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Super Business Associations Outline
General Exam Tips................................................................................................................................................................................ 1
Definitions ............................................................................................................................................................................................. 1
Partnerships ........................................................................................................................................................................................... 2
Areas that cannot be modified by contract ....................................................................................................................................... 2
Formulation ...................................................................................................................................................................................... 2
Revised Uniform Partnership Act (RUPA 1997): ............................................................................................................................ 3
Fiduciary Duty.................................................................................................................................................................................. 3
Partnership Property ......................................................................................................................................................................... 4
Partner’s Authority/Liability ............................................................................................................................................................ 4
Partnership Profit/Loss Share ........................................................................................................................................................... 6
Transfer of Partnership Interest ........................................................................................................................................................ 7
Corporations I ....................................................................................................................................................................................... 8
History of the Corporate Form ......................................................................................................................................................... 8
Limited Liability and Piercing the Corporate Veil ........................................................................................................................... 9
Theories of Liability ......................................................................................................................................................................... 9
Why are neglected corporate formalities necessary to pierce the corporate veil? Walkovszky v. Carlton debate. ........................ 10
Take Home Lessons on how to avoid getting the corporate veil pierced ....................................................................................... 11
Derivative Actions .............................................................................................................................................................................. 11
Corporation’s Objective and Conduct ............................................................................................................................................ 16
Business Judgment Rule Flowchart ................................................................................................................................................ 18
Duty of Care ................................................................................................................................................................................... 18
Duty of Loyalty Flowchart ............................................................................................................................................................. 22
Directors and Officers Generally.................................................................................................................................................... 22
Ratification ..................................................................................................................................................................................... 27
Close Corporations .............................................................................................................................................................................. 28
Voting Arrangements ..................................................................................................................................................................... 28
Oppression and Abuse .................................................................................................................................................................... 29
Dissolution ..................................................................................................................................................................................... 31
Hybrids ................................................................................................................................................................................................ 32
Limited Liability Corporations (General) ....................................................................................................................................... 32
Piercing the LLC Veil .................................................................................................................................................................... 33
LLC Fiduciary Duty ....................................................................................................................................................................... 33
Corporations II
(Federal Regulations) ......................................................................................................................................... 34
Background on Federal Securities Law .......................................................................................................................................... 34
Misrepresentation ........................................................................................................................................................................... 34
Insider Trading & the Use of Inside Information ........................................................................................................................... 35
Acquisition of Control .................................................................................................................................................................... 39
Shareholder Resolutions ................................................................................................................................................................. 41
Shareholder Inspection Rights ........................................................................................................................................................ 43
Mergers and Acquisitions ............................................................................................................................................................... 44
Freeze-out mergers ......................................................................................................................................................................... 46
Fairness Standard ........................................................................................................................................................................... 47
Takeovers ....................................................................................................................................................................................... 47
Takeovers2 ..................................................................................................................................................................................... 49
Takeovers3 (State Anti Takeover Statutes) .................................................................................................................................... 53
General Exam Tips
a) BA about politics and distribution of wealth involving social, ethical and political questions.
i) Who gets what and why in corporate America?
b) Manifestations of federalism
i) Corporations dually regulated on the federal level (Securities and Exchange Act of 1934, SEC) and state level
(laws governing corporations from state of incorporation).
(1) National regulation usually affects large publicly held corporations.
c) Think of BJR as really big advantage that comes with good faith, honesty and informed decisions that directors
start with at the beginning of the contest. Shareholders will try to dislodge the BJR, but if the directors can hold
onto it, they win.
d) Cite New Jersey statutes; refer to handout.
a) Joint venture – formed for a specific limited purpose. By contrast partnerships are similar to free-flowing
b) Types of companies
i) Corporation – limited liability, but double taxation. Very formal rules.
(1) Completely based on entity theory. Corporation then treated as a person under the constitution.
(a) What are the key goals that govts are trying to achieve by making corporations separate from
owners? (Creating a pro-business creation enviroment)
(b) What are the social and economic consequences of granting that status to the corporation?
(Removing liability from owners can be construed to encourage unethical/unhealthy corporate
(2) Director’s powers
(a) Only directors have the power to give dividends, one vote per director.
(b) Directors have the power to set compensation for directors
(c) Directors are elected by shareholders, one vote per share.
(d) Directors appoint officers.
(3) Why have different types of stock issued?
(a) Attracts a diverse body of shareholders that have different preferences of risk and return on stocks.
(4) Voting Definitions
(a) Cumulative voting – if 7 directors and 100 shares, you get 700 votes which you could put all toward
one candidate or spread them out. (Allows guaranteed control of a small portion of board) (Unlike
partnership which standard is one vote per partner)
(b) Voting Trust – A statutory mechanism where shareholders can transfer their stock certificates to a
trustee who votes in a certain way. (Stockholder is a stock beneficiary)
(i) Formally separate economic rights from voting rights, see a lot in family businesses (p623Case)
(c) Pooling Agreement – Two or more shareholders make an agreement to pool their votes to elect
directors. (When agree to do other things it is called a shareholder’s agreement)
(d) Irrevocable proxy – transfer of authority from stockholder to proxy for vote in certain way. (Can be
revoked unless coupled with an interest, ex – one share of stock. Similar to a voting trust) (can put
time limit as well)
(5) Closed Corp
(a) Closed Corp – a corporation with a small number of shareholders and a lack of a secondary market
where shares are traded.
(i) Lack of exit when no secondary market, if public company then almost always a ready exit.
(ii) Size is not determinative.
(b) Secondary Market – market where shareholders can trade stock without the corporation itself.
(i) NYSE, NASDAQ, ASE, London Bourse, etc.
(c) Primary Market – market where shareholders cannot trade without the corporation itself.
(i) Initial Public Offering
(d) Freezeout – taking advantage of majority shareholder position to force the minority shareholder out of
corporate offices and employment. P641Case
(6) Tender Offer – offer to buy out shareholders in a proportionate amount. Way to get control over a
company without dealing with the management.
(7) Insider trading
(a) Tippee – person who received a tip from an insider.
(b) Call – an option, which is a right to buy a security at a fixed price at a certain period of time.
(c) Warehousing – p506Case where friendly parties buy up stock so that friendly people will own stock
when the tender offer goes through.
ii) Partnership – personal liability, but taxed only once.
iii) Limited Liability Partnership – Combines best of both worlds. Just runs like a partnership
iv) Limited Liability Company - Combines best of both worlds. Just runs like a corporation.
Leveraged Buyout – like a mortgage puts a small amount down and uses corporation assets as security for the
large amount of debt. Hoping that profits will generate enough cash flow to pay off the principal of the debt
Management Buyout – same as a leveraged buyout only here management insiders look to cash out the public
Lockup Option –in context of takeover where a white knight gets market price of certain number or percentage of
shares. (treasury stock) This compensates for risk taking and time. Also acts as a deterrent for other potential
purchasers as drastically increases the price.
Treasury Stock – company stock that had been originally issued and repurchased by the corporation.
Control Premium – A premium above market value that is paid for shares to obtain control of the corporation.
Holding Company – parent company that owns subsidiaries that act as operating companies.
Preferred Cumulative dividend – if company misses a few dividend payments it will pay them everything owed in
the past before any other stockholders.
Liquidation Rights – stockholders rights to payment upon liquidation of the company.
Residual rights – getting the rest of what is left of the corporation after all payments to stockholders and creditors
is done.
Areas that cannot be modified by contract
i) Personal liability
ii) Dissolvable at will
iii) No blanket waiver of fiduciary duty
(1) RUPA 103(b)(3)– duty of loyalty may not be eliminated, however specific categories of activities that do
not violate the duty of loyalty may be eliminated, if not unreasonable.
iv) Rule Analysis
(1) RUPA 202(a): Don’t need a contract only an agreement.
(2) Remember that loss sharing is not an element of a partnership.
(3) Very little uniformity throughout the States and different versions of the UPA and RUPA adopted.
(4) All elements are conjunctive.
v) Elements of a Partnership (Conjunctive)
(1) Voluntary agency or voluntary association to form a partnership
(a) Don’t need contract to associate
(2) At least 2 or more persons
(3) Must be a business, not just an investment
(4) With anticipation of profit
(5) Co-owners with profit sharing and joint control (Usually the snag)
vi) Uniform Partnership Act (UPA 1914):
(1) Partnership Defined: §6
(a) A partnership is an association of two or more persons to carry on as co-owners a business for profit.
Revised Uniform Partnership Act (RUPA 1997):
(2) Formation of a Partnership §202
(a) The association of two or more persons to carry on as co-owners a business for profit forms a
partnership, whether or not the persons intend to form a partnership.
(b) (c)(3): A person receiving a share of profits establishes a rebuttable presumption of a partnership,
(i) received for payment of debt,
(ii) wages for employment,
(iii) rent,
(iv) retirement benefit,
(v) for sale of property
(vi) or interest charge on loan even if varies with profits of business.
vii) Cases
(1) Fenwick v. Unemployment Compensation Commission - No partnership established for an employee in a
beauty salon because although they met the first four requirements Fenwick maintained exclusive control
over the business. So although there was profit sharing, Mrs. Chesire, the employee, had no control
except to view the books.
(a) Might have been influenced by politics because she would have been the 8th employee and required
him to pay for insurance of some kind.
(b) RUPA §202(c)(3): Could apply here because she had 20% profit sharing.
(i) Question is whether it was compensation for being an employee.
(2) Martin v. Peyton - No partnership established because first four elements were met even though argued
as not voluntary association and only an investment, but for anticipation of profit under best scenario they
could get 40% profits up to$500,000.
Qualifies as profit sharing and creates presumption of partnership under RUPA §202(c)(3).
(ii) Question is whether it can be seen as a debt.
(c) Case really turns on control issue.
(i) The trustees here had enormous control over the partnership because they installed their own
CEO and could dictate who was a partner in the firm, they also had the right to inspect books and
veto business transactions.
(ii) No partnership because they could not initiate any type of investment and therefore only had
passive control.
(iii) Public Policy: probably decided that way because court wanted to encourage lenders to bail out
companies that were in trouble through investments without lenders having to worry about
whether they can be personally liable.
Fiduciary Duty
i) Made up of the Duty of care and Duty of loyalty
ii) RULE: Joint adventurers have the same fiduciary duty to each other that partners have.
iii) Cases
(1) Meinhard v. Salmon – a joint venture in real estate in time square. Meinhard had no idea about how to
manage real estate and was a co-adventurer. Salmon entered a deal for a new lease for himself. JV
because both on the lease.
(a) Cardozo Quote: A trustee is held to something stricter then the morals of the market place. Not
honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.
(i) Legal Scholars argued over whether disclosure enough or need disclosure and consent.
1. Prof Opinion: Cardozo probably just wanted him to tell him beforehand. However in today’s
context for corporations it is not enough to disclose and must have consent.
(ii) Public Policy: Found a fiduciary duty by analogizing to a partnership because Cardozo felt that
Meinhard was vulnerable being silent co-adventurer and must be protected from the managing
co-adventurer, however Meinhard had the same reciprocal fiduciary duty.
1. Salmon was the managing co-adventurer and could have abused the silent co-adventurer.
(b) Andrews dissent: Felt that joint adventures were for a specific limited purpose and so only have a
fiduciary duty in relation to that specific venture.
Partnership Property
iv) RULE: Separate Entity theory – Under UPA and RUPA partnership property treated as an entity. Partners are
owners of a portion of an undivided entity. Sees partnership as distinct from and superior from the rest of
v) Uniform Partnership Act (UPA 1914):
(1) Nature of a Partner’s Right in Specific Parnership Property: §25
(a) (2)(a): All partners have an equal right to specific partnership property for partnership purposes, but
have no right to the property for other uses unless other partners consent.
(b) (2)(b): a partner’s right to partnership property is not assignable unless all other partners also assign
the rights of the same property.
(c) (2)(d): on death of partner his right vests in the surviving partner or partners.
(d) (2)(e): partnership property not subject to dower or courtesy, allowances to widows or heirs.
(2) §31: Under UPA there is automatic dissolution whenever someone leaves.
vi) Revised Uniform Partnership Act (RUPA 1997):
(1) Partnership Property §203: Property acquired by the partnership is property of the partnership and not of
the partners individually.
(2) §802(b): Under RUPA it is not an automatic dissolution when a partner leaves, could be a buyout and the
partnership can survive even though the personnel changes.
vii) Cases
(1) Putnam v. Shoaf – Putnam wanted to sell her share of partnership to the Shoafs. Mrs. Putnam argued that
while she transferred her interest in the partnership property that she did not sell her right to a cause of
action for the money recovered from book keeper who was cheating.
(a) There is no personal property owned by the partner except to be able to share in profits and use the
partnership property when a partner. The entity of the partnership owns all the property.
Partner’s Authority/Liability
i) Personal Liability: Aggregate Theory: each individual owns their own separate share.
ii) Rule Analysis:
(1) UPA 9 and RUPA 301 are the same.
(2) UPA 13 and RUPA 305a are the same.
(3) UPA 14 and RUPA 305b are the same.
(4) UPA 15 and RUPA 306 are different. In UPA joint and several for some (contracts) and jointly for others
(torts). In RUPA jointly and severally unless contracted otherwise.
(5) RUPA 307 does not match a UPA section.
(6) 15/306 is the critical distinction between UPA and RUPA.
iii) RUPA § 306b: not liable for partnership obligations acquired before became partner. UPA silent.
(1) RUPA partners don’t take on the debts of the partnership acquired before they came onto the partnership.
RUPA uses aggregate theory.
iv) Uniform Partnership Act (UPA 1914):
(1) Partner Agent of Partnership as to Partnership Business: §9
(a) (1): Each partner is an agent of the partnership for the purpose of its business and if in partnership
name acts in the ordinary course of partnership business then it binds the partnership.
(i) Unless the partner had no authority to act for the partnership in that particular matter and the
person whom the partner was dealing knew or received notification that the partner lacked
(b) (2): An act of a partner not within the ordinary course of the partnership business binds the
partnership only if the act was authorized by the other partners.
(2) Partnership bound by Partner’s Wrongful Act: §13
(a) Wrongful act or omission by any partner acting in ordinary course of business or with the authority of
co-partners, the partnership is liable to the same extent of the partner so acting or omitting.
(3) Partnership bound by Partner’s breach of Trust: §14
(a) (a): Where partner acting within scope of apparent authority receives money or property from a third
person and misapplies it.
(b) (b): Where the partnership within ordinary course of business receives money or property from a third
person and it is misapplied by any partner while still in partnership custody.
(4) Nature of Partner’s liability: §15
(a) (a): Jointly and severally for everything chargeable to the partnership through 13 and 14.
(b) (b): Jointly for all other debts and obligations of the partnership, however any partner may enter into
a separate obligation to perform a partnership contract.
v) Revised Uniform Partnership Act (RUPA 1997):
(1) Partner Agent of Partnership §301: subject to sec303 and statement of partnership.
(a) (1): Each partner is an agent of the partnership for the purpose of its business and if in partnership
name acts in the ordinary course of partnership business then it binds the partnership.
(i) Unless the partner had no authority to act for the partnership in that particular matter and the
person whom the partner was dealing knew or received notification that the partner lacked
(b) (2): An act of a partner not within the ordinary course of the partnership business binds the
partnership only if the act was authorized by the other partners.
(2) Partnership liable for Partner’s actionable conduct §305:
(a) Wrongful act or omission by any partner acting in ordinary course of business or with the authority of
co-partners, the partnership is liable to the same extent of the partner so acting or omitting. (same as
(b) Where partner acting within scope of apparent authority receives money or property from a third
person and misapplies it. Where the partnership within ordinary course of business receives money or
property from a third person and it is misapplied by any partner while still in partnership custody.
(3) Partner’s Liability §306:
(a) Unless otherwise provided in (b) and (c) all partners are liable jointly and severally for all obligations
of the partnership unless otherwise agreed.
(b) A person admitted into a partnership is not personally liable for any partnership obligation before the
person’s admittance as partner.
(c) If limited liability partnership no liability despite inconsistent done before the vote to become LLP.
(4) Actions by and against Partnership and Partners §307:
(a) Partner may sue or be sued by the partnership
(b) Actions may be brought against the partnership or any other partners
(c) A judgment against the partnership is not a judgment against a partner; to get at a partners assets a
judgment must be against the partner.
(d) A judgment creditor of a partner may not get at the partners assets by a judgment against the
partnership unless the partner is personally liable under section 306 and:
(i) A judgment on the same claim is issued against the partnership and is unsatisfied or
(ii) The partnership is a debtor in bankruptcy or
(iii) The partner agrees that the creditor need not deplete partnership assets or
(iv) A court allows creditor to collect against partner because partnership assets clearly insufficient,
exhaustion of partnership assets is excessively burdensome, or appropriate exercise of courts
equitable powers or
(v) Liability is imposed on the partner by law independent of the existence of the partnership.
(e) (e): This section also applies to partner liability under section 308
vi) Cases
Martin v. Peyton - Partners are personally liable for the debts of the partnership.
(1) Nabisco v. Stroud – Stroud and Freeman were general partners and Stroud told a company that he did not
want there product and Freeman told them he did. It was shipped and thus binding on the partnership
because of UPA 9 and UPA 15b jointly liable for contract. UPA 18h and RUPA401 say that a majority
can assign the authority of partners but here there is only 2 partners so can never be a majority.
(a) Tried to take advantage of the exception in UPA 9 by putting Nabisco on notice but partner was
authorized so no dice.
(b) Practical Solution for 2 Partner Situation: Stroud could have dissolved the partnership if unhappy.
Could have made a partnership agreement that delegated authority. Could have even appointed a tie
breaker. Need a contract can’t go by default rules or stuck. Could have also delegated more votes with
one partner.
(i) The creditor would first go after partnership assets, but then could reach freeman for default.
Could they go after Stroud? Yes, all joint and severally.
vii) Hypo: Partnership with 2 partners and one loses confidence in other, says does not want other partner to take
any action unless she approves. Governed by UPA.
(1) Can’t tell him not to take more clients. Could however dissolve partnership.
(2) If three person partnership and two agree for third not to take clients anymore
(a) If usual course of business decision then could do it, however this is not a usual course of business
and would fall into extraordinary category where must get unanimity and thus impossible. Once again
could dissolve the partnership.
(3) If in two person firm one says I will not be liable for others actions
(a) It will do no good to tell clients that you are not liable. Could dissolve partnership.
Partnership Profit/Loss Share
i) Analysis: UPA §18 sets the default for equal sharing in profits, losses, and management. It also sets the
default for majority rule in ordinary business decisions and unanimous agreement for addition of partners.
