CORPORATIONS

MYERS, FALL 2014

I. AGENCY Agency is a fiduciary relationship that arises when a principal manifests assent to an agent that
the agent will act on the principals behalf and subject to the principals control, and the agent manifests
assent or otherwise consents to so act. Requires: (1) Manifestation of Assent (Agreement), (2) Agent acts
on behalf, (3) Principal exercises control. [3RST1.01]
a. Agent: Person who acts on behalf of principal, and is subject to the principals control. [2RST1]
b. Principal: A person for whom the agent acts [2RST1], and has the right to control the conduct of
the agent with respect to matters entrusted to the agent.
c. Servant/Agents: Agents where the principal has control over the agents physical conduct.
1. Contract: Principal is liable for contracts entered into by servant agents.
2. Torts: Principal is liable for torts committed by agent.
d. Liability: Only master servant relationship triggers respondeat superior, not independent contractor.
1. Master: A master is a principal who employs an agent to perform service in his affairs and
who controls or has right to control physical conduct of other. [2RST2(1)]
2. Servant: Agent employed by master to perform service in affairs whose physical conduct in
the performance of service controlled/subject to control by the master. [2RST2(2)]
3. Independent Contractor: Person who Ks with other to do something but is not controlled by
the other nor subject to the others right to control with respect to the physical conduct in the
performance of the undertaking. He may or may not be an agent. [2RST2(3)]
e. Independent Contractors/Non-Servant Agents: Agent has physical control over own work.
1. Contract: Principal is liable for contracts entered into by non-servant agents.
2. Torts: Principal has no liability for torts committed by non-servant agents.
f. Legal Consequences of Principal-Agent Relationship: (i) All agents (servant and independent
contractors) create contractual liability for principal; (ii) All agents have fiduciary duties to the
principal [2RST13]; (iii) Principals have duties toward their agents (i.e. indemnification).
g. Termination of Agency: Agency can be terminated at the will of either party (notion that we dont
like involuntary servitude). Different from K relationship which you cannot just breach.
h. Gorton v. Doty Non-K Agent: It is not essential that there be a contract between the principle and
agent or that the agent promise to act as such, nor is it essential to the relationship of principle and
agent that they, or either, receive compensation. [No K Necessary]
i. Facts: Woman consented that coach act in her behalf in driving her car by volunteering her car
& her condition that only he drive it shows the control she had. If she had specified she is
loaning the car to him, then that would have settled it.
ii. Dissent: Disagrees with application. Condition that coach be the driver not sufficient. Not for
Dotys benefit, instead for the schools benefit. Coach acted on schools behalf.
i. Agency v. Debtor-Creditor: A person who contracts with another to do something for him but who
is not controlled by the other nor subject to the others right to control with respect to the physical
conduct in the performance of the undertaking. He may or may not be an agent. [Cargill]
j. Gay Jenson v. Cargill Control Test: Agreement may result in agency even if parties didnt call it
agency and did not intend the legal consequences. Someone who Ks to acquire something from 3rd
person and convey it to another is agent only if agreed he acts primarily for the benefit of other. May
use circumstantial evidence to prove agency. [Act Primarily For Benefit of Other]
i. Facts: Warren (W) is a local firm operating as a grain storage facility & as a middle man
between the grain farmers & the worldwide dealer, Cargill (C). W then insolvent; doesnt pay
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farmers, and farmers sue C. W & C had an agreement where C finances W, C buys grain from W
& C has right of first refusal on the grain.
ii. Agent Acting on Behalf of Principal For Benefit of Other: W acted on Cs behalf in procuring
grain for C, as part of its normal operation which were totally financed by C.
iii. Principal Exercise Control Over Agent: C had influence/control over Ws financial situation.
k. Actual Authority: Principal gave the agent the authority explicitly; completely clear.
l. Implied Actual Authority: Implied authority is actual authority circumstantially proven which the
principal actually intended the agent to possess and includes such powers as are practically
necessary to carry out the duties actually delegated. To determine whether implied authority exists, it
must be determined whether the agent reasonably believes because of present or past conduct of the
principal that principal wishes him to act in a certain way or have certain authority.
m. Apparent Authority: An agent's power to act on behalf of a principal, even though not expressly or
impliedly granted. This power arises only if a third party reasonably infers, from the principal's
conduct, that the principal granted such power to the agent. The idea of apparent authority protects
third parties who would otherwise incur losses if the agent's signature did not bind the principal after
reasonable observers thought that it would. [Belief of 3rd Party]
n. Agency by Estoppel: Principal w/manifestation that agent has authority and is not otherwise liable
as a party to a transaction may be liable to a third party if induced to make detrimental change in
position because the transcription is believed to be on the persons account if: (1) Principal
intentionally or carelessly cause such a belief, or (2) Having notice of belief, principal took no
reasonable steps to notify them of false belief.
o. Inherent Authority/Undisclosed Principal: General agent may bind principal even where agent did
not have actual or apparent authority. A disclosed or partially disclosed principal is liable for an act
done on his behalf by a general agent, even if the principal has forbidden the agent to do the act: (i)
Act usually accompanies or is incidental to transactions that the agent is authorized to conduct, AND
(ii) 3rd party reasonably believes the agent is authorized to do the act. [3RST]
p. Mill Street Church of Christ v. Hogan Implied Apparent Authority: Authority to do acts
binding on principal based on past practice and way business operated. Agency can be established
by circumstantial evidence, including: acts, continuous course of conduct in successive transactions.
If action taken within apparent scope of agents authority, act binding. [Implied/Apparent Authority]
i. Facts: Church hired Bill Hogan to paint building; Bill in turn hired his brother Sam Hogan to
help. Sam was injured; sued church as principal.
ii. Past Conduct: Bill allowed by Church to hire Sam for previous work. [Implied Authority]
iii. Necessary to Implement Express Authority: In order to finish the work, Bill had to hire a helper.
iv. Agent Reasonably Believed He Had The Authority: Practice in the past; Bill never told
otherwise; Church even paid Sam for hours worked. [Apparent]
q. Watteau v. Fenwick Inherent Authority: If agent commits unauthorized action, and there is no
actual, implied, or apparent authority, principal still may be liable for loss based on the notion of
inherent authority. [Inherent Authority]
i. Facts: Agent managed tavern for Ds and his name hung over door; without Ds authorization he
bought certain products on credit; he did not pay P; P sued Ds.
ii. Holding: Defendant is liable for damages. Humble was acting with an authority that was
inherently reasonable for an agent in that position. The situation is analogous to a partnership
wherein one partner is silent but is still liable for actions of the partnership as a whole.
iii. 2RST194: Undisclosed principle is liable for acts of an agent done on his account, if usual or
necessary in such transactions, although forbidden by the principle.

iv. 2RST195: Undisclosed principal who entrusts an agent with the management of his business is
subject to liability to third person with whom the agent enters into transactions usual in such
business and on the principals account, although contrary to the directions of the principal.
r. Agent Ind-K: Agree to act but not subject to control over result of accomplish or physical conduct.
Extend credit to go buy lumber. Ind-K an agent for purpose of buying lumber.
s. Control 2RST220: (1) A servant is a person employed to perform services in the affairs of
another and who with respect to the physical conduct in the performance of the services is subject to
the other's control or right to control. (2) In determining whether one acting for another is a servant
or an independent contractor, the following matters of fact, factors considered
t. Control Agent or an Independent Contractor: Control of principal over party and parties
course of dealing determines whether person is servant-agent or independent contractor. If the
principal has the right to control the details of the way in which agent performs tasks, the agent is an
employee or servant. If the principal has limited control rights, the agent is an independent
contractor. [2RST220(2)]
1. Extent of control set out in agreement.
2. Whether the person employed is engaged in distinct occupation.
3. Kind of occupation employee is engaged in.
4. Who supplies tools and place of work.
5. Length of relationship.
6. Method of payment (salary or per job).
7. Whether work is part of regular business of employer.
8. Intent of parties to create master-servant relationship.
9. Whether principal is in business.
u. Humble Oil & Refining Co. v. Martin Master/Servant: Agency relationship does not depend on
what the parties call it. Parties cannot effectively disclaim it by formal consent. Although agreement
that worker is Ind-K, courts look at other factors (such as whether the employer/vendee had control)
to determine whether Ind-K or master-servant. [Master-Servant vs. Ind-K]
i. Reasoning: The relationship was more in line with a master-servant relationship because: (i)
Humble paid important operating expenses, (ii) the occupancy of the premises was terminable at
will, (iii) had strict supervision over finances, and (iv) gave little business discretion to the
service station essentially the purpose of the gas station was to sell Humble products.
v. Hoover v. Sun Oil Co. No Master/Servant: Master-servant relationship does not exist when an
independent contractor controls the day-to-day operations of the entity that is responsible for
damages suffered by a plaintiff. Liability in tort requires more control than liability in a contract
claim. Indicia of no control: (i) contractor set hours of operation; (ii) hired own employees; (iii) did
not write reports to principal; (iv) sold competitors products. [Day-to-Day Operations]
i. Reasoning: Although Sun Oil worked closely with Barone in several day-to-day operations,
Barone was not required to follow Sun Oils advice. Barone was also able to sell competing
products even if he elected not to do so.
w. Factors Considered in Humble Oil & Sun Oil
i. Rent.
ii. Compensation to operator.
iii. Utility bills.
iv. Reports.
v. Hours of operation.
vi. Subordinate employees.

vii. Duration.
viii. Appearances.
ix. Training, supervision.
x. Agents Duties to Principal
i. Obedience: Duty to respect definition of the scope of authority.
ii. Loyalty: GF effort to advance purpose of agency while achieving no self benefit that is not:
1. Disclosed
2. Consented to, or
3. Fair
iii. Care: Negligence standard.
y. Agents Duty of Loyalty to Principal: An agent is subject to a duty to act solely for the benefit of
the principal in all matters connected to the agency. [2RST387]
i. Profits: Unless otherwise agreed, an agent who profits from a transaction must pass profit to
principals, an agent may not profit even if it does not harm the principal. [2RST388].
z. Franchise Agreement: Franchisee will agree to operate its business in certain ways, as required by
the franchisor, in exchange for the use of the license. The purpose of this is to create standardization
in all the franchises nationwide (to achieve the brand). However, a franchise could still be a
servant-master relationship if there is sufficient control by the franchisor.
aa.
Murphy v. Holiday Inns, Inc. K Agent: Agency in K, the nature and extent of the control
agreed upon determines agency existence. No control where: (i) Defendant was given no power to
control daily maintenance of the premises; (ii) Defendant was given no power to control BetsyLens current business expenditures, fix customer rates, or demand a share of the profits; (ii)
Defendant was given no power to hire or fire Betsy-Lens employees, determine employee wages
or working conditions, set standards for employee skills or productivity, supervise employee work
routine, or discipline employees for nonfeasance or misfeasance. [No Control No Agency]
i. Reasoning: Not servant-master, this is a typical franchise agreement. Holiday Inn does not have
the control or right to control the methods or details of doing the work. Purpose of the
provisions was to achieve a system-wide standardization of business identity, uniformity of
commercial services for the benefit of both contracting parties. Betsey still had the control over
the day-to-day operations, and most other powers customarily exercised by an owner.
ab.
Agency & Franchising Agreements: Problem of free-riding, franchisee would take
advantage of other peoples investments (establishment of the brand name) and exploit it. If the
franchisee could do whatever they wanted, it would ruin the brand name.
ac.
Agency Liability 2RST219: (1) A master is subject to liability for the torts of his servants
committed while acting in the scope of their employment. (2) A master is not subject to liability for
the torts of his servants acting outside the scope of their employment, unless:
a. (a) the master intended the conduct or the consequences, or (b) the master was
negligent or reckless, or,
b. (c) the conduct violated a non-delegable duty of the master, or,
c. (d) the servant purported to act or to speak on behalf of the principal and there was
reliance upon apparent authority, or he was aided in accomplishing the tort by the
existence of the agency relation.
II. PARTNERSHIP A partnership agreement is the agreement among partners, whether written, oral, or
implied, concerning the partnership. [UPA101(7)]. Partnership is an association of two or more
persons to carry on, as co-owners, a business for profit. [UPA6] [38 States Adopted UPA]
i. Association of Two (2) or More Persons

1. Agreement necessary, but no written contract. Agreement is to associate, not to form a

partnership.
2. No formal partnership agreement required.
3. No governmental registration required.
4. If you fit the elements of a partnership, youre a partnership.
ii. Persons
1. Person can be a corporation (or any other business entity) or a natural person. Some
people are not persons under definition of law - minors, etc.
2. Can't form a partnership with yourself, but you could with a corporation of which you were
the sole SH.
iii. As Co-Owners
1. Not employee/employer.
iv. In a Business
1. Not a church, not a share of stocks.
2. Co-ownership of a rental property as joint tenants is not enough.
v. For Profit
1. Not-for-profits don't count.
2. Just b/c no profit made won't mean its not a partnership, as long as intended to make profit.
b. Partnership Agreement: Relations among partners and partnership governed by partnership
agreement. To extent agreement does not otherwise provide, the UPA governs. [UPA103].
c. Agency + Partner: Each partner is an agent of the partnership (principal) for the purposes of
business, partner has fiduciary duty to partnership. [UPA303(1)]
d. Partnership MGMT: Each partner has equal rights in MGMT and conduct of the partnership
business, though this default rule can be changed via partnership agreement. [UPA401(f)]
e. UPA7 Rules for Determining Existence of a Partnership: (i) Owning property does not of
itself establish a partnership, whether such co-owners do or do not share any profits made by the use
of the property. (ii) Profits received as payments will not create a partnership if these payments are:
i. (1) An installment payment on debt;
ii. (2) Wages of an employee or rent to a landlord;
iii. (3) An annuity;
iv. (4) Interest on a loan though the amount of payment varies with profits of the business;
v. (5) Consideration for sale of goodwill or other property by installments. [UPA7]
f. UPA7(4) Partnership Existence: Receipt of a share of profits of a business is prima facie
evidence of partnership, but no such inference shall be drawn if (exceptions):
i. Wages or Rent: Store may pay LL rent based on profits of the store w/o LL becoming its partner.
ii. Debt Repayment: Business owes ex-partners money, doesnt make them partner, makes creditor.
iii. Annuity To Deceased Partner: If you want to retire, your payments should not be based on
profits; but they may be if you are dead.
iv. Interest: If you lend money to the partnership & take as interest a share of profits, you are not a
partner. But if you invest money in partnership & take a share of the profits, you are.
v. Consideration For Sale: Distinction between allowing in a new investor and selling the business
is going to be tough to make if the seller still receives a share of profits.
g. Partner Liability
i. Profit Sharing Default Rule: Profits split per person/partner, w/o regard to contributions. But
you can change the default rule by agreeing to something else in the partnership agreement.
ii. Splitting Losses: If you make agreement on profits, losses split the same way.
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i.

j.

k.

iii. Joint + Several: Partners held jointly and severally liable for the obligations of the partnership
(UPA 15). Each partner is a guarantor of the partnerships full debts.
iv. Losses: Partnership agreement can say how losses (debts) will be split. If agreement says
Partner A is liable for 90% of debts, B 10% of debts, you can still sue B for full debt and collect.
v. Partner Liability + UPA13: Partnership liable for any wrongful act or omission of any partner
acting in the ordinary course of the business or partnership or w/ authority of co-partners.
vi. Obligations + UPA17: Person admitted into existing partnership liable for all obligations of the
partnership arising before his admission.
vii. Federal Income Tax Purposes: Income and losses of the partnership are attributed to the
individual partner; the partnership itself does not pay taxes.
Non-K Creation of Partnership: Sharing of profits is prima facie evidence of partnership, but no
inference drawn if such profits were received in payment as wages of an employee. Court looks at
the characteristics of a partnership. [Fenwick v. UCC Factor Analysis No P-ship]
1. Intent of Parties: Just b/c K said partnership, doesnt make it so. The real reason for the k
was to provide calculation for an increase in compensation, but to protect Fenwick in case
he couldnt afford it.
2. Share Profits: Not every agreement that gives a right to shares profits is a partnership, so not
conclusive.
3. Obligation to Share Losses: Only Fenwick liable for debts of partnership.
4. Ownership/Control of Partnership Property & Business: Fenwick contributed all the capital
& Chesire had no right to share capital upon dissolution. Fenwick also retained all control.
5. Power In Administration: Fenwick had exclusive control of MGMT of the business.
6. Language In Agreement: K called it a partnership, but also excluded Chesire from most of
the ordinary rights of a partner.
7. Conduct of Parties Towards Third Persons: Didnt hold themselves out as partners, she was
still working as the receptionist.
8. Rights Of The Parties On Dissolution: No different for Chesire than if she quit.
9. Co-Ownership: Agreement only to share profits, Fenwick had ownership.
Fenwick v. UCC Partner/Employee: Court determined that cashier was not a partner. She had no
authority or control, not subject to losses, not held out as partner, got nothing in the agreement but
wages, coownership was lacking, didnt matter K said partnership. Employees who work on
commission are not partners. Must be something more than sharing profits. [Characteristics]
i. Facts: Chesire works for Fenwick & asks for a raise. Fenwick agrees only if hes making enough
money, so he gets a lawyer to write an agreement, which said Chesire is a partner.
Partners vs. Lenders: Whether a business organization constitutes a partnership done on a case-bycase analysis of all factors to determine whether they reveal the intent to do business as co-owners;
no single factor is dispositive. Explicit partnership agreement may be deemed not to create a
partnership, and an agreement specifically denying a partnership exists may be found void. [Peyton]
Martin v. Peyton Profit Sharing: If K expresses in GF full understanding and obligation of
parties, court must say whether a partnership exists. Although profit sharing considered an element
of partnership, not all profit-sharing arrangements indicate partnership relationship. All features of K
consistent with loan agreement, no partnership formed. [Profits Not Dispositive]
i. Facts: D lent firm collateral securities to take out money to double-down on risky investment. In
return, Ds get share of profits, are kept advised of business, can veto business, can look at
books, can cause employees to resign, has option to buy 50% of firm, but cant initiate firm
business.

l. Fiduciary Obligations: Partner has a fiduciary duty to all other partners. Only fiduciary duties a
partner owes to the partnership & other partners are duty of loyalty & duty of care. [UPA404]
i. Duty of Loyalty [UPA 404(b)]
1. Partner (agent) must act with partnerships (principal) interests in mind.
2. Cant appropriate opportunities that belong to partnership. [Meinhard]
3. Cant act adversely to partnership.
4. Cant compete with partnership before its dissolution. [Meehan]
ii. Duty of Care [UPA 404(c)]
1. Partners duty of care is limited to refraining from engaging in grossly negligent or reckless
conduct, intentional misconduct, or a knowing violation of the law.
2. Partner does not violate a duty or obligation merely because the partners conduct furthers
the partners own interest (partner CAN further his own interests).
3. Partner may lend money to/transact other business with partnership & with regard to these
transactions, rights and obligations of the partner is the same as if he was not a partner.
iii. Duty of Good Faith [UPA 404(d))]
1. Partner must act sincerely, genuinely (vague).
2. Partner required to act in GF and fair dealing to the partnership & other partners.
m. Meinhard v. Salmon DOL Partner: Partners in business have fiduciary duty to inform another of
business opportunities that arise. Joint venture partners owe each other the highest obligation of
loyalty as long as their venture continues. Punctilio of honor most sensitive. This case extended
the duties of partnership far beyond duties under contract. [Duty of Loyalty Disclosure]
i. Facts: Meinhard and Salmon partner-up concerning particular property. After agreement ends,
Salmon enters into new agreement concerning same property without informing Meinhard.
ii. Holding: Salmon had fiduciary duty to disclose new business opportunity to Meinhard. Trouble
about his conduct is that he excluded his co-adventurer from any chance to compete, from any
chance to enjoy the opportunity for benefit that had come to him alone by virtue of his agency.
iii. Closeness of Business: There was a close nexus between the original joint venture and the new
opportunity, since it was essentially an extension & enlargement of the subject matter of the old
one. This would be diff if the new opportunity didnt involve the same thing.
iv. Agent of Venture: Salmon was also an agent of the joint venture, and this new opportunity was
only made available because he held that position in the joint venture. Salmon would never have
had this opportunity were it not for Meinhards initial investment.
v. Andrews Dissent: Isn't a partnership (where the majority would be correct), its a joint venture,
which is a partnership for a very limited purpose & contemplated that it would end at a certain
time. Where the parties engage in a joint enterprise each owes to the other the duty of good faith
in all that relates to their common venture. Fiduciary relationship only exists within that scope.
n. Withdrawing Partners + Accounting: Fiduciaries may plan to compete with entity to which they
owe allegiance, provided that in the course of these arrangements they dont otherwise act in
violation of fiduciary duties. Partner has duty to provide true and full accounting of business
affecting the partnership. [Meehan]
o. Meehan v. Shaughnessy Advance Warning: Fiduciary duty of partner does not prevent that
partner from secretly preparing to start his own law firm. Different than Meinhard duty to disclose
because with partners, its more personal. Must tell the truth, but dont generally have to tell in
advance. Want partners to be able to leave, but draw the line at lying. [Different Duty]

