that Radaszewski
hopes to obtain.
VI.
Financial Matters
A. Debt & Equity Capital
a. Financing required to conduct operation comes from a variety of sources:
i. Borrowing funds from friends or commercial sources
ii. Capital contributions from the owners of the firm
iii. Capital contributions from outside investors who thereafter either remain
inactive or become co-owners of the firm
iv. Retaining earnings of the business
b. Critical distinction is between “equity capital” and “debt”
i. Debt- associated with borrowing- must be repaid, interest must be paid
periodically, repayment not contingent on success
ii. Equity- synonymous with ownership- Value of owner’s equity = market value of
the property minus the market value of the debts that are liens against the
property
B. Types of Securities
a. Shares Generally
i. Shares are defined in MBCA 1.40(22) as the “units into which the proprietary
interests in a corporation are divided”
ii. A corporation can create an issue different classes of shares with different
preferences, limitations, and relative rights
iii. Each class must have a distinguishing designation,” and all shares within a single
class must have identical rights
iv. MBCA 6.01(b) sets forth two fundamental rights of holders of common shares:
1. (1) They are entitled to vote for the election directors an on other matters
coming before the shareholders
2. (2) They are entitled to the net assets of the corporation (after making
allowance for debts), when distributions are made in the form of
dividends or liquidating distributions
v. MBCA 6.01(b) permits these essential attributes of common shares to be places
in different classes of shares in whole or in part, but requires that one or more
classes with these attributes must always be authorized
vi. 6.03(C) adds that at least one share of each class with these basic attribute must
always be outstanding
b. Common and Preferred Shares
i. “Common shares” are a class or classes of shares that have the fundamental
rights of voting for directors and receiving the net assets of the corporation as
described above. MBCA 6.01(b), 6.03(c)
ii. Non-financial rights as well: a right to inspect books and records (MBCA 16.03), a
right to sue on behalf of the corporation to right a wrong committed against it
9See MCBA 7.40-7.47), a right to financial information (see MBCA 16.20)
iii. Common shares may be defined in various ways. Characteristics usually
associated with common stock as:
1. (i) the right to receive dividend payments contingent upon an
apportionment of profits
a. Cash, payment, or property
2. (ii) negotiability (capable of being transferred by delivery or
endorsement)
3. (iii) the ability to be pledged or hypothecated (ability to be pledged as
security or collateral for debt without delivery of title)
4. (iv) the conferring of voting rights in proportion to the number if shares
owned, and
5. (v) the capacity to increase in value
iv. Rights of Common Shares
1. Dividends - payment in cash or property
2. Liqudation
3. Voting rights - board of directors
c. Special Rights of Publicly Traded Preferred Shares
i. Culmulative Dividend Rights - a culmulatative divident simply means that if a
preferred dividend is not paid in any year, it accumulates and must be paid
(along with the following year;s unpaid culmulative dividends) before any
divident may be paid on the common shares in a later year
ii. Voting - Preferred shares are usually non voting shares
iii. Liquidation Preferences - Preferred shares usually have a liquidation preference
as well as a dividend-preference
iv. Redemption Rights - A right to redeem shares simply means that the corporation
has the power to buy back the redeemable shares at any time at the fixed price,
and the shareholder has no choice but to accept the price - “calls” the stock for
redemption
v. Conversion Rights - usually downstream
vi. Protective Provisions
1. Anti Dilution Rights
vii. Participating Preferred - the participating portion is considered at the common
rate
viii. Classes of Preferred
ix. Series of Preferred
C. Preemptive Rights and Dilution
D. Distributions
a. Introduction to Dividends
i. Cumulative v. Non-Cumulative
1. Cumulative Dividend: Id a preferred dividend is not paid in a year, it
accumulates and must be paid along with the following years’ unpaid
cumulative dividends
2. Non-Cumulative Dividend: Dividend that is not carried over from one
year to the next; if no dividend is declared during the year then the
preferred shareholder loses the right to receive the dividend for that year
ii. Participating v. Non-Participating
1. Participating: participating preferred shareholder is entitled to the
specified dividend and, after common shares receive a specified amount,
participating preferred SH shares with the common SHs in additional
distributions on some predetermined basis
2. Non-Participating: non-participating preferred shareholders are entitled
to the specified dividend payment and the specified liquidation
preference and nothing more, no matter how profitable the corporation is
b. Payment of Dividends
i. Default Rule: Dividends are paid at the board’s discretion; board is not required
to pay dividends. In fact, board cannot pay dividends until the board has paid off
the corporation’s debt
ii. In some circumstances, however, the court will compel the payment of dividends
1. Rule: Court will compel the payment of dividends if the corporation has
an adequate surplus AND the dividends were withheld in bad faith
2. Adequate Surplus
a. First, have to look at the stock picture of the corporation b/c
different types of stocks will have different policies mandating
whether and when dividends are appropriate
i. Ask what type of stock the corporation has issued
ii. Ask which stocks are cumulative and which stocks are
non-cumulative
iii. Ask whether any stocks are participating
b. If there is a surplus, must consider the size of the surplus (large?
small?) and whether it is the corporation’s first surplus
i. In the beginning of a corporation’s life, surpluses are
usually re-invested in the corporation to spur its growth
3. Bad Faith
a. There is a general presumption of good faith (court’s deference to
the board’s decisions)
b. Overcome presumption by showing that the policy of the
directors is dictated by their personal interests, rather than the
corporate welfare
c. In determining whether there was bad faith, courts can look at:
i. Financial state of the corporation – Is the corporation
paying large salaries to its employees?
ii. Freeze Out – Occurs when directors try to force SHs to sell
their shares; can only occur in closely held corporations
iii. Whether the corporation is doing something for a
particular SH to the detriment of others
d. Closely-held corporations are more susceptible to abuse/bad faith
by directors b/c no market for the shares of the corporation, SHs
of closely-held corps. tend to invest a lot of money, and there is
usually an overlap of directors and management
4. Payment of Dividends After Suit Brought
a. Has tinges of bad faith, but in the end, the SHs get paid, which is
the purpose of the suit in the first place
iii. Examples:
1. Gottfried v. Gottfried (App. Div. N.Y. 1947)
a. Facts: Gottfried Banking Corp. is a closely-held family
corporation. Action brought by minority SHs – Gottfried family
members – to compel the board to pay dividends.
b. Holding: Court would not compel the payment of dividends.
