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AGENCY

Rule: According to RSA 1(1), agency is the fiduciary relationship that results from (i)
the manifestation of consent by one person (the principal) to another (the agent) (ii) that
the agent shall act on the principals behalf (iii) and be subject to the principals control
and (iv) consent by the agent to so act.
Binds by principal by words or action.
o Manifestation of consent is objective and required for agent and principal
o Parties may unintentionally fall into agency relationship the key is being subject to
the principals control
Gorton v. Doty Doty authorized Garst to driver her car and exercised sufficient
control to establish agency relationship by saying Garst is only one who can drive
condition = control
Note: Consent was good enough for ct solely by coach driving and solely
by doty giving keys.
Cargill Cargill exercised sufficient control of its debtors business to be liable as
principal by placing supervisor on sight and having veto power over all transactions
(totality)
By contrast, veto over specified amounts OK
Manifestation by P (Cargill) for Warren to act on its behalf subject to
Cargills control. Was Warren acting subject to Cargills control?
o Agents liability on the contract (undisclosed principle)
Atlantic Salmon Curran purchased salmon from P, but did not disclose he was
acting on behalf of a corp. Curran liable. P deprived of ability fully evaluate the
contract. Must disclose that there is a P.
If principle is undisclosed to 3rd parties, actions taken by agent in furtherance of the
Ps business binds the P (agent is also bound!) Watteau v. Fenwick
UP is liable for acts of A done on UPs account, if usual or necessary in
such transactions, although forbidden by the UP.
1. Types of Authority conferred to Agent:
a. Express/Actual what P expressly told A he can do
b. Implied Incidental to what P expressly told A he can do (emanates from express
authority)
a. Mill Street Church v. Hogan Hired brother in past; Church knew job required
help; Helper suggested by church was unavailable. Church was liable when brother
got injured.
c. Apparent Look at Ps manifestations to 3rd party and whether 3rd party reasonably relied
a. Hogan had been hired in past salary paid then and now. From Sams
perspective, Bill had authority
b. Three-Seventy Leasing v. Ampex Ampex (principal) articulfated to Joyce (3rd
party) that Kays (agent) would handle the sale Joyce relied by corresponding w/
Kays (who had the apparent authority)
i. Apparent Authority when principle acts in a manner as would lead a
reasonably prudent person to suppose that the agent had the authority to
bind his employer to sell.
d. Inherent Based on job title
a. Watteau he had the authority to buy beer, but not cigars, then he bought cigars
2. Fiduciary Obligations of Agents Duty of Loyalty
o Agents duty to be fair/honest/exercise food faith in dealing w/ P Avoid COI, competing
with P, etc.
o

Common issues: (1) Secret Profits, (2) Usurpation of a business opportunity, (3)
Conflict of Interest
o Test Agents behavior resulted in financial gain for agent to the financial detriment of
principal. Both parts are required. If A referred away business for no personal gain, there
would be no breach.
A. Secret Profits A accountable to P for profits obtained b/c of As position and w/o Ps
knowledge
a. Reading v. Regem Soldier would not have received kickbacks for transporting
contraband across check point but for his position as an army employee/having
uniform P (Govt) entitled to profit, even though no loss. PP: Loyalty
B. Duty to Disclose Disclosure by A is essential when benefitting financially from position in
a transaction or knowledge acquired b/c of employment
a. Rash v. J.V. Intermediate Agent breached fiduciary duty by not disclosing that
he was on both sides of a transaction in which P was purchasing scaffolding
subcontractor. A used P to benefit personally.
i. Disclosing allows P to supervise and make fully informed decision
C. Duty Not to Compete (including Grabbing and Leaving) May not solicit former
employers customers (during or after employment) if those customers patronage
secured through extraordinary efforts. Non-competes enforceable if reasonable in terms
of: (1) scope of time; and (2) geographical limitations
a. Town & Country Former employers liable for breach of FD duty when started
own home cleaning company and specifically targeted former employers
customers who had been secured through extraordinary advertising and years of
business effort
b. Brazilian straightening hypo maybe not unfair competition (they go to him for
straightening).
o Relief for breach: Injunction; Damages measured by financial loss to P; % of: As profits
or As business
o Other duty owed by agents duty of care duty to act like reasonable business person

Types of Businesses
o

Sole Proprietorship: Unincorporated business that is owned and operated by one


person.
General Partnership: DIST from Sole Proprietorship. Two or more ppl share profits and
control, 202.
Registration. No formal filing with the state is requiredthe agreement between
the parties is effective. 103, Unif. Partnership Act. Nor is the agreement
required, only the definition (i.e., shared profit and control) in 202.
Relationship between and Power of Partners.
o Each partner has the power to bind the partnership/other partners when
they enter into contracts.
o Each partner is personally jointly and severally liable, unless there is an
agreement that at least one will be. Uniform Partnership Act, 306(a).
Duties. Partners have a duty of loyalty and care. 404(a). Also apply to LPs.
Partnership opportunity parallels corporate opportunity. 404(b).
Partners shouldnt compete with the partnership. 404(b)(3).
Partners have a duty to care to not engage in illegal or grossly
negligent conduct.
Dissolution. Dissolves under state law when one partner dies/retires/becomes

Limited Partnership1. DIST from General Partnership. One category of partners enjoy
limited liability.

1. Registration.
A filing with the Secretary of State called a statement of qualification
is required.
2. Relationship between and Power of Partners. There are two types of
partners:
o a. Limited partners.
Liability. Enjoy limited liability (so, only their investment in the
company is at strake)
Role: Must remain passive or leave liability shield and become GPS
o b. General Partners
Liability: Same as gps in general partnership, assets can be reached.
Note: NEEDS ONE GP. Can be corp who will assume personal liability
(Frigidaire)

Corporations

Hold legal status as person.


