BUSINESS ASSOCIATIONS OUTLINE
 1. INTRODUCTION
 2. AGENCY AND AUTHORITY
o Sole Proprietorship – A business carried on by a single owner
 The owner is legally the business, no separate identity
 No formalities
 You are in charge and do what you want with the business
 Unlimited liability – If the business owes money, you owe money
 Taxation – Profits and losses of the business are those of the owner
 Lifespan is coextensive with the owner
 Either no end to it or you sell the assets of the business
 Technically can’t sell a sole proprietorship because you are it
o Agency - A consensual relationship in which one person acts on behalf of and subject to
the control of another
 Principal – The one who action is taken for
o Elements of an Agency Relation
 Mutual Consent
 Both parties must agree as to the elements of the agency relationship
(formal or informal, express or implied)
 Don’t have to consent to the agency itself
 Manifestation, objective indication of consent
 Action on behalf of another
 Motive is irrelevant, doesn’t matter that they’re doing it for money
 Control
 There’s an element of subservience of the agent to the principal
 Need not be total or continuous, but the principal must be in charge
 No intent requirement, can intend an agency and still not create one
o Five types of authority
 Actual, Apparent, Agency by estoppel, Inherent agency power, Ratification
o Actual Authority
 Authority – The power of the agent to affect the legal relations of the principal
by transactions with third parties
 The agent can bind the principal in contract, but limited to the scope of the
authority
 Central issue, based on the principal’s objective desires
o Though they can do what is reasonably inferred in light of the
principal’s manifestations
 Creation – Principal’s manifestations of consent to agent has to be reasonably
interpreted and cause actual belief
 Objective and subjective
 Express (specifying exactly what the agent is to do) or implied (most
authority created this way, assuming what actions to take)
 Incidental Authority – Actual authority includes authority to do acts which are
incidental to it, still considered actual authority
 Acts which usually accompany or are reasonably necessary
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Section 118 – Both principal and agent have the power to terminate actual
authority at will
 Though, even with the power, they may not have the right
o Apparent Authority (Section 8)
 If manifestations of the principal to a third party (or those by the agent to a third
party that the principal authorized) would lead a reasonable person in T’s
position to believe that the principal had authorized the agent to so act
 Power to affect the legal relations of the principle, but professedly as agent
 Key element is the principal’s manifestations to the third party
 Examples of apparent authority as opposed to actual
 Accidents – Let someone use my stationary
 A lie – To avoid a problem or other reason
 Changed circumstances or uncorrected statements – Told one person he’s
the agent and then fired the agent
 Creation – Principal’s manifestations of consent to a third party
 Agents are always authorized to describe their authority truthfully
o Agency by Estoppel
 3 Elements:
 1. Belief in the agency relation (3rd party has to believe in it)
 2. Reliance by the 3rd party, a change of their position
 3. It’s the fault of the principal
 Very similar to apparent authority, generally subsumed under it
o Inherent Agency Power
 Section 161 – A disclosed or partially disclosed principal is liable for an act done
on his behalf by a general agent, even if the principal had forbidden the act, if:
 (i) The act usually accompanies or is incidentals to acts the agent is
authorized to conduct, and
 (ii) The third party reasonably believes the agent is authorized to do the
act
 It’s not very clear what it is, it’s not authority, apparent, estoppel
 Can think of it as a separate theory of authority, but have to have agency
power to have inherent agency power
 Generally, first ask if there is actual authority, then move to apparent, then
agency by estoppel, and if none of those, then inherent agency
 In a situation where a third party is harmed by an agent without another kind of
authority can deal with it in 3 ways
 1. Create a new rule – Secret Instructions to the agent
o Because they were secret, the principal is still bound
o Probably not the best way to deal with all problems, we’ll have lots
of rules
 2. Can stretch the rules to include more
o Stretch apparent authority or agency by estoppel
o Happens from time to time too
 3. Create a new category
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o Think of it more as a stop-gap measure when the other rules don’t
make sense
 Always go to it last, there is no clear “this is inherent
agency”
o Ratification (Section 82)
 The affirmance by a person of a prior act which did not bind him but which was
done or professedly done on his account, whereby the act, as to some or all
persons, is given effect as if originally authorized by him
 Elements – Need both
 1. Professedly done on “principal’s” account
o Agent says it was done on his account
 2. Affirmance by principal
o Manifestation of an intention to treat it as authorized
o OR engages in conduct justifiable only with an intention
 Go pick up car instead of saying it’s not his and agent had
no power
 Ratification is not the same as acquiescence
 Acquiescence (R2 43) – If the agent performs a series of similar acts
without the principal objecting, it’s an indication that he consents to the
performance of similar acts in the future
o Acquiescence gives rise to actual authority
o Spectrum of Agency
 General/Special
 General agent – When a principal authorizes an agent to conduct a series
of transactions involving a continuity of service
 Special agent – Agent authorized to conduct a single transaction or a series
of transactions not involving continuity of service
 Master/Servant
 Master (principal or employer) – Principal has control over the physical
conduct of the agent in the performance of the service
o Has control or the right to control “the manner and means of the
agent’s performance” (R3)
o Servant (agent or employee)
o Agent has caused physical injury to a person or property
 Affects the extent of vicarious liability – The master is liable for torts of
the servant within the scope of employment
o Respondeat superior
o Whether the ER should be held liable for this tort, it’s a policy
question
 Matter of fairness between the ER and 3rd party
o Regardless of whether the master authorized it, or even forbade the
act
o Ex; ER liable for bouncer beating someone up because force was
within the scope of liability
o Ex; ER probably not liable for taxi driver’s accident while using the
car for recreation, not within the scope
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Some factors to consider, none are necessary in making the determination
if someone is a servant:
o Extent of control the principal may exercise
o Whether it’s a distinct occupation or regular business of the ER
o Whether the EE or ER supplies the tools and location
o Duration – duration or special agent
o Method of payment, by the hour or for the job
 Independent Contractor
 Can be an agent or non-agent
o Not an agent if they can’t act for the P, they’re just doing the
assigned job
 P is liable if it’s an agent
o Is an agent if in terms of doing the assigned job, have more leeway
 Basic element is control
o To be an agent, P must have some control, but not as much as a
master/servant – it’s this if you don’t have enough control to be
master/servant
o This matters because of the extent of vicarious liability
 “Stranger”
 Ex; Hiring someone to update a bathroom at home and only telling him
the product not how to do it, independent contractor
o Handyman then hires someone to give orders to, to help him, likely
will be a servant
 If a plumber hires an electrician, it’s an independent
contractor agent because he’ll have some control over his
actions, but less than of a servant
o Handyman then goes to Lowe’s – the relationship there is stranger,
there is no relation
o Non-agent
o Principal’s Status – Who’s liable on a contract between A and third party?
 Disclosed – When an agent and third party interact, the principal’s existence and
identity are known to the third party
 Easy and typical case – P is liable, A is not, 3rd party is liable
 Partially-disclosed – A principal whose existence is known to the third party, but
not his identity
 Third party is accepting some risk by not knowing the identity
 P is liable (unless the third party is not liable)
 A is liable (default rule) to third party unless A and the third party agree
that A will not be liable
 Third party is liable (unless P is excluded from the contract)
o Except, third party is not liable if the agent or the principal knew
that the third party would not have dealt with the principal had his
identity been known
 Undisclosed – Existence and identity are both unknown
 P is still liable, A is liable, third party is liable unless P is excluded
o Morris Oil Co. v. Rainbow Oilfield Trucking
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Was Rainbow Dawn’s agent when it incurred debt from Morris?
First go through the elements to determine if there was agency
 1. Mutual consent – Yes
 2. Acting on behalf of another – Tricky in this case, might look like
independent contractors
o But by lending their certificate to Rainbow, Dawn cannot use it, and
so Rainbow is acting on Dawn’s behalf legally
 3. Control – The ability to terminate a relationship that someone else
needs is an element of control
o Also, contractually Dawn had complete control over operations
 Argument against agency relationship
 1. Not acting on behalf of Dawn, really just circumventing the law
 2. The contract expressly says R is not the agent of D
o This isn’t controlling, the intent of parties does not matter
 Actual authority – Would have to have been a secret instruction because Morris
wasn’t aware of the agency
 Apparent Authority – No because no representation to a 3rd party
 Estoppel – No, 3rd party didn’t know there was agency
 Ratification – Saying it was professedly done on the P’s account would be
stretching it, but don’t necessarily need ratification here anyway
 3. FIDUCIARY DUTIES OF AGENTS
o Fiduciary – A relationship of special trust and confidence marked by utmost good faith
and loyalty
 An agent is a fiduciary only in respect to matters regarding the scope of agency
o 3 types of fiduciary duties:
 1. Contractual duties – A has a duty to act in accordance with promise
 2. Duty of care – Have to do it carefully, properly, with due care
 Not infinite care, but the appropriate amount
 R2 379 – Distinguishes between paid and gratuitous agents
o Paid – There’s a minimum, the skill which is standard for the
locality for that kind of work and any special skill they have
 Min objective level + your potential
 Higher min level you expect of them when paid
o Gratuitous – Lower standard (reliance), can’t make anyone worse
off
 Just someone doing you a favor, so you can’t expect that
much of them
 3. Duty of loyalty – Act solely for the benefit of the P in matters connected with
the agency, cannot act for your interests or someone else’s
 1.) Accounting for profits (R2 388) – Agent who makes a profit in
connection with agency must give such profits to P
o Big exception is if it’s customary, tips can be kept
 2.) Non-competition (R2 393) – A can’t compete concerning subject
matter of agency
 3.) No conflicting interests
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4.) Confidentiality – A can’t use any of the information he receives
confidentially for the detriment of P or the benefit of A (very broad, even
if the secret doesn’t relate to your job)
o Can only be used for the benefit of P, even after termination
Tarnowski v. Resop – P hired the D to be his agent to look into music machines, D does
only a superficial investigation and gives P false information while also taking a
commission from the third party
 He’s suing for the profit his agent made and damages incurred for suing the
seller
 Accounting for profits - P is entitled to the secret commission (very strict rule)
 There’s a good chance the agent’s profits lessened the principal’s profits,
but it’s a bright line rule and counts even if his actions didn’t hurt the P
 Damages – (R2 407(1)) P is entitled to secret profits plus damages, even though
he already won a judgment from the seller
 Usually in business we’re not trying to make the P better off, just not
worse than before
 This isn’t necessarily a double recovery – you can’t get a thing plus its
value, but you can get recover for 2 things
o There are things you can get in a fiduciary duty setting that you
can’t get in a contractual setting
Reading v. Attorney General – Sergeant wears his uniform while delivering alcohol in a
truck so as not to be stopped and owes that money to the Crown
 Accounting for profit – He should have to turn over the secret profit
 It was probably his role as a soldier that got him the job
 P gets to keep the money here, but in other cases why should the P and not the
government keep the money?
 Probably in large part convenience
 It also encourages litigation because otherwise people wouldn’t pursue
claims if the government is getting the money
Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure
(Jensen & Meckling)
 It is generally impossible for the P or the A at zero cost to ensure that the A will
make optimal decisions from the P’s viewpoint
 Agency cost is the sum of:
o 1. Monitoring expenditures by P
o 2. Bonding expenditures by A
o 3. Residual loss (Cost of the divergence between the A’s decisions
and those that would be the best for the P)
General Automotive Mfg. Co. v. Singer – D is liable to P under accounting for profits
because he was running his own secret business on the side while working as the
manager of Automotive
 He violated his fiduciary duties of good faith and loyalty because he didn’t
disclose the information or turn away the business he was keeping for himself,
even if it didn’t harm P
 He wasn’t acting for the sole benefit of the P
 This is a VERY strict law
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o Bancroft-Whitney v. Glen – D is president of the company, decides to leave and work
for a rival, but recruits a number of current employees to go with him by using
company information to offer higher salaries
 Glen’s duty: “the most scrupulous observance of his duty, not only affirmatively
to protect the interests of the corporation committed to his charge, but also to
refrain from doing anything that would work injury to the corporation…”
 Glen’s actions
 He helped raid the company and lied about it to them
 Disclosed salary information
 Encouraged postponing salary raises there
 Even though they are all at will EEs and can leave any time, Glen can’t harm or
damage the company by helping a competitor raid the company
 He went beyond and took them
 Even if he had disclosed it, he may still be in trouble
 Disclosure is not enough, your actions in fact must be loyal
 Regarding his duties to the second company, he owes full loyalty to both
 If you can’t satisfy both, that’s his problem, the law isn’t going to give
him a way out
o The solution is not to put yourself in positions of conflicting duties
(temporal issue – don’t put yourself in that position)
 A competitor cannot enlist someone to violate his fiduciary duty
 Bender is the competitor, so he has no fiduciary duty to Bancroft, but Glen
was Bender’s agent in violating Glen’s fiduciary duty
 Because he asked Glen to do something that violated his fiduciary duty, he
is also liable
 He received benefits of Glen’s infidelity
 4. INTRODUCTION TO PARTNERSHIPS
o Partnership – An association of two or more persons to carry on as co-owners a
business for profit
 2 main bodies of law
 Uniform Partnership Act
 Revised Uniform Partnership Act (revised in a majority of states)
 No formalities – you can become a partnership accidentally or unintentionally
 RUPA allows you to file your partnership but doesn’t require it
 UPA says a partnership is not different from partners
o Under RUPA it’s a separate entity
 Control – joint ownership and management, both have ultimate control and
managerial decisions
 Partners can alter rights by agreement but not necessarily their powers
 Liability – unlimited plus
 Each partner is liable for anything they do and anything other partners do,
joint and several liability for business obligations
 Partners can alter their own rights and liabilities among themselves, but
they are still going to be liable to 3rd parties
 Taxation – Profits and losses of the partnership are those of the partners
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 Direct taxation, pass-through
 Lifespan – at the will of the partners and for the life of the partners
 If any partner dies or decides to end the partnership, then it can end
 UPA: a change in partner membership creates a whole new partnership
 RUPA: not the case anymore, but not that much of a difference
 Exit – A partner has the power to exit at any time, but not necessarily the right
(may be liable for the exit)
o Partnership Formation
 Statutory elements (RUPA 202(a)) – Test for every case
 A consensual association – But the law will determine if that’s a
partnership, not you (you don’t have to intend to form it)
 To carry on as co-owners – Not enough to co-own property or share
revenues
 Business for profit – Doesn’t mean you have to be profitable, just that you
are trying
 Sometimes when there is no express agreement, courts use another test for
implicit agreements (case law elements)
 An agreement to share profits
 Agreement to share loses
 Mutual right of control or management
 A community of interest in the venture (not clear what this really is)
 (These aspects aren’t always good tests, real test should be statutory
elements)
o Partnership by Estoppel
 RUPA 308 – Partnership by estoppel, similar to agency by estoppel, but not the
same
 Not really partners, but you’ll be liable as if you were
 Elements:
 1. Manifestation that suggests a partnership – Somehow presented as a
partner, either by saying so or allowing someone to say so
 2. Reliance – Someone enters into a transaction based on this
manifestation
o If there’s a public/commercial manifestation, then there doesn’t
need to be reliance
 Ex; Young v. Jones – Firm allows a group in the Bahamas to
use its name and then publicly calls itself a global firm
 Even though there is no real partnership, there is a
public manifestation of partnership, so reliance is not
necessary and a court would generally find
partnership by estoppel
 Liability:
 They’re liable if manifestation is authorized by all partners
o If ABC are partners and they allow Z to present himself as a
partner, then the partnership is liable
 For a purported partner, liable as a partner if partnership is liable
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o Otherwise, with consenting purported partners
 If there is no partnership or if there is one but not every partner approved,
the partner who didn’t consent won’t be liable and it will make the
consenting people (both purported partner and partner that consents) liable
o Creates a virtual partnership between the purported partner and
consenting partner
o Property Rights in a Partnership
 Partnership property – What you’re putting into the partnership
 UPA – Tenancy in partnership
o Partners have the right to possess partnership property for
partnership purposes, but for nothing else, no personal reasons
 RUPA – Partners have no interest in the property
o The partnership owns it, but partners can still use it for partnership
reasons
o Not the same, but very similar
 Real issue; Is it partnership property or is it partner’s property being lent
to the partnership?
 Interest in the partnership (RUPA 502)
 Partners own an interest in the partnership
o They can sell (assign) this, but nothing else regarding the
partnership, not property or the partnership itself
 Interest – A share in profits and losses and a right to share in the
distribution
 Assignment doesn’t affect partnership (all you’re selling is the right to
cash flows)
o Typically it only includes the profits, not the losses
o Can alter the rights to the partnership, but not the obligations
 Still liable, even if you assign your interest to someone
 If a partner assigns his interest and the rest don’t, they have options:
o UPA – Non-assigning partners can dissolve the partnership (even if
they normally wouldn’t have the right to)
 Protects the remaining partners if that other partner decides
to no longer work hard since they are no longer making a
profit
o RUPA – Non-assigning partners can expel that partner
o Creditors
 Old rule – Dual Priorities UPA 36(4), (70-71)
 Partnership creditors (creditors of the partnership) have priority in getting
paid out of partnership assets
 Personal creditors (creditors of a partner) have priority in getting paid out
of personal wealth, individual assets of partners
 Then if debts to partnership creditors remain unpaid after partnership
assets are exhausted, they reconcile the difference with partnership
individual assets (Bankruptcy Code allows for this change)
 New Rule – Partnership creditors first
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It’s a separate entity, so it must first pay off it’s debts before it gives any
back to partners
 If there’s not enough money in the partnership to take care of the debts,
then the partners have to personally cover it
o Capital Accounts
 Capital Account – An account on a partnership’s balance sheet representing a
partner’s share of the partnership capital (or equity)
 Capital Account = (Contributions that partners put into the business +
profits) – distributions (what the partnership pays out to partners)
 Indemnification and Contribution
 Indemnification – Reimbursement of a loss or expense incurred by another
 Contribution – The right of a person who pays a debt to recover
proportionally from others who are also liable on the debt
 A partner has the right to be indemnified by the partnership and the
partnership can seek contribution from partners
o Martin v. Peyton – Plaintiffs claim the Ds became partners with them, the firm they
were lending money to
 Ps claim they were not partners, and their interests in profits should be construed
as a measure of compensation for loans, not an interest in profits
 Question is whether they agreed to associate themselves with the firm as
to “carry on as co-owners of a business for profit”
 Argument they are partners
 Share in profits (a big one, makes you look like partners)
 They consented to the relationship, whatever that might be
 The lenders had a lot of control – the right to veto, all access to books,
fixed the amount partners could draw, demanded resignation of partners in
case they wanted to fire and of them
 The right to become partners later on
 Argument they were not partners
 Their control was still limited, they didn’t have the power to initiate
transactions on behalf of the partnership
 Maybe the profit sharing is just to repay the loan
o It’s ok to secure a loan
 They say they were trying not to be partners
 Weighing the elements
 Consensual relationship – Yes
 Business for profit – Yes
 Carrying on as co-owners – Maybe, option to become partners later
suggests partnership
 In the aggregate, this court says it did not create a partnership, but another court
might decide differently
o Lupien v. Malsbenden – P, Lupien, contracted with Cragen and York Motor Mart for
the construction of a Bradley car kit and sues D, Malsbenden, when the contract is
breached, holding him to partnership liability – Court for P
 D claims he was not a partner in York Motor Mart and isn’t liable
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To make the case for partnership:
 The loan D makes was made without interest (not unheard of, but this
doesn’t sound like a loan, it sounds like an investment)
 D had the right to participate in control of the business and did so
frequently, he was there more often than Cragen
 Association, business for profit, carrying on as co-owners
 All suggest partnership
 He may just not have wanted the liability, but here he’s gone too far to say
that it’s just a loan and not partnership
o He was taking an active role in a way that pure lender don’t
o Rappoport v. 55 Perry Co. – Question is whether an agreement between two families
allowed one to make their children partners without the others’ consent
 Provision under review said consent was required for certain actions, except in
regard to their children
 Plaintiffs argue it referred to making children partners
 Defendants argue it only referred to making assignments, transferring
profits
 Partnership Law – No person can become a member of a partnership without the
consent of all the partners (§40)
 In the absence of an agreement, they can sell/assign their interest in the
partnership without agreement, so since they can already do this, does it
make sense that they would specifically provide for it for their children?
o Probably not, but it doesn’t perfectly track partnership law either
 Ds may have wanted to prevent assignment to anyone but children
because you might not have the same motivation if you give away your
profits
o You can still agree to give the profits to someone, even if you can’t
assign your interest
 They can’t prevent you from doing what you want with
money
 Court holds that consent was required
 5. RIGHTS AND DUTIES OF PARTNERS
o Rights of Partners
 RUPA §103 – A list of default rules for when the partnership hasn’t spelled it out
 Equal share in profits (and losses)
 Equal rights in management (right to participation)
 Right to information
 Right to consent to addition of partners
 No right to salary
 Actual authority of partners – Default rule under the UPA is that each partner is
an agent of the partnership for the purpose of its business
 Apparent authority – Authority to bind for apparently carrying on in the usual
way the business of the partnership of which he is a member
 Ambiguous under UPA, but under RUPA, clear that the apparent course of
business means the partnership business OR business of the kind carried
on by the partnership
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Third parties – Under RUPA, it is changed so that third parties require actual
knowledge or a receipt of notification of a partner’s lack of authority to prevent
partnership liability
 You can also change the agreement of rights among partners, but it won’t
necessarily apply to third parties
o Management of Partnership
 Every partner is an agent of the partnership
 Acts for apparently carrying on business in ordinary course are binding
o Unless third party has notice that partner lacks authority
 Acts not for apparently carrying on business in ordinary course are not
binding
o Unless acts are authorized, then they're binding
 Partnership liable for wrongful acts in ordinary course of business
 Differences in ordinary course of business may be decided by majority (50%
plus one)
 Every partner has an equal vote
 Other differences require unanimous consent
 Tension between these rules – Partnership is supposed to agree
o Obligations of Partners
 Under UPA, a partnership is not recognized as an entity and suit cannot normally
be brought against an association that is not an entity
 Partners have joint and several liability for wrongful acts and omissions of
the partnership
o But for other obligations, they are jointly liable, so an action on a
contractual obligation must be brought against all the partners
 Many states have statutorily patched up this rule
o Many adopt a Common Name Statute, which allows a partnership
to be sued in its own name
 Under RUPA, a partnership may sue and be sued in its own name
 Still joint and severally liable, but new barrier to collecting against an
individual partner
o A suit against a partner based on a claim against the partnership,
partnership assets must be exhausted before an individual’s assets
can be reached
 Partners have fiduciary duties to each other
 Duty of care
o Refrain from grossly negligent or intentional misconduct
 Duty of loyalty
 Concept of good faith and fair dealing
o Obligation as opposed to fiduciary duty
 They still exist, but RUPA seems to be limiting fiduciary duties
 Duty of loyalty and care set forth in RUPA (both limited, narrowed the
scope in RUPA)
o Differences between partners settled by majority is mandatory
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Summers v. Dooley – One partner sues the other after the first hires an EE and
his partner refuses to reimburse him because he never agreed to hire him; Court
for D
 P claims his partner received profits and benefitted from the third man’s
labor and should be estopped from denying the need of the EE
 Court denies him relief, saying he needed a majority to hire him
o “Any difference arising as to ordinary matters connected with the
partnership business may be decided by a majority of the partners”
(UPA § 53-318(8))
 Court holds this language mandatory rather than permissive
o But the other partner doesn't have a majority either, only two
 Not entirely satisfying
 Court says it’s unfair to make the other partner pay the EE when it was for
the sole benefit of one partner
o Not a fair statement since he incurred the expense for the benefit of
the partnership
 Sanchez v. Saylor – (In line with Summers) Two partners, one refuses to give his
personal financial information to a third party considering lending the
partnership money, the other partner sues for breach of fiduciary obligations
 Court holds for the D – Neither partner has the right to impose his will on
the other, differences regarding ordinary matters require a majority
o Cites Covalt v. High that in the absence of an enforceable
agreement covering disagreements in the partnership, it is
dissolution, not an action for breach of fiduciary duty that is the
appropriate avenue
o Differences between partners are subject to the partnership agreement
 National Biscuit – Holds that differences MAY be settled by majority, subject to
any agreement between them which can be implied based on a course of conduct
 Look to default rules – every partner has equal rights in management
o If they didn't take away authority by majority vote, they have the
authority
 Sounds more technically correct, but there seems to be logic in Summers
 Not always going to be easy to say what is an affirmative step, when you need
majority
 In many cases that won't be a very satisfying rule
 Some states follow one or the other of these two
o Conflict of laws or choice of law – Law governing the internal affairs of organizations
to decide which state’s laws apply
 Corporations, LLP, and limited liability companies
 The general choice of law rule is the state where the corporation is
incorporated or where it’s organized
 General partnership
 Requires no filing of organizational documents, so, under RUPA, it’s the
law of the state where the partnership has its chief executive office
o Authority of a Partner
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
RNR Investments Limited Partnership v. Peoples First Community Bank – RNR
had a provision limiting the general partner’s spending and when they defaulted
on a loan, they claim the bank failed to review the limitations in the limited
partnership agreement and was estopped from foreclosing
 The partner who got the loan did not have actual authority to make it, but
he did have apparent authority
o His action could be considered in the ordinary course of business
o Third party didn't have notice of the lack of authority
 Argument they had notice – They were given the partnership agreement,
but it doesn't list the exact amount of the loan he could get for them
o No way of knowing the amount wasn't authorized, only provisions
by which they may have deduced that there was a limit
 This doesn't count as notice
o It has to be actual knowledge or notice that there is a problem, not
facts from which you could decide there was a problem
o Liability for Partnership Obligations
 Davis v. Loftus – Question is whether partners in a firm called “income partners”
are considered partners in the suit under partnership law
 Court says “income partners” are not partners under UPA
 Look to the elements:
o Mutual consent: Yes
o Business for profit: Yes
o Carrying on as co-owners: Not really, they don't share in profits and
losses
 They receive a fixed salary plus a bonus
 No right to vote on management or conduct
 Argument they should
o They were given bonuses, could be seen as share in profits
o Titled income partners
o Maybe control isn't as important as we think, even though they have
no control it's not a big deal
o Community of interest, arguably everyone has that
o Sharing of losses, can argue that's a question of law, if we decide
it's a partnership, we'll say they do have to share losses
 Hobo Bob and Bill Gates have to share losses if the court
says they're a partnership, even if Gates tries to make Bob
pay all the liabilities
o The Partner’s Duty of Loyalty
 Meinhard v. Salmon – Two partners in a joint venture for 20 years for building
on a leased property, then when one gets an opportunity to extend the lease, he
leaves the other out, who then sues
 Joint ventures, like copartners, owe the duty of finest loyalty
 Can argue he shouldn't be keeping secrets from his partner
o He was the managing partner and this was related to the business
o He couldn't have known about this project unless he told him, can't
have that unfair advantage over the other
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
Argue the other way that he maybe shouldn't have to share because he did
all the work, made it all possible and Meinhard had already been well paid
o Their agreement was also up
 Was this in the scope of the partnership?
o Pretty close, but it was during the partnership he decided to extend
the lease, so maybe it counts
o When is close enough will be a factual question
 Court says at least he should have told him, given him the opportunity
 Ex ante, Salmon probably wouldn't have wanted to bind himself
o Almost certainly they wouldn't have come to the court’s agreement
 Latta v. Kilbourn – One partner cannot, directly or indirectly, use partnership
assets for his own benefit, he cannot in conducting the business of a partnership,
take any profit clandestinely for himself
o Suits by a Partner Against a Partnership
 Suit for an accounting (UPA §22) – When a partner is wrongfully excluded from
business, if the right is granted under the partnership agreement, for
appropriation of an unauthorized benefit, or whenever else it is reasonable
 They are rare and usually indicate mistrust, so dissolution is often more
appropriate
 UPA §13 – Interpreted not to authorize a suit by a partner against a partnership,
so courts often limit remedies to an accounting or dissolution
 Weak justification that practical difficulties don’t allow for other suits, so
there are exceptions to it
 RUPA §305 – Changes it to permit a partner to sue the partnership during the
partnership, rather than just dissolution and accounting
o Bane v. Ferguson – Whether a retired partner has a claim against the firm for acts of
negligence that caused the firm to terminate his retirement benefits, duty of care
 Court holds that he is no longer a partner and is owed no fiduciary duties
 Even if he was still a partner, he probably wouldn’t get anything
 Their plan just didn’t work out and making a bad decision is not the kind of thing
you can sue for under the duty of care
 Meinhard Court might have dealt with this differently, but that was duty of
loyalty, which courts are much more stringent with
 Possible selfishness or betrayal type duties, they’re stricter
 Could potentially turn it into a duty of loyalty issue
 Trying to extend the life of the partnership, like they did in Meinhard
 Arguing that the partners making business decisions were being carefree
because they had a different risk profile and it didn’t matter as much to
them if things went awry
 This wouldn’t work but many times people will try to change duty of care
into duty of loyalty
 6. PARTNERSHIP DISSOLUTION
o Ending a Partnership
 UPA: three stages
 Dissolution – someone leaves the partnership
o Dissociation of any partner triggers dissolution
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
Winding up – process of settling partnership affairs after dissociation
o Ex; Manufacturing widgets, have to complete the existing contracts
for widgets, finish existing business
 Termination – the end of the partnership
o After dissolution the partnership is really continued until the
termination
 RUPA: Adds dissociation
 Dissolution – The beginning of the end of the partnership
 Dissociation – The change in the relation of the partners caused by any
partner ceasing to be associated with the partnership
o What was formally known as dissolution is now dissociation
o Dissociation may or may not lead to a dissolution
 RUPA §801 default rule: partnership continues, dissociation doesn’t end it
unless one of the events in §801 occurs
o Under UPA, the partnership came to an end
 But there are major exceptions and the differences between
UPA and RUPA are not all that great
o RUPA moves to an entity theory to prevent a technical dissociation
 In every dissociation
o Either the partnership is dissolved and wound up
o OR dissociating partners interest is purchased
o These are kind of the same thing
o Causes of Dissociation (RUPA §601)
 Each partner always has the power to dissociate at any time
 But they don’t necessarily have the right to do it
o They have it in an at-will partnership, not for a term
 As per partnership agreement by a specified event
 By unanimous agreement of the other partners if the partner has assigned her
interest in the partnership
 Judicial decree from misconduct
 If a partner’s actions adversely and materially affect the business you can
go to court and ask for a dissociation (beyond simple misconduct)
o Willful and persistent material breach of agreement or duties or
something that makes it not reasonably practicable to continue with
partnership
 Certain bankruptcy events
 Bankruptcy is a cause because that partner can’t pay their own weight
 Death or incapacity
 Incapacity could by physical, mental or emotional, but it has to be serious
o Wrongful Dissociation (RUPA §602)
 In breach of an express provision of partnership agreement
 Before the expiration of a term
 Judicial decree that kicks you out, still wrongful if you didn’t want to
 Bankruptcy
 Death or incapacity is not
 Some culpability associated with these, death isn’t your fault
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o Causes of Dissolution (RUPA §801) (old rules - UPA §31)
 Partnership at will is an exception, dissolution follows dissociation (unless
agreement says otherwise) (WHY?)
 By agreement of partners
 An expiration of a term
 Illegality, if the partnership becomes illegal
 Judicial decree of impracticability
 Judicial decree to protect transferee
 If a partner transfers his interest, the transferee can obtain judicial
dissolution if it is equitable after the end of the partnership term
 Court would try to avoid that as much as possible
o Effect of Dissociation
 Dissociated partner or partners are no longer members
 Authority – No longer have actual authority
o But they may still have apparent authority
o RUPA §702 – partnership is liable to third parties for actions of a
dissociated partner for 2 years, if the third party reasonably believed
he was still a partner
 The dissociated partner is then liable to the partnership
 Liability – for actions before you left, no liability for new obligations
o §703(a) for preexisting before dissociation
o §806 liable for winding up obligations
o §703(b) creates a 2 year window for the protection of innocents
 For the protection of other partners who reasonably believe
the dissociated partner is still a partner, you are still liable
 Dissolution process: Wind Up (UPA §30)
 Sell assets – Have to sell everything
o Historically, this meant you have to sell everything separately
o But could sell everything as a package, so even though your
dissolving, the partnership is coming to an end, the business is not
coming to an end
o Liquidation value – value of a business if its assets are sold
individually
o Going Concern Value – value of a business if its assets are sold
together, as a business
 Usually higher than a liquidation value
 Courts have hated dissolution because they thought it led to
liquidation value, but it could lead to going concern value
 Pay off creditors, defined as liabilities (including partners) (UPA §40)
o 1. Pay off creditors other than partners
o 2. Pay off partners for obligations other than capital or profits
 Ex; a loan a partner made to the partnership
o 3. Pay off partners in respect of capital
o 4. Pay off partners in respect of profits
 Distribute net proceeds
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o Farnsworth v. Deaver – Regarding distributions in dissolutions
(UPA §40(b)) (84)
 Court: partners must contribute towards the losses sustained
by the partnership according to their share in the profits
 Alternative is a buy-out (RUPA §701(b))
 If a partner’s dissociation doesn’t result in dissolution, the default rule is
that the dissociated partner must be bought out
 The buyout price is the amount that would have been distributable to the
dissociating partner if, on the date of dissociation, the assets of the
partnership were sold at a price equal to the greater of the liquidation
value or the value based on a sale of the entire business
o Not theoretically that different from the whole thing dissolving
 One reason not to have an actual dissolution is transaction costs
o Not that easy to put together a sale of the business and it might not
be that easy to find a buyer
o Winner’s curse – The fact that the winner of an auction is likely to
overpay and thus have regret
 Have to be willing to bid more than the people who know
the business, since partners inside will likely be bidding
 Problem of a virtual dissolution is that the price is going to be someone’s
guess unless we really try to sell it
 Dissolution or buyout, but in the end, it’s the same thing in some ways
o But in neither case is the business necessarily destroyed
 Consequences of Wrongful Dissociation:
 701(c) damages under 602(b) must be offset against the buyout date
 701(h) deferred payment until the expiration of the term or completion of
undertaking (Still get to earn interest)
 Under the UPA it said the buyout amount would not earn good will
o Goodwill – The value of a business’s reputation and other
intangible assets; essentially, the difference between a company’s
asset value and going concern value
 RUPA rejects this unless the partnership’s goodwill is
damaged by the wrongful dissociation
 803(a) no right to participate in winding up
o You’re at their mercy, they get to complete the business and you’re
still liable for what they do
o This is pretty important
o Girard Bank v. Haley – A partner in an at-will UPA partnership sent a letter that said
she was terminating the partnership
 Court held that under §31 of the UPA, dissolution is caused “by the express will
of any partner” and did not need a justification
o Creel v. Lilly – Partnership of a retail business between 3, one dies and the other two
wind up the business by assessing his value in the partnership, buying out the wife of
the third partner, and continuing the business
 Wife sues because she wanted actual liquidation
 She is not entitled to it because winding up doesn’t always mean liquidate
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
Historically, the estate had the right to compel liquidation, but many courts
viewed this as a harsh measure and adopted judicial alternatives that were similar
to RUPA
o Disotell v. Stiltner (Supplement, 6) – Although the statute would seem to be in favor of
liquidation, this court, like Creel, holds that it does not (basically ignoring UPA)
 A buyout can reduce economic waste and their effort to avoid further loss to the
partners justifies the buyout
 They basically apply the RUPA rule to the UPA, saying others have done so
o McCormick v. Brevig – Brother and sister in a partnership, she claimed he had engaged
in conduct warranting a decree of expulsion and wants liquidation, he wants a buyout
 Distinguishes the facts from Creel and holds that when a dissolution is court
ordered, partnership assets must be reduced to cash in order to satisfy obligations
of the partnership and distribute any net surplus to the remaining partners
o Some reasons for wanting to require liquidation
 Spite or wife not being able to stand the idea of her husband’s business carrying
on without him
 Might not trust the appraisal, or being bought out and want an auction tell us
what the real value is
o Page v. Page – Two brother in a linen business, one wants declaratory judgment to
make them dissolve it to make sure that he doesn’t get declared a wrongful dissolution
 Trial court said it was a partnership for a term – a reasonable time to enable the
partnership to pay off its debt
 Court holds it’s a partnership at will and he can dissolve
 The other brother really just had a hope that they would pay off all the
loses, but that doesn’t make it a partnership for a term
 Other brother claims that it’s finally profitable and he wants to dissolve so that
he can open his own business, not sharing profits
 Court let’s him dissolve the partnership, but warns him that if he does
open his own business it would be a breach and he would be liable
 Expulsion of a Partner
o Winston & Strawn v. Nosal – P is expelled from a law firm following his request for
partnership information and his threat to sue if his request was not granted
 Company seeks declaratory judgment that the expulsion was valid – Denied
 They can expel a partner for just about any reason or no reason
o The problem is that he was trying to uncover records from the firm
that he was allowed in his position
 He thought they were increasing their own shares while decreasing others
 They’re allowed to do that but they cannot do it without the full awareness
of the remaining capital partners
 They’re trying to protect themselves by denying him the information
 Partners owe one another the duty of good faith and fair dealing
 No particular set of standards for this, not easy to pin down
o Crutcher v. Smith – They tried to say his minor wrongful acts caused a dissolution
 Court holds for his argument that the other partners took definitive steps to
exclude him from the partnership and stripped his rights as a partner
 He was wrongfully expelled from the partnership
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 7. LIMITED PARTNERSHIPS
o Shortcomings
 Sole proprietorship
 Very limited funding
 Unlimited liability – you can lose everything
 Partnerships
 Too many managers – Can theoretically have unlimited people managing
 Limited funding – only amount the individual partners can bring to bear
 Unlimited liability plus – your liability plus other partners
o Limited Partnership
 Limited Partnership (RULPA §101) – A partnership formed by two or more
persons with two types of members; general and limited partners
 Two classes of partners
 General partner – partner with a right to manage the business and with
unlimited liability
 Limited partner – without the right to manage the business and with
limited liability
o Under RULPA§302 can provide for certain voting rights
o Limited liability – the legal limitation of an investor’s liability to her
investment in the business, such that business creditors cannot go
after personal assets
 Limited liability or no liability is known as limited liability
o Must be one general partner at all times but there can be any
number of limited partners, even zero
 From society’s perspective need someone liable, from
operational need someone to manage it
 Advantages
 Greater access to funding – Those investors who are limited don’t have to
worry about what they’re really getting into
o Don’t have to manage the business, worry about losing their home
 More efficient management – general partners manage the business
o Don’t have to deal with everyone every time they make a decision
o Forming a limited Partnership
 RULPA §201 – To form a limited partnership a certificate of limited partnership
must be filed in the office of the Secretary of State
 Cannot be formed accidentally
 Minimal information
 Notice of existence
 Without this filing, it’s a regular partnership and not limited
 Written agreement is optional
 Ought to have one, better to create one rather than rely on default laws
 Limits to what you can name it
 It must indicate limited partnership status (most states L.P. is enough)
 You can’t contain the name of the limited partner in it
o Limited Liability
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
Passive investor status
 Limited partners who don’t run the business, just putting in money
 They may be liable as partners if they engage in control of the business
 Holzman v. De Escamilla – 3 partners in a farming business, 2 claiming they
were not general partners, but were found to be general partners
 Pretty clear that the two “limited” partners were really in charge
o Limited partners could sign checks without the general manager and
he couldn’t sign without them
o They forced him to quit
 They clearly took part in the control of the business, though it’s not clear
how much control is too much for a limited partnership
o Suggesting things and voting on fundamental matter isn’t enough
 Gateway Potato Sales v. G.B. Investment Co. – Gateway, a creditor, brought suit
to recover payment for goods to the limited partnership, including the limited
partner because it participated in the control of the partnership business
 In Arizona, a limited partner can be liable beyond its investment even if it
had no contact with the creditor
o If the control of the limited partner is "substantially the same" as
that of the general partner
 Statutory interpretation issue – RULPA is moving towards requiring direct
contact, though here they don’t rely on that contact
o Arizona continues to apply the “substantially the same as test”
o You’re trying to generalize statutory trend, but in this state it hasn’t
gone as far as that trend, it’s not binding yet
 You don’t need direct contact to have actual knowledge, but the court
interprets actual knowledge to having direct contact, even though the
statute doesn’t require it (Not sure that’s right (Prof.))
 History of Increasing Availability
 Originally; specific purposes
o Specifically granted limited liability by legislatures in specific cases
 Expanded for industrialization
o Then came so many cases, saw that it was necessary for economy to
grow, so more and more laws so now we have pretty much
universal availability of limited liability
 Eventually; universal availability
 Increasing Diversity
 Originally – LPs and corporations only
 Eventually – LLCs. LLPs, LLLPs, etc.
o Expanded the availability of limited liability
o Is this a good thing? – Policy argument
 There are benefits, but also costs
 Society seems to have answered, they like limited liability
 Just because it’s a given doesn’t mean it’s necessarily right
o Very Basic Finance
 Introduction to Debt
 Debtor – One who owes a monetary obligation to another (Ex; borrower)
21