Though there is a surplus, this on its own is insufficient to compel
dividend payments; the plaintiffs must also prove bad faith. This
they could not do b/c ultimately, board could point to sound
business reasons for withholding dividends.
2. Dodge v. Ford Motor Co. (Mich. 1919)
a. Facts: Ford Motor Co. decided to stop paying a special $10 million
dividend, choosing rather to invest the surplus back in the
company. Ostensibly, this investment would finance a new
company plant, pay above-market wages, and reduce the price of
Ford cars. In his testimony, Henry Ford explicitly stated that his
purpose for getting rid of the dividend was to reduce the return to
SHs.
b. Holding: Court would compel the payment of dividends. There
was a sizeable surplus and Henry Ford explicitly stated that he
had begun refused dividend payment b/c he was trying to
minimize SH return – an action that is directly contrary to the
general philosophy underlying SH investment, which is that of
trying to maximize SH wealth.
VII. Fiduciary Duties of Officers and Directors
A. Duty of Care and Business Judgement Rule
a. Rational for the Business Judgement Rule - Implicit understanding shareholders when
they purchase shares they want the board to make decisions not judges
b. Two Ways to Overcome the Presumption: - Shlensky v. Wrigley (App. Ct. Ill. 1968)
i. Substance - Need to prove irrationality, waste, etc.
ii. Process - Can overcome by procedural – decision was not reasonably informed
c. Del. Gen. Corp. law § 102(b)(7) – Enacted immediately after Van Gorkom
i. Allows for company in charter to disclaim personal liability
ii. Relates only to care violations, does not protect against duty of loyalty, not in
good faith violations or intentional conduct or knowing violation of law;
transaction from which the director derived an improper personal benefit
iii. If the exam alleges a breach of duty of care,
1. need to opt-in and then need to look at whether
2. they are looking for something other than monetary damages, and
3. then determine if they are asking for something else and not just a
duty of care claim
B. Duty of Loyalty
a. Del. Gen. Corp. Law §144
i. Creates categories of exceptions for automatically void rule
ii. What if the director fails to disclose that he has an interest?
1. Legislature is giving corporations a way to do conflict of interest
transactions
2. If the director does not disclose or the board did not know then should be
ok
iii. This statute does not tell you whether it passes fiduciary obligation duties – still
need to apply the test- all that is does is make it not automatically void
iv. Majority of disinterest directors or shareholders to approve the transaction then
business judgment rule applies
v. Majority of interest shareholders then what rule do you apply? – There is a split
1. Some courts say you need to use a fairness test
2. Other Courts say statute does not make distinction so you need to apply
the business judgment rule
b. Marciano v. Nakash
i. Self interest – Director is getting a benefit that the other shareholders are not also
receiving
C. Duty of Oversight
a. In re Caremark Intern. Inc. Derivative Litigation, Ct of Chancery Del. 1996
i. Director’s Duties to Monitor Corporate Operations:
1. Potential liability for directorial decisions
a. Director liability for a breach of the duty to exercise appropriate
attention may, in theory, arise in two distinct contexts.
i. (1) Such liability may be said to follow from a board
decision that results in a loss because that decision was ill
advised or “negligent”
ii. (2) Liability to the corporation for a loss may be said to
arise from an unconsidered failure of the board to act in
circumstances in which due attention would, arguable
have prevented the loss
b. First class of cases are subject to review under the Business
Judgment Rule, assuming the decision made was the product of a
process that was either deliberately considered in good faith or
was otherwise rational
2. Liability for failure to monitor:
a. What is the board’s responsibility with respect to the organization
and monitoring of the enterprise to assure that the corporation
functions within the law to achieve its purposes
b. Director’s obligation includes a duty to attempt in good faith to
assure that corporate information and reporting system, which
the board concludes in adequate, exists, and that failure to do so
under some circumstances may, in theory at least, render a
director liable for losses caused by non-compliance with
applicable legal standards.
D. Derivative Suits and the Demand System
E. Demand and Fiduciary Duties in Context
a. Part One: DEMAND
i. Demand is only an issue if the Corporation moves to dismiss
1. If there is no motion, move to Part Two
ii. In a derivative suit, a shareholder must make a demand on the corporation,
unless demand is excused
iii. Has shareholder made a demand?
1. YES
a. If the shareholder makes a demand to the board, then he
concedes that demand is required
b. Demand – a written formal request by the shareholders to the
board to bring suit against the directors on behalf of the
corporation
c. Board makes a decision whether to dismiss the demand
i. Board’s decision to dismiss is reviewed under the
Business Judgement Rule
2. NO
a. Was demand required?