Categories:
o Public: >1mill in assets >500 shareholders.
Law: State law governs incorporation, must also comply with
federal law
o Closely held: Not significant assets and few shareholders
Law: State law governs small corps, but if have securities,
federal law applies.
Registration:
o Basic corp document: Must be a public document (charter, cerif. Of
incorp., articles inco
Name of corp
Address of corp
Names of Incorporators
Capital Structure
Purpose (any lawful purpose)
o By laws: private doc that sets forth internal rules
o Coprorate kit of standard forms for each state is filed with SOS, who
returns certificate
o Organizational meeting: Founders draft bylaws, adopt bylaws, and
elect directors
Directors appoint officers
Sell stock (subject to security requirements)
And file corporate name
Role of Shareholders:
o 1) Elect directors, residual owners of the company
o Liability: Shareholders are perfected from PL. All PL is limited to
investment amoun
Defining Features: More than 2 features is subject to corp law and taxation,
regardless of what it calls itself
o 1) Limited liability for
shareholders (ease of raising capital) and
o 2) Centralized management:

officers (day to day) and directors (manage for shareholders the


officers and make long term strategic decisions): subject to
fiduciary care breach
3) Continuity of life: survives the departure of indiviiduals
4) Free transferability

o
o

Role of Corporations

A.

B.

Primary objective: shareholder wealth maximization (Dodge v. Ford) Directors owe


fiduciary duty to shareholders to maximize profits ( can ignore society, employees,
officers, but not sh.holders)
o Board not required to change working strategy to potentially earn more profit
o Can be other important interests, but if conflict, s/holder profit maximization
must prevail
o But See ALI principles of corporate governance
Objective should be to enhance corporate profit and shareholder gain.
May devote a reasonable amount of resources to charity (even if
corporate profit not enhanced)
NOTE: Public Benefit Corporation S362 DGC: NY and CAL also has
90% of shareholders must approve. Other 10% get fmv. Name
must contain PBC
Balances stockholders pecuniary interests, the best interests of
those materially affected by the corps conduct (employees), and
the public benefit Operate in sustainable manner
Social Responsibility (CTS usually refer to corp through BJ Rule)
NEW JERSEY A corporation may make reasonable charitable contributions that
benefit shareholders, provided its not a pet project. Donations limited to 1% of capital
and surplus by statute.
A.P. Smith v. Barlow A donation made to Princeton was reasonable and
helped strengthen the companys relationship with the University which
would hopefully lead to top grads joining company
DELAWARE Making contributions is a specific power of the corporation, but is subject
to corporate benefit (ie. some profit maximizing rationale). As long as serving
corporate benefit the donation may serve a laundry list of purposesscientific,
educational, emergency relief, etc. (tolerant, can be tenuos).
NEW YORK Contributions are within corporations authority irrespective of corp
benefit
a. Factors to consider (from A.P. Smith v. Barlow) Was donation:
1. Discriminately (opposed to indiscriminately) made
2. Made to pet charity of directors
3. Modest in amount and well w/in statutory limitations (if applicable)
4. Voluntarily made in the reasonable belief that it would aid the public welfare and
advance the interest of the corp in the community (ex. of benefits good will;
tax benefits)
Pennsylvania: Not just charitable, but can be communitarian because directors not
liable under consumer live (no fiduciary duty). Has to benefit something, not just
sholders
Social Responsibility v. Irrationality
o Although a corps directors have discretion in the means they choose to make
products and earn a profit, they may not reduce profits in order to benefit the
public Dodge v. Ford SUBJ Breach of good faith

There, Fords decision to lower prices, and not issue dividends, was found
to be irrational and thus, not protected by the BJR. Cannot operate
corporation like a non-profit organization.
However, Ford did not do a very good job in articulating his position as a
business decision (lowering prices to increase demand; drive out
competition; customer loyalty; etc.)
o A corporations decision that benefits the community may not be challenged
unless the conduct is causing financial loss the s/holders and involved one of the
exception to the BJR Shlensky v. Wrigley OBJECTIVE
The court gives BJR protection because there is no fraud, illegality, or
irrationality.
There, we see much more importance placed on being responsive to
community
Wrigley presented decision as economic/business decision P should have
presented evidence that night games would provide economic benefits &
increase in revenue would offset cost of installing lights. Also deference of
judges to BJ
ALI Even if corp profit and s/holder gain are not thereby enhanced, the corp may
devote a reasonable amount of resources to: public welfare, humanitarian,
educational, and philanthropic purposes
More in line with reasoning of Wrigley than Dodge

Negativ externalities: Corp law requires board to place shareholders first. Externalities are
costs created by doin this: pollution, union busting, consumer risks, layoffs. LLC
incentivizes investment but results in these. Positive externalities exist when benefits go
to non-shareholders.
The Nature of the Corporation
Promoters
After corp filing article of incorporation they go to the Secretary of State for review
There may be a period of time when someone wants to act on behalf of the business, but the
business hasnt been incorporated yet (articles are pending review, etc.) Ex. Sign a lease for
an office space; buy inventory from 3 party
PROMOTER Investor, etc. representing and acting on behalf of the unincorporated business
(afgent)
o Promoter is personally liable UNLESS the party to the contract knows the corporation
is not in existence but nevertheless agrees to look solely to the corporation and not
the promoter
o Once a corporation is chartered by state It needs to ratify the promoters transactions
Can be express (agree verbally to be liable) or implied (pay employee and
accept benefits)
Promoter still on the hook unless there is novation (Rare)
THEORIES OF PREINCORP LIABILITY Defective Corporations (we have this to protect
shareholder assets)