i. Facts: Partners at law firm decided to strike off on their own. They began to make plans to start
new firm (including retaining clients, etc) without disclosing plans to firm. Moreover, they lied
when questioned about it by other partners.
ii. Reasoning: Breached their duty of loyalty by acting in secret and obtaining an unfair advantage
over the firm by (1) denying (lying) they were leaving, (2) preparing notices to go out
immediately (before firm could compete) to the clients, and (3) delaying to provide the firm
with a list of clients they intended to solicit.
iii. Avoid Liability: Could say, if you resolve in your mind you are leaving, must give notice.
p. Partnership Property: All property originally brought into the partnership or subsequently
acquired, by purchase or otherwise, for the partnership, is partnership property. Partner does not own
the property personally. Belongs to partnership. [UPA8(1)]
q. Property Rights & Interests
i. Property Rights of Individual Partner: (i) Rights in specific partnership property, (ii) Interest in
partnership, and (iii) Right to participate in the management of the partnership. [UPA24]
ii. Ownership: Each partner is a tenant-in-partnership with her co-partners as to each asset of the
partnership. Each partner, collectively, owns the whole partnership. [UPA25(1)]
iii. Partnership Interest: A partners interest in the partnership is her share of the profits and surplus,
which is personal property. [UPA26]
r. Putnam v. Shoaf Assets: Co-partners do not own any asset of the partnership; the partnership
owns the asset and the partners own interest in the partnership. Interest is an undivided interest.
i. Facts: Putnam sold her partnership interest to Shoaf; business had negative financial position of
$90k. Shoaf agreed to assume all personal liability for partnership debts, and Putnam was
relieved of any partnership liability. Partnership recovered a lot of money from a lawsuit (which
was not known to any partners before conveyance). Putnam sues to get a share of the money.
s. National Biscuit Company v. Stroud Joint Liability: Acts of partner within scope of partnership
business binds all partners. Partners severally, jointly liable for the acts/obligations of partnership
(unless no authority to act, 3rd party knows restriction). Where equal partners exists, differences on
business matters must be decided by majority of partners. [Joint Liability of Partners]
i. Facts: Two partners in bread company disagree about normal course of business: delivery
procedure. One partner acts without approval of other concerning policy of delivery; there is no
provision in partnership agreement that prevents one partner from acting independently of other.
t. Summers v. Dooley Advantage At Expense: The essence of a breach of fiduciary duty between
partners is that one partner has advantaged himself at the expense of the firm.
i. Facts: Two partners in trash collection business explicitly disagree about hiring of new
employeewhich is not part of ordinary course of business.
ii. Holding: Though partners have equal decision-making rights, a majority is required for
decisions concerning hiring, etc. When 2 partners: deadlock.
iii. Rule: Make explicit governance terms in partnership agreement in order to avoid these
problems.
iv. Profit MGMT: Partner must account for any profit acquired in manner injurious to interests of
the partnership, such as commissions or purchases on the sale of partnership property;
v. Partnership Assets: Partner cannot without the consent of the other partners, acquire for himself
a partnership asset, nor may he divert to his own use a partnership opportunity; and
u. Day v. Sidley & Austin No Violate for Devalue: Members of partnership do not violate
fiduciary duty to one partner simply because partner believes position was devalued. If other

partners following agreement provisions in a manner that is beneficial, then they are meeting their
duty. Fiduciary duty in partnership ensures partner does not profit for themselves at Pship expense.
v. Disadvantages of Partnerships
i. High Transaction Costs: Not good for financing.
ii. Less Stable: Partnership is less stable than a corporation, which has unlimited duration.
iii. Investor Liability: Investors are personally liable for partnership activities if partnership funds
are insufficient. Partners are jointly and severally liable for contract and tort claims.
iv. Transfer Interest: Very hard to transfer interest in partnership.
III. CORPORATE FORM All stakeholders take risk, at varying levels. SH paid last.
a. General Components and Creation
i. Concept of Legal Personality: Semantic and functional utility. Can be sued. Thought of an
entity. Exists as a legal fiction. [1]
ii. Limited Liability: SH not personally liable for corporate obligations. Only risk initial invest. [2]
iii. Ownership: SH technically own but do not manage corp. BOD manages business affairs.
iv. Free Transferability of Ownership Interests: Can sell off shares in corporation.
v. Continuity of Existence: Perpetual, unless shortened in certificate of incorporation.
vi. Centralized Management: Board of Directors; NO SH right to participate. [3]
vii. Entity Status: Can exercise power and rights in its own name; sue/be sued.
viii. SH Rights: Each SH is an owner of the corporation. SHs have the right to vote.
ix. Repurchasing Shares: Corporate assets flow to SH, so modern statutes treat them w/ div.
x. Limitations on Stock Repurchases: Repurchasing allowed for following purposes.
xi. Paying SH: Inflated salaries in closely held corporations.
xii. Liquidation: Paying each SH their pro rata share of corp. after payments to creditors. [4]
xiii. Flexible Capital Structure: Issue securities, stock or debt with interest. [5]
xiv. Number of Shares: Arbitrary. Cant make company more valuable by dividing shares.
xv. Market Capitalization: Price per share X total amount of stock issued.
b. Internal Affairs Doctrine: Law of state of incorporation. If incorp in DE, DE law applies.
c. Public vs. Private Corporations: Public corporations buy/sell stock on a secondary market, such as
NYSE, eTrade. Company is not a party to transaction. Lack liquidity
i. Closely Held Corp.: Owned by a family, privately. No idea of worth of corp.
d. Modules of Corporate Law: Must choose state for incorporation. Law of state of incorp. governs.
i. State Statutory Law: Enables organization, provides endowments, facilitates transaction.
ii. Judge-Made Law: Sets level of care, regulate traditional conflicts, provide remedial structure.
iii. Federal Law: Regulates traditional conflicts directly, positional conflicts indirectly.
iv. Private Ordering/Soft Law: Regulates positional conflicts directly.
v. Issuing Stock: Power to issue stock is vested in the board.
e. Creating a Corporation
i. Incorporators: Can file with the department of state a certification of incorporation, pay a fee
and have an incorporated business. Must file Certificate of Incorporation. Must be identified in
articles of incorporation. [DGCL101(a),(b)]
ii. Place of Incorporation: Closely held corporations tend to incorporate locally, publically in DE.
DEs statutory structure is very lenient and favors management, so managers push for
incorporation in the state. Favorable statutory framework offers corporate-friendly, valuemaximizing aspects that attract people to DE.

iii. Why DE?: DE has court of chancery, did not merge of court of law and equity. DE still has
courts of equity. Separate court, mastery of corporate law, open 7/days. Stability of Corporate
Law in DE. Dont know if things legal in CA. Poison pill, in CA, no answer to question.
iv. In-Between Period: Must be a way for naming initial directors before stock is issued, or for
issuing stock before the directors are elected by the SHs.
1. NY Method: Incorporators have the powers of SH until stock has been issued, and the
powers of directors until the directors are elected.
2. DE Method: Initial directors can be named in the certificate of incorporation. Functions of
incorporators pass to named directors when certificate filed and recorded. Directors adopt
bylaws, then hold an organizational meeting.
f. Powers of Incorporators: If directors have not been appointed, initial incorporators run corporation
until initial meeting. (i) For purposes of adopting bylaws. (ii) Electing directors (if the meeting is
of the incorporators) until the first annual meeting of SHs. (iii) Electing officers if the meeting is
of the directors. [DGCL107]
g. Amend Cert. of Incorp.: Must be initiated by BOD with majority SH vote. [DGCL242(a),(b)(1)]
h. Corporate Bylaws: By laws contain anything not inconsistent with articles of incorporation. If by
laws inconsistent with article of incorporation article wins. Distinction exists because of who can
amend and change the articles and the by laws. [DGCL109]
i. Adoption: Directors initially adopt bylaws; SHs have right to amend or adopt. [DGCL109]
i. Promoter: Conducts business on behalf of organization yet to be incorporated. Different from
incorporator, transacts business on behalf of business. Work on behalf of founders as agent.
j. Promoter Personal Liability Rule: A promoter who makes a contract for the benefit of the
contemplated corporation is personally liable on the contract and remains so even after the
corporation is formed. Corporation must adopt promoter contract. [Camcraft]
i. Implied Adoption: If fail to ratify, but know existence/act as if contracted, implicitly agreed.
ii. Promoter Liability Exceptions: Clear language in K is not parties intent to bind promoter. Party
who contracted with the promoter knew corporation was not in existence at the time of contract
and nevertheless agreed to look solely to the corporation for performance, express or implied.
iii. Excusal: Promoter may be release. Both explicitly or implicitly. May expressly release promoter
if corporation is never formed.
iv. Sign on Behalf of Corp.: If know only signing on behalf of corp, and never forms, implied.
k. Promoter Liability Southern-Gulf Marine v. Camcraft: One who contracts with, acknowledges
and treats as a corporation, incurring obligations, is estopped from denying its corporate existence,
particularly when obligations are sought to be enforced. A party, having given its promise should not
be permitted to escape performance by raising an issue as to the character of the organization to
which it is obligated, unless its substantial rights might thereby be affected. [Promoter Liability]
i. Facts: Camcraft would build a ship for SGM specified that SGM was a US corporation. SGM
not actually incorporated at K, later incorporated in Cayman Islands. Camcraft didnt deliver b/c
of incorporation. Court held for SGM, Camcrafts substantial rights not affected by issue.
l. Corporation General Liability Rule: A corporation that is formed after a promoter has entered into
a contract on its behalf is not bound to the contract, except for these occurrences: (i) Ratification, (ii)
Adoption, (iii) Novation, (iv) Continuing Offer: Proposition can be accepted/rejected by corporation
when it comes into being.
m. Internal Governance & Allocation of Power
i. Board and Officer Actions: Single directors have no authority to act for the corp. or in its name.
ii. Corporate Formalities: Must be present for valid actions of the board.

10

iii. Meetings: Directors can only act as a body, and must do so at a duly convened meeting at which
a quorum is present.
iv. Notice: Formal notice not required; for special meetings.
v. Quorum: Consists of a majority of the authorized number of directors.
vi. Voting: Majority of those present; not those voting.
n. Director MGMT: Business shall be managed by board of directors as except as otherwise provided
by the articles/charter. [DGCL 141(a)]
o. SH Voting
i. Notice of Meeting: Annual meetings must have agenda, special must disclose purpose.
ii. Record Date: Date prior to meeting in which notice is given to members (cutoff).
iii. DE: (1) SH entitled of notice; (2) SH entitled to vote.
iv. Quorum: A majority of the shares entitled to vote is necessary for a quorum unless the certificate
of incorporation specifies a higher or lower figure (1/3 minimum).
v. Ordinarily: Majority shares entitled to vote (sometimes only majority present).
vi. Fundamental Changes: Amendments to Certificate, merger, sale of significant assets,
dissolution. Majority, or 2/3 of outstanding shares.
vii. Election of Directors: Requires only a plurality vote; highest # wins.
p. Voting Trust: Arrangement in which SHs publicly agree to place their shares with a trustee who
then legally owns them and is to exercise voting power according to the terms of the agreement.
q. Allocation of SH Power
i. SH Power: Election of directors, voting on mergers, amendments to bylaws and certificate of
incorporation, removal of directors.
ii. Certificate: Changes can only be made by the Board and approved by SH.
r. SH Agreements: Important in close corporations and some controlled corporations. Often address
restrictions on disposition of shares, buy/sell agreement, voting agreements and agreements with
respect to employment of officers or payment of dividends. Contracts are specifically enforced
where SHs and corporations are parties but when some SHs arent parties, then turns on whether it
is fair to non-signatories.
IV. LIMITED LIABILITY Owners (SHs) have limited liability; debts and liabilities incurred by the
corporation belong to the corporation and not to the SHs, since they are separate legal entities. Also vice
versa, corporation not responsible for debts of SHs. [Liability of SH MBCA6.22]
a. Separate Legal Entity: A corporation is a separate legal entity (created by the law of a specific
state), apart from the individuals that may own it (SHs) or manage it (directors, officers, etc.). Thus,
the corporation has legal rights and duties as a separate legal entity. As a legal entity, a corporation
can sue/be sued, contract, own property, etc.
i. Increased Fundraising: LL facilitates fundraising willing to invest if not liable for debts.
ii. Manage Risk: LL allows corp. to manage risk. Limited liability for SHs at least limited to what
invested in the corporation.
iii. Continuity of Existence: Death of SH does not terminate entity, since shares can be transferred.
b. Management and Control: Management is centralized with the officers and directors. Each is
charged by law with specific duties to the corporation and its SHs.
c. Pierce Corporate Veil/Alter Ego: Court may pierce the corporate veil and dissolve the distinction
between the corporate entity and its SHs so that the SHs may be held liable as individuals despite the
existence of the corporation. Very rare.
i. Fraud or Injustice: Where the maintenance of the corporation as a separate entity results in fraud
or injustice to outside parties (i.e. creditors).

11

d.

e.

f.

g.
h.

ii. Disregard of Corporate Requirements: Where SHs do not maintain the corporation as a separate
entity but use it for personal purposes.
iii. Undercapitalization: Where the corporation is undercapitalized given the liabilities, debts, and
risk it reasonably could be expected to incur.
iv. Fairness/Equituy: The veil may also be pierced in any other situation where it is only fair that
the corporate form be disregarded.
Pierce Corporate Veil Four (4) Factor Test [Van Dorn]: Four factors are present and not piercing
would produce grave injustice. Unity of Interest and some of the following factors.
i. Formalities: Lack presence of corporate formalities (articles of incorp, meetings/minutes, etc.)
ii. Commingling of Funds
iii. Undercapitalization of Firm
iv. Use of One corp. of Assets by Another
v. Unity of Interests
Observing Formalities Walkovsky v. Carlton: In order to maintain a cause of action piercing the
corporate veil, the plaintiff must allege that a SH used the corporate form to conduct business in his
individual capacity.
i. Facts: Instead of setting up a single taxi corp., D sets up ten corps., each of which has two taxis
and $10K insurance (minimum required). P gets in accident, sues D, and insists that D pay him
more than $10K by taking money from other corps.
ii. Holding: Allowed to incorporate business for purpose of escaping liability, but whenever
anyone uses control of corporation to further his own rather than the corporations business, he
will be liable for the corporation actsliability extends to commercial dealings and neglect.
iii. NY Veil-Piercing Standard: Court will pierce veil when (i) Corporation used for purely personal
interests. (ii) There is fraud.
iv. Dissent: Corporations were intentionally undercapitalized to avoid responsibility for accidents,
which were likely to happen. All income was continuously drained for this purpose.
Enterprise Liability: Treat all corporations as if they are one. Breaks down vertical barriers among
and between corporations. Treats as one entity.
i. Factors: (1) Common employees; (2) Common record keeping; (3) Centralized accounting; (4)
payment of wages by one corporation to another corporations employees; (5) Common
business name; (6) Services rendered by the employees of one corporation on behalf of another;
(7) Undocumented transfers between corporations; (8) Unclear allocation of profits and losses
between the corporations; (9) Same officers; (10) Same SHs; and (11) Same telephone number.
[Olympic Financial v. Consumer Credit]
Difficult to Avoid Enterprise Liability: (1) Requires more separation between individual
corporations. (2) Require accounting for supplies. (3) Making sure drivers only go in certain cars.
Sea-Land Services, Inc. v. Pepper Source Alter Ego: Separate corporate existences, failure to
pierce the corporate veil, would sanction a fraud or promote injustice, must be something more than
just a creditor not being able to recover. Requires: (i) Unity of personal and corporate interests. (ii)
Evidence of fraud/injustice. [IL PCV Standard]
i. Facts: D, owns five separate corps., defaults on payment. P sues and seeks to pierce corp. veil so
that assets of all five corps. will go toward payment. Claims corps. are simply alter egos of D.
ii. Holding: Both prongs not satisfied. Failing to pay debt does not mean there is fraud to pierce the
veil (because could use that in almost every case). CT asks for more: fraud/injustice/bad intent.
iii. Unity of Interest and Ownership: There was no differentiation/separation between the
corporation and the owner. used same office, same phone line, & expense acct to run most of

12

the corporations. None of the corporations ever held a meeting. borrowed funds from
corporation for personal expenses, and the corporations would borrow money from each other.
didnt even have a personal bank acct.
i. Reverse Piercing: RP matters because SHs receive profit last. R-Ping the veil allows you to get at
assets that otherwise would be unavailable. Can have reverse piercing without enterprise liability.
i. How to Protect: Respect formalities, holding meetings, separate finances. Get owner to co-sign.
ii. Unjust Enrichment: No UE when escaping liability. K creditor assumed risk and no tort creditor.
j. Roman Catholic v. Sheffield Alter Ego: Alter Ego applies between parents and subsidiaries, not
two subsidiaries, it works vertically, not horizontally. When a parent controls several subsidiaries, a
subsidiary is not liable for the actions of the other subsidiaries. [Subsidiaries Alter Ego]
i. Facts: P buys dog from priest in Switzerland; dog not delivered; P sues archbishop in CA,
claiming under the alter-ego theory that priest and archbishop are subsidiaries to the same
corporation (church) and equally liable.
ii. Holding: Alter ego theory does not apply. Not enough that P will not collect damages if no PCV.
Although the monastery may have been an alter ego of the Catholic Church. There is no
respondeat superior between subagents.
iii. Reverse Pierce? (1) Vatican does not own monastery. (2) No showing of failure to hold mtgs. (3)
Commingling of funds. (4) If reverse pierce down, may be able to hold SF entity liable. (5) Pope
liable? No. He is just an employee, he is not the owner.
k. In Re Silicone Gel Breast Implants Parent Domination: Must show substantial domination of
subsidiary by parent company. Some jurisdictions also require showing of fraud. Company that
renders services to another company (ensuring that product is safe) may be liable to a third party
when it fails to use reasonable care. [Substantial Domination]
i. Facts: BM buys MEC; corps. form parent-subsidiary relationship (never merge) thus preserving
limited liability of each. But there are numerous connections between corp.: Common directors
& officers; common departments, BM monitors and finances MEC (BM name on MEC
products), BM helps manage MEC.
ii. Holding: BM may be liable for MEC either through veil-piercing or direct liability. (1) Bristol
Myers ignored formalities. (2) No board mtgs. (3) Negotiated on behalf of Silicone. (4) Made
major financial decisions. (5) Set wage policies.
iii. Problems For Bristol Arise From Help To Silicone: (1) Helped conduct market tests. (2)
Lawyers did work. (3) Bought insurance. (4) Bristol HR worked for silicone.
l. Torts No Fraud: To determine whether to pierce the veil in a parent-subsidiary situation, no
showing of fraud is required under DE law. Most states that require fraud only do so in contracts
cases, not torts. Plaintiff does not need to establish fraud because no mutual bargaining position,
therefore no consent by plaintiffs to corporate structure of defendant and its subsidiary.
m. Frigidaire v. Union Properties, Inc. Piercing Veil: Limited partners do not incur general liability
for the limited partnerships obligations simply because they are officers, directors, or SHs of the
corporate general partner. Undercapitalization no reason to open liability to limited partners who
control general partner, but theres remedy of piercing the corporations veil. [LLP]
i. Facts: Limited partnership with corporation as general partner (which also has limited liability).
ii. Holding: Law allows limited partners to sit on board of sole general partner corporation.
Limited partners do not incur general liability for the limited partnerships obligations simply
b/c they are directors of corporate general partner.