RUPA if extraordinary matter then must get unanimous agreement. They are the same.
ii) Uniform Partnership Act (UPA 1914):
(1) Rules determining Rights and Duties of Partners: §18
(a) (a): Each partner shall share equally in the profits and surplus and share in the losses at the same
percentage as the profit sharing.
(b) (b): Partnership must indemnify partners for personal liabilities and cost incurred in the ordinary
conduct of its business.
(c) (c): A partner who contributes more than original capitol will receive interest from date of advance.
(d) (d): Interest on capitol is from the date of repayment.
(e) (e): All partners have equal rights in the management of the partnership.
(f) (g): No body can become a partner without unanimous consent.
(g) (h): Differences arising as to the ordinary matters of the partnership business may be decided by a
majority vote. However partnership agreement cannot be changed without unanimous consent.
iii) Revised Uniform Partnership Act (RUPA 1997):
(1) Partner’s Rights and Duties §401:
(a) Same as UPA
iv) Cases
(1) Kovacik v. Reed – two people entered into a venture, even though it resembled a partnership, perhaps the
control aspect was what prohibited it as a partnership. Reed contributed the services and Kovacik
contributed the capitol. It was a loss and Kovacik wanted to share the losses, but they had only agreed to
share profits.
(a) Loss sharing is not needed to be a partnership so all loses could be placed on Kovacik.
(b) Note: Third party however could go after Kovacik and/or Reed no matter what the loss sharing
agreement. Just must go through partnership assets first.
(c) According to UPA and RUPA, if no separate agreement then losses shared in same manner as the
profit sharing equation. Default is equal profit sharing and loss sharing. UPA and RUPA direct
contradiction of court verdict.
(d) Verdict of the court is that the service partner already lost and so financial partner bears the entire loss
sharing burden.
(i) View that Inequitable verdict perverse incentives: People would be hesitant to start a business
with a service partner and the service partner would have little incentive to make work except
1. Might try to keep the business alive by doing anything being that put sweat into it. Might take
unnecessary risks if no loss sharing. Could be service partners fault why it failed.
(ii) View that Equitable verdict because finance venture on other guy’s back.
1. Gives power to exploit labor of service partner, while service partner has the same risk
v) Hypo: If not a pure breakdown of full service partner and full financial partner then how should court find.
(1) Kovacik v. Reed was a very fact specific decision that is hard to reproduce on a broad scale. Could be
more troubling if mix involved.
Transfer of Partnership Interest
i) RULE: to become a partner must get unanimous consent from rest of partners. Can change this default rule
by unanimous agreement.
(1) Rule so strict because of personal liability issues.
ii) Analysis:
(1) UPA 18g same as RUPA 401i.
(2) UPA 27 and RUPA 503 are generally same
iii) Uniform Partnership Act (UPA 1914):
(1) Rules determining Rights and Duties of Partners: §18g
(a) No member can become a member of a partnership without consent of all partners.
(2) Extent of property rights of Partners: §24
(a) Rights in specific partnership property, interest in the partnership, and right to participate in
(3) Nature of Partner’s interest in the Partnership: §26
(a) Partner’s interest in the partnership is share of profits and surplus
(4) Assignment of Partner’s interest: §27
(a) Conveyance of partner’s interest does not dissolve the partnership, however the assignee cannot
interfere with management of partnership nor can request any information, nor can inspect
partnership books, assignee only gets the profits.
(b) If partnership dissolves the assignee may require an account of the last agreed to by all partners.
iv) Revised Uniform Partnership Act (RUPA 1997):
(1) Partner’s Rights and Duties §401(i):
(a) No member can become a member of a partnership without consent of all partners.
(2) Partner not co-owner of Partnership property §501:
(a) Partner not co-owner and no interest in partnership property can be transferred by a partner
voluntarily or involuntarily
(3) Partner’s transferable interst in partnership §502:
(a) Can only transfer share of profits and losses.
(4) Transfer of Partner’s Transferable interest §503:
(a) Does not by itself cause the partner’s disassociation.
(b) Does not allow the transferee to participate in management of partnership or inspect books.
(c) Generally same as 27
v) Cases
(1) Putnam v. Shoaf – Putnam wanted to sell her share of partnership to the Shoafs. Mrs. Putnam argued that
while she transferred her interest in the partnership property that she did not sell her right to a cause of
action for the money recovered from book keeper who was cheating.
(a) UPA 26 and RUPA 502: Could transfer partner’s interest if other partner’s did not want the Shoafs to
be partners, but this is only profits and surplus and losses. (Like silent partners.)
Corporations I
History of the Corporate Form
i) Key Questions to ask about corporations
(1) What are the key goals that govts are trying to achieve by making corporations separate from owners?
(2) What are the social and economic consequences of granting that status to the corporation?
ii) Formation of Corporations
(1) Requirements to incorporate
(a) Depends on each state, Articles of Incorporation for different states will look different.
(i) Usually incredibly easy and kit oriented.
1. Form books sometimes available so don’t even need a lawyer.
2. Very democratic and egalitarian, open to everyone.
(ii) Must file the Articles of Incorporation with the secretary of state.
(iii) Must write by-laws
(b) Privileges and Immunities clause – corporations are separate entities under constitutional law and are
considered persons.
(c) Internal Affairs Doctrine – corporation will be governed by the state of incorporation for internal
corporate governance.
(i) Ex – Rules about when a corporation may declare a dividend, or what percentage of stockholders
must approve a merger.
iii) National
(1) Federalism keeps the corporate laws from going too far either one way or another.
(2) Pros of national regulation
(a) Uniform laws for all corporations
(b) Prevents the race to the bottom (William Kerry???) seen with state corporate law.
(c) Skeptical of the market and states to discipline for breach of fiduciary duties, but federal intrusion is a
big threat.
(i) Sarbanes-Oxley Act of 2000 – Lesson is that federal government will eventually step in if states
don’t keep on there toes and keep directors accountable.
(3) Pros of state regulation
(a) Genius of American federalism, allows the corporations to choose the rules that are most convenient.
Looks at as a race to the top(Yale Romano).
(b) Law and Economics progressive corporate law theory
(i) Empirical evidence shows that corps that incorporate in Del. do not experience drops in stock
1. Rebuttal that most people don’t know the difference.
(ii) Shareholders want there corporations to incorporate in pro management states so that more
control and stock goes up.
1. Rebuttal that this does not really make sense and can look at failed corporations like Enron as
an example.
(c) If had tough national regulation then corporations would incorporate offshore.
(d) Good thing that Del is so prominent because mitigates the nonuniformity of each state having
different corporate laws.
iv) New Jersey
(1) NJ “betrayed” the nation which was moving toward antitrust and monopoly.
(a) It weakened laws on trusts and corporations so that they could get away with anything. This would
entice more corporations to incorporate in NJ and bring in more tax revenue.
(2) Woodrow Wilson got the seven sisters act passed effectively repealing many of the pro-corporation laws.
(This is why we study Delaware law and not NJ law.)
v) Del aware
(1) Out “Jersey-ed” NJ by lowering the franchise tax and matching favorable corporate law.
(2) Why are most corps in Del?
(a) Combination of very pro corporate legislation and a long history of pro corporate case law that
affords more protection for management and less for shareholders.
(i) Large body of case law that provides more certainty than some fly by night state.
(ii) Court of Chancellery specially for corporate cases, a special judiciary.
(iii) Many excellent corporate law attorneys there because of longstanding history.
(b) Del mounted a campaign in NY advertising better corporate deals.
(i) Don’t even have to have meetings in Del to be incorporated there.
Limited Liability and Piercing the Corporate Veil
vi) Factors considered when piercing the corporate veil Eman p44
(1) Whether claim is tort or contract
(2) Whether defendants have committed fraud or wrongdoing
(a) Like siphoning out all corporate capitol
(3) Whether the corporation was adequately capitalized
(4) Whether corporate formalities were followed
vii) HYPO: You are the heir to a family farm that specializes in growing fruit. Ace, Inc. owns the fuel trucks
delivering to the farm, which were in disrepair. A truck explodes and destroys the property. The cost of the
environmental cleanup is massive. Ace, Inc.’s only assets are the fuel truck and a $10,000 liability insurance
policy. There are 9 sister companies that also have run down trucks. Obviously they were set up this way to
protect the owners from there intentional negligence. Archie Mogul is rich owns the businesses, and is the
CFO of the company his father Bob is loaded too. Cynthia Mogul is loaded too.
Theories of Liability
(a) Respondeat Superior (Agency Theory) – same as agency theory and must prove that Archie was the
principal and that Ace, Inc. was his agent. Must show the reverse of a normal relationship, basically
that the director dominated the corporation. Tort theory that holds an individual liable for a
corporations negligent acts.
(b) Enterprise Liability – deals with expanding the corporation horizontally and getting the assets of
subsidiaries and brother/sister companies. Here would add the other 9 companies just in case they
had any assets as well.
(i) Note: that this form of liability is separate and distinct from finding personal liability for the
owners of the business.
(ii) Note2: Nothing is wrong with having the same shareholders for separate corporations.
(iii) Veil piercing more likely if the parent and subsidiary are operating portions of a single business
and the subsidiary is undercapitalized. Here the parent corp. is liable.
(iv) Ex – if all the companies shared an office and had the same phone number.
(c) Piercing the Corporate Veil (Disregard of the corporate entity) – relies on different theories and is
based on running the business for there personal benefit. (Vertical Veil Piercing)
(d) Fraud – Tough to prove because must meet all the elements of including reliance and direct
(i) Ex – If owner was paying personal expenses with corporate monies causation will probably not
be met because it is not hurting you the third party.
(2) Discovery Requests
(a) Piercing the corporate Veil
(i) Quarterly Meeting (board meetings minutes)
(ii) Articles of Incorporation
1. Also By-Laws
(iii) Names of board members (Find out if actually appointed board members)
(iv) Tax Returns
(v) Stock Certificates
(vi) Corporate Books and Bank Accounts
1. Are they paying personal expenses with corporate monies?
2. Is there improper intermingling of persons and corporate assets?
(b) Enterprise Liability
(i) Each corporation must have own set of documents.
(ii) Business Transactions between each other
1. Ledger of Transactions/record keeping (Ensure that arms length transactions)
(iii) Addresses of Businesses (Are they the same)
(iv) Telephone number
(v) Purchasing records
1. Do they have joint business records?
(vi) Employees working for multiple companies. (Intermingling) (Enterprise liability per se)
Why are neglected corporate formalities necessary to pierce the corporate veil? Walkovszky v. Carlton debate.
(3) Three key Reasons.
(a) Sense that anyone who disregards the corporate form should be opened up to liability and punished.
(b) Failure to observe corporate formalities might be a sign that creditors were mislead and deceived.
(c) Indirect evidence that shareholders were siphoning off assets to thwart creditors. Most influential
evidence is when someone uses corporate assets to pay for personal bills.
(4) Debate on intentional undercapitalization of companies. (Should this be more important then formalities)
Walkovszky v. Carlton debate.
(a) Externalizing costs to third parties - Must weigh the public benefit of the service that the corporation
provides v. the cost of higher minimum liability insurance.
(i) Ex – taxis on the road.
(b) Tort v. Contract Veil Piercing - Court more likely to pierce the corporate veil for tort rather than
contract damages because tort creditors could not foresee getting hurt nor choose who hurts them. As
opposed to contracts where the contracting party makes an affirmative choice.
(i) Pro rata tort liability as a solution – instead of joint and several liability apply pro rata tort
liability to all those that own shares in the corporation.
(ii) Unfortunately statistics show that more people able to pierce the corporate veil as contracts
creditors. (Could be because tort claims are always made while contracts claims are more definite
in nature)
(c) If always allow veil piercing might thrust the responsibility on owners of corporation that don’t even
run it and take away responsibility of the corporation itself as an entity.
(1) Walkovszky v. Carlton (Tort)– Taxi cab case where there was a bunch of different companies that had
only a single car each and the minimum liability insurance.
(a) Majority(Fuld) – Enterprise liability might apply here but that does not make personal liability for the
shareholders themselves. No evidence of intermingling of corporation and personal assets here.
Fraud is not available here because they took the required insurance. Legislator must make higher
(b) Dissent (Keating) - The shareholders should be held individually liable for the actions of the
corporation because under the circumstances of this case the legislature did not intend to shield the
shareholders with a specific intent to avoid there responsibility to the public by under capitalizing the
corporation and getting the minimum insurance requirement where the corporate enterprise provided
enough profits to provide additional insurance.
(2) Kinney Shoe Corporation v. Polan (Contract)– Polan forms a corporation, Industrial which is deliberately
undercapitalized. Then Industrial and Kinney Corp enter in sublease agreement, which industrial never
pays. Industrial had no assets and no bank account and first payment of behalf of industrial was a personal
check from Polan.
(a) Three Part Test
(i) Unity of interests of the corporation and the shareholder
(ii) Would it be inequitable not to pierce the corporate veil
(iii) (Permissive and not mandatory): Would a reasonable credit investigation have shown that the
corporation was grossly undercapitalized.
(b) Court renegotiates the deal for Kinney, something that should have been done as a sophisticated
contract plaintiff. (Keep in mind that for contract can have arms length deal where torts there is no
(c) Practical Solution – Kinney could have gotten a personal guarantee from Polan if the corporation
was undercapitalized. Should always do a personal guarantee when find out that corporation is just a
Take Home Lessons on how to avoid getting the corporate veil pierced
(1) Do not commingle personal and corporate funds
(a) Do reimbursements if must and get a business credit card.
(b) Keep corporate financial books separate from personal books and funds.
(c) Take funds out of the corporation in dividends or salary on a regular basis
(i) Do not withdraw funds haphazardly. (Same for loans)
(2) Always issue stock certificates even if they are to yourself
(3) Always adopt and comply with bylaws and articles of incorporation even if it is just you and a friend
running the corporation.
(a) Hold regular board and shareholder meetings and keep minutes of meetings
(4) Appoint a board of directors
(5) Comply with any statutory capitol and insurance requirements (Walkovszky)
Derivative Actions
Individual v. Corporate Actions
(1) RULE – Distinction between direct and derivative suits is determined by who has been injured, the
corporation or the shareholder.
(a) Tooley Rule
(i) Who suffered the alleged harm, the stockholders or the corporation?
(ii) Who would receive the benefit, the corporation or the stockholders directly?
(2) Direct – a suit brought by a shareholder against a wrongdoer on his own behalf. (Usually on voting or
dividends.) (plaintiff can recover damages) (No bond posting requirements)
(a) Pros
(i) Will not have to post a bond
(ii) Right to recover damages for yourself
(iii) Avoid the demand requirement (if looking for injunctive relief)
(iv) Unlike derivative suit to settle do not need the court to approve as being fair to the corporation
and shareholders.
(3) Derivative – when a shareholder brings a suit in the name of the corporation. Naming the corporation as a
nominal defendant to give the court jurisdiction over the corp.. (Usually duty of care and loyalty suits are
derivative) (Plaintiff can recover damages for corporation, only benefit is that which comes from being a
shareholder of the corporation that has received damages)
(a) Pros
(i) Remedy for insider wrongdoing - The discipline of the marketplace (decline in market price when
insiders wrong the corporation) does little to deter wrongdoing.
(ii) Deterent effect – potential wrongdoers in other corporations will think twice.
(b) Cons
(i) Waste of corporate time – wastes time and energy of corporate executives.
(ii) Risk Averse management – Managers will become risk averse instead of maximizing shareholder
(iii) Strike Suits – The incentive is for corporations to settle even when little merit exists. This
encourages nuisance suits.
(c) Public Policy Behind Derivative Suits
(i) Corporate Law is really about striking the balance between the authority of managers that run
the corporation v. the accountability of managers as fiduciaries to the corporation.
(ii) Provides a mechanism to consider the corporation as a separate legal entity from shareholders.
(4) Cases
(a) Cohen v. Beneficial Industrial Loan Corp (Derivative)– Plaintiff filed suit against a Del. corporation
in NJ on the basis of diversity jurisdiction.
(i) Internal Affairs Doctrine – cost of attorneys fees not just a procedural question and thereby
becomes a choice of law question. Erie dictated that forum state applies own procedural laws, but
substantive laws are from the state of incorporation. Here procedure was to use NJ law for bond
(ii) Bond Posting Requirements are one of the only exceptions to the internal affairs doctrine. NJ
applies its own procedural law here.
1. Policy Reasons for bond posting requirements
a. Prevents frivolous lawsuits by allowing anyone to file suit, but if own less than 5% then
must post bond, if own more then no bond needed.
i. Court has to draw the line somewhere even though seems unequitable to single out
small shareholders.
ii. Shareholders can join shares to meet the requirement
b. Used to indemnify the defendants for attorney fees if plaintiff loses.
(b) Eisenberg v. Flying Tiger line, Inc. (Direct)- Plaintiff alleges that his vote has been diluted since his
shares had been converted to FTC the holding company, as opposed to FTL the operating company.
(i) Voting Rights classic direct claim - This is a direct suit because the shareholders voting rights
have been infringed. The corporation is not harmed. Therefore no bond requirement or demand
needed. Probably not a strike suiter.
(c) Tooley v. DLJ H/O (Modern Rule)- Asserts a bright line rule for determining whether a case is a
derivative or direct suit. Two Part Test.
(i) Who suffered the alleged harm, the stockholders or the corporation?
(ii) Who would receive the benefit, the corporation or the stockholders directly?
ii) Demand
(1) Analysis – Del and NY are the primary jurisdictions on demand. Although worded differently they
represent the same rule. Take away rule is that you never make a demand on the board, you always
litigate whether demand is futile in court first. Futile demand just means can file suit, only a threshold
requirement, although merits usually go the same way. Del law 1 and 2 correspond with NY 1, and Del 3
corresponds with NY 2 and 3. Demand only applies to derivative suits. Can’t just ratify the transaction,
but must be a financial interest.
(a) Policy Reasons why corporations deny suit.
(i) It is a huge distraction and is expensive, destructive and embarrassing.
(ii) If suit then could give bad publicity and drive stock price down, however if not disclosed then
stock and corporation hurt in the long term.
(b) Policy Reasons why demand good policy.
(i) Directors need a lot of authority, relieves the court of deciding on the merits, although still retains
a lot of litigation for the threshold requirement.
(ii) America has a national commitment to free enterprise, unlike the soviets.