De jure corporation Filed articles of incorporation and received charter but have not
completed all necessary steps to organize corp (adopt bylaws, issue stock, hold the
organizational meeting) Recognized as corp for all purposes
De facto corporation Partially-formed corporation, that when invoked, leads to court treating
the business as if it was a corporation for purposes of adjudicating the rights and duties of
private parties, even though the statutory formalities for formation of a corporation have not
been met. You have done everything not your fault.
o Steps: 1) Analyze from promoters perspective 2)GF effort to incorporate 3) Legal right
to incorp 4)Act ascorp
o Impact: Ct will consider it a corp with LL
Corporation by estoppel 1) one who contracts with what he think to be and treats as a
corporation, incurring obligations in its favor, is estopped from denying its corporate
existence, particularly when the obligations are sought to be enforced 2) to prevent windfall
o Equitable defense so party asserting the defense must have acted in good faith and not
have affirmatively misled the other party If did rely on account of good faith, no
irreparable harm causes
o Southern-Gulf Marine v. Camcraft P relied on the corporation when entering k and
tried to avoid k when learning corp wound up being incorporated in another state.
Court invoked corporation by estoppel.
Corp cant be different then the parties contemplated.
Camcraft wanted to avoid because the cost went up. If it went down and SGM
didnt perform, they wouldve sued SGM. Not fair. Rationale=equity
IF party thinks incorporated in 1 place, but somewhere else, OK
Planning for Pre-contractual liability: 1) Parties dealing w/ promoter insist on personal
liability until corp is formed 2) parties should address how corp will be capitalized and how
liability will be satisfied 3) parties should agree on what happens if corp is not formed 4) add
clause to discontinue K if they are not satisfied with the incorporation of the newly formed corp.

Limits of Limited Liability


Piercing the corporate veil (only closely held, not public)
o The corporate veil represents a legal assumption that the acts of a corp are not the
actions of it s/holders, so that the s/holders are exempt from liability for the corps
actions. However under certain circumstances courts may pierce the corporate veil and
permit creditors to reach s/holders personal assets. To pierce you have to show that
the shareholders are not treating it as a separate entity (but as their own personal
thing).
o WHEN D IS JUDGMENT PROOF: PCV, ENTERPRIS L, RP
o Requirements to pierce (From Sea-Land):
1. Unity of interest and ownership; and
There must be such unity of interest and ownership that the separate
personalities of the corporation and the individual s/holder(s) no longer
exist (they are one personality).
Factors to determine whether separate identities have been disregarded:
(Sea-Land)
1. Failure to comply w/ corporate formalities or to keep sufficient business
records

a. No corporate meetings, no bylaws, single location


b. BUT one person can act on behalf of 2 or more entities as long
as formalities followed Frigidaire
2. Commingling of funds or assets
a. Use of corps bank account for personal use
b. Sea-Land Paid personal expenses (alimony, childs education)
w/ corp funds
3. One corps treatment of another corps assets as its own (shuffling)
a. Borrowing money from one corps w/o paying interest
b. More relevant w/ respect to enterprise reliability
4. Undercapitalization
a. Insufficient funding, or capital to support the corps operations
b. Not important in New York New York test regarding
undercapitalizing:
o Pierce if siphoning funds, trying to be judgment proof/shield
itself
o Dont pierce if Not profitable to undercapitalize; expenses
are high; common in industry to do so; poor management
Walkovszky v. Carlton (New York) Court refused to pierce a taxi
company in which the owner created nine corporations to operate cabs.
Court did not find sufficient unity of interest. Only argument was
undercapitalization but company did comply NYs insurance minimum!
Undercapitalization was not enough in Walkovszky New York, but it was
in Sea-Land.
If he did successfully pierce, wouldve become stockholder. When you
reverse pierce, first you pierce D (who has no assets) then go after his
other corps but become creditor not a stockholder. SAME FACTORS
o Stockholders only make money if profitable (pierce), but when RP
you get assets or debt (so youre a creditor and creditors get paid
first)
2. By adhering to corp protection & not piercing, court would be
sanctioning fraud/promoting injustice
An unrecovered judgment does not satisfy this rule
Something akin to fraud or deceit (REQUIRED IN NY)
Bad faith making it inequitable to hid behind veil
o Purposes of law undermined; legal rules skirted; unjust enrichment;
intentional scheming to defraud creditors; undercapitalizing to avoid
paying liabilities
o Intentionally putting all assets into a liability-free corporation while
heaping liabilities upon an asset-free corporation.
Sea-Land Services v. Pepper Sauce Court found unity of interest
prong met b/c of commingling, not following corp formalities. However,
says inability to satisfy judgment is not sufficient to meet second prong.
Remanded. On remand, lower court found that refusal to pierce would
unjustly enrich a s/holder who acted in a way to avoid liability to creditors
Alter ego liability term for piercing w/ respect to subsidiary liability Imposes liability
on a parent for the liability of its subsidiary BUT not another subsidiary (distinction from
enterprise liability)
Sheffield Same requirements to impose liability on a parent company under
alter ego theory as for piercing the corporate veil. Court refused to pierce after

Sheffield never received a dog he purchased from a monastery in Switzerland.


Should have claimed enterprise liability!
Parent:sub factors: 1) sub grossly inadequate capital 2) parent pays capital and
expenses 3) parent uses property of sub 4) daily operations same 5) Sub does
not observe corp formalities (keeping books separate)
o Shielding companies from liability may shift expense to taxpayers (persons goes on
Medicaid/Medicare/food stamps, etc.) But as a society we have decided there are
policy interests to provide corp s/holders w/ limited liability to encourage investment in
corps and for corps to take risks
o Tort Claimants: Unlike Sealand where there was a K (thus need to show fraud)
because parties assume risk, torts are different. No K. Rule: totality of circumstances
to see if alter ego or mere instrumentality: common officers, consolidated statements,
parent finances subsidiary, parent pays salaries, parent uses subsidiaries prop as its
own, same address notepads etc, consolidated financial statements etc. In re Silicone
Enterprise Liability (horizontal, couldve been argued in Sealand)
o When separate corps (sister corps) are owned by the same s/holders and do not have a
separate existence of their own, integration of resources, creditors may reach the
assets of 2 or more of the corps as though they are one entity
While assets of sisters corps may be reached, there wont be personal liability on
part of s/holders (piercing is a separate issue)
Concern is whether the sister corps are separate from one another; NOT whether
individuals are separate from the corps
To avoid: (1) separate employees (if borrow, pay sister corp not employee); (2)
separate bank accounts/records; (3) Minimize undercapitalization (Important in
NEW YORK)
o Requirements virtually the same as piercing:
1. Unity of interest among all sisters corps; and
Not treating as individual corps
Factors:
1. Lack of respect for the separate existence of the corps
2. Integration of resources to achieve a single business purpose
3. Corps all use the same accounts and services, have the same
officers and employees, or keep collective record
4. Centralized control
5. Shift funds (shuffling)/personnel around
2. Adhering to corps separate corp status would sanction fraud/promote injustice
Notes
o Most piercing cases occur w/ respect to closely held corporations in large corps,
s/holders are too disperse to have unity of interest with corp; and auditors also ensure
requirements are met
o If corporate veil pierce s/holders treated as partners and each is jointly and severally
liable
o With parent company and EACH individual sub piercing and enterprising liability is
essentially the same
Limited Partnership : May have a Corporation as the general partner (he who
enjoys liability). In Frigidaire, two men who were LPs did not incur liability even
though they were also directors, officers, and shareholders of the parent and GP
of their little firm. Why?
Meticulous in separation of their roles, signed K on behalf of the LP as
agents of the parent.