13

V. SH DERIVATIVE & DIRECT ACTION Corporation is separate from owners. Limited Liability
shows that, partitions assets between owners and corp. Corporation by itself can sue and be sued without
owners doing anything. Sometimes suit has to be filed by corporation or cannot be filed at all.
a. Derivative Suits: SH bring suit on behalf of the corporation in order to hold directors accountable
for breaches of fiduciary duties. Damages are awarded to the corporation (not to the individual SHs)
and attorney fees are paid by corporation when suit succeeds.
i. Payment: Key to understand derivatives, is understanding settlement and how attorneys are
paid.
ii. No Self Suit: When board has conflict of interest, when board done something wrong, not
cognizable that they would sue themselves.
b. Litigation Costs: SH is acting as the agent of the principal company. It is problematic when a
minority SH brings a suit to benefit his own interests. It is the SHs attorney, who gets 20% of
damages, who really benefits. SH does not directly recover. [More Symbolic]
c. Limiting Derivative Strike Suits: In order to limit strike suits and otherwise protect against overdeterrence, statutes limit SHs who may bring derivative suits, many states enacted statutes requiring
-SH in a derivative suit to post a bond or other security to indemnify the corporation against
certain litigation expenses if loses the suit. [Kahn Classic Strike Suit]
d. Demand Requirement: In order to deter frivolous suits, a complaining SH is required to exhaust
internal remedies before bringing suit. Before a SH may bring a derivative suit, he must request that
the directors bring the suit, and they must refuse.
i. Business Judgment Rule: If the directors refuse on the basis of a good faith business judgment,
the court will dismiss the derivative suit. However, directors may sometimes refuse in bad faith.
e. Purpose of Demand: (1) Relieve courts from deciding matters of internal governance by providing
corporate directors with opportunities to correct alleged abuses; (2) Provide corporate boards with
reasonable protection from harassment; (3) Discourage strike suits for personal gain; (4) Creates a
form of ADR by providing corporation directors with opportunities to correct alleged abuses.
f. Cohen v. Beneficial Industrial Loan Forum State Law: SH derivative suit will follow state nonprocedural laws regarding the derivative suits when possible. SH who brings a derivative action
assumes a position of a fiduciary nature. He sues as a representative of a class that did not elect him.
State has plenary power to impose standards promoting accountability. [NJ Bond Statute]
i. Facts: Cohen files derivative suit on behalf of beneficiaries. Claims officers guilty of waste,
fraud, mismanagement. NJ statute required less than 5% SHs who bring a derivative action to
post a security bond; lower court required bond and appealed. Violated substantive rules that
make them liable. Cohen owns $9,000 worth of stock. Cohen required to port bond
ii. Held: New Jersey statute should be followed because it is not a procedural matter that would
preempt federal rules. Statute is constitutional, and can be used on ongoing litigation, as long as
the attorneys fees covered are solely the fees accrued post-enactment of the statute. Further, the
statute does not violate the Constitution because necessary to prevent frivolous lawsuits.
g. Direct vs. Derivative: Suit is direct if it alleges some direct loss to SH. Derivative suit if whatever
loss SH derives from some loss to the corporation. If the claim is that MGMTs breach deprived the
SH of some other right (like right to inspect SH list), the SH must sue directly in her own name.
i. Damages: In derivative, goes to corporation. If direct, goes to individual SH.
h. Eisenberg v. Flying Tiger Line, Inc. Direct/Derivative: If SH brings suit alleging MGMT
interfering w/rights and privileges of SH, not challenging MGMT acts on behalf of corporation,
personal suit. Since not a derivative action, posting of a security bond is not required. Because harms
to voting rights are harm specific to SH and not Corp, claim is direct. [Derivative v. Direct Suits]

14

i. Facts: Before merger, Eisenberg could vote for directors of Flying Tiger; after merger, cannot.
ii. Special Injury Test: Special injury determined a wrong that is separate and distinct from that
suffered by other SHs, or wrong involving a contractual right of a SH such as the right to vote or
to assert majority control which exists independently of any right of the corporation. [NY]
iii. Tooley Test: (i) Who suffered alleged harm, corp or SHs, (ii) who would receive benefit of
recovery, SH or the corporation. Cf. Special Injury Test
i. Grimes v. Donald Futility: Under DE law, when a plaintiff makes a demand, he waives his right to
contest that demand was futile. In DE, never make demand, argue was excused, and then can get
discovery. [DE Demand Futility Exception Applies Tooley Test]
i. Facts: CEO employment contract contains constructive termination w/o cause provision,
which means that if the board interferes w/ the CEOs duties, he can claim constructive
termination and collect money/benefits. SHs sue, arguing that provision prevents board from
effectively controlling the CEObut is it a derivative or direct claim?.
ii. Holding: Because formal demand made, barred from pleading demand would have been futile.
j. Basis To Excuse Demand DE LAW [Aronson]
1. Majority of BOD Has Material Financial / Familial Interest;
2. Majority of BOD Incapable Of Acting Independently (i.e., domination, control);
3. Underlying Action Is Not Product Of Valid Exercise Of BJ.
k. Marx v. Akers Demand: A director will always be an interested party, for the purpose of the
excusal of a demand, when the director is voting on director compensation, but a plaintiff has to
demonstrate with particularity that the compensation is excessive. [NY Demand Request]
i. Facts: Suit against IBM re excessive compensation to directors.
l. NY Demand Futility Rule: No universal demand requirement. NY rejects DE reasonable doubt
standard, finding that demand is excused when: (1) Majority of BOD interested in the transaction.
(2) Directors failed to inform themselves to a degree reasonably necessary about the transaction, or
(3) Transaction so bad it cannot be product of business judgment. [Marx Weaker Standard]
m. Universal Demand Rule: As a bright line test, eleven states adopted a universal demand rule.
n. Wrongful Refusal: Refusal of demand was wrong. If demand is made and rejected, board entitled to
presumption of BJR unless SH can allege facts with particularity creating a reasonable doubt that the
board is entitled to the benefit of the presumption. [Reasonable Doubt]
i. No Independence/Due Care: If reason to doubt independence or with due care, in responding to
demand, SH may have basis post to claim wrongful refusal. SH then has right to bring
underlying action with the same standing as SH which would have had demand excused as
futile.
o. Purpose of Demand Requirement: (1) Relieve courts from deciding matters of internal corporate
governance by providing corporate directors with opportunities to correct alleged abuses. (2) Provide
corporate boards with reasonable protection from harassment by litigation on matters clearly within
the discretion of directors, and (3) Discourage strike commenced by SHs for personal gain rather
than for benefit of the corporation.
VI. SPECIAL LITIGATION COMMITTEE BOD may create a special committee composed of
independent disinterested directors to decide on whether to bring the derivative action. A BOD may
legally delegate authority to a committee of disinterested directors when the Board finds that it is tainted
by the self-interest of a majority of directors. BOD is not abdicating b/c decision to create a committee is
revocable. SLC may hire investigators, counsel. If they decide it should not go forward, they may file a
motion to dismiss/motion for summary judgment.
a. Action of SLC Comprised of Two (2) Components [Auerbach]

15

b.

c.

d.

e.
f.

g.

i. Selection of Procedures Independence of Committee: SLC may need to show GF in choosing

methods. Evidentiary proof may be required, depending on nature of investigation. Consider:
scope, halfhearted as to constitute a pretext or sham, inconsistent with BJR, no shield of
BJR.
ii. Ultimate Substantive Decision of Committee: Falls squarely within the embrace of the business
judgment doctrine, involving as it did the weighing and balancing of legal, ethical, commercial,
promotional, public relations, fiscal and other factors familiar to the resolution of many if not
most corporate problems.
Auerbach v. Bennett NY SLC: While the court may properly inquire as to the adequacy and
appropriateness of the committees investigative procedures and methodologies, it may not under the
guise of consideration of such factors trespass in the domain of business judgment. [NY SLC]
i. Facts: After reports of several multinational companies offering bribes and kickbacks to foreign
officials, GTEC appointed outside counsel and auditors to determine if anyone at GTEC was
involved in similar conduct. Defendants appointed a three-person special litigation committee
comprised of members who were not on the board at the time of the wrongdoing.
Assessment of SLC Motion To Dismiss
1. Independence of Committee: First step, inquiry into independence and good faith of
committee and process. Check duty of loyalty and duty of care (illegal recommendation or
no action). If committee can make a respected decision, case is dismissed (no 2nd step)
2. Decision of the Committee: Consideration of law and public policy in addition to
corporations best interests.
a. Was the decision-making process carried out in good faith?
b. Was the substance of the decision an exercise of sound BJR?
Zapata v. Maldonado (DE 1981) DE SLC: (1) D corporation has the burden to prove that the
Committee is independent and is exercising GF and conducted reasonable investigation. (2) In the
courts discretion, the court should apply their independent judgment. Court asks whether the right
decision made. NY, the courts stop after step 1. NY court does not ask this question [DE SLC]
i. Facts: P brings derivative suit against all directors of company; does not make demand as it
would be futile. Special committee (of two new directors) concludes case should be dismissed.
ii. Demand Issue: When demand is refused, SH ability to sue is terminated, unless refusal was
wrongful. Where demand is properly excused, the SH retains ability to sue.
iii. Balancing: Court must balance the SHs interest in bringing a legitimate derivative suit against
directors with the corporations interest in limiting meritless or frivolous suits.
Avoid Adverse SLC Judgment: (1) Ensure independence of SLC; (2) Conduct investigation in GF;
(3) Act with reasonable methodology; (4) [DE] Defend decision as a good decision.
In Re Oracle Corp. Derivative Litigation (DE 2003) SLC Insider Trade: Social influence may
affect director behavior of SLC. A committee must show that (i) its members are disinterested and
used proper methodology, (ii) the committee is independent, (iii) it proceeded in good faith, and that
(iv) it reasonably investigated the claim. [DE SLC Insider Trading]
i. Facts: Insider-trading allegations against board members. Corp assigns two Stanford U.
professors to committee to determine whether there was insider trading. Turns out there are
many ties between Stanford, professors and company. [Chancellor Strine]
ii. Contextual Approach: Question of independence turns on whether a director is, for any
substantial reason, incapable of making decision with only best interests of corporation in mind.
Bias Producing: Variety of motivations, including friendship, may influence demand-futility. To
render director unable to consider demand, relationship must be bias-producing. Allegations of mere

16

personal friendship or a mere outside business relationship, standing alone, insufficient to raise
reasonable doubt about directors independence. [Martha Stewart]
h. NYSE Listing Requirements of Independence: (1) Must comply with listing requirements; (2)
Stock exchange will want to ensure certain standard; (3) Nominating rules, committee must come up
with new members; (4) Must be independent: no material relationship at all; (4) Must ID directors
that are independent and disclose the basis for that determination.
i. Not Independent: If (1) Employ of company in last 3 years, or, (2) Immediate family member is
or has been an executive officer in last 3 years; (3) Director has received or has immediate
family member who receive $100K.
VII. CORPORATE PURPOSE Corporations must have a purpose or goal. So the question is What
purposes are within the bounds set by the articles of incorporation and statutory law under which the
corporation was formed? BJR short circuits question. Main purpose is often to maximize SH wealth.
a. Balance Maximizing Profits + Moral Obligations: Balance between various constituencies, i.e.
BOD, CEOs, Employees, SH (protected by DGCL), Creditors, etc.
b. General Powers: In addition to the powers enumerated in DGCL122, every corporation may
exercise all the powers granted by law or by its certificate of incorporation, together with any
powers incidental thereto, promotion or attainment of the business or purposes set forth in its
certificate of incorporation. [DGCL121]
c. Specific Powers: (1) Perpetual existence; (2) Right to sue and be sued; (3) Purchase/sell property;
Make donations [Barlow]; (4) Form other corporations and partnerships; (5) Make contracts; (6)
Lend money, invest; (7) Pay pensions.
d. Powers of a Corporation: A corporation has express power to perform any act authorized by the
general corporation laws of the state & those acts authorized by the articles of incorporation. In most
states, corporations also have implied power to do whatever is reasonably necessary for the
purpose of promoting their express purposes and in aid of their express powers, unless such acts are
expressly prohibited by common or statutory law.
e. Corporate Social Responsibility: A corporations objective should be to produce the best possible
goods and services, that no other legal standard is enforceable, and that any other standard allows an
unhealthy divorce between management (making decisions) and ownership; or (2) Corporations
have a social responsibility must balance interests of SHs, employees, customers, and public.
f. BJR + Purpose: Purpose of a corporation is to make a profit for the SHs, but a court will not
interfere with decisions that come under the business judgment of directors. Protects CEO decision,
majority owner can act on whims at expense of the minority owner.
g. State Law: State law often sets forth the acts that a corporation may legally perform. These acts
should be in the aid of a proper corporate purpose.
h. Vires: If the corporation engages in an improper purpose or uses an improper power, that purpose or
act is said to be ultra vires (beyond the corp powers) or intra vires (within corp powers).
i. Charitable Contributions: Corporation may participate in creation/maintenance of community,
charitable, and philanthropic funds as the directors deem appropriate and will. Must: (1) Further
corporate ends, (2) Advance interests of the corporation. [A.P. Smith]
j. A.P. Smith Mfg. Co. v. Barlow (1953) Donations: Corporation can make charitable donations as
long as: (1) Consistent with state law. (2) Some form of corporate benefit. (3) Contribution was
made in furtherance of corporate rather than personal ends. [Right to Donate]
i. Facts: Corporation gave a gift of $1500 to Princeton University; a SH. Corporations president
challenged the gift & other execs say the gift was an investment (qualified graduates would
work for them), that it created a favorable environment for the company, and that the public had

17

a reasonable expectation of such socially oriented contributions by the corporation. Its more
like advertising; theyre furthering their corporate image.
k. Donations DGCL122(9): Ever Corp. created under this chapter shall have the power to
Make donation for public welfare or for charitable, scientific or educational purposes.
l. Dodge v. Ford Motor Co. (1919) Limit on Purpose: Corporation organized primarily for profit
of SHs, powers of the directors are to be used for that end. Directors have reasonable discretion, to
exercise GF, to act for this end. Directors have power to declare dividends. Discretion not interfered
with unless guilty of fraud, misappropriation, or bad faith, when there sufficient funds to do so w/o
detriment. While no obligation to pay dividends, corporation has to hold SH interests as primary.
i. Facts: Clark (25%) and Dodge (75%) are dual SHs of small medical corporation. Clark is active
manager and sole possessor of secret formula; Dodge is passive. They enter into agreement by
which Dodge agrees to vote to keep Clark as director w/ proportional income so long as Clark is
faithful, efficient and competent; and as long as Clark will later disclose formula to Dodges
son. Then Dodge breaches agreement.
ii. Dissent: Argued that the statute was aimed at procedural matters, and as such should be
preempted by Federal Rules of Procedure.
m. Shlensky v. Wrigley: In the absence of fraud, conflict of interest, self-dealing, corporations
decision is final and not reviewable by courts. [BJR]
i. Facts: Wrigley owns 80% of Cubs; decides there will be no night games, didnt want to disrupt
the neighborhood and president believed baseball was a daytime sport. Minority SH sues,
claiming corp. is losing money by forgoing night games.
n. Corporation Wins Corporate Purpose: In absence of fraud, illegality, or self-dealing, directors
decision is final and not reviewable by court. Complaint did not show lights would be better. The
effect of night games in neighborhood might be better served with only day games. By being
attentive to neighborhood, they were acting in the interests of the firm.
VIII.DUTY OF CARE Requires corporate directors to act with the care of an ordinary prudent person
in the same or similar circumstances. Law insulates officers and directors from negligence liability in
order to avoid risk adverse management of the firm.
a. Business Judgment Rule: BJR itself is a presumption that in making a business decision, directors
of a corporation acted on an informed basis, in GF and in honest belief that the action taken was in
the best interests of the company. Only protects intra-company disputes [Ford + Omnicare]
i. Omnicare: An application of the traditional business judgment rule places the burden on the
party challenging the boards decision to establish facts rebutting the presumption. The effect of
the proper invocation of the business judgment rule, as a standard of judicial review, is powerful
because it operates deferentially. Unless the procedural presumption of the business judgment
rule is rebutted, a court will not substitute its judgment for that of the board.
b. BJR Round Up No BJR If
1. Fraud
2. Illegal Activity: Criminal activity.
3. Self-Dealing/Conflict of Interest
4. Uninformed Decision: Burden on D to show informed. [Gross Neg.]
c. Duty of Care Analysis
i. Exercise of Business Judgment? Was the D negligent, did the director fail to live up to standards
of what we would expect?
ii. Reasonable care? Did exercise of BJ did decision amount to waste?
iii. If no waste, was there fraud?

18

d.
e.

f.

g.

h.
i.

j.

iv. If no fraud, was there self-dealing conflict of interest?

v. Is there illegal decision/uninformed decision?
Subjective DOC Components: Protects against allegations that directors did not fulfill objective
components, but carves out an exception for the subjective component. [DGCL 102(b)(7)]
Waste: An exchange so one-sided that no business person of ordinary, sound judgment could
conclude that the corporation has received adequate consideration. Prove exchange was so one sided
that no adequate consideration given. Test extremely tough/radically different from BJR. Any
rational business purpose? If so, then no waste, claim fails. [Litwin]
Kamin v. AmEx Duty of Care/BJR: Directors room rather than the courtroom is the appropriate
forum for thrashing out purely business questions that will have an impact on profits, market prices,
competitive situations, or tax advantages. Minus a showing of bad faith, fraud, oppression, arbitrary
action, or breach of trust, BJ decisions of corporate directors not rescindable for mistaken judgment.
i. Facts: Minority SH of Amex file derivative suit claiming distribution of special dividend waste.
ii. Looks at Countervailing Considerations: (a) Loss would have had adverse impact on company
financial statement. (b) BOD knew of tax consequences [important]. (c) Considered affect tax
advantage method would have on companys financial statement.
Accounting Background
i. Balance Sheet: Snapshot of assets and liabilities. What you have and what you owe.
1. Left Hand Side = Assets.
2. Right Hand Side = Liabilities.
ii. SH Equity: Assets Liabilities.
iii. Assets = Liabilities + SH Equity.
1. Assets are put on the balance sheet according to their historical cost. Sometimes numbers
are not best estimate of value of thing reference (i.e. depreciation).
iv. Income Statement: Show over time how much revenue came in, what cost to generate revenue,
profit generated.
v. Income = Sales Expenses.
Valid Business Judgment: (1) Made by financially disinterested directors or officers; (2) Who have
become duly informed before exercising the judgment; (3) Who exercise judgment in a good faith
effort to advance corporate interests.
Uninformed Decision: When BOD do not avail themselves of material information, or do not
conduct an adequate decision-making process, BJR will not shield. A gross negligence standard:
material information that is reasonably available: (1) Reasonably available is defined later; (2)
material means that a reasonable person would want to know about it to make decision in
question.
i. Plaintiff Must Show: Party attacking a board decision as uninformed must rebut the presumption
that its business judgment was an informed one. [Van Gorkham]
Smith v. Van Gorkom Duty of Care (1985): Determination of whether a BJ informed turns on
whether directors have informed themselves, prior to making business decision, of all material
information reasonably available. Gross negligence the proper standard for determining whether BJ
reached by BOD was informed. Material means that a reasonable person would want to know
about it to make decision in question. [DOC, BJR, DGCL102(b)(7)]
i. Facts: Trans Union sought a leveraged buyout1 by a larger company. Management did cursory
research into value of company and quickly arrived at $55/share. Buyer accepted price but
wanted protection: negotiated an option for X shares at $38, so that if another buyer
offered$60/share, Buyer made instant profit on X shares. Also, Trans Union agreed not to solicit

19

other bids for 90 days (test market). Management made only brief presentations to BOD re
buy-out. Majority of SHs approved, but minority sued.
ii. Entire Fairness Defense: Directors still avoid liability if the stock price was entirely fair. Court
must consider timing, initiation, negotiations, structure, disclosure to directors/SHs.
iii. Uninformed Facts: (i) BOD not adequately informed VG role in sale/price, (ii) Uninformed
intrinsic value of corp, (iii) Grossly negligent two hour meeting without prior notice.
iv. Holding: (1) Failure to inform themselves of all info reasonably available to them and relevant
to their decision to recommend the merger and (2) failure to disclose all material info such as a
reasonable SH would consider important in deciding whether to approve the offer.
v. Dissent: Experienced directors such as these are not easily taken in by a "fast shuffle." Wouldnt
have entered into a multi-million dollar corporate transaction without being fully informed.
Congress put in place tax credits, encourage investments, got tax credit if invested in R.R.,
could use credits to reduce tax liability.
k. Post-Van Gorkom DGCL102(b)(7): allows corp. to include in corp. charter provision that
eliminates personal liability for BOD for violating Duty of Care, but not Duty of Loyalty or
prohibition of intentional misconduct.
l. Francis v. United Jersey Bank (1981) DOC Fail: Directors must discharge their duties in good
faith and with that degree of diligence, care and skill which ordinary prudent men exercise under
similar circumstances in like positions. Lack of knowledge about business or failure to monitor the
corporate affairs not a defense. Pritchard didnt fulfill any of the directors obligations. [DOC Fail]
i. Facts: Majority SH and director did not pay attention to how her sons ran insurance company.
ii. Avoiding Liability: (1) Keep minutes, demonstrate objection to loans, (2) Adhere to formalities.
iii. Insolvent Corp: When corp. insolvent, creditors become SH.
m. Basic Requirements for Being on BOD: (i) Ability to read financial statements. (2) Backbone to
object to conduct. (iii) Basic supervision. (iv) Extreme cases, should resign.
IX. DUTY OF LOYALTY DOL means directors must place interests of corporation above their own
personal gains. Problems arise b/c directors have other business involvements causing COI, it is often
for this reason that they are placed on BOD. Must exercise authority over processes in GF attempt,
advance corporate interests, not simply personal interests. (1) Fair Transaction, (2) Full Disclosure.
a. Duty of Loyalty Analysis
i. Fair: Was transaction fair?
ii. Disclosure: Who knew what?
iii. Interested Transactions: Court review for fairness. Independent directors are disinterested
directors (sanitize conflicted transactions). SH can also sanitize conflicted transaction.
b. Avoiding DOL Liability: (i) Hire advisors. (ii) Keep lawyers around to document everything, (ii)
Highlight ALL of the reasoning/rationales behind decisions.
c. Disinterested Majority Rule: Voidable only if the director had not made a full & complete
disclosure of the transaction (its value, her interest, profit, etc.) to a quorum of disinterested
directors, or transaction shown to be unfair and unreasonable. Director has BOP showing transaction
fair.
d. Interested Transaction: (i) Transaction between corporation, one or more of its directors, (ii)
Transaction between corporation and 3rd party where director has financial interest. [DGCL144]
e. Interested Transactions Bayer v. Beran: Fiduciary duty to further interests of SH. Burden on
directors to show fundamental/entire fairness. As long as act served legitimate/useful corporate
purpose, fact there may be a benefit is not enough to show breach of DOL. [DOL + BJR]

20

f.

g.

h.

i.

j.

k.

l.