(c) Reasons why Demand is bad policy
(i) Other corporate officers probably have empathy to protect their own
1. Many directors serve on multiple boards and would want to protect themselves.
2. Board members probably cannot be impartial because of all the peer pressure.
(ii) Rebuttal – Might want to distance yourself from wrongdoer and castigate, but unlikely.
(iii) Company could contribute large sums to legislators. (NJ and Del history)
(d) What can shareholders do if can’t win a cause of action for a derivative suit against excessive
compensation to directors?
(i) Corporate Elections – Could vote out of office but all too often there are soviet style elections
with only one candidate.
(ii) Threaten to sell stock – especially if a large shareholder.
(iii) Pierce the corporate veil – difficult to do because any publicly traded company must follow SEC
regulations including basic formalities.
(iv) Role of Fed Gov – Mandatory percentage of outside directors is a good start but not enough, will
have to look more toward domination and control.
1. Del. will do so because afraid of fed gov reigning in on there turf.
(2) Procedure for making a Demand in Del.
(a) Just send a complaint to the corporation contact requesting to file on behalf of the corporation.
(b) Board of directors and counsel will send mail back to shareholder telling outcome, whether will bring
suit or not. (Supposed to decide what is in the best interest of the corporation)
(i) Board will usually never tell why they decided to not go through with the suit.
(c) If refused the shareholder would have to show that the transaction wasn’t a sound business judgment.
You waive the first two prongs by making the demand.
(i) No waiver even if the board comes out and says interested.
(3) 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 action was taken in the
best interests of the company.
(a) This presumption can only be overcome by conflict of interest, fraud, illegality, or gross negligence.
(Simple carelessness is not enough to establish a breach of corporate duty of director) (Directors are
not liable for ordinary negligence)
(4) Delaware Law (Grimes): When is a demand futile?
(a) A reasonable doubt exists that the board can make an independent decision to assert the claim if
demand were made. The following is a basis for excusal:
(i) Majority of the board has a material financial or familial interest in matter.
1. Simply ratifying the challenged transaction does not establish interest.
2. Public Policy: Simply being named in a suit that could hold you personally liable doesn’t
establish interest in the transaction. (Can not be a conclusory allegation)
3. Can’t just ratify the transaction, but must be a financial interest.
(ii) Majority of the board cannot act independently due to domination or control
1. Sarbanes-Oxley Act of 2000 – requires certain percentage of outside directors to prevent this
(iii) The underlying transaction was not a valid exercise of the business judgment rule.
1. Extremely tough burden to establish that it was unsound business judgment.
2. Many times argue that it was not a business judgment at all. (Brehm, Francis, Caremark)
(b) Requirement of Particularity
(i) Examples
1. Charging the board itself with a violation of due care is not enough.
2. Even if self dealing was approved by the board must be more specific.
a. Can’t just ratify the transaction, but must be a financial interest.
(ii) No discovery, must use the tools at hand.
1. Public filings with SEC
2. Summary Procedure as stated in 8 Del. C. §220 (Shareholder right to inspect books and
records). P246Case (See Brehm)
New York Law (Marcs v. Akers): When is a demand futile?
(a) Majority of board interested in challenged transaction [direct financial benefit or controlled by
Director with direct financial benefit]
(i) Simply ratifying the challenged transaction does not establish interest.
(ii) Public Policy: Simply being named in a suit that could hold you personally liable doesn’t
establish interest in the transaction. (Can not be a conclusory allegation)
(iii) Can’t just ratify the transaction, but must be a financial interest.
(b) Directors did not fully inform themselves about the challenged transaction
(i) Procedural - Must at least try to learn about what they are deciding
(c) Challenged transaction was so egregious on its face that it could not have been the product of sound
business judgment of directors.
(i) Substantive – Never valid if no one of sound judgment would endorse it.
(d) Requirement of Particularity
Model Business Corporation Act:
(a) Advocates universal demand in all cases without exception, and permits a derivative suit to
commence in 90 days unless the demand is rejected earlier.
(a) Grimes v. Donald (i) Rule: When you make a demand you waive your right to claim demand is futile.
1. Practical Solution – never make a demand on the board. Let the court decide whether
demand is futile.
(b) Marx v. Akers – Plaintiff filed suit to see if met the demand futility requirement.
(i) It did not because transaction did not include a majority of interested inside directors (3 out of
18). Allegations were conclusory so no dice.
(ii) However for the setting of compensation for outside directors no demand was necessary because
they were a majority of directors and a raise to directors’ salaries is always a interested
transaction because it is a personal financial benefit that the shareholder will never share.
(iii) Court threw out the waste claim on the merits.
Problem p255
(a) This is a derivative suit
(b) Demand excused because majority are interested.
(c) Cannot be excused because just ratifying not benefiting.
(i) Could argue that dominated
(ii) Could argue that not informed
(d) Could argue that failed to make a decision because no vote, just acquiesced. Invalid BJR.
iii) Demand Refused
(1) Suit against third party
(a) Court will almost always use BJR and not allow suit.
(2) Suit against an insider
(a) Stuck proving third prong which is basically overruling the BJR
iv) Special Litigation Committees
(1) Eman p349
(2) Analysis
(a) SLC’s are made up of disinterested directors and determine whether the it is in the corporations best
interest to litigate the suit.
(i) Sometimes the board enlarges the board to appoint independent directors to SLC.
(ii) SLC usually procures independent counsel.
(b) Even though merits look like probable conviction the SLC’s job is to determine the best interests of
the corporation not the merits.
(c) NY actually most liberal toward corporations in SLC context. Del can review because their courts
more competent and other jurisdictions vary.
(3) MBCA: the court could appoint the independent committee.
(4) NY Law – When demand refused and SLC formed?
(a) Bright line rule that Court will not review based on the BJR. (Burden on corp. to show independent)
(b) Court only worried about the procedural aspects of the investigation.
(i) Whether interviewed the right people or right documents.
(ii) Also whether the SLC itself was truly independent.
(5) Del Law §141– When demand refused and SLC formed?
(a) *Note: If demand excused use two part test, however if demand was required then still use one part
test like NY as today would be equivalent of .
(b) Two part test
(i) Procedural: Court reviews the work of the committee on a procedural basis. (Same as NY)
1. Whether truly independent and done in good faith using reasonable procedures. (Burden on
corp. to show independent)p266Case
(ii) Substantive: Second part of the test is discretionary and is that the court exerts its own business
1. Del. courts more comfortable deciding this issue because they are much more knowledgeable.
2. Policy reasons
a. Tension between authority and accountability
b. Social reason psychological or structural bias against actually litigating the issue by the
SLC members. Usually empathy or not wanting to bite the hand that feeds them.
(6) Cases
(a) Auerbach v. Bennett – Case before demand futility law clear. Today would have not needed a SLC
because only four members of the 15 member board were involved.
(i) Used new board members for the SLC that were not implicated. Determined that should not sue
because of:
1. High cost of litigation
2. Damaging publicity
3. Nobody on the board profited personally and no violation of duty of care.
(ii) It was not illegal to bribe in foreign companies at the time.(Trying to open up new markets) After
this case new legislation was passed.
(iii) Even though merits looked like conviction the SLC’s job is to determine the best interests of the
corporation not the merits.
(b) Zapata Corp. v. Maldonado – Derivative suit without demand. Today would have probably never
formed the SLC. Would allow shareholder to sue and then make motion to dismiss for failure to
make demand. ***Demand would have not been excused today.
(c) In re Oracle – Alleged insider trading against four defendants. Breach of duty of loyalty and claim of
breach of duty of care against the other directors (Asleep at wheel).
(i) SLC left out significant information in regards to independence like the members investigated
were Stanford professors and large donees.
(ii) Judge Stein – suggests that must take into account factors such as love and friendship into
independence. Moves beyond economic reasons to psychological and social. Thinks that law and
economics is too reductionist.
1. SLC could have felt informally pressured. Fiction that people on the same board can judge
with an equal eye.
(iii) Policy: Disclosure and transparency is often more important then substance.
1. Since litigation is almost always already commenced before the SLC forms the courts are
more comfortable holding them to a tougher standard.
(iv) Practical Advice: Advice clients to find people for SLC that are absolutely beyond reproach.
Corporation’s Objective and Conduct
i) Ultra vires – beyond the power of the corporation. If so then shareholder could get an injunction.
(1) Today the Ultra Vires doctrine is dead. Nothing is beyond the corporation as long as it is lawful.
Corporation could limit there purpose but today they would not do it and if silent then assume that
anything lawful is purpose.
(a) DEL §101(b) – an organization may be formed to conduct any lawful business or purpose.
ii) Policy Reasons
(1) Wealth is now concentrated in corporations and not private individuals.
(a) General socio-economic shift from 19th century.
(2) Abstract: Democratic society will not survive if everything is absorbed into government role.
(a) Possibly about the cold war and political ideology, corporations have to make us safe from
communism. Private sector and not the government must help democratic institutions.
(b) Good will and improvement of the community.
(c) What’s good for America is good for the corporation
(3) Direct: Direct benefits to the corporation by helping to educate the future supply of management.
iii) Warren Buffet on matching gifts
(1) Let employees pick the charities and match the gift. Good corporate move.
iv) Limits on the policy
(1) Could not give an unreasonable amount.
(a) Many statutes limit the donation to 1% of capitol and surplus
(2) No pet projects or personal ties are allowed.
v) Del §122(9)
(1) Charitable donations are authorized that serve the basic purpose of business corporation to maximize
profit. Basically any charity is ok as long as make a connection to benefit the corp. even if very
attenuated. Must be some connection.
vi) New York §202(a)
(1) No reason necessary to make a charitable donation
vii) Cal §207(e)
(1) No reason necessary to make a charitable donation
Penn §102(d)
(1) Can give to charities in local communities. No one interest of shareholder v. community trumps one
ix) Problem p275
(1) In del. you are counsel to CEO that wants to donate 100 grand to minority school. A friend of CEO
operates it. The before tax earnings of the corp is 20million. CEO wants to keep the donation
anonymous. In Del and then all other places.
(a) Must make a connection to corp from donation. Easy, diversity.
(b) Since friend runs charity might be pet charity problem.
(i) Run it by the board and recluse himself from the vote. This ensures no conflict of interest.
x) Cases
(1) A.P. Smith Mfg. Co. v. Barlow – Corporation wanted to donate to Princeton University. Issue on appeal
was whether the action was intra vires even with no express authorization in the certificate of
incorporation. Court held that it was ok
(a) RULE: What’s good for America is good for the corporation.
(2) Dodge v. Ford Motor Co. – Dodge brothers owned 20% of Ford and wanted a special dividend paid and
an injunction against building a smelting plant. Ford made it sound like he was running a charity by
saying that the corporation was too profitable. Ford had to give the dividend but was able to build the
(a) RULE: OK to donate to incidental charities, but must run the company for the primary purpose of
profit maximization.
(i) Completely polar from the Smith rule.
(b) Ford really could have presented it better way, really could have said that cutting off capitol to Dodge
and cutting prices means better market share and drive competitors out of business.
(i) Practical Advice: Control clients, really a case of the client getting away from you. Ford could
have charity as secondary purpose. Instead was wise ass and pontificated about self.
(c) Focus in this case was short term profit maximization, Dodge law of primary purpose to maximize
profits still good law, but has been cut away.
(i) Modern Rule: Now no longer have to maximize short term profits and can maximize non
shareholder constituencies as well.
1. Benefit of creditors, customers, employees, management, communities, local governments
(zoning and tax breaks), and suppliers of goods.
a. Rebuttal: Law and economic theory would have only creditors as relevant.
2. Limits
a. Revlon duty: when selling whole company directors have a duty to maximize profits for
(3) Shlensky v. Wrigley – Shareholder brought case to compel the corporation to install lights for night
baseball to bolster revenues. Because of BJR court allows Wrigley to do whatever he wants. Installing
lights might actually lose money and night baseball could drive the property value of stadium down.
Court really stuck profit rationalization in Wrigley’s mouth, he was concerned about the neighborhood.
(a) Distinction between Ford (Law evolved from the Dodge days to refine the BJR.)
(i) Here long term maximization of profits where Ford it was mainly concerned with short term
maximization of profits.
(ii) Also causation argument because no concrete proof was given that lights would bolster profits.
(b) Hypo: If Wrigley owned 51% of cubs and 80% of whitesox and made one only day ball and other
night ball.
(i) This would be duty of loyalty problem, BJR only applies to disinterested directors.
(c) Hypo2: If had Wrigley on the stand, make him pontificate like Ford and maybe court will buy into it.
Conflict of Interest
or Self Dealing
(Duty of Loyalty)
“good faith”
Gross Negligence
(Duty of Care)
Failure to
Failure to
Business Judgment Rule Flowchart
Duty of Care
i) 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 action was taken in the best interests of
the company.
(1) This presumption can only be overcome by conflict of interest, fraud, illegality, or gross negligence (duty
of care) or breach of duty of loyalty. (Simple carelessness is not enough to establish a breach of duty of
care by director to corporation) (Directors are not liable for ordinary negligence)
(2) Policy reasons in favor of BJR (Van Gorkom)
(a) Certain amount of risk taking and innovation is essential to make businesses grow and prosper.
(Board will be risk averse if fear suits)
(b) Courts are poor judges of business transactions.
(c) Would scare away good talent if had to worry about liability.
(i) Many corporations have director/officer liability insurance now, but still not enough.
ii) RULE: Duty of Care (gross negligence) is Satisfied if:
(1) No conflicting self interest.
(2) Director/officer can’t be inadequately informed about the facts of the decision.
(a) Will take into account surrounding circumstances (Van Gorkom)
(i) Short time period for decision.
(ii) Scope of transaction especially in takeover/merger/consolidation context where must do more
than simply rubberstamp management decisions.
(b) Exceptions
(i) Del Corp Law 141(e): Directors can rely on other directors, lawyers, accountants or committees
if the director believes that reliable and competent.
1. This is above and beyond the protection of the BJR and is separate and independent.
(3) No Failure to act as director (Acts of omission) (Francis)
(a) Fails to attend meetings
(b) Fails to learn rudimentary functions of business
(c) Fails to read reports or financial statements
(d) Nature and size of business Directors of financial institutions owe a fiduciary duty to creditors as well
as shareholders and typically a higher duty of care.
(i) Also in small business may need less attention than in a big business.
(4) Can’t Fail to attempt to stop inappropriate behavior when put on notice of it. (Francis, Caremark)
(a) Director knew or should have known that violation of the law was occurring
(b) That the director took no steps in good faith to prevent or remedy the situation
(c) Such Failure proximately caused the losses
(5) Decision was not completely egregious.
(a) Can be unwise (Kamin)
(6) Can’t Fail to monitor
(a) Directors must put in place an information and reporting system that will inform directors adequately
of appropriate information in a timely manner to satisfy its responsibility.
(i) Graham - Do not have to install and operate a corporate system of espionage to ferret out
(7) Note: Court may be influenced by signs of self dealing and fraud
iii) Analysis
iv) Cases
(1) Kamin v. American Express – AM bought DLJ the depreciated rapidly then they were faced with a choice
of realizing the loss or giving the stock out as a dividend in kind. The company gave the dividend and a
shareholder brought suit to declare it a waste of corporate assets.
(a) RULE: Dividends and distributions are choices left solely to board of directors under the protection
of the BJR. (Ford one of few cases that force them)
(i) Directors thought the realization of a $20 million loss would hurt the company stock price more
than the benefit of the tax break.
(ii) If majority of directors were interested then could
(b) Ethics - AM exploited accounting practices to try and conceal the cost from investors.
(i) What if directors made it a surplusage because inside directors had compensation bonuses tied to
the profits of the corporation.
(ii) Balance Sheet v. P/L ratio – distribution affects the P/L but not the balance sheet. Should use
other things than P/L ratio.
(c) Efficient Market Theory – All material information released to the public would be incorporated into
the market price of the security because of securities analysts like muturla fund analysts.
(d) Hypo: Company buys piece of property for 500 million then it depreciates to 50 million. Company
can now sell it and take tax credit or keep it. Market knows of loss already and with efficient markets
has adjested price already. Double loss if don’t take credit.
(i) Even though the board is exasperating a problem with a double loss, unless the decision is
absolutely egregious the courts will not muck with the decision. Even an irrational mistake is not
enough to hold for damages.
(e) Hypo2: Were the Dodge brothers at fault in Ford case?
(i) No because they are just shareholders and not controlling shareholders.
(2) Smith v. Van Gorkom – SH suing for damages to the shareholders in a class action direct suit. MBO and
LBO was not feasible so Van Gorkem near retirement found Pritzker a known acquirer and offered $55.
Current market value of shares were $38, but actual value probably higher than $55. CFO says that offer
is on the low side of fair and corporate counsel says that can be sued if don’t accept the offer. The board
of directors never saw the merger agreement and made a decision after 2 hours. Key was to find out what
the actual value was, not just the word of director.
(a) RULE: Board was grossly negligent in failing to inform themselves of the nature of the transaction
so no protection from BJR. Form is more important than substance.
(i) Del Corp Law 141(e): Directors can rely on other directors, lawyers, accountants or committees
if the director in good faith believes that reliable and competent.
1. Directors rely on corporate counsel, however court says can’t rely on that because it was not
even in the form of a not a report so no reliance.
(b) Dissent – sophisticated board of directors that know the corporation like the back of their hands.
(i) Heavy hitters busy and may only spend 20hrs a year looking at a corporation if outside director.
(c) Public Policy: Idea was to make boards of directors stay awake at the wheel otherwise they would be
open to personal liability. No fraud involved but massive passivity, this was attempt to wake directors
(d) Practical Application: After this case although not required Directors should always get a fairness
evaluation by an expert. (Mandate for corporate attorneys and investment bankers in valuation of
(i) Unfortunately directors hire investment bankers as “yes men” to rely on them and avoid liability.
(e) Alteration of BJR after case: Now add gross negligence part. Here could argue the courts do decide
certain aspects of business decisions, like if its completely egregious. However still process oriented
(f) Del Legislative Response – tried to overrule Van Gorkem.
(i) Del §102(b)(7) - Gives directors protections from money damages in gross liability cases.
Applies only to directors not officers, allows a corp. to put in certificate of incorporation as a
1. Does not apply to officers
2. Does not protect against conflict of interest, fraud, embezzlement, crimes, bad faith.
3. Can still get injunctive relief.
(ii) Pro protecting directors from monetary damages.
1. Makes them more cautious and might want more compensation for the risk
2. Standard still gross negligence so shouldn’t scare most away
3. Mainly problem is for outside directors that cannot devote a great deal of time to board and
worried about the enormous liability.