Creditor – One to whom a monetary obligation is owed (Ex; lender)
Debt – Monetary obligation, no matter how you do it
o Usually involves 2 obligations
 Repayment of principal
 And (usually the periodic) payment of interest
 Time Value of Money (why there’s interest)
 $1 today is worth more than $1 tomorrow (3 reasons why)
o 1. Risk – You pay me a dollar today, I have it; if you say you’ll pay
me tomorrow, I may never get it
o 2. Inflation – It will cost more tomorrow because of inflation
 Dollar is worth more today than tomorrow
o 3. Opportunity costs – You give me a dollar today, I can invest it
and earn more than a dollar tomorrow
 Interest is that incentive to get people to lend
o $1 today > $1 tomorrow and that’s worth much more than $1 later
o Compounding – the process of accruing interest upon interest
 $1 after one year at 10% interest becomes $1.10
 2nd year it’s 11 cents, equals $1.21
 It snowballs over the years
 8. INTRODUCTION TO CORPORATIONS
o Corporation – A separate legal entity created by authority of law
 Shareholders/stockholder – The holder of a share of stock; an owner, or residual
claimant, of a corporation
 Security – An instrument that evidences a financial right with respect to a
corporation
 Management – General terms that refers to the directors and offices of a
corporation
 Actually broken down into two levels – officers and directors
 Director – member of the board of directors
 Board of directors – The governing body of a corporation
 Shareholders elect them
 Officers – An employee who manages the day-to-day affairs of the corporation
 Appointed by directors
 Dividends – A distribution of a corporation’s earnings to its shareholders
o Corporations
 Formalities – Many requirements
 Doesn’t even exist unless you follow formal requirements
o Can’t form one counter intentionally
 Control – Separation of ownership and management
 Shareholders elect directors, ultimate managers of the corporation
o Can elect themselves, though usually only in Mom and Pop
o Generally they hire business experts
 Legally they are separate, and usually factually as well
 They then appoint officers, who are more intermediate managers
 Officers hire EEs to the extent necessary
 Liability – limited to investment
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 Obligations of the business are not the obligations of the shareholders
 Taxation – firm taxation or double taxation (482)
 One of the main drawbacks of the corporation
 It pays taxes on its income, then shareholders pay taxes on their income
o If you have $1 in income in a sole proprietorship, you pay 33 c in
taxes at 33% and you get .67, in a corporation you end up with .45
 S corporation – Permits owners of qualifying corporations to elect a
special tax status with flow-through taxation if they fulfill the conditions
 Lifespan – indefinite, lives forever or until dissolved
 Shareholders’ deaths don’t affect the business
 Exit – get out of the business by selling the shares
 Factually it may be more difficult
o Mom and pop won’t be any easier to sell than a sole proprietorship
o But big corporation it’s easier
o Incorporation – Establishment of a business as a corporation (DGCL §102)
 First select the state of incorporation (Not necessarily where you operate)
 Internal affairs doctrine – a choice of law rule under which courts will
apply the corporate law of the state of incorporation to determine the
internal rights and duties applicable to a corporation
o They will use all the external laws of where you’re doing business,
but the corporate law will be the state of incorporation
o Personhood is defined by the state of incorporation
o You can choose to incorporate in any state based on the laws that
you prefer
 Next file certificate of incorporation/charter (DGCL §102)
 The constitution of the business pretty much
 Has to include your name,
o Depends on state laws whether it’s Co., Inc., but it can’t be Bank
 Has to include the powers of incorporation §102(a)
o Nature of the business or purposes to be promoted
o Anything not included in the charter is ultra vires
 Used to be a serious problem – meant to protect the
shareholders and third parties, not everyone else
 Today it’s irrelevant – began stating the purpose more
broadly and eventually they came to say any lawful activity
o Goodman v. Ladd Estates – If a shareholder or director participated
in the ultra vires act, he cannot thereafter seek remedy under an
ultra vires claim
 Ps bought the shares of the corporation from the previous
owner who was involved in the ultra vires guaranty and they
had knowledge
 Must list classes of stock – §102(a)(4) and §151 (about specific stocks)
o Stock – A security representing an ownership interest in, or residual
claim against, a corporation
o Charter has to include the total number of shares of all classes of
stock and the number of shares of each stock
23

 List the kinds of stock and the terms (however you want)
o Common stock – A security representing a basic ownership interest
in a corporation
 Most companies only have common stock
 Typical rights – To vote on certain limited matter and the
right to the residual profits if the board of directors declares
dividends
o Classified Stock – Stock issued in different classes, the terms of
each of which are specified in the charter (when you have more
than one type of stock)
 Can set out each class of stocks rights
 Common second class of stock might be preferred stock
o Preferred stock – Security representing an ownership interest in a
corporation that includes some preferential claims but also some
limitations
 Preferred stock would be whatever the charter says, but a
common one may or may not have the right to vote
 Usually has a preferred dividend, preferred shareholders
have to get dividends first before the common shareholders
 There’s a preference, but often a limitation as well
 Has to include incorporator/initial directors
o Incorporator – A person who files the certificate of incorporation
for a business
 Usually include incorporator’s address, not directors’
o Related term is promoter, person who establishes a new corporation
 Technically not the same thing
 Mom and pop are the promoters
 The incorporator is the technician, could be your
lawyer or law firm
o Parent corporation – A corporation that owns another corporation
 Under DGCL §101 Anyone can incorporate a business, even
another corporation
o Subsidiary – Corporation owned by another corporation
o Affiliate – Anyone who controls, is controlled by, or is under
common control with, another
 Ex; parent and subsidiary, or co-subsidiaries
o Name of incorporator and the initial directors if they are known
 Often won’t know directors yet, not elected
 If a person takes action on behalf of a corporation before it exists, they
risk liability for those actions
o Until it exists, I’m an agent without principal, I’m really a principal
 Any other matter you want
o Can put in rules for the business that will govern the business
Hold Organizational Meeting (DGCL §108)
 Meeting of directors, or incorporators, if directors haven’t been chosen
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o Minutes – The records of the proceedings of meetings of a
corporation’s shareholders or directors
 Adopt bylaws (DGCL §109)
o Bylaws – A document, more detailed than the charter but
subordinate to it, that governs the internal affairs of a corporation
 Much more detailed rules for how the business will be run
 Issue shares – Theoretically owners aren’t owners yet, until they buy stock
o Authorized but unissued shares – Shares of stock which have been
authorized by the corporate charter but have not been issued
 Once you issue shares they’re outstanding
 The number you decide to issue is arbitrary
 Treasury stock – Shares of stock which have been authorized and issued
but are not outstanding because they have been repurchased by the
corporation (commonly treated as authorized but unissued shares for most
purposes)
o Modern statutes have done away with this really
 Hold Shareholder Meeting (DGCL §211)
 §211(b) – Annual meeting for the election of directors
o One of the least followed rules because of mom and pop
corporations
 §216 – Quorum – Minimum presence necessary for a valid meeting
o Delaware is the default rule, more than 50% of the shares, though in
the Charter you can lower or raise it
 Hold Directors Meeting
 §141(a) is the key provision – the business and affairs of every corporation
shall be managed by or under the direction of the board of directors
o Board it the ultimate governing body that is consistent with the
Charter and bylaws and law
 One key task it to appoint and monitor officers
o Directorships are actually part time jobs, officers are full
 DGCL §142 is flexible to the organization structure as to
what type of officers
o Officers then hire EEs
o Race to the Bottom
 Internal Affairs Doctrine
 State of incorporation determined by costs and benefits
o Can choose any state, so go where it’s best for you
 Competition among states
 Why? Taxes and fees
o Corporate taxes and fees, that money is pure profit to the state
 How? Service and substance
o Innovation in the law, clarity in law, consistency, and
responsiveness to needs of corporations
 Who benefits?
 Corporations vs. Society (Race to the Bottom)
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o Normally think law should be passed to benefit society, but states
may wish to pass corporate friendly law
o Fact of externalities – A state might pass a law that is bad for
society because the cost of that harmful law is passed across all fifty
states, while the revenue goes to that one state
 Even if a state doesn’t, the state next door can still pass that
law and it will apply to business in your state
 Shareholders vs. Management (Race to the Top)
o States are going to pass laws that please those who decide where to
incorporate, the directors
 It historically hasn’t been that hard for directors to get
shareholders to sign off on whatever they want
 So it’s beneficial to directors more than shareholders
o Race to the Top theory says that it’s good to compete and people
will pick the laws that are most efficient
 Better in the long run for stability
 Delaware – Regardless, Delaware has won
 History – Corporation used to not be able to own corporations
o Used to use trusts to expand power (why we have anti-trust laws)
o New Jersey began allowing corporations to own other corporations,
clear winner until Woodrow Wilson got rid of these practices
o Delaware stepped in and passed friendly laws and never looked
back
 Small states have the advantage
o They have more incentive
 The revenues can be quite large (Delaware is about 17%)
 Harm from a bad law will be relatively small since most
states just incorporate there and conduct business elsewhere
o Less incentive for a large state
 The revenue is relatively small (CA is .1% at most)
 The harm is quite large, the laws actually matter to the state
 Current superiority – Good system for corporate law, things done quickly
o Good judiciary, they are corporate law experts
o Often other states will pass more blatantly pro-management laws
and Delaware responds moderately
 Increasingly there are more federal law regulations, and the
government may step in if Delaware makes such changes
 They don’t need to as much since they have things other
states don’t have
o Other states don’t have to worry, they’re not losing much, but they
could gain if government steps in and takes it away from Delaware
 9. THE PURPOSE OF CORPORATIONS
o Theories of the Corporation
 Traditional View – Shareholders are the owners (what we’re familiar with)
 Shareholders elect directors, who are kind of like their agents (or trustees)
26

No one else matters under this view, everyone else is a third party with
which the corporation deals with at arms length
o Profit for the shareholders is the main goal
 Contractarian Theory – Everyone is an investor
 Communitarian Theory – Everyone is a stake holder
o Dodge v. Ford Motor Co. (Traditional View) – Ford, who controlled the board,
declared they wouldn’t pay any more dividends, but put the $ back into the company
 Court’s view is the purpose of a corporation was to create a profit
 Usually directors get to decide dividends, but their role is the choice of
means, not to change the end of making profits itself
 Court says his motive was philanthropy, finds that unacceptable
 Dividends – If not altruistic, he may not want to pay dividends to reinvest, or
prevent competition by not giving the Dodge brothers funds, or to avoid double
taxation
 Prices – They didn’t like that he was lowering prices, but he may have done that
so more could buy cars, making it harder for others to compete
 Salaries – He may have raised salaries to keep other companies from taking his
workers at a time when labor was in demand and turnover was high
 Ford was trying to look like a decent man and doing good things, but the court
was having none of it
 Courts often just don’t know what they’re doing when it comes to business
o Contractarian Theory – Everyone is an investor
 Shareholders
 Shareholders have no special status, everyone is just an investor
 Input cash usually, sometimes property or labor
 Rights – Expect residual profits and control
 Lenders
 Input cash into the business
 They want interest, which comes first, before dividends, and covenants
 Covenant – A contractual obligation or prohibition; in a loan contract, a
provision binding the borrower, which gives the lender an element of
indirect control
o Have to promise to use this money for this particular reason, not
pay dividends when you can’t pay interest
 Trade Creditors
 Input property
 Investing in you and expect something back, payment
 Employees
 Input labor
 They expect wages
 Customers
 Input revenue, they’re investing in you
 Rights are products or services the business makes
 Society
27

Invest through security, police, army, infrastructure, roads, things that
make business possible, really investing in local areas to get businesses to
come to an area
 They expect taxes and societal benefits
 It’s nothing more than a web of contracts, contractual relationships
 Most common theory among academics
 Not law, but it has influenced the law tremendously
 Purpose of the corporation under the contractarian theory is to benefit
shareholders, maximize their profits to benefit everyone else
 Logically it would seem to benefit everyone, but shareholder benefit is a
proxy for societal wealth
o Shareholders are the only ones with the proper incentive to run the
business since the make all the real profit and take all the real loss
 All other persons in this web are naturally risk averse
 Shareholders have the proper incentives, but maybe not when they’re insolvent
 Healthy business, any extra goes to the shareholders, but when it’s
insolvent, they have zero interest
o Shareholders then have little to lose and much to gain in engaging
in risky behavior and might become overly risky
 Insolvency – Inability to pay debts when they are due (It’s a state)
 Bankruptcy – A legal process for the liquidation or reorganization of a
business that often is triggered by insolvency
 Assets minus liabilities is what the shareholders get
 Equity is whatever is left after liabilities
 Greater than zero means you have an ownership interest
 But you may have more liabilities than it’s worth in which case you don’t
own it anymore theoretically
o Bankruptcy is to satisfy creditors
o Credit Lyonnais – In the vicinity of insolvency, the corporation’s right decision may
diverge from what shareholders or another group wants who have improper incentives
 Expected values = the sum of (probability x value)
 Weighted average value
 Corporation
 From corporation’s perspective (anyone’s) settling for 15.55 makes sense
and settling for less does not make sense
 Shareholders
 If they don’t settle and they get the full potential amount, they get 39
million, 25% chance of that happening
o Not to settle for shareholders is worth 9.75 million, so they won’t
want to settle, small chance for a big payoff
 If the company is in insolvency the shareholders will want to invest in
overly risky investments because of the small chance it pays off well
 That risk goes to creditors, they are forced to suffer that 8 million loss
 Creditors
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
Creditors will be willing to settle for anything over 5.8 million, fear of that
means they will settle for less than 12 million
o Fear of going to trial and getting less
 They have improper incentives as well
 In the vicinity of insolvency they owe a duty to the corporate enterprise
 If it’s a sole proprietorship, you look to that one rationale person
 Viewed as a separate person, that’s the one with the proper incentives
 Pretty decently settled law
 NACEPF v. Gheewalla – Creditors of a Delaware corporation in the zone of
insolvency sue for breach of fiduciary duty
 Reaffired the traditional view – separation of owners
o Directors for the benefit of shareholders
o Shareholders are owners
 But also rejected Credit Lyonnais
o Directors must continue to discharge duties for benefit of
shareholders until actual insolvency, even in the vicinity of
insolvency
o Credit Lyonnais wasn’t even under attack, kind of a surprise
 General rule is that directors do not owe creditors fiduciary duties beyond
contractual terms
o Creditors take the place of shareholders in an actually insolvent
corporation, first money is going to them
 Then they can bring a derivative action, but they cannot sue
in a direct action
o NACEPF claims the court should recognize creditor’s right to
challenge directors’ business judgment as breaches of fiduciary
duty – Court rejects this
o Social Responsibility Theory
 Concession Theory – Earliest version of social responsibility theory
 A response to the traditional view of shareholders as owners
o But a quid pro quo – Society allows corporations to exist and in
return, they can make demands that they be socially responsible
 As we’ve moved away to where it’s not a special concession to get limited
liability, this theory doesn’t resonate like it used to
 Communitarian Theory – Not a web of contracts, a web of relationships in which
shareholders have no special place, no owners and everyone is a stakeholder
 Instead of concluding like contractarians that it has to be in favor of
shareholders, they should consciously be run for the benefit of everyone
o Socially Responsibly Behavior
 Pursue profits at all costs
 Profits are good and increase other profits
 It’s wise to pursue what they’re best at
 Excel at business
 Could include making profits, but not limited to it
 Making money by making products and society can benefit from the
whole business enterprise
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 More Milton Freidman’s position
 Social consciousness
 Take others into consideration too, be green, treat EEs well
 Usually what people mean when we talk social responsibility
 Charity
 Give away your profits or forego them for the good of society
 Pursue the interest of society
 Profits are secondary
 Not realistic, or at least not what people argue for
 The real range is the second or third point
o Charitable Donations
 Social consciousness vs. Charity
 Not that different, on one hand
o Both foregoing potential profits for some greater good
o Fundamentally the law should treat them the same
 But charity is entirely optional, social responsibility is not
o Social responsibility – You are making moral decisions for safety
precautions in the office, on products
o You can’t punt on moral responsibility, you have to decide to what
extent morality is bearing on you
 Can be moral or immoral, say you only have to go this far,
but you still have to decide
 DGCL §122(9) – Every corporation created under this chapter shall have the
power to make donations for the public welfare or for charitable, scientific or
educational purposes
 A.P. Smith Mfg. Co. v. Barlow – Company makes a donation to Princeton and
shareholders sue, Court says they can give the donation
 Shareholders – The Charter didn’t authorize it and the state law regarding
charitable donations came into effect after the Charter was passed
o A corporation is primarily for the profit of stockholders
 But before the Charter, the legislature said every Charter was subject to
change by the legislature
o Justice Story, in a concurrence, had said states could write such
laws reserving the power to amend, change the terms
 10. LIMITED LIABILITY
o Limited Liability
 General Rule – Others are not liable for corporate obligations
 Includes shareholders, manager, EEs, lenders, etc.
 Argument that since proprietors and partners are liable, shareholders
should be too
o In terms of civil liability you could imagine EEs being liable for
certain things, why not lenders
o Maybe no one should have special status
 2 Arguments for Shareholder Limited Liability
o 1. Corporations are separate legal entities
o 2. Double Taxation – paying for it with double tax
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

 Legislative trend is not only to preserve LL, but to extend it
Limits?
 Contracts vs. Torts
o When entering into a contract, you are accepting the risk, you can
contract around the knowledge that shareholders have LL, so a
certain amount of fairness comes from that
 With torts, you get hit by a car first and then find out what
the corporation is, so that LL justification fails
o Contracts are more likely to be less dire, more likely just to be
money matters
 Torts more likely to be health matters (not always)
o Piercing the veil is more common in contracts than tort cases
 Public Corporations vs. Small Businesses
o A lot of logistical concerns if we got rid of LL for corporations
 Shareholders generally have less control of big corporations,
doesn’t seem fair to attribute corporation’s actions to them
o The real issue is LL in a small corporation
 For egalitarian concerns, maybe we should have it
 Seems unfair that Bill Gates can have LL, but not
Mom and Pop
 Reasons for LL disappear more with close corporations
 Individuals vs. Corporations
o Should LL extend to Corporations when they are shareholders?
 Maybe corporations will invest less in safety if parent
corporation is not liable for subsidiary
o Likely to lead to less expansion and risk taking without LL if we
create a rule of LL for corporations
 Could be broken down into different corporations
 One bad widget could bring down the whole
corporation, so we break it down into different
subsidiaries for different things, widgets in one
 Instead of vertical, parent and subsidiaries, might try to just
have separate businesses
o Have to think about how people will respond to laws, not just
what’s the right thing to do
 Limited Liability vs. No Liability
o We call it limited, but it’s really no liability for shareholders
o Used to have calls on liability
 Shareholders put up a certain amount, but if something goes
wrong, they might have to put up more
 Used to be extremely prevalent, especially for banks
 If you didn’t then you could lose your stock
o Pro rata – Liable for a certain percentage
Exceptions
 Failure to Incorporate
o Then it’s a partnership with unlimited liability, in theory
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
Seems a bit harsh, modern trend it not entirely to enforce
that exception
o De Facto Corporation Doctrine – a legal doctrine under which
courts may treat a business that was not properly incorporated as a
corporation if the promoters made a good faith effort to incorporate
and treated the business as a corporation
 Based on shareholder action
 McChesney: Doctrinal Analysisand Statistical Modeling in
the Law – (1) a statute in existence by which incorporation
was legally possible, (2) a ‘colorable’ attempt to comply
with the statute, (3) some actual use of exercise of corporate
privileges
o Corporation by Estoppel – a legal doctrine under which courts may
prevent someone from denying corporate existence if they
acknowledged the corporate entity and would earn a windfall by
subsequently denying corporate existence
 Based more on third party action
o Hypo: Southern-Gulf Marine v. Camcraft – First company formed
as Texas corporation as Y, having completed the ship, the builder
claims that the corporation it built it for never existed and they
don’t owe them the ship
 He contracted to make the ship, an expensive process, now
he doesn’t want to sell it, maybe because it’s worth more on
the open market
 Corporation by Estoppel
 Piercing the corporate Veil
 Direct Liability
o Piercing the Corporate Veil - holding shareholders personally liable for the
obligations of the corporation
 As a protection against insider abuse, whereby insiders pass risks to outsiders,
with gains to insiders and losses, because of LL, going to creditors
 Court’s don’t take this step lightly, they are putting creditor expectations
ahead of insider interests in LL
 Very rare, most people don’t even bother challenging it
 1. Failure to respect the corporate form
 Failure to maintain corporate formalities
o Technical formalities
 Failure to maintain separate identities
o Making sure it’s not really just an alter ego, a dummy corporation,
for their own personal affairs
o Unity of interest in ownership
 2. Also requires some form of injustice
 By definition, an inability to pay an obligation doesn’t count
o Fact that a judgment can’t be paid isn’t enough
 Fraud
 Undercapitalization – failure to provide adequate capital for the business
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o Radaszewski v. Telecom – P cited no evidence of improper
motivation or violation of the law, just that it was undercapitalized
 COA said insurance counted as being properly capitalized,
even if the company didn’t have the cash
 Syphoning of funds – excessive withdrawal of corporate assets
o Not just when things go wrong and there happens to not be enough
o Hard to draw a direct line between your fault and not
 Intentional scheme to evade responsibility – Scheme suggests something
nefarious, something wrong
o Particularly difficult to tell what this means
 Unjust enrichment
o Walkovszky v. Carlton – Business owner sets up ten corporations and each corporation
has two cabs with the legal minimum insurance and nothing else in the corporation
 If he gets hit with a large judgment, he only loses those two cabs, instead of the
whole business
 Seems like he’s trying to avoid liability
 Court says avoiding liability is why we have corporations
 Have to look at 2 part test
 1. There is no lack of separate identities, he didn’t co-mingle the funds
o Carlton did not fail to respect the corporate form
 2. The fact that he was run over is not enough to create an injustice
o Maybe undercapitalization
 Each company ha no assets, not even the cars, but he did
have the insurance required
 Money in his pocket or money in insurance
 For it to be enough cash, it doesn’t have to cover every
conceivable event, maybe having insurance means he
doesn’t need that cash on hand
 Issue: allowing LL when a reasonable person might
have taken greater precautions
 They did not allow him to pierce the corporate veil, but they suggest enterprise
liability to the P
 Enterprise Liability – A legal theory under which a court may hold an
entire business enterprise (i.e., a corporation and all of its affiliates) liable
for the obligations of a constituent corporation
 Some courts use the enterprise liability doctrine to disregard multiple
incorporations of the same business under common ownership
 It pools business assets to satisfy liabilities of any part of the enterprise,
entire business enterprise liable for obligations of constituent organization
 Assets of individual owners are not exposed
o Even if he’s not personally liable, can pierce it sideways and hold
all those companies liable jointly
o Fletcher v. Atex, Inc. – Plaintiff’s are trying to sue the parent company and to pierce the
corporate veil on an alter ego theory, they must show the two corporations operated as a
single economic entity and that an overall element of injustice or unfairness was present
 Argument they were operated as a single entity
33