i. Analysis: Aronson Test to determine whether demand
was required or is excused as futile: Shareholder must
raise reasonable doubt that:
1. At least half of the directors (only directors that
were in place on the day that the suit was brought)
are disinterested or independent OR
a. Interested – director is receiving a
financial benefit that the other
shareholders are not receiving
b. Not independent – strong connection to
party being sued
i. Mere social ties do not suffice
need to demonstrate:
ii. Familial affinity
iii. Particularly close, or intimate, or
person or business affinity
iv. Evidence that in the past the
relationship has caused the
director to act non-independently
2. Transaction valid under the Business Judgment
Rule (looking at the underlying transaction
a. Raise red flags that there was no process
in making the decision or that the decision
was irrational
b. DO NOT perform the §144 analysis in this
part of the test
b. YES (Failed Aronson test)
i. Shareholder suit subject to dismissal
ii. Shareholder must make a demand and await response
iii. If corporation moves to dismiss, Business Judgment Rule
applies to the dismissal decision
c. NO (A reasonable doubt has been raised that about one of the
prongs in the Aronson test) – If demand is excused and board
dismisses, apply Zapata Test to dismissal decision
i. Analysis: Burden shifts to the corporation
1. Corporation mist show that directors at the time
the motion to dismiss was made and/or the
Special Litigation Committee
a. Are disinterested, and/or
b. Are independent, and/or
i. Social ties analysis: Mere social ties
are enough
c. Made a reasonable investigation when
making decision to file a motion to dismiss
the action
2. Court determines if motion should be granted
a. Consider § 102(b)(7): If this is a duty of
care violation, and the plaintiff is asking
for only damages
b. Public policy
c. Egregious
d. Pristine Review Process
b. Part Two: BREACH OF FIDUCIARY DUTY
i. Once demand has either (a) been properly made or (b) properly excused, you
proceed to analyze whether there has been a breach
ii. There are two duties
1. Duty of Care - General presumption that the directors and officers of a
corporation will act to further the best interests of the corporation on
behalf of the shareholders
a. In order to demonstrate that the board has breached its duty of
care, you must overcome the Business Judgement Rule
b. The plaintiff can overcome the presumption of the business
judgment Rule if he can prove that the board made a business
decision that was:
i. Substantively – irrational or wasteful
1. Very difficult to prove because you need to prove
that the benefit received is small in comparison to
the cost – See Wrigley
ii. Procedurally deficient: Factors (Van Gorkum; Eisner)
1. Negotiations/Meetings
a. Factor in what happened in the build up to
the meeting at which the decision was
made
b. If a decision was not reasonably informed
it can be overcome with action after the
fact to remedy
2. Boards knowledge of the circumstances before
meeting
3. Timing/length of meeting
4. Information provided to the board when making
the decision
a. Do they have a copy of the
contract/proposal or did they ask
appropriate questions
5. Notice
a. Did they have notice of the meeting and
the nature of the decisions to be made
6. Reliance
a. Was an expert needed?
b. Was reliance on the facts provided
reasonable
c. Did the board receive legal advice?
d. The more facts require expert knowledge
of the field or issue in question, the more
reasonable the reliance would be
7. Note: If the board was not reasonable informed
when a decision was made, the deficiency can be
overcome by the boards action after the fact (e.g.
ratification)
iii. Remember: Del. Gen. Corp. Law § 102(b)(7) Enacted in
response to Van Gorkom
1. Allows a company to disclaim personal liability for
its board member in its charter.
2. (1) Must be in the charter, need to opt into this
provision
3. (2) Relates only to duty of care violations
a. Does not protect against breaches of the
duty of loyalty, intentional misconduct,
breaches of good faith, or charges relating
to improper personal benefits
4. (3) Only applies if you are asking form monetary
damages from the directors
a. If you are only asking for monetary
damages, the case will be dismissed
b. If you are suing for injunctive relief, then
the case will proceed.
2. Duty of Loyalty
a. Has there been a self-dealing transaction or board inaction?
i. If it was a self-dealing transaction – Proceed to General
Presumption and to the Exceptions under DE § 144
1. Self-dealing transaction: Director is getting a
benefit that the other shareholders are not also
receiving
ii. If there was board inaction: Proceed to Duty of Oversight
Analysis
b. General presumption: The fiduciary relationship between the
directors and the corporation imposes fundamental limitations on
the extent to which a director may benefit from dealings with the
corporation he serves
i. Concerns about the duty of loyalty are not raised if
everyone is getting the financial benefit
c. HOWEVER: DE § 144 outlines three exceptions to this
presumption of automatic voidability
i. Are the directors fully informed of the relationship
between the interested parties and did a majority of the
fully informed disinterested directors approve in good
faith?
1. Disinterested director: director who has no
financial interests in the matter that is the subject
of such action OR a familial, financial, professional,
employment or other relationship with the person
who has a financial interest that would reasonable
be expected to affect adversely the objectivity of
the director when participating in the action
2. Must be a majority of disinterested directions; a
deadlock will not overcome the presumption
3. If there are not a majority, then look to the
second exception
ii. Are the material facts as to the interested parties’
relationship to the contract or transaction disclosed to or
known by the shareholders and the contract or
transaction is specifically approved by a good faith vote of
the shareholders?
1. So long as a majority of the shareholders (based
on their percentage ownership) have approved
the transaction in good faith, regardless of their
interest, the automatic voidability is removed
2. THEN, if a majority of the disinterested
shareholders (based on percentage) approved the
transaction, you apply the business judgment rule
3. IF a majority of disinterested shareholders (based
on percentage) reject the transaction, you have a
circuit split:
a. Some courts say that you apply the
business judgment rule
b. Some say that you apply the intrinsic
fairness test
4. If you cannot meet this exception, move to the
third exception
iii. Is it fair to the corporation? Does it pass the Intrinsic
Fairness Test
1. The intrinsic fairness test is a heightened standard
2. This prong removes the automatic voidability
3. Board has the burden of proving that the decision
was intrinsically fair
a. Fairness in Process
i. Note: it is possible for a process to
pass muster under the BJR but not
under the Intrinsic Fairness Test
b. Substantive Fairness
i. This can be a decision that results
in something slightly less than
“waste”
3. Duty of Oversight (Part of the Duty of Loyalty) (Stone: Apply the
Caremark standards, but it comes under the Duty of Loyalty)
a. The most difficulty fiduciary duty to show a breach of because
there is not any intentional wrongdoing or board action
b. Two ways to violate the duty of oversight:
i. Directors utterly fail to implement any reporting of
oversight systems OR
1. Under Caremark it seemed to matter that the
system or controls met commercial standards, but
Stone seems to imply that there just needs to be
some system in place
2. Broader approach under Caremark – needs to be
reasonable designed to get information and is not
so far below best practices
ii. Having implemented such a system or controls,
consciously failed to monitor or oversee its operations
thus disabling themselves from being informed of risks or
problems requiring their intention
4. Under Ritter and Caremark, whether the board has liability depends on
four levels of analysis:
a. Do you have knowledge of illegal activity? or
b. Do you have knowledge of red flags? or
i. Majority of the board needs to know in order for the
whole board to be liable
1. Can be implicated individually
ii. Failure to follow up and resolve
c. Do you have a system in place? or
d. Have you failed to monitor that system?