4. Directors now have personal liability insurance as a result, but always limits.
(iii) Con protecting directors from monetary damages
1. Deter board members from being lazy
2. Way of saying rock star on board and will be paying attention as well.
(3) Brehm v. Eisner – Directors gave Orvitz an excessive compensation package then terminated him when
he failed to do anything incurring huge penalties. No breach of duty of care because relied on expert
opinions Del Law §141(e) (this does not protect against waste.)
(a) Del Law §220 - Stockholder must use the tools at hand.
(i) Committee minutes, private contracts, public records. Must have good purpose then must use
rifled precision.
(ii) This section prevents frivolous suits.
(b) On Remand
(i) Del 102(b)(7) protection doesn’t apply because rose to level of bad faith. Not acting with
shareholders interests at heart.
(ii) Used the 220 claim to get corporate meeting minutes and saw that board members didn’t even
read the contract and no expert was present. No demand was necessary and easily fits into the
third prong of failure to make sound BJR, because they never even made a business judgment.
(c) Compare to the Grasso case where high compensation but he actually did a good job so might be
(4) Francis v. United Jersey Bank – Filed bankruptcy when sons were making loans to themselves,
amounting to depletion of corporate assets. Mother was director and controlling shareholder, but did
everything wrong as director, never attended meetings or read books.
(a) Del Law §141(a): “Power of Board of Directors” – The business and affairs of every corporation
organized under this chapter shall be managed by or under the direction of a board of directors.
(b) RULE: Directors have to keep informed of what is going on and must keep up with financial
statements (even though don’t have to audit), can rely on subordinates (Del 141(e)), but not when
have notice that they are acting inappropriately.
(i) This is an objective standard based on the reasonable person. No special standard for elderly,
drunk, bed ridden depressed mothers.
(ii) However if the director has special skills then will be held to higher standard. (Ex – CPA,
(c) No business judgment to discuss just a total abdication of director duties
(i) Directors don’t need to be business savvy (But must get a basic idea of business)
(ii) Directors do not have to attend every meeting (But should make good faith effort)
(iii) Directors have to study financial statements (Don’t need to audit but must review)
(iv) If illegal activity occurs and put on notice must try to correct problem not enough to just inform
others. If they insist on following through then can resign the board or threaten to bring
suit.(Practical Advice: want something in meeting minutes showing that you tried to stop them)
1. To be found liable there must be causation p354Case.
a. Doesn’t have to be the primary factor could have comparative negligence.
(d) Directors of financial institutions - owe a fiduciary duty to creditors as well as shareholders because it
is like holding money in trust for clients. (Why creditors could bring derivative suit)
(i) Regular Companies – A fiduciary duty to creditors will arise when a company becomes insolvent.
(Creditors step into the shoes of shareholders)
(5) In re Caremark International Inc. Derivative Litigation – Charge was against the directors for allowing
kickbacks for referrals to Caremark’s products. No evidence that directors had any knowledge of
kickbacks. Case was settled.
(a) Directors could have fought case by motion to dismiss for failure to make demand. (No demand
excusal appropriate) Could have also used Del 102(b)(7) as shield from liability but must be in the
certificate of incorporation. Have to use prong three of Grimes that no business judgment at all.
(b) RULE: Directors have a duty to monitor and a more particular duty to investigate if something comes
(6) Martha Stewart Case – Company based on the reputation of Martha Stewart but no duty to follow
Martha Stewart around or monitor the personal lives of directors.
v) Hypos
(1) Problem p355 – You are on BOD, business going bad and in deep debt, customers pay $500 in advance
for year. All have is $5,000. CEO wants to spend on advertising campaign. If don’t work will have to go
out of business with no assets to pay creditors or shareholders. A trusted member of board says 5%
chance will work. Corp still hiring and getting new customers in mean time. No resignation. Not
(a) Legally have responsibility to shareholders not creditors, but can also look out for community.
(b) Corporate Charities (Depends on where you are)
(i) Penn – shareholder interest doesn’t have to trump community interest.
(c) Really the tension of whether to file bankruptcy or take a chance for potential profit of shareholders.
Legal v. Ethics.
(2) Hypo: You are counsel for Car corp. where mid level managers are indicted for price fixing few years
ago. Company has no reason to suspect wrong doing now, senior management doesn’t like watchdog
mentality. How to counsel in wake of Caremark.
(a) Need to convince that need a reporting system otherwise could be liable.
(i) Establish an active ethics committee with high level management.
(ii) Employee ethics handbooks and clear chain of reporting to ethics committee then to board.
(iii) Procedures to test effectiveness of system.
(iv) Remove price fixing incentives
(v) Could advise to put clause for 102(b)(7) but if acts done in bad faith then no protection.
b) Waste
i) Usually in Executive compensation cases. (Grimes and Brehm) almost impossible to win because the
transaction must be unconscionable. No one of ordinary business judgment would do it. Completely
Duty of Loyalty Flowchart
Duty of Care
Failure to
Duty of Loyalty
Failure to Monitor
IDT (Del 144)
Controlling shareholder Transactions
ii) RULE: There is a fiduciary duty between the directors and officers to the corporation. They must work to
benefit the shareholders and the corporation given the scope of there relationship.
(1) Fiduciaries must subordinate their private interests to the corporation when they conflict. Look at
Meinhard v. Salmon Cardozo quote.
Directors and Officers Generally
Types of Interested Director Transactions
Corp A
Corp B
Corp A
Corp B
(2) Interested Director Transactions
(IDT): financial interest, familial relationship
H (spouse, child, grandchild,
parent, sibling), or business entity associated with the director in some way.
(a) Interested (No hard and fast rules, but immediate relation is always a problem) – Interested if a party
to transaction, or director has a business or familial relationship to the person in the transaction and
showing close enough that would affect the director’s judgment, or if the director has a material
pecuniary interest that would affect his judgment adversely to the corporation.
(3) Historical Rule: Used to be that self dealing transactions were completely banned, but now there is more
of a focus on whether it was fair.
(4) Cases
(a) Bayer v. Beran – Company wanted to start an advertising campaign and had director’s wife sing.
Similar to Diagram 1. Couldn’t get benefit of the BJR because it was implied that as CEO he
controlled the rest of board.
(i) RULE: If the board approved in correct way then burden on plaintiff to show unfair to
(ii) Board of Directors never actually voted on this, court says ok because all inside directors, but
today would never fly. (Burden of proof would shift to corporation to prove fair?)
1. Enron – if board takes steps that breaks its own policies it is not damning evidence but pretty
(b) Lewis v. S.L. & E., Inc. – Rich and Leon owned all of LGT. Rich Leon and Donald owned all of
SLE. Rich and Leon failed to run the two corporations as a separate entity. If Rich and Leon owned
both corporations then no shareholders harmed but could pierce the corporate veil here if a third party
was injured on property because they did not follow formalities. Also might be liable for breach of
duty of care similar to Francis because they never had any meetings, total abdication of director
duties. Like Diagram 2.
(i) RULE: In a contract between a corporation and an entity where the directors have an interest the
directors have an affirmative duty to show that it is fair and reasonable.
1. Burden of Proof will often be outcome determinative (Proving fairness by corporation or
unfairness by the plaintiff).
2. Threshold requirement of demand for D of L and D of C, but futility allows shareholders to
get away from it.
(5) Question on Compensation p377
(a) How management and directors should set an appropriate pay scale for themselves.
(i) Hire an outside consultant to give advice
1. If inside and outside directors setting own salary
(ii) If all inside directors
1. Have outside directors make decision through committee, also advice from outside expert.
(b) Closely held Corps (Majority shareholders usually run the corporation)
(i) Could get ratification from shareholders (Just the disinterested ones)
(ii) Could hire independent directors to set salary (But how independent could they be)
(iii) Can tie compensation to performance (However might incentivize cooking the books)
(6) Problems p377 – Wife is singer that wants to break into opera. H is CEO of corp and majority
shareholder in corp. shares worth 100million.
(a) 1. BOD votes to give $20million donation to start opera. Wife doesn’t sing.
(i) 20% of capitalization of company. CEO could have dominated the board. Normally a BJR
decision about charities, however problems could arise if characterized as a pet charity. Probably
unreasonable because of wife’s interest and large amount because IRS allows for 10% deduction
limit thus unreasonable.
(b) 2. Wife sings for no money
(i) If she now sings for opera even more evidence that pet charity. Might be ok if she was a genuine
star, otherwise it starts to look like a conflict of interest, even if sings for free could further career.
(c) 3. Kane owns 100% of corp
(i) Fine because all his money
(d) 4. Wife a genuine star and gets lead in play
(i) Similar to Oracle case where 20million dollars probably influences decision makers. If corp.
cedes all control over charity and sings for free, ok. ALI test just based on affects decision not
even whether financial. Might be ok if donation 5 years ago.
(e) If she a genuine star and under 10% donation and board approved probably ok and under BJR.
iii) Dominant Shareholders
(1) RULE: Dominant/Controlling (can determine outcome of voting) shareholders retain a duty of loyalty to
their fellow non-controlling minority shareholders. Based on principles of equity.
(a) Parent Sub - Can apply to an individual or a parent/subsidiary relationship.
(i) Parent controls board of subsidiary. If owns 100% of subsidiary then no problem.
(b) Closed Corp – Probably 50% or more of corp.
(c) Public Corp – ALI suggests 25% or more should be a presumption of control.
(d) Standard of Review –
(i) BJR – when minority cannot show that preference (self dealing) with majority shareholder burden
of proof is with the minority shareholder.
(ii) Intrinsic fairness test - when a minority can show that the subsidiary gave the majority
shareholder a preference (self dealing) burden of proof is shifted to the controlling shareholder to
show fairness of transaction.
(2) Remedy
(a) Rescission and damages
(3) Cases
(a) Sinclair Oil Corp. v. Leiven – Sinclair owns 97% of subsidiary Sinven. Three claims
(i) Breach of loyalty on dividends – Court dismissed.
1. RULE1: When dividends are given out on a pro rata basis to all shareholders it is subject to
BJR and not self dealing.
a. Hypo: Breach of duty of loyalty if dividends given to only one class of stock that the
minority didn’t have then breach of loyalty. Parent could own 80% of class A and get
benefit. However corps. Can’t create new stockholder classes by fiat.
(ii) Misappropriation of Corporate Opportunity – Made claim that Sinclair deprived its subsidiary of
opportunities, but no good here because all the opportunities were Sinclairs to begin with. If took
from Sinven probably different story. Dismissed. BJR applies.
(iii) Contract breach (Duty of loyalty conflict of interest) – Sinclair owns 100% of International and
international breached its contract with Sinven. Thus court found damages for minority
shareholders of Sinven for unfair self dealing.
(iv) Public Policy: Parent owns 97% of subsidiary, the equitable argument for minority is compelling
but really kills the parent. Bad deal because have huge stake in the corp. but don’t own 100% of
(v) Question 3 p389
1. How to avoid law suits for duty of loyalty when a Parent company owns a large portion of a
a. Contract with a lot of vendors not just parent
b. Tie compensation of S directors to subsidiary performance.
c. Get outside directors on the board.
d. Could get minority shareholders to ratify it if really worried.
i. Only count the minority shareholders not controlling shareholders.
(b) Zahn v. Transamerica Corporation – Transamerica dominated the board of Axton-Fisher. AxtonFisher had tobacco with book value of $6million and market value of $20million. Transamerica’s
plan was to liquidate the assets of corporation and reap benefits. Transamerica owned much more
class B stock then class A.
(i) RULE1: When directors are confronted with a conflict of interest with shares they should protect
the class of shares that bears the greatest risk. This is usually the common stock (equity).
Directors owe primary loyalty to common stock holders.
(ii) RULE2: Must have full disclosure to minority shareholders when proposing a transaction
involving those fellow shareholders even if they are not common stock.
1. Would have been ok if disinterested board of directors disclosed the information and then
made the callback of class A stock. Problem here is the court found they did this to
specifically benefit themselves not anyone else.
(iii) Shareholder Structure
1. Class A – Preferred (bond like) cumulative dividend with liquidation rights, no votes unless 4
consecutive missed dividends. Convertible to Class B at any time and Subject to callback at
$60 per share.
2. Class B - common stock (equity like) voting rights and residual rights.
(iv) Options
1. Option 1 – Disclose all information on market value of assets and liquidation plan then call
Class A stock.
a. Result – Class A converts to Class B and share residuals equally. Court imposes this
option on remand.
2. Option 2 - Decline to call class A and move forward with liquidation plan. Class A stock
gets more dough. (Plaintiff wants this option)
3. Option 3 - Call class A shares but not tell anyone about the asset value or liquidation plan.
a. Result – This is what the corp did and no one converted to class B stock.
iv) Sale of Control
(1) Cases
(a) Zetlin v. Hanson Holdings, Inc. – minority shareholder brings suit against a controlling shareholder
who sold his shares for a control premium.
(i) RULE: A controlling shareholder may sell his shares for a control premium and keep the profits
1. Exceptions
a. Looting – Cannot sell your shares to someone who intends to loot the corporation by
unlawful activity.
b. Stealing a corporate opportunity – For example if company was going to give a tender
offer to all stockholders and the corporation assets were in extremely high demand and
you say just buy my controlling block. You have stolen the corporate opportunity for the
other shareholders.
(b) Benign Reasons why might offer control premium.
(i) Undervalued stock or think can manage company better and bring up the profits. (Shareholder is a
free rider)
(ii) Costs a lot of money to buy everyone out, if can control with 30% instead of 100% you can then
diversify your portfolio.
v) Corporate Opportunities (Prof. thinks highly tested and practical area)
(1) Description: Subset of duty of loyalty but not same as conflict of interest, here no transaction between
director and corporation. The director appropriates unilaterally. Compare to Cardozo quote in Meinhard v.
(2) Del “Line of business test” (Very fact based, weak test)
(a) Corporation must have the financial capacity to take the opportunity
(i) Golf Corporation did not have the capitol to buy the property at the time.
(ii) It is possible that the corporation would raise the funds to do so.
(iii) This encourages directors to try to finance the endeavor, not just take it for themselves. Inside
directors have the advantage because has access to financial statements.
(b) Must be a similar line of business to the corporation
(i) Golf Corporation not in the business of developing property.
(ii) However the board had occasionally discussed buying and developing the adjacent land to the
golf course.
(iii) Also the golf course was against development and therefore would want to acquire land to
prevent development.
(c) Which the corporation has an interest in and is an advantage to the corporation
(d) By embracing the opportunity the officer or director will be in direct conflict with the interests of the
(3) Massachusetts “Fairness Test” (Very fact based, ambiguous, uncertain)
(a) Has to be fair. Gives little practical guidance to the corporate director.
(i) Capacity in which offer received. (Offered to corp. or you personally)
(ii) How insider learned of opportunity (Learned while acting as corps. agent)
(iii) Use of company resources (Jet to Florida to scout opportunity or on company time(weak if small
amount of time))
(iv) Inside and outside director
(v) Public or Closely held corp. (Easier to monitor close corp.)
(vi) Low level or high level employee. (not as unfair if low level employee)
Minnesota “combo” test (Combines uncertainty and weakness)
(a) First determine whether the opportunity was within the corporations line of business
(b) Second determine the equitable considerations of fairness. If fair then ok.
American Law Instituted Test (Experts in field whose goal is to improve law, nonbinding and product
of 15 years of development) p383-384Case
(a) Advance Disclosure Required – full disclosure is required before a director senior executive or
controlling shareholder can take advantage of the corporate opportunity. Otherwise it is not
(b) Disinterested directors or shareholders – Unless the corporation’s rejection is by a majority of
disinterested directors or shareholders the insider will have to show that the transaction was fair to the
(i) If disinterested majority reject the opportunity then protected by the BJR.
(c) Stricter duty for senior executive – any transaction is a corporate opportunity, no matter what the
circumstances learned of when the senior executive knows that it is related to the type of business that
the corporation is engaged or expects to engage in the future.
(i) Outside director – corporate opportunity when becomes aware in connection with performance of
functions as director or senior executive or under circumstances that should reasonably lead him
to believe that the opportunity is meant to be offered to the corporation.
(d) Controlling shareholder – corporate opportunity if learns of it while acting on the corporation’s behalf
or the opportunity is one that is held out to other shareholders and is type of business the corp engages
or expects to engage and is not the type of business the controlling shareholder does.
(e) Burden of Proof – The party defending the claim of a corporate opportunity has the burden of proof to
show fair if the opportunity was not authorized in advance by a majority of disinterested directors or
disinterested shareholders.
(i) Can’t use the fairness defense unless disclose to the corporation first.
(a) Constructive Trust – property is treated as if it belongs to the corporation that owned the opportunity.
The court may make the corporation pay the key player for his direct investment cost.
(a) North East Harbor Case – Corporation is suing the former president of the company for buying
adjacent pieces of land near the golf course. She told the board after her purchases. Property went
from $385thousand to $1.5million. On remand all claims barred by latches.
(i) Alternate Suits
1. Could have case against board for D of C
a. They were asleep at the wheel.
2. Case because she was dominating the board
(ii) Properties
1. Gilpen Property – brought to her in a professional capacity.
a. Received in official capacity so is a corporate opportunity even if she waits to do it until
after she leaves the corporation.
2. Smallridge Property – though golf outing with postmaster of town.
3. Access Property – Found out about it through personal capacity, through ownership of
Smallridge property.
Hypo H/O
(a) (1)
(i) ALI 5.05(b)(1)(B): If using corporate expense accounts and maybe if on corporate time. Using
Jets or expense account to get there.
(ii) ALI 5.05(b)(2): also look at whether this was in the same line of business or was a business that
the corporation was engaged in or could be expected to engage in because they toyed with other
sporting goods in the past.
(iii) ALI 5.05(b)(1)(A): Also could argue that doing it because it was his work function. However this
is a tough sell because he left work.
(b) (2)
(i) ALI 5.05(b)(2): would this throw the senior executive in competition with the corporation.
(ii) Sales not going well so maybe corporation could not buy it. But sent him out to look so probably
not. Is corp interested in and will it make a conflict.
(c) (3)
(i) Del test creates disincentives for executives. Must show that could actually pursue the
(ii) Under the ALI test no difference and would have to disclose.
(d) (4)
(i) ALI 5.05(a)(3)(B): CEO is a superior and is disinterested and probably meets the standards of the
business judgment rule.
(ii) If a director not enough must get it approved by a majority of the disinterested board or by a
majority of disinterested shareholder.