i. Facts: President of radio program hired wife to sing; paid her handsomely. Question is whether
this constitutes an interested transaction and whether president breached fiduciary duty.
Safe Harbor (DGCL144): Review of interested transactions may be governed by BJR, expands
board members ability to enter into interested transactions. An interested transaction is not per se
voidable, and BJR applies, as long as one of three conditions under DGCL 144 are met:
i. Material facts are disclosed to the entire board and the majority of disinterested directors
approves (interested director can vote, but cant be deciding vote because must be majority).
ii. Material facts are disclosed and SHs approve. [Fliegler]
iii. If failure of Safe Harbor, could be void. Look to fairness test in Sinclair and Weinberger.
Kahn v. MFW (2014) Independent Committee: Where transaction involving self-dealing by a
controlling SH is challenged, the applicable standard of judicial review is entire fairness with the
D having the burden of persuasion. D bears burden of proving that transaction with controlling SH
entirely fair to the minority SHs. Defendants may shift the burden of persuasion to the plaintiff if
they show that transaction was approved by a well-functioning committee of independent directors.
BOT v. Benihana Interested Transaction: A transaction involving an interested director is valid
if the material facts as to the directors interest are disclosed or known to the board of directors and
the board in GF authorizes transaction by an affirmative vote of disinterested directors. If
DGCL144 standard is not met, and director breached DOL, then Entire Fairness applies. [No DOL]
i. Facts: Same director negotiated purchase of preferred stock by Co B, which he had an interest
in. The rest of the board knew that the director had an interest in Co B and approved the
purchase.
ii. Holding: Decision within the bounds of BJR. Aoki argued 144 not applicable because directors
didn't know Abdo negotiated deal. Didn't matter because the directors already knew Abdo, as
principal of BFC would have approved whatever deal negotiated. [Fully Informed 144(a)(1)]
Corporate Opportunities Standard: Duty of loyalty prevents directors and officers from taking
opportunities for themselves that should belong to the corporation. Directors/Officers may not: (1)
Use corporate property/assets for personal uses or to develop his own business. (2) Assume for
himself properties or interests in which the corporation is interested or can be said to have a
tangible expectancy or which are important to corporations business or purposes.
Defenses to Corporate Opp.: (1) Opportunity was presented in individual capacity, not as fiduciary
of corporation. (2) Corporation unable to take advantage of opportunity. (3) Officer/dir may take
advantage of corporate opportunity if it is disclosed to the corporation first, and it is unable to take
advantage. (3) Corporation refuses the opportunity. If the corporation, by independent directors or
SH, turns down an opportunity, then fiduciaries may take advantage of the opportunity.
Four (4) Broz Factors: Director may not seize for himself an opportunity from his corporation,
when: (1) Presents conflict of interest between the director and his corporation, (2) Corporation is
financially able to undertake the opportunity, (3) Opportunity is in the line of the corporations
business, and (4) Opportunity in which the corporation has an interest or a reasonable expectancy of
interest, and is of practical advantage to the corporation. [Broz v. Cell + Gruff v. Loft]
Corporate Opportunity Factors: If 5 elements met, individual has no lawful seizure of
opportunity.
i. Business Opportunity Presented To Corporate Officer/Director:
ii. Corporation Is Financially Able To Undertake,
iii. In Line With Corporation's Business
iv. Is Of Practical Advantage,
v. One In Which Corporation Has Interest Or Reasonable Expectancy,

21

m. Broz v. Cellular Information Systems Corporate Opportunity + DOL: A formal presentation is

not required under the circumstances in which the corporation does not have an interest, expectancy,
or financial ability to pursue opportunity. [Corporate Opportunity Meinhard]
i. Facts: Broz was president/sole SH of RFB Cellular and board member of another cellular
company, CIS (emerging from bankruptcy). Broz contacted about acquiring cellular licenses
(not offered to CIS); Broz asked other directors of CIS if they were interested in acquiring
licenses; they were not. Meanwhile, PriCellular acquired CIS and sought to acquire the same
cellular licenses. However, Broz outbid PriCellular and acquired the licenses for RFB.
n. In Re eBay, Inc. Line of Business: Opportunity in line with corporations business when an
opportunity in which corporation has fundamental knowledge, practical experience, ability to
pursue.
i. Facts: Goldman Sacs gave eBay directors access to hot IPOs in exchange for continued
banking business. SHs pissed that eBay did not make investments on their behalf (i.e., that
directors kept info to themselves).
ii. Holding: Court finds that eBay directors violated duty of loyaltyeven though making IPO
investments is not in line with eBays business. Court suggests that even if conduct does not run
afoul of corporate opportunity doctrine, it may still constitute a breach of fiduciary duty.
o. Martha Stewart Case: Group of investors wanted to buy stock in Martha Stewart company.
Company not interested in issuing stock. When issuing stock, does not create profit for corp issuing
stock. Company was not in need of any additional capital.. Nothing conflicting about selling stock.
p. SH Fiduciary Duties: SHs hold no duty to the corporation. SH can use info and give it to a
competitor, use dividends to set up a competitor. SHs are not agents of the corporation, and are not
responsible to it. But this rule changes when the SH dominates the corporation.
q. Majority SH Fiduciary Duty: Manifest in several circumstances: (1) If a majority SH deals with
corporation (such as contractual relationship), transaction closely scrutinized to see minority SHs
treated fairly. (2) Corporate transactions, where the majority has voting power to effectuate a
transaction, the effect on minority SH may be reviewed by courts to see that majority acted in good
faith and not to detriment of the minority SH.
r. Wholly Owned Subsidiary vs. Control Subsidiary: Problems arise when you have a controlled
subsidiary, and there are other SH, not wholly owned, a majority owned subsidiary. The risk is that
the controlling SH is going to use control that benefits him, at expense of minority SH.
s. Sinclair Oil v. Levien Intrinsic Fairness: Intrinsic fairness standard applied to parent-subsidiary
relationships with evidence of self-dealing, where parent (i) receives benefit to exclusion of and (ii)
expense to the subsidiary. Defendant bears burden of showing fairness of transaction. Otherwise,
BJR applies. [Controlled Subsidiaries-Parents]
i. Facts: Sinclair Oil (parent) owned 97% of SinVen Oils (subsidiary) stock. When Venezuelan
government began to nationalize foreign oil companies, Sinclair looted SinVen by having it pay
$100 million in dividends. P (minority investor in SinVen) claims that (1) Sinclair denied
SinVen development opportunities by paying out dividends and (2) breached contract.
ii. Contract: recd the benefits of the K, so it must comply with its contractual duties. Sinclair
International fell behind on payments to SinVen. Sinclair Intl. was in breach of the contract.
Sinclair Oil decides not to bring claims v. Sinclair Intl. SinVen hurt by not enforcing K.
t. Zahn v. Transamerican Corporation Majority SH Voting: Since transaction dominated by
majority, dominating board must prove fairness. [Majority SH Fiduciary Relationship]
i. Facts: Transamerica owns 66% Class A and 80% Class B; discovers that Axton-Fischer has
valuable asset of tobacco unknown to minority SHs; decides to exercise call option and buy out

22

Class A SHs and liquidate company. Had there been disclosure of assets, Class A SH would
have participated in liquidation.
ii. Holding: (1) Transamerica owed a duciary duty to the minority SHs. (2) Transamerica
breached that duty by calling Class A stock. Real violation was the failure to disclose asset value
to minority. Looks as if board acted to benefit only Transamerica majority, not all SHs.
Disinterested directors could have called the Class A stock. But here, the directors were
controlled by majority SH. (i) Classes well known. (ii) Art. of incorp. (iii) Call feature built-in.
X. RATIFICATION Ratification is not a complete defense. SH must be disinterested and well-informed
to properly ratify a transaction.
a. DGCL 144(a): A contract/transaction between a corporation and one or more of its directors or
officers will not be void or voidable solely for this reason if contract/transaction fair as to
corporation at time authorized, approved or ratified by BOD or SHs. Ratification does not immunize
transaction from scrutiny, but shifts BOP and/or standard. [Majority Disinterested BOD/SHs]
b. SH Approval DGCL144: Under 144, if approved by SH, not voidable. Majority of disinterest,
no burden shift. Presumably before, company could walk away, now approved, not voidable.
i. Void: Not legally binding and not enforceable. Cannot be performed under law.
ii. Voidable: Valid K and can be enforced. Usually only one party bound, unbound may chose void.
c. Fliegler v. Lawrence Ratification/Interested Transaction: Usually SH ratification means BJR
applies to transaction and P has burden showing waste/fraud. Court adds to 144(a)(2), there is no
presumption of fairness when ratification performed by interested SHs. Only when majority of
disinterested SHs vote does BJR apply. SH can still attack transaction, but must overcome BJR. If no
144(a)(2), court will assess the fairness of transaction, under DGCL144(a)(3).
i. Facts: BOD conducted interested transaction. Majority SHs voted in favor of transaction
(ratification)but only 1/3 of disinterested SHs voted and not clear who was interested.
d. Ratification Context DGCL144: Ratification decisions involving DOL claims are of two kinds:
i. Corp. + Directors: Interested transaction between corporation and directors (or between the
corporation and an entity in which the corporation's directors are also directors or have a
financial interest), DGCL144(a)(2) provides that an interested transaction of this kind will
not be voidable if it is approved in good faith by a majority of disinterested, fully informed SHs.
Turns DOL claim, where BJR not applicable, to something that looks like BJR. [Wheelabrator]
ii. Corp. + Controlling SH: If 144(a)(2) approval granted, SOR remains entire fairness, plaintiff
must demonstrate the merger was unfair. [Parent-Sub]
e. In Re Wheelabrator Tech Ratification + DGCL144: When a transaction is between a
corporation and its directors, but not a controlling SH, approval of the transaction by a majority of
disinterested SHs invokes the business judgment rule with regards to the directors duty of loyalty.
[Ratification + Burden Shifting]
i. Facts: Majority of independent SHs approve merger.
ii. Issues: (1) Disclosure: CT says who cares about duration of meeting. (2) DOC: Even if did not
act w/DOC, decision was ratified by SH, so that negates DOC claim. (3) DOL: If deal approved
of by majority of disinterested BOD or SH, effect is not to eliminate judicial review, but flip
burden and show waste. Turns DOL claim (where BJR does not apply) into DOL claim where
the BJR does apply.
f. Quorum DGCL144: Under statute you can get quorum by counting the disinterested BOD. But
you can count interested BOD. Can still be counted towards a quorum.
g. Ratification DOL Roundup
i. Parent corp, self-dealing cases, entire fairness test applies to defendant. [Sinclair]

23

ii. Minority/disinterested SHs ratify deal between Corp/Controlling SH, Plaintiff BOP to show not
entirely fair. [Wheelabrator]
iii. Disinterested SHs ratify deal with Corp/Directors, BJR applies to defendant. [Wheelabrator]
iv. Director self-dealing, ratification by disinterested SH means, BJR applies. [Fliegler]
XI. GOOD FAITH Directors/officers in making decisions in their capacities, must act with a conscious
regard for responsibilities as fiduciaries. Violation of DOGF may include intentional dereliction of duties,
intentionally act for purpose other than corporations benefit, or intentionally violating law.
a. Waste: Waste can overrule BJR. Court willing to review merits of business decision. Burden on P to
show BOD acted outside the bounds of biz judgment, decision was irrationality. If there is no
justification, no possible reason for doing what you did, then can find waste. [Litwin]
b. Three Types of Bad Faith Conduct [Walt Disney]
i. Subjective Bad Faith: Intent to do harm.
ii. Gross Negligence: Lack of due care/no intentinsufficient to show lack of good faith.
iii. Intentional Dereliction of Duties: Conscious disregard for ones duties, triggered when (1) D
acts with purpose other than best interest of company; (2) D intends to violate law; or (3) D fails
to act despite duty to act.
c. In re Walt Disney Derivative Litigation (DE 2005) Compensation + GF Duty: Irrationality
tends to show decision not made in GF. (i) Intentional dereliction of duty, and (ii) Conscious
disregard for ones responsibilities is an appropriate standard for determining whether fiduciaries
have acted in good faith. [Compensation GF Fiduciary Duty]
i. Facts: Disney gives Ovitz extremely favorable termination agreement, if no cause Ovitz gets a
ton of money, including great stock optionsin total about $130 million. The board
unanimously approved agreement. When Ovitz is fired, he cashes out; SHs file derivative suit
against Ovitz and Disney board.
ii. Holding: BOD not liable. P failed to meet BOP. Compensation committees now totally separate.
Chancellor Chandler somewhat adopts gross negligence standard for bad faith. Not irrational.
Ovitz needed downside protection.
d. Independent Defense DGCL141(e): Relied on outside help to hire. 141(e) Dir. Protected here.
e. Director Responsibility Rule: Director's obligation includes a duty to attempt in good faith to
assure that a corporate information and reporting system, which the board concludes is adequate,
exists, and that failure to do so under some circumstances may, in theory at least, render a director
liable for losses caused by non-compliance with applicable legal standards. [Caremark]
i. Caremark: Says the board has an obligation to implement information systems, chain of
command of reporting within corp, to make sure violations of law are detected and reported to
board so board can take action
f. In re Caremark (1996) Duty to Monitor/Oversight: Directors of a corporation have a duty to
make good-faith efforts to ensure that an adequate internal corporate information and reporting
system exists. Directors are potentially liable for breach of duty to exercise appropriate attention if
they knew or should have known that employees were violating the law, declined to make a good
faith effort to prevent the violation, and the lack of action was the proximate cause of damages.
[Inattentive Director Claim Difficult Standard Lack of Oversight]
i. Facts: Caremark had a regular practice of entering into financial arrangements with referring
doctors. Caremark SHs promptly brought derivative suits, alleging breach of DOC for failing to
oversee conduct of employees, exposing company to enormous civil/criminal penalties. Parties
negotiated a settlement and agreed to implement the creation of a compliance/ethics committee.

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ii. Held: No evidence BOD knew there were ARPL violations, and no systemic or sustained failure
to exercise oversight. However, terms of settlement merely required Caremark to institute
policies to further assist in monitoring for violations. Therefore the settlement was approved.
g. DOGF Not Independent FiDu Rule: Although GF may be described colloquially as part of a
triad of fiduciary duties, obligation to act in GF does not establish an independent fiduciary duty
that stands on the same footing as the duties of care and loyalty. Only the latter two duties, where
violated, may directly result in liability, whereas a failure to act in GF may do so, but indirectly.
Fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary
conflict of interest, encompasses cases where fiduciary fails to act in GF.
h. Oversight Rules: (a) the directors utterly failed to implement any reporting or information system
or controls; or (b) having implemented such a system or controls, consciously failed to monitor or
oversee its operations thus disabling themselves from being informed of risks or problems requiring
their attention. [Stone Scienter Req. Not Present in Caremark]
i. Stone v. Ritter (2006) Oversight Liability Requirements: Raises bar for BOD liability. Imposes
knowledge requirement. Less likely BOD will incur liability. Showing of bad faith is necessary to
establish director liability. No breach of duty of good faith because compliance systems set up (even
though they ultimately failed); no evidence BOD knew of any red flags.
i. Facts: AmSouth Bank sanctioned by government for failure to file Suspicious Activities Report.
ii. Reasonable Reporting: Must attempt in GF to have systems to make sure violations of law
detected and reported to BOD. Maintain (i) Compliance officer/department. (ii) Report to board.
(iii) Board-enacted procedures. (iv) No showing of red flags. [Van Gorkham]
iii. Knowledge Requirement: (i) know you had duty and consciously disregarded doing it; (ii) had
systems in place but no monitor or report to board; (iii) utterly failed to implement compliance.
XII. SH VOTING Corporate form delegates broad discretion to a centralized management structure.
This discretion is limited by corporate by-laws and charter, but very few corporations place substantive
controls in these documents. SHs have the right to vote, the right to sell, and the right to sue. SHs want
corporations to make profits (some want socially responsible way) and directors want to keep job.
a. Model Business Corporations Act
i. MBCA7: Annual SH meeting, elect directors. Might vote on amendments to Art. of Incorp.
ii. MBCA8.05,06: 05 says one year term by default. 06 says can stagger terms [Powerful Impact]
iii. MBCA7.07: Who gets to vote? Record date. If you buy after a certain fixed date then not
entitled to vote. Limitations imposed on who allowed to vote based on when bought the stock.
iv. MBCA8.04: If there are different classes of stock
v. MBCA7.2a: Who wins? The director who gets most votes, wins. A director who gets one vote,
can be director, if no one else gets one vote. Just need more votes than anyone else, dont need
majority.
vi. MBCA8.08: Director removal. Dont have to wait until annual meeting to vote out, but need a
special meeting to consider the issue.
1. Voting is diff: Need more votes to throw director out, than to keep him
vii. MBCA8.04: SH, in writing, consent to do something dont need to have meeting. This is a way
to throw a director out without meeting.
viii. MBCA7.22: SH do not have to go to meeting to vote. Proxies, agents who are authorized by
SH to vote in certain way.
b. SH Voting: SHs are owners of corporation, objects of managements fiduciary duty, and ultimate
sources of corporate power. SHs have two ways to exercise this power, vote and the derivative suit.
Right to vote may be allocated to others not owning the shares through a proxy or voting trust.

25

c. Control/Power: SHs only meet annually, BOD only meets once/month, officers there everyday.
d. Cumulative Voting: Each SH gets number of votes equal to number of shares owned x number of
director slots; SH can allocate votes however. Ensures minority SHs have some say. [DGCL214]
e. Non-Cumulative Voting: Each voter gets one vote per slot per share. Voter cant focus votes on one
candidate. Ensures majority always rules; incumbent managers prefer non-cumulative method.
f. Quorum DGCL216: Can reduce quorum, but still need a third of the shares represented at the
meeting. Therefore, when a SH signs a proxy statement, it gives the board of directors the right to
vote on their behalf. This can get expensive because of mailing and postage.
i. Default Rule: Majority of shares must be present to achieve a quorum.
ii. By-Law Rule: Default rule can be changed in corp. by-law, but quorum cannot be less than 1/3.
g. Election of BOD DGCL211: SHs must elect directors annually either the whole board or a
staggered board (allowed under DGCL 141(d)) (most often 1/3). A staggered board makes it very
difficult to take over the Board by an aggressive SH and lets the board entrench itself. In order to
change to a triggered board, the charter has to be amended at a SHs meeting.
h. Amendment to Charter DGCL242(b)(1): Board of directors has to recommend amendment to
the charter and the SHs have to vote to approve. Board cant self classify.
i. Proxies DGCL212(b): Allows each SH permitted to vote at a meeting to authorize another
person to act for the SH by proxy. State law requires reimbursement for expenses; federal law
requires truthful disclosure. [SEC14(a)]
i. Collective Action Problem: Since there are millions of SHs, no one SH is going to influence
management anyway and therefore, investment is purely passive and there is rational apathy. To
combat this rational apathy, SEC has proxy rules that encourage SH activism.
j. Proxy Fights: Results when insurgent group tries to oust incumbent MGMT by soliciting proxy
cards, SHs sign authorization to allow them to be their proxy and electing its own representatives to
the Board. P allowed to recover fees/expenses as to violation of proxy rules but no more. Like tender
offers, proxy fights are subject both to the 1934 Securities Exchange Act and to state corporate
statutes. Proxy fights are an alternative to bringing a derivative suit doesnt have to replace it
i. Controlling Corporation via Proxy Votes: Few SHs own enough shares to make any difference
at meeting and few SHs even attend these meetings. Because outcome of meeting depends on
number of votes cast, person with most proxies usually wins.
ii. Tender Offers: Tender offers are another method of acquiring control of a corporation by
offering to purchase shares for a price higher than market value. Both proxy fights & tender
offers are regulated by the 1934 Securities Exchange Act (SEA).
k. Corporation Proxy Expenses: Reimbursed if (1) Not excessive, and (2) SHs are informed.
Incumbent group covered as long as fight based on policy, rather than personal reasons; insurgent
group bears expenses unless BOD/SHs later agree to reimbursement. Reasonable and proper [Levin]
l. Personal Gain: Has to involve policy/interests of corporation and cannot be about pure personal
gain/interest. Purpose of persuading SHs of correctness of position and soliciting support for policies
which BOD believes, in GF, in the best interests of corporation. [Levin + Rosenfeld]
i. Reimburse Incumbents: Firm can reimburse incumbents whether they win or lose.
ii. Reimburse Insurgents: Firm can reimburse insurgents only if they win, and only if SH ratify.
m. Levin v. MGM (1967) Paying For Proxy: Incumbent directors may use corporate funds and
resources in a proxy solicitation contest if sums not excessive and SHs are fully informed. Protects
incumbents from insurgents with enough money to take on proxy fight. [Incumbent Use of Funds]

26

i. Facts: Split between two factions of corporate management. Controlling management uses corp.
funds in proxy fight to convince SHs to vote in their favor. Method and means of soliciting
proxies is questioned.
ii. Holding: Court defers to BOD, they can choose to spend money how they see fit. There was no
illegal or unfair method of soliciting proxies.
iii. Reasoning: Not excessive nor illegal. Company will foot bill in contested election. Logic is
financial burden for incumbents should not be based on whether incumbent thinks it should be
in place. Insurgent must bear all of the downside cost.
n. Rosenfeld v. Fairchild (NY 1955) Reasonable Expense Reimbursement: BOD may decide to
reimburse reasonable expenses from proxy fight made in good faith about an issue of policy;
moreover, court defers to board on what constitutes reasonable. [Definition of Reasonable]
i. Facts: Minority SH seeks refund of proxy expenses via derivative suit.
ii. Reasoning: MGMT may look to corporate treasury for reasonable expenses (subject to judicial
scrutiny when challenged) of soliciting proxies to defend position in a bona fide proxy contest.
o. Private Actions For Proxy Rule Violation: Foundation of security laws. The securities act of 1933
and Securities exchange act of 1934. They delegate to SEC about what can and cant do.
1. 14(a): Commits the SEC to issue rules governing the solicitation of proxies.
2. 14(a)(9) Broad Anti-Fraud Prohibition: No solicitation shall be made by means of proxy
statement that has any statement broad or misleading material fact.
p. Techniques Separating Control from Cash Flow: Efficient to give SHs voting right since they
have strongest incentive to maximize corporate value. Capital structures affect voting and ownership
of shares. Statutory prohibition against MGMTs ability to vote stock owned by corporation.
q. Need for Violation of Proxy: (1) Material Defect, (2) Proxy Necessary To Deal. [Borak]
r. J.I. v. Borak Proxy Violation Private Actions: SEA27 grants private parties implied right to
bring a suit against a party for violating 14(a) of the Act. [No Scienter Requirement]
i. Facts P challenged solicitations of proxies to approve merger.
ii. Proxy Statement Misleading: Corporation told SHs that their board of directors recommended
approval of merger w/o disclosing that nominees were under control and dominion of dir.
iii. Reasoning: CT creates an implied private cause of action exists under 14(a) of the Exchange
Act so that P can collect damages caused by false or misleading proxy solicitations (no scienter
requirement). Such actions will help to supplement SEC litigation.
s. Mills v. Electric Auto-Lite Lenient Private Right: Where an omission in a proxy statement is
determined to be material, SH has established sufficient causation between the violation of 14(a)
and his injury. [Materiality + Attorneys Fees]
i. Rule: Minority SHs sue board for material omission in proxy statement regarding merger.
ii. Damages: Determine relation between defect/transaction: (i) if proxy defect relates to merger
terms, minority SHs can recover FV/shares. (ii) If proxy defect relates to something else,
monetary damages appropriate only if merger resulted in reduction of earnings/earning
potential. For mergers, injunctive relief would be horrible because it would undue all the work.
iii. Attorneys Fees: Corp. must reimburse P for attorney fees if corp. violated securities law.
Reimbursement not conditioned on winning damages. [Deterrence]
t. Materiality: Fact is material if there is a substantial likelihood that a reasonable SH would consider
it important in deciding how to vote. Where there has been a finding of materiality, a SH has made a
sufficient showing of casual relationship between the violation and the injury for which he seeks
redress if, as here, he proves that the proxy solicitation itself, rather than the particular defect in the
solicitation materials, was an essential link in the accomplishment of the transaction. [Mills]