VIII. Management and Control of Corporations
A. Authority of Officers
a. Introduction
i. Shareholders elect directors to the board; once this happens, the board as the
vast amount of power and authority in the corporation
ii. Board will then appoint or elect main officers; main officers will elect or appoint
those below them
1. Corporation by-laws provide authority for this
2. Corporation by-laws set out generals tasks and responsibilities for each
officer
iii. Many director actions are approved by a majority vote
1. Board will hold a majority vote as long as quorum is present
b. Authority
i. Authority issues arise frequently when there is a lone officer inking a deal by
himself and the other people in the enterprise refuse to recognize the deal
(“renegade officer”)
ii. Actual authority
1. If alleging that the agent has actual authority, must have a source for the
authority or incidental authority derived from that source
a. Official documents (articles or incorporation, bylaws, contract)
b. Course of conduct
2. Ratification After the Fact: Regardless of whether the agent had the
actual apparent authority at the time the transaction occurred,
a. if the corporation does noting to correct the act
b. or correct the impression in the mind of the third party
c. or if the corporation takes subsequent action affirming the act or
impression
iii. Apparent Authority
1. Occurs when a third party reasonably believes that the agent has actual
authority to enter into the agreement
2. Power of position: Whatever power the position the agent is in would
normally have associated with it is what a reasonable 3rd party dealing
with the agent would expect the agent to have
3. Defenses to Apparent Authority
a. Disclaim the activities at issue
b. Conduct to the contrary
4. Scope – actions must actually fall within the scope of the actual or
apparent authority
a. Is it an “ordinary” business matter or an “extraordinary” action
i. Look at what the nature of the contract however, an
extraordinary contract can be ordinary (e.g. contract with
Kobe Bryant)
ii. Agreements for lifetime employment are almost always
beyond the scope of apparent authority - Lee v. Jenkins
Brothers (2d Cir. 1959)
1. Binds the corporation and the board indefinitely
2. Distinguished from pension plans or other fringe
benefits.
5. Apparent Authority is essentially a question of fact: includes the following
factors and others:
a. Nature of contract involved
b. Officer negotiating it
c. Corporations usual manner of conducting business
d. Size of the corporation
e. Reasonableness of the contract
f. The amounts involved
g. Who the contracting third party is
B. Authority of Shareholders
a. Shareholders have a limited number of rights and realms of authority
i. Election and removal of directors
ii. Amend article and bylaws
iii. Approve fundamental transactions
b. Election and Removal of Directors is the most basic and fundamental right of a
shareholder
i. Shareholders must vote to elect directors
1. About 70 % of large public companies have a voting system that is a
majority vote
2. Generally occurs on a cycle, certain seats come up for a vote every so
many years
3. Proxy votes, no need to be present
4. Plurality was the normal way to vote for directors
a. After Disney this all changed. So long as a person gets most of the
votes passed not including withdrawn votes
b. Now it is a majority system for most corporations
ii. Affirmative vote of a majority of the shareholders to remove a director (off cycle)
1. Used to be that a director could only be removed for cause, but now it can
be done for any reason. Need to call a special meeting
c. Public Corporation
i. Shareholders cannot form agreements to control the decision traditionally vested
in the judgment of the directors of a corporation- (e.g. officer appointment,
retaining individuals, salary determination) –McQuade v. Stoneham (1934)
d. Closely Held Corporations
i. Closely held corporations do not have to show as much concern about
shareholder agreements taking too much control as a matter of public policy
ii. Three things need to show: Galler v. Galler (Ill. 1964)
6. Closely held corporation
a. Look at size
b. Look at overlap of shareholders and directors/officers
c. Look at whether there is a public market for the shares (Does not
necessarily be a stock exchange)
7. No objecting non-signing shareholders
a. Is there harm to other shareholders
8. No harm to the public
a. Is there any harm to creditors?
b. In order to determine whether there has been any harm to
creditors, must pick apart the SH agreement provision-byprovision
i. Dividend payments (narrowly tailored), salary (narrowly
tailored), continuation agreement, election of directors
ii. To the extent that some provisions are harmful to the
public and others are not, the harmful provisions will get
struck as void as against public policy; the non-harmful
provisions will remain as valid under Galler (presuming
all aforementioned criteria are met)
iv. It is ok in a closely held organization to create an agreement to bind director to
hires specific persons as officer, not ok in McQuade.
v. Payment of a dividend is different because it could harm creditors and
vi. Must narrowly tailor the dividends agreement in shareholder agreement
vii. Shareholder agreement is specifically enforceable unless it is struck down as
against public policy
c. After Galler two trends erupt...
i. States started creating closed corporations different statutorily
ii. Statutes started to allow shareholder agreements to be binding, even if
against public policy
1. Need to be in the articles or bylaws and approved by all shareholders
2. Signed by all the shareholders and made known to the corporation
iii. If you purchase shares without knowledge of a shareholder agreement you
have a set number of days to withdraw and get your money back (90 days
from discovery or 2 years, whichever is less)
C. Shareholder Voting and Agreements
a. The process used to elect directors can take one of two form:
i. Straight Voting – Each shareholder may case as many votes as he or she has in
shares per director position
1. Effect: Shareholders with the greatest number of shares will always win
ii. Cumulative Voting – the number of total votes each shareholder may cast is first
computed and then each shareholder is permitted to distribute these votes as he
sees fit over one or more candidates.
1. Increases minority participation on the board of directors
2. Effect is that it allows the minority shareholders to get at least one
director on the board if they employ a correct strategy
3. Opt-in provision, in CA it is the default rule
b. Pooling Agreements
i. Pooling Agreement – shareholders acting together to agree how to vote, such that
between them they would be able to outnumber the votes of the rests of the
shareholders
1. Pooling Agreement vs. Shareholder Agreement
a. Difference in Definition
i. Pooling agreement is an agreement between shareholders
to collect their shares and vote together; presumptively
valid because voting in any way they want is a
shareholder right
ii. Shareholder agreement is an agreement among
shareholders to allow the shareholders to engage in
particular activities; presumptively invalid because
usually used to control or prevent director acts
iii. Agreement can have both shareholder agreement portions
and pooling agreement portions
b. Difference in Validity/Enforceability
i. Pooling agreement is automatically valid, but not
automatically enforceable
ii. Shareholder agreement is not automatically valid, but
once determination made that it is valid under
McQuade/Galler analysis, it is automatically enforceable.
ii. Voting Trust – When one shareholder gives someone else the ability to vote
shares on his behalf
1. Voting trusts are typically established to give extra share votes to a
minority interest
2. Voting trusts divorce the economic right (amount of money invested in
company) and the voting right, so there must be clear procedures in place
governing the use of voting trusts
3. Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling (Del.