LPs enjoy LL unless they participate in control of the LP (but can act as
agents for the GP if CORP) and the person Ked with understands this.

Shareholder Derivative Actions (shareholder to regulate corp. mgmt.. Corps are individuals)
FEES: $ won normally goes to corp (even if D wins) unless closely held out of equity.
Indemnity: Must corps have for directors unless it goes to trial Del145b. If action is
settled, corp can pay for both sides. If it goes to trial, d will have to pay damages and legal
fees.
1. Direct or Derivative?
Direct: enforce shareholders rights against corp. Normally class actions
1. Individualized harm to s/holder who gets direct benefits (Eisenberg The
reorganization that deprived P of vote in company affairs actually benefitted
corp by allowing it avoid regulations )
2. Seeking non-monetary relief declarative/injunctive ( Grimes Sought
declarative relief concerning with respect to allegation that board was abdicating
its duties)
If direct s/holder may avoid following steps and bring suit (no need to post
bond or make demand)
Derivative: Usually monetary damages for breach of fiduciary duty . Loss to
shareholders upon harm to corp
Generally, if something involves a breach of one of the fiduciary duties, that
almost inherently is a derivative suit (the corporation is being harmed).
2. Many jurisdictions require s/holder to post bond that will cover cops legal costs if s/holder
loses to discourage strike suits based on ownership: < 5% (of outstanding shares) or
$50,000 (worth of shares) (required in NY & NJ, but not DE) Cohen NEW YORK . PP to
prevent nuisance, revenge suits. IF P loses, pays A Fees.
3. Requirement of demand on directors
Normally demand is made to initiate suit or to take corrective action
NOTE: When demand is made, she is not entitled to discovery (tough to plead
with particularilty)
Universal demand Demand required in all cases unless corp would suffer irreperable
harm as a result
NOTE: If demand is req/not excused company will file Motion TD and ct wlll grant if it
agress
NEW YORK Demand requires unless excused as futile
Demand excused if: (Marx v. Akers)
1. A majority of the board is interested in the challenged transaction;
2. The board did not fully inform itself about the challenged transaction; OR
3. The challenged transaction was egregious on its face that it could not
have been a product of the directors sound business judgment
Marx Demand was not excused regarding excessive compensation claim b/c a
majority of the board (15 of 18) were disinterested. Also no particularity
DELEWARE Demand required unless excused as futile Remember: DGCL 141(A) BJ
RULE

Demand futile if a reasonable doubt exists that the board is capable of making
an independent decision to assert the claim in demand: (Grimes v. Donald)
1. A majority of the board has a material financial or familial interest;
2. A majority of the board is incapable of acting independently for some
other reason such as domination or control; OR
a. Perhaps a minority number of shareholders, but they are executives
3. Underlying transaction is not the product of a valid exercise of business
judgment
Reasonable doubt = flexible standard that weighs in favor of the stockholder
Cannot be mere suspicions or stated solely in conclusory terms.
Must be plead with particularity must use tools at hand such as public
records
This can be done with DGCL Sec 220 (right to inspect books)
NOTE: Once you make a demand, you waive your right to say that demand
should be excused. You would still have the right to say that the boards refusal
to act on the demand was wrongful.
If demand excused s/holder represents corp and controls suit; If demand
required corp controls
Does Board accept demand? After ENRON/Worldcomm much more common
4. Wrongful Refusal
If demand is refused, s/holder still has wrongful refusal claim subject to BJR protection
Presumption of BJR, unless the stockholder can allege facts with particularity
creating a reasonable doubt that the board is entitled to the benefit of the
presumption. Then you go back to the 3 reasonable doubt factors.
To overcome BJR, s/holder must establish one of the exceptions the BJR using tools at
hand
Exceptions: (1) Conflict of interest; (2) Illegality; (3) Lack of informed decision
making; (4) Irrationality; (5) Gross Negligence
Tools at hand: relevant records reflecting corp action (ex. minutes of meeting)
If s/holder overcomes BJR, s/holder takes control of the lawsuit
5. If s/holder has power of the suit (b/c of demand being excused or wrongful refusal) Corp
can still appoint an SLC
Special Litigation Committee Often delegated decision making w/ respect to whether
suit should proceed
SLC has authority and makes determination of what to do with suit Almost always
decides suit should be dismissed
NEW YORK BJR protection of SLCs decision (Auerbach v. Bennett) as long as
procedures were followed
Prong 1, Factors:
1. Good faith
2. Disinterested/independent committee members
3. Investigative procedures were adequate and appropriate
Prong 2, if factors met, court will not look to substance of the SLCs decision and
will dismiss (defer to the SLCs substantive decision).
o Very hard for claims to go forward in NY!
Auerbach Demand excused. SLC determines not in best interest of corp to go
forward w/ suit. Court finds SLC was disinterested and followed adequate
procedures in good faith. Court dismissed.
DELAWARE BJR protection of SLCs decision (Zapata v. Maldonado)

Prong 1, Factors (burden is on the corporation to establish):


1. Good faith
2. Disinterested/independent committee members
a. Cant be ties between committee members and board (college,
tight knit community, social ties). In Re Oracle
3. Investigative procedures were adequate and appropriate
Prong 2 court applies its own independent business judgment! (gives them a
lot of discretion)
o Balances law and public policy with the corps best interests (looking at
substance)
a. Court was worried about SLC indepdent judgment. SLC has
empathy for the board.
b. Reason why DE chancery ct thinks it can make a better decision
c. Tainted board, before problems demand was excused, which is
what lead to conclusion, so company does SLC, but those people
are very likely through structural bias to root against P
If all factors met, and court satisfied after applying its independent BJ, will
dismiss
o Despite fourth factor, dew claims go forward in DE!