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u. Seinfeld v. Bartz Materiality of Proxy Defect: An omitted or misleading fact is only material, if
it was likely to have a reasonable effect on SH decision for voting. Substantially likelihood inclusion
of alleged omitted information would alter mix of available information. [Limit of Materiality]
i. Facts: Board neglected to include Black-Scholes valuation of option grants in proxy statement.
ii. Held: Failure to include Black-Scholes option valuations not material under 14(a)-9 analysis.
v. Vote Buying: A SH may not sell her vote or separate her ownership interest from her voting right for
consideration. Attaching the vote firmly to the residual equity interest ensures that an unnecessary
agency cost will not come into being.
w. SEA 1933: Covers any sale by a corporation of its own securities.
x. SEA 1934: Covers sales between parties on public market, applies to publicly traded companies.
y. SH Filing Requirements: A SH does not fall under general SEC filing requirements if it does not
solicit proxies for itself. Ex: a pension fund that submits a SH proposal may not be subject to SEC
requirements even if campaigns on behalf of proposal, b/c it is not asking SHs to give it proxies.
z. SEC14(a)(9) Disclosure Standards: Materiality, causation, and scienter. [Mills]
i. Materiality: Whether statement would have been significant in a reasonable SHs deliberation
ii. Causation: Federal courts require that the challenged transaction have caused harm to the SH.
1. Loss causation: Easy to show if SHs of the acquired company claim the merger price was
less than what their shares were worth.
2. Transaction causation No recovery if the transaction did not depend on the SH vote.
iii. Reliance: Complaining SHs do not need to show actually read/relied on alleged misstatement.
iv. Scienter: How much fault is required? Negligence is sufficient under 14(a)(9).
v. Prospective or Retrospective Relief: Federal courts can enjoin the voting of proxies obtained
through proxy fraud, enjoin the SHs meeting, rescind the transaction or award damages.
XIII.SH PROPOSALS If SH proposal, corporation will reject.
a. SH Proposals 14(a): Instead of independently soliciting proxies, a SH may service notice on
MGMT of his intention to propose action at the SHs meeting. No proposal, unless:
i. Entitled To Vote: SH entitled to vote at SH meeting to which MGMTs proxy statement relates.
ii. Existing SH: SH at the times the proposal is submitted.
b. SH Proposal 14(a)-8(c)(5): Under Rule 14a-8(c)(5), a SH proposed resolution for a proxy
statement can only be turned down when the proposal both: (1) concerns less than 5% of total
earnings or assets, and (2) when it is not significantly related to the business.
i. Exception: Non-economic factors (social/ethical issues) may be considered to overcome this
rule, if do not meet the first prong.
c. SH Proposal Exclusion: Basis for exclusion, burden on corp. to get permission from SEC
i. Improper Under Law: Cannot violate state or federal law (i.e. order corp to bribe); legal
loophole, can propose in form of recommendation instead of order where state law makes it
improper to bind corp. in some action
ii. Irrelevant: No personal grievances; must concern 5% of assets/earnings or be otherwise
significantly related (includes ethical concerns that have little monetary connection).
iii. Problems of Authority: Cant concern MGMT functions, affect specific director or election, or
conflict with company proposal.
d. Soliciting Proxies: People who solicit proxies must furnish each SH with a SH proposal. In it, they
must disclose information that may be relevant to the decision the SH must make. SH proposal
would include an annual report, and anyone soliciting proxies must disclose conflicts of interest and
any major issues he expects to raise at the SH meeting. Must be extensive disclosure, file with SEC.

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e. Inclusion in MGMTs Proxy Statement: If SHs notice of proposed action conforms to proxy rule,
MGMT must include the proposal in its own proxy statement. If MGMT opposes the proposal, SH
may also give a statement in support of proposal, and MGMT must send it out w/ its statement. If
MGMT wants to omit proposals, they have to file with SEC, including reason. SEC will review &
agree/disagree. If agree, they issue a no-action letter.
f. MGMTs May Omit SH Proposals
i. Improper Action: Proposal is not a proper subject for action by the SHs;
ii. Business Operations: Proposal relates to ordinary business operations;
iii. Non-Corporate Purpose: Noncorporate purposes are personal claims or grievances, matters not
within control of issuer, matters not significantly related to issuers business, election of
directors, proposals previously submitted.
g. Lovenheim v. Iroquois Brands, Ltd. (1985) Relevance: Proposals will be includable
notwithstanding their failure to reach the 5% threshold if significant relationship to issuer's business
is demonstrated on face of resolution or supporting statement, such as non-econ factors ethical
issues.
i. Facts: SH in importing company submits proposal regarding methods of foie gras production.
ii. Held: Foie production otherwise significantly related. Shown significant relationship to
business.
h. AFSCME v. AIG, Inc. Basis For Exclusion/Bylaws: SH proposal does not relate to an election
under SECs exclusion rules from a proxy statement if it seeks to amend bylaws to establish a
procedure by which certain SH entitled to include in proxy materials their nominees for BOD.
i. Facts Corporation excluded proposal from proxy statement, and SH filed suit. Under SEC rules,
SH proposals must be included in a corporations proxy statement. However, one of those
exceptions is if the proposal relates to an election for membership on corporations board.
ii. Held: SECs prior, original interpretation of the rule controls and the exception does not apply to
proposals involving elections generally. AFSCMEs proposal regarding all future elections must
therefore be included in AIGs proxy statement.
i. Fiduciary Out Rule: Provisions in articles, bylaws, and amendments must include such provision
allowing BOD to escape pursuing the task, if it will force them to violate fiduciary duties. [CA]
j. CA, Inc. v. AFSCME SH Amending Corp. Bylaws: (1) Proper subject for action by SHs is
bylaw amendment that directs corporation's BOD to pay proxy expenses. (2) When bylaw
amendment proposed by SHs fails to allow directors to keep full FiDu power, determining if
reimbursement is proper but directs corporations BOD to pay back proxy expenses, corporation is
in violation of the law. [DGCL109 v. DGCL141]
i. Facts: AFSCME proposes bylaw that requires CA, Inc to reimburse SHs nominating board
members if they are successful in electing a director; CA asks SEC permission to exclude
proposal; SEC passes ball to DE court.
ii. Conflict: DGCL109(c) allows SHs to adopt bylaws, but DGCL141(a) gives directors power
to manage corp.
iii. Process v. Substantive Business Decisions: Process-related bylaws do not interfere with board
members prerogatives. SHs can propose new bylaws that concern corp. process and procedure.

XIV. MERGERS, ACQUISITIONS & TAKEOVERS

a. Level of Transaction
i. SH Level Transaction: Make offer directly to SH. [Tender Offer, Hostile Acquirer]
ii. Corporate Level Transaction: Cannot have total asset purchase without approval of BoD. Board
has to adopt merger proposal. Never going to be a merger that board members dont like.

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b. Statutory Merger DGCL251

i. 251(a): Two corporationss can merge.
ii. 251(b): Merger agreement (1) BOD agree to terms; (2) Mode of enacting terms; (3) Change
Cert of Incorporation; (4) Change COC in other context; (5) Shares; (6) additional provisions
iii. 251(c): SHs of each corporation must approve.
iv. State Law: Merger accomplished via procedure prescribed by state corp. law.
v. Parties: Two parties negotiate merger.
vi. Approval: BOD passes resolution approving agreement; terms spelled out in merger agreement.
vii. Surviving Company: Larger acquiring entity absorbs smaller target, only larger entity survives.
viii. Required Approval: Votes of BOD and SHs of acquired company. Sometimes SHs of acquiring
company vote if transaction is large (merger of equals).
ix. Appraisal Rights: Dissenting SHs of acquired company entitled to appraisal of stocks.
c. SH Approval DGCL251(c): Majority of SHs. Usually required on both sides. Not required if:
1. Short-Form Mergers: Acquirer gets 90+% of shares in target corporation [DGCL253]
2. Wholly Owned Subsidiaries: Certain exceptions apply. [DGCL251(g)]
d. Voting Approval Process
i. Target: BOD approval required. If board approval obtained, then approval by a majority of all
SHs (not just a majority of a quorum or a majority of the shares voted) required. [DGCL271]
ii. Acquirer: BOD approval only, or if sufficiently small, no approval at all. [DGCL251(b)]
iii. Exceptions Acquirer SHs: (i) Merger agreement does not amend articles of incorporation of
acquirer, (ii) Each share of outstanding stock in acquiring corporation remains identical share
after merger, and (iii) Shares issued or delivered by acquiring corporation under merger
agreement does not dilute outstanding common share by more than 20%. [DGCL251(f)]
e. Surviving Voting Rights DGCL251(f): Voting rights of surviving corporation nullified when:
i. Charter Not Modified: No amendment to acquiring corporations charter.
ii. No Security Exchange: The security held by the surviving corporations SHs will not be
exchanged or modified (no change in the shares owned).
iii. Outstanding Stock Increase: The surviving corporations outstanding common stock will not be
increased by more than 20% (wont be issuing more than 20% of total shares).
f. Merger: Two become one. When merger becomes effective, corporate existence of all constituent
entities shall cease. Show pre-merger entities and post-merger entities. Surviving entities have all
rights privileges powers and privileges of all corps in merger. All assets become part of New corp.
i. SH Voting: In most states, a valid merger requires a majority vote by the outstanding stock. The
default rule is that all classes of stock vote on a merger unless the certificate of incorporation
states otherwise. A corporation considering a merger always has to get approval of the SHs of
the target corporation.
g. Merger Agreement: Must specify what happens to old SH. They get cash return. Stock becomes
transferred into IOU. Merger = Private Eminent Domain. If requisite number of people agree
merger becomes effective. No consensus necessary among SH. Merger binding on all.
h. Short-Form Mergers DGCL253
i. Parent-Sub: Often used in parent-subsidiary situations.
ii. Sufficient Control: Once acquiring firm gained sufficient control of acquired firm (typically
90%), SH to cash out a minority unilaterally. Minority SHs still get an appraisal right (judicial
review of the fairness of the price).
iii. Required Approval: Only a board resolution (no SH vote).
iv. Appraisal Right: Minority SHs still get appraisal right.

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i. Sale of Assets DGCL271: Company buys most or all of the assets of another corporation. Sale of
substantially all assets is fundamental transaction for the selling company, requiring SH approval.
i. Total Purchase: Acquiring firm buys all (or substantially all) assets of acquired firm.
ii. Required Approval: BOD resolution, SH approval by target/selling corp., not acquirer.
iii. Appraisal Right: No appraisal right to minority (transaction concerns assets, not stock).
j. SH Dissenter Appraisal Rights DGCL262: Dissenting SHs in statutory mergers, short form
mergers, and freeze-out mergers entitled to appraisal by independent party. If the company is listed
on stock exchange, dissenting SH is bound by stock exchange price.
i. Exceptions For Both: (i) Stock listed on national securities exchanges or held by more than 2000
different entities [DGCL262(b)(1)]. (ii) SH voted in favor of merger [DGCL262(a)]
ii. Acquirer SHs Exception: Merger did not require SH approval under 251(f). [DGCL262(b)(1)]
k. Liquidation or Dissolution: Board approval is first needed. If board approval is obtained, the
liquidation or dissolution must then be approved by a majority of all SHs (again, not just a majority
of the shares voted). [DGCL 275]
l. Asset Sales vs. Statutory Mergers
i. Transfer of Assets and Liabilities: In a sale followed by liquidation, assets and liabilities transfer
through affirmative acts and agreements on a one-by-one basis. Liabilities only transfer to the
extent that the buyer is willing to assume them. In a merger, all assets and liabilities transfer by
operation of law.
ii. Tax Consequences: A sale followed by liquidation is generally taxable in the tax year in which it
occurs, unless the sale is for stock, in which case it is not taxable (but the issuer of the new stock
must file a registration statement). A merger generally qualifies as a tax-free / tax-deferred
reorganization.
iii. Proxy/Registration Statements: A sale followed by liquidation requires a proxy statement by the
target. A merger generally requires proxy statements from both parties and a registration
statement from the acquirer if any securities are offered as consideration.
iv. Appraisal rights: A sale followed by liquidation generally does not trigger any appraisal rights.
A merger generally triggers appraisal rights, but this differs by state and can get complicated
m. Appraisal Rights: Can grant appraisal rights when a corporation combines with another so as to
lose its essential nature and alter original fundamental relationships of SHs among themselves and
to corporation. SH does not wish to continue membership therein may treat his membership in the
original corporation as terminated and have the value of his shares paid to him.
i. Value: In appraising value of shares, the court determines the fair value of the shares, excluding
any element of value arising from the merger or consolidation. [DGCL262(h)]
ii. Forfeiture: A SH who has demanded appraisal right may not vote in the corporations election or
receive dividends or stock distributions. [DGCL262(k)]
n. Liquidation or Dissolution: Board approval is first needed. If board approval is obtained, the
liquidation or dissolution must then be approved by a majority of all SHs (again, not just a majority
of the shares voted). [DGCL 275]
o. Friendly Acquisitions + Problem Spots: Look for (i) Self-dealing (side payments to directors or
officers), (ii) Independent committees, (iii) Procedural formalities (SH approvals, proper disclosure),
(iv) Appraisal remedies. Appraisal generally only available to those who do not vote for transaction
and do comply with other procedural requirements.
p. De Facto Merger Doctrine: De facto merger occurs when transaction is not structured as a merger,
but is in substance a merger of seller/buyer. Meant to detect these transactions, usually as asset sale,

31

to prevent companies from avoiding assumption of seller's liabilities while enjoying all benefits of
merger. Minority rule; looks to substance over form. [Glen Alden PA]
i. Review Substance Over Form: Will review provisions of agreement and also the
consequences. To determine properly the nature of a corporate transaction, we must refer not
only to all the provisions of the agreement, but also to the consequences of the transaction and
to the purposes of the provisions of the corporation law said to be applicable.
q. Farris v. Glen Alden De-Facto Merger Doctrine: When a corporation combines with another so
as to lose its essential nature and alter the original fundamental relationships of the SHs among
themselves and to corporation, a SH who does not wish to continue membership may treat his
membership in the original corporation as terminated and have the value of his shares paid to him.
i. Facts: Glen Alden is failing company w/high tax loss. List is diverse holding company with 38%
of Glen Alden stock. Glen Alden buys all of Lists assets, issues stock to List SHs, changes
name to List Alden; present directors of both companies become directors of new company and
dissolve List. New company owned 75% by List SHs, 25% by Glen Alden SHs.
ii. Held: Glen Alden improperly deprived minority SH of right to an appraisal of their shares.
iii. Reasoning: Refer not only to all agreement, but consequences of transaction and purposes of
corporate law. Reorganization converted Glen Alden from mining company to diversied
holding company. Signicantly changed Glen Aldens capital structure, former SHs of Glen
Alden now own shares of corporation that is leveraged to a much greater extent than Glen
Alden.
r. Hariton v. Arco Electronics No DE De-Facto: In DE, courts accept that corporate MGMT can
structure a combination under any technique it chooses. Form trumps substance. When sale of all
assets, no appraisal rights. If you meet form, youre good. Court does not second-guess corporations
characterization of transaction. [No De-Facto Merger Doctrine In DE]
i. Facts: Similar facts/issue as found in Farris. The question is whether an asset sale and merger be
treated the same when result is nearly identical.
ii. Held: Less CT intervention the better, minority SHs know risk of asset sale = no appraisal
rights.
s. Statutory Formalities in DE: Each statutory provision is of equal dignity/independent legal
significance. When appraisal rights do not exist for sales, court likely to hold that a sale of assets,
even if it looks like a merger, not a merger. [Hariton]
t. Merger Protection: (1) Art. of Incorporation, require unanimous approval. (2) Buy-out
arrangement.
u. Getting Assets of Corporation: (1) Merge with company. (2) Proxy fight and elect people to BOD.
v. Triangular Mergers: Acquiring parent company forms and owns 100% a subsidiary company that
will be acquirer. Acquiring subsidiary merges with target, leaving acquiring parent owning surviving
corporation. Preserves limited liability since target not same corporation. If target defaults on loans
after merger, creditors cannot get to parent. If target is surviving corporation, then this is a reverse
triangular merger. If subsidiary is surviving corporation, this is a forward triangular merger.
w. Public Company Appraisal Rights DGCL 262(b): The target company is listed on a national
stock exchange or there are more than 2000 SHs. These SHs get appraisal rights unless the
consideration is one of the following: (1) Stock of the surviving corporation. (2) Stock of another
corporation that is publicly traded. (3) Or cash in lieu of fractional shares.
x. Appraisal Rights Checklist

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i. Type of Merger: Long form or short form, under short form, always get appraisal rights.
Basically, if you are a SH of a publicly traded corporation, that is engaging in a long form
merger that is giving shares as consideration, you do no get appraisal rights.
ii. Quality of Target: Public or nonpublic. If target publicly traded, might not get appraisal.
iii. Consideration Received: Shares or cash. With shares, you may not get an appraisal right.
iv. Tender: SHs that dont tender do not get appraisal rights if acquirer seeks tender offer.
y. Limiting Appraisal Cash DGCL262(h): When youre figuring out how much money a SH
should get from an appraisal right, youre supposed to remove any extra wealth from the
transaction. Dont want to give them value or it gets rid of incentive of doing the deal in first place.
XV. FREEZE-OUT MERGERS & ACQUISITIONS A technique by which one or more SHs collectively
hold majority of shares in corporation and gain remaining shares in that corporation. Majority SHs
incorporate a second corporation, which initiates a merger with original target. SHs using this technique
then in position to dictate plan of merger. They force minority SHs in original corporation to accept a
cash payment for their shares, effectively freezing them out of resulting company. Transaction not
protected by BJR because its a classic conflict-of-interest scenario.
a. Freeze-Out vs. Short-Form Merger: Short form, own 90%+ so dont need SH votes. In freeze-out,
own 50-89%, so need to invoke Weinberger Rule.
i. Possible Solutions: (1) Have majority of Co. B minority SHs approve merger. (2) Have an
independent committee of directors represent Co. B SHs.
b. Conflicts of Interest: Directors are on both sides of the transaction. Co. A wishes to pay minimum
for Co. B remaining shares but A controls Bs board, which still owes fiduciary duty to minority SHs.
i. Self-Dealing: Majority SH conducts freeze-out merger to purchase all shares owned by
minority.
ii. Merger at Arms Length: In general, mergers conducted at arms length only set aside if so
grossly unfair as to constitute constructive fraud, and plaintiff initially bears BOP.
c. Freeze-Out SOR: Plaintiff must (i) allege specific acts of fraud, misrepresentation, or other items
of misconduct that indicate unfairness, and must (ii) demonstrate some other basis for invoking the
fairness obligation. In Weinberger, court discovered evidence that some people valued for more than
$21, and there were some models that seemed to support this [Weinberger]
d. Basis For Invoking Fairness Obligation: Can be met by looking at totality of the circumstances.
Weinberger not limited to cases of deception or fraud, but also encompasses broader notions of
procedural fairness and fair dealing. [Rabkin].
e. BOP Shift To Corp: Defendant majority SH has BOP showing (i) entire fairness and (ii) either (a)
approval by informed majority of minority SHs, or (b) approval by independent committee of BOD.
f. Independent Committee: If an independent negotiating committee of directors dealt at arms length
and assessed the terms of the merger, this would be strong evidence of fairness. [Sanitizing Effect]
i. Approval By Informed SH Vote: Defendant majority SH also bears BOP showing vote was fully
informed and D completely disclosed all material facts. In Weinberger, D did not meet this
burden because did not disclose valuation report showing share value worth more than merger.
g. Why Weinberger Instead of Statutory Appraisal Rights
i. Injunctive Relief: You want something other than appraisal, such as injunction to prevent a
merger until price improves.
ii. Value of Stock: (1) In appraisal, you are entitled to value of stock at time of merger. (2) In
fairness can get value, as of today. So possibly more upside.
iii. Appraisal N/A: Sometimes a statutory right of appraisal is not available for a particular
transaction, but Weinberger is (since merger wasnt entirely fair). Sometimes deal structured not