1947)
a. So long as the parties agree there is no function of the arbitrator.
Role is limited to situations where there is a disagreement
b. Agreement is not interpreted to empower the arbitrator to
enforce decision he might make. Shareholders must vote in
accordance with the decision
c. Deadlock and Dissolution
i. Deadlock
1. Occurs when there is a disagreement over a matter and opponents are
equally divided; can occur at the shareholder and the director level
2. Deadlock at the director level does not automatically mean that the
corporation ceases to operate because
a. Many operations and activities do not take place at the director
level, but at the office level
b. The corporation can simply keep the current board in place
3. Remedies for deadlock include:
a. Arbitration – not always the best route, because the court will still
have to step in and decide what to do in the event that the
corporation’s directors or shareholders do not follow the
arbitrator’s recommendation
b. Dissolution
ii. Dissolution
1. Compared to Partnership Dissolution
a. Partnership Dissolution – Mere withdraw triggers dissolution,
every partner has the automatic right to withdraw at anytime, and
partners remain responsible for the partnership’s debts
b. Corporate Dissolution – Only achieved by one of the means set out
below, shareholders do not remain responsible for the
partnership’s debts
c. Similarities – Liquidation, pay off creditors, partners and directors
still have fiduciary obligations
2. Dissolution of a Corporation Can be Voluntary
a. In order to achieve voluntary dissolution, there must be: (1) A
proposal to dissolve made by the majority of the board; and (2)
Approval of the decision to dissolve by a majority vote of the
shareholders
b. Difficult to do; will likely to get corporation to involuntarily
dissolve
3. Dissolution of a Corporation Can be Involuntary
a. Is a discretionary remedy; courts are reluctant to order
dissolution of an otherwise solvent corporation
b. Courts are reluctant to order dissolution of a corporation if the
corporation’s directors are behaving improperly
c. Rarely invoked: In order to be successful, the corporation would
have to convince the court that it is being harmed in some way by
remaining intact.
IX.
Public Offerings (Securities Act on 1933)
A. Introduction
a. History and Theory
i. Enacted in response to the stock market crash of 1933
ii. General trend has been from placing greater importance on disclosure to now
more merit and judgment based rules
iii. “Disclosure” is the key
b. State Laws
i. There are also state securities laws “blue sky laws” –need to be concerned about
laws in every state that you are offering stocks in
1. Often they run in parallel to federal laws
2. Many states have more of a merit based systems rather than a disclosure
based system
c. Registration
i. Securities Act of 1933 - § 5 makes it unlawful to sell securities to the public
without registering
1. Registration statement must be submitted and include:
a. Prospectus –sent to investors
b. Additional information –on file but does not have to go to
investors
ii. E.D.G.A.R. system is how registration is filed with the SEC – requires extensive
formatting
iii. Once you have filed, need to do quarterly and annual updates about company
iv. Every time there is a financial crisis there are calls for more costly disclosures
v. After registration can issue shares at an exchange (NASDAQ) or over the counter
(NY Stock Exchange)—these exchanges are require more rules
1. Including: auditing committees, independent directors, etc.
vi. Most shares are owned through brokers and are bundled. I.e. Mutual funds
d. Process of Going Public
i. Need to have input from company to determine what the company does and what
its goals are
ii. Must check accuracy of information with respect to the rules- Emphasis on
accuracy—Due diligence process—looking for anything that needs to be
disclosed
iii. Underwriters is the company that sells the shares to the public
1. They are invested in the offering and are on the hook for mistakes
2. Often many underwriters involved
3. Managing underwriter(s) is listed at the top. See Facebook Prospectus i.e
Morgan Stanley, J.P. Morgan...
4. Sold to the underwriters as a discount—get a fee and a chunk of the
shares
iv. Accountant plays a huge part in the process-compiles financial statements
1. General trend is that auditors also have counsel
v. Prospectus and information must include policies and information on how
company will work
1. Policies as to capitalization, types or shares, financial data, dividends
policies, compensation
B. “Gun Jumping Rules”
a. Baseline Rule: corporation cannot offer or sell shares to the public without first
registering with the SEC
i. In order to enforce this, there are so-called “gun-jumping” rules in place that
prevent a company from offering shares/accepting sales before the appropriate
time period has run
ii. If a company violates the gun-jumping rules, every person in the offering (i.e. –
those to whom the company prematurely made an offer or from whom the
company prematurely accepted an offer) has the right to rescind their
transaction
b. Stages of Registration Under the Gun-Jumping Rules *Must always keep in mind when
the corporation is in one stage vs. another, and what activities are permitted/prohibited
when the corporation is in one stage vs. another
i. Pre-Filing Period – No offers or sales
1. 30 days prior to time scheduled to file registration statement
2. Key: Applies so long as the information outside the time window does not
get communicated
3. Cannot make any offers and sales of securities--cannot condition the
market
4. SEC created-Safe harbors—if certain types of information of information
is released it would not be considered offers
5. Offer – any information designed to condition people to want to accept
your offer
6. Not an offer:
a. Regularly released factual business information
i. Regularly released? Manner, type, and form
b. Forward looking information, must be a reporting company or a
“well known seasoned issuer”
i. “Well known...” can release pretty much anything and it
will not be considered an offer
ii. Waiting Period –No sales or acceptances
1. Can make offers – in the form of a prospectus
2. Can get IOIs – Indications of Interest
3. “Book building” – Can make the indications of interest automatically go
effective on the date the registration goes effective
iii. Post-Effective Period – Copy of Final
1. Once the SEC has approved the registration, the post effective period has
begun
2. All sales must be accompanied by a final, formal prospectus (containing
the price information and any changes made by the SEC)
C. Public Offerings
a. The goal for many companies is to “go public”—raise substantial amount of capital by
making public offerings of their securities—going public often has the advantage of
reducing a corporation’s need to rely on bank debt
i. Selling securities through a public offering also gives the existing shareholders
liquidity
ii. Funds acquired are also sometimes used to make acquisitions of other companies
iii. Public offerings allow companies the ability to better compete for employees
b. Many closely held companies feel uncomfortable with the amount of disclosure required:
i. Conflict of interest transactions have to be disclosed
ii. Need to “clean up its balance sheet”
iii. Company is also strictly liable under §11 of the Securities Act of 1933 for
material misstatements and omissions
c. Exemptions from Registration Requirement
i. Section 4(2) of the Sec. Act of 1933 exempts transactions by an issued not
involving any public offering from the registration requirements of §5. – turns on
whether the particular class of persons affected need the protection of the act
ii. Look at the nature of the people whom the corporation is making the offers and
to whom the corporation eventually sells the securities
1. Look at whether the people to whom the corporation is selling are
sophisticated OR if they have access to the information that they would
need pre-purchase
a. Ask whether the people have access to the information they
would normally need before purchasing offers
b. If they have access to the information, ask whether they
understand the information
c. Ask if the people can absorb the risk of purchasing the securities
iii. Amount of people that the offer is extended to is not dispositive, but the court is
more likely to find an exemption if the offer is to a smaller amount of people
X.