Control to the extent of domination, cash management, control issues,
same directors (indicative that’s it’s just a sham and the same company)
 Court says on cash management that this is nothing like co-mingling of
funds or siphoning of funds, subsidiary still has the money, all cash
transactions are at arms length, not treating the money as their own
 Referring to the subsidiary as part of one business, the court says they’re
just being colloquial, not having an effect
 11. SHAREHOLDERS VS. MANAGEMENT
o Directors
 Job description
 Often part-time, working somewhere else full time
 Consist of insiders (CEO and his subordinates), but mostly of outsiders
 Agency problem
 Key issue is the risk that agents (directors) will serve their own interests
rather than those of the principal (shareholders)
 Agency cost – The costs associated with an agency relation, especially the
agency problem
 Directors are not agents, they are not subject to anyone’s control
o More colloquial or economic sense we use this term
 Essentially trustees, but shareholders have a lot of say, as opposed to how
normal trustees work
 Directorial Authority
 Statutorily very broad
o Shareholders and courts do not run the business, directors do
o But they must ac in the interest of the corporation (the shareholders)
 Equitable fiduciary duties
o Law of equity imposes duties of care, loyalty, good faith
 Practically limited by certain shareholder rights
o Shareholders elect directors, so somewhat accountable
o Shareholder Rights
 Economic
 Right to distributions
o Any profit or equity is really theirs, but no right to dividends
o It’s illusory, they’re not entitled to profit right now
 Selling
 Control
 Fundamental matters – certain matters they have approval right
o If two companies merge, but not much else
 Election of directors
o They can often remove and replace them as well
 Information
 Most of the time you’re not entitled to information
 The real information rights come from government
o Large public companies have to disclose information continually
 Litigation
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 Shareholders can sue to enforce their other rights
 (Limited) structural accountability for directors
 Market for corporate control – Developed by Contractarian theory
o Shareholders follow the Wall Street Rule – An investment policy
pursuant to which shareholders buy shares if they are satisfied with
a company’s performance and, if they are dissatisfied, they sell
shares rather than vote against management
o The more dissatisfied they are, the more they sell, the less demand
for the security which leads to lower stock prices
 Incentivize entrepreneurs to come in and turn things around,
so they have to keep shareholders happy to keep prices up
o Corporate Hierarchy
 Purely legal view
 Directors are in charge
 Old View
 Ultimately really shareholders are in charge
 “Traditional” View – Berle-Means Thesis
 They noted the separation of ownership and control
 Executive officers (management) are in charge, not the directors and not
the shareholders
 New View
 Executive officers run the business
 Directors monitory officers
 Shareholders influence directors
o Rational Apathy –Indifference based on the reasoned conclusion that attention is futile
 Shareholders in public corporations
 Dispersed – Lots of shareholders, dispersed, no contact with each other
 Small Investment – Only invested a little extra
 Diversification – The process of reducing risk by investing in multiple
opportunities
 Voting rights
 Irrational to pay attention – It makes no sense to follow the company, even
paying attention is a waste of time
o Their individual votes are meaningless
o Coordination problems and communication issues
 “Wall Street Rule” – Don’t bother getting involved
 Pernicious golden rule – Just trust the officer and leave him alone
o Changing Circumstances
 The rise of the Institutional Investor – An institution that trades large volumes of
securities, usually by managing other people’s money
 They hold a majority of public stock and are run by financial experts
 Not that dispersed, maybe dozens in relevant areas
 Much weaker case for apathy
o Can be economically worthwhile for them to pay attention
o Their vote can make a difference
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o In theory there’s less apathy, and seems to be playing out in practice
 Voting rights are changing
 Shareholder access is changing
o Descriptions of directors, different models
 1. Agency
 2. Trust
 3. Representative democracy
 Like our government, can pass a sweeping law we’re all against
o But ultimately can be held accountable
 4. Division of authority
 Maybe they each have their own realm
o Shouldn’t be telling each other what to do
o Charlestown Boot & Shoe Co. v. Dunsmore – Shareholders voted to choose a
committee to act with the directors to close up the corporation’s affairs, they refused to
work with him and contracted debts larger than legally allowed
 In the allocation of legal power, the governing rule of law is that the directors
have the right to manage the corporation as they want, don’t have to listen to
shareholders
 Subject to bylaws or Charter, they have discretion
 Court says it’s unfortunate they didn’t listen and it cost, but tough luck
 Models
 Agency – Not really the right result since shareholders weren’t able to tell
them what to do
 Representative democracy – They can vote them out
 Division of Authority – Probably/arguably wrong decision under this
o Directors make business decisions
o Shareholders involved in investment decisions, the flow of capital
 They wanted to get out of the business, and this is arguably
an investment decision
o Blasuis Industries, Inc. v. Atlas Corp. – The majority shareholders wanted to increase
the number of members on the board to get a majority of people on their side; question
is whether the board acted against its fiduciary duty when it blocked it in good faith
 Court says they acted in good faith to protect the company from this move
 But it’s an offense to the shareholder/director relationship
 Models
 Representative democracy – Most fits this, to agree that shareholders get
to vote in who they want
 Division of authority – Also in line with this
 Agency – They can’t circumvent what shareholders are telling them to do
 Trustee – Presumably directors could do whatever they feel appropriate
 Argument directors should is that they technically have the power to add people
 But fiduciary duties go beyond the technical limits of the law
o Just because you can do it, doesn’t mean it’s in compliance
 Power struggle between directors and shareholders
 Ideological underpinning is that the directors are elected by the
shareholders and we need to preserve the relationship/voting power
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 This is a voting context and may not be left to business judgment
 2 Part Test
 1. Determine whether the board has acted for the primary purpose of
thwarting the shareholders vote (Very lenient part of the test)
 2. They must have a compelling justification
o Very difficult to prove, potentially only if there’s fraud and you’re
doing this to gain time to stop the fraud
o Condec. v. Lunkenheimer – Condec wanted to merge with Lunkenheimer, who resisted,
then Condec attempted to gain a majority in Lunkenheimer through tender offers,
which Lunkenheimer tried to block by diluting their interest to a minority
 Court held that a corporation can’t have retaining control as its main purpose in
issuing stock, breach of fiduciary duty if not for a legitimate business purpose
 12. CORPORATE ACTION/VOTING
o Director Action
 Directors must act as a group – Only have authority generally as a whole
 Meetings – Where they act together
o Must give notice in advance
 Minimum and maximum number of days
o Quorum – Minimum presence required to have a valid meeting
 Can only legally lower it to a certain point in most states,
but can raise it
o Majority vote – An affirmative majority of those present and
eligible to vote (Directors’ action is usually majority vote)
 Absentees don’t count, only those present
 Abstentions count as a negative vote
 Different from 2 other standards
 True majority – affirmative majority of all possible
votes (3 must vote for it if there are 5 directors, no
matter how many are there)
o Absentees and abstentions count
 Majority of votes cast – Affirmative majority of
votes that are cast
o Neither absentees nor abstentions count
o Most states allow Virtual Meetings
 Written Consent without a meeting is allowed
o Potential problem with not allowing everyone to hear all options, so
we require it to be unanimous
 Committees – Board of directors can break up into committees
 Essentially the same rules apply within the committees
 Can be given final authority over a particular matter/area
o But usually they are sort of advisory in setting policy
 Informal Action – If they all agree and don’t see the need for a meeting, CEO
asks each of them instead for written consent, etc.
 Technically not correct, but a lot of times the court will let it go
o Particularly if it’s a close corporation where they don’t always
follow the detailed rules or public corporations if it’s a formality
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
Problem with binding a future board – Theoretically they can’t bind a future one
 General principle – One board can’t bind a future board, but a committee
can bind a board with authority on some actions
o Even though a board is more powerful, it can’t
 Any time a committee makes a decision they are taking away the power of
a future board to make another decision
o Ex; Very difficult to retool a factory built to make widgets
 Even if they can’t bind them legally, they have pretty much
made them stuck with widgets
o Officers
 Statutory law is woefully inadequate
 Some states have no rules
 Some states specify certain offices
o NY – President, VP, Secretary, Treasurer
o Tells us little, probably meant different things when written
 In general titles are meaningless
o President is not usually in charge, it’s the CEO
o CEO, CFO, COO; VP
o VP suggests a lot of power but it can also be virtually meaningless
 Can be one or 100 VPs
o Bylaws may not be very helpful, written in the broadest language
 Case law is forced to make difficult decisions
 Forced to borrow from agency concepts – apparent authority, inherent
authority, acquiescence,
o Leads to wide disparities in powers courts recognize
o Shareholder Action
 Limited Voting Rights
 Directors manage the business, shareholders don’t generally have a say,
but there are some things they do
o They vote on the election of directors
o Right to vote on Charter Amendments
 Usually both directors and shareholders
 They do have a veto power
o Certain fundamental transactions (ex; mergers)
 Has to be done through a charter amendment anyway
o Other matters put before them
 Board may decide at their option to ask
 Or some legal requirement
 Requirements
 Meeting
o Still have to be notice and a quorum
 Required to vote
o Default is majority vote, but staring to see majority of votes cast
o Fundamental transactions/matters require a true majority
 50% + 1, affirmatively get most of the shares on board
o Charter or bylaws can change quorum and vote requirements
38

Written consent
o Directors have fiduciary duties, Shareholders don’t have fiduciary
duties, can do what they want and act selfishly
o Very different approaches on this
o Election of Directors
 Historically directors were elected by Plurality Vote
 An election in which the candidates or options with the most affirmative
votes win, without regard to absentees, abstentions, or negative votes
o Highest number of yes votes wins
 Two important consequences
o 1. Majority shareholders elect all directors
o 2. Incumbent directors always win unless challenged, and not
usually challenged
 Had plurality vote because of rational apathy; the need to ensure a winner
o Here, only need one election and someone is going to win
o In a contested election where there’s a good chance no one will get
the majority, makes sense to make it the one with the most votes
 Moving away from it
o Less apathy and contested elections are less rare
o Worst thing that can be said about it, it prevents shareholders from
kicking out directors unless they’re willing to wage a huge contest
 Minority Representation
 Even before moving away from plurality, people got around it
 Class Voting – Charter can define the terms of the stock and specify that
certain classes of stock elect their own directors
o Can distribute representation between different shareholders
 Cumulative Voting – A voting scheme in which each voter has multiple
votes which they can distribute among the candidates freely, including
multiple votes per candidate, equal to the number of shares she holds
o Usually done in small corporations
 Capped Voting – Shareholders have reduced voting rights as their
holdings increased, they get capped at some point
o Providence & Worcester – Court upheld a limitation in the Charter
that gave 1 vote per share for first 50 shares, but only 1 vote per 20
shares after that, it’s a form of weighted voting
 Purpose of the provision is to make more difficult for
anyone to get too much power
o Downside is that management, which usually owns a significant
amount of shares, suddenly gets their power reduced
o In most states voting rights have to be in the Charter
 Voting against Directors
 Can abstain (can’t vote no)
o Abstaining would send a powerful signal that they’re unhappy
o Didn’t really happen because of rational apathy and people selling
rather than going against, but if that did happen it was a vote of no
confidence and you were doomed
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

 Once it started becoming more common, it’s not as true
o But shareholders want the power to remove directors
Majority voting changes everything
o They can only win if they get a majority of the votes
 You have to get more approval than disapproval
 Can get a director out without running anyone against him
o Unprecedented success
 Went from extremely rare to the majority in a short time
 Now the default in about 5 years
Modified Plurality Voting – Elected by plurality, but those who don’t
achieve a majority, the other directors can kick you off, knowing the
shareholders wanted him off (Plurality plus)
o Often required to tender resignation so others can decide or not to
accept it if you don’t get a majority
o Directors are required to follow their own business judgment in
deciding when to kick a director out
o This is the alternative directors came up with to majority voting
 Directors between shareholders and removing a director
 Now only effective if allowed by directors
o Control
 True Control = Majority voting power
 Majority of shares, pretty much in complete control of the corporation
 But you don’t need that much power to have control
 Effective Control is less than 50%
 Not all shares will vote
o Say only 60% attend, need only 30%
o Rare that there’s 100% representation
 Influence approximates control
o In a large public corporation, a few shareholders with a significant
minority of the shares can have a lot of power
 Someone with 5% of IBM can have a lot of power
o Managers will try to keep you satisfied since you need to convince
less people to be on your side to get the majority than they do
o Ringling Bros.—Barnum & Bailey Combined Shows v. Ringling – Ringling and Haley
decide to combine their shares to take power away from the third shareholder, North
 Shares could be voted cumulatively, by combining, R (315) and H (315) get to
vote for 5 directors, N (379) gets to vote in 3, out of 7 directors
 General rule on shareholder voting is they can vote for whoever they want,
so their attempt to bind each other’s voting is not illegal
o Such pooling agreements have been found valid
 Wide liberality of voting as long as he violates no duties to fellow
shareholders
 Haley wouldn’t vote how she was supposed to vote, unfair to their agreement
 They entered into this agreement to take power away from North
 Court holds that Haley’s votes are struck, leaving one vacant seat
 Outcome is really not unfair to Ringling, actually more unfair to Haley
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
The agreement contemplated that they were friends when deciding how to vote
 So next year will be 3 for R, 2 for H, 4 for N
o Classified Stock and Weighted Voting
 Corporations can set up two or more classes of stock to ensure that all
participants, or a particular minority shareholders will have representation on the
board (Ex; Class A given power to elect 3 directors, Class B power to elect 2)
 13. FEDERAL PROXY RULES
o Why Proxies?
 Proxy – Agent, authority, and instrument
 (1) one who is authorized to act as a substitute for another (especially, in
corporate law, one who is authorized to vote another’s shares);
 (2) the grant of authority by which a person is so authorized;
 (3) the documents granting the authority; i.e., the agent, the authorization,
and/or the instrument under which a shareholder’s vote is cast indirectly
 Most often conducted by management, but soliciting shares by anyone is proxy
 Two people competing to get your shares is a proxy contest
 Quorum Requirement
 Have proxy because you have to have a minimum presence
 Rational apathy
 Problem is shareholders aren’t going to go to the meeting
o Shareholders are dispersed and may not be near the meeting, and
the shares may represent a small fraction of their wealth
o Why we have proxies
 They are governed by federal law
 Very different from state corporate law
 Form often trumps substance at state level, but that’s not the case here
o Why Federal Proxy Rules (Section 14(a) of the Securities Exchange Act)
 Accountability
 Management is the one seeking your vote
o Only officers and directors will be there
o Proxy solicitation – any attempt to obtain the right to vote
shareholders’ shares
 If you’re rationally apathetic you don’t even care
o To the extent that you do, you follow the Wall Street Rule
o Things are changing these days, less voting strictly with
management
 So we need some rules to put limits on them
 State law was inadequate
 Why federal stepped in
 State law was really about fraud – If management isn’t inclined to say
very much, just saying let us vote for you, then it’s not really fraud and
they can get away with a lot
 You would think it’s an internal state affair, but large public corporations
are a national concern and if states are dropping the ball, federal
government can step in with a uniform rule
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
Mandate adequate and accurate disclosure (14(a)3)
 Anyone engaging in a proxy solicitation must have full disclosure in
connection with transactions that shareholders are being asked to approve
o Adequate amount of information and it all has to be true
 By law proxy solicitation is defined extremely broadly
o Not just asking for proxies, but even friendly conversations could
count
 So the SEC had to carve out little situations like chatting
with friends
 Proxy Statement (Ex; on page 1417) – a disclosure document required by
federal law to be delivered in connection with a proxy solicitation
o Must contain information relevant to the vote
 Compensation information, conflicts of interest in
ownership stakes, etc.
o Must give relevant information on fundamental transaction on
which they have the right to vote, like mergers
o But it’s more than that, shareholders want to know about the
company, they receive information through the annual report
 Annual Report to Shareholders – Corporation must send an Annual Report
to its shareholders when proxies for the election of directors are solicited
on behalf of a corporation that is subject to Proxy Rules either in advance
of or concurrently with the proxy statement
o Balance sheet, describes the company’s performance, financial
conditions, in a number of ways
 Anyone seeking to come in, seeking to replace a director has
to tell shareholders all about themselves
 Since people can’t go to meetings, they’re like the
replacement to the meeting
 They have to tell you how they intend to vote
 Since it’s so close to you voting, we want to give
you all the information
o Also has to be accurate information
 Anti-fraud liability – the company will be held liable for the
information in the disclosure
 It has to be materially accurate
o Standard of materiality – If there is a substantial likelihood that a
reasonable shareholder would consider it important in deciding how
to vote
 “Might consider” was too loose
 Not outcome determinative, either, though
 There must be a substantial likelihood that the disclosure of
the omitted fact would have been viewed by the reasonable
investor as having significantly altered the total mix of info
made available
o Statute on Fraud (False or Misleading Statements) – 14a-9
 Prohibits false or misleading statements or omissions of material fact
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 You cannot lie or deceive, no misleading omissions, no half-truths
 Much more demanding than common law fraud
 Adequate and accurate information so that investors can then invest wisely
 Great idea to give people this information so they can decide how to act,
but people are still rationally apathetic
o It’s an efficient way of gathering information by putting it on the
company, but if people don’t have the incentive to pay attention,
then giving them the information won’t change things
 Even without people reading it, though, it can serve the function of
keeping people accountable
o Others might read it – institutional investors, analysts
 The terms are silent, but the SEC enforces rule 14a-9
 The SEC cannot adequately review proxy statements, there are too many
every year, and time doesn’t permit independent examination of each one
o So look to whether there is an implied cause of action to allow
shareholders to sue
 Cort v. Ash – In determining whether a private remedy is implicit in a
statute not expressly providing one:
o 1. Is the P a special beneficiary of the act?
 Yes – shareholders are
o 2. Was there legislative intent to allow shareholder action?
 No – They were silent on this
 New securities laws will sometimes say there is no private
cause of action
o 3. Would it be consistent with the underlying purpose of proxy rules
to imply such a remedy?
 Yes
o 4. Is this an avenue relegated to state law so that it would be
inappropriate to infer a cause of action based on federal law?
 Maybe, but it’s really been accepted as part of federal law
o They decide to allow an implied cause of action under the proxy rules
 Idea generally is enforcement, but we often don’t allow more enforcement of a
law, perfect enforcement is costly
 The mere fact that congress passed a law doesn’t mean they want it strictly
enforced and the low budget might even suggest they only want them to
enforce a certain amount
 J.I. Case Co. v. Borak – Supreme Court held that a shareholder could bring a
private action for violation of the Proxy Rules because it provides a necessary
supplement to Commission action
 Effective tool of enforcement
o Mills v. Electric Auto-Lite Co. – Claim that a corporate merger was accomplished
through the use of a proxy statement that was materially false or misleading, what
causal relationship must be shown between the statement and the merger to establish a
cause of action?
 Must be materiality, reliance, causation
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
Lower courts look to fairness for causation because then they can see if harm
was caused
 Supreme Court here doesn’t like that, they don’t really have anything to
do with each other, not really causation
 Recognition of the fairness of the merger as a complete defense would
allow the stockholders to be bypassed
 Materiality and Reliance
 Materiality, the defect must have a significant propensity to affect the
voting process
o TSC Industries, Inc. v. Northway later states that a material fact is
when there is a “substantial likelihood that a reasonable shareholder
would consider it important in deciding how to vote”
 Court holds that if it’s material we can assume the shareholders relied on it
o Now we’re saying if you’ve proven materiality, you’ve proven
reliance
o There’s a jump there – the kind of thing that could have been relied
on does not equal reliance, but the court is ok going there
 Causation
 Proof that the proxy solicitation itself was an essential link in the
accomplishment of the transaction
o If the votes were necessary, then we’ll say the material falsehood
caused the transaction
 Proxy solicitation caused the harm if you needed those votes
to get what you wanted
 No need to supplement it with whether the defect had a
decisive effect on the voting
o Just because it’s necessary doesn’t mean it’s sufficient
o They don’t mention what happens if the vote’s not necessary
 Footnote 5 – No need to decide (omitted in our book)
o Virginia Bankshares, Inc. v. Sandberg – Whether a statement regarding directors
reasons for recommending certain corporate action can be materially misleading under
14(a)-9 when the votes are not required by law or corporate bylaws
 Court holds that minority shareholders whose votes were not required for
approval of a proposed freeze-out merger failed to show that materially
misleading statements in a proxy statement caused injury
 Although not necessary, proxies were solicited and obtained for the “freeze-out
merger” being enacted, where minority shareholders would lose their interest in
the bank and be bought out
 Freeze-out – action taken by majority shareholders in a close corporation
to frustrate the expectation of minority shareholders
o Shareholders forced to give up their shares for money
 Not entirely unfair because minority shareholders are entitled to the fair
value of their shares
o They can seek an appraisal of their shares under state law if they
think it’s unfair
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