33

as a statutory merger, but a sale of all assets followed by liquidation; there is no statutory
appraisal right here, but Weinberger is available. [Need Weinberger For Remedy]
iv. Appraisal Rights Not Perfected: SHs failed to follow the procedures under the statutory
appraisal provision, e.g., you voted for merger because of a lack of disclosure.
v. Tactical Strategy: Breach of FiDu in a merger allows you to bring class action, rather than going
alone in statutory appraisal. Hundreds of people in class might induce settlement.
h. Advising Signal in Weinberger
i. No Conflict on Valuation: Keep Signal people on UOP Board out of feasibility/valuation study.
ii. Special Committee: Have UOP form Committee, with real authority and bargaining power.
iii. Investment Advisor: Signal should hire new, independent investment banker to do valuation.
iv. Time: Signal should take time, deliberate, really negotiate, get improvement in price.
v. Corporate Formalities: Keep minutes of all this; elaborate process and record-keeping.
vi. Disclosure: Full disclosure to min SHs. Condition merger on MOM.
i. Entire Fairness Test: Two prongs when assessing Freeze-Out Merger. [Weinberger]
i. Fair Dealings/Fairness of Procedure: Procedure of merger must be fair as to adequate timing,
initiation, structure, inquiry, negotiation, sharing of information, duty of disclosure, complete
candor. Where majority SH is contractually required for a limited time to pay an above-fair price
should it want to conduct a freeze-out merger, but delays merger until just after time period
expires, this is manipulative conduct, triggering Weinberger inquiry. [Rabkin]
ii. Fair Price: No single technique for valuing stock, but valuation should be liberal, FMV, based on
all relevant factors, past and future performance. Objectively reasonable fair price [Kahn]. In
determining fairness of price, court looks to any techniques or methods generally considered
acceptable in financial community and admissible in court. [Weinberger]
j. Weinberger v. UOP (DE 1983) Freeze-Out Entire Fairness Test: Majority SHs have BOP
showing fairness of transaction, unless majority of minority SHs approve merger, where remaining
minority SHs shoulder BOP. Enough that you have fair dealing and fair price for the transaction, no
need to show valid business purpose. [Abuse of Corporate Process No Arms Length Transaction]
i. Facts: Signal owns 51% of UOP, controls half UOP board. UOP president former S officer. S
decides that acquiring remaining UOP stock up to $24/ share is good investment. Two S officers
who were also UOP directors, conducted a feasibility study. S offers $21/share, S and UOP
BODs approve merger at $21. Interested directors abstain but non-S UOP board members never
find out S would have paid up to $24/share. 51% minority SHs approve.
ii. Held: BOD breached duty of loyalty for not sharing relevant report with UOP SHs. Merger for
the sole purpose of freezing out minority SHs is abuse of corporate process. Also accounting
methods used to determine price of UOP did not meet the requirements of DGCL262.
iii. Reasoning: Where corporate action approved by an informed vote of a majority of minority
SHs, the burden entirely shifts to P to show transaction unfair to minority.
iv. Independent Committees: CT suggests independent committee to conduct negotiation (resolve
conflict of interest problems and satisfies fair dealings and fair price
k. Kahn v. MFW BOP Shift BJR: Where transaction involving self-dealing by controlling SH
challenged, applicable standard of judicial review is entire fairness with D having burden of
persuasion. Defendants bear ultimate burden of proving transaction with controlling SH entirely fair
to minority SHs. Even if you put mechanisms in place.
i. BJR Applies: (i) Controller conditions the procession of the transaction on the approval of both
a Special Committee and a majority of the minority. (ii) SC is independent. (iii) SC is

34

empowered to freely select its own advisors and to say no definitively. (iv) SC meets duty of
care in negotiating a fair price. (v) Vote of the minority is informed. (v) No coercion of minority.
v. Patriots MA Approach: In MA, a majority SH must show both that merger served valid
corporate objective unrelated to personal interests and transaction was fair to minority. This provides
more protection to minority SHs than DE law. Totality of the circumstances. [Business Purpose +
Entire Fairness Test $ to SH]
ii. Facts: D bought New England Patriots. D owned all 100,000 voting shares and put in his own
directors. Sullivan created second corporation, appointed same directors, voted to merge two
companies into new one. Defendants argued each class of shares approved merger.
iii. Holding: Merger unfair and illegal, but since merger ten years old, not reversed. Controlling SH
owed fiduciary duty to minority SHs, burden on Sullivan to prove merger furthered goals of
corporation rather than just his own interests and is fair to Plaintiffs. Sullivan failed to prove.
l. Rabkin v. Hunt Chemical Corp. DE Remedy + Independent Committee: Appraisal may not be
appropriate where showing of fraud, misrepresentation, self-dealing, waste, or gross overreaching.
Not about deception, but procedural fairness. If deception or bad faith, court reviews facts more
leniently in favor P. Cant K for premium then skirt obligation. [Appraisal Not Only Remedy]
i. Facts: T&N Inc. was majority SH of Hunt. T&N agreed to sell 64%interest in Hunt to Olin at
$25/share if purchased within one year. Olin decided to wait out the year and then offer
$20/share (after forming a committee to determine if $20/share was fair). Hunt minority SHs
filed suit alleging Olins offer grossly inadequate because he intentionally manipulated the
timing so he wouldnt be held to $25/share deal.
ii. Held: Plaintiffs facts demonstrate unfair dealing by Defendants as majority SHs to Plaintiff
minority SHs, but Plaintiffs unique circumstances. Trying to obtain a contracted-for price rather
than the appraised value) merit an alternative remedy. [Comment on Weinberger]
iii. Reasoning: Court combines K law with corporate law, recognizes fiduciary duty for Defendants
to not intentionally avoid commitment made to minority SHs under the initial purchase contract.
XVI. TAKEOVER DEVELOPMENT & TENDER OFFERS Whereas a merger requires board
approval, a takeover (an open market purchase of stock or a tender offer) may be executed w/o
approval. Although SH has a duty under both corporate law and federal securities law to disclose all
material information regarding offer, no duty to pay fair price. As long as a tender offer not coercive,
entering into such transaction is voluntary on part of minority SHs. If these SHs do not like price, they
remain SHs and force controller to cash them out, under which they will still have appraisal rights.
a. Friendly Takeover: Corporate level transaction. Board presumably thinks its a good deal.
b. Hostile Takeover: (i) Incumbent board does not sign off. (ii) Tender Offer. A hostile takeover occurs
when Co. A purchases the majority of stock of Co. B w/o approval and replaces its board. May occur
when A makes an unsolicited tender offer to B; or when Co. C is negotiating a merger with B, and A
swoops in to make an unsolicited tender offer.
i. Conflict of Interest: BOD at risk of losing their jobs with takeover, but SHs might get great
premium from purchaser. BOD supposed to act in best interests of SHs, not themselves.
ii. How To Make Takeover Friendly: (i) Build incentives in. (ii) Give executives some nice things
(iii) SH happy for the payment of a premium for the stock.
c. One-Tier Tender Offer: Bidder offers $X/share, hoping that SHs will accept offer. Sometimes a SH
will hold out for a higher price, which could interfere with acquisition. [Never Done]
d. Two-Tiered Tender Offer: Bidder makes first bid at higher price, and announces that once he obtains
51%+ of shares, he will offer less per share. SHs will likely take first offer out of fear of missing out.

35

e.
f.
g.
h.

i.

Condition offer held open for length of time and people tender shares. Conditioned on getting enough
shares. Want a total of 50.1% of shares. Stock: 50/share. Acquirer: 60/share now, $58/post-merger.
Tender Offer No DGCL251 Vote: When acquiring corporation borrows a lot of money and then
issues cash for a tender offer, SHs do not need to vote because it does not implicate DGCL251.
Usually sign that directors do not think SHs will vote for merger.
Golden Parachutes: Pay out millions to get person to stop fighting transaction. Built into employment
agreements, to make sure no fights over beneficial agreements, incentivize friendly transactions. These
people get big buyouts, and SH gets more money per stock this incentivizes premium for stock.
Tender Offer + Proxy Contest: Where BOD does not approve merger, SHs who desire it must mount
an effort to elect of BOD who will. This process of nominating and attempting an election of a slate of
insurgent directors is called a proxy contest or a proxy fight.
Federal Regulations of Tender Offers: See SEC Rule 14.
i. Rule 14d-10(a): Equal treatment of SHssame tender offer must be made to all SHs.
ii. Rule 14e-1(a): Bidder must hold tender offer open for 20 business days, reduces effectiveness.
iii. Rule 13e-4(f)(8): Prohibits issuer tender offers other than those made to all SHs. [Unocal]
Takeover Defense Mechanisms: Companies developed several defenses to hostile takeovers,
making it too expensive for acquirer.
i. Exchange Offers: Corp. issues notes or debt. Disincentive for acquirer because it loads company
with debt which ruins the valuation of the company.
ii. Stock Buy-Back: Purchase your own stock, at a control price. Expensive and means the
company will have to take on more debt and it could be a deterrent for a takeover.
iii. Crown Jewel Lockup: If deal falls apart, you have option to buy crown jewel asset.
iv. Poison Pill: When triggered, all SH except acquiring shares have option to purchase more stock
at a discounted price. This makes it easier for other SHs to purchase more stock, making it
harder and more expensive acquirer to get majority/control. [Option to Buy]
1. Timing: BOD can do this before or after tender offer is made.
2. Control: Can be adopted by BOD w/o SH approval; only BOD can redeem pill.
a. Dead Hand Pill: Only directors who were on the board when pill was adopted can
redeem the pill. [Invalid Carmody]
b. No Hand Pill: New BOD cannot redeem pill for 6-months. [Invalid Mentor Graphics]
3. Flip-In Pill: Allows non-acquiring SHs to purchase shares in own company, before merger,
at a deep discount. Dilutes shares, increases targets debt. As soon as target becomes more
than 15% owned by acquirer, SH entitled to buy more shares of company they already own.
a. One Step: Percentage of SH Ownership. [Overcomes Goldsmith Problem of Flip-Over]
4. Flip-Over Pill: A type of poison pill strategy in which SHs have the option to purchase
shares in the acquiring company at a deeply-discounted price. A flip-over pill is a SH rights
plan used as a defense against hostile takeovers, and is one of the more commonly-used
poison pill strategies. Rights plan can be included in the bylaws of the company, meaning
that it must be permitted by an acquiring company. (1) Percentage of Ownership; (2)
Merger.
5. Worth: Poison pill rights are usually worthless until hostile takeover/merger plan occurs.
6. Revocability: Built into the right is power to redeem them for a dime. So anytime before
someone actually acquires, the board can redeem the poison pill rights.
7. Fiduciary Duties: BOD must still consider tender if offer is fair and reasonable, even if the
poison pill is in place.
8. Policy: Gives bidder incentive to negotiate friendly offer.

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j. White Knight: Find a more attractive bidder who is friendly with MGMT.
i. Termination Fee: Usually significant.
ii. Option: Right to buy assets at discount if party drops deal.
iii. No-Shop Provision: Cant look for better bidders, DE discourages because limits SH wealth.
iv. Lock-Up Agreement: Guarantees white knight deal will go through
1. Pro: Good for acquired corporation because attractive bidder and good for white knight not
to waste time with risk he will be outbid in the end.
2. Cons: Since protects from third party bidder, might eliminate better offers.
k. Greenmail: Boards have broad powers to repurchase their own stock under DGCL160(a), and no
requirement of equal or pro rata treatment among SHs. When a corp. offers a greenmail premium to
re-acquire shares owned by a hostile bidder, certain duties arise because of conflict of interest in
that BOD may be acting to preserve control rather than protect corporation. [Cheff v. Mathes]
i. Lack of Usage: Not frequently used now, because (i) 50% tax on greenmail profits (IRC5881).
(ii) Many better defenses available.
l. Cheff v. Mathes (Del. 1964) Defense Standard/BOP: BOD bear BOP proving (i) motivated by
sincere belief buyout was necessary to maintain what the board believed to be proper business
practices. (ii) Business judgment rule kicks in when the directors prove a good faith and reasonable
investigation behind their decision. Intermediate standard slightly less than COI transaction.
i. Facts: Holland Furnace Company suffered declining revenues. Maremont inquired about
merger; Chef learned that Maremont dismantled and liquidated other companies; he declined
merger invitation. Maremont bought Holland stock and demanded seat on board; Chef refused
to give him seat on board; Maremont bought even more stock. Holland initiated defensive
measure, used company money to fund stock option plan, which drove up stock price and made
it more difficult for Maremont to acquire equity. However, Maremont initiated greenmailing
plot, where he agreed to sell back Holland stock to Chef for inflated premium price.
ii. Reasonable Grounds: Threat of liquidation or changing business model. [Door-to-door]
m. Tender Offer Threats: Inadequate price, nature/timing of offer, illegality, impact on SHs
(liquidation), risk of non-consummation (acquirer cannot pay), quality of securities (i.e. junk bonds).
n. Mechanisms of Corporate Control
i. First Mechanism: Fiduciary duties and derivative litigation to enforce such duties.
ii. Second Mechanism: Proxy contests. Using SH voting to replace poor MGMT.
iii. Third Mechanism: Market for corporate control.
o. Unocal Two-Prong Test: Not a fairness review, but heightened scrutiny that is a modified BJR test.
In enacting a defensive tactic, the BOD must prove both:
i. Investigation: Reasonable grounds for believing that a threat to corporate policy and
effectiveness exists.
ii. Proportionality: Reasonable relation between the defensive measure and threat posed. Balance
defensive tactic with threat.
p. Unocal v. Mesa Petroleum Co. (Del 1985) Enhanced Scrutiny: Evaluating defense to hostile
takeover, BOD must satisfy a two-pronged threshold for actions to fall within ambit of BJR: (i)
Reasonable grounds for believing that a danger to corporate policy and effectiveness existed because
ones stock ownership; and (ii) Defensive measure was reasonable in relation to threat posed. Court
must find real threat and defensive measure must be proportional. Threats do not include plant
closings and layoffs because this does not affect SHs. [Preservation]
i. Facts: Mesa attempts two-tier tender offer for Unocal, undervaluing stock and financing w/junk
bonds. Unocal directors adopt self-tender, triggered if Mesa gains control of 51% of stock,

37

whereby Unocal tenders cash for remaining stock (excluding Mesas shares)see Rule 13e-4(f)
(8). Unocal takes on debt to finance tender offer, thereby making it less attractive to Mesa.
ii. Holding: Selective tender offer was reasonably motivated by desire to defeat inadequate bid and
ensure minority SH received adequate payment. Both prongs satisfied, so BJR applies. Because
omnipresent specter board may be acting primarily in own interests, rather than those of
corporation and SHs, there is an enhanced duty which calls for judicial examination at threshold
before the protections of the business judgment rule may be enforced. Unocal test gives
directors significant latitude while allowing some closer judicial scrutiny of tactics.
iii. Rule 13e-4(f)(8): Requirement of equal opportunity to all SHs in the tender offer. Partially
overrules Unocal self-tender defense, excludes bidder, no longer permitted.
q. Revlon Duties: Once you determine that company going to be sold, BOD duty changes from
preservation (Unocal Duties) and changes to maximizing SHs interests once a corporation is for
sale, BOD job (Revlon Duties) is to be auctioneer and drive price up as high as possible.
r. Revlon v. MacAndrews & Forbes (Del. 1986) Appropriate Defense: Under heightened Revlon
standard, BOD not entitled to deference accorded by the BJR; rather, the BOD breaches its duty of
loyalty to SHs if it does not seek the best terms. [No BJR]
i. Facts: Pantry Pride wishes to acquire Revlon; PP makes offer of $40-45/share and Revlon
rejects it saying price inadequate. Revlon institutes initial defensive measures: poison pill and
self-tender (via Note). Tactics made PPs offer group to fair price. Revlon finds White Knight
(Forstmann) makes bid in return for (1) no shop provision, (2) $25 million cancellation fee if bid
failed, (3) crown jewel lockup, white knight was given right to buy valuable division of Revlon
at discount price if bid fails. Revlon accepts Forstmann, PP sues for injunction.
ii. Holding: Revlons initial defensive measures were reasonable under the enhanced Unocal
standard in order to protect against inadequate bid. Once Revlon sought out White Knight to
make competing bid, Revlon effectively put up for sale by BOD. Revlon duty attaches to
maximize the sale value, meaning same defensive measures no longer appropriate. Rather, BOD
must exercise fiduciary duties (care, loyalty) to get best price. Lock-up agreement inappropriate
because it arbitrarily truncates bidding process.
iii. Lock-Up/No-Shop Provision: While not per se illegal, impermissible under Unocal when BOD
primary duty becomes that of auctioneer responsible for selling company to highest bidder.
s. Revlon Triggers
1. Active Bidding: When a corporation initiates an active bidding process seeking to sell itself
or to effect a business reorganization involving a clear break-up of the company, OR
2. Abandon Long-Term Strategy: In response to a bidder's offer, a target abandons its longterm strategy and seeks an alternative transaction also involving the breakup of the
company.
t. Revlon Defense: If, however, the board's reaction to a hostile tender offer is found to constitute only
a defensive response and not an abandonment of the corporation's continued existence, Revlon
duties are not triggered, and Unocal duties are only triggered.
u. Paramount v. Time (Del. 1989) Clarifying Revlon + Applying Unocal: Directors not required
to favor short-term SH profit over an ongoing long-term corporate plan as long as there is a
reasonable basis to maintain the corporate plan. [BJR Applies When Breakup Not Imminent]
i. Facts: Time enters into merger negotiations with Warner Bros., whereby Time would retain
control of new company. As defensive measures, both parties agree to a share-exchange
program (no need to issue debt), a no shop-clause, and an agreement w/ banks not to finance
third-party attempts to acquire Time. Then Paramount makes surprise 11th hour bid: Time

38

rejects it as inadequate/a threat to Times corp. culture. Time and Warner make new deal
whereby Time takes on debt to purchase 100% of Warner stocks. [DGCL251(f) No SH Vote]
ii. Held: BJR applies to defensive measures once both prongs of Unocal are satisfied. Here,
directors are not obliged to abandon a deliberately conceived corp. plan for a short-term SH
Court finds Revlon analysis applies in two situations (three per QVC): (1) Target company
initiates active bidding process. (2) In response to bid, target abandons its corp. strategy and
seeks alternative bidder. Revlon does not apply b/c Time not putting itself up for
sale/abandoning strategy; Time-Warner negotiations did not mean dissolution or breakup of
Time inevitable. Times defense measures did not put Time up for sale.
iii. Unocal Duties Analysis: (i) Court found that there was a threat because selling to Paramount
would destroy the synergies, corporate policy and culture, (ii) Response was proportionate
because Paramount could still go through and buy Time-Warner.
iv. Unocal vs. Revlon Standard: When Unocal applied, deference to BOD. When Revlon applied,
BOD decisions scrutinized because merger inevitable and concern with maximizing SH wealth.
v. Paramount v. QVC (Del. 1994) Expansion of Revlon: If transaction leads to change of control,
Revlon duties. Lock-up agreement is invalid to extent that it prevents the board from exercising its
fiduciary duties to investors. [SH Lose Future Opportunity Control Premium]
i. Facts: Paramount and Viacom enter merger negotiations when QVC makes surprise bid; in
response, Paramount and Viacom enter into lock-up agreement: no-shop provision, termination
fee, stock option agreement whereby Viacom has option to purchase 20% of Paramount at low
strike price w/ subordinated debt or require Paramount to pay cash difference of market price
and option price (this would greatly reduce value of Paramount). QVC files suit.
ii. Reasoning: Revlon implicated because, while no bust up of company contemplated, Viacom
would be controlling SH, whereas in Paramount, control was in the market. Control premium
was going to be paid and creates a heightened possibility that management isnt going to protect
SHs. BOD had obligation to get best possible deal for the SHs under entire fairness analysis.
w. Cash vs. Shares: If merger consideration is stock/cash mix, closer it gets to cash, closer you are to
Revlon because its more like selling control since you have a diluted interest in the combined
company. [Paramount v. QVC]
x. Protecting the Deal: Standard way to lock-up deal nowadays is a termination fee. Also, exclusivity
provisions, where during certain periods, target companys directors cannot talk to someone else
while negotiating with primary suitor usually these provisions have fiduciary out clauses.
i. Termination Fees: Reasons for (i) Bad reason easy to facilitate entrenchment of the board. (ii)
Reimburse the first bidder for incurring the transaction costs of initiating the merger such as
research want to encourage this. This will justify a fee of around 3-4% of the deal. Cannot do
a preclusive termination fee under this justification. (iii) Want to entice the first bidder to
transact with you/trying to protect the deal for synergies but the question of how large a
termination fee this will allow is questionable.
ii. Termination Fee Revlon/Unocal: Have to analyze lock up provisions such as termination fees in
relation to Revlon and Unocal standards. If Revlon is implicated, then a termination fee above
3-4% will be disallowed because the synergies argument is not available.
y. Lyondell Chemical Co. v. Ryan Revlon Duties + Timing Of Deal: Revlon duties do not require
BOD to seek out competing bids, only that they get best price. Revlon duty to seek best available
price applies only when a company embarks on a transaction, on its own initiative or in response to
an unsolicited offer that will result in a change of control. Revlon duty does not arise simply
because a company is in play, it arises once negotiations begin.