(1) Del §144 (Use as modern Rule)p396
(a) No interested director transaction shall be void solely because the director participated in the vote if
all material facts as to the relationship and transaction are disclosed and:
(i) Majority of disinterested directors in good faith approves it or;
(ii) Majority of shareholders approve it in good faith or;
(iii) The transaction is fair to the corporation as of the time it was authorized or ratified by the board
of directors, committee, or shareholders.
(2) Effect of Ratification (Del.)
(a) IDT: Del § 144
(i) (Entire Fairness) Ratification by majority of disinterested DirectorsBJR (Burden on
(ii) (Entire Fairness)Ratification by majority disinterested shareholders Waste(Burden on
(iii) (Entire Fairness)No ratification or ineffective ratification  Burden stays on Defendant to show
(b) Transactions between controlling shareholder/Majority shareholders
(i) Ratification by a majority of minority shifts burden of from controlling shareholders 
minority shareholders to prove unfairness.
(c) IDT’s
(i) If after disclosure it is ratified in good faith by majority of disinterested directors then reinstitute
the BJR. (Burden on the plaintiff and will almost always lose)
(ii) If after disclosure it is ratified in good faith by majority of disinterested shareholders then
standard is Waste. (Burden on the plaintiff and will almost always lose)
(iii) If one of first two prongs is not met then fairness is the standard. (Burden of proof lies with the
defendant, not as hard as BJR or waste but still tough)
(d) Controlling shareholder
(i) If ratification by majority of the minority then fairness is the standard. (Burden of proof on the
plaintiff because shifts from “defendant fairness” after ratification)
1. Kept it at fairness not waste because potential for manipulation of minority shareholders is
much greater then in the interested director transaction. P401Case (de facto and de jure
(e) Corporate Opportunity
(i) ALU 5.05 ???
(3) Cases
(a) Flieger v. Lawrence – Complaint by a shareholder over an interested director transaction. A
Delaware case where Agau Corp. argues that majority of shareholders approved it. However the court
reads in disinterested shareholders into good faith lang. So the burden never shifts and Agau must
prove the intrinsic fairness test.
(i) Can argue that the legislature knew the proper lang and did not put it in
1. In this case common law trumps the statute.
(b) In re WTI shareholders Litigation – Waste was merging with WTI and the non interested directors
WTI shareholders approved it. Since no evidence of de jure or de facto control over WTI standard is
BJR, however if Waste did have effective control over WTI the standard would be fairness with
burden of proof on the directors.
(i) Remanded for application of the BJR.
Close Corporations
Voting Arrangements
(1) P623Case Good Note
(2) Cases
(a) Ringling Bros. Corp v. Ringling Oppression and Abuse – Agreement between Ringling and Haley to
pool votes in electing directors. Haley breaks agreement and votes other way, says that Del law
doesn’t recognize pooling agreements only a voting trust or irrevocable proxy.
(i) Lower Court read as if a irrovacable proxy given to Mr. Ringling. SC throws out Hasley’s votes.
Improper to imply a irrevocable proxy and Hasley’s votes are not counted because of her breach
of contract messing with another shareholders votes.
(ii) Rule: Court really wants serious mechanism when dealing with voting and sends message that
will enforce pooling agreements and if breach them you will pay.
1. Use either a voting trust or an irrevocable proxy for definiteness. (Could structure that vote
own shares unless disagree then trustee votes both shares)
(iii) Hypo p613: If you were Loos what would you do?
1. Conflict of interests with two old clients and would not want to be involved.
(b) McQuade v. Stoneham – Stoneham is the majority stockholder and enters into an agreement where he
would elect all the directors but unless unanimous agreement could not change salaries or bylaws.
McQuade actually moonlighting as a magistrate and couldn’t have the job anyway.
(i) RULE: illegal for shareholders to restrain the judgment of directors.
1. Can make an agreement to elect directors as a shareholder however cannot constrain directors
discretion to make decisions in best interest of the business.
(ii) Practical Application – McQuade could have protected himself by securing a long term
employment contract that gives protection against termination without cause. Casep622
(iii) Dissent - ???
(c) Clark v. Dodge – C has 25% and D has 75%. They enter an agreement to do four things, all but the
last are against the McQuade ruling. Court rules contract valid. Pharmaceuticals.
(i) Dodges commitments
1. Set salaries of employees
2. How they vote as directors
3. ¼ of income to Clark as long as worked there.
4. Clark continues as director
a. Classic shareholder agreement on voting for which directors.
(ii) RULE: When there is no harm a unanimous shareholder agreement can be made for them to
contract certain director prerogatives.
1. Clarification of the McQuade rule.
a. All shareholders must agree and no harm to third parties.
2. Court thinking of other people too like creditors.
a. Reads a reasonableness in the agreement for third parties otherwise could set lavish
salaries that is unfair to creditors.
(iii) NY §620: (Enacted right after Clark case) – Where no minority shareholders left certificate of
incorporation may provide that shareholders can take on director prerogatives.
1. Every shareholder must agree and subsequent buyer must be informed of it.
(d) Galler v. Galler – Two brothers own ½ and ½ and made an agreement to ensure the support of
widows in case of ones death. One died and the other brother reneged.
(i) RULE: Makes the distinction to say that shareholders in a closely held corporation are free to
contract regarding the management of the corporation absent the presence of an objecting
minority, threat of public injury, or statutory prohabition. (Don’t need unanimity just no
1. Court does this to protect the interest of minority shareholder in close corporation. Must
allow shareholder agreements because there is no readily available exit strategy.
(ii) Practical advice: Always make sure that your client has a buyout agreement. Need an exit
Oppression and Abuse
(3) Mass (Wilkes) “Golden Rule”: Shareholders in a close corporation owe each other a duty to act for
legitimate business purposes, but not harm the minority unnecessarily. (only duty to corporation for
public company.) (Most states adopted)
(a) If minority shareholder brings suit majority has burden of showing legitimate business purpose.
(b) If legitimate purpose shown then burden shifts to minority shareholder to prove that same legitimate
objective could be achieved through an alternative action that is less harmful to the minority
(4) Policy to protect minority shareholders in close corporation
(a) Shareholders in close corporations make their money through salaries and pensions.
(i) If no dividends than no return on investment.
(b) Lack of secondary market to sell shares (No easy exit)
(i) Public corporation ready market to sell. For public shareholders owe duty to corporation but not
to other shareholders.
(c) Average person would not think of all these things and it is inequitable.
(d) Judicial efficiency because sets the precedent that will be liable if attempt to mistreat and freeze out
minority shareholders.
(5) Del (Nixon) “You made your bed and now must lie in it” “Tough Love”: Pursuant to Del § 102, 109,
141(a) a stockholder entering into a minority position in a Delaware corporation may enter into
stockholder agreements that include buyout provisions, voting trusts, etc.. It is unfair for a special
judicially created rule for minority investors when there is no specially negotiated provisions in the
certificate of incorporation, by-laws, or stockholder agreements.
(a) Policy – wants shareholders to work it out themselves, think ahead of time and not rely on court.
(Judicial efficiency).
(i) Law and economics favors because emphasis is on freedom of contract and economically
efficient transactions.
(ii) No paternalism.
(6) Remedies
(a) Personal liability against other shareholders (Wilkes) or directors.
(7) Questions p651
(a) (1) How to distinguish Wilkes and Ingle?
(i) No shareholder’s agreement in Wilkes so common law fiduciary duty applied (just an agreement).
In Ingle there was an actual contract.
(ii) Ingle started out as an employee and there was an inherent bias because he was not an original
(b) (2) What could Ingle have done to protect his rights?
(i) Should have negotiated an employment contract. Also Glamore could have made the terms in the
contract explicit.
(c) (3) What is the basis for the dissent in Ingle?
(i) That there was an implied agreement that Ingle would run the business unless he did a bad job
and buy-out only applies if Ingle leaves voluntarily.
(d) (4) If Ingle convinces court that unfair, what remedy?
(i) Court would not force the company to keep him on but would probably come up with a damage
remedy similar to wrongful termination.
(8) Cases
(a) Wilkes v. Springside Nursing Home, Inc. – closed corporation for nursing home where had no written
agreement but understanding that all would be directors and hold offices. Bad blood developed and
they shut out Wilkes as a officer and director for no other good reason. Then tried to buy him out with
a lowball offer.
(i) RULE: Shareholders in a close corporation owe each other a duty to act for legitimate business
purposes, but not harm the minority unnecessarily. (only duty to corporation for public company.)
1. If minority shareholder brings suit majority has burden of showing legitimate business
2. If legitimate purpose shown then burden shifts to minority shareholder to prove that same
legitimate objective could be achieved through an alternative action that is less harmful to the
minority shareholder.
(ii) Tempered from Donahue Case which was simply duty same as partnership, after this case a gap
exists between partnership fiduciary duty and corporation duty.
1. If in control then should have the right to be selfish that is why people pay control premiums.
2. Can harm minority interests, just not for spiteful reasons.
(iii) Practical Advice: Could have advised Wilkes to get a long term employment contract. Also need
to have an exit strategy in the form of a buyout agreement.
(iv) Hypo: Suppose Wilkes really was negligent, could he have still won.
1. Yes, could have setup a dividend structure in addition to the salaries. This would be simple
and fair, gives some return on investment but not as much as before. This is the responsible
way to get rid of an irresponsible employee.
2. Could have also went for breach of loyalty with IDT. His salary was cut off so that other
directors salaries could be raised. Would fail under the fairness test. Only thing is that courts
are unwilling to get involved with salaries. ??? Majority of disinterested
directors/shareholders could do it ???
(b) Nixon v. Blackwell p659Case - states Del rule of tough love.
(c) Ingle v. Glamore Motor Sales, Inc. – NY Case that takes the Del tough love approach. Ingle was an
employee that bought into the corp and had a shareholders agreement that had a low buy-out in the
case Ingle “ceased to be employed”. Ingle thought this protected him because not “terminated” but
Glamore dumped him.
(i) NY Rule: – a fierce employment at will state, takes the Del approach of “tough love”.
1. Even though Ingle took on great personal guarantees to help the business his shareholder
agreement did not protect him.
2. Ingle did not even challenge the low buy-out, he invested a big commitment in terms of labor
and emotion to the business and just wants his spot back.
3. Ingle started as an employee and not as an original shareholder, probably sways the court
into thinking this is a simple employment contract case.
(ii) Dissent – argues that treated like a servant because he is an employee.
(d) Smith v. Atlantic Properties Inc. – There is a shareholder agreement that requires 80% ratification to
do anything with the corporation. Here Wolfson is the minority and wants to reinvest the profits. The
majority wants to issue dividends with the profits. They are in deadlock and money sits and they get a
huge tax fine for too much unspent money.
(i) Mass Rule: The minority stockholder has a fiduciary duty to fellow stockholders even if veto
power is in accordance to the stockholder agreement.
1. Both dividends and reinvestment of profits fall within the BJR. Wolfson is dealt with harshly
because he is so obnoxious.
2. Mistake was to be so vociferous and vetoing just to spite the rest of the shareholders.
3. Ad hoc controlling interest created and held by the minority. Wolfson is minority in control
with respect to dividends and rest of shareholders are majority in control with respect to
4. Court declares dividend. (very rare)
(ii) Practical Advice: Bad to have a supermajority provision in a corporation.
(e) Jordan v. Duff and Phelps – A very paternalistic outcome where Jordon owns stock and has no
employment contract but a buyout contract for stock. He resigns but he was not told that a merger was
in the works and his stock could have been worth much more. Court reverses and remands. Recision
probably not an option but could get monetary damages.
(i) RULE: Close corporations buying their own stock have a fiduciary duty under common law to
disclose material facts to sellers.
(ii) Easterbrook (majority)
1. Sees as minority shareholder oppression case
a. Shares are bought out for way less then what they know the shares are worth.
b. Result is that makes the company more valuable for those who have the shares.
c. Sees as opportunistic because of Hansen’s personal benefit as a major shareholder.
2. Employee at will does not mean the company can just fire him to get his shares back. The
fiduciary duty trumps any such agreement.
a. Not just an employee but a shareholder
3. Stock to Bargain – stock is a way to entice people to come to the company. Why would
someone accept if the stock carried no rights and could be pushed around.
4. Still must prove causation
(iii) Posner (dissent)
1. Sees as an at will employment case like Ingle. Like Del “tough love.’
a. Argues that could have fired Jordon the day before the merger and it would have been ok.
2. If Jordon was really valuable than would have told of merger to make stay.
3. Stock to Bargain - Stock could have been bought by Jordon at market value, knowing what he
signed away he should have negotiated for a better deal. If he was a better employee maybe
he would have gotten a better deal.
(iv) Hypo: Would same duty to disclose if Jordon sold to a third party
1. Probably not because no self interest by the corporation and Hansen involved.
(9) RULE: In all fifty states unhappy or mistreated minority shareholder can also seek judicial involuntary
dissolution of the corporation.
Grounds for dissolution
(a) Deadlock of directors
(b) Deadlock of shareholders
(c) Waste of corporate assets
(d) Abuse or oppression of the minority shareholder
(i) Usually defined broadly as conduct that defeats the reasonable expectations of the minority
shareholder to be employed or participate in the business.
(a) Involuntary Dissolution – liquidation of all assets and distribution to creditors and remaining to
(b) Buy-back – corporation or majority shareholders forced to buy back the shares of the complaining
minority shareholder when breach of fiduciary duty.
(i) In case of oppression some statutes allow the court to force the non-complaining shareholders to
buyout the complaining shareholder.
1. In Alaska case the court says has the equitable power to do so even without a statute.
(c) Right of appraisal - if drastic corporate change like merger.
(d) Articles of Incorporation – provides for a remedy in the said situation of say shareholder death.
Policy against dissolution(liquidation) (use less drastic solution)
(a) It is not very economically sound.
(b) Non-complaining shareholders could just repurchase the company assets
(c) Companies often worth more as whole than when sold in parts because of the worth of the going
concerns of company.
(a) Alaska Plastics Inc., v. Coppock – A minority shareholder was deprived of benefits given to other
shareholders like going to meetings and so forth. Case based on what is shareholder’s rights in case of
Limited Liability Corporations (General)
i) Features
(1) Tax purposes - treated like a partnership, only distributions to investors on the individual level are taxed.
(a) Investors in LLCs are allowed to avoid the double taxation from dividends and income that comes
with being a partner.
(2) Limited Liability - like corporation has limited liability, great for investors.
(3) Flexibility – provides flexibility for internal management of the organization, unlike the rigid rules of a
corporation. Allows even more flexibility than partnerships.
ii) State LLC laws
(1) State very diverse on how to handle LLCs.
(a) ULL Act did not come out until many states had already made their own LLC statutes.
(b) Form books for how to start an LLC
(2) No definitive choice for where to organize LLC but Del has made a big push.
iii) Management of LLC
(1) Partnership model - run as a member managed firm, one vote per person, all have right to manage and
very egalitarian and democratic. (defaults)
(2) Manager managed LLC model – investors elect to appoint managers and cede their authority to them for
management purposes.
iv) Cases
(1) Waste Water & Land Inc. Westec v. Lanham – A LLC was formed but the members never changed their
business cards to hold themselves out as an LLC.
(a) RULE: Members of LLC that would normally be entitled to limited liability will not get the limited
liability unless they inform third parties that they are an LLC. (must be informed at time of contract
not after the fact)
(i) Common Law of Agency – an agent is liable if he does not fully disclose the principal that agent
1. Constructive notice of articles of incorporation is not enough must inform third party that
(ii) Policy – Otherwise LLC members would be encouraged to commit fraud so that they would have
power of bargaining without disclosing limited liability.
(2) Elf Atochem North America Inc v. Jaffari – two corporations started a joint venture in an Del LLC to
produce maskants. One was a Cal and the other was a Penn corp.
(a) RULE: Consistent with maximum freedom of contract the parties can contract provisions that are
different from the default rules set out in Del. LLC statute.
(i) Here the forum selection clause is valid and binding.
(ii) If all members of an LLC sign an operating agreement defining its governance the LLC is bound
to it.
Piercing the LLC Veil
i) Policy on piercing the LLC veil
(1) It is a normative matter on whether the veil should be pierced in either the case of the corporation or the
(a) Because so few formalities with LLC should have to follow them or else.
(b) LLC formalities help investors to not be mislead
(i) LLC formality could be to hold oneself out as an LLC
(c) Veil piercing is good because externalizes risk
(2) Courts recognize that to pierce the LLC veil, would have slightly different criteria then for corporate veil
piercing based on formalities.
(3) ULLCA p303Case
(a) Suggests that we should not have veil piercing for LLC.
ii) Cases
(1) Kaycee Land and Livestock v. Flahive (a) RULE: In absence of fraud a claim to pierce the LLC veil shall be treated the same as for
corporations. No reason to treat LLCs differently from Corporations.
(i) The rules of common law are not to be overturned by a doubtful implication.
LLC Fiduciary Duty
i) Policy on limiting fiduciary duty in LLCs
(1) Law and economics encourages freedom of contract.
(2) Public policy in protection of fiduciary duties, but here they are contracting to protect themselves.
(a) Sophisticated commercial investors know what they are getting into.
(b) Some commentators want to extend to corporations
(i) LLC similar to closed corp. where all shareholders can agree, however to eliminate duty of
loyalty in public companies is unfair to public shareholders.
(3) Depends on equal bargaining power.
(a) Creditors would not have access to operating agreement unless asked for it.
ii) Questions p310
(1) If Hunt with approval of all board of LLC was negotiating and McConnell just jumped in and got
(a) Tortuous interference – LLC would have the first right of refusal if deal brought to the LLC first.
(b) Under restricted fiduciary duty then seems ok because allowed to backdoor the deal.
(c) McConnell has a right to compete, but might still be a breach of fiduciary duty because still have duty
of good faith and honesty.
(2) How to make less ambiguous?
(a) Could have made it explicit for only competition on hockey team and not so broad terms.
iii) Cases
(1) McConnell v. Hunt Sports Enterprises – LLC formed where used boiler plate language to say that could
compete with the LLC for hockey franchise, was probably not so clear and unambiguous because sought
declaratory judgment to confirm and would make no sense to enter into such an agreement in LLC. Court
says sophisticated commercial investors and must now sleep in their bed.
(a) RULE: LLC members can contract to limit there duty of loyalty. (Diff from corps.) Not actually a
blanket waiver otherwise the court might have rebuked it.
(i) Parnerships
1. UPA: Can restrict the duty of loyalty but can’t use a blanket waiver.
(ii) Corporations
1. Del § 102(b)(7) – corporations can eliminate liability for negligence, but not for duty of
Corporations II
(Federal Regulations)
Background on Federal Securities Law
i) Backdrop is the great depression which fueled passage of both acts.