They got $42 a share from an appraiser, but it was actually worth $60 a share and
they knew it while telling them that it was fair and even high
 The directors have fiduciary duties to the shareholders, counting on them
to tell the truth and they have a duty to do so
 We might not care about the opinions of a car salesman, but we do care
about those of the directors
A board’s statement of reasons for approving a merger can be actionable
 Look to whether they really don’t believe the value was fair
o Maybe internal memos, minutes, emails, showing that they knew
the price was too low
o We are allowed to conclude that they must have been lying
o Here there was some evidence that they couldn’t have believed it
You can sue based on opinions but it also actually needs to be false
 To prove it is a false statement of material fact, have to have the objective
falsehood, that it is in fact a lie, not just that the opinion was
o An opinion can be a statement of fact subject to fraud liability
 Both subjective truth that I believe and also as an objective
statement that was not true – Has to be both
Causation
 Loss causation – a theory of causation requiring proof that the deception,
as opposed to unrelated circumstances, caused a loss
 Transaction Causation – a theory of causation requiring proof that the
deception caused the transaction which caused a loss (what the court
utilizes)
o Sounds a lot like reliance
o Because reliance and causation are supposed to be two separate
elements, people were increasingly coming to demand loss
causation (courts and legislatures)
 Don’t have to prove too much, just require an essential link
o If that was there, then that’s enough
Proxy solicitation was unnecessary in this instance – so why did they solicit?
 Plaintiff argues they solicited proxies for appearance, to avoid bad press,
to show they were included in the process and that their vote was thus “an
essential link” in the transaction and causation had been proven
o Court rejects this as speculative, they don’t want to get into that
kind of analysis
 Another element is that majority shareholder approval may have been
necessary as a legal defense
o If there’s a conflict of interest transaction, approval by a
disinterested party will cleanse the conflict of interest
 Not fully, but they’ll have a legal defense that it was
approved by minority shareholders
o Claim was that directors did have to get minority shareholder
approval and that shareholders lost the ability to challenge
 Court’s response
o Claim was that the shareholders are losing a remedy
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
Even though the vote wasn’t essential, the fact that they did
seek approval caused them harm because they lost the right
to challenge this merger much more easily
o They say it’s a logical non-issue
 If the company told the truth, you lose
 If as you say, plaintiffs, the company lied in seeking
shareholder approval, then shareholder approval was
uninformed
 Under the law, only informed shareholder approval
can be used as the defense, cleansing it
 Either was you don’t lose a remedy
o Rosenfeld v. Fairchild Engine and Airplane Corp. – Stockholder sought to compel the
return of money to the corporate treasury which had been used to reimburse both sides
in a proxy contest for their expenses
 Basic rule is that the corporate treasury pays the expenses of incumbents, win or
lose; insurgents get reimbursement only by winning
 Few cases on this grant the board wide discretion to authorize corporate payment
of incumbent’s voting related expenses
 They need only relate to corporate “policy” as opposed to “purely
personal” quest for power
 Any control or issue contest can be characterized as a question of how the
corporation should be managed, not who, so all incumbents’ expenses are
payable by the corporation
 Must be “reasonable” but no decision has denied incumbents full amount
 This case permitted reimbursement of the insurgent because the proxy contest
was over “policy” not “personality” and shareholders approved the payment
 14. SHAREHOLDER ACCESS
o How important is it that shareholders have access to the corporate proxy
 Argument against it is that shareholders don’t run the business, directors should
be running the business and shareholders aren’t experts
o 14a-8 is a proposal to enhance shareholder democracy (ICC says they have some say)
 Addresses when a company must include a shareholder's proposal in its proxy
statement
 Also includes a list of criteria pursuant to which a proposal can be
excluded
 Application
 The company applies the criteria, with shareholders making a proposal
and the company deciding if they feel they can exclude it
o If they do decide to exclude it, they have to tell the SEC about it
o If the SEC disagrees, they’ll tell them they have to include it
 Both have the right to pursue it because the SEC isn’t the final arbiter
 Criteria for inclusion
 You have to have a certain minimum holding
o $2,000 in market or 1% of the value
 Your proposal plus the description has to be 500 words or fewer
 Criteria for Exclusion – Proposals that may be excluded
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
Proposals on elections
o One of shareholders roles is to elect the directors, yet 14a excludes
elections, even suggestions for changing election rules
o *14a-11 now does allow election
 A proposal that is not a proper subject for action under state law
o If the proposal would cause the company to violate state law
o Anything shareholders can’t do, which seems to cover just about
everything else
 Proposals that deal with moral and religious issues are not excludable
o No state law that shareholders have a say here, but none that say
they don’t
 Commission has taken the position that significant social
policy issues of the company are generally not excludable
because the proposals transcend day-to-day business matters
o It’s allowed because if it’s something styled as a proposal for
director action, not as a mandate, then that is ok
 You’re asking the directors, not telling them
 Almost anything that is a mandate it against state law, but
proposals can maybe be accepted
o That is just made up, a strained interpretation of state law
 Proposals on minor matters that account for less than 5% of business
o Such a proposal can be excluded
 What about companies with a lot of small things under 5%?
 What about moral or political issues with no percentage?
 Proposals that deal with a matter relating to the company’s ordinary
business operations
o Roosevelt v. E.I. Du Pont de Nemours & Co. – Court holds that a
proposal From Friends of the Earth Oceanic Society could be
excluded because it related to the conduct of ordinary business
 The court held that a shareholder does have an implied right
of action under §14(a) of the Act and Commission Rule 14a8 when a company refuses to include the proposal
 SEC has taken a weird stance
o They decide when it’s worth discussion and not
o They don’t want all kinds of moral causes
o Fluctuated greatly throughout the years
 Have gone through periods of allowing a lot, then a little
o Today there are a lot of corporate governance proposals (less moral and political)
 Corporate governance – the entire body of rules and policies that relate to the
control the of a corporation; includes, among other things, state corporate law,
federal securities law, and corporate charter, bylaws, director resolutions, and
contracts
 Ex; proposals to eliminate takeover defense, to require more independent
directors, to require shareholder approval in more areas
 Should they be able to make these proposals?
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
One hand, getting involved in things they don’t have a right to get
involved in
 On the other, these aren’t about playing the game, but the rules of the
game
 A few types of corporate governance proposals have become increasingly
important
 Changing from plurality voting
 Voting up or down, or at least approval of executive compensation
 The right to nominate directors
 Should they have a say on pay of directors?
 Pro – They own the company, they should have a say
 Con – They might not be able to comprehend such salaries
o Shareholder Nominations
 Shareholders absolutely have the right to nominate directors, the question is
whether they can get that nomination onto the corporate proxy
 It was federal law that created a proxy rule system, but then said you can’t put
directors on the ballot (proxy solicitation)
 SEC has made various proposals to get shareholders the right to nominate
 Meanwhile Delaware passes Section 112 – Shareholders have the power to
nominate directors as long as it’s permitted in the bylaws
 Mostly a good provision, making it clear what they can do
 But it’s bad because this was already true, sort of like an opt in provision
that it says they can do it as long as it’s permitted in the bylaws
 Amending the Charter requires permission of shareholders and directors,
but shareholders have the ability to amend the bylaws
o Shareholders can amend the bylaws to put in a process for electing
directors, even if the directors don’t like it
 Not a very race to the bottom step (unless it’s just a strategic step)
 In any event too little too late – Federal law stepped in
 14a-11 passed to allow shareholder nominations, but very limited circumstances
 1. You have to be a 3% shareholder for 3 years
o We’re really talking about institutional investors and since a lot
don’t hold for that long a lot can’t
 2. Very few nominees that they can nominate – no more than 25% of the
nominees, but at least one
o Can’t replace the whole board
 3. Can’t do so with the intent to control the whole company
o Seen as a corporate governance maneuver
 If these are fulfilled, can include your nominees regardless of state law
o State law can expand it, one that gives more rights, but they can’t
come up with a regime that reduces the rights
o This is binding
o Moving beyond non-binding proposals to binding proposals
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
CA, Inc. v. AFSCME Employees Pension Plan – Shareholders want to amend
the bylaws to encourage proxy contests by refunding people who wage proxy
contests under certain circumstances – Can that proposal be excluded
 1. Is this appropriate action for shareholders under state law?
o Shareholders can amend bylaws
o §141(a); says directors govern except as provided in the Charter
 §141(b) the bylaws may contain any provision relating to
the rights and powers of directors, etc.
 They’re in conflict, but you can see §141(a) as saying it
includes provisions that say they can change the bylaws
 These exceptions perhaps create a loop
o Bylaws have to be procedural rules, they’re not substantive rules
 So if it’s a procedural rule that happens to affect director
power, that’s ok
 Not about business provisions, but corporate governance
 They said this was a procedural provision
 Amending the provision as a procedural rule is ok
 2. Does it violate state law?
o They still struck it down saying it was against the law
o The law says they are not required to reimburse insurgents
 Only if the directors think it’s a good idea
o They ultimately lost, doesn’t survive this challenge
o Risk and Return
 Risk and return are directly related
 Risk – Uncertainty; the possibility that future returns will deviate from
expected returns
 In order to make more profit you have to be willing to accept more risk
 If you want to make sure you get your money back no matter what you
won’t be taking the risk and getting higher returns
 Knowing an expected return tells you nothing about risk
 One type of risk is the risk created from leverage
 Leverage – The use of debt in a business
o More debt means more leverage
 The use of debt creates risk – It creates a greater potential for gain, but
also a greater potential for loss
 For a business
o Value $1,000,000
o Income $100,000/year
o Borrow $1,000,000
o Interest 7%, $70,000
 A = $200,000
o 70,000
o $130,000, 13%
o Making 13% instead of 10%
 B = $150,000
o $70,000
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o = $80,000 or 8%
 If we’re right we can make a lot more, or if wrong can reduce profitability
 C = $100,000
o $70,000
o = $30,000 or 3%
 Leverage creates risk pretty much for everyone
 Diversification reduces risk
 Process of reducing risk by investing in multiple places
 More likely among ten different companies to on average perform average
 Reduces the change that your actual return is going to deviate substantially
from your expected return
 But it won’t ever reduce it completely
 15. CLOSE CORPORATIONS
o Comparisons
 Public corporation
 Close Corporation
 Many shareholders
 Few shareholders
 Dispersed shareholders
 Close shareholders
 Diversified shareholders
 Invested shareholders
 Apathetic shareholders
 Involved shareholders
 Public information
 Personal knowledge
 Formal
 Informal
 Dividends
 Employment
 Easy exit
 Transfer restrictions
 Minority control
 Minority has no control
 Agency problem
 Abuse
o Public vs. Close – Not always a clear distinction
 Close corporation - a corporation with a small number of shareholders, or with a
few that have a controlling interest
 Public corporation - a corporation with many shareholders and which is required
to register with the SEC
 Many states have some form of formal close corporations statutory provision
 A close corporation can be considered a statutory close corporation (337)
o You have to affirmatively choose – elect to do so (§343)
 If you do that you have a set of provisions with less formality
 When people say just close corporation, they don’t mean statutory close
corporation
 It exists on the books but people who form close corporations don’t
always know about statutory close corporations
o Only a tiny fraction of new corporation elect to become statutory
close corporations
o General corporate law is usually very flexible
 Contractarian theory has had a huge impact
 DGCL §141(a) – Business of the corporation shall be managed by a board of
directors except as stated in the Charter
 Can take away some of the directors discretion
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
§142(b) – Offices may be chosen in any manner in the bylaws
§109(b) – Bylaws may contain any provision not inconsistent with law or the
Charter
 Sounds like it can change any provision
 §102(a)4 – Charter can specify the designations for different classes of stock
 Already a lot of provisions where you can shape the business
 Close corporations have the ability to change things with these exceptions, but
they don’t always know about them
o Control Arrangements in Close Corporations
 Class Voting
 Class A and Class B with different abilities
 One makes more decisions, one gets more money or any combination
 Can arrange affairs in line with classified stock
 Subject to few (if any) restrictions
 Nixon v. Blackwell – Ps were non-employee shareholders who argued that
the directors, who were all EEs, were improperly pursuing a liquidity
policy that favored EE-shareholders who could receive cash for stock
when they retired
o Court held stockholders need not always be treated equally and the
claim was without merit
 Irrevocable proxy
 One shareholder authorizes another to vote his shares, binding authority
o Expert can be given an irrevocable proxy and the financier can give
him his vote while he runs the business
 Key problem with proxies was that they were revocable
o Common law came up with a solution
 They are usually revocable at will but they can be
irrevocable if coupled with and interest in the business
 Haft v. Haft – Father gave son his stock, and in exchange, father got a
lifetime proxy to vote the stock
o Court held Father’s interests in the corporation by virtue of his
position as founder and CEO was sufficient to render it enforceable
o DCL§212(e), an interest sufficient to support an irrevocable proxy
must be either an interest in the stock itself or an interest in the
corporation generally
o Used to have to be an interest in the stock itself, but was amended
to allow an interest generally
 Working at the firm is enough of an interest
 Not really what was meant by coupled with an interest, but
they decided to be generous
 Voting Trust
 Plan which shareholders transfer their shares to a trustee for the purpose of
creating a voting block
o They come to an agreement and the trustee will vote how they tell
him to for a defined period
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o Trustee becomes a registered owner, has exclusive voting power
over the shares, but the dividends don’t go to him
o Trustee vote can be based on anything
 What the majority wants
 What one party wants, in which case it becomes like an
irrevocable proxy
 It was mistrusted at first and courts invalidated them because they
separated shareholders’ voting power and economic interests
o Eventually came to be accepted with limits
o Public disclosure required usually with the corporation
o Time limit, ten years is common
 Pooling agreement
 A plan in which shareholders agree to vote their shares together
o Shareholder, pooling, voting agreement are all the same thing
 Vote together based on majority, based on agreement, based on one party
o It’s a contract, they decide, formally or informally vote as a block
o Sometimes no one shareholder will have voting control and voting
coalitions are formed
 Difference in enforcement between this and voting trust
o Trustee understands the agreement and votes the trust for you
o Pooling agreement, you have to vote it, you can decide not to
 Modern trend is in favor of granting specific performance
for voting agreement
 It’s going to be difficult to figure out damages in many cases
 No requirements like a voting trust
o Same rules don’t apply
o McQuade v. Stoneham – Agreement between the shareholders to elect each other as
directors and officers, then two of the three refuse to do so
 D’s – directors must act in the best interest of the company, thus a contract to
compel them to keep a director is illegal
 P – they must keep him on as long as he is loyal
 Court – Stockholders may not, by agreement among themselves, control the
directors in the exercise of their judgment, contract was void
 They cannot just listen to shareholders
 Shareholders can still get together to decide to vote together but they
cannot go further and tell directors what to do,
o Cannot bind directors to certain decisions on selection of agents at
defined salaries
 Directors cannot pool together
 Even though they were the same shareholders who had decided to elect
themselves as directors, it wasn’t ok
 Deliver next best thing would have been to say to fire anyone who does not agree
to keep these directors on
 Don’t have to interpret it as binding the directors
 But binding the shareholders to do what we want them to do
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
Court could say that having made this promise, they were still liable for any
damages, or for fulfilling it as far as possible such as firing those who didn’t vote
for it (But that’s not the path that they went)
o Clark v. Dodge – Two years after McQuade, court holds the opposite, both in NY
 Agreement for position and salary between shareholders was held valid
o Galler v. Galler – Two brothers who owned a close corporation, entered into an
agreement that if one of them should die, their family would gain equal control
 Normally courts will focus on the fact that all shareholders party to the
agreement, if so, they’ll enforce it
 Here that’s not exactly the case, there was another shareholder, but he
wasn’t complaining
 Where no other minority shareholder is complaining, no valid reason for not
allowing coming to an agreement they want
 Traditional view you’re more inclined to see it as mandatory in which case
they probably don’t have the right to change
 If you’re a contractarian, you think people should be able to contract as
they see fit
 Isadore refuses an agreement to pay benefits to his brother’s widow
 Why should the agreement be legal?
 It’s compensation, not just a gift after the fact
o This is an agreement ex ante, you continue working, we’ll pay you
this other benefit
 This isn’t insurance – Benjamin is already ill when they make this
agreement (Factually speaking this really was a gift)
 General rule – in a corporation, shareholders can bind shareholders in an
agreement, but not directors
 But in a close corporation if all the shareholders are a party to the
agreement, the courts will uphold the agreement, will allow the directors
to be bound by the shareholders
o As long as there is no fraud, prejudice to creditors, or complaining
minority interest
o S Corporation – a close corporation that has elected to be taxed as a partnership rather
than as a corporation
 Federal law has created this
 You avoid double taxation, usually that’s pretty good, but not necessarily
 If one of the levels of tax is really low, it may not actually be good
 Ability to defer payments is also a benefit and in a partnership they have
to pay right away
 Some instances where it’s better to be taxes as a close, though usually
better to be taxed once
 Requirements
 Unanimous consent to become an S corporation
o Termination by a majority
 You have to have 100 shareholders or fewer
 All shareholders must be individuals (or states or certain trusts), people, it
can’t be a subsidiary
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 No shareholders may be non-resident aliens
 You can only have one class of stock
 16. FIDICIARY DUTIES OF CONTROLLING SHAREHOLDERS
o Most of the basic corporate-laws norms were designed with an eye to the publicly held
corporation and when applied to close corporations their expectations are often
frustrated
 As a result, many traditional norms can be overridden by an agreement in a close
corporation
o Donahue v. Rodd Electrotype – Sons, who have shares in the corporation, cause the
corporation to purchase their retiring father’s shares for $800/share
 The problem is that they don’t allow the minority shareholder to sell her shares at
this price and it’s not easy to sell shares to anyone else
 Generally speaking shareholders do not owe each other fiduciary duties
 They can behave selfishly
 However, here the Court holds that because of the resemblance of the close
corporation to the partnership, essential trust and confidence to the enterprise,
and danger to minority interests, they owe the same fiduciary duties to each other
as partners
 Court called the majority shareholders’ purchase of shares from a member of the
controlling group a preferential distribution of assets
 Really not like a preferential distribution, not like they’re giving dividends
to the majority shareholder that they’re not giving to minority
o Unless the price they’re paying is too high
o It might feel like a preferential distribution, but it’s different, just
the opportunity to get out of the corporation
o Wilkes v. Springside Nursing Home – 4 Decide to work together and after a while 3
decide to cut off the other, firing him as an EE since directors choose the officers
 No more salary for him but they still had to pay him the same dividends in theory
 But they don’t pay out any dividends
 The earnings of a close corporation don’t usually pay that much in
dividends, you’re expected to work there
 By terminating his employment or position as an officer or director, the majority
frustrated his purpose in entering the corporation and denied him an equal return
on investment – freeze-out
 What makes a freeze-out so dangerous, you’re investing in the business
without getting anything out of it
 Breach of fiduciary duty – 2 Part test
 1. Whether the controlling group can demonstrate a legitimate business
purpose for their actions
 2. Then it is open to the minority shareholders to demonstrate that another
course of action could have been conducted that would have been less
harmful to the minority shareholders
 Here, there was no legitimate business purpose, so don’t even get to prong 2
 The others could have fired him as long as they had a legitimate business
purpose
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
Even if you have a perfectly good business reason for firing him, the route with
less harm might be to buy him out
 A legitimate business purpose and a personal purpose might blend
together, hard to tell
o Zimmerman v. Bogoff – Says corporations still have a lot of room to do what they have
to do after Donahue
o Smith v. Atlantic Properties – D was a majority shareholder who refused to vote for
dividends and the company was fined by the IRS
 Court treated Wolfson as majority shareholder, held against him
 He only has 25% but they each have veto power and so for some relevant
purposes he is considered a majority shareholder
 Nothing like fraud or stealing here in the legal sense
 He wanted the company to reinvest because you have to pay taxes on
dividends, and he is rich, so doesn’t need the dividends (why he may be
seen as selfish)
 Can reinvest or pay dividends to avoid IRS penalties
 He argues that the others refuse to do all the repairs a engineer came in
and said could be done
o Penalty is there because you’re not using money
 But they’re potentially selfish for not reinvesting and repairing and also
because he’s not getting any benefit from the dividends
 They don’t care what he has to pay in dividends
 The penalties are the fault of both sides
 2 ways to avoid it and neither wanted to give in on the other
 It’s the unused cash that’s the cause of the penalties
 Are they really like minority shareholders here
 He has the veto power
 But in this case 40% of the voting power could decide to dissolve the
corporation
o Thus NOT really minority shareholders
o There was literally nothing else Wolfson could do while the others
could have dissolved the company
o Merola v. Exergen Corp. – P was a former VP and the corporation and former minority
stockholder, brought suit against the majority stockholder, alleging he violated his
fiduciary duties to the P by terminating his employment without cause
 Court holds that although there was no legitimate business purpose for firing
him, neither was the termination for the financial gain of the majority
shareholder or contrary to public policy
 Not every discharge of an at-will EE who owns stock gives rise to a
breach of fiduciary duty
 Also, here, he’s really an EE, not really a partner (other cases they were partners)
 Shareholders who are essentially partners should be treated like partners
and get partnership-like fiduciary duties
 The case for him being like a partner
o He took on the position with the expectation of becoming a majority
shareholder
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
Case that he wasn’t a partner
o He’s not a founder (not necessary, but a factor)
o Didn’t have quite as big a share as the other cases
o No real tie between his salary and his stock shares, he was really
employed
o He was nothing more than an EE, no special relationship
o No evidence he was required to buy stock as part of employment
 Shareholders in close corporations do not all have fiduciary duties to all the
others
 It’s just the ones that have partnership like roles
 Not for just EEs that aren’t like partners
 17. VALUATION AND THE EFFICIENT MARKET HYPOTHESIS
o Commodities and Special Goods
 Commodities – Products that are abundant and fungible, e.g. produce
 Laws of supply and demand get us the right price for things like apples
 Don’t have to worry about what it costs, the market tells us
 Special goods – rare or unique items, like land, each parcel is different
 Not always going to be easy to value them, especially if they’re not for
sale
 Can maybe get an expert to appraise it
 Or might have an auction to see what people are willing to pay
o Not going to be the highest price that anyone is going to pay, the
highest price someone is going to offer
o You’re going to get the second highest price plus a topping bid
o But it’s a pretty good indication of the value
 Corporation itself is like a special goods
 But the stock for a corporation can really be a commodity
 If a strong market for an asset then it’s regulated by supply and demand
o What makes a strong market?
 1. Liquidity – the ability to buy or sell quickly
 2. Availability of information – Need a lot of information to buy and sell
 In a public corporation we do have that, federal laws require disclosure of
information, but not for close corporations
 3. Efficiency – ability to buy and sell shares cheaply
o The efficient market hypothesis tries to deal with the question how strong are markets
 Efficient market hypothesis – Theory that in a strong market, such as the US
capital markets, prices quickly reflect all available information
 Does not mean that prices are accurate, but it’s probably the best guess as
to what securities are worth at any given time
 We have so many buyers and sellers analyzing the company and engaging
in transactions that their combined efforts will produce an appropriate
value
o 3 Forms of the Efficient Market Hypothesis
 1. Weak form – Current prices reflect all past price information such that you
cannot beat the market by looking at trends
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

A falling or a rising price, even if it’s an all time high or low is not a good
reason to buy or sell
o Generally speaking, stock prices move up
o But around that upward trajectory, stock prices move randomly
 It’s generally accepted as true
o The proof is that stock prices move randomly
o New price unrelated to old price
2. Semi-strong form – Current prices reflect all publicly available information,
past and present
 As a result, you can’t beat the market through fundamental analysis
o If I learn a company is doing well, it’s probably too late
o By the time it gets to you, it’s old news
o So many analysts that know before you that they drive it up
immediately
 Generally accepted as more or less true
o Not as strong as weak form
o Proof would be random price movements
 New information is random so it supports this notion
o But we also have experience, which tells us that mutual funds, etc.,
consistently beat the market
 Few do for a long time
 Even if there are a very few that always do, there’s a chance
these investors are lucky
o Or they may not be beating the market at all if you adjust for risk
 Every year they may beat the market by a few points, but if
you’re taking twice as much risk as others, and making the
same gains, you not winning out
 Efficient market hypothesis is generally known as semi-strong
o Seems impossible to have an efficient market
o Have all this information, fundamental analysis, but you can’t beat
the market
 But without all that you can’t have an efficient market
 Depends on analysts who know they can’t beat the market,
but try
o Equilibrium level of disequlibrium – analysts can make just enough
money to compensate them for their efforts
 When the market becomes more efficient, can’t do this as
much, analysts drop off, then the market isn’t as efficient
and more analysts come along
 If nothing else, maybe someone can beat the market, but not us
3. Strong market - Current prices reflect all available information, whether it’s
public or private
 If it’s true, then you can’t beat the market even with inside information
o If you have inside information on a company, it’s already too late
o Other people know it and they’ve affected the stock price
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
Insider trading – the use of material, non-public info in trading the shares
of a company by a corporate insider or other person who owes a fiduciary
duty with respect to such information
 This hypothesis is not accepted as true, more of a theoretical stake holder
o Public information should not affect the stock price, by that time it
should be a non-issue
 The fact is, announcements do affect so this hypothesis can’t
be correct
 Investment then just sounds like it’s gambling your stocks do well
 But if you diversify, then it’s not like gambling
o Then more like an investment than gambling
o Lessons for investors
 First, don’t try to beat the market
 Maybe someone can beat it, not us
 Have to not just be pretty smart, but smarter than anyone
 Diversify – Buy into mutual funds that diversify for you, but not without
knowing more
 There are those that are actively managed, paying someone to try to beat
the market for you
 Index funds passively invest in the market, not trying to beat it, just make
the market return
o Efficient market hypothesis says invest in these – you’re going to
save the cost of paying someone to try to beat the market who can’t
 These two should do the same, earning the same in the long run
o The difference is you have to pay a fee to the actively managed and
transaction costs and taxes on those transactions, so you earn less
o Close corporations
 Don’t have a market with supply and demand to tell us what things are worth
 Old Man and the Apple Tree
 First offer of 50$ for the worth of the wood – salvage value
o A method of valuation
 Going concern value and liquidation or salvage value
o What it’s worth as a tree with apples or as firewood
o Generally going concern value will be higher
 Next offer of $100, which is worth this years crop of fruit
o At least he’s considering a productive use of the tree
o But it’s going to make apples for more than one year, so not enough
 Next of $1500 because it should live for 15 more years
o 15 years productivity, for the rest of its life
o But didn’t consider the time value of money
 Dollar today is worth more than dollar tomorrow
 $1500 since the last person offered it so that must be the market price
o Some intuition in that, willingness to pay is an indication of value
o But that doesn’t mean you take one person’s willingness to pay as
the value
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o Great reality check on theoretical value, but not just anyone’s
willingness to pay
 $75 which reflects the book value (assets – liability = equity)
o But that doesn’t equal market value
 $225 which counts earning
o Revenue – expenses
 $270 which he offers and is discounted cash flows
 Lots of methods people might use in valuation
 Any could lead to the right result, but some are more likely to, and any
method can lead to the wrong result
 Valuation is a difficult game
 Should have some sense of it, going to affect your transactions
o Dot.com Bubble and the Crash of 1987
 People attributed the run-up in prices of dot.com companies to “irrational
exuberance”, arguing that as the bull market developed, it generated optimism
about the future and stimulated demand
 But if individual investors were carried away, why didn’t professional
investors step in and force their prices down?
 Crash of 1987 demonstrate the difficulty of valuing common stocks from scratch
 1. Investors almost always price stock relative to yesterday’s price,
adjusting up or down, but when investors lose confidence in that price
there may be a confused period before a new benchmark is established
 2. The hypothesis that stock price equals intrinsic value is nearly
impossible to test, so the crash didn’t conclusively disprove the
hypothesis, but many now find it less plausible
o Piemonte v. New Boston – P’s were stockholders in a corporation whose stockholders
voted to merge with the defendant corporation in circumstances which entitled each P
to demand payment for his stock from the resulting corporation and an appraisal
 Parties raise objections to the judge’s conclusions, Court holds that the judge
followed acceptable procedures, but that there are instances where he may have
been in error
 Judge used the Delaware Block Approach – a method of valuation which weighs
three different techniques (market value, asset value, and earnings value) to
determine the value of a business in a judicial proceeding
 On the theory that each of them individually might not be the right price,
but all 3 might give a better idea
 Don’t have to know how – Not our job and no longer used in Delaware
 This was a method they used for a long time, but no longer
 Need some messy calculations to figure out close corporations
 18. TRANSFER RESTRICTIONS AND BUY-OUTS
o Transfer Restrictions – A charter provision or agreement that restricts a shareholder’s
ability to sell her shares
 Might be to keep a family business in the family or among a group of friends
 Problems with transfer restrictions is that they might undermine control, you
might not be able to sell if you want to, you may not get full value of shares on a
transfer
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
Modern cases hold that “reasonable” restrictions are valid and enforceable
Common types
 First refusal – shares must first be offered to corporation on the terms the
third party offered
 First option – shares must first be offered to the corporation at a price
fixed under the option
 Consent restraints – prohibits a transfer of stock without the permission of
the corporation’s board or shareholders
 Mandatory sales give the corporation or remaining shareholders option to
purchase upon one or more contingencies
 Ex; option to repurchase stock from an EE when fired or upon death
 Pricing provisions – problem that in a close corporation, price of the shares
cannot be set on the basis of market value
 Book value – may be unreliable because it reflects historical costs of assets
rather than present value and ignores good will value
o But not sufficient enough to avoid book value provisions
 Capitalized earnings – fix the price on the basis of a multiple of earnings,
less likely to produce an unfair price than book
 Periodic revisions – agree on a price that is subject to periodic revision at
agreed-upon intervals
o Buy-out Agreement – An agreement that allows or requires a partner or shareholder to
end her relationship with the other partners or shareholders and receive a cash payment
in return for her interest in the business
 Benefits – Might want them because it gives control
 To solve problems, depending on the terms of the buy-out
 Potentially liquidity if the shareholder wants out
 Problem with buy-out agreements is the you might be stuck
 Pricing might be a problem
o F.B.I. Farms, Inc. v. Moore – Family forms FBI, Moore divorces Linda, one of the
children, and is awarded monetary judgment, with Linda getting all the shares, Linda
never satisfied the judgment and a sheriff’s sale commenced to sell the shares in the
farm, where Moore bought them
 But there was a provision in the Board minutes that if any stock be offered for
sale, the farm had the first opportunity to purchase the stock
 Right of first refusal – an agreement providing that, before a shareholder
can sell her shares to a third party, other shareholders would have the right
to buy such shares at the price at which they would have been sold to the
third party
o Corporation tried to cancel the transaction and claim the right of
first refusal
 He thought maybe the restrictions wouldn’t apply
o One claim was that he was not a voluntary participant
o Another was that the restrictions were manifestly unreasonable
 At common law, any restraint on property was not allowed
 We might want to not allow restraints if it’s scarce, want to give it to
people who will utilize the land, to stimulate commerce
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
Ownership should mean the ability to sell
But most transfer restrictions are legal
o It’s not just ownership of property, it’s maintenance of a
relationship in a corporation
o But they have to be reasonable
o It’s done by statute, so the ways and times statutes allow it
 The corporation loses on right of first refusal because they’re not self-executing
 They knew that she was going to sell the shares and didn’t say anything
 Court interpreted it as having the right of first refusal and failing to
exercise it
 Court holds the Board of Director Approval requirements are legal
 Plaintiff says these are unreasonable since he was divorced and there was
a breakdown of the group, have to be designed to serve legitimate purpose
o But if you look at the whole thing, maybe this is what the point of
such restrictions are about, from point of view of the family
 Court doesn’t accept the unreasonable argument
o Reasonableness of a term of contract is evaluated at the time of
adoption and it was reasonable when they entered into it
o You don’t generally get out of a contract because circumstances
have changed
 If it is a valid contract that doesn’t mean that enforcing it is going to be
consistent with good faith and fair dealing
o But the point of restrictions might be to deal with family dealings
 Plaintiff says they shouldn’t apply to involuntary transfers and the sheriff’s sale
was involuntary
 If it’s involuntary, the person you’re seeking to bind was never party to it
in the first place
o It’s not so obvious that a person should be bound by a provision that
they didn’t agree to
 Intent of the corporation was to restrict voluntary and involuntary transfers
o But the court partially agrees that it shouldn’t apply to involuntary
transactions
o Sometimes an involuntary transactions can be voluntary
 Ex; someone dying, you could think of it as voluntary if
they have it in their will or given it when they’re alive
 Not having a will is in a sense voluntary
o The kind of involuntary transaction that would be ok to get around
this would be divorces, perhaps shouldn’t be binding
o But he didn’t get the shares in the divorce
 If he had then maybe it would have been involuntary
 He went and voluntarily bought the shares – it was a voluntary transaction
o So he can’t now complain that the restrictions shouldn’t bind him
o Evangelista v. Holland – Shareholder agreement that the company could buy out the
estate of any deceased shareholder for a set price, sought to enforce it, even though
there was evidence that it was worth over double
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
Court held for the corporation, there was a mutuality of risk when they entered
into it and such agreements may have purposes
o Gallagher v. Lambert - EE bought stock as an employment provision with the
restriction of a mandatory buy-back provision, he has to sell it back if terminated for
any reason, and he is an at-will EE
 The company fires him just before the date on which the buy-back price would
have been higher
 Price of the buyback is book value
 Issue with that price is that the price after January 31 would be a lot more
 He is fired for no good reason, no business related reason
 He claims that he was fired because if they kept him on the rest of the
month, they would have to give him the 3 million
 Majority claims it shouldn’t matter, they don’t even give much time to it
 He got what he bargained for in an at-will contract
 Dissent claims there is an implied covenant of good faith and fair dealing in
every contract
 Doesn’t mean you can do everything you want in at at-will contract
 Other claim is that there is a fiduciary duty of good faith because he is a minority
shareholder
 If essentially partners, they have fiduciary like duties
 So maybe it depends on whether he was essentially a partner
 He’s the third largest shareholder, but it doesn’t seen like he was a founder
o Tough call (though not for the court it seems)
o Jensen v. Christensen & Lee Insurance, Inc. – Wisconsin court held an EE didn’t have a
claim for wrongful discharge because the state limited such actions to those that violate
public policy
 But they held that he may have a claim that the directors had beached
o Jordan v. Duff and Phelps, Inc. – EE is under a contract that says he has to sell back his
shares if he is fired or quit, he quits for personal reasons and later learns that
negotiations for a merger were in process, but hadn’t been disclosed to him beforehand
 Buy-out agreement was the book value at the end of the fiscal year, so he stayed
on until the end of the year and got more money
 But in January the company had a merger that increased the value
 Generally there is no duty for the company to tell him anything
 In this instance they focus on them having a duty to disclose information that are
material facts
 They don’t have to give you information as shareholders but they do have
that duty if they’re trying to get you to act
o Could say they’re not trying to deal with him, he’s just quitting,
forcing them to take the shares
o Or that there is no fiduciary duty because he isn’t in the role of
being like a partner
 What about them transacting
 Fiduciary duties to shareholders when they’re transacting
 What if the merger is not complete
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
Could be problematic to have a rule that forces companies to tell quitting
EEs about secret moves of a company
 In the end, the merger fell apart and there was no deal
o Worked out 3 years later
 He didn’t win on remand
 They said he had to prove that he would have dropped his plans to move
and would have stuck around for 2 more years until the third merger
attempt – no way to really prove this
o Take-along right - an agreement providing that, before a shareholder can sell her shares
to a third party, other shareholders have the right to sell their shares to such shareholder
at the price at which the shares would have been sold to the third party
 Have to take the other shareholders along
 It’s about liquidity – If one person is able to negotiate a good price to get out,
other who might be stuck should be able to go along with that price as well
 Might also want it because you don’t know if you can trust a new person as
potentially a controlling shareholder
 Problem with it is that it can make transactions a lot more difficult
 Might destroy opportunities for transactions to go through if someone only
wants to buy a limited amount of stock
o Right of first refusal – Can easily be bought by minority shareholder as well
 Potentially for the same reason they want take-along – don’t want another
majority shareholder they might not like
 19. CORPORATE DISSOLUTION
o Charter Amendment
 Not what they were made for, but they can allow for dissolution
o Shareholder Vote
 In most states, shareholders can vote for the dissolution
 Often it’s a super-majority vote
 In NY now it’s a majority
 Some will require director approval before
o Judicial Decree
 Why seek a judicial decree if the shareholders can vote – there’s not a majority
 Allowed to dissolve it for 3 types of reasons
 1. Waste of corporate assets
o If it really just can’t be run properly, the court will consider just
dissolving the business
 2. Deadlock – inability to obtain the votes for any action
o Not just for dividends, has to be any action at all
o Usually 50% of the shareholders can seek dissolution
 On the theory that that proves deadlock
o Sometimes states will allow minority shareholders
 Sometimes minorities can cause deadlocks
o Ex; NY Law §1004 – Half the shareholders can seek dissolution for
deadlock, or if there’s a super-majority provision, then 1/3 can
 Problem – super majority could be any percent
 3. Oppressive Conduct
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o 1. Illegal or wrongful conduct – violation of an explicit right
 May be difficult to prove, but an easy case
 High standard for the P
o 2. Good faith and fair dealing
 Can reach some subtle forms of misconduct
o 3. Reasonable expectations
 Frustration of the reasonable expectations of shareholders
 A lot less than the violation of an explicit right
 Not a mere hope, but a reasonable expectation, objective
o Varies from state to state
o The law is becoming increasingly liberal
o Judicial Reluctance
 Court have historically been hesitant to order dissolution
 Bad social policy to shut down a profitable business
 Over time it was realized that’s not a very reasonable concern
 Order of dissolution doesn’t have to shut down the business and mostly
doesn’t shut down the business, even partnerships
 Can sell the business as a whole, a going concern
 Courts can determine alternative forms of relief
 Mandatory buy-outs (usually majority buys out minority, but not
necessary)
 Can just sell the business as a going concern, don’t even have to order a
mandatory buy-out
o Matter of Kemp & Beatley, Inc. – 2 former EEs of a corporation, one leaves, the other
is fired, bring suit because they still hold stock and whereas before they all received
distributions of the company’s earnings, they no longer did – seeking dissolution
 Claim is that fraudulent and oppressive conduct rendered the stock virtually
worthless; dissolution is permitted when controlling faction is guilty of
“oppressive conduct”
 This statutory language sounds stricter than reasonable expectation
 Court interprets oppressive conduct as conduct that substantially defeats
“reasonable expectations” held by minority shareholders
 Oppression should only be deemed to arise when the majority conduct
substantially defeats reasonable expectations that were central to the
decision to join the venture
 Court holds it’s not unreasonable for a fact finder to determine their change in
policy regarding dividends amounted to an attempt to exclude petitioners and
constituted oppressive action
 Court looks for other possibilities, they don’t necessarily want to order
dissolution
 They have broad ability to issue alternative relief, but shouldn’t hesitate to
order dissolution when appropriate
o Meiselman v. Meiselman – Many close corporations are based on personal
relationships that give rise to certain “reasonable expectations”, but these become
difficult to fulfill if relationships break down
 Majority then has the opportunity to exclude minority
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
o
o
o
o
o
Interests must be determined by “reasonable expectations” which are known or
assumed by the other shareholders
 Also, close corporations shareholder rights are not as narrowly defined as in a
publicly held corporation
 This can change over time
The Duties of Care and Loyalty in Closely Held Corporations
 These duties are often insufficient in close corporations where actions that treat
shareholders unequally or defeats legitimate expectations found in close
corporations, but not public
 “Reasonable expectations” analysis fills that gap in corporate law
MacCallum v. Rosen’s Diversified, Inc. – Minority shareholder, who was a director and
CEO, is fired and wants to redeem his shares but they cannot agree on the price
 Remember previous case that said EEs are not always given fiduciary duties
 Or only essentially partners have partnership like duties
 Factors to consider how he’s treated
 His position, his having under 3%, the fact that he was a “key” employee,
almost entirely successful for the financial success of the business
o But even a very important EE is still an employee
 Doesn’t sound like a very persuasive argument
 Court finds for McCallum, remand for determining the fair value
 They say his reasonable expectations at the inception were defeated
 Terminating a CEO, as opposed to an EE without a significant role in
management, then offering to redeem his stock at that price was
sufficiently unreasonable
 They just fired him, didn’t fire him then offer a low price on his stock
 He said they should buy him out, wasn’t a company policy
 Court’s reasoning suggests it was because they fired him and gave him a
low-ball price
o Suggesting they could just fire him and not offer a low-ball price
 By making the counter offer, which can be seen as a nice thing to do,
might be evidence of a freeze out
 What may seem generous to you, might not seem to the fact finder
Mullenberg v. Bikon Corp. – Minority shareholder sued the majority on grounds of
oppression, Court agreed and gave him the option of buying out the majority
 Courts are not limited to statutory remedies
Dissolution – Minority shareholder petitions for dissolution are commonly just a trigger
for requiring a mandatory buy-out of the minority shareholder’s stock
 Courts often hold that grounds for dissolution exist and then order a mandatory
buy-out
Charland v. Country View Golf Club, Inc. – Minority shareholder sought dissolution
because one of the officers was engaged in illegal activities, they opt to buy him out
 The parties couldn’t agree on a price, so they went to price to seek evaluation
 Minority discount – a reduction in the pro rata value of a company due to the
lack of power held by minority shareholders
 Even though their economic rights are the same, their voting rights are
very different in minority and majority shares
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
Minority shares are worth less on the market and the discount takes this
into account
 But if the entire company was going to dissolve there wouldn’t be a
minority discount, just get your pro-rata value
o Should the baseline be selling shares on the market or the company
being sold?
 Marketability (liquidity) discount – a reduction in the pro rata value of a
company due to the lack of a market for the company’s ownership interests
 Don’t have to worry about it in a public corporation
 But that would affect everyone equally and should already be taken into
account in the underlying price of the company
o The court seems to view it as only something that affects the
minority shareholders
 Unfair to include either discount
 Starting with the premise that there is some wrongful conduct going on,
someone is alleging they’ve been harmed
o The one causing the harm would gain the benefit of the misconduct
o Might tempt people to make you want to dissolve the company and
pay you less to kick you out
 Court says there should be no discount
o Brodie v. Jordan – Widow receives her husband’s share of a close corporation and is
being frozen out; not allowing participation of any kind, no access to any information,
not getting any payments
 Most lenient standard is reasonable expectations
 She didn’t expect a job at the corporation or to be part of it, didn’t even
argue that she did, the company didn’t pay dividends
 Her reasonable expectations couldn’t have been that much
o Possibly the ability to sell
 In many close corporations people expect money, but they work for it
o Her husband got money, but he worked for it
 Assuming that’s the case what can she expect?
 Maybe the court should have framed it in terms of his expectations
o Wouldn’t she inherit the right not to be frozen out from him
o He asked for a buy-out while working there and they said no, then
voted him out and he stopped getting paid
 Proper remedy for a freeze out according to this court is that the shareholders
should be put in a position as if there had been no wrongdoing
 Pretty usual remedy, certainly for contractual violations
 Whether it’s the remedy for torts is a dicey question
o There was wrongdoing, so should we allow people to commit
wrongs and only pay if they get caught
o Court is worried about a windfall, but maybe that’s better since they
committed a wrong
 Court’s holding as to the remedy was ordering damages
 She didn’t have an expectation of being bought out or having a job with
economic rights
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
Hard to imagine what the damages will be, even if calculated, the problem
won’t end
 Ongoing relationship that would have to be monitored by the court, not an
ideal situation
 Without requiring them to buy someone out if they just die, there’s no ability to
then sell those shares – What do the heirs get?
 Nothing seems to be as wrong an answer as everything
 20. DUTY OF CARE & BUSINESS JUDGMENT RULE
o What should a fiduciary duty of care mean?
 Could be that you take reasonable steps to make sure it is well managed
 Making sure you make decisions to the best of your ability
o Francis v. United Jersey Bank – Creditors sue Pritchard because her sons took money
from the corporation, is a corporate director personally liable for failing to prevent the
misappropriation of trust funds by other directors? - Yes
 Directors have a duty to be knowledgeable about the business
 Not detailed inspection, just general monitoring
 It may not itself uncover wrong doing, but might lead to suspicion and a
duty to inquire further
 Directors are making decisions about running the business, and should
know about what’s going on
 If she does discover anything she has to take steps
 Steps to stop the misconduct
o Object and if that doesn’t work, maybe file suit
 If you try to do these things and they don’t work, should resign
o Not the ideal solution, but they may have to
 Generally directors are accorded broad immunity and are not the insurers of
corporate activities
 But NJ laws says directors have to discharge their duties in good faith with
diligence, care, and skill of ordinary prudent men
o She was a director in name only, by any standard she will have
breached her duty of care
 But did that cause the plaintiff’s loss?
 Idea is that she’s a but-for cause
o Her negligence was a substantial factor in causing the loss
 We certainly could have causation, but could easily not have it
o The court here doesn’t want to speculate, she did nothing
 Legal basis for not being sympathetic is she is a director, if she didn’t
want to be one she could have quit
 Shareholders are the ones owed fiduciary duty
 But those are her sons, likely going to waive it here
 Creditors are the ones suing here how?
 Could have been based on insolvency
 But here it’s based on the fact that this is more like a bank, which owes
fiduciary duties not just to shareholders, but creditors
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o In re Emerging Communications, Inc. Shareholders Litigation – Court held D could be
liable because he had specialized knowledge, which imposed a duty on him
 His specialized financial expertise made it incumbent on him, as a fiduciary, to
advocate the board reject a price he knew to be low
o Causation
 Issues where (1) the violation is an omission and (2) where the board acted, can
an individual be excused because the result would have been the same if she
acted differently
 Barnes v. Andrews – D violated his duty of care by not paying attention to
corporate affairs but that the Ps had to prove that the losses would not
have occurred if he had properly performed his duties – no such showing
o Kamin v. American Express Co. – Derivative shareholder action, company gives out
dividends of stock of failing company they own, shareholders wanted the company to
take the hit and sell the stock because they can save 8 million in taxes by doing so
 Company’s argument that taking a 25 million dollar loss is going to hurt the
financial statements and the company
 But it doesn’t matter what the financial statements say, people know
 Shareholders would rather the 8 million as a savings
 But a lot of time people will act as if the financial statements matter
o So you can’t throw it away completely
 The court ends up being deferential
 They are allowed to exercise their honest business judgment, and mere
errors are not sufficient
 Dividends are exclusively a matter for the board of directors
 They are not above review entirely, but the court says it has to be more than a
bad decision
 Beyond fraud, etc., maybe a conflict of interest
 Directors could have been playing with the financial statements to increase
their own salaries, which are dependent on the financial statements
o But court says most weren’t conflicted
 Default rule is that the courts follow the business judgment rule and exceptions
from that should be rare
 But how do we reconcile the Pritchard case, going on about the duty of care,
with the this case, which seems to be pretty deferential
 We can reconcile them with the divergence of standards of conduct and
standards of review
o Standard of Conduct and Review
 Standard of conduct – a legal rule, addressed to an actor, that states how the
person should conduct a given activity or play a given role
 Standard of review – a legal rule, addressed to the courts, that states the test by
which an actor’s conduct should be reviewed to determine whether judicial relief
should be granted
 They are often the same, but they diverge in corporate law
 Standard of conduct in corporate law is you have to act as an ordinary,
careful, and prudent person in similar circumstances or in the management
of their own business
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o A lot like standard tort language of ordinary care, avoid negligence
 Standard of review is the Business Judgment Rule – A legal doctrine that
protects business decisions from judicial review; in Delaware, a
presumption that, in making a business decision, the directors of a
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
o It protects business decisions from judicial review
o If you have an informed basis (careful part)
o In good faith (as long as not acting in bad faith)
o Rational (does not mean reasonable, people could differ on what
reasonable means)
 If the business judgment rule applies, management (almost) always wins
 Two components to it
 Substance and process components
 Substance – offers almost complete protection
o If you’re trying to challenge the substance (we should have gone
with widgets, rather than gadgets), you will lose
o The standard is waste, irrationality, no one could have though that
was a good idea
 No win situation, you’re going to lose
 Process – Here you have (barely) a chance
o If you’re challenging the process (you didn’t spend enough time
thinking about that, didn’t consider other things), the deference is
still pretty strong, but it’s not guaranteed you’re going to lose
o Based on gross negligence
 Standard of care is negligence
o Applied as avoiding negligence
 Standard of review is gross negligence
o You should avoid negligence, but we’ll only hold you liable if you
were grossly negligent
 Why this divergence of standards of conduct and review?
o Justifications
 Statutory grant of Authority – Section 141(a): Directors manage corporations
 Not shareholders or courts
 Let’s leave the decisions alone as much as possible
 Business is risky – results do not tell us much about quality of decisions
 Second-guessing after-the-fact
 You can make a very good decision and it just fails
 Management is an art, not a science
 Assumption of risk by shareholders
 You can get rid of that risk by investing in multiple businesses
 By not diversifying, you’re accepting that risk
 Incentives for business people
 Willingness to be a director can be affected if you’re going to be held
liable
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o They don’t make that much money and are going to be put on the
line for the failure of a business
 Have to shield them from that
 Even if they were willing to take on being a director, then maybe they
wouldn’t take risks in business
o Why take that risk if they can be sued if wrong
o We want businesses to take risks and so we have to provide
protection from liability
 Spreading costs
 Normally when we hold someone liable, it’s a form of insurance to hold
the company liable, who can then spread out the cost by a rise in price
 Here it would work the opposite
o Shareholders each lose a small amount, but aggregated can have a
billion dollar cost against a few directors
 Instead of spreading cost, you’d be concentrating it
 Courts are not business experts
 They don’t know what they’re doing for the most part
 Courts aren’t all like Delaware who hears lots of business cases
o But even there they know they’re not business experts
 For all these reasons, we say we ought to have this divergence
 But do corporations really deserve a rule that is special from about every
other area of law?
o Possibly because in business we affirmatively want to take risks
 Versus medicine where we would like there to be no risks
 Investing our surplus in business, but our lives in medicine,
so we don’t want our doctors trying to take lots of risks
o This gets debated a lot
 21. DUTY OF LOYALTY & ENTIRE FAIRNESS TEST
o Guth v. Loth – Key duty of loyalty
 Corporate officers can’t use their positions of trust and confidence to further their
private interests
 Rule demands of corporate officer or director the most scrupulous observance of
his duty, not only to protect the corporation, but refrain from doing anything that
would injure it
o Once upon a time is was the case that you couldn’t have a conflict of interest at all
when conducting business, it was automatically voidable
 Thirty years later this rule changes
 Valid if approved by a disinterested majority of directors
 By 1960, general rule that no transaction was automatically voidable, whether
there was a disinterested majority or not, but would give it more scrutiny and see
if the transaction was fair
o Lewis v. S.L. & E. – Donald refused to sell his shares under the agreement he and his
brothers had entered into because he claims they had wasted the assets of the company
by charging too low of a rent and thus losing profits they might have made
 It was originally perhaps a good lease for ten years
 Lease expires and they continue it
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
o
o
o
o
They don’t get the business judgment rule
 1. There’s a conflict of interest with the directors
 2. The rule requires a business judgment and according to the brothers,
they never even gave it consideration
o If you don’t make a decision you can’t claim the business judgment
rule, and here any profit being lost by the company was being made
by the other company they owned that rented the property
 Didn’t matter to them who made the profit
o It matters to the plaintiff who had no shares in the other company
 The burden of proof is now on them to prove the rent was fair and reasonable
 They didn’t meet that burden – it was only covering expenses
 Remanded to determine the difference between the fair rental value and what
they charged, added to the book value, so no penalty to the directors
 Theoretically encouraging this type of behavior by not really penalizing
 Book value is usually lower than market value, but the shareholders
already agreed to sell according to book value
Remedies for Violation of the Duty of Loyalty
 Remedies for such a violation are usually restitutionary
 Result of this is that the legal sanctions for violation of the duty of loyalty are
usually much less severe than the legal sanctions for violation of the duty of care
 For violating a duty of care, must pay damages although he made no gain
from the wrongful action
 For violating duty of fair dealing, need only return a gain to which he was
never entitled
 But there are some cases where remedies for duty of loyalty make the director
worse off
Note on the Duty of Loyalty
 Fairness requires not only that the terms of a self-interested transaction be fair,
but that it’s in the corporation’s interest
Note on Associates of Directors and Senior Executives
 An enterprise or individual that a director or senior executive has a significant
relationship with is referred to as an “associate”
 If the director negotiates with the corporation on the associate’s behalf or
advances their interest, the same rules of conduct should apply to D as if
he had acted on his own behalf
 The associate knew or should have known he was participating in a breach
of fiduciary duty, he would be liable as an aider and abetter
Sinclair Oil Corporation v. Levien – Derivative action by shareholders who sue Sinclair
to account for damages sustained by its subsidiary, Sinven, which is engaged in
petroleum operations in Venezuela
 Basis for fiduciary duty is that they are majority shareholder
 Levien owns 3%, Sinclair 97%
 Because of Sinclair’s fiduciary duty and its control over Sinven, its transactions
with Sinven must meet the entire fairness test
 High degree of fairness and shift in the burden of proof to Sinclair
 Sinclair argues it’s the business judgment rule
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
But the court holds that when the situation involves a parent controlling
the transaction and fixing the terms of the subsidiary, and the parent
receives a benefit the test of intrinsic fairness applies
 In order to invoke the Entire Fairness Test, there needs to be self-dealing or
something that arises like self-dealing
 If fiduciary is getting something to the exclusion of minority shareholder
 When a fiduciary stands on both sides of the transaction
 Act in such a way that they get a benefit to the detriment of the other
 P argues they paid out excessive dividends in their self-interest because they
needed cash and industrial development of Sinven was prevented
 Court holds the dividends were not self-dealing, minority was getting
them too, so the business judgment rule is applied
 Important to point out that dividends are really left to the judgment of the
directors, but if there is a conflict of interest, they might have to get
involved
 Motive that Sinclair needed the money was irrelevant
o Amount of dividends isn’t something courts want to get involved in
 Corporate opportunity claim that Sinclair prevented Sinven from expanding
 Sinclair had lots of opportunities and it decided which to give to which
subsidiaries
 The law doesn’t require a parent to be generous to a subsidiary, just not to
mistreat it
 Breach of contract claim
 They didn’t purchase the minimum amount and the payments were late
 Sinclair bought all of Sinven’s crude oil, but still their breach because
Sinclair has control over how much Sinven produces
o Self-dealing because contracting with the subsidiary for Sinven
products, minority shareholders of Sinven did not share in this
 Breached contract was to the detriment of Sinven
 So the entire fairness test is applied here
o They failed to prove that Sinven couldn’t have obtained the contract
minimums and are liable
o Gantler v. Stephens – Ps claim the Ds, who are officers and directors, of First Niles,
violated their fiduciary duties by rejecting opportunities to sell the company and instead
reclassified it to benefit themselves, and disseminated a misleading proxy statement to
induce shareholder approval
 Presumably they rejected the offers to allow the recapitalization exchange
 Recapitalization exchange - an exchange of securities intended to
restructure the company’s capital structure, especially with respect to
classified stock
 They create two classes of stock
o One with high dividends and low voting and the other with low
dividends and high voting
 Public shareholders are going to go for the high dividends and low voting
o Don’t care about voting anyway
 Management holds onto the high voting shares
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o They keep control, get to decide the directors and dividends
 Shareholders are basically pushed into trading their shares for non-voting shares
 Management gets control without any financial loss
 Saying they’re doing it to give better value to the shareholders
 Whether rejecting another offer in exchange for an internal offer could be selfdealing because the directors stood to benefit
 Self-dealing – when a fiduciary stands on both sides of a transaction, or
causes the company to act in such a way that the fiduciary receives
something from the company to the exclusion of, and detriment to, the
shareholders
 They were facing the possibility of losing their jobs (but courts are really
reluctant to allow that because that’s always going to be the case)
 They had other businesses that would also be affected
o That the court says is real, the something more they require
o The other shareholders don’t have contracts that would be
benefitted like them
o So it’s a conflict of interest that rises to self-dealing
 What was unfair here
 Conflict of interest is not in itself wrong as long as it’s fair
o If I’m on both sides of the transaction I may still be ok
o But it causes mistrust, not that something wrong has happened
 Here they couldn’t prove their decision was fair
o They neglected two offers, they didn’t seem interested in pursuing
the sale of the company so that they could instead pursue their own
other deal
o Going to be hard to prove that you rejected another offer and
pursued your own offer if you didn’t pursue those offers at all
 Another important point, the court points out, is that the court holds that officers
have the same fiduciary duties as directors
 Fairly big deal that the court holds this
o Clash between authority of directors, their ability to take risks, and accountability, they
can’t just do whatever they want
 Courts are trying to find the right balance
 Value of authority is seen in the business judgment rule
 Versus the entire fairness test
 22. BUSINESS JUDGMENT RULE IN DELAWARE
o Smith v. Van Gorkom – In a nutshell: the directors approved a take-over very quickly
and the shareholders sue because they didn’t get the right price
 They wanted to sell because they were losing some profits due to taxes
 Worth more as a subsidiary or merged
 Synergy AB would be greater than A + B
 Directors credentials were really good
 Argument that they weren’t well informed
o Not given advance notice, relied on a 20 minute presentation, didn’t
read the actual agreement, decided to sell the company without
asking about its value within 2 hours
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