Limited liability companies

Fastest growing business entity. Started in Wyoming. Advantages include flexible structuring
(vs. corporation), limited liability to members, and pass through taxation. Disadvantages
include uncertainty in case law due to being relatively new, no public offerings, and liability
varies state to state creating confusion.
Members are owners (receive limited liability) and mangers run the firm (could be the same)
o Partnership like decision making authority.
TO receive same tax treatment as corp: need Limited liability and another feature of corp
(i.e manager managgd)
Members owe fiduciary duties to each other (but see McConnell)
Operating Agreement: Partnership agreement or corporate bylaws
Formation: Articles of Organization filed with secretary of state to create an LLC
Derivative: Members can sue derivatively if manager or members refuse to bring an action
or an effort to cause the manager or those members to commence is not likely to succeed.
1. If an individual does not provide notice that he is entering a contract on behalf of an LLC, the
individual is liable on the contract Water, Waste & Land v. Lanham
o Statutory language providing that the filing of articles of organization w/ the secretary
of state provides notice that the LLC is an LLC should NOT be interpreted broadly
Notice is provided when company puts LLC at the end of the company name.
Water, Waste & Land While D was an agent of LLC, he failed to disclose his
principal to the 3rd party with whom the agent dealt and under agency law, this failure
rendered him liable on the k to the 3rd party
2. Delaware LLC act gives members broad flexibility in drafting the operating agreement and it
gives maximum effect to freedom of contract Elf Atochem v. Jaffari and Malek LLC
o Flexibility in how business will be operated, who is in control and who can do what can
be customized in operating agreement

Elf Atochem LLC contracted away the right to go to court in DE, which is a preferred
method given DEs great experience with LLCs; however, the contract still prevailed
despite shortcoming of arbitration.
Only when the agreement is inconsistent w/ mandatory statutory provision will it
be invalidated
Ex. Waive liability for tort of contract w/out attention to intent
3) In dispute amongst shareholders, where each have equal control and cant act without the
other, one is not mandated to give up a right or add more $ merely to save the company.
One party doesnt have to acquiesce to the other. Fisk. Moreover, in the same scenario, no
breach of impled covenant of good faith and fair dealing merely by blocking financing. When
one class of shareholders has an equal veto power, they are allowed to use it. Fisk
o Fisk Factors for Dissolution (reasonally practical)
1) members vote is deadlocked at the board level
2) operating agreement gives no way to break deadlock
3) due to the financial situation of the comp, there is effectively no business to
operate.
3. LLC veil may be pierced in a manner similar to a corporate veil Kaycee Land & Livestock
v. Flahive LLC
o Even if piercing is not in LLC statute, no reason to treat an LLC different than corp to
remedy an unjust result. It would be illogical to allow persons to abuse LLCs in a
manner that is prohibited for corps.
o Factors (similar to the corporate context):
Look to see what the agreement provides (LLC operating agreements are
allowed to be flexible)
Commingling of funds
Undercapitalization (maybe not in NY though)
See if parties are not treating the LLC like a separate entity
o NOTE: Enterprise liability and reverse piercing may work as well according to wade.
4. The operating agreement governs and can define the scope of LLC members fiduciary duties
McConnell v. Hunt Sport Enterprises
o If terms are clear and unambiguous, the operating agreement can limit or define the
scope of the fiduciary duties.
McConnell Original LLC seeks to acquire NHL team and McConnell formed separate
group to acquire that same team. This was permissible b/c freedom of contract
prevails. The operating agreement said members may compete.

General Partnerships
A partnership is an association of two or more persons to carry on as co-owners of a business
for profit
There are some mandatory rules in partnership statutes that cannot be trumped by the
partnership agreement (ex. cannot waive duty of loyalty) BUT, otherwise statutes provide
default rules Partnership agreements govern
A. Formation of a Partnership FACTORS considered under an objective totality of the
circumstances approach:
1. Intention of the parties

Important to look to when agreement isnt clear (evidential although not


conclusive)
Whether parties operating the same as before the agreement Fenwick v.
UCC
Whether relationship is for a fixed or indefinite duration Southex
UPA (1997) stresses partnership may form despite the absence of intent
2. Right to share profits
UPP (1914) Sharing in profits is prima facie evidence of partnership
UPP (1997) Sharing in profits leads presumption of partnership
Both provide exceptions payment to others; wages to employees; paying off
debts, etc.
3. Obligation to share in losses (strongest indication Implied in UPA required
in some states)
Is one party indemnifying all the losses? Southex
Does agreement state explicitly to the contrary? Fenwick (she was not sharing
in losses).
Jointly and severally liable
4. Ownership and control of the partnership property and business
Whose hands is capital in? Fenwick (Fenwick contributed all the capital and
retained ownership).
Who owns intangible assets such as IP Southex
5. Community of power in administration
Is one party responsible for lions share of management decisions Fenwick &
Southex
6. Language of the agreement
Not always dispositive
Partner may not be enough Fenwick (though it said partnership, it
excluded Chesire from most of the ordinary rights of the partner)
Contract said Agreement not Partnership agreement Southex (Partner
used colloquially)
Is it more consistent with a loan than a partnership agreement Martin v.
Peyton
o Creditor/Debtor relationship does not create partnership (P wanted
creditor liable).
o Examination of books; not so onerous veto provision; suggestion
regarding mgmt
7. Conduct towards third persons
Do the individuals hold themselves out as partners? Fenwick (filed taxes as
partnership (because it was in their interest to do so) but made no other indication
to others never registered as such)
Is party conducting business w/ others in its own name, rather than in name of
partnership? Southex
8. Rights of the parties upon dissolution
Art the rights the same as for an employee who quits? Fenwick (same impact as
if employee)
1. Owning Property
Joint tenancy, tenancy in common, joint property, etc. does not by itself establish
a partnership, even if the co-owners share profits made by the use of the property.
1914 and 1997 UPA
B. Fiduciary Obligations of Partners