(1) People believe that the depression was caused by the 1929 stock market crash. They blamed the crash on
insider trading, believed the key to preventing future crashes was ending securities fraud. (Probably not
completely true).
ii) Securities Act of 1933 – governs primary market transactions.
iii) Securities Exchange Act of 1934 – governs secondary transactions.
(1) Purposes
(a) Protect investors
(b) Assure public confidence in the integrity of the securities markets
(2) 10(b) p433Case– Must be in the public interest or to protect investors.
(a) Applies to public and private corporations.
(3) Three Causes of Action
(a) Private right of action
(b) SEC civil enforcement actions
(c) Criminal actions by US under the securities laws.
i) Elements (Private cause of action)
(1) Misstatement or Omission
(2) Materiality
(3) Scienter
(4) Reliance
(5) Causation
(6) In conjunction with purchase or sale of security (directly from 10b5)
ii) Cases
(1) Basic Inc. v. Levinson – shareholders bring suit because of misstatements about merger.
(a) Misstatement
(i) Three false statements made denying negotiations under way. One to press, one to NYSE, one to
(b) Materiality
(i) Misstatement Rule: If a reasonable investor would find that the information was important in
deciding whether to hold or sell the security.
1. Time: Materiality determined at the time the statement is made.
2. Reasonable investor does not mean sophisticated investor.
3. Contingent or Speculative events – balance the probability of occurrence v. the magnitude if
a. Merger negotiations are almost always material because huge impact.
(ii) Omission Rule: Substantial likelihood that disclosure of the omitted fact would have been
viewed by a reasonable investor as to significantly alter the total mix of information available.
1. Not material if already available through public materials.
(iii) Corporation wants the test to be that can say anything before agreement in principle.
1. Preserves negotiations cause could derail the negotiations, however might resemble an
auction where more bid.
2. Also a bright line predictable test for managers.
3. Don’t want to overwhelm investors with info.
(iv) Court thinks transparency is more important. (Not paternalism but disclosure)
1. Shareholders do not need to be protected from an avalanche of info.
(i) Met by proof of intent to defraud
(ii) or recklessness disregard whether someone would be defrauded
(i) RULE: Reliance is presumed when based on material public misrepresentations using fraud on
the market theory.
1. Efficient Markets – information is incorporated into the stock price when it hits the street.
a. Each investor will not be required to prove reliance on misstatements. However will
assume that price is lower then it should be because sophisticated people would have
invested based on the misinformation.
b. Reliance on market professionals to get accurate market price.
(i) Basic causation.
i/c/w sale or purchase of security
(i) Sold based on misstatements
Insider Trading & the Use of Inside Information
i) Background
(1) Most people think of insider trading as immoral and wrong, however it is only a recent development that
it became a criminal violation. Used to not be wrong.
(a) SEC v. Texas was first civil case by SEC.
(b) Chiarella v. US was the first criminal insider trading case.
(2) Law and economics view
(a) Beneficial and efficient because cheap compensation for insiders and does little harm to long term
(b) Another way to release information to the market is large transactions by insiders.
(3) History
(a) No duty to disclose at common law before Goodwin, then to now with mandatory disclosure.
(b) Could never make false statements
ii) Theories of Insider Trading
(1) Disclose or abstain (TGS)
(a) Chiarella - Limited to a fiduciary duty of some kind to shareholders.
(2) Tipping/Tippee Liability (Dirks)
(3) Misappropriation (O’Hagan)
(4) 14e-3 (O’Hagan)
iii) Classic Insider Trading
(1) Individual defendants are buying or selling with shareholders of company. Duty to shareholders.
iv) Who is an insider?
(1) Insider - Anyone who has access to material nonpublic information.
(a) Ex - An employee
(2) Constructive insider – outsiders hired by the company that have access to material nonpublic information.
(Anyone that has a relationship of confidentiality with the corporation)
(a) Ex – underwriter, consultants, financial printers, accountants, lawyers.
v) How long must an insider wait once in market to trade on it?
(1) RULE: Must wait until the information has reached its widest possible dissemination.
(a) Need to give the market time to analyze and absorb the information. (SEC v. Texas)
(i) Ex – Dow Jones ticker usually enough, but point is to allow individual investors time to make
move on it.
(b) Cost of being an insider is that must be more conservative than noninsider brokers getting information
off the wire.
(c) Many companies set standard wait periods for employees to trade on stock.
vi) Cases
(1) Goodwin v. Agassiz – decided before 10b-5. Common law of insider trading where director bought stock
from another stockholder based on geological theory. Never disclosed it. (State Law)
(a) RULE: When a director personally seeks a stockholder for the purpose of buying his shares without
making disclosure of material facts within his particular knowledge that the stockholder could not
have known that transaction must be closely scrutinized.
(i) Greater danger of an affirmative fraud when face to face transaction. This was a voluntary
transaction and did not know who was buying from.
(ii) On other hand if know the director looking to buy stock you know something is up.
(b) Public Policy for insider trading
(i) Ban on insider trading would make it too burdensome to get a quality director. How far can we go
without turning people off to the job.
(c) Materiality
(i) Determined at time of statement, here 700 shares good evidence that directors thought
information would be material to reasonable investor.
(d) Can’t go out and lie, but no duty to disclose.
(e) Hypo: Would it be any different for selling stock to non shareholder.
(i) No, say dumping stock because know insider information. If no duty to tell own shareholders
the information then no duty to tell average person on the exchange.
(ii) Insider trading was only illegal when resembled fraud.
(2) Securities and Exchange Commision v. Texas Gulf Sulfer Co. – Misrepresentation and Insider Trading
actions brought by SEC. Article written which put a fantastic discovery in a very gloomy and poor light.
(Federal law)
(a) Misrepresentation Claim by SEC (3 elements)
(i) Misstatement or Omission
1. Court remands to determine if misleading statement, today would have just determined false
but first case they were cautious.
(ii) Materiality
1. Materiality test slightly different from Basic test, difference between “might” and “would” a
harder standard.
(iii) Scienter
(b) Insider Trading
(i) RULE: Classic insider trading rule either disclose or abstain when have access to material non
public information of company.
1. If have legitimate corporate purpose then no duty to disclose.
a. Don’t have to disclose to landowner buying from but would have to disclose to
shareholder buying or selling stocks from.
(ii) Hypo: could you get corporate stock options and not be inside trader
1. No, because although not hurting anyone else, you hurt the corporation and thus a breach of
duty to shareholders.
2. Industry funds might be ok, but if big player even those are not too diluted. SEC might
(3) Chiarella v. US – Printing company hired by an acquirer. An employee discovers the target company
and purchases against the company policy and makes mucho bucks. (Federal law)
(a) RULE: If you are not an insider or a constructive insider for the company that you traded, there is no
duty to those shareholders and thus no insider trading.
(i) No fiduciary duty to the target company, would have been a breach if shorted the acquirer.
(b) Should SEC have prosecuted Chiarella?
(i) One thing to lose job because of violating work rule, but another to be indicted for insider trading.
Strange fish for novel case.
(ii) SEC goes after small fish every once and while and brings a few remote tippee cases to keep
people anxious.
1. SEC looking to protect the appearance of integrity of the stockmarket
2. People feel this is naïve because an enormous amount of insider trading goes on undetected.
(c) Burger dissent – argues that a breach based on misappropriation theory. A fiduciary duty was broken
and so doesn’t matter to whom it is owed.
(4) Dirks v. Securities & Exchange Commission – Can draw parallels to the Enron scandal where fictitious
accounting. Dirk was a securities analyst that found out about fraud from an insider Secrist. Reporters
won’t print the story. Dirk tells his clients to sell and the price plummets. (Federal law)
(a) Tipper Liability
(i) Tipper is liable if didn’t trade but intended to give a gift to a tippee and there was a breached of a
fiduciary duty.
(b) Tippee Liability
(i) Did the tipper receive a benefit or intend to give a pecuniary gift to tippee.
(ii) Does the person who received the tip (tippee) know or should have known that the information
was received improperly (through breach of a fiduciary duty).
(c) When is there liability
(i) No liability if the tipper gets no direct or indirect benefit.
1. Backstratching would be liable because no such thing as a free gift.
2. Charities not insulated.
3. Could argue that Secrist had a psychological gain by exposing the fraud, but court does not
(d) What is the court doing by adding the benefit test
(i) Distinguishes between a whistle blower and inside traders.
(ii) Protects securities analysts (p497Case)
1. Market pricing is substantially benefited by analyst initiative to investigate corporations. Will
help market get to the correct price. (Efficient Markets)
2. Bad because only protects those with access to analysts.
(iii) Modern Rule: p501Case, as of 2000 SEC promulgated regulation FD, that security analysts
could not use insider information.
1. SEC overruled the SC through rule making authority.
2. Corporate officers can no longer able to disclose information to stock analysts.
a. Otherwise must let everyone know.
3. Could be that SEC changed rule because of technology because now don’t need stock
analysts to disseminate data.
(e) Why did SEC bring charges against Dirk?
(i) Could say ungrateful because he uncovered the fraud, but the idea was to have everyone on the
same playing field. (Really just wanted to beat chest, embarrassed)
1. Clients got a benefit that the average investor didn’t have. Although he tried to disseminate
the information to the press.
2. Agencies were pushing the envelope on what insider trading is, Chiarella was at the same
(f) Hypo1:Insider spreads info that is true just to hurt the corporation.
(i) Court says that vindication is not a benefit
(ii) Could argue that gets the benefit of revenge, if friendship is a benefit then revenge should be too.
(g) Hypo2: You are representing someone who gets a tip from an insider and trades on it. Advise.
(i) Would want to find the original source of tip and figure out if there is an original breach of duty
by the tipper.
(ii) Next look at the tippee’s state of mind and determine whether should have known that a breach
(iii) If it was you then don’t want to know where source came from. Plausible deniability.
1. That is the push or pull because don’t know how reliable the info is, but if do know then
could be insider trading.
(h) Questions p500
(i) (2a) What if Dirks and Secrist routinely exchanged stock tips?
1. Quid pro quo and could be benefit of back scratching.
(ii) (2b) Can revenge be a benefit?
1. Court says no, but might feel differently if litigated
(iii) (2c) What if Dirks merely overheard Secrist in a public elevator?
1. No liability, not enough because he did not benefit from the disclosure. Assume Secrist just
2. Breach of duty not enough must be breach of loyalty, can’t be negligence. ???
(iv) (3.) Dirks bribes Secrist for information and is guilty but what about his clients?
1. Yes, depends on facts. If something that only an insider would know like FDA denied drug.
2. Helps the case a lot if you are just joe investor and not a sophisticated investor.
(5) US v. O’Hagan – (Federal law) Not a sympathetic defendant as was the case in Chiarella and Dirks.
O’Hagen was a lawyer for Grand Met which was seeking to acquire Pillsbury. He bought up Pillsbury
which hurts Grand Met even a little bit because the share price of Pillsbury goes up. O’Hagen is a
constructive insider.
(a) RULE: Misappropriation Theory - basis for liability when a person in possession of inside
information breaches a fiduciary duty to someone else. (when confidential information is
misappropriated for securities trading purposes, in breach of duty owed to the source of information.)
(i) So here O’Hagen has a duty to his law firm which runs to their client Grand Met. He breached
that fiduciary duty when trading the target company and so is liable for insider trading.
(ii) Ginsberg gets around the narrow duty requirement.
1. p504Case Disclose or disclose and approve?
a. Just disclose, O’Hagen must tell all sources that will be trading on insider information to
avoid liability under misappropriation. This includes the law firm and the client GM.
However he does not need to get their permission.
b. (*Note: If sources don’t approve will probably get an injunction in state court.)
c. Today it is illegal for a law firm to grant permission to trade on insider information. ???
(iii) Public Policy for using misappropriation theory
1. SEC wants to protect the appearance of integrity of the market. Congressional purpose of the
Exchange Act is really to protect the public’s view of integrity of the markets. Ensuring the
confidence of the public.
2. Supreme Court has made comments suggesting that not every act of trading with non-public
material information is insider trading. (Not everyone)
(b) RULE2: 14e-3 p506Case: inspired by Chiarella the SEC passed this rule to prevent insider trading
related to tender offers.
(i) Elements
1. Prohibits trading on nonpublic material information related to a tender offer.
2. No requirement to breach a fiduciary duty.
(ii) Public Policy
1. Only relates to tender offers, not mergers so narrow, but powerful tool.
2. Promulgated for tender offer because it is so volatile and so much potential for abuse that
there is a special need for investor protection in this area.
3. Fiduciary limitation was judge made, so SEC should be able to get rid of it, however all other
insider trading laws have the breach of fiduciary duty requirement.
4. (Misappropriation and 14e-3 are massive expansions of both civil and criminal law for insider
trading) (Might be unethical but should not be illegal)
5. Fixes state law loopholes in a uniform and comprehensive way, however would probably be
illegal under state law anyway.
HYPO: You are a psychologist treating a executive of a big company. She discloses insider
information as part of treatment. (Assume duty for psycho). Has he violated 10b-5 if trades.
(i) Not liable under classic insider trading model because he is a constructive insider, not an officer
or director of the company.
(ii) He is not a tippee under Dirks because patient is not giving the information as a gift so really not
a benefit
(iii) Under misappropriation he is liable because breached a duty of confidentiality.
(iv) 14e-3 only relevant if a tender offer.
HYPO 2: patient in waiting room and hears all the information. Violation of 10b-5?
(i) No because no fiduciary duty here. (Assume not tender offer)
HYPO 3: Priest gets info from parishioner during confession. Then goes to broker.
(i) Breached duty under misappropriation. Even if priest told parishioner it is no good because must
tell all the sources of information.
(ii) If P1 tells P2 and he trades on it, P2 not liable unless P2 knew that P1 violating a fiduciary duty
of confidentiality. (Second part of misappropriation test and is conjunctive.) However, P1 would
be liable under misappropriation. Helping the Catholic Church is a benefit especially if money is
shared by parish.
HYPO 4:CEO on plane accidentally leaves important documents in seat saying confidential merger
and another passenger sees and calls his broker.
(i) Passenger has no liability because no duty to another air line passenger, however if left
intentionally could be a subtle way to leave a gift. No duty of loyalty even broken so no
Hypo Wrap-up
(i) If eavesdropping then might be ok if no fiduciary duty broken and no benefit to the tipper. But if
told by someone then a much greater chance of insider trading liability.
(ii) Supreme Court defines benefit broadly – even mistress a benefit.
(iii) Timing of Materiality – for affirmative misrepresentation, it is when the information is
disseminated, but for insider trading it is determined when the trade is made.
p508Case Chestman
(i) Three Rules adopted by SEC in 2000
(ii) No fiduciary duty between family unless told before the fact to keep it confidential, or if had a
preexisting fiduciary duty by previous discussions about that material
Acquisition of Control
i) Background Info.
(1) Three methods for acquisition of control
(a) Proxy fights – probably least used today.
(b) Mergers
(c) Hostile Takeover by tender offer
ii) Acquisition Techniques
(1) Negotiated (“friendly”)
(a) Merger
(i) Approval of both boards of directors and both shareholders
(b) Sale of Assets
(i) Both companies boards are involved in purchasing and selling of company.
(2) Hostile
(a) Proxy Fight
(i) Inefficient and risky, like a political campaign where trying to push out the incumbents.
(b) Tender Offer
(i) Doesn’t have to be hostile, but basically can bypass the board of directors and go straight for
iii) Proxy fights and proxy rules
(1) Background of Proxy Fights
(a) General Materiality for proxy fights
(i) Whether reasonable shareholder would find the information important in deciding vote.
(b) Proxy law hybrid of state and federal regulations
(i) 14a-9: False and Misleading proxies
1. Prohibits the solicitation of proxies by false and misleading statements in regard to material
facts in connection with proxies.
a. Materiality - Whether reasonable shareholder would find the information important in
deciding vote. (Basic – substantial likelihood that shareholder thinks it is important.)
2. Provides Triumvirate of actions including a private right of action like 10b-5 but only applies
to public companies unlike 10b-5.
(2) Director election proxy fights
(a) Del 144(a): Business and affairs of a corporation is managed by the board of directors. (Senior
management really runs the corporations day to day operations, outside directors and directors in
general not good for day to day stuff.)
(i) Board of Directors appoints managers
(ii) Shareholders have the right to nominate people that will have statutory control of the corporation.
(b) What does the average ballad look like
(i) Soviet style elections, vote for the one candidate or don’t vote.
1. Would not be acceptable in a political democracy, but for corporations its way it is.
(c) How to get on a slate to run against other directors
(i) Send out nominating materials for alternative candidates on behalf of the corporation.
1. Incumbents get reimbursed for costs
2. Insurgents do not get reimbursed unless they win and shareholders ratify there expenses.
(ii) Big risk because proxy wars are rarely successful and usually have a substantial cost
(d) SEC letter
(i) Business roundtable lobbied against it and it is now dead.
1. Having someone on board solely interested in shareholder interest is bad.
(ii) Allowed for shareholders with 5% aggregate to put alternate choice for directors
1. Cannot be used for corporate takeover.
(iii) Triggered by
1. 35% of shareholders refuse to vote in favor of management candidate or
2. Shareholder resolution requesting access to the corporate ballad gets more than 50% of vote.
(iv) Human resistance of incumbents not wanting to relinquish control.
(e) Cases
(i) Levin v. MGM – Battle between two factions that want to run MGM differently, Levin wants
control and brings derivative suit of waste against incumbent directors’ use of corporate assets to
solicit proxies. Court finds in favor of incumbents.
1. Public Policy – Court glosses over any conflict of interest to prevent insurgents from ousting
good incumbents, otherwise a wealthy insurgent could oust a good incumbent.
a. This is about shareholder democracy where want maximum communication to
stockholders even if corporate assets must be used.
b. This could however become a vehicle for incumbents to entrench themselves.
c. It would also be expensive to fund every insurgent candidate because could be anyone.
2. Problem p543Case: You launch a proxy war against an incumbent director for a business
decision to expand comics.
a. Will probably not win the suit as long as the incumbents dress it up as a communication
to shareholders.
b. If majority of stock of public relations firm is held by brother then classic interested
director transaction.
i. Under Del. not automatically voidable, but will look at it.
ii. If no ratification by an uninterested board of directors or shareholders then must
prove fairness.
c. If personal friend all directors is illustrator of new comics
i. No conflict of interest because must be a personal or familial benefit, not a friend
benefit. (Note that this is different from benefit context of tippee and even in SLC
context for Oracle case).