Argument they were
o They had recently done their internal finders review and they had
recently just considered selling, so might have a good idea already
o If it’s a close call, 2 hours may not be enough, but if it’s an easy
call, might not even take that long
What evidence do we have as to whether 55 was fair
 The stock price was 38 and the efficient market takes into account all
information - 50% premium
 We had shareholder approval, suggests they thought it was a good price
 No better offer came along, no one was willing to offer more
 They were willing to go through with it because there was going to be a
market test - an opportunity for the market to present alternatives to a
proposed transaction in the way of competing bids; auction
The court said the market test was virtually meaningless in face of restrictions
 Court was wrong
o The original agreement didn’t allow for an auction, but it did allow
them to entertain offers
o It would be public, so it wouldn’t matter that thy couldn’t solicit
o Merger Agreement acknowledged that the directors may have a
competing fiduciary obligation to shareholders under certain
circumstances
 Meant that the company can do whatever they have to do to
comply with fiduciary duties
 Complete freedom to take other offers
o Also, later amended so that they could have an auction
o Company even brought in Solomon Brothers to try to find a better
offer – got two offers that just didn’t pan out
 In other words, there was an auction and market test
Two possible concerns with price
 1. They didn’t determine what the right price would be
o Intrinsic value – theoretical value of company, based on analysis of
info; “real” value, or what price “should be” (invented in this case)
 Directors didn’t try to determine the intrinsic value because
they thought it was a huge premium already
 Court says they knew the market had undervalued their
stock, but more likely they just said it was undervalued
without any real meaning, as directors do
 Who should determine intrinsic value
 Court’s not comfortable with market or board
 But the court is the worst person to decide
 2. Or that they didn’t take the best price, whatever that may be
o Court doesn’t like that they asked if 55 was fair as opposed to what
they could get
o They ran the numbers to determine what price would be worth a
leveraged buy out
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o LBO – the purchase of a business financed primarily through debt,
especially junk bonds
 You borrow money to buy the company and then you expect
the company to pay off the debt, in which case you bought
the company for free
 Junk bonds – high-risk, high-return bonds
 MBO – an LBO done by management
o They were trying to bypass the intrinsic value for a better test
 It might have been wrong, but it was a very good strategy
 Business judgment rule wouldn’t challenge the substance but the procedure
 They were trying to figure out the best price they could imagine and then
to send it to the market to test it
o Court didn’t really understand what this was
 They offered the price, so didn’t negotiate that much
 Further negotiations were in the lockup option – a provision in an
acquisition agreement designed either to preclude a competing bidder
from acquiring a company or to provide compensation to the original
bidder in case it loses in a bidding contest
o Basically a deal that makes it much easier for Pritzker to win and
harder for anyone else to win
o Company negotiated him down to half the size of the lockup
o That’s real negotiations, it’s about the price the next person would
be willing to offer
 They also negotiated an auction
 The court is just overlooking the negotiations they had
 Directors are held liable for gross negligence under the BJR
 First case where directors are held liable for breach in the duty of care
o Effects of this case – very disturbing to the business community
 Sent shock waves throughout the industry
 People not wanting to be directors, insurance companies not insuring
 Advising clients to be more careful with these issues
 Many states passed laws that allowed them to eliminate director liability in all
cases but the worst – DGCL §121(b)(7)
 Allows them to put in the Charter that directors are not personally liable
for breach of the duty of care (Can’t eliminate liability in duty of loyalty)
 Exculpation statute – a law that limits, or allows the limitation of, director
liability for breach of fiduciary duty
o Shareholders pretty much across the board accepted it
 Some states they can opt out, Delaware they can opt in
 Pretty much universal
 Court was trying to breathe life into the duty of care
 But they got it wrong and as a result it backfired because now there’s less
liability than ever before, pretty much gone now
o In fairness it doesn’t eliminate the duty of care, it just eliminates the
liability for duty of care
 Not very good law anymore, important historically to see what comes after
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o Cede & Co v. Technicolor, Inc. – Whether the board’s approval of a merger was
protected by the Business Judgment Rule
 Court found that even though they were grossly negligent, it was entirely fair
 Court has backed off Van Gorken – WHY?
 1. It’s all laid out in the case (the law)
 Delaware courts always go through the progression of the law
 2. The court is talking about conflicts of interest and whether they were
cognizable
 Not just any conflict of interest invokes the entire fairness test, it has to be
real/material
 Though we’ve kind of limited conflict of interest to dollars and family
 3. Individual directors conflict versus the boards conflict
 If most of the board is objective, we don’t have to worry about it
 4. The triad of fiduciary duties
 Traditional story was two – loyalty and care
 Here the court said three – good faith, loyalty, and care
o Good faith had been out there but no one has ever made much of it
o They don’t say much about it anyway, presumably deals with
something to do with honesty
 5. This case redefined the relationship between business judgment rule and the
entire fairness test
 Used to be straightforward
o Duty of Care was under the business judgment rule
o Loyalty was under entire fairness test
o Then along comes this case and it changes
 Business judgment rule is a presumption, court takes that seriously
o Start with business judgment rule, Ps have to rebut that presumption
 Care – Gross negligence
 Loyalty – Self-dealing
 Good Faith – Intentional misconduct (eventually this one is
developed)
o If you rebut it, then it goes to the entire fairness test
 Court reworks it – we always use the business judgment rule and
depending on what happens, always end up with the entire fairness test
 Court says they have proven gross negligence, but that’s just a rebuttal of the
business judgment rule so they send it back to determine it
 Despite gross negligence it was perfectly fair
 Logically this is not inconceivable, but factually problematic
o We used to think that these tests were outcome determinative
 Defendants were going to win if they had the business
judgment rule
o And how could it be fair when it was grossly negligence
 The price in the end was fair
 This framework remain in effect in Delaware, but it had been highly criticized
 23. DISINTERESTED APPROVAL
o Competing values of authority and accountability
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Courts would rather let the directors go, they can get things very wrong
Courts believe it would be better if they could eliminate the conflict of interest
than preside over it and review it
 One way is to list the things that we’ll recognize as a conflict of interest
 Another possibility is to actually eliminate the conflict of interest
o DGCL §144 – No contract or transaction in which one or more of the directors or
officers have a financial interest shall be void or voidable solely for this reason
 If there’s a conflict we apply the entire fairness test
 If it’s sanitized you get a shift in the burden of proof
 Disinterested – not having a (material) financial stake
 Conflicted transactions can be decided by unconflicted decision makers
 1. If it’s approved by majority of informed disinterested directors
 2. If it’s approved by informed shareholders
o Doesn’t say they have to be disinterested
 Potential solution is to not let the disinterested shareholders
vote, have them rewrite the law
 What they actually did was say read into B that it has to be
disinterested
o They don’t have the right to vote on it until it’s presented to them
 3. Or it’s fair and reasonable to the court
o Instead of entire fairness test sounds like you can have director or shareholder approval
 Courts have in fact decided that in spite of §144, entire fairness test still applies
 Instead of reading it A, B, or C, it’s A, B, and C
 Satisfaction of any one of these three would simply preclude it being
voidable solely on the basis of self-interest
 Many states had this language and were interpreting it in this way long before
Delaware adopted this
 Legislature knew this and adopted it anyway
 Fair to say they meant it this way, what was happening in other states
 This statutory provision was to kind of get rid of the old common law rule where
any conflict of interest made an agreement voidable
o Who has the conflict – Director or Controlling Shareholder?
 Director interest (most of what we’ve been talking about)
 Default is entire fairness test
o Burden on the D to prove entire fairness
 Independent director approval – unclear
o Some states say entire fairness but the burden on the plaintiff
o Or could be the business judgment rule with burden on plaintiff
 We don’t have a conflict of interest, so shouldn’t we apply
the business judgment
 Delaware tends to apply this if at least a majority of the
board is disinterested
 Independent shareholder approval
o Business judgment rule with the burden on P
 Controlling shareholder interest
 Default
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o Entire fairness test; burden on D
 Independent director approval
o Entire fairness; burden on P
 Independent shareholder approval
o Entire fairness, burden on the P
o Cookies Food Products v. Lakes Warehouse – Ps claim that the D, by acquiring control
of Cookies and executing self-dealing contracts, breached his fiduciary duty to the
company and fraudulently misappropriated and converted corporate funds
 D enters into an exclusive distribution contract
 He then buys more stock, has 5 of the 11 directors, he’s paying himself for
his work there, he extends his contracts, he started collecting royalties on a
taco sauce recipe he came up with
 Court says yes, this is self-dealing (which doesn’t mean it’s wrong)
 The amounts we’re talking about are material
 Brings us into the entire fairness test
 Entire Fairness Test (700)
 Two basic aspects; fair dealing and fair price
 Fair Price (substance)
 Against – They could have paid professionals less than he got for the jobs
o The fact that they’re not paying dividends and he’s taking all the
value out as salary for himself
 But, they couldn’t pay dividends because of a contractual
relationship on their debt
 In favor – He makes and extends the success of the business
o They could have paid professionals, but he was the one who did it
and others probably wouldn’t have done as well
 Fair dealing (process)
 Against – He dominates the board
 In favor – The contracts in existence are there before he dominated the
board, he only extends them
o Perfectly unconflicted board
 Court decides it’s fair in the end
 Looks like they mostly focus on the success
 Even the plaintiffs expert acknowledged that he deserved it, even if they
could have maybe found a cheaper person
o Effect of Approval by Disinterested Directors of Self-Interested Transactions
 Why interested transactions approved by disinterested directors should still be
reviewed for substantive fairness
 By virtue of their personal relationship, directors are unlikely to treat each
other with the wariness of third parties
 A review of the substantive fairness can be thought of as a surrogate for
review of the fairness of the process
 Some states expressly require some form of fairness test even if transactions
have been approved by disinterested directors
o Waste and Shareholder Ratification
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Waste entails an exchange of corporate assets for consideration so
disproportionately small as to lie beyond the range at which any reasonable
person might be willing to trade
 If there is any substantial consideration and a good faith judgment that it
was worthwhile, there should be no finding of waste
 Shareholder ratification of waste requires unanimous consent
 On theory no one should be forced to make a gift of their property
o Kahn v. Lynch Communications Systems, Inc. – P claims Alcatel breached its fiduciary
duties to Lynch and shareholders by dictating terms of their merger, making false
statements, and paying an unfair price
 Kahn wants Lynch to buy Telco, but Alcatel wanted them to buy Celwave
 Lynch eventually agrees and the other shareholders sue
 Alcatel only had 43% of the voting power, but was in fact in actual control
 He had a veto power, could stop any other acquisition because they had
bargained for a required 80% of shareholders to approve any business
combination
 But he didn’t quite have the majority share or majority of the directors
 Should he have a fiduciary duty not to veto a decision
 Hard to say he shouldn’t use his veto power to vote against the transaction
since they bargained for it
 Forcing a transaction where he has a conflict of interest can be a problem
o Fiduciary duty to otherwise not do things that are harmful just
because he wants it
 The Independent Committee unanimously rejects the Celwave acquisition
 Then Alcatel offers to buy Lynch, committee counter-offers
o Sounds like a negotiation
 Alcatel says if they don’t accept, they will go to the shareholders with a
hostile takeover at a lower price
o Court really focuses on this claim of a hostile takeover, which a
company is legally allowed to do
o Shareholders will only say yes to something that is a good offer
 If it’s really worth 17$ they shouldn’t accept it anyway
o Court thinks this is a threat
 Lynch had an independent committee approve the transaction, but Court doesn’t
believe it’s really independent
 So they are not safe under §144 and they don’t get the BJR
 Alcatel exercised control over Lynch
o They didn’t make the decision because they agreed with it, they
made the decision because they had to
o Court is not convinced it was a disinterested committee despite
them meeting halfway
 Burden on entire fairness would not be shifted by the use of an independent
committee which concluded its processes with “what could be considered a
quick surrender” to the dictated terms of the controlling shareholder
 Court holds Alcatel was a controlling shareholder and the burden of
proving the entire fairness of the merger remained on Alcatel
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o Gantler v. Stephens
 1. Court said fully informed shareholder vote only approves director action that
didn’t require shareholder approval
 Sanitizing has to be something else, not just a vote that’s already legally
required
 2. The only director action that can be ratified is that which shareholders are
specifically asked to approve
 No inferences, narrowing this doctrine
 3. The cleansing effect of the vote is to subject the challenged action to business
judgment as opposed to extinguishing the claim altogether
 Some courts had said otherwise (Van Gorken); that it can extinguish the
claim altogether
 24. CORPORATE OPPORTUNITIES
o Fiduciary should not take for itself an opportunity that belongs to the corporation
 It would be theft similar to taking property from the corporation
 Subset of the duty of loyalty
o Factors to Consider (Some courts use one, some all, just to consider)
 Financial ability of the corporation to take that opportunity
 If they can’t take it, then there’s no harm done
 Some argue this should be irrelevant because the company may be able to
find a way, given the chance
o Just accepting they can’t, the director may have incentive to make it
seem impossible or create impediments to take the opportunity
o Some courts consider this, others don’t
 Line of business
 If the type of opportunity in the line of business, direct competition
o The more closely related, the better
 Some say this should be absolutely necessary, others say irrelevant
o Relevant – this is what we’re talking about with corporate
opportunity
o Irrelevant – Companies can get into different lines of business that
don’t have to be that related
 Conglomeration – the process of internal diversification;
expansion into unrelated lines of business
 Related by nature is a fuzzy concept
 Interest or expectancy
 Best example is Meinhard – Partnership had an interest or expectancy in
extension of the lease
 Ex; If a company finds oil and before they buy it, one EE goes out and
tries to buy the land – not producing oil yet, but they’re about to
 Some say it’s a rationalization after the fact
o But some courts still rely on this
 Resulting conflict
 Test goes a little further
 Source of the opportunity
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Whether you received the opportunity by corporate assets, or on corporate
time, or if it was on your own time – Very important today
 If you use corporate assets, courts are extremely likely to find it to be the
source of opportunity
 Party involved
 Different levels of fiduciary duty depending on who’s involved
o Officer > Director > EE > shareholder
o More likely as officer and so on
 Really more a problem of officers who are more likely to be involved in
the day to day affairs of the company
o Officers are expected to devote everything to this company, we
know that directors have other jobs
 Fairness
 Fairness of holding the manager accountable for his outside activities
o Hawaiian International Finances, Inc. v. Pablo – President of company advises
company of real estate, they buy it and he gets a commission
 Court says he was not acting in bad faith
 The amount paid was fair
 Company wasn’t injured
o They had to pay the commission and they couldn’t have taken it
 Argument against is that they could have paid less on the property
 Court holds he still had to tell them about it and they had to agree for it to be ok
 Not just that he didn’t tell them, they have to agree too
 Could probably make this decision without the Corporate opportunity doctrine
 Can’t make a secret profit, general fiduciary
o Northeast Harbor Golf Club, Inc. v. Harris – Country Club president acquired property
adjacent to the golf course, which real estate agent had offered her in her capacity as
president and later piece playing golf (Look at the factors (methodical like on exam))
 Financial ability of the club
 Court is skeptical there was none – Evidence they had engaged in
fundraising, concern that maybe they would have been able to
 Line of business
 Court says this is conceptually difficult to answer
 Trial court says golf and real estate are not the same
o But a golf course may be interested in surrounding real estate,
certainly could be important to them
 Interest or expectancy
 Tough one – on the one hand there’s nothing special about this land, but
on the other it’s adjacent to the property
o Court could go either way on this
 Resulting conflict
 Not really in competition with the golf course by buying this
 Source of the opportunity
 First one she gets the opportunity to buy it because of her role as president
 Second one she’s playing golf – not as easy, but a court could find it
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Party involved
 She’s probably like chairman of the board, but still a high a position as
there probably is in the organization, or at least up there
 Fairness
 She came to them after she already bought it, not a good factor
o Almost worse this way, if she didn’t tell them it may have
suggested she didn’t even consider it
 Court thinks she’s acting in good faith (almost surprising because of this)
 Court looks at ALI approach (Principles of Corporate Governance §5.05)
 Requires disclosure upfront if it’s a corporate opportunity; central feature
o Corporation must then formally reject the offer
 Even the rejection of a corporate opportunity has to be fair
 But if she didn’t seek their approval, she can’t even fall back
on entire fairness
 But it doesn’t tell us anything about whether it’s corporate opportunity
 If someone doesn’t disclose under the ALI approach then they don’t
necessarily lose (something close though)
o You can get approval after the fact but it has to be fair
 Fully informed disinterested approval, specific vote
o Here’s it’s too late for this
 Under ALI, it’s better to disclose
 Years after she’s done this and they know about it, doing nothing, another board
decides to sue her
 They affirm the corporate opportunity doctrine, but it’s barred by the
statute of limitations
o Broz v. Cellular Information Systems – Broz owns RFB and is a director for CIS,
receives an opportunity to purchase a cellular license, he offers it to CIS, who declined,
but PriCellular who had recently agreed to buy CIS sues him for violating duties to CIS
 Financial – Directors all say they can’t afford
 Line of business – Yes
 Interest or expectancy – CIS probably don’t have much of an interest or
expectancy
 Resulting conflict – Already in some conflict, not going to make it much worse
 Source of opportunity – Unclear why Broz got the opportunity, could have been
because of another of his roles
 Party involved – He’s a director
 Fairness – He treated CIS fairly by telling other directors about it
 He didn’t ask for corporate approval, probably because he thought he
didn’t need it
 Delaware law doesn’t require him to disclose
 Director or officer can take the opportunity for himself if he doesn’t
believe the company is entitled to it without formal presentation to the
Board
 “Safe harbor” – By presenting it to the board, it removes post hoc judicial
determination they improperly usurped it
 If it ends up being a corporate opportunity then it’s the entire fairness test
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o
 25.
o
o
Complicated factor – Broz is director of CIS, but Price Cellular is the one suing
 Saying they had an expectancy interest
 They were going to be buying CIS and Price Cellular had plenty of money
 Claim he stole an opportunity from his future boss
 Assume they would have bought it – Court says he owes them no duty
 He may in the future be a fiduciary of price cellular, but he’s not now, no
duty to them
Energy Resources v. Porter – Porter worked for ERCO, got a joint development grant
from the DOE for Howard and ERCO, Howard refuses to work with ERCO, Porter
quits and creates a company to get the grant just with Howard
 This was a corporate opportunity for ERCO
 Company had financial interest
 It was in their line of business
 They had an interest and expectancy
 It would lead to a conflict
 Source of opportunity was at least partly ERCO
 Party involved is a little weaker, he’s the VP of ERCO
 Argument it wasn’t a corporate opportunity
 D claimed it ceased being a corporate opportunity when Howard refused
to work with ERCO
 Claim that it was maybe a personal opportunity because it was based
around Porter, not either of the companies
 Before he invokes a refusal to deal he has to tell the company about it
 If the company had really refused to deal with ERCO, not able to be
persuaded, then maybe he would have been able to quit and work with him
 The DOE said Porter is the main guy so basically he gets to choose whether he
goes with Howard or ERCO to get the grant either way
 It is not the case that if Howard walks away from this ERCO can’t have it,
only that if Porter leaves
 He established the company because Howard refused to work with ERCO
o Could no longer not be an opportunity because Howard refused to
deal with them
DUTY OF GOOD FAITH
Historic View
 There were two main duties – Duty of loyalty and care
 Care – Business judgment rule (directors win)
 Loyalty – Entire fairness test (shareholders win)
Good Faith, located
 Business Judgment Rule
 “[A] presumption that, in making a business decision, the directors of a
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.”
 § 144 – Board authorization
 “... if ... the Board or committee in good faith authorizes the contract or
transaction ...”
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§ 102(b)(7) – Director exculpation
 “... provided that such provision shall not eliminate or limit the liability of
a director ... for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law ...”
 § 145 - Indemnification
 “... if such person acted in good faith ...”
 Directors could only be freed from liability only as long as they were
acting in good faith
 Good faith has been out there forever, but we generally talk about the other two
when talking about breaching fiduciary duty
 Cases were never really clear on what good faith is
o Good Faith, Content
 Really standards of conduct
 Honesty
 Sincerity (In the sense of effort, doing your best)
 Decency (Appropriate standards, decent in transactions)
 Legality (Complying with the law, and also the Charter and bylaws)
 Breach of duty of good faith
 Might be something like actual dishonesty
 Intentional misconduct
 Outrageousness
 Intentional violation of law
 Clearly something different than care or loyalty
 Good faith is about being bad, morally bad, different than the others
o Cede & Co.
 Court said a triad of fiduciary duties, no one had spoken of that before
 They didn’t say more on what it means, long time before we got guidance on this
o In re the Walt Disney Company Derivative Litigation – Ovitz is hired as president of
Disney, let go after about a year and receives a 130 million severance payout;
shareholders brought derivative actions claiming breach of fiduciary duties and waste
 Duty of care
 Court says they don’t act carefully but not held to breach the duty of care
because they weren’t grossly negligent
o They say it fell far short of corporate best practices but good
enough to avoid liability
 Bad faith
 Plaintiff complains the trial court changed the definition on the standard
for breach of duty of good faith
o Previously, conscious and intentional disregard
 Proof of subjective bad intent was not necessary
o Court says “intentional dereliction of duty, a conscious disregard
for one’s responsibilities” is the standard, requires bad intent
o Court says there’s not that much of a difference
 Absolutely not the case that just the lack of due care, gross negligence
itself, without any intent, should be a breach of duty of good faith
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Negligence – standard of duty
 Gross negligence – standard of review for duty of care
 Recklessness – sound like we’re moving into a duty of faith
 Shareholders want good faith to be the same as duty of care because of the
exculpation statutes
 Care type issues can become good faith if bad enough
o But it is not automatic that a breach of duty of care becomes a
breach of duty of good faith
 By now most directors won’t be held liable for breach of duty of care
 Not worth suing for care since they won’t generally be liable
 Shareholders have been trying to turn a duty of care issue into a duty of
good faith issue because it’s not exculpable
o Stone v. Ritter – Company EEs break the law by taking measures to prevent “Ponzi”
scheme, directors don’t know about it, shareholders bring a derivative action
 This is a Caremark case (1996 case) – Directors should have known of the illegal
conduct of EEs and because they didn’t, they breached their fiduciary duties
 Caremark was essentially the same case as this one
 Suggesting that you do need some kind of system in place for monitoring
the company, which Ps try to claim in this case
 Court doesn’t say they’re overruling it, they’re narrowing or reinterpreting
 Court says where a claim of directorial liability for corporate loss is predicated
upon ignorance, only a sustained or systematic failure of the board to exercise
oversight will establish the lack of good faith necessary for liability
 Case is dismissed, the directors had no reason to know about it
 Duty of oversight or duty to monitor seems like part of the duty of care
 But court puts it under the duty of loyalty
o Failure to act in good faith may result in liability does not
automatically result in the direct imposition of fiduciary liability,
but may result in liability because it is a condition of the duty of
loyalty
 Saying the duty to monitor is part of the duty of good faith
 Duty of good faith is a subsidiary of loyalty
 With exculpation statutes, directors wont’ be liable under the duty of care
 Disney and Stone turn Care cases (and should be exculpated) into loyalty cases if
it’s bad enough
 On the one hand problematic - taking duty of care type conduct which
should be exculpated and turning it in to loyalty which can be prosecuted
 Can get past it by saying they could be overlapping fiduciary duties and
not liable for a pure breach of duty of care, only pure would be covered by
exculpation statute
 Results
 1. Case says there is no tried of duties
o Faith is a subset of loyalty
 Not clear what this means, just saying it’s a subset
o Loyalty includes conflicts and good faith
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2. Duty of loyalty is not limited to just financial recognizable conflicts of
interest, now things like intentional misconduct, good faith
 The duty to monitor changes
 Makes it more prone to liability, but not by much
 Standards to satisfy breach of fiduciary duty for review is a systematic
failure, approaching utter failure to do anything
o Only a sustained or systematic failure of the board
o Failure to implement ANY system
o Compliance Programs
 Effective compliance program under the Sentencing Guidelines, hallmark is due
diligence; at minimum must have:
 1. Standards and procedures reasonably capable of reducing such conduct
 2. Assigned individuals to oversee compliance with standards
 3. Due care not to delegate substantial discretionary authority to those
with a propensity for illegal activities
 4. Communicate corporate standards to EEs and agents
 5. Monitoring and auditing to achieve compliance and reporting system
 6. Appropriate disciplinary mechanisms
 7. Respond appropriately if offense is detected
 These are not mandatory but sentencing judges are required to consult them
 26. MANAGEMENT COMPENSATION
o In re the Walt Disney Company Derivative Litigation – Such a large termination
payment put in place to get him to join the company
 If someone wants Obtiz they’re going to have to pay him something competitive,
but then should they be hiring someone who right up front demands something
like 150 million?
 They refuse to give him an upfront signing bonus, so they change it to give it to
him on the backend
 Seems like one is less bad than the other, probably better to pay him when
he’s full of promise rather than when you’re firing him
 2 duties of care
 One in authorizing the agreement
o Probably poorly done, but not grossly negligent
o One of the key duties is informed-ness
 Court concludes they knew enough
 Another in terminating it
o Brehm v. Eisner
 DGCL §141(e) – Directors are protected for relying in good faith on information
given to them by experts
 Nobody made the relevant calculations regarding how much he was
getting paid, but no liability because they rely on this
 Directors can’t be auditors as well, they have to rely on reports, etc. when
they get them from other people
 Limit on the limit on 141(e) – Directors cannot abdicate their power
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Experts don’t have the ultimate authority to make decisions, directors can
still make bad decisions under §141(e)
o They weren’t making a judgment here, signing off on something
and they don’t even know what it is
 This provision was about if there’s a mistake, or fraud committed upon
you, it’s not your fault and you’re liable
o Not really about this type of decision but Court holds the Board
relied on the experts decision not to fully calculate the amount
He is given no-fault termination
 Only if fired for good cause do they not give him anything
 They had no choice, there was no realistic argument that it was for cause
Entering into the contract
 May have been a breach of duty entering into a contract they know will
later bind them in a way that will be unacceptable at the time
o Not that the court says there is
Issue of waste (sometimes called substantive due care)
 Rather than look at process, look at substance
 SOR for waste – Pretty low standard
o Irrationally squander or give away asset
o Cannot be attributed to any rational business purpose
 It’s not waste by the court, they’re not in a position to judge the risk
 Court says it’s fanciful to think that he would have engineered an early
departure, also he had an opportunity to make maybe more at another job
o The court is missing the point – It’s not about whether Ovitz tried to
get himself fired, but whether the company entered into a contract
that incentivized him to get fired
 Court talks about how he had plenty of incentive to stay too
 On the 130 million, the court is somewhat sympathetic – this is pushing
the limit it’s so high, but they still get the business judgment rule
WHY? – Court’s don’t want to get into substance, it’s process due care only
 Courts do not measure their judgments
o But in the end, theoretically reserve the right to look at substance
Duty of loyalty issues – friendship between Eisner and Ovitz
 That could very possibly be a conflict of issue reason, but it’s not
 Courts almost always reject friendship claims
o All these people are colleagues, could easily turn every care issue
into a loyalty issue if you allow friendship to be a cognizable issue
 But a lot of times people do things for friends they wouldn’t do for money
o It can be a more corrupting influence in substance and process
This first case is decided just on the pleadings
 Even though it pushed the limit of judicial respect, they decided it was still
upheld under the business judgment rule
 Saying a lot about how important the business judgment rule
They re-plead the case and had a trial on the merits
 Every claim seemed to go the directors way, not sufficiently proven
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These are the leading cases on management compensation
 They seem to say you can kind of get away with anything
 They point out this is not the model of good behavior, hoping perhaps to
push people in a better direction, but it was still upheld
o Structural Bias – A prejudice that members of a board of directors may have in favor of
one another and of management
 1. Implicit conspiracy – quid pro quo
 In our interest to work as a team against those shareholders
 2. Relationship – friendship and collegiality
 Don’t want to turn on colleagues
 3. Psychological phenomenon known as in-group bias
 Just by dividing people into groups you can get people to agree to a lot
more (Directors versus people)
 It has psychological empirical evidence behind it, but courts tend to be skeptical
of structural bias
 Courts are sort of looking the other way if they say there’s no structural
bias, though in some cases they have taken it seriously
o Hostile take-overs and derivative litigation
o Executive Compensation
 Considered to be an issue these days
 It seems to keep growing, in good times and in bad (ex; recent financial
crisis, still huge compensation)
 Until recently compensation records were quite poor, so shareholders
didn’t even know what they were getting
 Reasons people justify it
 They’re superstars, like athletes
o In some instances probably true, but all worth it?
 To pay competitive salaries, we need to pay above average
o But companies are then all trying to up each other
o In good times, look how good, we need to keep it up
o In bad, we need to bring it up and keep the good people or get the
good ones to help us
 Difficult case, how much executives are be paid is a matter of business judgment
 If we had a functioning market we could be very comfortable, but the
complaint is that we don’t really have a market system
 He we have colleagues setting each others salaries from shareholder
money
 This is the claim of structural bias – bias towards management
 What we would like is an impartial decision making body
o Directors would be nice, if they could do it unbiased
o Courts don’t want to get into it, they don’t know what to do
o But do we just turn a blind eye to these problems?
 Incentivize management is an idea to fix this
 Pay them according to how the company is doing
 Great idea people thought
o Move to stock-options
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Stock options – A right to buy stock in the future at a price set at the beginning
of the contract (Option makes them want to drive stock prices up)
 Problems:
 1. How many stock-options are you giving
o How many do they deserve, can price it out to see how much it’s
worth, but not really money
 2. Stock prices tend to move up
o They’re going to benefit anyway, even without effort
 3. Makes disclosure of compensation difficult
o Stock options could mean a lot of things
 End up not being as great as everyone thought they would be
 Also maybe incentivizes the company to make the stock price go up,
maybe to even commit fraud (Enron)
 If stock-options become worthless, they’re then not incentivizing anyone
 People can re-price the options, lower the exercise price
o Re-incentivizing management
 Problem with this is that if you’re just re-pricing options every time if
goes down, are you really incentivizing them?
o Such a problem Congress made it nearly impossible to re-price
o Now we’ll just give you new options, no limit on how many new
options you get
 After Congress’ attempted they just found a way around
o Say on Pay
 Increasing shareholder activism – Push for shareholder say on pay
 Right to approve or not management compensation, doesn’t really jive
with normal separation of powers
 Working as an advisory role in the end – at least ask our opinion, and then
you can reject it
 Shareholders would have a non-binding vote on compensation packages
 In theory, to keep management in check
 Pretty embarrassing if they keep passing things shareholders rejected
 Limited effectiveness because it’s not binding – a lot of people maybe not
voting for this reason
 But they tend to vote in favor anyway, not what people expected
 Possibly rational apathy
 Maybe more sinister is that institutional investors own these shares and
want to keep executive compensations up for everyone
o Federal government on executive compensation
 2009 they put a salary cap of 500,000 for executives
 A lot of people would say a cap is a bad idea
 More acceptable forms of involvement was SEC trying to get better disclosure
 Shareholders can really know what’s going on
 Didn’t just have to disclose, you had to expense them
o What their worth was and count that as an expense
 Required a total compensation number by the SEC as well
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
What is the compensation this year based on expensing options and
everything else
 Discussion of your compensation practices
 How you go about setting your compensation practices and why so that
shareholders can understand
 Lots of moves regarding executive compensation
 If we can’t trust them how can we give them BJR, but if we don’t give it
to them, courts are going to be involved all the time
o Compensation Litigation in Close Corporations
 It has been difficult in the past to successfully challenge executive compensation
in a publicly held corporation when approved by disinterested shareholders or
directors
 But courts often hold it unreasonable in close corporations
o 1. It’s usually not approved by disinterested directors or shareholder
o 2. Likely to involve a significant fraction of corporation’s earnings
 27. FIDUCIARY DUTIES OF CONTROLLING SHAREHOLDERS (II)
o Zahn v. Transamerica – Holder of Class A stock in Axton-Fisher claims that
Transamerica caused Axton-Fisher to redeem its Class A stock at 80/share instead of
permitting them to participate in the assets on the liquidation of the company
 On a simplified version of the facts, look in Charter
 Voting rights
o Class A = limited; Class B = Control
 Liquidation
o Class A = B x 2
 Redemption rights
o Company can redeem Class A at $60/share
o Redemption – a forced buy-back of stock by the issuing company
o Redeem – to force a buy-back of stock by the issuing company
pursuant to a contractual right
o No automatic redemption rights, it would be in the Charter
 Conversion rights
o Shareholders can convert Class A into Class B
o A convertible bond would be to take the debt security into stock
o But it can be among classes of stock
o Conversion – the exchange of one security for another with the
issuing company
o Convert – to exchange one security for another with the issuing
company pursuant to a contractual right
 If $60 in assets:
 Liquidation
o Class A gets $40 (2/3 of total)
o Class B gets $20 (1/3 of total)
 Redemption
o Class A gets $60 ($60)
o Class B gets $0 (everything else)
 If $240 In assets:
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
Liquidation
o Class A gets $160 (2/3 of total)
o Class B gets $80 (1/3 of total)
 Redemption
o Class A gets $60 ($60)
o Class B gets $180 (everything else)
 The directors fiduciary duties were implicated
 Also majority to minority shareholders
 Transamerica held all the Class B stock and had control of the board of
Axton-Fisher
o When they found out the increase in tobacco they made the plan to
redeem Class A and liquidate the company to gain the benefits
 The problem in this case is not really redemption or liquidation
 It could arguably be unfair either way
 The problem was the lack of information – Class A didn’t convert into
Class B because they didn’t give them information to know to convert
o They thought it was bad times, where it was better to stay Class A
 Speed v. Transamerica Corp. – the state court decided the duty issued differently
 The redemption right is a continuing option on the part of Class B
shareholders to buy out Class A in their favor
o Redemption Provisions
 A redemption provision can only hurt you as a shareholder
 The provision itself suggests maybe that the state court’s opinion is right
o Option to buy you out at any time for $60 so they will only do it
when it’s worth more than that
 It’s not really cheating the shareholders – they entered into it and it says
what it means on its face
 Not only can they do it, they pretty much have to
 Failing to do so may lead to a problem of fiduciary duty
 The whole point is to exercise it when it makes sense, when it’s worth
more than the redemption price
o Jones v. H.F. Ahmanson – Ahmanson had 85% of Savings & Loan Association,
Shareholders had 15%, they claim Ds breached fiduciary responsibility in the creation
and operation of United Financial
 Association is not a public corporation, its shares had an extremely high book
value and were not actively traded
 To remedy this, Ahmanson deposited its shares into United Financial so
they could then be sold to the public
o 1 Association share = 250 United Financial shares
 Now much more marketable and the price starts to rise tremendously
 But S & L shares are worse than before, people wouldn’t buy their high
priced shares when they could buy UF
 The 15% shareholders were denied access to those initially and then after UF
was doing well, they were offered the opportunity to join, but now at a discount
 Only 51 – 1, when really it should be 250 – 1
 Minority shareholders then sue majority for breach of fiduciary duty
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
They are directly hurting minority shareholder, not hurting the company
o It was already hard enough to sell the shares, now it was impossible
 The majority shareholders could have done a stock-split
 Stock-split – technical splitting of each share into two or more shares
 Amend the charter and each share will turn into 250 shares
 Company is still worth the same, idea is that it will increase liquidity
o It doesn’t affect the business in any way, just makes the shares more
marketable because they’re more affordable
o At least that’s the theory
 They don’t do this, they’re making more money by splitting it through UF
o Taking profit from minority by buying their stock at reduced price
o If the majority creates a new company with the shares, he can then
sell the rest of the percentage off to the public in the new company
 First seemed like they didn’t give minority an opportunity, not going to be liable
just for not helping
 But it’s actually harming the minority and perhaps trying to get some kind
of unfair advantage
 Arguably the entire situation is implausible, that the court was duped
 Efficient market hypothesis – is it really plausible that the minority are
going to be kept so low and the others increased so much that this little
liquidity problem is going to cause this great a disparity in price?
o But then again stock-splits should be irrelevant too, but they tend
not to be, despite all logic
o Perlman v. Feldmann – Claim is that payment for the stock included compensation for a
corporate asset, the ability to control the allocation of steel in a time of short supply
 Shareholders sued to share the premium
 Court agreed, said control was a corporate asset and a controlling shareholders
should not be able to sell that control and keep the profit for himself
 Since he sold it already, he had to share the profit
 Company wasn’t really harmed, court was trying to find harm
 If you have 1% of the shares, you should have that much of the vote
 But if you have 51%, you have 100% of the vote
 Taking voting control, something that should be given to all the
shareholders
 She’s really selling everyone else’s 49% of the vote, including hers
 This case is not good law
 Shareholders can sell their shares at a premium
o Zetlin v. Hanson Holdings
 A controlling shareholder is free to sell and a buyer is free to buy a controlling
interest at a premium price
 Aggravating factors – Only a problem if there’s more
 Main one is selling to a known looter who then steals everything from the
shareholders
o Good idea since it’s almost looting by proxy, but bad idea because
all I’m really doing is selling at the best price
o We don’t stop with known looters, but suspected looters
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
We never really know they’re going to loot, so have to go a
little beyond knowledge to should have known
What would constitute a known or suspected looter would
be very difficult to implement
 28. SHAREHOLDER SUITS
o One of the fundamental debates in corporate law pits the authority of directors to make
business decisions against their accountability
 Business judgment reflects deference, authority
 Entire fairness reflects accountability
o Director Accountability
 Shareholder Rights
 Voting
 Selling – Sell if you don’t like what’s going on
 Information - More you know, the more you can exercise other rights
 Suing
 Shareholder Protections
 Elections
 Markets
 Courts – Would rather things be decided by elections or markets
o Shareholder Suits
 Direct actions – a lawsuit initiated by an injured person on her own behalf
 Declared dividends
o Direct action against the company if they don’t pay you your
dividend
 Denial of voting right
o Your right, not corporate
 Securities laws violations
o Federal securities law violations are direct (most, not all)
 Derivative actions – a lawsuit initiated by one person on behalf of another,
especially, in corporate law, a suit brought on behalf of the corporation by its
shareholders
 Why we allow this in corporate law, might be a conflict of interest
o Embezzlement – Board isn’t going to want to sue itself
 Or if they do, might just pursue a slap on the wrist
 Money was stolen from the corporation, it was really the
corporation that was hurt
o Breach of fiduciary duties
o Why Allow Derivative Actions
 Director conflicts
 They may not want to since they were the ones who stole or breached
fiduciary duties
 To police misconduct
 We don’t want directors to be able to get away with anything
 To enforce indirect shareholder rights
 Since they are the ultimate beneficiaries, everything in the corporation
ultimately benefits or harms them
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o Why Not Allow Derivative Actions?
 Director Authority
 §141(a) – directors run the business and we’re taking away power
o Business decision, should we sue or not, maybe leave that to the
directors
 Shareholder incompetence
 We might rather have experts making these decisions
 Some shareholders are more incompetent than others,
o Might have a vendetta against the company
o Or a creditor suing just to cause problems
o Or an activist just pursuing a cause
 Litigation costs
 Recovery might not even cover the litigation costs, just not worth it
 Tarnish companies reputation, bad press with public or investors
 We might lose and its expensive time-wise
 Incentives can be skewed
 Directors
o Incentive to settle
 Low chance of liability under the BJR, but if they are there’s
a risk it’s a huge amount
 Eliminates the possibility of an outrageous verdict
 Don’t have to admit culpability
 The corporation, not the directors, pay for it
o Also a strong incentive not to settle
 Don’t want to give everyone the idea they can just sue you
and get money
 Shareholders
o Supposedly rationally apathetic, probably don’t care
o But even if they are paying attention, if they sue they’re going to
have to pay litigation expenses
 Recovery pays for lawyers if you win, but the recovery goes
to the corporation, not directly to you
o Probably not worth it, only possibly if you’re a large shareholder
 Attorneys
o Derivative litigation can be profitable for them
 If they win or settle, they can get attorney’s fees
o Entrepreneurial attorney – an attorney acting as a businessperson
with respect to lawsuits, making investment decisions with her time
and taking the risk of profit and loss
 Not really about rights of shareholders, but increasing the
profitability of the firm
 With this is the possibility of strike suits (courts/legislators worried here)
o Strike suit - a lawsuit initiated not with the intention of winning on
the merits, but with the intention of obtaining a profitable settlement
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
Classic is a frivolous suit where you aren’t going to win, but
it might be worth it for them to give you the money to go
away
 Can also be a strong case we don’t intend to follow through
on, but want a settlement
o Tooley v. DLJ – Shareholders sue because of the loss of time-value of money caused
by the company delaying in closing a proposed merger
 In corporate litigation almost always going to start with direct or derivative
 1. Who suffered the alleged harm
o Corporation or shareholders
 2. Who would receive the benefit of any recovery or other remedy
o Corporation or shareholders
 Court holds they have no claim
 It’s not a derivative claim
o No injury to the corporation and no recovery to the corporation
 The right answer is that it’s a direct claim, except for the fact that they
aren’t harmed and there is no remedy
 Lower court held it was derivative by using the “special injury test”
 If all the shareholders hurt, it probably means that the corporation’s been
hurt, but not necessarily
 Court goes through the history – Courts have not been clear on when it’s either
 Grimes v. Donald – A court should look to the nature of the wrong and to whom
the relief should go, and P wasn’t seeking to recover damages for injury to the
corporation
 Found it to be a direct action, when it seems like it should be a derivative
o They focus on who gets the recovery and since it wasn’t the
corporation, it’s direct, but none to the shareholder either
 Not only was Grimes wrongly decided, but this court announces in this new test
that Grimes was rightly decided
 Even with Tooley they’re making mistakes
 But we have the benefit of knowing the elements
o One test now, they acknowledge the confusion before
o Barth v. Barth – P brought direct claim against D for substantially reducing the value of
his shares of common stock
 Generally, shareholders can’t have direct action to redress an injury to the
corporation, even if the value of their stock is impaired
 Court holds this is not always the case in a close corporation
 Shareholders in a close corporation stand in a fiduciary relationship to
each other and must deal fairly with each other and the corporation
 The money has to go back to the corporation for other shareholders and
creditors benefit, not implicated in close
 Or bad guys might be in charge and the money is then going back to him
 Some courts have applied an exception
 Delaware doesn’t agree
o Glen v. Hoteltron Systems, Inc. – P claims D diverted assets of their company that only
the two of them owned to his own corporation
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
It’s a corporate opportunity so the corporation is the one harmed
 Seems like a silly formality to be derivative when it’s just the two of them
o But Court says prospect of money going back to the one causing
injury exists in any derivative action, no new rule for close corps
o Pro Rata Recovery
 Involve derivative action, when it’s granted, the recovery goes straight to certain
shareholders
 Each get a share of the recovery equal to percentage ownership of stock
 They still must satisfy all the elements for bringing a derivative action and
the amount of damages is measured by injury to the corporation
 Cases suggest it will be decreed when the bulk of the corporation’s shares are
held by persons who could not themselves have brought the suit because they are
subject to a personal defense (such as acquiescence or laches or wrongdoer)
o Clarke v. Greenburg – Whether a P in a derivative action is required to account to the
corporation for money from a private settlement – YES
 Allow plaintiffs to settle
 Because then greater incentive to bring suits or because they’re bearing
the cost of litigation so it would be unfair to tell them they can’t
 We maybe shouldn’t allow them to settle
 Abuse of the system, suing just to get a settlement (strike suit)
o But the real risk is a little different than a strike suit
 Problem is that by settling, money is going directly to you and the corporation
can settle for less and it can harm other shareholders who aren’t part of it
 P must account for money received in a private settlement
 They were allowed to sue on behalf of the corporation and they owe that
money to the corporation
 Attorney’s fees – It was a legitimate expense if he gets attorney’s fees
 Attorney would still be entitled to the attorney fees
o Modern rule on settlement of derivative actions
 Derivative action can settle only when the court’s approved it
 Not going to allow them to settle on their own
 The general standard is fair, reasonable,
 Downside is that judges have an interest in pushing settlements anyway
 They have lot of cases, both sides saying it’s a fair deal
 Not many courts are going to be willing to say its unfair
o Are derivative actions strike suits
 Corporate world, courts and sometimes the legislatures seem to think so
 Empirical evidence
 Shareholders rarely win a trial, suggesting it’s a waste
 If there are settlements, we see that they are small dollar recovery for Ps
and large for attorneys, really about attorney
 Procedural victory and a change in management tends to follow so may be
meaningful
 29. LIMITS ON SHAREHOLDER SUITS
o Limitations on Standing
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
Contemporaneous Ownership Rule – a rule of standing requiring that, in order to
initiate a derivative action, a plaintiff must have been a shareholder at the time of
the action complained of and must maintain ownership through the end of the
lawsuit
 Demand Requirement – a rule of standing requiring that, in order to initiate a
derivative action, a plaintiff must have made a demand upon the directors that
they pursue the action complained of
 Two exceptions
o Demand futility – if it would be futile, many courts won’t make you
 Futile when the directors are conflicted
o Irreparable harm – if requiring you to make the demand would
cause irreparable harm
 Merger would be a reason, won’t be able to undo the
merger, so could be for injunctive relief
o Bangor Punta Operations v. Bangor & Aroostook R.R. – Bangor Punta sells BAR to
Amoskeag, claim is that Bangor Punta mismanaged the company and directly harmed
the corporation before it was sold
 The suit was purported to be on behalf of the corporation but the actual
beneficiary was the new majority shareholder who bought it after the fact
 Even though corporation is suing corporation, they say it’s really about the
shareholders
 It matters whether it’s direct or derivative because of the contemporaneous
ownership claim
 The shareholder cannot be barred from suing directly
 But if it’s a derivative, then he can’t sue because he wasn’t a shareholder
at the time of the harm
 Court is saying in equity, they can’t maintain the present action
 Where equity would preclude the shareholders from maintaining an action
in their own right, the corporation would also be precluded
 A shareholder may not complain of acts of corporate mismanagement if he
acquired his shares from those who participated or acquiesced in the
allegedly wrongful transactions
o Presumably having known it, they adjusted the price accordingly
 Corporation was in fact injured, but the wrongdoing was already reflected in the
price they bought it for, so allowing recovery wouldn’t be fair
 Court focuses on this concern – shouldn’t be able to pay less and recover
 That’s not something you would need to do in a direct, which it actually is,
so the court is looking at it as a derivative
 Didn’t have to do this through the contemporaneous ownership rule, but they did
 But that rule can’t really be based on lack of harm
o You can be harmed when not a contemporaneous owner, if a
corporation was harmed, and that harm persists
o Very inclusive rule to say non contemporaneous owner means you
weren’t harmed
 Really just to prohibit frivolous lawsuits, prevent the manufacture of plaintiffs
 Prevent people from buying and then suing after the fact
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
Here we have a situation that in equity begs for a solution and contemporaneous
ownership rule is probably forced into here where it’s not really a derivative
action
 This is an odd situation, an odd case, it’s generally more straightforward
 The court really went with equitable principle rather than
contemporaneous, even though they said it was that (don’t stress on these)
o Rifkin v. Steele Platt – Buyers bought a corporation without knowing the sellers had
made inaccurate financial representations, he’s suing on behalf of the corporation on
certain things, but also alleging he was defrauded as a buyer – elements of both
 Breach of fiduciary duty claim is derivative-ish
 Defrauded is direct
 Matters whether direct or derivative for the same reason
 If direct, he can sue, if derivative contemporaneous rule blocks
 Unlike the other case, where they didn’t make a claim that they were defrauded
 It wouldn’t be a double recovery here, would be fair to let them proceed
 Rule about no recovery if buying from the wrongdoer won’t apply if they were
defrauding you
o Marx v. Akers – Complaint alleges the board wasted corporate assets by awarding
excessive compensation to IBM’s executives and outside directors – Question is
whether the P had to make a demand on the board to initiate a lawsuit
 §626 – Before a derivative claim, P has to show efforts to secure initiation of
action by board, unless such a demand was futile
 If it’s futile it may be excused
 Court says it won’t be sufficient to just name a majority of the board as
defendants in the complaint
 You could then just always draft one that includes all the defendants
 So courts will look to whether you were really conflicted in the matter
 You also have to make particularized allegations of demand futility
 Procedurally make allegations, detailed pleadings, specific statements
 Very demanding as a substantive matter; you don’t yet have discovery
o You have to put together a mini case to allow the case to proceed
 Demand futility shown by NY rule
 1. Majority of the board is interested in the challenged transaction
o Loyalty
 2. The board did not reasonably inform themselves
o Duty of care
 3. So egregious on its face
o Substance or good faith
 Sounds like all the fiduciary duties
 Court says demand is not futile on aspect of executive compensation
 Most were outside directors so they’re not conflicted and can make a good
decision whether or not to sue
 But director compensation part they are conflicted
 When directors are setting their own salaries, they are necessarily
conflicted
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
But court holds there is no cause of action, they have not stated a wrong to
the corporation which had to have been compensation rates excessive on
their face and not possible to be of a valid business judgment
o Sounds like a waste standard, substantive
o If it’s not, then we have to litigate every board of director decision
 But waste test is not obviously right because we use that when there isn’t a
conflict of interest
o Conflict we use the entire fairness test
 Substance and procedure
o Procedure have to prove entire fairness
 Some slight of hand here
 Have to meet the waste standard, but there is an acknowledged conflict
o They don’t want to get into compensation, so they’re willing to look
past structural bias
o Ill-fitting
o Delaware Approach – slightly different test
 Complaint must allege particularized facts which create a reasonable doubt that:
 1. Directors are disinterested and independent; and
 2. The challenged transaction was otherwise the product of a valid
exercise of business judgment
 Reasonable doubt means something like any reasonable possibility that it’s true
 Pretty low standard to establish, but that’s not the way it work, so it’s
unclear why they use that standard
 We have to have reasonable grounds to believe is what they really mean
 That’s better than proving there’s not a conflict, but you still have to demonstrate
it with particularized allegations
 Also, if you make a demand, you waive demand futility
 But in order to not make the demand, you have to plead particularized
allegations without discovery
 You have a pretty bad choice
o Model Business – You have to make a demand
 After making the demand, 90 days for a response before you can sue
 Good idea because why get into litigation before we really have information
 Bad idea because the corporation will likely reject it in their business judgment
 Can argue it’s a wrongful decision, but good luck with that
o Zapata v. Maldonado – Dealings within the company that allowed senior officers to
exercise their options before the market price rose as a result of the tender offer, saving
a considerable amount of taxes and preventing Zapata from realizing a tax deduction
 Derivative action that went to trial
 They didn’t make a demand but it was dismissed as futile
 Then the board made an independent litigation committee that decided it
should be dismissed and they moved for dismissal or summary judgment
 The committee is two directors who are new and not interested
 They were given final authority – board couldn’t overrule it
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
Theory – The corporation gets control of litigation unless they’re
conflicted, and since they were here, they can delegate authority to the
unconflicted committee
 Argument they can’t is structural bias
o That these are their colleagues, friends
o Court kind of agrees – seems to justify caution
 BIG issue where Courts recognize structural bias
 One is compensation issues
 The other is derivative litigation
 Third is possible takeovers
 They create a 2-step test
 1. Look at whether this really was an independent committee
o Corporation has to prove that they were independent
 2. Then the court applies their own business judgment
o VERY ODD – courts don’t apply their own judgment
o They think there’s a structural bias we have to do something about
 But the reason for the business judgment rule is that courts
don’t know business
o Intended to thwart instances where it meets step one, but doesn’t
comply with the spirit
o This is not just reviewing something like conflict of interest, which
they already proved, this is further saying they get to decide
 This is an intermediate standard of review
o Conflicts – we have entire fairness test
o Structural bias in derivative litigation – this test
 No case heard of that found for in part one and then found
against in part 2
o Concept of independence
 Historically we focused on whether a director was disinterested, but that’s not
really enough, so courts are looking to independence
 Disinterested – not having a (material) financial stake
 Independent – able to make a decision based on the substantive merits
rather than based on extraneous considerations or influences
o Special litigation committees
 In re Oracle Court – Derivative action brought for insider trading, a two-person
“special litigation committee” moved to dismiss the action
 SLC was not considered independent because the other person regularly
gave money to the university
 This kind of analysis takes the concept of independence very seriously
 Is it really the case that a tenured professor is going to care about someone
who gives money to the university?
 Bean v. Stewart – Personal friends were nevertheless found to be independent
 Court says allegations of mere personal friendship are insufficient to raise
a reasonable doubt
 Someone could much more easily conclude they were not independent in
this case over Oracle
100
 This is a SC case decided after Oracle – More likely to follow Beam
 But the truth is courts are wrestling with what to do with this
 30. EXCULPATION, INDEMNIFICATION, AND INSURANCE
o Fall out of Van Gorken was exculpation statutes which allows the corporation to limit
or eliminate duty of care liability
 Opt in provision in Delaware, have to amend the Charter
 But you cannot exculpate them for breach of the duty of loyalty
o Delaware SC decided it was an affirmative defense
 This is after Emerald Partners – Protection under §102(b)(7) is in the nature of an
affirmative defense; burden of demonstrating good faith is upon the D seeking
the protection of the statute on exculpation
 Consequence of this is we can’t just dismiss on the pleadings
 Business Judgment rule had allowed them to get rid of litigation pretty early on
 Courts seem to want to get rid of cases early on, less litigation cost
 Now if it’s an affirmative defense, maybe it requires discovery and a trial
o This reduces the risk of settlement value strike suit
o Malpiede v. Townson – Claim is that the sale of Frederick’s to Knightsbridge was a
breach of the board’s fiduciary obligation to maximize shareholder value because they
didn’t conduct an auction with a level playing field as required by Revlon
 Plaintiffs challenging director conduct have the burden to allege well-pleaded
facts that the conduct falls within the exceptions of the Delaware statute
 No-shop – a provision in an acquisition agreement providing that the target may
not solicit competing offers, but may entertain them if they arise
 No talk – a provision in an acquisition agreement providing that the target may
not even entertain a competing offer until the current offer is consummated (or
terminated)
 This one is rare, much more susceptible to breach of duties
 Especially problematic in regard to Revlon
o If a company is for sale, directors have to seek the highest price and
how can you get this if you’re not talking to anyone else
 D’s say they’re exculpated, they can’t face liability for this, seek dismissal
 No duty of loyalty claim because the board was not in conflict
 Possibly a duty of care claim, but they don’t decide because even if it
existed, the directors are exculpated
o There’s no way to find them guilty, so they can dismiss the case
 When only seeking damages (not an injunction) don’t have to go to trial
o Exculpation protects directors only from money damages
o Had they sought injunctive relief, the exculpation would not have
released them
 But, could still go to a trial and try to determine whether or not there was a
breach of care and then not count the exculpation until the damages stage
 Even if you can’t get money, it might show that they did something wrong
 If we don’t have these cases, then the duty of care almost does disappear
 Revlon issue – the D doesn’t seem to be seeking the best price, seems like they
favor Knightsbridge and the provisions prevent finding a better offer
101