39

i. Facts: Merger negotiation between Basell (bidder) and Lyondell (target). SHs claimed that under
Revlon the directors failed to get the best price for stock. No solicitation of offers.
ii. Held: Revlon duties do not require BOD to seek out competing bids, only get the best price.
Directors had a good idea of what corporation worth, drove hard bargain with buyer. Acted in
good faith. Under BJR court shouldn't second guess how directors came to their decision.
iii. FiDu + Revlon: Even assuming that the Lyon dell directors did absolutely nothing to prepare
for Basells offer, BOD took variety of steps designed to get the best price reasonably
attainable, including soliciting and following the advice of financial/legal advisors, attempting
to negotiate better deal, approving the merger at a blowout price too good not to pass to SHs.
iv. DOC + DOL: In order to meet Revlon duties, BOD must act with duty of care or loyalty/good
faith. DOC BOD did everything they should have. Under DGCL102(b)(7) directors are not
liable for breach of duty of care claims. DOL utterly fail to attempt to obtain best sale price,
breach requires conscious disregard of fiduciary duty.
z. Omnicare Modern Statement Of Unocal Analysis
i. Reasonable Grounds: BOD must demonstrate "they had reasonable grounds for believing that a
danger to corporate policy and effectiveness existed." To satisfy that burden, BOD required to
show they acted in good faith after conducting a reasonable investigation.
ii. Reasonable Relation: BOD to demonstrate that their defensive response was "reasonable in
relation to the threat posed." This inquiry involves a two-step analysis. BOD must first establish
that the merger deal protection devices adopted in response to the threat were not "coercive" or
"preclusive," and then demonstrate that their response was within a "range of reasonable
responses" to the threat perceived.
1. Coercive: If aimed at forcing upon SH a MGMT-sponsored alternative to a hostile offer.
2. Preclusive: If it deprives SH of the right to receive all tender offers or precludes a bidder
from seeking control by fundamentally restricting proxy contests or otherwise. If defensive
measures are either preclusive or coercive they are draconian and impermissible.
aa.
Omnicare v. NCS Unocal + Negotiated Acquisition: Heightened Unocal analysis applies
when a board deploys defensive measures to protect an original merger transaction, even when that
merger transaction would not result in a change of control (i.e., even when Revlon does not apply).
Lock-up agreement may be appropriate as long as not absolute and fiduciary out. There must
always be a fiduciary out clause, defensive measures cannot limit or circumscribe fiduciary duties.
Without fiduciary out, protection is preclusive and coercive. [Fiduciary Out Requirement]
i. Facts: NCS is a healthcare company, 65% of which is owned by its chairman and CEO. It has
$308 million in debt. Omnicare bids $313 million for NCS; NCS establishes independent
committee to assess bids. Genesis makes superior bid, seeks exclusivity agreement. Omnicare
make improved bid, which NCS uses to elicit better bid from Genesis, conditioned on no-shop
provision, termination fee, and provision that chairman and CEO use their 65% shares to vote
for it. Finally, Omnicare makes superior bid, and NCS withdraws support for Genesis bid even
though 65% of shares have already been committed because they are afraid accepting Genesis
will breach fiduciary duty.
ii. Held: NCS directors violated fiduciary duties by creating an absolute lock-up committing 65%
of vote in favor of Genesis which prevented them from considering superior bids. Defensive
devices fail Unocal test because preclusive and coercive. Consistent with QVC decision.
iii. Dissent: Majority errs in proposing a bright-line rulethese issues should be decided on a caseby-case basis. Moreover, without the initial agreement between NCS and Genesis, there would
have been no topping bid. [Leave King Parties Alone]

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ab.

Exercise of Corporate Power

i. Power Over Assets of Corporation: Actions involving the first type of power invoke the BJR, or
Unocal if an action is in response to a reasonably perceived threat to the corporation.
ii. Power Between BOD and SH: Actions invoke a Blasius analysis.
a. Stroud v Grace: DE held when BOD takes action with intent to strip SH of franchise,
must satisfy heavy burden demonstrating compelling justification.
b. Hilton: BODs action takes place in contest of an unsolicited tender offer, Unocal
provides basic SOR for BOD actions. In applying proportionality prong, courts treat
BOD action that purposefully disenfranchises SH as strongly suspect.
ac.
Hilton Hotels v. ITT Corp. No Disenfranchisement Rule: Even if a defensive action is
normally permissible, BOD adopts it in good faith with proper care, BOD cannot undertake such
action if the primary purpose is to disenfranchise SH in proxy contest. [Extension of Unocal]
i. Facts: Hilton announced tender offer for ITT. Hilton announced it would initiate proxy contest
at ITTs next annual meeting. ITT rejected Hiltons tender offer, constructed defensive plan to
split ITT into three distinct entities. Plan restructured ITT board of directors, keeping directors,
but staggering board into three classes and one class elected each year. ITT sought to implement
plan before its next annual meeting and without SH approval.
ii. Held: Comprehensive Plan violates power relationship between ITT's board and ITT's SHs
impermissibly infringing on SHs' right to vote on members of BOD. Court focuses on power
relationship between ITT's board and ITT SHs, not ITT BOD actions relating to corporate
assets. SH were stripped of right to vote, and entire comprehensive plan should be enjoined.
[Blasius]
iii. Unocal: First prong while inadequacy of an offer is a legally cognizable threat, per Time, ITT
has shown no real harm to corporate policy or effectiveness. Second prong installation of a
classified board for ITT Destinations, a company which will encompass 93% of current ITT's
assets and 87% of revenues, clearly preclusive and coercive under Unitrin.
ad.
Defensive Measures: Determine whether
i. Reasonable Grounds: Reasonable grounds for believing a threat to corporate policy. [Unocal]
ii. Reasonable Relation/Proportionality: Defensive measure is reasonable in relation to the threat
posed and is not be preclusive or coercive. [Revlon]
iii. Investigation: BOD can show good faith and reasonable investigation. [Unocal]
iv. Independence: Defensive measure approved by majority of independent directors. [Close Corp.]
ae.
Mechanisms of Discipline: (i) Fiduciary Duties, (ii) Proxy Contests (use SH voting to replace
BODs), (iii) Market for corporate control, if director manages poorly, threat of purchase.
XVII.
SH INSPECTION RIGHTS Pursuit of SH interests may practically require inspection of
some corporate records, especially the list of SHs. At CL, a SH had a right to inspect his corporations
books and records if he had a proper purpose. Imagine that you think the corp. I which you have
shares is being badly managed and you want to communicate with other SH about this. If you decide
you want to include your own slate of directors in proxy, then you cannot force the Corp. to include
that in its proxy materials, so you will need to solicit other SH to get on your side. [DGCL220]
a. SH Inspection: Access to corporate records such as SH lists must be permitted to qualified SHs on
written demand. Petitioner must furnish an affidavit that the inspection is not desired for a purpose
other than the business of the corporation, and that the petitioner has not been involved in the sale of
stock lists within last 5 years. Liberally construed. [1315 Business Corp. Law]
b. Rule 14a-7: Firm can either mail your materials on your behalf and then bill you later, or it can give
you the SH list. Most choose to mail on your behalf and keep the lists confidential. There is nothing

41

in fed law that forces the corp to give you the list, and it is not preempted by fed law, so these battles
for such lists are fought under state law.
c. Exception to Internal Affairs: This is important exception to internal affairs doctrine when it
comes to internal affairs of the firm, the laws of state of incorporation will control. [2RSTConflicts]
d. Crane Co. v. Anaconda Co. (1976) Inspection Rights: Court must determine whether purpose of
inspection falls within the business of the corporation (i.e., effects wellbeing and value of company).
If it does not, then no inspection right. [Proper Purpose]
i. Facts: Crane wished to make tender offer for Anaconda stock. Crane bought 11% of stock and
requested shareholder list so that it could approach individual shareholders w/ offer.
ii. Held: Informing stockholders of tender offer falls within business of corporationtherefore,
Anaconda must provide list.
iii. SEC: Under federal proxy rule 14a-7, a security holder, or tender offeror, may insist that the
issuer either provide her with a list of security holders or mail her communications to them.
e. State Ex Rel. Pillsbury v. Honeywell Proper Purpose: No absolute right to inspect. Because you
might have problem with MGMT, not necessarily proper biz purpose. Inquiry must be connected to
economic interest as SH, must concern corp. investment return. SH must provide a proper purpose to
inspect records other than SH lists. Mere desire to talk with other SHs not an absolute right.
i. Facts: P learned that Honeywell manufactured munitions for Vietnam War; solely motivated by
this knowledge, P bought 100 shares in Honeywell; P then requested SH ledger. No go.
f. NOBO List: Non-objecting beneficial owners. SEC requires corporation to compile list at request
and people can object to being listed. These people do not object to being listed (non-objecting).
g. Sadler v. NCR Corp. Proper Purpose + NOBO List: NY law (unlike DE law) authorizes the
compilation of a NOBO list upon request.
i. Facts: NCR is a computer company subject to takeover by AT&T; NCR implements poison pill
to stave off takeover; AT&T wishes to replace directors in order to deactivate poison pill; AT&T
needs more stock, and seeks NOBO list of SHs who consent to disclosure of their names (NCR
does not have NOBO list on hand, it would take 10 days to compile one).
ii. Later Amendment: NY law was later amended so that a corp. shall not be required to obtain
information about beneficial owners not in its possession.
h. Model Business
i. 7.01 Annual Meeting
ii. 7.02 Special Meeting
iii. 7.03 Court-Ordered Meeting
iv. 7.04 Action Without Meeting
v. 8.05 Terms Of Directors Generally
vi. 8.06 Staggered Terms For Directors
vii. 7.07 Record Date
viii. 8.04 Election Of Directors By Certain Classes Of SHs
ix. 7.20 SHs' List For Meeting
x. 8.08 Removal Of Directors By SHs
xi. 7.22 Proxies
XVIII.
CONTROL PROBLEMS & CLOSELY HELD CORPORATIONS Closely held, or
close, corporation has been referred to as the incorporated partnership. As with a partnership, closely
held corporations often, but not necessarily always, have only a handful of participants. Hallmark of
closely held corporation is owners desire to control identity of partners and keep ownership close.
Owners may wish to limit SHs to family members, employees, persons who live in the vicinity of the

42

corporations business, and the like. Usually, ownership is kept close through share transfer
restrictions that are often found in a buy-sell agreement , but also found in the articles of
incorporation or the by-laws. No secondary market readily available.
a. Public vs. Close Corporations
i. Public Corporation: (1) Dispersed SH, (2) Market for Shares, (3) Common Law/Fiduciary
Duties Govern
ii. Close Corporation: (1) Only a few SHs (DE Law: Fewer 30), (2) Controlled by SHs, (3) No
Market for Shares, (4) Governed by Contract/Voting Agreements
b. Stroh v. Blackhawk No Economic Interest Necessary + IL: Shares of stock do not need to be an
economic investment in the company; they can just be issued with voting rights. But, not vice versa
they cannot be denied voice in voting. [Illinois Law]
i. Facts: SHs claimed that the term proprietary in the definition of shares in the Business
Corporation Act meant a property right and that the shares must represent some economic
interest in the property or assets of the corporation. Corporation claimed the word proprietary
did not necessarily denote economic or asset rights
ii. Held: Stock is valid. Under applicable Ill. statute, a corporation may proscribe the relative rights
of classes of shares in its articles of incorporation, subject to their absolute right to vote.
Corporation has the right to establish classes of stock in regards to preferential distribution of
the corporations assets. SHs right to vote is guaranteed.
c. Voting Trusts: Voting trusts SH who wish to act in concert turn their shares over to a trustee. The
trustee then votes all the shares, in accordance with instructions in the document establishing the
trust. Trusts are often used to maintain control of a corporation by a family or group, when there is a
fear that some members of the family or group might form a coalition with minority SH to shift
control. Different from voting agreements bc there the agreements are by SH simply committing to
electing themselves, or their representatives as directors.
i. Statutory Provisions for CHCs.
ii. Involuntary Dissolution.
d. Voting Agreements / Pooling Agreement: These agreements provide that all signing shareholders
shall vote together or, in event of failing agreement, as a designated individual directs. Signatories
agree to pursue a common course of conduct as they agree, in the election of directors, or across the
entire spectrum of shareholder affairs, including amendments to the articles of incorporation and
major transactions such as merger, sale of assets or dissolution. In the event of failure to agree, a
stated consequence follows so that the pooling agreement is more than merely an illusory contract.
Cumulative voting can make sure BOD is allocated amongst different investors.
i. BOD Appointment: Courts usually have difficulty with SH agreements requiring the
appointment of particular individuals as officers or employees since such agreements do deprive
the directors of one of their most important functions.
ii. Specific Performance: Many statutes now expressly provide that shareholder voting agreements
shall be specifically enforceable.
iii. Breach of Agreement: Knowledgeable attorneys are careful to spell out in detail the
consequences should one or the other party-breach a shareholder voting agreement.
e. Ringling Bros. v. Ringling Voting Agreement: SHs can agree to pool their votes and third party
intercede when there is any disagreement as to how to vote.
i. Facts: Three SHs w/ cumulative voting arrangement, # of seats X # of shares = # of votes, so
that one can allocate votes however one likes. Two SHs align votes to outvote the third; enter
into voting agreement with two components: (1) Confer and vote together, and (2) Pool votes to

43

f.

g.

h.

i.

elect five directorsbut if they cant agree on fifth, an arbitrator will decide. Suddenly, second
SH aligns with third, and arbitrator picks fifth director.
ii. Held: SHs should be allowed to benefit as they see fit from their voting rights, and this often
means banding together to strengthen their position. However, the court decided not to
invalidate the voting and held the members that were voted by Haley and North would remain.
iii. Reasoning: First, voting agreement is valid. Second, nothing in agreement states that the
arbitrator can simply pick a director when the first & second SHs dont vote together, his role is
limited to resolving disagreements between them, not electing directors on his own.
McQuade v. Stoneham Limits On Agreements: Directors may not by agreements entered into as
SHs abrogate their independent judgment and ability to hire/fire directors. Directors must exercise
indep BJ on behalf of SH and when directors agree in advance to limit their judgment then SH dont
receive all benefits of independence. So must hold agreements like that void. [Minority SH]
i. Facts: Three SH (including one government magistrate) own shares of baseball club. Enter
voting agreement that requires three SHs to use their best efforts to elect one another to BOD.
Then one SH uses his power to fire another, who sues claiming violation of agreement.
ii. Held: The agreement is invalid. It is well-settled that SHs may combine to elect directors. But,
the power to unite is limited to the election of directors and is NOT extended to contracts
whereby limitations are placed on the power of directors to manage the biz of the corporation.
Clark v. Dodge Dialing Back McQuade: Court rejects the McQuade standard as too rigid and
arbitrary. McQuade rule is designed to protect minority SH who are not party to the agreement. Case
is not controlling when a corp has no minority SH, or the plaintiff is not a party to agreement.
i. Facts: Clark (25%) and Dodge (75%) are dual SHs of small medical corporation. Clark is active
manager and sole possessor of secret formula; Dodge is passive. Enter agreement where Dodge
agrees to vote to keep Clark as director w/ proportional income if Clark is faithful, efficient and
competent; as long as Clark later discloses formula to Dodges son. Dodge breaches agreement.
ii. Held: Agreement is enforceable.
iii. Avoiding Dispute: Including buy-out provision in employment agreement avoids situation.
Galler v. Galler 2d Cir.: Voting agreements are enforceable as long as they are signed by all SH
(and perhaps in situations in which any nonsigning minority SH cannot or does not object).
i. Facts: Two brothers equal partners in drug company. They enter into an agreement to protect
their heirs financially. Agree to pay limited dividends & salary to surviving wives, and to
nominate four directors, two brothers & their wives; when one brother dies, wife can nominate
new director in his place. One brother dies, and other brother does not honor agreement: freeze
out wife of dead brother.
ii. Held: Court analyzes all agreement provisions (dividends, salary, duration, directorships) and
finds agreement permissible b/c it does not hinder boards ability to function. Considerations in
assessing agreement (i) Public Harm; (ii) Objecting Minority Interest; (iii) Harm to Creditor.
Ramos v. Estrada CA Law: SH agreements, whether or not it is a close corporation, that require
SH to vote according to the will of the majority are valid. Under California law, corporation does not
have to be legally a closed corporation for any number of SH to enter into voting agreement.
i. Facts: Two groups were required to vote for BOD upon whom majority of each respective
ground agreed. Terms of agreement expressly state that failure to adhere to agreement
constitutes an election by SH to sell his or her shares pursuant to buy/sell provisions of the
agreement. Agreement also calls for specific enforcement of such buy/sell provisions.
ii. Issue: Distinction between a SHs agreement and a proxy (which can expire, must be changed
according to the will of the SH, and is otherwise subject to more rules).

44

iii. Held: Agreement valid despite the fact that the corporation at issue was not a close corporation.
iv. Reasoning: Court emphasizes that the statutes concern was to provide parties an opportunity to
reach an agreement in cases where, absent the agreement, the parties may be damaged by an
unforeseen event, such as a change in the majority voting block.
XIX. ABUSE OF CONTROL When majority frustrates minoritys reasonable expectations of benefit
from their ownership shares. A freeze-out does not need to be condemned at outset. But there are some
ways where problematic. Examples, when a minority is forced to sell shares at less than fair value,
depriving the minority SH of corporate offices and employment, refusal to declare dividends, may
drain corp earnings in issuance of crazy salaries to majority, pay high rent by corp for property leased
from majority sh. Best way to avoid problems associated with freezeout, create buyout.
a. Closed Corp. FiDu: SH of close corp owe each other duty of strict good faith and loyalty (as if
partners). And if challenged by minority SH, a controlling group in closely held has to show a legit
biz objective for its action. And minority SH, P can still prevail if can show majority can obtain that
biz objective in a manner less harmful than how they did it. If there was an alternate course of action
less harmful to minority. More strict than BJR, but less strict than other duties. [Intermediate Duty]
b. Wilkes v. Springside Nursing Home Intermediate FiDu: If majority effectively frustrates the
minoritys purpose in entering into the corporate venture and denies him an equal return on his
investment, we have a breach of fiduciary duties. [MA Law Labor + ROI]
i. Facts: Four men create closely held corp.; three freeze out one (Wilkes) by depriving him of
salary, firing him as director/officer w/o cause. Wilkes claims breach of fiduciary duty.
ii. Holding: Majority fails to satisfy first prong, no legitimate business purpose for firing Wilkes.
Majority was simply acting with ill will and attempting to deprive minority of stock return.
iii. Role of Dividends: In close corp, dividends take on more important role than in public. So long
as each investor works, the firm doesnt need to distribute dividends, because salary. Salary is
tax deductible, might be preferable to use salary, instead of issuing dividends. If firm distributed
salaries disguised as dividends, in losing his job, also lost his ROI.
c. Ingle v. Glamore Motor Sales NY Approach: A SH does not have a right to indefinite
employment in a CHC if there is an agreement which provides for termination rights. Minority SH
in CHC, who contractually agrees to repurchase of shares upon termination of employment for any
reason, acquires no right from corp. or majority SHs against at-will discharge. [NY Applies K Law]
i. Facts: Ingle, an at-will employee at Glamore, entered into shareholder agreement making him
director/secretary. Agreement included a termination clause giving majority right to purchase
back Ingles shares should he leave the corp. for any reason. Eventually, Ingle is fired and
deprived of stock (freeze-out).
ii. NY Court on Close Corporations: Rejects MAs proposition that a close corp. and partnership
are similar. Thus, fiduciary duties take back seat to contracts.
iii. Policy: Otherwise, creates disincentive to make employee a SH b/c it would result in additional
protections. Ingle agreed to this contract, he got his $ back, and thats where the inquiry ends.
iv. Dissent: Cites Wilkes, by treating the essence of plaintiffs complaints as a claimed breach of a
hiring contract by the employer rather than an unfair squeeze-out of a minority SH in a CHC by
majority, court simply concludes that P has no rights at all. Repurchase provision protected
Glamore in case Ingle left business, not to give Glamore the right to terminate him at any time
d. Brodie v. Jordan MA + Reasonable Expectations: Remedy for freeze-out should, to the extent
possible, restore to the minority SH those benefits which she reasonably expected, but has not
received because of the fiduciary breach. Remedy, however, cannot put the P in a significantly better
position than she would have enjoyed absent the wrongdoing. [MA Law]

45

e.

f.

g.

h.

i.