Securities Fraud
A. Rule 10B-5
a. In the context of this class, “securities fraud” is synonymous with “insider trading”
b. Under federal securities law, Rule 10(b)(5) is the foundational rule against insider
trading and other fraudulent activities
i. Authorization: Securities and Exchange Act of 1934, § 10
c. c. Rule 14(e)(3) is also an important rule against insider trading in the context of
takeovers
i. Authorization: Securities and Exchange Act of 1934, § 14(e
d. Rule 10(b)(5) Employment of Manipulative and Deceptive Practices
i. It shall be unlawful for any person, directly or indirectly, by the use of any means
or instrumentality of interstate commerce, or of the mails or of any facility of any
national securities exchange,
1. (a) To employ any device, scheme, or artifice to defraud,
2. (b) To make any untrue statement of a material fact or to omit to state a
material fact necessary in order to make the statements made, in the light
of the circumstances under which they were made, not misleading, or
3. (c) To engage in any act, practice, or course of business which operates or
would operate as a fraud or deceit upon any person.
ii. in connection with the purchase or sale of any security.
iii. History
1. Used to be used very aggressively until the 1970’s and 80’s
2. Implied right of action- Private citizens can bring actions
3. DOJ and SEC can also bring actions – criminal vs. civil side
4. Sarbanes-Oxley Act – SOL 2 years after discovery, 5 years after action
5. Jurisdictional Hook
a. Need to use interstate commerce to be caught under the rule
b. Can be exempt from 1933 Act if you meet the requirements
previously discussed, but still have to comply with Rule 55
c. Blue Chip Stamps Case– Only applies to people who purchase or
sell securities
i. Have to actual purchase the stock, otherwise there would
be too many proof issues
B. Rule 14(e)(3) Transactions in Securities on the Basis of Material, Non-Public Information
in the Context of Tender Offers
a. Prohibits, during the course of a tender offer, trading by anybody (other than the bidder)
who has material, non-public information about the offer that he knows (or has reason to
know) was obtained from either the bidder or the target.
C. Insider Trading
a. Elements of an insider trading claim:
i. Material (TSC or Basic)
ii. Non-Public
iii. Duty (Chiarella or O’Hagan)
iv. Breach (primary or derivative)
b. Analysis for a Rule § 10(b)-5 Violation
i. Materiality
1. When determining liability for alleged insider trading, must first
determine whether the information at issue is or was “material”
2. If the event giving rise to the information has already occurred they you
apply the TSC Industries Standard of Materiality
a. Information is material if there is a substantial likelihood that a
reasonable shareholder would consider it important in deciding
how to vote
i. E.g. would it alter a shareholder’s decision in the total mix
of information
ii. The fact that people have bought shares does not prove
materiality. The more shares that have been bought;
however, the more likely that information is material
(persuasive evidence)
3. If the event giving rise to the information is contingent or speculative,
then apply the Basic Standard of Materiality in addition to the TSC
Standard
a. Probability- Likelihood that the event will occur
i. Possible factors:
1. Has the event been pitched to the board?
2. How many times have the directors met to discuss
the event?
3. What was said in discussions
4. Instructions to investment bankers
5. Board resolutions
6. Does this even concern an area that the board has
not previously commented on publicly, but now do
not?
7. What is the proximity (in time) of the trade/pass
to the actual occurrence of the event?
b. Magnitude- Consider the event in the context of the company’s
lifecycle (If this event were to occur, what impact would it have?)
i. The greater the magnitude, the less probability is required
for this to be material (or vice versa)
ii. Non-Public
1. “Effective public disclosure” occurs when the information is fully
available to the market.
2. Potential factors to consider
a. Where: Effective and sufficient enough for the investing public to
understand. Cannot put information in some remote publication
b. When/How long you have to wait: Must abstain from trading until
information is fully available to the public and the public has had
time to fully digest it
i. Timing depends on when the “order to trade” is given.