Maybe they did seek the best price since it was a year long process, not
illogical that a no-talk provision could be a good idea at some point
o But if it’s a factual question, seems hard to get rid of it on the
pleadings before you even get to judge
o Indemnification and Insurance under §145
 Indemnification – reimbursement of a loss or expense incurred by another
 (a) allows indemnification in direct actions
 (b) allows indemnification in derivative actions
 (c) requires indemnification if defendant is “successful on the merits or
otherwise”
 (d) requires specific authorization for any indemnification payment under a or b
 (e) allows advancement of expenses
 Allows the company to advance expenses for litigation to you, provided
that the agent reimburse the company if you are not entitled
 (f) allows additional rights
 Increase rights to indemnification in the Charter, to go beyond the legal
minimum
 (g) allows liability insurance for corporations to fund its indemnification
obligations
 Might seem problematic to allow insurance, which allows the corp to
indemnify indirectly, when we wouldn’t allow indemnification directly
o Premium payments for such policies based on the probability of risk
 Presumably companies with more safety and internal
controls will have to pay less
o The theory is that the director herself could have bought the
insurance and it shouldn’t make a difference that the company
compensates her by paying the premiums
o Corporation is insolvent, insurance allows us to know there‘s
someone to pay the director even when the company can’t
o Waltuch v. Conticommodity Services, Inc. – Silver trader seeks indemnification of his
legal expenses from his former employer
 P – He is entitled to indemnification for both his private and company actions
 Indemnification was allowed by the terms of the Charter
 But the court doesn’t allow indemnification
o §145(a) says it’s limited by good faith
 D says it’s not exclusive and the Charter can expand the right to indemnify so the
company doesn’t say it needs good faith
 Court – you can expand, but you can’t go against Delaware law
o Not requiring good faith is inconsistent with the law
 No indemnification under a (direct actions), but he can get it under c (successful
on the merits or otherwise)
 He was not successful on the merits, but he was successful because he
settled and didn’t have to pay anything
o Escape from an adverse judgment for whatever reason
 (a) and (b) are really about if the D loses
 He can be indemnified unless acting in bad faith
102
 For (c) it’s not optional, they must if he wins
 Distinction between power and rights
o Citadel Holding Corp. – Suit is brought against Roven and he demanded
indemnification under the company’s general indemnification agreement
 Charter indemnification excludes section 16(b), which is the action he assumed,
but he still gets indemnification
 Allow advancement of cost because he might be entitled to
indemnification, but it says he won’t be entitled to indemnification
o So it seems odd that even though they won’t allow indemnification,
they have to give him advances, which he has to pay back
 Solution is section (c) – if he ends up winning the section 16(b) suit on the
merits, the corporation must indemnify him, even if they tried to preclude that
 §145(c) – entitled to it notwithstanding the charter
 An unlimited right to advancement of expenses – you always have the chance of
winning, even if your contract tries to exclude it
o In re Landmark Land Co. – Agent who participates in illegal conduct against third
persons cannot be said to have acted in good faith
 Going to mean that we’re going to put all the onus on this person, even if we’re
granting that it benefits the corporation
 Corporation might even be looking the other way, benefitting
 Difficult case – where’s the cutoff between loyalty and good faith issues
 Good faith has generally been defined to exclude intentionally illegal
behavior
 Policy determination that the law can’t condone illegal behavior
 31. SHAREHOLDER RIGHTS TO INFORMATION
o Saito v. McKeeson HBOC, Inc. – P alleges wrongdoing on company’s part and wants
access to information to prove it, uses DGCL §220 (Inspection of books and records)
 Right to information can be important in making particularized allegations
 One way to do this is through inspection rights – right of shareholder to
inspect the corporation’s books and records
 Shareholders cannot freely seek access to corporation information
 Statute says you have to have a proper purpose reasonably related to their
interest as a shareholder, including possible corporate wrongdoing
 Directors might not want to allow the intent to sue to be a legitimate
purpose, but from corporation’s perspective that’s clearly legitimate
 Not limited to documents created by the corporation
 You can still have access to third party documents, the sources has little
bearing on shareholder’s right to information in corporation’s possession
 Standing limitation
 Shareholders who bring derivative suits must be stockholders at the time
of the transactions (§327)
o But this doesn’t mean you can’t get information before that time
 Even if contemporaneous shareholder rule should govern, there can be
continuing wrong and background information may be important
o Pillsbury v. Honeywell – Pillsbury buys stock so they can go to other shareholders and
get the company to stop manufacturing weapons
103