(ii) Rosenfeld v. Fairchild Engine & Airplane Corp. – New York case where shareholder derivative
suit to return $250,000 corporate funds in a proxy war by both sides. Directors kept the
1. Rules
a. One – The corporation may only reimburse either party if the dispute concerns questions
of policy as opposed to purely a personal power contest.
i. Dissent – argues that this is an easy hurdle.
b. Two – Corporation may only reimburse reasonable and proper expenses.
i. Can still have entertainment costs.
c. Third – The corporation may reimburse incumbents whether they win or lose.
i. New board may reimburse the outgoing board.
ii. If incumbent board then will probably be reimbursed.
d. Fourth – Can reimburse insurgents only if they win and shareholders ratify the payment.
2. Problem p549Case: Proxy fight between CEO of Inquirer (33%) and Geddes (10%). Who
gets reimburst.
a. If CEO throws lavish party at home for shareholders?
i. Lavish implies improper, however rule is reasonable and entertainment costs are ok.
Probably couldn’t fly around world with corporate jet. (Question is whether this
contest over power or policy, most cases it is both)
b. If Geddes wins and threw a much more reasonable event
i. No reimbursement unless shareholders vote on it after he wins the election.
Shareholder Resolutions
(a) 14a-8: Shareholder Resolutions p566Case
(i) In question answer form to compel public to understand without lawyers. Allows shareholders to
present shareholder proposals
(ii) 14a-8[i](5) – Exception that allows the corporation to not publish the shareholder resolution if
proposal relates to less than 5% of total assets and less than 5% of net earnings and gross sales,
and is not otherwise significantly related to the issuer’s business.
(iii) 14a-8[i](7) Ordinary Business Operations– Exception to 14a-8 that says a corporation may
exclude a shareholder proposal in a proxy statement if it is related to the day to day operations of
the corporation, however if it relates to a strategic policy or something that will significantly
affect the corporation it must be included.
(iv) 14a-8[i](6) Absence of power– Exception to 14a-8 that says if a proposal is beyond the power to
effectuate a corporation may exclude a shareholder resolution.
(v) 14a-8[i](8) can exclude if related to an election to the board of directors.
(vi) 14a-8[i](11-12) deals with duplications and resubmissions.
1. Duplication: Can exclude a shareholder resolution that is the same as another one.
2. Resubmissions: Can exclude it if no support within the last 5 calendar years.
(i) Procedurally the board will only have the study done if 50% of stockholders approve it.
(ii) Shareholder resolutions should be phrased as recommendations to the board, never directives
because it would go against the BJR.
Policy reasons behind Shareholder resolutions
(i) Relatively cheap way to get issues to directors and shareholders. (Not very burdensome compared
to a proxy fight)
1. Practically speaking shareholder resolutions never pass.
a. Rationale is that of an apathetic shareholder who realizes can’t influence and so will not
bother. Average shareholder will not even vote.
2. Only reason shareholders can make such proposals is because of SEC.
(ii) Why corporations even bother to litigate against them if never passed?
1. Ego of the board of directors, don’t tell me what to do.
(iii) Prof suspects that most companies pass policy considerations, not because of shareholder
resolutions but because of Corporate social responsibility.
1. Think of petroleum companies marketing themselves as environmentalists. Cooping sixties
social protests to be a marketing tool today.
Problems p578 – Firm X makes three models of cars, two models are four door sedans, and third
model is the X- testostero which sells for $180,000 and loses money. A shareholder proposal to put in
bylaws that want only four door sedans. You are corporate counsel.
(i) A. Company shall discontinue sports car.
1. Improper because it is part of ordinary business operations and can be excluded.
a. Could be related to long term strategy like in Dole. Then must put in.
b. Also not appropriate because makes demand on how to run corporation, which
shareholders have no right to do, that is up to board of directors.
i. However this only buy time as Corp. must allow SH to amend.
(ii) B. Shareholders recommend discontinuing the sports car.
1. Not clear how much of corporate assets it takes up so may not be 5%.
2. Also may have the same ordinary business problem as before
3. Must try to make some kind of social or ethical argument like Lovenheim.
(iii) C. Amend by-laws to only allow production of sedans.
1. Anything having to do with by laws is significant
2. More problematic then B and depending on state law and certificate of incorporation may not
be able to change the by laws. Also can’t make do anything illegal.
a. 14a-8[i](1) - May not be proper under state law for shareholders to address subject.
Hypo – You are trying to elect another slate of directors, could you do so under 14-8a as a
shareholder resolution, not like a slate of candidates for normal elections.
(i) No, 14a-8[i](8) says can exclude if related to an election to the board of directors.
(ii) If you want to run your own slate of directors you must wage a proxy war where get the
shareholder list or have corp mail out the proxy statements on your behalf. (Need the shareholder
list to get the large shareholders to vote your way, not trivial matter)
(f) Cases
(i) Lovenheim v. Iroquois Brands, Ltd. P566 – Patte case with Geese.
1. Rule: Significantly related as defined in the 14a-8[i](5) exception is not limited to economic
a. Public interest injunctions ok because could be ethically and socially significantly related
to corporation’s business.
i. Company image could be damaged if don’t find out and stop it.
2. Why would corporation fight ethical proxy statements?
a. Corporation should be free of harassment
b. Could create a public relations problem that never existed
c. Prevents proxy statements from being cluttered.
3. Would be considered bad form for shareholder resolution to challenge BJR, just says form a
committee then leave ultimate decision to board.
(ii) The NYC Employees Retirement system v. Dole Food Co. p570 – Case where wanted the Dole
board of directors to do a study on the pros and cons of a national health care system.
1. 14a-8[i](7) Ordinary Business Operations– Exception to 14a-8 that says a corporation may
exclude a shareholder proposal in a proxy statement if it is related to the day to day
operations of the corporation, however if it relates to a strategic policy or something that will
significantly affect the corporation it must be included.
a. Here not acting as union members but as large shareholders.
2. 5% of shareholders ratified which is a small win considering shareholders never even read
proxy statements.
3. Also tried to argue that making a national health care system was beyond power to effectuate,
but shareholders just wanted a study done on it.
(iii) Austin . Consoldiated Edison Company of New York, Inc. – Here trying to get the corporation to
look at a pension plan. However this is better done by unions as a bargaining unit.
1. Rule: Burden of proof for excluding a shareholder proposal under 14a-8[i](7) is on the
corporation to show that it relates to ordinary business operations.
Shareholder Inspection Rights
(a) Exceptions to Internal Affairs Doctrine
(i) Determining when a shareholder must post a bond in a derivative suit. (Forum state decides)
(ii) When a shareholder is seeking a shareholder list. (Can use the state of residence of the
shareholder, or if corporation can use the law in the state where do majority of business)
(b) NY § 1315 - must be a purpose related to corporations business. (Construe liberally)
(c) Del § 220 – may get list for a proper purpose reasonably related to a person’s interest as a
stockholder. (Primary purpose must be economic but can have other purposes)
(i) Burden of Proof – must have proper purpose, if for shareholder list corporation bears the burden
of proof, if for corporate books and other records, stockholder has the burden.
1. Burdensome for corporation to compile all kinds of records, but shareholder list probably
readily available.
2. Makes more difficult for books, because competitors would buy stock and inspect books.
(Protection of proprietary information)
(d) Policy
(i) Similar to the shareholder resolution context, but here instead of court promoting communication
between stockholders the opposite. So why the discrepancy.
(e) Problems p590-591 Shareholder proposal to split stock to 10 for $100 instead of 1 for $1000.
(Assume NY Law)
(i) 1. Company X requests a shareholder list after the purchase of a few shares.
1. Under NY law threshold test is must have stock for 6 months or 5% of outstanding shares. So
will probably not even make the threshold test.
2. If for tender offer, Crane tells us that it is good purpose to get shareholder list. However must
look to lang. Here might just be a ploy to get the stockholders list and peddle cars to boost
sales. Since selling for $150,000 instead of $180,000 probably just a discount but could be
looked upon as a possible tender offer (weak argument though). Not proper purpose if just
trying to sell cars.
(ii) 2. If a shareholder wants the list to see if other shareholders want to join in demanding that the
company effect a stock split.
1. This is a proper purpose.
(iii) 3. Investment banking stockholder wants to offer services to other shareholders and split stock so
can diversify.
1. No, this is an upscale junk mail scenario and should not be a proper purpose for getting list.
2. Wants to offer advice to shareholders which is unrelated to the company.
(iv) 3b. Company then has tender offer of other stock for same value of target corp stock.
1. Could go either way depends if they are sincere tender offer or just trying to market the banks
diversification services.
(v) 4. Ask for records of employment practices of corporation’s supplier. Ask because think might
be discriminatory practice by supplier.
1. Depends on how frame the question, If can make a case for a financial impact then ok.
2. Depends on how far they are willing to go with the purpose.
3. Burden shifts because other records.
(f) Cases
(i) Crane v. Anaconda Co. – NY case where shareholder wants to get the shareholder list to inform
fellow shareholders of tender offer. Ok.
1. Rule: NY BA law 1315, must be a purpose related to business and is interpreted very
(ii) State ex rel. Pillsbury v. Honeywell, Inc. – Del case where guy wants to get the shareholder list
for the sole purpose to protest Vietnam and corporations involvement in making napalm. Not ok.
1. Burden of Proof – must have proper purpose, if for shareholder list corporation bears the
burden of proof, if for corporate books and other records, stockholder has the burden.
2. Here the court said that Vietnam has nothing to do with his return on investment.
a. He only bought the shares to influence policy.
b. Could have argued economically that practices were hurting the company. (Dow’s
argument for long term strategic plan) Anything would have been better then saying just
for political beliefs.
(iii) Sadler v. NCR corporation – NY case where AT&T gets a resident shareholder of NY to bring
suit. At&T wants the shareholder list so can wage a proxy war. Ok.
1. Rule: Corporation has the burden to show bad faith or improper purpose.
2. Able to get the shareholder list even where would be prohibited under the foreign
corporations state of incorporation.
Mergers and Acquisitions
(1) General
(a) Merger - statutory form of combinations that varies from state to state
(i) Usually two corporations combine to form a single entity
(ii) Must file articles of merger with the appropriate state authority.
(iii) Only one corporation will survive but will get all the rights and obligations of the two previous
(2) Del Model – four steps that are substantially the same as NY law.
(a) Four Steps for a Del merger
(i) Draft a Merger agreement, which contains the terms and conditions of the deal.
(ii) Get the Merger agreement approved by a majority of both boards of directors
(iii) Then must get the Merger agreement approved by a majority of shareholders from both
1. Unlike most corporate actions where need a majority of those shareholders that vote. (Proxies
2. Here need a majority of outstanding shares has to vote for it.
(iv) Must file articles of merger with the secretary of state
(b) Sale of Assets
(i) A purchasing corporation need not have the transaction approved by shareholders. (Del. Model)
(ii) A selling corporation needs to have a majority of outstanding shares vote for transaction.
(iii) Mergers get appraisal rights while Sales of Assets do not.
(c) Del § 262(b)(1) – Rights of appraisal for Del. is not available in merger when:
(i) Public company
1. No need for appraisal rights because if public then have a ready market to get rid of the stock.
(ii) Held by more than 2,000 stockholders and shares have similar characteristics.
(iii) However if it is a closely held corporation then must follow the statutory formalities to get right
of appraisal.
1. Must have voted against the merger and give notice that seeking right of appraisal.
2. Then would get the fair market value of the shares.
(3) De facto Merger Doctrine
(a) Recognized by NJ
(b) Del legislator tried to overrule the tough love approach of the court but courts did not want to go the
equitable route. (Just a little wiggle room here otherwise must conform to the intent of congress.)
(c) Merger automatically receives the liability of other corporation, however sometimes structured as a
sale of assets to avoid liability of purchased corporation.
(4) Cases
(a) Farris v.Glen Alden Corporation – Penn. case where the minnow swallowed the whale. Key issue is
what is more important form or substance. Firm was trying to achieve a de facto merger where there
would be a combination of the two firms without giving the dissenting shareholders of GA appraisal
(i) Penn Rule – must look past the form to the substance of the transaction which is a de facto
merger, thus Penn shareholders are entitled to a right of appraisal.
1. Minnow swallows the whale because in Del would not have appraisal rights for a sale of
2. Economic analysis of the court was off
a. GA was better off with shares of the combined company.
b. Happens that both shareholders voted on it. List because seller must vote and GA to issue
the stock.
(ii) Policy reasons for giving a right of appraisal
1. Lots of room for abuse of minority dissenters especially by crafty corporate lawyers. Why
should they be allowed to circumvent the statutory law.
(iii) Policy reasons against giving a right of appraisal
1. Don’t want to have to pay cash for the shares
2. Creates uncertainty because who knows what the court will set fair market value at
3. Might kill the merger agreement if have to give right to appraisal.
GA (Penn Corp)
List(Del Corp)
Appraisal Rights
Appraisal Rights
Sale of Assets
Appraisal Rights
No Appraisal Rights
(b) Hariton v. Arco Electronics, Inc. – stockholder wanted an injunction against the de facto merger, but
the court held to a tough love approach. Here both companies shareholders approved the transaction.
(i) Del Rule – tough love approach where do not care about substance, just form.
1. Law and Economics View
a. Del is the most pro contract, freedom of contract, law and economics place in the
b. Freedom of choice will be respected by courts and minorities will not be protected by
paternalistic court.
c. Attempt to empower transactional lawyers to weasel out of law by exploiting weaknesses
in the statutes.
d. All sorts of nonjudicial protections for minority stockholders already.
Freeze-out mergers
(a) Freeze-out Merger – When a controlling shareholder (50% or more in close corp or 20% or more in
public corp) buys out the minority shareholders even if the minority objects. Once a majority
shareholder then they can do whatever they want with the corporation. Minority shareholders cannot
refuse to be cashed out.
(i) Really the same thing as a cash out merger.
1. If cash out price is below market value then it is per se unfair.
2. Minority stockholder has no choice in matter unless a supermajority provision in the
certificate of incorporation.
(b) Weinberger v. UOP, Inc. – Here Signal owned more than 50% of UOP and had a lot of cash so
wanted to completely buyout the rest of the company in a two tiered cash out merger. But here way to
much self dealing by controlling shareholders.
(i) Rule: If majority wants to cash out the minority shareholders it is fine and do not need any
purpose, however must treat minority shareholders fairly.
(ii) Extension of Sinclair Oil Corp. v. Leiven only here applied to the freeze-out merger context.
1. Recap of Sinclair – dividends fell under the BJR but the failure of Sinclair to enforce
agreement when have a 97% subsidiary doing business with a 100% subsidiary had to pass
the intrinsic fairness/entire fairness doctrine.
2. Burden of proving fairness fell on controlling shareholder. Unless like in the Flieger v.
Lawrence and In re WTI shareholders Litigation ratification of the deal will shift the burden
of showing unfair to minority shareholder.
(iii) What Signal did wrong
1. Make sure controlling shareholder has nothing to do with the transaction (completely
isolated) (Affects the litigation posture, which is usually determinativc)
a. CEO of UOP was formally a CEO of a 100% owned subsidiary of Signal.
i. Crawford fails to negotiate and just takes Signal’s offer.
b. Two interlocking UOP/Signal board members (elected by Signal) did a study on the
cashout merger for benefit of Signal and never shared with other UOP directors.
i. Should have never allowed interlocking directors to work on transaction, want all
outside directors.
2. Rushed Timing of 4 days was given for UOP to consider the proposal
3. Disclosure not enough and must have completely independent members (Should get the most
neutral and reputable investment banking firm available)
a. The so called fairness report was most damning as was brought to Signal with a blank
b. Signal/UOP directors did not vote but made there presence known, really don’t want
them to influence any part of the transaction.
(iv) If appointed an independent counsel of independent directors p733Case
1. Court would still apply the fairness standard however the burden would be shifted to the
minority stockholder to prove unfairness.
2. Same rules that applies for the ratification of shareholder votes.
(v) Policy reasons why court applies fairness test
1. Such a potential for abuse of the minority shareholder interests that need a better form of
(vi) Policy reasons why a parent would want 100% instead of just 51% majority
1. Makes life a lot easier legally.
Fairness Standard
1. Fair dealing
a. No negotiations
b. No disclosure of report and conflict of interest
2. Fair price
a. Court addresses fair price because of draconian method used by trial court.
b. Fair price includes all relevant factors including the value of the company.
c. Should use the best valuation method available at the time and commonly used by
investment bankers.
i. Each side will submit a valuation technique and court decides which one is more fair.
Will not mix the methods. This is a much more flexible approach then what was used
in the past.
Fairness Test
Fair Dealing
Duty of Candor
Fair Price
Duty to negotiate
aggressively for
minority shareholder
Utilizing modern
techniques and
including all relevant
(1) General
(a) Like Proxies Takeovers are governed by a mix of federal and state law.
(b) Tender Offers – public offer to shareholders of a target corporation where the prospective acquirer
offers to buy shares a specified price on specific terms.
(c) Williams Act – Federal Act that consists of some amendments to sec 13 and 14 of the Exchange Act.
The Act attempts to regulate tender offers and make sure that they are done fairly both to shareholders
and to the corporation.
(i) Anyone who either alone or in group acquirers 5% of a company’s stock identify itself with the
SEC within 10 days, but in mean time can continue to purchase stock. (Prevents creeping tender
offers like in Cheff case)
(ii) Anyone can make a tender offer but there are public disclosure filings to SEC involved and it is
fairly expensive.
(iii) Any acquirer that raises the price of the tender offer must apply the new price for any shares
already tendered.
(iv) Any acquirer must hold the tender offer open for at least 20 business days.
1. Anyone who tenders may withdraw the acceptance within the first 15 days. (stock goes into
escrow account)
(v) Tender offer applies on a pro rata basis.
(d) Two Step Acquisition
(i) Would be a tender offer for first step to acquire a controlling share, then in second step it is a
cash out merger. (Not really a two tiered tender offer) Used to acquire 100% of the company.
1. If cash out price is below market value then it is per se unfair.
(2) Del § 160: gives a corporation the power to sell and purchase shares of its own stock.
(3) Poison Pills p784Case
(4) Cases1
(a) Weinberger v. UOP, Inc. – Here a two step acquisition was used but it was not coercive because it
was delayed and was for the same price.
(b) Cheff v. Mathes (1964) – Del case where target company Holland was actually big time fraudsters
that sold furnaces door to door posing as govt. inspectors. This was a derivative suit for breach of
loyalty, but really more like a waste case??? because corp bought back own shares at a premium.
Court found actions ok.