(e.g. if you give your broker the order to trade one minute
after public disclosure)
iii. Duty
1. Those in possession of material, non-public information have a duty to
either abstain from trading on the information OR to disclose the
information
2. Chiarella Test- Classic Theory
a. You owe a duty to a company if you have a relationship with the
company in which you are trading
i. Examples of a relationship
1. Employee
2. Director
3. Officer
4. Controlling shareholder (not just majority of
shares)
5. Temporarily retained people (e.g. accountants,
lawyers, investors, bankers, etc.)
b. Duty to disclose arises from
i. The existence of a relationship affording access to inside
information intended to be available only for a corporate
purpose and
ii. The unfairness of allowing a corporate insider to take
advantage of the that information by trading without
disclosure
3. O’Hagan Test - Misappropriation Theory
a. If you obtain information in the context of a relationship of trust
and confidence, you owe a duty to abstain from trading or to
disclose to the source of the information on which you trade—
even if it is an outsider
b. Relationship of trust and confidence between the tipper and the
source of the information
i. 10(b)(5)(2)(1): Announces three non-inclusive
relationships that will count as relationships of trust and
confidence
1. Where a person agrees to maintain information in
confidence
a. For 5th Circuit ONLY: There must be
BOTH
i. An explicit/implicit mutual
agreement to keep the information
confidential and
ii. An explicit/implicit mutual
agreement not to trade on that
information
2. When two people have a history, pattern, or
practice of sharing confidential information such
that the recipient of the information knows or
reasonable should have know that the person
communicating the information expects the
recipient will maintain confidentiality
3. A “bright line” rule that states that a duty of trust
and confidence exists when a person receives or
obtains information from spouses, parents,
children, or siblings. Does not create automatic
relationship between unmarried partners, stepparents, or step-children.
iv. Breach
1. Trading on the information without disclosure
a. Rule 10b-5-1
i. Addressed conflicts among courts over whether a person
can be found guilty of insider trading merely by a showing
that the person traded while in knowing possession of
insider information, or whether a showing that the person
actually used such insider information was necessary
ii. The Rule revels that a standard closer to “knowing
possession” rather than use is appropriate
iii. Rule does provide a safe harbor for certain pre-planned
trades
2. Passing the information for a personal benefit
a. Tipper Liability (Secondary)
i. Tipper has a duty to the source of the information and
ii. He intentionally passes the information without
disclosure
1. Benefit can be: financial, reputational, gift
b. Tippee Liability (Derivative Liability)
i. If the tippee trades on information that he knew or
reasonably should have known resulted from a breach of
duty.
c. Analysis for a Rule 14(e)(3) Violationi. Materiality – See above
ii. Non-Public - See above
iii. There is no Duty Prong
iv. Relates to a Tender Offer
1. Broad offer to shareholders to purchase shares
a. Cash offer
b. Public Exchange Offer
v. Breach
1. The breach occurs for traders when they trade and they know or should
have known that they are in possession of information that comes from
the target or the bidder
2. The breach occurs for people who pass where it is reasonable to believe
that they will trade on the information
XI.
The Takeover Movement
A. Development of the Williams Act
a. The Williams Act does essentially do two things
i. It provides for disclosures by the bidder
1. Need not be made or filed in advance by the offer, element of surprise is
preserved
2. Does require that anyone who acquires five percent or more of the stock
of a registered company must disclose the acquisition and notify the issue
within ten days
ii. Provides a set of bidding rules to govern the conduct of tender offers
b. In essence, these rules provide:
i. That there is a minimum period during which a tender offer must remain open
ii. That a tendering shareholder has the right during the offer to withdraw shares
tendered
iii. That all tendering shareholders must receive the highest price paid in the offer
iv. That id the offer is over-subscribed then all shareholders must have their shares
purchase pro rate in proportion to the number of shares they tendered
c. Central idea behind the Williams Act
i. Slow down the process, and give shareholders information about the offer, and
give target management a chance to respond, and
ii. To assure that shareholders would be treated equally and get the highest
possible price
B. Ways of Conducting a Takeover:
a. Proxy Battle/Contest – Election contest with dueling proxy statement and cards that
shareholders can vote on
i. Need to send out “proxy statement” – material information about the candidates
ii. Need to issue a “proxy card,” different than a ballot. Giving another
person/corporation the right to vote on your behalf
iii. Shareholder’s meeting- reality most shareholders are widely dispersed so they
will send out proxy cards
1. Usually the decision has already been made through the proxies
iv. Two Varieties:
1. Full Slate – Elect an entirely new board
a. Anything that a Court could say that is leading up to asking for a
proxy card requires a proxy statement
b. Generally speaking when you are soliciting for proxy cards
insurgents will submit different color cards to differentiate
c. Exceptions
i. Encouraging someone to vote or telling them how you will
vote you do not need to file a proxy statement
ii. If you elicit less than 10 proxy votes then you do not need
to file a proxy statement
2. Short Slate – Elect a subset of the board – has to be a minority of the
board
a. Proxy rules say that the second proxy card in time supersedes any
card that has been submitted
b. “Bona fide nominee rule” cannot vote for a candidate that has not
consented to being on the proxy card
i. Only names that you can vote for are the names that the
insurgent has agreed to challenge. Cannot add extra
people to the insurgent card.