Improper purpose – Court holds it’s not a proper purpose germane to his
economic interest as a shareholder
 Once it is determined the shareholder has a proper purpose, any ulterior
motive doesn’t matter
o Seinfeld v. Verizon – Shareholder sues corporation for information on the
compensation of its highest officers because he thought they were wasteful/excessive
 P was essentially trying to change the standard
 He says that in order to have derivative litigation, you must have
particularized claims, and he shouldn’t have to prove anything now since
he’d have to prove it at trial
 Pretty good argument but court disagrees
 Court holds shareholder must have some evidence to suggest a credible basis
from which a court can infer wrongdoing
 Strike a balance between the rights of shareholders and management
 Court is getting something confused, it’s not that management has rights
o They have authority to run the business
o They don’t have a right not to be bothered by the shareholders
 Don’t want everyone to be able to pose all kinds of costs on the
corporation on fishing expeditions
o If you have reason to suspect something, maybe it’s worthwhile
 The threshold
 Court calls it the lowest possible burden of proof, but also say it’s not
insubstantial – So is it a low burden or a high burden?
o This case is only the second time that the court has found the claim
to be entirely without a credible basis
o They’re not routinely getting rid of these claims
 This test is for when we’re trying to establish and investigate wrongdoing
o Different if trying to communicate with other shareholders
 It’s not a binary question – do you get documents or not, it’s that you only get
the information related to what you’re investigating
 Not going to get information on wrongdoing if you just ask for the
shareholder list
 Also can’t get information on any kind of misconduct, only specific claim
 It’s not a proper purpose to want information just on compensation
 Same argument that you don’t want to let shareholders in on everything
 But it also seems that at every turn we’re going to let corporations pay
whatever they want without restriction
o Information Rights
 1. It can be costly if you have lots of shareholders doing it in lots of corporations
 Courts are trying to strike a balance
 2. Shareholder lists
 Pretty liberal in giving these out under state law (except Pillsbury)
 Federal law (14a7) Any corporation must either give shareholders a
shareholder list or offer to mail the material to other shareholders at the
one shareholders expense
104

When there’s a conflict between state and federal, federal would govern
o But courts don’t consider this as a case of preemption
 Under federal law, both can be applied at the same time
o Corporation then has an option of giving you the list or mailing on
your behalf under federal
 If state law didn’t say you have to give the list, then federal
law gives you the option of those two
 So, in most cases, because of state law, you have to give
them the list
 3. Required disclosure
 Traditionally state law doesn’t require corporations to disclose information
to shareholders
 Model Business Corporation Act changes this
o Requires annual financial reports
 Better than nothing, but still pretty limited
 Delaware doesn’t even require that, they don’t have to talk to shareholders
o One exception – any time they are asking for shareholder action,
they have to give information (Every year election of directors)
 4. Candor
 Corporation doesn’t have to say anything, but if it chooses to speak, it
can’t mislead the shareholders
 Courts used to speak about the duty of complete candor
o Now they say a duty of materiality – idea being that complete
candor means I have to be completely above board
o Materiality says for the most part accurate
 When it switched the court said there was not real change here
 State law information rights are not that big
 This, among other things, led to the federal government stepping in
o History of Securities Regulation
 State securities regulation
 Originally securities weren’t regulated besides common law fraud
 Blue sky laws – state securities laws
o One main feature was merit regulation
o If you want to sell securities in a state the state got to regulate it and
determine if they wanted to sell it, judge it on the merits
o Merit regulation wasn’t the best idea
 Is the government really able to tell what’s a good
investment and how can they really enforce it when it’s a
national problem
 Stock Market Crash of 1929
 Seemed to have caused the Great Depression
 Led to an absolute need for federal securities regulation
o Eventually it supplanted state law (it’s now close to meaningless)
o Federal government decided not to engage in merit regulation
 They can sell anything and you can buy anything
 Federal securities regulation
105

Mandated disclosure
o Adequate and accurate disclosure
o Shareholders get relevant stuff, government gets even more
o With complete information, they can decide for themselves if they
want to buy it
 Antifraud liability
o Company is liable if the information is inaccurate
o A lot more regulation than under state
 No merit regulation
o Federal Securites Laws
 Securities Act of 1933
 Primary markets – the market for securities sold by issuers to investors
o This is what it regulates for most part
o For securities sold by the company to public
o IPO – Initial public offering
 The first sale of stock by a private company to the public
 Mandated disclosure – Must register securities and file a detailed
statement, deliver a prospectus before selling securities to the public
o Registration statement – document, including a prospectus, which is
required to be filed with the SEC in connection with public offering
o Prospectus – a document used to offer securities for sale in a public
offering
 Total information about the company
 SEC then reviews that for adequacy
 Once done, declared effective
o Unless exemption if available (Not a public offering, just a private)
 Antifraud liability
o Company is liable for false or misleading statements or omissions
of material fact (deception)
o Pretty high standard
 Securities Exchange Act of 1934
 Regulates primarily secondary markets
o Secondary market - the market for securities sold by investors
among themselves
o Almost all securities transactions are secondary markets
o Similar to primary, but different in rules
 Very common, people trading all the time, so can’t have the
same detailed process
 Still have mandated disclosure
o But we say they have to file periodic reports on company
performance; Yearly and quarterly
o Must file additional reports under certain circumstances
o Idea being that shareholders will be more or less up to date
 Antifraud liability
o Manipulation and deception
106
o Company is liable, but you are also liable if you make false or
misleading statements, individuals
 Securities industry generally
 Securities and Exchange Commission - the agency established to oversee
the enforcement of the federal securities laws
 Federal security law is not the same as state corporate law
 State corporate law, form trumps substance
 Federal securities law, substance trumps form
 There’s no race to the bottom
 When federal law is regulating it doesn’t care what anyone else is doing
like states have to worry about what other states are doing
 32. RULE 10b-5
o Rule 10b-5
 SEC rule under Exchange Act § 10(b)
 Congressionally delegated authority
 Forbids, in connection with purchase or sale of securities:
 Devices, schemes and artifices to defraud
 Practices which operate as a fraud or deceit
 False or misleading statements or omissions of material fact
 Enforcement
 By the SEC
 Private investors
o Courts have found there to be an implied private cause of action
o Not clear it was intended by Congress or the SEC, but it has
become a significant provision in litigation in securities laws
 Elements
 Interstate commerce
 Material misstatement of omission required (Deception must significant)
 Scienter – Intent to deceive (or recklessness)
o All lower courts have agreed that recklessness will suffice, though
SC has never said so
 Connection with a purchase or sale of securities
o For you to sue you have to have bought or sold securities
 Reliance
 Causation
 Damages
o Can only recover your economic loss, possibly an injunction, not
more than that
o Basic v. Levinson – Basic begins engaging in merger negotiations, but gave false
statements that they weren’t doing so, shareholder sells shares and claim they were
injured by selling shares at artificially depressed prices in a market affected by
petitioners’ misleading statements
 Materiality – Substantial likelihood that a reasonable shareholder would consider
important in deciding how to act
 Court holds that preliminary merger negotiations aren’t immaterial
107




But when the event is contingent or speculative in nature, this standard makes it
difficult to tell, so they go with the probability/magnitude test
 Whether merger discussions are material depends on the facts
o Case by case
 SC rejects the agreement-in-principle approach of lower courts (merger
negotiations not material until an agreement had been reached)
o Doesn’t mean it’s not material if there’s not been an agreement
Courts were worried about revealing corporate secrets, so now if you have to
reveal merger negotiations, that could be a problem
 But this is not about disclosing all material information
 Materiality is about accuracy of disclosures, not timing, said SC
 You don’t have to automatically say anything, don’t have to disclose
everything all the time, but you have to be accurate about material things
o The only thing you can do is to always say no comment when asked
about merger negotiations if you want to keep secrets
 No comment is the functionally equivalent of silence
Reliance and fraud-on-the-market theory
 If we require each and every plaintiff to show reliance, we can’t have a
class action, but it’s part of the requirements
 Fraud-on-the-market theory
o Sounds like the efficient marker hypothesis – based on the
assumption that current market prices reflect current information
 So current prices reflect that misinformation
 Don’t have to have relied on the information if I relied on
the market, which should have relied on that information
 You lied to the market, so you re-lied to me
 Sounds like we’re getting rid of reliance, but it’s just a rebuttable
presumption of derivative reliance
o 1. Court says they can still rebut the reliance by showing it didn’t
really affect the price
o 2. Can also rebut it by showing it’s not an efficient market, which
means we can’t assume that a lie affects the price
 Not going to work with a stock that trades on the NYSE
 But not all businesses will trade on an efficient market
o 3. The individual would have sold no matter what, no reliance
 Realistically can scratch this third one off the list
 They’re trying to preserve some semblance of reliance
o Watered down to the point where we assume reliance (bizarre)
Rule requires it to be in connection with a purchase or sale of securities
 This case isn’t really about those things, but courts have been very relaxed
on this one (Dissent takes note of this)
 Court basically says there was a fraud and they knew there would be a sale
or purchase in association with that later
o There just has to be some minimal connection
 If we didn’t do that 10b5 wouldn’t ever really apply to the company
108
o Santa Fe Industries, Inc. v. Green – Company performs a short-form merger, minority
shareholder thinks the price was significantly too low, so sues under 10b-5
 Claim Santa Fe knew the valuation was fraudulent
 But really it’s about an improper purpose of trying to freeze out the
minority, really nothing more than a breach of fiduciary
 They didn’t withhold information or misrepresent it
 SC says the federal law doesn’t protect shareholders against a breach of fiduciary
duty without any misrepresentation or lack of disclosure for 10b-5
 Federal securities law isn’t really about fairness, only about disclosure
o Once disclosed, the fairness of it is at most a tangential concern
o Not saying unfairness is ok, but there are other rules for that
o 10b5 is about disclosure
 Before this the federal laws were being interpreted very broadly
 This is one of the first cases where the SC stops it
 Looking at fairness anyway
 Valued
o P’s valuation of the shares was over 700
o Morgan Stanley was 125
o Company gives 150
 If a company is worth more dead than alive, you ought to kill it
o If they’re getting out, they should probably be paid the high amount
 State court said 254 because there’s nothing that said they had to liquidate
 It’s also not manipulative
 The term refers generally to practices such as wash sales
o Basically wash is when you buy and sell at the same time to make
the stock look active and cause the price to go up, then sell
o Hypo – Ps decide not to buy based on overly pessimistic evaluation of the company
 Then turns out they do really well, and I want to sue
 Can’t sue, it’s not really in connection with a purchase or sale of securities
 We don’t know how many shares the person was going to buy
 Goes too far to allow people to sue on what they didn’t buy
 This is what the SC decides – it goes too far
 Blue Chips Stamps v. Manor – SC says it would open up a can of worms
o For a private plaintiff to sue under a 10b5, you have to actually be a
purchaser or seller
 33. INSIDER TRADING
o Insider Trading – the use of material, non-public info in trading the shares of a
company by a corporate insider or other person who owes a fiduciary duty with respect
to such information
o Goodwin v. Agassiz – Court found the D’s not liable when shareholders sued insiders
in the corporation for purchasing stock from them based on information they had
 Court held directors and officers have no such duty, at lest in an impersonal
market, liability requires a face to face transaction
 Very old case, pre-dates federal securities law
o In the Matter of Cady, Roberts & Co. (Modern case law) – Those with access to insider
information cannot engage in securities transactions to benefit from that information\
109

Not limited to insiders, who is obligated rests on 2 principles:
 1. Existence of a relationship giving access to information intended to be
available only for a corporate purpose, not personal benefit
 2. The inherent unfairness involved where a person takes advantage of
such information knowing it’s unavailable to the one dealing with
o SEC v. Texas Gulf – This is not the law
 New rule in second circuit (767)
 Anyone in possession of material inside information must either disclose it
to the investing public, or, if he is disabled from disclosing it in order to
protect a corporate confidence, or he chooses not to do so, must abstain
from trading
 But Rule 10b-5 is about deception (767)
 Second circuit said that Rule 10b-5 is based in policy on the justifiable
expectation of the securities marketplace that all investors trading on
impersonal exchanges have relatively equal access to material information
o Insider trading is inherently fraudulent
 But it might not be true that there should be a level playing field
o Why bother playing – people play because they might get ahead
 There are good reasons for it, but not clear it’s the perfect fit
o Chiarella v. United States – Printer who saw documents about target corporation in his
line of work and purchased stock then sold after takeover attempt, earning $30,000
 He is indicted by the SEC, Court here said SEC’s position was not correct
 Rule 10b-5 doesn’t cover insider trading as such, it covers deception
 May cover insider trading, so have to ask if it’s deceptive
 Failing to disclose information is fraud only when he is under a duty to do so
 Duty to disclose arises when one party has information the other party is
entitled to know
 10b-5 it has to be about deception, Court says insider trading it not necessarily
 Insider trading in breach of a fiduciary duty can be deceptive though
o If you’re an insider and you have a duty to disclose and you don’t,
that’s deceptive
o Fiduciaries implicitly represent that they are acting in good faith,
which the public does not represent (Printer doesn’t have that duty)
 Essentially he is a stranger with no fiduciary duty to the company
 Ground work for 10b-5’s dealing with insider trading
 Have to have a breach of fiduciary duty
 Nonfiduciaries don’t violate 10b-5 by insider trading
o Dirks vs. SEC – Secrist was a former insider who tells Dirks the company has fraud and
to investigate, Dirks tells others about his investigation, who then sell their stock
 SEC only censures him because he helps them expose the fraud
 Not concerned with him, just trying to minimize damage from Chiarella
 SEC theory – Where tippees comes into possession of material corporate
information they know is confidential, they must refrain from trading or publicly
disclose that information
 He has no fiduciary, but they wanted to get him anyway
110

SC rejects SEC – There has to be a breach of fiduciary duty here (not because
10b-5 requires fiduciary duty, but because it makes it deceptive)
 SEC – Tippee automatically assumes the fiduciary duty when they get the
info
 Court – A tippee assumes a fiduciary duty to the shareholders only when
the insider has breached his fiduciary duty to the shareholders by
disclosing the information to the tippee and the tippee knows or should
know that there has been a breach
o Test for whether a disclosure is a breach of duty depends on
whether the person will benefit from the disclosure
 Secrist had no breach of fiduciary duty under this rule because he got no benefit
 Since no breach by Secrist, there could be no breach by Dirks
o Dirks would have to inherent the fiduciary duty
 You inherit fiduciary duty when there is a breach and you know it
o Secrest didn’t breach, so no one down the line can be in breach
o Once one person breaks the chain of both breach and knowing of
the breach, it ends it, no one else is liable after
 You must have an unbroken chain of fiduciary duty
o United States v. O’Hagan (Court is expanding liability) – Grand Met hires law firm
O’Hagan works for in acquiring Pillsbury, he buys Pillsbury stock and sold it after at a
huge profit
 Tender offer – public offer to buy a minimum number of shares from
stockholders, usually in an attempt to take control, offered at a premium
 Greats opportunity for insider trading
 Court says insider trading applies not only to permanent members of the
corporation, but attorneys, accountants, etc. who temporarily become fiduciaries
 Only attorneys for the relevant client are constructive insiders
o He’s an outsider, no duty to shareholders of Pillsbury
 Not an acceptable solution since tender offers were a problem of insider
trading – saying it was ok would have created quite a problem
 SEC loses in Chiarella, is somewhat limited in Dirks, so want to expand here
 They expand rule 10b-5 under misappropriation theory, Court agrees
o A fiduciary who pretends loyalty to the principal while secretly
converting the principal’s information for personal gain dupes or
defrauds the principal
o It’s about an outsider duty to the source of the information
 Weak connection to purchase or sales of securities
 But the Court doesn’t require a strong connection
 Securities transaction and breach coincide here
o He’s not breaching anything by having the information, he breaches
it when he engages in securities transaction
 The two then are related
o Misappropriation theory comports with 10b language in allowing
liability for a lawyer working for the bidder
 One big loophole in misappropriation theory is disclosure
111