Partners & joint adventurers owe each other a heightened dutynot honesty alone, but the
punctilio of an honor
o Necessary elements of a joint venture (from Sandvick):
(1) express or implied agreement that joint venture is formed
(2) contributions, of different kinds and not necessarily all equal, in the
undertaking;
(3) shared profits, but not necessarily losses
(4 )equal voice in controlling the project
Similar to partnership but only for fixed term/purpose and principles of PL apply.
The duty of loyalty owed by partners to each other involves: (1) accountin g for any profits;
(2) refraining from acquiring a partnership asset and misappropriating for his own use a
partnership opportunity; and (3) refraining from competing w/ the partnership w/in the scope
of the business prior to dissolution
o Meinhard v. Salmon Salmon breached his duty to his jv, Meinhard, by agreeing to
purchase property leased together by the two without informing Meinhard. The
opportunity was an incident of the enterprise.
Salmon had a higher duty as a result of being on-site manager (supreme duty of
undivided loyalty).
What would have satisfied the duty? Tell Meinhard about the opportunity, give
Meinhard an option to become a partner in the new deal (the thought of self was
to be renounced). This involves business duty but can be compared to
discussions of fiduciary duty.
DISCLOSURE: Punctilio of honor (Cardozo)
o Sandvick v. LaCross L&H purchased top lease prior to the expiration of the original
lease without notifying S&L (did not matter that there was no express agreement that
they were going to continue the relationship)
When a partner is involuntarily expelled for a business, the general rule is that his expulsion
must be in good faith
o Partnership expulsion is virtually always guided by terms of the partnership agreement
o Guillotine method: allows immediate expulsion as long as in good faithquick/efficient/
free market motives
Lawlis v. Kightlinger & Gray Partnership agreement provided for guillotine
method that was decided on by all partners. Expulsion of Lawlis for
incompetence and poor behavior was in good faith and no notice was required
per the partnership agreement
o Partner v. Employee: Biggest factor is whether individual controls direction of the firm.
If an employee, rules for termination are subject to employment law under EEOC,
whereas termination rules for partners are determined in partnership agreement.
Generally, all breaches of fiduciary duty involve some sort of financial impact
Fiduciary Duties of Directors
BJR Rule: Judicial deference to the boards substantive decisions:
Rationale: Shareholders take risk with investing, ct. is not composed of experts, decision
paralysis (cautiousness).
Scope: Applies as long as there is no fraud, illegalility, COI, gross negligence

Duty of Care (directors, officers, and controlling shareholders owe fiduciary duty)

NOTE: Shareholder ratification excuses directors from this breach


A. Duty to deliberate An allegation that some course of action other than that taken by the
board would have been more advantageous does not give rise to a cause of action if board
exercised reasonable BJ.
BJR applies and court determines whether any of the exceptions apply. There cannot
be arbitrary action.
Kamin v. American Express Boards decision to declare a dividend in kind of shares
of another company, rather than sell shares and take capital loss, was protected by the
BJR b/c it was a rational decision in which the board deliberated btw two options and
there was no allegations of fraud, irrationality, etc.
o Even seemingly unwise decisions make it without recklessness, gross neg, fraud,
illegality, breach of loyalty. Mistakes are to be expected. If make too strict,
would chill business decisions
B. Duty to be fully informed The board is protected when relying in good faith on repots by
experts of officers
Under Del 141(e) Board protected when:
1. Reasonable reliance;
2. In good faith;
3. Expert was selected with reasonable care; and
4. Board reasonably believed the expert was competent
Van Gorkom BJR did not apply to a merger on grounds of lack of informed decision
making. Board relied on CEO without any assurance that CEO was fully informed and
without taking time to confirm anything they were told or review any documents.
Boards decision to approve took 2 hours. DIDNT investigate
o Direct class action: Shareholders did not get enough $. Board should have
sought other offers, get ind. Value of company, seek outside counsel and
financial adice. Time constraints no excuse.
Disney: No breach due to experts.
C1) Duty to Monitor/Supervise (similar to duty to be fully informed

Francis v. United Jersey Bank board must read financial statements. Ms. Pritchard
did not act in the way a reasonable business person would have. She fell below the
standards that board members must adhere to.
o Gross negligence = breach of duty of care
o Sometimes as a board member you must resign or object. Sometimes you have
to threaten to sue your co-directors.
o BJ Rule only protects INFORMED decision not to act, not just not acting. Normally,
people can rely on subordinate UNLESS on notice of possible illegal acts (should
look at financial statements)
o To Prove: 1) directors knew or should have known violations were occurring,
directors took no good faith preventivie measures 3) failure proximately caused
loss
Optimal corp governance: lectures, ethics programs, indep. Audit,
handbooks, etc.
C. Response to Van Gorkom Del 102(b)(7) & other similar corporate statutes allow
companies to include in its corporate charter a provision that:

Eliminates/limits the personal liability of directors (not officers) to corp/shareholders for


monetary damages for breach of fiduciary duty of care Protection above and beyond
the BJR
o Does not include:
1. Breach of duty of loyalty
2. Acts or omissions not in good faith, illegality, or intentional misconduct
3. Transaction which the director derived an improper personal benefit.
D. With 102(b)(7) and similar protection afforded to directors Duty of care essentially
irrelevant
Note: Ps can still seek injunctive relief against corp for breach of duty of care
EXCEPTIONS to 102(b)(7) and BJR:
1. Where plaintiff proves gross negligence in breach of duty of care
2. Where defendant is a financial institution that owes a fiduciary duty to creditors
(those whose money you are holding)
102(b)(7) type provision limit liability to s/holders NOT to creditors (No BJR
for duty of care to creditors, who want to decrease risk rather than
increase profits).
Francis v. United Jersey Bank Ms. Prichard held liable for her
dereliction of her duties which was a substantial factor in the liability to
creditors b/c her sons spawned their fraud in the backwater of her
neglect.
Obligation of Good Faith (If it breaches, really breaching duty of loyalty)