v. Expenses of the insurgent are not paid for by the corporation, but the expenses
for the management are paid for by the corporations
vi. Difference between a proxy vote and a takeover is whether the shareholders
remain the same
vii. Proxy votes have become much more common because of the costs and risks
associates with takeovers
viii. Shareholders have been pushing for proxy access, allow shareholders to push for
candidates to be added to the corporation proxy card
1. Business community is strongly opposed to such access
2. Two rules
a. 14a11- mandates that every public companies allow shareholders
to place candidates on the business proxy card - Stuck down by
DC Circuit
b. 14aa – Revision of old rule –shareholders can get a vote to amend
bylaws to add shareholder access subject to certain conditions
b. Tender Offer
i. Do not need all the shares, only the effective amount of the shares
ii. May strategically decide not to ask for 100 percent to reduce cost
iii. Most takeovers are actually structured as mergers – Parent/bidder creates
subsidiary that buys a portion of the shares of the target
1. Then can merge once you have enough of the shares to approve a merger
with the subsidiary
C. Leveraged Buyouts
a. An LBO involved an aggressor (an existing management, another corporation, or a
corporate raider) who purchased all or most of the outstanding stock of the target for a
substantial premium over market price
b. The acquisition was financed through loans that initially might involve short-term
“mezzanine” or “bridge” loans and the transaction is structured so that the repayment of
this newly created debt ultimately became the obligation of the target corporation
i. In making financial calculations to see how much debt a target can carry, the
standard measure is “EBIT” –net “earning before interest and taxes” – because
the tax obligation is eliminated by the interest deductions for payment on the
new debt
c. In best of all worlds, everyone benefited
d. In the worst, the corporation is unable to carry the load of the new bed and went into
bankruptcy; at that point, the issue became whether the LBO transaction itself could be
attacked as a fraudulent conveyance
D. Takeover Defenses
a. White Knight Defense – target corporation finds someone to compete in bidding and
this particular person or entity favors the incumbent management and agrees to keep
incumbent management post takeover
b. Stalking Horse – target corporation finds someone to compete in bidding solely for the
purpose of increasing the bidding price (“if we’re going out, we might as well get the
highest price for our shares”)
c. Lockup Defense – target corporation makes a promise of an important asset to the
“white knight” or “stalking horse” and guarantees that this asset will become available to
the white knight or stalking horse regardless of whether the management is successful in
defending against the takeover; has two primary effects:
i. Encourages the white knight or stalking horse to participate
ii. Makes the takeover more expensive (b/c whatever debts or obligations the
company has pre-takeover subsequently become the responsibility of the raider
company post-takeover)
d. Scorched Earth Defense – target corporation tries to sell off its best assets (trying to
make the company unattractive); in order to protect itself, target company usually makes
sales contingent upon the takeover actually happening
e. Contractual Provisions Defense – if a company knows it might eventually become the
target of a takeover, it can place certain provisions in its various contracts and
documents that could frustrate takeover efforts
i. Golden Parachutes – large severance packages
ii. Shark Repellants – provision that you put in the articles and bylaws to make
takeovers more difficult
1. Staggered boards
2. Supermajority vote required for mergers
3. Fair price in the second step merger offer
f. “Takeover wars are over”—Poison Pill
i. Stock plan that you issue to your stockholders
ii. ‘Shareholder rights plans” In shareholder agreement, bylaws, or articles
iii. Issue to shareholder a right that they pay a nominal value for with a triggering
event (i.e a takeover activity)
iv. Once a right gets triggered shareholders have a right to purchase additional
shares of the company at some nominal value. Not the insurgents
v. Usually the existing board has the right to redeem the right through negotiation
and deactivate “poison pill”
vi. Ironically, no poison pill has ever been triggered.
1. Takeover company will attempt to negotiate with the board and if they
don’t then they can bring a suit for fiduciary duty violation.
g. Anti-Greenmail Defense – they will buy a bunch of shares like they are going to
takeover but will just ask the company to buy them out
E. New Regulatory Rules in Response to Takeover Era
a. Tender offer can not be on first come first serve, must be pro rata
b. Need to leave it open 20 days
c. Have to file disclosure statement
d. Allow shareholders to withdraw within a certain amount of time
e. Have to offer everyone the same amount
f. Have to hold it open to all holders, cannot offer to one class and not the others
g. Section 14e
i. Regulates how long the offer must remain open
ii. What the target company has to do – board has to send statement to
shareholders discussing the takeover and say that they
1. Recommend
2. Remain neutral
3. Unable to take position
iii. Rule 14e(3) – Takeover equivalent to 10b5 – insider trading
1. Information comes from an insider in the takeover activity
h. NO RULE that you need to treat the bidders fairly, need to do what is in the best interest
of the shareholders
i. State laws involving the takeover movement
i. Prevented takeover entity from changing the board for a certain amount of time
ii. “Non constituency statutes” – give officers the ability to consider other
constituencies and not violate fiduciary duty (i.e. employees, states)
F. Judicial Review of Defensive Tactics
a. A corporation does not have unbridled discretion to defeat any perceived threat by any
means available
b. Fiduciary Duties in the Takeover Context
i. Can boards remain passive in the face of a potential takeover (i.e. – do nothing)?
1. Mixed opinions on whether a board should have to act
a. Some say no b/c there is evidence to suggest that if the board
injects itself into the process, it can get a bidding war going that
will ultimately enhance the value for SHs
b. Some say yes b/c technically, a company can launch and complete
a takeover w/o the board’s consent (and even over the objection
of the board); it is ultimately up to the SHs to decide whether to
take the offer or not
ii. Federal law, however, imposes an obligation to act on boards; they must do one
of three things:
1. Recommend the offer
2. Affirm that it is not taking a position
3. Affirm that it does not have sufficient information to do anything
iii. State law similarly (usually) imposes an obligation to act on boards
1. SHs can bring a breach of fiduciary duty suit against boards for the failure
to act
2. “Unconsidered failure to act is not protected by the BJR.” – Caremark
c. Evaluating the Actions and Fiduciary Obligation of Directors in the Takeover
Context
i. Duty to Preserve the Company
1. Court applies the Unocal test when evaluating defensive actions of the
board taken in order to preserve the corporation
2. Analysis: In order for the board to be allotted the protection of the business
judgment rule,
i. the board must demonstrate that it was responding to a
legitimate threat to corporate policy and effectiveness,
ii. and that its actions were "reasonable in relation to the
threat posed."
1. May consider additional factors such as the impact
on employees or the surrounding area
ii. Duty to Maximize Shareholder Value
1. Despite the board’s best efforts, at some point, the sale AND break-up of a
company becomes inevitable; at this time, the duty of the board changes
from attempting to preserve the corporation to attempting to maximize
SH value; at this point, courts will apply the Revlon standard
2. Revlon rule – at some point when the sale and breakup of the
company becomes inevitable the duty goes from preserving the
corporate enterprise to maximizing the value for shareholders
3. When is the sale AND break-up of a company “inevitable”?
a. When the board is no longer in a defensive posture and the board
makes representations that it is likely going to be sold AND
broken up
i. Pay attention to whether the company manifests just that
it will be sold OR if it will be sold and broken up; if just
that the company is just going to be sold, but not broken
up, likely not in Revlon territory
b. E.g. – If the company brings in a white knight and offers the white
knight a lockup  good indicator that the company will be sold
and broken up (b/c trying to saddle “new” company with debt via
the lockup).
c. E.g. – If the board opens up for bids but fails to put any conditions
on those bids  good indicator that the company will be sold and
broken up