i. Facts: Classic freeze-out. Majority ices out minority, excludes him from day to-day operations.
Minority asked majority to buy back shares; majority refused.
ii. Reasonable Expectations: MA court backs away from legitimate business purpose test.
iii. Held: Forced buyout not permissible. Gives more than reasonable expectations. Forced buyout
would place plaintiff in a significantly better position because it creates artificial market for the
plaintiffs shares in a close corporation an asset that, by definition has little or no market
value.
Smith v. Atlantic Properties MA Majority Freeze-Out: Wilkes applies not just to majority SHs
but to anyone who controls the firm, so even minority SH can control and breach fiduciary duties.
i. Facts: Group of guys form close corp. to handle real estate property. Agreement includes 80%
majority rule: one minority member can thwart all majority votes.
ii. Held: Determining factor for fiduciary duty owed is whether party would considered
controlling. Because Wolfson was controlling, in that he alone prevented the dividend payouts
despite no real business justification, the court affirms that a fair dividend should be declared.
Wolfson was unreasonable and did not demonstrate utmost good faith and loyalty to the
business.
Nixon v. Blackwell DE Law: You have tools at front end when you decide to buy into a CHC and
it is not the courts job to bail you out if you fucked up and didnt protect yourself. [DE Law]
i. Held: Under DE law, if a company was designated a close corporation, then certain statutory
protection would apply to minority SHs. (DGCL342). However, the Court found that E.C.
Barton was not designated as a close corporation in their articles of incorporation, and so the
statutory protections did not apply to them. No fiduciary duty owed to other SHs.
Jordan v. Duff & Phelps 7th Cir. Fiduciary Duty: Failure to disclose violates Rule 10b-5.
Company must disclose material information. Under 10b-5, there is a causation requirement: must
show that misrepresentation/omission caused damages. [Fiduciary Duty To Disclose]
i. Facts: Employee enters into repurchase agreement w/ company, if leaves, corp. will buy back
shares according to most recent book value not always indicative of market value. P leaves
company w/o knowing company is in merger talks and has been valued at $50 million P shares
would have been worth 20 times as much. Merger falls through, replaced by another merger.
ii. Judge Easterbrook: Easterbrook believes former employee/SH was owed a fiduciary duty by
corp. Remand to find out if Jordan would actually have used info. [Abstain + Disclosure]
iii. Judge Posner: Disclosure would have been useless to him, so firm not under obligation to
disclose. If duff was public corp, with disinterested board, would be easier argument to make, bc
maximizing value for stock, and keeping info secret is good. The abstain/disclose rule does not
apply when SH cannot use info he receives. The terms of SH agreement here explicitly provided
that shares did not give Jordan any employment rights hence any kind.
Statutory Dissolution Provisions: These are cases where minority SH invoke special stat
provisions allowing the courts to order dissolution in certain circumstances and the general equitable
powers of the courts. Recall that one of the better ways to avoid a freeze-out problem is to include a
buy-out provision in SH agreement. In the event, there is none, an alternative provision may be
dissolution provisions. Where states have statutes that authorize the more drastic remedy of
involuntary dissolution, there, courts may infer the power to order the lesser remedy of a buyout.
i. CA Corp. Code 1800: Any SH can petition for dissolution in CHC. Circumstances where can
petition for dissolution. Board cant reach a decision and stuck. Theres some unfairness.
Pro of Stat: Forces majority to bargain with frozen out entity. Majority knows you have this power,
so will try to bargain with you to try to get SH not to use this remedy

46

j. NJ Stat Ann. 14A:12-7: Gives the court ton of discrepancy. Court can order the sale of corp stock.
acted oppressively and unfairly similar to CA. Court has lot of latitude to force one party to buy
another parties shares. Courts always describe this as an extreme remedy
k. Alaska Plastics v. Coppock Statutory: A judgment ordering a CHC to buy minority SHs stock at
fair value is appropriate remedy when provided for in incorporating documents. Court orders an
involuntary dissolution of the corporation, there is significant change in the corporations structure,
or if there is a breach of a fiduciary duty among the directors. [Dissolution Might Allow Buyout]
i. Facts: Three originals BODs paid themselves, never paid out dividends. Muir never got any
money. Most they offered her was $20,000, an accountant valued shares between $23,000$40,000. BOD failed to inform her SHs meetings, gave directors fees, and kept her out of the
loop. After numerous failed attempts to negotiate a purchase or settlement, she sued both
directly (personal action) and derivatively. She argues she deserves dividends.
ii. Reasoning: Ordinarily, there are four ways in which this can occur (1) Provision in the articles
of incorporation or by-laws. (2) Petition the court for involuntary dissolution of the corporation.
(3) Demand a statutory right of appraisal upon some significant change in corporate structure,
such as a merger. (4) In some circumstances, purchase may be justified as an equitable remedy
upon finding a breach of a fiduciary duty between directors/SHs, corporation or other SHs.
l. Dissolution vs. Exit Provision: Where two parties agree on an exit provision, if the court deems it
inequitable, and the requirements are met for stat dissolution, the court is allowed discretion to
override the exit provision and go with dissolution. [Haley]
m. Haley v. Talcott Dissolution Over Exit Provision: It was not reasonable for the LLC to continue
to carry on business in conformity with the agreement of the LLC. The parties were directed to
confer and, within four weeks, they were to submit a plan for the LLC's dissolution.
i. Facts: Haley and Talcott each owned 50% of a restaurant. They were organized as an LLC. The
LLC owned the land on which the restaurant sat. To get the land, LLC borrowed money, and
thus, there is a mortgage on land. Terms included an exit provision of the LLC allowed Talcott
to buy out Haley. However, Haley personally co-signed for mortgage on property, which meant
that even if he was no longer a co-owner, hed still be on the hook to pay back the mortgage if
the LLC went bankrupt. Haley sued for dissolution of the LLC.
ii. Held: Exit mechanism was not a reasonable alternative. It was not sufficient to provide an
adequate remedy to the manager member under the circumstances, as the manager would be
personally liable for the debt of the LLC. Manager member was entitled to a judicial dissolution
iii. Stryne Reasoning: Case presents conflict btw two basic principles of DE: 1) Freedom of
contract is in conflict with equitable powers DE courts have to strike down things that are
inequitable per stat. 2) If stat permits it, even if legal task, then court can strike it down.
n. Avoiding Haley Penalty Default: Put something in there that you know nobody wants. It would
function as a penalty, and force the party who doesnt like it to bargain over this and to make sure
there is more equitable provision. Forces parties to affirmatively choose whatever contract provision
they want. In Haley, Stryne in some ways creates a penalty default.
o. Pedro v. Pedro Buy-Back: Courts have discretion to review the reasonableness of exit provisions.
i. Facts: Brothers entered into a stock retirement agreement that allowed them to buy back shares
of a deceased brother at 75% of net book value. After the missing funds could not be located by
two accountants who were frustrated in investigation by Appellants, Appellants fired
Respondent and took away all his benefits. Respondent then brought this action, claiming
Appellants breached fiduciary duty owed to him, that he had a contract for lifetime employment.

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ii. Held: Entitled to fair value of his stock. Price his brothers bought from him was too low. So
entitled to the difference between the market value and SRA agreement/formula value. Entitled
to lost value of his wages based on fact he was employed for life. And entitled to attorneys
fees. Facts of the case at issue demonstrated a compelling case for the appraisal and sale of
shares back to the corporation from a SH who was treated unfairly. [Unfair Treatment]
p. Stuparich v. Harbor Furniture Involuntary Dissolution: An involuntary dissolution is an
extreme remedy that will be granted only when there is strong evidence of an abuse of discretion by
the majority. [Abuse of Discretion Involuntary Dissolution]
i. Facts: Malcolm owns majority of voting stock; upon mothers death, find out that Malcolm also
owns that voting stock. Sisters ask to buy out Malcolm-he refuses. Sisters want to separateMalcolm refuses. Malcolm, wife, and son all work for the corporation. Altercation between one
sister and Malcolm. Plaintiffs then brought this action to dissolve the company.
ii. Held: There was nothing illegal or abusive in Malcolm, Jr.s purchase (at a reduced rate) and
control of a majority of the company shares because Malcolm, Sr. is entitled to sell his shares at
whatever value he desires. There is also no right for a minority SH to force a majority SH to
purchase their shares if they are dissatisfied.
q. Auction Design
i. Standard Auction: English ascending price auction. Open-bidding, highest bid prevails. Public
auction.
1. Very easy to understand.
2. Winning bid is likely to be unrealistically high.
3. Good for seller, not buyer.
4. When only two bidders, it is good because you just need to bid 1 more than reservation price
of non-winning bidder. Lower than winning bidders reservation price.
ii. Blind Sealed Bid Auction: Each person bids, nobody knows what others are bidding, highest bid
prevails.
1. Not that difficult to understand.
2. Could just bid reservation price.
3. Winner whoever puts down highest price, but it is price you have to pay.
4. No windfall. No difference between reservation price and price you pay if you win.
iii. Vickery Second Price Auction: Sealed bid. But if you are the winner, you win but you dont pay
your bid. You pay second bid price.
1. Not tricky. Google used same version to price its IPO share.
2. Windfall for the bidder.
3. Virtue draws people into auction. Better for sellers.
iv. Descending Price: Seller starts high, and whoever jumps first, wins. Windfall all accrues to
seller, in way opposite of English auction.
XX. TRANSFER OF CONTROL What limitations on CHC SH who wants to sell share/transfer?
a. Fransden v. Jensen-Sunquist Agency, Inc. (1986): An agreement that gives a SH the right of first
refusal does not convey the right to control the sale of assets or liquidation of the company.
i. Facts: Jensen-Sundquist (JS) is closely held corp: few large SH and controlling SH. Fransden is
minority SH (8%): negotiates agreement with majority SHs: (1) right of first offer if the
majority SHs wants to sell its stocks, and (2) majority agrees not to sells stock unless minority
SH gets the same price. First Wisconsin, which wanted to obtain the Bank, offered to buy JS at
$88/share; Fransden objects, claiming right of first offer.

48

b.

c.
d.

e.

f.

ii. Held: There was never an offer to sell stock to Wisconsin. Wisconsin was never interested in
becoming a majority sh in Grantsburg. Thus the right of first refusal was never triggered.
iii. Reasoning: The right of first refusal is a right to buy the shares of the majority bloc in JensenSundquist if they are offered for sale, and there would be no offer of sale if Jensen-Sundquist
simply sold some or for that matter all of its assets and became an investment company instead
of a bank holding company. [Posner]
Invest Capital: Those who invest the capital necessary to acquire a dominant position in the
ownership of a corporation have the right of controlling that corporation. Absent looting of corporate
assets, conversion of a corporate opportunity, fraud or other acts of bad faith, a controlling SH is free
to sell, and a purchaser is free to buy, that controlling interest at a premium price.
Limitation on SH Power: Minority SH not entitled to inhibit legitimate interests of other SHs. It is
for this reason that control shares usually command a premium price. The premium is the added
amount an investor is willing to pay for the privilege of directly influencing the corporation's affairs.
Zetlin v. Hanson Holdings, Inc. (1979) Control Premium Rule: Minority SH are not entitled to
inhibit the legitimate interests of the other stockholders. It is for this reason that control shares
usually command a premium price. The premium is the added amount an investor is willing to pay
for the privilege of directly influencing the corporation's affairs.
i. Facts: Majority SH sold stock at premium. Minority SH sued, seeking a portion of the premium.
ii. Held: Zetlin loses. Plaintiff rule which would effectively mandate that a purchaser give a tender
offer to all SHs when they are only seeking a controlling interest in a corporation. The rule
change should be provided by the legislature and not the courts, but the current law has never
held that such a policy should be in place. There is nothing improper about selling a controlling
block at a premium.
Perlman v. Feldmann (1955) WWII Crazy: There is nothing wrong with a controlling SH selling
his shares, but FiDu will apply. [Controlling SH Premium Sale]
i. Facts: Feldman was chairman, director, president, and majority SH of Newport Steel (steel
producer). He negotiated sale of company to Wilport, a steel end-user, which sought direct
access to a supply-source during steel shortage of Korean War. Feldman received a very high
premium for his stock, whereas minority SHs did not.
ii. Held: Feldmans siphoning off for personal gain violated his fiduciary duty (as an
officer/director/majority SH) because sale of a corporate asset Feldman had duty to use asset for
gains of all. Minority SHs were left with earning less than if the merger never occurred.
iii. Dissent: Feldmann did not violate any duty here. As a majority SH, Feldmann is entitled to sell
his shares for the best price he can receive. There was no evidence that Wilport was going to
abuse their control or not act in the best interests of the other SHs. Similar position as in Zetlin,
which allows for a majority SH to get the best price for their shares without having to account
for any premium to the minority SHs.
iv. Note: Not clear whether the majority means that it was wrong to sell control at premium or it
was wrong for Feldman to sell in circumstances suggesting some harm to corps ability to engage
in interest free advances.
Essex Universal Corporation v. Yates (1962) Change of Control Provision: Where a SH makes
agreement to sell shares AND board positions, might not be against public policy, if the SH is a
majority SH, and by selling his shares, it only accelerates the process of new buyer getting his
people on BOD. Threshold of how much is majority is discussed below between judges.
i. Facts: Yates was president, chairman, and majority shareholder (28.3%) of Republic Pictures;
sold stock, at control premium, to Essex. Essex requested a contract guaranteeing resignations

49

of majority of directors on board. There was a staggered board, 6 and only 1/3 of directors
came up for election each year. Essex didnt want to wait, requested immediate control.
ii. Issue: Whether the stock purchase agreement is invalid because it provided for the termination
of prior board members and subsequent control of management for Plaintiff.
iii. Lumbard Held: P loses. Holding such agreements to be illegal and thus requiring purchasers of
majority stock interests to wait until assuming control would discourage the easy and efficient
transfer of corporate control that is generally beneficial to the economy. There is no apparent
policy reason to forbid a purchaser of a majority stock interest from taking control. Accordingly,
the provision in the Yates agreement transferring immediate control to Essex is lawful.
iv. Clark: Just issued a concurring opinion, nothing novel here.
v. Friendly Dissent: Directors owe a fiduciary duty to the corp. A director has to elect as a
replacement director the person who will serve interests of corp in best manner. A contractual
obligation to replace old board with nominees of new guy would violate public policy unless the
new guy is buying a clear majority, more than 50%, and it would be entirely plain that a new
election would be a mere formality.
XXI. INSIDER TRADING Insider trading involves use of nonpublic information by any person having
a relationship (director, officer, attorney) giving access, directly or indirectly, to information intended to
be available only for a corporate purpose and not for the personal benefit of anyone. By use of the
information to trade or to tip others who trade, such person makes a gain, or in the case of trading on
negative news, foregoes a loss by remaining silent when there is a duty to speak. Prohibited per 10b-5.
a. Rule 10b-5: Has been the general antifraud rule applicable to the purchase or sale of any security.
The rule prohibits material omissions or misleading statements, whether oral or written.
b. Who Is Harmed
i. The Stock Seller: One way to look at it, is if you bought this from someone, who if they held
onto it, they would have made the money, not you. So to extent that I am making profit,
somebody is getting screwed.
ii. General Market: Makes market nervous. Might be reluctant to buy/sell. Unverifiable claim, that
existence of insider trading can diminish confidence in market, but does not mean it is wrong.
iii. Potential Buyer: Could make acquisition more expensive for you.
c. Duty to Disclose: There is no duty to disclose when the information is speculative, and it is not a
face/face transaction, but is done on open market. There is no fiduciary duty owed by directors to
individual sh. Their fiduciary duties are only towards the corp.
d. Goodwin v. Agassiz (1933) Pre-SEC: There is no duty to disclose when the information is
speculative, and it is not a face/face transaction, but is done on open market. No fiduciary duty owed
by directors to individual sh. Their fiduciary duties are only towards the corp. [State Law]
i. Facts: Officers/directors at exploratory mining company had inside info regarding new ore
deposits; bought stock in company anticipating increase in stock value.
ii. Issue: Whether Defendant, as president and the purchaser of Plaintiffs shares, owed Plaintiff a
duty to disclose information that would affect the value of the shares.
iii. Held: The trading was ok. (1) D owed duty to corp, not to its SH, they had no duty to disclose
info to plaintiff, provided they bought on stock market and wasnt face/face, (2) Info they had
was speculative. (3) There was no fraud or wrongdoing alleged here.
e. Development Of State Common Law Of Insider Trading: Three distinct rules emerged as insider
trading law developed.

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i. Under Majority Rule Of No Duty Rule: Liability was based solely on fraud. You are selling me
stock and you ask me is this company going to merge soon, and I say no, even though I know
somebody is. Have to obstruct the plaintiff from finding things out.
ii. Modern Rule: Came from Georgia Oliver v. Oliver. Minority rule; duty to disclose. Directors
had duty to disclose all material info to sh before traded on that info.
iii. USSC Offered Third Alternate Special Facts/Circumstances: Under this rule, although
directors generally owe no duty when trading in securities, a duty can arise under special
circumstances, and the Strong case identified the two most important fact patterns for when
special circumstances: (1) Concealment of identity; (2) Failure to disclose significant facts that
would have dramatic impact on stock price
f. State Law: All state insider trading laws apply to chcs. Federal law is more important for public
companies. Common law generally focuses on harms to individual shs, where fed is less concerned
with individual shs, and more concerned about market in general.
g. Van Shack: Modern case of CHC insider trading. Owned property acquired by city of Denver. P was
widow of a member of van shack family. Even though she was holder of single largest block of
shares, was not an officer and wanted to sell her shares. A family member who was a director,
misrepresented the facts to the widow about the property being sold for airport. Offers to buy out
widow for 1.5m. Court held that failure to disclose the info as part of that sale was a violation of that
directors fiduciary duties and awarded a judgment to widow for 750k in addition to what was
already paid.
h. SEC 10(b) and Rule 10b-5: Rule 10b-5 makes it unlawful for any person in connection with the
purchase or sale of a security: (a) To employ any device, scheme or artifice to defraud. (b) To make
any untrue or misleading statement. (c) To engage in any act, practice or course of business which
would operate as a fraud or deceit on any person.
i. Omission of Fact: "an omitted fact is material if there is a substantial likelihood that a reasonable
SH would consider it important in deciding how to vote."
j. Insiders Cannot Have Advantage Rule: Insiders can not act on material information (information
that a reasonable man would deem important to the value of the stock) until the information is
reasonably, publicly disseminated.
k. Abstain/Disclosure Rule: Either the company can keep it quiet and no one trades, or tell everyone,
and then everyone can trade.
l. SEC v. Texas Gulf Sulphur Co. (1969): Court announces the abstain or disclose.
i. Facts: Similar fact set to previous case. Directors of exploratory drilling company attempt to
quell rumors about mineral discovery while simultaneously buying up stock in company.
ii. Holding: Court here holds that insiders who traded prior to public dissemination violated.
Whether company violated rule is unclear, but the court of appeals holds that press release was
calculated to influence investors. And that is enough.
m. Chiarella v. US (1980): The rule applies only to insiders who commit fraud, those with a fiduciary
duty to the corporation. The duty to abstain arises from the relationship of trust between a
corporations SHs and its employees; thus insider training is ostensibly rooted in fraud theory. Here,
Chiarella owed no duty to company; no duty to disclose = no fraud. [Narrow Disclose/Abstain Rule]
n. Tipper/Tippee Liability: (1) Has tipper/insider breached fiduciary duty? There is no breach unless
insider expects to profit directly or indirectly from passing along info. Giving out information for
free breach of duty/insider trading. [Personal gain includes nontangible benefits] (2) Does
tippee/outsider know about breach of duty? If the insider has breached duty, and tippee knows or

51

o.

p.

q.

r.

should have known about breach, the tippee is liable. If, however, the insider has not breached duty
(or tippee does not know about it), then tippee is not liable.
Dirks v. SEC (1983) USSC: An outsider can be liable for insider trading. But here, Dirks (as
tippee) was exonerated for liability. [Exposing Fraud]
i. Facts: Dirks is research analyst who exposes fraud at insurance corporation, warns others about
companys misdeeds; those people sell their shares in company. Dirks is a tippee, not an insider.
ii. Held: Section:10(b) should not be read so broadly as to hold tippees liable when they use inside
information received by insiders who were not breaching their fiduciary duties in their
disclosure. The Court held that the insider must first breach a fiduciary duty and then the
tippees conduct will be examined to see if they breached a duty.
iii. Dissent: Reasoned that the SHs are injured when anyone else benefits from information not
publicly disclosed, so the court should not distinguish between information given to tippees
from insiders breaching a duty from those who are not breaching a duty.
Post US v. Chiarella: Left open the possibility that many nontraditional insiders would be able to
profit unfairly from their positions. While SEC Rule 14e-3 required no duty and could be used
against individuals trading on information about tender offers, other outsiders who wrongfully
received non-tender offer information that could affect share prices had no duty to SHs on the
opposite side of share trades. Often these outsiders have stolen or misappropriated market
information from one source in order to purchase shares of other corporations in which they owe no
fiduciary or similar duty to anyone. Arguably, under Chiarella, no duty to those with whom one
trades means no Rule10b-5 insider trading liability. To remedy this situation courts developed the
misappropriation theory
Misappropriation Theory: Person commits fraud in connection with a securities transaction, and
thereby violates 10( b) and Rule 10b-5 , when she misappropriates confidential information for
securities trading purposes, in breach of a duty owed to the source of the information, rather than in
breach of a duty to the investor on the opposite side of the trade, as in the classical case of insider
trading. Not a catchall. Instead, it is the last on a list of four ways to define insiders or their
equivalents upon whom the disclose or abstain prohibition is visited.
U.S. v. OHagan Misappropriation Theory: Insider trading under the misappropriation theory
satisfies SEC Rule 10b-5s requirements of fraudulent practices. [Almost Overrules Chiarella]
i. Facts: OHagan is partner at law firm that represents Grand Met, which is planning to make a
tender offer of Pillsbury. OHagan buys Pillsbury stock. OHagan owes a fiduciary duty to
Grand Met (hes an insider), but not to Pillsbury (hes an outsider)so it cant be said that he is
violating a fiduciary duty under the Disclose or Abstain Rule (i.e., he is not trading stock of
company in which he is an insider).
ii. Held: OHagan had duty to source of the information. He violated this duty in connection with
the sale of a securityi.e., defrauded the insiderand is ostensibly liable under 10b-5. CT
upheld misappropriation theory. If an outsider acts deceptively toward an insider when
misappropriating confidential info for securities trading, he may be liable under 10b-5. In such a
case, the outsider acts in breach of a duty owed to the source of the information.
iii. Outsiders Duty to Keep Info Confidential: Under SEC Rule 10b-2 (1) A person agrees to
maintain info in confidence. (2) Person who has history, pattern, or practice of sharing
confidences with possessor of the info. (3) Person who receives info from a family member
(spouse, parent, child, or sibling).
iv. Rule 14e-3: Prohibits insider trading relating to a tender offer (no need to establish breach of
fiduciary duty).

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v. Current Law: Think of OHagan as superseding dirks. OHagan is summative statement, but
might need to refer to Dirks to see about application.
s. Foundations for Insider Trading
i. Disclose or Abstain Rule: Fiduciary/insider.
ii. Misappropriation Theory: Outsider with duty to insider.

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