(i) Rule: Since an inherent conflict of interest in a takeover context BJR will not apply right away.
(Two part test that is very pro-management)
1. Did the director defendants have a “good faith” belief that there was a danger to the
corporate policy and effectiveness.
a. Here unlike BJR directors have the burden to prove good faith. However unless BOD are
stupid and say that in personal interest then will pass, similar to the proxy solicitation
2. Did the directors conduct a reasonable investigation.
3. If both of previous tests are passed then the BJR applies
(ii) Policy arguments of decision
1. If court really knew of massive fraud would have found differently. Standard is adequate
however the judges just got the first part wrong. Maramount was really the white knight here
and shareholders wound up with nothing.
(iii) Greenmail – similar to blackmail where threaten to takeover the company just so the company
will buy back the stock from you for a premium price to thwart the takeover.
1. Here Maramount made $600,000 in six months.
2. Another motive here was that they did not want Maramount in there books to expose there
fraud. (conflict of interest here)
3. Corporation justifies its actions by protecting employees and preventing liquidation.
(iv) No Modern Greenmail - Now the IRS puts so many taxes on profits from Greenmail that no one
would use it.
1. Policy considerations against Greenmail
a. Does nothing to defeat a subsequent purchaser to do the same thing. Could take on so
much debt that no one wants it anymore but this is like shooting oneself in the foot.
2. Policy considerations for Greenmail
a. Encourages an auction type atmosphere for shareholders. (Law and economics people)
(c) Unocal Corporation v. Mesa Petroleum (1985) – Del case where oil company’s assets was worth
more than the actual stock price. So Mesa tried to buy it and Unocal made a poison pill to stop the
transaction. Unocal would give a really high self tender for remaining shares if Mesa gets a certain
percentage and Mesa would not be able to tender. Court held for Unocal. (Poison pill case)
(i) Rule: Three part test
1. Did the director defendants have a “good faith” belief that there was a danger to the
corporate policy and effectiveness. (Good faith)
a. Here unlike BJR directors have the burden to prove good faith. However unless BOD are
stupid and say that in personal interest then will pass, similar to the proxy solicitation
context. (Can compare the real BJR to having a prima facie case made out, better then
just a presumption)
2. Did the BOD conduct a reasonable investigation. (Procedure where informed)
3. Were the defensive actions taken reasonable in relation to the threat/circumstances.
(Balancing test)
a. Severity of the Action - Normally would not be able to discriminate against certain
shareholders, but here Mesa is left out of the self tender because they are abusing the
minority, also because Unocal does not have to subsidize Mesa’s takeover.
b. BOD can take into account p781Case
i. Inadequacy of the price
ii. Nature and timing of offer
iii. Questions of illegality
iv. The impact on constituencies other than shareholders. (creditors, customers,
employees, perhaps community in general)
4. If three previous tests are passed then the BJR applies
(ii) Two step Acquisition - Mesa took a two tiered approach where it wanted to get control of the
corporation then force a cash out merger of the rest for junk bonds. Highly coercive in nature.
1. Wants the deal to be coercive and the second part risky to induce a large tendering of shares.
2. Goal is to make a disincentive for the seconds group.
(iii) Junk Bond – debt securities that are highly subordinated, like a second or third mortgages.
(iv) Here there was NO DUTY OF CARE violation similar to Van Gorkem, even though it is a slap
on the face to management that the corporation is worth more dead then alive with the good will
of the company.
1. No problem here because they are informed and use independent directors.
(v) Note: a discriminatory self tender is not be legal under Williams act, but now have more effective
poison pills.
(1) Tying it all together
(a) Unocal, Van Gorkem and Revlon all in 1985. Revlon was the first of the high stakes takeovers, but
left us with as many questions as it answered.
(b) Note: in many takeovers animosity between the target company board and the acquiring board can
make the deal very sour.
(2) Types of Defensive tactics and Poison pills
(a) Greenmail (Cheff)
(b) Discriminatory self tender (Unocal)
(c) Outstanding stock repurchase by corporation. (Revlon)
(i) Sopps up the shareholders that would have immediately tendered and gets rid of them.
(ii) Also gets rid of excess cash to make the company look less desirable.
(d) Shareholder Rights Plan (Revlon)
(i) Gives company extra debt and can be prohibitive on the potential acquirer.
(ii) Could be a showstopper if no provision that could render it moote.
(3) Policy Considerations for allowing defensive tactics
(a) If directors can show that had a strategic long term plan for the corporate enterprise then ok.
(b) Whether it is paternalistic for directors to decide for shareholders best interest
(i) Short term lucrative deal
(ii) Long term plan to make stock worth more in long run
1. Might be speculative for directors to say long term price will rise and could lose an
opportunity for a control premium.
(c) Democratic legislatures have enacted Other Constituency Statutes
(i) These explicitly allow BOD to take into account other constituencies in defense of a hostile
tender offer.
1. Agrees with the Del courts even though Del doesn’t have one of these statutes.
(4) Deal protection devices – Most provisions are not per se invalid, if they are a deterrent then its ok,
however if it is preclusive in aggregate then not ok. If defensive measures are too draconian given the
circumstances then the court will strike down.
(a) No Shop Provision
(i) Could be good for auction if only for a limited amount of time and used to lock up a good price.
(b) No Talk Provision
(i) P2, Del hostile to not talk provisions because fiduciary duties can not be fulfilled if BOD can only
(ii) Almost preclusive to bidders, bidders need to get information from the company to realistically
give an offer.
(c) Termination Fee
(i) Used to stack the deck in favor of a merger with a certain company.
(ii) However could be justified as expenses for the bidders fees, not the bidders fault that it gave the
low bid.
(d) Lock-up provision
(5) Hypo: “What to take from Unocal and Revlon” – a takeover bid for above market price.
(a) Absent narrow circumstances of Revlon, BOD can take into account many things for defensive
tactics. (ex – employee health benefit plan, other constituencies than shareholders.)
(6) Big Time Takeover Cases2
(a) Revlon v. MacAndrews & Forbes Holdings, Inc. – Pure sale of company probably worth $53, if bust
up probably worth $60-$70. Revlon CEO uses this fact to justify defensive measures. Court gives
injunction against Revlon contracts with the whiteknight.
(i) Rule1: Primary duty of loyalty to shareholders, not creditors (note holders)
(ii) Rule2: Once bust-up of the company becomes inevitable then the director’s role changes from
defender’s of the corporate bastion to auctioneers charged with getting the best price for
stockholders at a sale of the company. (Maximizing short term profits)
(iii) Rule3: Although lockup, termination fees, no shop provisions are not per se invalid, when all put
together they are not good for shareholders.
(iv) Initially court says ok to take defensive actions through buy back of old shares and makes a note
purchase rights plan where each trade of common stock would get a right to one Revlon note.
Right can be accessed if someone gets 20% of company. If not triggered then worthless.
1. Not a show stopper poison pill because the right can be revoked
2. Shareholders would hold out in hopes another 20% would tender so could reap higher note
(v) However when BOD of Revlon knows break up inevitable and just goes for the whiteknight
regardless of other prices it is a breach of duty.
1. Whiteknight got lockup provision of the crown jewel of Revlon and termination fee.
(vi) Golden Parachutes – severance packages for the BOD designed to make BOD less likely to try to
entrench themselves and more about shareholder needs.
1. Ironic because in this case golden parachute was prejudicing them to choose the whiteknight
so they could continue to run company instead of being unbiased to buyers.
Lockup provision for Crown Jewel – best divisions of the company.
(b) Paramount Communicaitons Inc. v. Time incorporated (Paramount 1) – Time/Warner merger where
Time had long term strategy and so no Revlon duties, however bypassed a great tender offer where no
shareholders had a chance to vote on it. First was going to merge with Warner but then straight out
acquisition so not sale of assets or merger.
(i) Clarifies when Revlon duty:
1. When board wants to bust up the company.
2. In response to a bidders offer the corporation abandons their long term strategy. (Similar to
Revlon where hostile bidder came in and Revlon sought another buyer)
a. Improper to favor one bidder over another when breakup is inevitable (Revlon).
b. Time never abandoned their long term strategy. (Paramount 1)
3. Any superficial change of control does not trigger Revlon duties
a. Merger of Time with Warner, Warner stockholders got better deal, but Time was still had
managerial control.
b. Chancellor court finding (Good Law) - Also the shareholders of Time were originally all
minority shareholders and now it is still the case. Time was a public company with no
majority shareholder before and after the proposed merger. Everybody is minority
shareholder and is on equal footing.
(ii) Policy issues
1. Time passed a very high tender bid for long term strategy that failed. So should BOD have
the right to make such decisions for the shareholders.
a. The new Time/Warner (Time made out right acquisition of Warner) was not favorable to
Paramount anymore so Time shareholders lost the opportunity for the control premium.
Even though theoretically it is still possible.
(iii) Questions p806
1. What is the justification for allowing Time BOD to pass up a $200 tender offer w/o letting
shareholders decide?
a. Even though the shareholders might be savvy, it is really the BOD that runs the company.
Long term strategy falls under the BJR. Time case most deferential example to BOD, if
Time BOD did not have so much integrity then court might have gone the other way.
2. Did the Time shareholders lose a control premium?
a. Theoretically it is still possible to get a control premium because still owned by all
minorities and is in the public domain, however a much bigger company now so not as
desirable. Shareholders lose an opportunity although might not be only one for control
3. What is advice if in Revlon the company would stay in tact and getting a better price then
anticipated, how to proceed?
a. Could argue long term strategy like Paramount 1. However if a complete change in
control then hard to justify not listening to the new offer.
(c) Paramount v. QVC (Paramount 2) – Bunch of preclusive defensive measures with Viacom struck
down by the court.
(i) Restates Revlon Rule
1. Duty to maximize shareholder value is when sale of control occurs. (Note here shareholder
value maximized not just price)
a. Extension of Revlon to apply not just when inevitable that company is getting broken up
but when a change in control. However still narrow because only applies in merger where
lose opportunity for control premium.
b. Controlling share could be 20% in a public owned company.
2. This test is an enhanced scrutiny test burden of proving both elements is on the BOD
a. Board must evaluate all offers and inform itself in a reasonable way. (Procedure)
b. BOD actions must be reasonable in light of the circumstances. (Substance)
3. Unlike in Revlon which mandated an auction if bust up inevitable, here if Revlon duties arise
BOD can:
a. Have an auction
b. Canvass the market
c. No single blueprint for fulfilling duties.
4. Note: Three levels of review
a. BJR when no conflict of interest with director
b. Entire fairness when some personal conflict with a director
c. Enhanced scrutiny test even when all independent directors in a sale of control context
(ii) Distinguishing Paramount1
1. In P1 remained a minority owned company, here it goes from no controlling shareholder of a
public company to a public company with a controlling shareholder. In Time still no
majority shareholder so could still get a control premium. In P2 could not do that.
(iii) Policy
1. The court gets involved here instead of BJR because of danger to minority shareholder abuse.
(iv) Practical Advice if BOD gets very high cash offer
1. If really high then probably fine, but probably should canvas the market. Could be rushed
timing issues.
2. If a non cash component then must determine the adequacy of the offer (junk bonds, cash,
stock). Certainty of financing or regulatory problems with a merger.
(v) Questions p820
1. What result if the Viacom bid was for 49% of voting shares?
a. Still no good because 20% is considered a controlling share in a public company for
practical pruposes. If close corp then 51% would control.
b. If a No talk provision then won’t turn on change of control but Unocal test where
draconian defensive tactics get struck down.
2. If all P directors are independent then why enhanced scrutiny?
a. To protect and prevent abuse against minority shareholders.
b. Burden of proof is big deal and puts it on the BOD. Under BJR almost impossible for
shareholders to prevail. Here a lot better chances. Directors can be made immune from
breaches of duty of care.
3. A potential buyer with a good bid demands a no shop clause and termination fee?
a. Proceed very cautiously, these things are not considered suspect, BOD must still have
due diligence.
b. Rationale must be very well documented.
4. How does the ALI test stack up to Del law?
a. The ALI test says if reasonable then legitimate and budern of proof goes to shareholders.
b. Roughly follows Del law, depends on how interpret key phrases like essential economic
prospects and reasonable response.
(d) ACE Limited v. Capitol Re Corp. – No change of control here just a strategic alliance. Had a no shop
clause that made lawyers decide if fiduciary duty.
(i) Court says that it is an abdication of BOD duties and other people cannot determine what a
fiduciary duty is. Cannot let corporate lawyers decide this issue because almost per se violation
of Smith v. Van Gorkem.
(ii) RULE: Can’t contract away your fiduciary duties.
1. Court says that bidders cannot negotiate away the target boards fiduciary duties, fiduciary
duties trump contract duties. Shame on the bidder because they should have known they are
savvy business people that know when to draw the line with favorable terms.
2. Can’t have a friendly merger that abrogates the power of directors.
(iii) Policy
1. Attaching personal liability on target directors for making deals like this would make
directors overly cautious and this comes to full circle, (see policy arguments for duty of care.)
(e) Omnicare Case H/O – confirms the trend of chancellory court in ACE. Here so locked up that the
court did not even have to decide if actions were reasonable. Struck down provisions that locked up
voting shareholders on merger vote.
(i) RULE: Unless there is a fiduciary out, any lock up of a merger transaction will be held invalid
even if no Revlon duties. Apply enhanced scrutiny of Unocal to mergers.
1. Having a negotiated acquisition to locked up may constitute a breach of fiduciary duties of
the target BOD.
2. Extends the Unocal test to the context of negotiated acquisitions.
a. Target board must show that actions not preclusive (“a show stopper”) or coercive.
b. Also must show that actions are reasonable for particular threat.
3. Decision by Del supreme court split which is extremely rare.
Takeovers3 (State Anti Takeover Statutes)
(1) General
(a) All fifty states have some form of antitakeover statutes. All these statutes can be opted out.
(b) Three generations or waves of Anti takeover statutes.
(i) First Generation imposed waiting periods and fairness thresholds.
1. 20 day wait on tender offer and state official had to here case.
2. In Edgar v. MITE Illinois statute was struck down on the constitutional level because specific
regulation of tender offers interfered with the Williams Act and imposed on interstate
(ii) Second Generation amended state laws that governed the internal affairs of the corporation.
Changes corporate laws for corporations in state.
1. Control Share Act Statutes
2. Fair/Best Price Statutes
a. Any person looking to acquire must pay same best price to any shareholder. (Similar to
the Williams Act where if tender offer and up price must give to all even those already
tendered.) Extends the rule to the entire acquisition process.
b. Could be waived by BOD and shareholders in bylaws.
(iii) Third Generation, two models from 1990s
1. Moratorium statutes (Del, NY, NJ)– Prohibits the acquiring company from merging with
the acquired company for a specified period of time after the acquisition.
a. Makes it impossible to carry out a two tiered front loaded tender offer followed by a cash
out merger.
b. Also makes it impossible to use the target assets to finance the acquisition.
c. Encourages friendly acquisitions.
i. Exceptions if BOD waives it or bidder gets 85% of company.
2. Other Constituency Statutes (Stakeholder statutes) – BOD can take into account other
people then just the shareholders.
a. PENN – most well known and can take into account many things w/o the shareholders
being the primary concern.
b. Disgourgment Provisions – standard way to prevent a takeover ???
(iv) Side Note
1. Penn – tin parachute, where would have to give employees 1 week pay for each year working
there. Penn has the strongest anti takeover statutes and gives a lot of discretion to directors.
(2) Policy considerations
(a) Is it legitimate for legislators to allow other considerations then maximizing shareholder wealth?
(i) Pro: Purpose of CTS anti takeover legislation is to protect shareholders against two tiered front
loaded tender offers followed by cash out mergers.
1. Can achieve the same end with a Best Price statute, in a more straightforward way then
restricting voting rights.
2. Can help prevent someone from coming in and busting up a company.
(ii) Con: real purpose of this act is to protect incumbent management. That was the primary lobbyist
for the statutes.
1. In CTS only applies to Indiana corporations, could be another company in NY with Indiana
shareholders, so purpose is really to protect local management.
2. Union members and local communities may lobby for it too, but the management was the real
force behind the legislation.
3. Shareholders will not be able to get a control premium. (Shareholder value might not be
4. Those shares will be less attractive then corporations in other states.
(b) Should other people than shareholders be taken into consideration?
(i) Stakeholders
1. Creditors
2. Employees
3. Auditors
4. suppliers
5. Local Communities
6. Local govt
(ii) What is the role of the corporation (Property v. Entity Theory)
1. Is it to maximize wealth as property for shareholders, or is it an enterprise that
everyone can benefit from not just as property. (Prof Opinion.)
2. Property: Is the purpose of the corporation merely to maximize shareholder value.
3. Entity – corporation as an enterprise that makes money for all stakeholders not just
a. Who better then to protect those other people then the legislator.
b. Protects the tax base
c. Concern is that someone must lose, the market for corporate control doesn’t ensure
fairness so legislators must do so. Legislators are very antagonistic to hostile takeovers.
(c) Do management concerns match shareholder interests?
(i) Management operates more efficiently if don’t have to worry about takeovers, however the short
term interests of shareholders are not fulfilled by allowing management discretion.
(3) Cases
(a) CTS corporation v. Dynamics Corporation of America – This case is about an intersection of state
and federal law where the state law won the day. Took the position that states are the primary
regulators of corporations.
(i) Federalism
1. Rejects congresses power to prevent state regulation under the dormant commerce clause.
2. Rejects that the Williams Act preempts state law for takeovers.
(ii) Statute: If an acquirer reaches a certain threshold then does not get the right to vote unless a
majority of disinterested shareholders vote for it. (Management shares cannot vote so only non
acquirer and non management shares can vote) (Anyone with a interest in corporate control
cannot vote.)
1. If Shareholders vote to not give voting rights to acquirer
a. Corporation can redeem the acquirer shares at fair market value.
b. Can let the acquirer stew with stock minus voting rights.
i. Becomes only an investment and no power.
(iii) What was the purpose of the statute?
1. SC found the purpose to be protecting Indiana shareholders.
a. Prof. – doesn’t buy this argument
2. Posner
a. Weighs the benefit to Indiana shareholders v. burden on interstate commerce.
b. Finds that there is an international market for corporate control and states are neing
allowed to interfere with a federal concern.
3. SC rejects Posner’s argument because they are worried about a slippery slope that would
invalidate all of present state corporate law.
a. Will prevent states from allowing cumulative voting, staggering director elections, and
supermajority requirements for a merger.
b. May say that the whole law of corporations is invalid. (Prof – This is why the court went
for states rights)