Full disclosure forecloses liability under misappropriation because then
there is no “deceptive device”
 But it’s still a breach of duty of loyalty under state law
 Footnote 7 – can still be liable where they owe a duty of loyalty and
confidentiality to two entities and they only tell one
o Rule 14e3 promulgated by SEC after Chiarella and Dirks
 Saying no trading with non-public information, regardless of fiduciary duties
 It’s a lot like section 10b and yet the SEC’s theory was rejected under 10b5 but
upheld under 14e3
 10b only authorizes the SEC to proscribe fraud
 SEC is authorized to promulgate rules to prevent fraud and that makes 14e
a prophylactic measure
 Chiarella and Dirks are still good law
 Nothing wrong with them, it’s that 14e3 relates to tender offers
 If not a tender offer it goes under 10b5
o 2 major differences in 10b and 14e
 14e’s delegation of authority is much broader than fraud, but scope limited to
tender offers
 34. BUSINESS COMBINATIONS
o Acquisition – a general term that refers to a business combination of any type
o Takeover – an attempt by an acquirer to gain control of a target
 Acquirer – one seeking to take over a business
 Target – business that is the object of a takeover
o 3 Main Types of Acquisitions
 1. Stock Purchase – acquisition in which an acquirer buys the stock of the target
from the target shareholders
 The target becomes the subsidiary of the acquirer
 In relation to the other forms it’s A + B = A + B
o Both there before and after
 Shares purchased directly from shareholders (Ex; tender offer)
o Theoretically, the target company isn’t involved, really a
transaction between the target and the shareholders
o No say for target directors, each shareholder makes up their own
mind, no approvals
 If they get enough, they become controlling, if not, they don’t
 2. Asset Purchase – acquisition in which the acquirer purchases the assets (and
maybe the liabilities) of the target
 One company ends up taking the assets of both
o A+B=A
 Two companies can technically remain, but in the end there’s really only
one operating company
o The other would be a shell company – a corporation without
significant operations, often formed for a particular transaction
o What usually happens is the target dissolves
 Need specific approval of target’s directors and shareholders
o If selling all the assets, need directors and shareholders
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 Shareholders don’t get a say in much, they do get it in this
o Acquirer approval is not necessarily required
 3. Merger – an acquisition in which an acquirer and a target combine into one
 A+B=AB (AB can actually be A, B, or C)
o Can be called any of those, the one corp, the other, or a new name
 Constituent corporation – corporation party to a merger (A and B are)
 Surviving corporation – the constituent corporation that survives the
merger
o If B merges into A, A is the surviving
 Resulting corporation – new corporation formed as a result of the merger
 Need approval of both companies directors and shareholders
o Merger Procedures (DGCL §251)
 Prepare Merger Agreement
 Technical requirement, it sets forth what will happen in the merger
 Especially the consideration for the shareholders
 Approval of directors of each company for the merger
 Approval of the shareholders of each company
 Law considers this very significant since it can change the entire
corporation, so they let shareholders vote
 Delaware, says need a true majority, over 50%
o No’s count as no, but so do abstentions
o Need affirmative Yes
 File with Secretary of State
 Generally they file a certificate of merger
 Dissenting shareholders are entitled to appraisal rights
 The right to forego the contractual consideration in a merger and to
receive instead the fair value of the shares
 But can have companies from two different states merging, which law governs
 It’s both laws, the merged corporation doesn’t exist yet
o Merger Consideration
 Standard Merger – all combined into resulting corporation
 Consideration is shares in the surviving corporation
o You had shares of B and in exchange for approving the merger you
get shares of C
 The number of shares depends upon the value of constituent corporations,
not automatically getting the same number of shares
o The number of shares may vary in each corporation and each of
their individual values then vary
 Legal Possibilities
 Any consideration
o It can also be securities, property as consideration, not just shares
 Can be anything (bottles of whiskey)
 Different consideration
o Can say A gets common stock and B gets preferred stock or any kid
of combination
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o Cash-out merger – a merger in which one company’s shareholders
receive cash instead of shares in the surviving corporation
 Doesn’t really look like a merger, more like an asset
purchase
o Merger of equals – a merger in which there is no real acquirer or
target, but two equal companies truly combine into one
o Appraisal Rights
 Appraisal rights - the right to forego the contractual consideration in a merger (or
similar transaction) and to receive instead the fair value of the shares
 Most states allow an option of appraisal rights, this is pretty major
 Once upon a time required unanimous consent (now usually just a
majority)
 Delaware
 Idea was that if you don’t like mergers, sell your shares if it’s a public
corporation
o If consideration is bad, you’re not going to be able to get the right
consideration
 In purely public transactions where you receive shares, you don’t have to
have an appraisal right
o Just for mergers, and not all mergers get appraisal rights
 Other states
 You have more expansive appraisal rights, not just for mergers, but asset
purchases and certain charter amendments
 Delaware Procedures §262
 Company must give notice of appraisal rights
 Shareholder must demand an appraisal before the vote
 Shareholder cannot then vote in favor of the merger (no or abstain)
 Then petition the court for an appraisal within 120 days
 Court then determines the fair value of shares
o Any reasonable techniques can be used
o Generally no minority discount applied to shares
 Argument against it – market isn’t willing to pay for those
shares so why would you get it
 If you didn’t – controlling shareholder could become very
oppressive an then don’t get fair value
o It may be less than merger consideration
 1. §262(h) provides that the determination of fair won’t
include fair value arising from the value of the merger
 Synergistic advantage – combine certain skills,
resources, etc., so the whole is greater than its parts
 Supposed to be looking now, not in the future with
the benefits of the merger
 2. An acquirer usually pays extra, premium
 Premium – an amount above the market price paid
by an acquirer to target shareholders in order to
purchase the shares
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
3. Appraisals are costly, there’s transaction costs involved
 At least in Delaware, the shareholder pays that
 In other, the corporation pays and it’s not a factor
 To be able to afford it, should be a pretty big
shareholder, and big difference between fair value
and appraisal to pay for those litigation costs
o Ex; Santa Fe v. Green
o Hollinger v. Hollinger – Hollinger International wants to sell Telegraph, it’s biggest
asset shareholders sue, claiming it’s a sale of substantially all the assets
 §271 – Corporation can sell substantially all its property and assets when
authorized by a majority of shareholders
 D claims – §271 not implicated at all because International is not selling its
assets, it’s the asset of subsidiary
 Maybe that subsidiary needs shareholder approval, but that’s easy because
those shareholders are part of the corporation
 Court disagrees because the parent company was a party to the agreement, it was
a signatory to the agreement
 Technically, it didn’t have to be there, in which case, then maybe it would
have been ok – BUT that can’t really be
o We include them for the buyer, liability, no formal reason
o Court here is rejecting the formal argument, looking at substance
 Strange because form is supposed to prevail over substance
 Possible demarcation point, the court says they don’t need to decide since
they fail on the other point
 Even if they were doing all this, they still have to apply §271
 Courts have just pulled out numbers on what “substantially” means
o Some say over 50%, sometimes even below 50%, sometimes higher
 This court didn’t really say what that means
 They rely on the Gimbel test to decide this (1043, bottom)
 1. Quantitatively vital – A big number
o Court says it isn’t here, it’s not substantially all
 2. Qualitatively vital – Does it substantively affect the existence and
purpose of the business
o Not saying this was a matter of feelings, still about economics
o Could imagine one asset is 30% of the assets, but 100% of the
profits – that sense it is qualitatively very important
 Not just whether it’s 80-90%, maybe it’s disguised by just
that one number
 35. FORM AND SUBSTANCE IN BUSINESS COMBINATIONS
o Loopholes?
 Stock-for-assets transaction
 Corporation A issues shares of its own stock to Corporation B in exchange
for substantially all of B’s assets
 Cash-out merger
 Merger in which the acquiring company buys the stock of the target
company for cash, in effect cashing out the stock of the target company
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
Law allows merger consideration to be anything you want it to be
o 3 levels of defense if we think it might not be fair
 Fiduciary duties, shareholder vote, appraisal remedy
o Nothing inherently wrong with the cash-out merger
 Short-form merger – procedure under some states laws under which corporation
may merge with a subsidiary without a shareholder vote
 Delaware §253 provides that a parent can merge with a 90% subsidiary
without shareholder approval
 It has to be a very simple straightforward merger, no Charter amendments
o In a normal merger you can do whatever you want with the charter
 Triangular merger – between one corporation and the subsidiary of another
 The subsidiary is usually just a shell corporation organized specifically for
purposes of this merger
o There is no law that allows this in particular, they just invented it
out of law
 Acquirer might want to acquire the target through the subsidiary because
the law provides in a statutory merger you need the approval of both
constituent corporations
o The merger is technically one company and the subsidiary of the
other company, you can avoid shareholder vote of the acquirer
o S’s shareholders, which becomes B (the buyer)
o In a takeover, the acquirer needs to pay a premium and the target,
who gets the premium, will be happy with the deal, while the
shareholders paying the premium might not be
 After the triangular merger, can follow up with a short-form merger
o Merge A into B without shareholder approval
o In two steps, effectuated a merger, but eliminated the requirement
of the vote of the acquirer
o This procedure is almost exactly the same as a one step procedure,
but without the shareholder vote on one side
 This is the height of form trumping
o Substantially the same
o The only difference is that you can’t sneak in charter amendments,
but other than that, it is a merger
o Perfectly legal (CA some problems page 1081)
o Considerations
 Structure after the merger
 M and AP – one surviving company
 SP and TM – two corporations, parent and subsidiary
 Ownership
 M, TM, and AP – the acquiring corporation will get 100% of everything
 SP – minority shareholders left over
o You don’t have complete freedom to do whatever you want
 Liability
 M – joins two companies’ liabilities, either’s liabilities can ruin it
o Unknown past, big risk
116

SP and TM – keep liabilities separate
o Unless pierce corporate veil, but generally separate
 AP – liabilities optional (Can decide whether to buy the liabilities or not)
o Might want to buy the liabilities to lower your purchase price
 It’s reducing the cost of the assets
o But there’s always the risk the court will find liabilities for you
anyway, even if you don’t assume them
o Exceptions where you may be liable:
 1. If you agree to assume them
 2. It amounts to a de facto merger, not just purchase
 3. Purchasing corporation is merely a continuation of the
selling corporation
 4. Transaction is entered into fraudulently to escape liability
for such obligations
 Approvals
 Merger – needs both sets of directors and shareholders approvals
 TM and AP – both directors, usually just the target shareholders
 SP – none, theoretically just go to consenting shareholders
o Bypassing directors, just whichever shareholders are willing to sell
 Appraisal rights
 Delaware – only appraisals with merger
 Some other states allow it for asset purchases or triangular as well
 Consequences
 Renegotiation of contract
o Stock purchase of TM, no renegotiation may be necessary
o A and B will still have separate corporations
 Non-transferable rights – rights of a company that cannot be transferred to
anyone else (such as right to intellectual property)
o You could lose the main asset by doing the transaction improperly
o SP – there is no transfer, the transfers are shares, not at the
corporation level, so you wont’ have to worry about this
o M – the two become one, some rights will be deemed to be
“transferred” and therefore invalid since you can’t transfer them
o AP – all rights are transferred
 You don’t automatically get any non-transferable rights
 Tax and accounting can be pretty serious
o Used to be much more serious
o Farris v. Glen Alden Corp. – Large corporation, List, purchases 38% of Glen Alden
stock, then they agree to have Glen Alden acquire all of the assets of List, Glen Alden
shareholders approved, one shareholder sues
 In form it’s an asset purchase, under which acquiring shareholders (Glen Alden)
had no rights of dissent or appraisal; structured to look like a merger
 End results will be pretty similar, one company, assets both in that
company, and shareholders of both will be shareholders of surviving
 P said it was done to basically be a merger (substance over form)
 This really is a merger, Court says we call it a merger
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
De facto merger doctrine – a rule that transactions which are not styled as
mergers but which essentially are mergers may be treated as mergers (for
purposes of shareholder vote and/or appraisal rights)
 An argument against is that it’s better for the corporate world to just be
able to know what they have to do rather than courts come in and judge
what they’re doing
 Appraisal remedy is for shareholders rights – when they don’t want to continue
membership after corporation combines and loses its essential nature, they can
leave and have value of shares paid
 If that’s the logic then does it apply here?
o Without the right of appraisal the shareholder would have his
current stock taken away and another thrust upon him
 PROBLEM – it won’t be so easy to make these distinctions, it’s not going
to be limited to just mergers
 Legislature says the shareholders of a corporation shall not be entitled to the
rights of dissenting shareholders, not entitled to appraisal rights in an asset
purchase – Seems pretty clear by statutory language
 Court says that’s a general rule not in no cases whatsoever
o When it’s an asset purchase but really is a merger, then we’ll give it
to them (pretty clearly wrong)
o The legislature intended to overrule the de facto merger doctrine
 Committee reports say this is intended to overrule
o Aftermath – they amend the law again saying the goal is to abolish the de facto merger
doctrine as part of the statute
 Terry v. Penn Central Corp. – De facto is gone, but in a case where one is
substantially smaller, they reserve the right to, referring to decision in Farris
 Even though legislature is saying no
o Hariton v. Arco Electronics, Inc. – They don’t follow the de facto merger doctrine
 Equal dignity rule – a legal doctrine that different sections of a law are of equal
dignity, and that action taken under one section will not be judged by the
requirements of another section
 This is an adoption of form over substance
 Want corporations to be able to plan, just follow the rules and be ok
 What you think of the theory may depend on your view of corporate law
 If you see it as a set of mandatory rules, then maybe Glen makes sense
o Can’t let you avoid that approval, it’s mandatory
 But if you view the law as enabling, then maybe this isn’t problematic to
you at all
o You can do an asset purchase, or you can do a stock purchase,
we’re just giving you options on what you can do
o Delaware rule is the majority rule
 Once upon a time de facto existed pretty much everywhere
 By and large its’ gone, at least with respect to shareholders
 But creditors sometimes can – why?
 Big issue is that shareholders are in control, they have a say, they entered
into the Charter, have a say, even if indirect
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o Matter of internal affairs, and internally people should be bound by
the rules
 But third parties, that won’t be binding
o Rule among partners will be liable to third parties no matter what,
no matter how they contract for themselves
 36. FREEZE-OUT MERGERS
o Cash-out merger – a merger in which the acquiring company buys the stock of the
target company for cash, in effect cashing out the stock of the company being absorbed
 Appraisal rights might cause us not to worry as much about fairness of this
 You’ll get at least fair value, because if you don’t you can pursue it
 Also requires majority approval on both sides
o Freeze-out – a merger in which minority shareholders are forced to receive cash for
their shares and to lose their status as shareholders (involuntary cash-out merger)
 Don’t confuse with a freeze-out – action taken by majority shareholders to
frustrate minority (not the same, just sound the same)
 Sort of opposite in some way
 Freeze-out the problem is that minority shareholders can’t sell, so the
solution is to force a buy-out
 In a freeze-out merger, the problem is the forced buy-out
o Weinberger v. UOP, Inc. – Shareholder challenges cash-out merger between UOP and
it’s majority owner, they withheld information
 There is self-dealing so we apply the intrinsic fairness test
 Have a parent and subsidiary and parent appoints some of its officers to be
in subsidiary – On both sides of the transaction
o Not a personal financial transaction of directors, it’s the parent
being felt through them
 A buyer does not have to disclose their best price to the seller as a rule
 Problem is that this study by board members on the highest price was
prepared by conflicted directors using information from the subsidiary
o Directors of subsidiary, who are also EEs of parent, generated
information to give to the parent, but not to the subsidiary directors,
even though they owed a duty to them
 Not the type of information, it’s the way it was developed that makes it
material information that has to be disclosed
 They were also agents of the parent company, with duties to them not to
say anything – Court says no dilution of obligation with dual duties
 Kahn – fully informed disinterested shareholder approval will shift the burden to
the plaintiff to prove that it’s unfair
 No shareholder ratification because the shareholders weren’t fully
informed – Material information was withheld here
 No ratification, so Signal has to prove fairness
 The concept of fairness has two basic aspects – fair dealing (process) and
fair price (substance)
 Not a two part test – one question of entire fairness, with two aspects
119

No fair dealing in this case because Signal was creating a lot of time
pressure, quickly approved it, didn’t have full disclosure, they didn’t
negotiate the price
o Doesn’t sound like an arms-length negotiation
 Court doesn’t ultimately decide the issue of price
 Court thought the fairness opinion they got was a hurried process, they
were very skeptical, even though it was a high premium
 But it really bothered the court that they prepared the opinion with a blank
o Sounds weird, but it’s really not – They have someone doing the
analysis and we’re not going to wait on the opinion of price
 Just drafting it, and won’t submit it if it’s not fair
 May not want to put it in so it’s not seen before confirmed
 Remanded for determination of remedy
 Court says remedy should be whatever the trial court deems appropriate
o Gave them lots of discretion, particularly with what a fair price
would be with an appraisal
 Can bring in any kind of evidence you want
o They really open up the remedies
o Coggins v. New England Patriots Football Club – He effects a cash-out merger,
shareholders lost their right to the company
 Not about price, they just really wanted to be a shareholder of the Patriots
 Two part test: (1) Business purpose test (2) Entire fairness
 Business purpose– there must be a legitimate business purpose for the cash-out
 If it’s satisfied, they should proceed to determining fairness
 Logically, almost no situation where there is a legitimate purpose for this
 This might be the only case where there is a business purpose – NFL
wants the companies owned by a controlling shareholder
o Court says they already had control and he just wants more
o Not entirely true because he had to finance this acquisition
 Needed to do an LBO to become a controlling shareholder
 Breach to commit the company to paying off his debt for
personal shares so he had to get rid of shareholders
o As good a reason as you’ll ever find and the Court rejects it
o Maybe saying that freeze-out mergers are just prohibited
 Delaware once had the business purpose test, but they get rid of it
 Mass rejects Delaware’s rejection
 Plaintiffs wanted their shares back but it got remanded to calculate the value of
shares as if there had never been a merger
 Impossible to go back in time to get rescission
o The amount of the shares had expanded, much bigger recovery
o Glassman v. Unocal Exploration Corp. – Parent engages in short-form merger with
subsidiary, Court holds that in such a merger, appraisal is the exclusive remedy
 They don’t have to apply all the fiduciary duties; no need to constitute a
negotiating committee, hire experts, arm’s length negotiation
 Statute is incompatible with these – it would defeat the summary nature of
the short-form merger process
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Exceptions to it
 Duty of disclosure remains because shareholders have to be able to decide
if they want to accept the offer or seek an appraisal
o They still need information
 Fraud and illegality
o Almost always going to make an exception here
 In Delaware – 90% parent can kick out minority shareholders with no other
protections except an appraisal remedy
 37. TAKEOVERS
o Takeover – an attempt by an acquirer to gain control of a target
o Hostile takeover – doesn’t have the support of the board of directors of the target
 Hostile to management, not necessarily to shareholders
 Usually if you don’t have management approval, you need to use a tender offer,
go straight to the shareholders
o Open market purchases – go out and seek as many shares as you can
 About 10% if you can, idea is to do it quietly so as not to drive the price up
 Once they know you’re going to buy, it goes up
 Then you do a tender offer to get to 51% at least
 Then a freeze-out merger to get to 100%
o As a general matter, shareholders like takeovers because they like the premiums
 Managers don’t because it generally means they loose their jobs as the newcomer
tries to improve the business
o Reasons for Takeovers
 1. Undervaluation – market value is less than the fair value (like on sale)
 Efficient market hypothesis suggests it’s a bit doubtful
o Doesn’t mean it’s not true
 2. Synergy – Combination when the sum is greater than its parts
 If true, this is a net gain for society
 Economies of scale – reduction in unit costs generated by buying or
producing in volume
o Idea that if we have a large fixed cost, costs less per unit
o Ex; widgets
 Price of factory plus $1 for cost of material
 Costs less per widget when you make more
 Economies of scope – the reduction in unit costs generated by producing
similar or related items
o That skills or assets may be transferable
o Ex; widgets and gadgets are different, but the same machine can
make both
 2 companies, can combine if they’re both not fully
productive to produce both and we’re saving money
 Financial synergy – advantage that larger companies have over smaller
ones in raising money
o Internally financing, can rely on retained earnings rather than go
outside
121
o But also externally, even if they have to borrow, they might have 5
or 6 projects and go through transaction costs once
 Conglomeration – process of internal diversification
o Move from widgets to gadgets to trinkets
o 50s and 60s we thought this was a good idea
 Even if unrelated, financial synergy
 Good management in one area can do anything
o 70s 80s maybe not such a great idea
 Lots of drawbacks that come from this lack of focus
 3. Agency Costs – costs associated with the agency relation, especially the
agency problem (pursuing own interest)
 Takeover can reduce agency cost – allow shareholders to act together
o Being brought together by acquirer, the one who wants the takeover
o New controlling shareholder can replace the existing management
with better management, thereby reducing agency cost
 Why replace them:
o Inefficient management
 They may not be good enough, smart enough
o Excessive compensation
 Maybe paying too high a salary
o Self-aggrandizement
 May be trying to pursue size/power rather than profit
 4. Wealth transfer – a shift in wealth from one group to another, often without
any net benefit to society
 EEs are an example of people who get hurt
o In cutting costs after a takeover, can affect salaries or even jobs
o Taking money from EEs and giving to shareholders
 From creditors
o The creditors lending the money for the takeover will be charging
the appropriate rate of interest, knowing it’s risky
 LBO – buying through debt, it’s all of a sudden more risky
o But the preexisting creditors lent money at a certain rate, and now
it’s a lot more risky
 Value of that bond is going to drop almost in half because
you’re only getting half the interest you should be getting
o Value of shares is going up but value of bonds and other debt is
maybe going down
 Government
o Takeovers are a lot of times pursued for tax advantages, which
means the government is losing out
 Wealth transfers probably do account for some of the value
o But no evidence that it’s all or even most based on wealth transfers
o Reasons for Defense
 Who gets to decide when there’s a good reason against the takeover
 Shareholders favor hostile takeovers generally, getting paid a premium
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


o They have the right to vote and sell shares, since it’s their property,
they should be able to sell their shares in a takeover
 Management doesn’t like them, losing their jobs or concern about
shareholders
o So what justifies their interference?
Coercive offers
 Shareholders aren’t getting a fair offer, we should be able to defend them
 Ex; Two-tier tender offer – a tender offer at a premium, seeking control
but not full ownership, with the explicit or implicit promise of a
subsequent freeze-out merger offering inferior consideration to remaining
shareholders
o You tender in my tender offer you get a premium, you don’t, you
get cashed out at a lot less per share ($50 front end, $20 back end)
o Even those who don’t want to sell might out of fear it’ll go through
anyway and then get the low price
o Move from being blatant to less obvious as people realized they
were coercive,
 Ex; $50 on front end and $50 worth of junk bond on the
back end are not really worth the same
o Shareholders actually do want protection from coercive offers
o Courts are willing to step in and protect
 Moved away from these to all cash, all shares tender offer - an offer to buy
any and all shares for cash, with the promise to follow-up promptly with a
cash-out merger at the same price in cash
o Understood to be the perfect non-coercive offer
 51% must accept for it to go through, so you get the
majority and then minority still get the same price
Undervaluation
 Market undervaluing the company is a good reason to block a takeover
o Efficient market hypothesis suggests this is implausible
 Management may know the most about the company, but they’re also
conflicted, really can’t trust them to tell us the company is undervalued
o Shareholders don’t generally want this protection
o If you think it’s undervalued, tell me why and let me decide
Opportunity loss
 Management can argue that a better deal may be there tomorrow
o Problem is the negotiating tactic can just become a ruse
o You can always say a better offer is possible
 At some point have to ask who has the final say
o Shareholders like bargaining on their behalf to a point
o But there’s a problem in finding when it ends
Incompatibility
 Not enough synergy, maybe losses involved, they don’t fit well together
o Not the best deal for the business
 Sounds plausible, but shareholders don’t really care about the fit
o They care in a merger, but in a buyout, they’re being cashed out
123

Other Constituencies
 Claim they should look to the community, the creditors, EEs
o But if they can pursue the interest of everyone generally, there has
to be someone who doesn’t like this
 If you give management the freedom to consider other constituencies,
you’re really maybe giving them a cover for not wanting it out of fear of
losing your job
 Entrenchment
 Managements efforts to block
 Just do whatever they can to keep their jobs
o Takeover Defenses
 Previously considered:
 Constituencies statutes (adopted by many state, not Delaware)
o Authorizes them to consider others outside shareholders
o But these haven’t had much effect in the real world
 Directors just aren’t willing to make the claim that they’re
not acting in shareholder interest and that it’s ok
 Staggered board
o Directors can be staggered, can have elections for 1/3 of the board
 Makes it more difficult to replace the board
 Well over a year before you can replace the board
 Might not do the takeover if they have to wait that long to
get control
 Voting rights
o Class voting – most shares might not have voting at all and few
shares have high power and just never sell
o Capped – no one can really have control over the board, you’re
voting will always be capped
o Can make it impossible for a takeover, even if you buy majority of
shares
 Additional Mechanisms:
 Greemail – the repurchase by a target of its own shares from an acquirer at
a premium
o Management can buy back the percentage already bought by the
acquirer if they just go away
o Shareholders hate this – Instead of getting a premium, the offer
goes away and we end up paying the premium
 White Knight defense – takeover defense in which the target convinces a
friendly third party to make a superior offer
o Prefer independence, but would rather be a subsidiary to a friendly
rather than hostile company
 Good for shareholders, especially if you can create an
auction, unless the white knight is given advantages that get
rid of advantages of the process
o Termination fee – a fee to be paid to a friendly would-be acquirer
should the proposed transaction not be consummated
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

Problem is that it raises the acquirers cost – they’re getting
the target, minus the termination fee
o Lock-up option – a provision in an acquisition agreement designed
either to preclude a competing bidder from acquiring a company or
to provide compensation to the original bidder in case it loses in a
bidding contest
 1. Asset lock up – issue to white knight an option for my
best assets (Lock up the iphone for Apple)
 They get that asset out of the deal no matter what
 2. Stock lock up – issue white knight an option on say 20%
of my shares, new shares
 Even if they don’t get company, they can buy those
shares at their offered price
o They get a profit because they bought those
shares at the lower price and then got the
highest hostile bid offer price for them when
it was taken over by the acquirer
 Hostile bidder has to raise more money to buy the
company
o No shop provision – a provision in an acquisition agreement
providing that the target may not solicit competing offers, but may
entertain them if they arise
 No talk prevents you from even talking (Highly likely to be
a breach of fiduciary duties, so don’t see it very often)
Poison pill – a takeover defense in which shareholders of the target (other
than the acquirer) are granted the right to acquire securities (or other
assets) at a significant discount
o Makes hostile takeovers very difficult, or impossible
o Rights become valuable upon the occurrence of a triggering event,
like someone buying 20% of the company’s shares
 Any time before the triggering event, the board of directors
can redeem the rights, just cancel them
 But once triggered they become valuable
 Right allows the shareholders to buy additional shares of
stock at a discount
 Rights in the hands of acquirer become null and void
 Basically means we’re diluting the acquirer’s interest
 Almost never been triggered
o If you’re going to succeed, have to find a way around it
 1. Negotiate a friendly deal so lucrative management can’t
resist
 They can then redeem the rights before they trigger
 2. Get the court to order redemption
 They have to act in interest of shareholders and that
means getting rid of it
 Good luck with that
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
3. Trigger a proxy contest by getting shareholders to get rid
of management and replace them
 New management can redeem the poison pill
 This one is the one that ends up happening in a lot of
these
o Unocal Corp. V. Mesa Petroleum Co. – Whether a corporation’s self-tender for its own
shares which excludes from participation a stockholder making a hostile tender offer
for the company’s stock is valid – YES
 Mesa made an offer for $54 on the front end, $54 worth junk bonds back end
 After the 51% tender offer took place, the company offered to purchase
the remaining 49% for $72 worth high quality bonds
 Each shareholder would get the average – 54 and 72, average of 63
 Mesa is excluded, says its discriminatory and a breach of fiduciary duties
 Unocal is worried about the shareholders Mesa was trying to hurt
 Mesa was trying to get a deal at the expense of the other shareholders
o This is a coercive deal, the type shareholders want protection for
 Claim they don’t owe them a duty, or at least they’re not breaching a duty
while trying to protect shareholders
 Court applies an intermediate test
 Not exactly the business judgment rule, not exactly entire fairness
 There is a conflict of interest here, maybe not to the level of self-dealing
o This is the second major adoption of structural bias
o Because the board may be acting in its own interest, there is a
higher examination before they get the BJR
 This is before the switch to using EFT after all 3 of the fiduciary duties
 This Court has a threshold inquiry before we determine if they get the BJR
o Basic test for reviewing defense to hostile takeovers is this
 Two-part test – test of reasonableness
 1. Reasonable grounds they believe there’s a threat
 2. Must be reasonable in relation to the threat posed
 Whether they can defend first depends on if there’s a threat
 A coercive offer is considered a threat
 May include inadequacy of price offer, the nature and timing of the offer,
questions of illegality, impact on constituencies
 Threat of coercive offer here
 Company’s response was a collective tender offer
o Objective was to defeat the offer or protect second tier shareholders
 But this isn’t just going to help the second tier, it’s paying them more
o Goes beyond and makes any deal impossible
 After this getting 54 on the front end, but 72 on the backend,
no shareholder is going to take the front end
 When that happens, there’s no takeover and also no deal
since the company’s 72 was only on the backend
o Changing it from something everyone has to accept, whether they
like it or not, to the opposite
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
Court says there is no argument for discrimination against Mesa
 Selective stock repurchases are legal, can buy back from who you want
 Accepted before when the company wanted to pay greenmail
o Revlon, Inc. v. MacAndrews – Court found the Revlon directors had breached their
duty of care with their defensive tactics against a hostile takeover
 Defensive strategies such as White Knight, lock-up, and poison pill are not per se
illegal, only when used to block best price
 Poison pill is ok in other circumstances
 Moran, recently heard, upheld the poison pill under the Unocal test
o Adoption of the poison pill is ok, question is whether its continued
use is reasonable during a hostile takeover
 If it’s not the court will generally make them redeem it
 In the face of the poison pill, Pantry Pride kept raising their price
 The court says this is exactly what we would want to see
 Normally the board is in charge of running the company, protecting shareholders
 Buyer comes along, they can decide if in their interests, or try to block it
 But eventually, a breakup is inevitable, and at that point the duty has
changed from preservation of the company to getting the best price
 It’s not actually necessary to think of it as a different duty, they’re
supposed to act in the best interest of the shareholders
 Directors tried to say they’re considering the bond holders
 Unocal said they could look to other constituencies
 Court rejects this – they can only consider other constituencies as they
benefit the shareholders, end goal is shareholder wealth
 Fundamental problem – they were not trying to get the best price, they were just
trying to benefit the white knight
 Court is saying you have to get the best price, but leaving it up to
companies’ discretion, lots of flexibility in how
 After Revlon a lot of people though you were in trouble if you brought in a
White Knight, you can’t make that sale inevitable
 Any of those defenses could be used as a tool to get a better price, or in
order to destroy the whole auction
 You can even promise a fair auction, and then cheat if you’re trying to get the
best price
o Very general process for takeover
 When a board is resisting they have to pass the 2 part test
 But if get to the point where sale becomes inevitable, they must pursue the best
price
 38. OTHER FORMS OF BUSINESS ASSOCIATION
o Law of BA has been one of increasing flexibility
o Used to just be corporations and partnerships, Then limited partnerships
o Eventually get to LLC – limited liability company
 An unincorporated legal entity created by authority of law
 Unincorporated means not a corporation
o LLC law is at root simply a mix of corporate law and partnership law
 Just takes principles from the other two
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o Basics – starts with terminology
 Certificate of formation – the document establishing, and governing the internal
affairs of, a corporation
 Charter for and LLC
 Operating agreement – an agreement among members that sets forth the structure
and terms of an LLC
 A lot like partnership agreement, but also like bylaws
 Members – the owners of the LLC
 Like partnerships have partners
 Managers – designated managers of the LLC
 They are optional
o Under LLC law, the operating agreement can make the business as much like a
corporation or as much like a partnership as you want
 LLC can be member-manager or manager-manager
 Member – like partnership
 Manager – like a corporation
 Can have sharing of profits and loses as desired
 Can have limited or unlimited liability
 Hard to imagine anyone would choose liability
 Continuity or limited life
 Member interests can be transferable or not, as desired
 Can choose to be taxed as a corporation or a partnership
 Single or double
 Can even specify fiduciary duties, probably within limits
 All in the operating agreement
 Could be anything in between these two, whatever you want it to be
o Increasingly seeing more and more LLCs
 But there are some problems
 A lot more uncertainty, not as sure what the rules are unless we digest the
operating agreement
o LLC complete flexibility
 In some sense moving towards this contractarian theory, contract whatever you
want
 Maybe not really a place for traditional view, or maybe it’s just another option,
creating all the rules, or not
o LLP – limited liability partnership
 Essentially a partnership with limited liability among the partners
 Roughly going to be responsible for your own actions, but not those of the other
partners
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