Courts had struggled with whether there are 2 (care, loyalty) or 3 (care, loyalty, good faith)
fiduciary duties. This became an issue after 102(b)(7) eliminated monetary liability for breach
of duty of care. Walt Disney carves out good faith from duty of care, and Ritter then places
it under duty of loyalty Directors can be financially liable
Violating duty of good faith involves (see Walt Disney)
1. Subjective bad faith;
Intent to do harm to the corporations interests
2. Conscious disregard of duties OR dereliction of duties
Abandonment of duties
Francis may have been more than gross negligence. She completely
abandoned her duties. BUT GROSS NEGLIGENCE is not
A. With respect to compensation not informed of market rate, etc.
Walt Disney Board was informed and did not violate any fiduciary duty when it
provided for a $130 million severance package to new company president after
consulting compensation experts, market rates. They even brought in an outside
consultant to help the board review the deal. The consultants looked at what he made
at CAA, what other executives made at Disney, and elsewhere, and they believed it
was appropriate.
B. With respect to oversight/duty to monitor sustained or systematic failure of oversight
a. Directors must exercise oversight if (Graham): (i.e., duty to monitor arises when)
1. Have suspicion (notice); OR
2. Operate in highly regulated industry
b. If no red flag of wrongdoing:
1. Keep informed; OR
2. Delegate responsibility; OR
3. Resigns
c. If required to exercise oversight (if duty to monitor has arisen):

1. Must implement reporting system; and


2. Implement internal controls to monitor if any violations occurring
d. Directors liable if they (Stone v. Ritter):
Utterly failed to implement any reporting system; or
Having implemented a system, the directors consciously failed to monitor it
e. When a director learns of wrong doing by other directors (applies in all situations):
1. Object; or (Make sure objections are noted in corporate minutes/in writing)
2. Resign
Stone v. Ritter Court found, following bank being assessed significant fines for
employee misconduct, that the company had established adequate systems and
properly monitored. No claim by shareholders
If it is in bad faith to exercise oversight, this is breach of DUTY OF LOYALTY!
REMEMBER: Rather have breach of care because much higher standard to
show failure to monitor/ good faith.

Duty of Loyalty (NY Rule : Full disclosure of all material facts to COI to bd and get
disinterested director vote or if no disclosure and COI look at fairness w/ bop on D directors to
prove fairness)

General rule: no BJR protection BJR protection yields to requirement of undivided loyalty.
Directors owe a duty of loyalty to the corporation to place interests of the corporation ahead
of their personal interests.
Step 1 Identify issue Was there:
1. Self-dealing/Conflict of Interest P has initial burden
Board member on both sides of transaction. PRESUMED IN DEL N
Benihana Director Abdo arranged to deal to sell preferred stock (to
raise money for renovations) to another company which he was the vice
chair of.
Dual directorships : sine owe duty to two companies, recuse from both and
appoint SLC
Director has material financial incentive or related to someone who does.
Bayer v. Beran Company hires directors wife to appear in new
commercial.
NY now requires maj of directors to be independent or outsiders.
Compensation: Especially if inside director gets comp based on profits.
Dominant shareholder
If there is self-dealing, did the dominant shareholder receive something at
expense of minority shareholders to their detriment (BJ Rule Wont Apply, Go to
Intrinsic Fairness)
BJ will apply if shareholders treated equally (same dividends
proportionally) Sinclair
But, wont apply when Parent breaches K with subsidiary by paying late,
not adhering Sinclair
Liquidation: Preferred stock (paid first even in liq, but no voting), common
stock(voting), upon liquidating if common has right to redeem preferred stock,
that is fine but must disclose. See step 3 Zahn
2. Usurpation of corporate opportunity
a. Board members or officers

Broz Broz, a director of CIS, gets offer to purchase license on behalf of his
company, RFBC (where he was sole shareholder). CIS had held similar cellular
licenses but was selling them due to financial hardship.
Dominant shareholder
Did DS usurp corporate opportunity to detriment of minority. (If they did, NO BJ
go to intrinsic fairness)
Look to facts: subsidiary in Venezuela but no gas companies (everyone is
leaving) BJ rule will apply. Sinclair
Step 2 Was there approval by the board/shareholder ratification:
If no board approval or shareholder approval Fairness test w/ burden on D
Bayer Board did not approve transaction at the outset and only later ratified
Broz Received informal board approval Did not seek formal board approval
If approval by majority of disinterested board members (no quorum required)
Traditional BJR protection under safe harbor provision of Del 144(a)(1) w/
burden on P
If material facts as to the interested directors relationship/interest in the
transaction are disclosed to the board and a majority of disinterested directors
authorize the transaction in good faith
In interested directors best interest to recuse himself
Benihana Abdo received formal approval from a majority of disinterested
directors who were informed of Abdos relationship to the transaction.
If approval by majority of interested s/holders and no controlling s/holder Fairness
test w/ burden on D
Fliegler Only 1/3 of disinterested s/holders approved option to buy mineral
rights.
In Fliegler it was a minority of disinterested shareholders that approved.
The burden will stay with defendant. The burden will shift to the plaintiff
where there is a controlling shareholder, but a majority of the
disinterested shareholders approved.
If approval by majority of disinterested s/holders and disinterested s/holders are
majority of all s/holders Heightened BJR protection with only exceptions being
gift or waste under Del 144(a)(2)
Waste (Disney) squandering corporate assets
Gift giving away corporate assets
Wheelabrator Majority of s/holders were disinterested and majority of the
disinterested s/holders approved WTIs merger with Waste as did board.
If approval by majority of disinterested s/holders when disinterested s/holders are
minority of all s/holders and there is a controlling s/holder who owns 51%+ Fairness
test with burden shifting to P
No BJR protection b/c majority of minority s/holders may have been controlled by
majority s/holder (the invisible hand)
Wheelabrator dicta
Step 3 What test to apply:
If transaction freshened/sterilized apply test noted above (traditional BJR or heightened
BJR w/ only exceptions being gift or waste)
Rationale: Goal is to protect owners. If disinterested parties approve why should
court get involved? Allow for some limited exceptions b/c possible that interest
parties may unduly influence disinterested parties/ transaction could just simply be
egregious.

Fairness test with burden on D D must show entire (inherent) fairness under rigorous
scrutiny
1. Self-dealing/COI Was transaction conducted at arms length?
Factors: (Bayer
Substantive fairness
1. Salary (was amount paid for the services reasonable?) - look to
comparable salaries
2. Was there an independent third party involved?
3. Cost (was spending that amount reasonable considering revenue, etc.?)
see market
4. Competence/ Qualifications (of person hired were they adequate?)
Procedural fairness
1. Was/how was contract negotiated
2. Who took part in negotiations
3. Who made decision to hire
2. Corporate opportunity Did taking opportunity constitute usurpation?
Factors: (Broz)
1. Capacity (corp must be financially able to take the opportunity for itself)
In Broz, CIS was insolvent and was liquidating similar licenses
The counter argument will always be that just because the company is
incapable now, does not meet that they wouldnt have been able to
become capable had the opportunity been disclosed. They could have
discussed the matter with the company.
2. Line of business (opportunity must involve the type of business the corp
is typically engaged in Consider whether the opportunity provides a
practical advantage)
In Broz, CIS was diveFsting itself of licenses getting out of that line of
business
3. Interest/Expectancy (Does the corp have an interest (kual or otherwise)
or a reasonable expectancy in receiving such an opportunity in the
ordinary course of business or, perhaps is the opportunity too risky?)
EBay Directors accepting high-profit IPO investments from GS as
incentive to continue business relationship. Gift was expected by corp
since it was given as incentive for the crop, not directors individually,
to do business w/ GS again
In Broz, CIS divesting the line of business and thus had no idnterest in
purchasing such a license. CIS was giving up other cellular rights that
it had.
4. Conflict of interest (by embracing the opportunity, will the self-interest
of the director be brought into conflict w/ that of the corp
In Broz, Broz owed duty to CIS, not PC (which had not yet closed on
purchase of CIS)
Note: When director or officer takes corporate opportunity, they can
decide for themselves whether or not to seek formal board approval.
Only in Delaware
1. Seek and obtain (Benihana) Safe harbor under 144(a)(1)
case dismissed
2. Dont seek (Broz) 4 factor analysis
In DE, wouldnt matter if entity presenting opportunity doesnt want to
work w/ corp

Generally, doesnt matter if opportunity presents itself to


director/officer in individual or representative capacity same analysis
applies
3) For Dominant Shareholders Where BJ Rule Doesnt Apply (self dealing,
usurpation)
Intrinsic fairness Test: BURDEN ON D.
Factors: Didnt breach, everyone equal, sharing of info, disclosure.
Liquidation: Must disclose. Not fair for dominant common stockholders
who have right to redeem preferred stock before liquidating t not disclose
material info about the new price of the shares upon liquidation Zahn.
Commons need to make informed decision so they can convert b4
liquidation.
HYPO: Inventory is 240 upon liq. (A gets 2-1) but B can recall back
for 60 (as per charter). SO instead of getting 160, A would only get
60 and get fucked. This is why B (board) must disclose to minority
about material prices and inventory.
Fairness test with burden shifted to P P must show entire (inherent) unfairness under
rigorous scrutiny
Same factors as above are applies (based on the issue)

Disclosure and Fairness (Securities)


Securities Act of 1933: IPOS: Mandates disclosure through registration statement.
Prospectus is the first part of statement and ordered by SEC. Reasonable disclosure is
everything a reasonable prudent investor would want to know. There can be unlimited
risk, just no misrep. Or fraud
Must be delivered to potential investors before sale
Exemptions from registration statement: Private placement (priv. offerings), Regulation
D (private placement but put caps and safe harbors to avoid or reduce required
disclosure.
Identifying when something is a stock or security to fit within confines of the
federal statutes
Security: Catch all phrase for stocks, notes, bonds. Must be registered with the SEC
LLCS: Because LLCS are not incorporated, 1) look at operation agreement to see
who is managing (board of investors or managers) 2) Did investor have
meaningful control, or was he passive. 3) If he has control, he has access to info
to make informed decision and shouldnt be protected 4 ) If meaningful control,
no a security. Rule: Courts look at economic reality of the facts,not the label
Robinson v. Glynn (Robinson had meaningful control of board, could appoint,
make decisions)
If Robinson had purchased an investment K, it wouldve been a security.
o With these, investor pays $ with expectation of profits from others.
Howey test but flexible. Not just solely anymore, but can he
exercise meaningful control. EX: HE has control but cant exercise,
Security.
Partnerships: Very similar to Llc. Is partner, member managing? GPS
generally not. LP or member managed, probably is.

CORPS: Note, public will have to register. Closely held: If they have securities,
same thing.
Section 5a of Securities Act: If its a security, MUST have registration
statement. Remember, prior to issuance, must file statement with prospectus to
warn potential investors.
o When security not registered : Strict liability under Securities
Act Section 12(a)(1) when does not register, fails to deliver
adequate prospectus.
LIMITED PARTNERSHIP: This is what happened in Doran
(Limited partners, no control). Stock in oil was a security,
didnt file. Strict liability when had to stop drilling and lost $
o Section 12(a)(2) Securities Act : Private civil. Liab. Who sells a
security in insterstate commerce who makes material
representation or mission on statementand cannot prove he
did not know of misrepresentation (intentional or negligent
violations) D has BOP
Elements for P : 1) sale o security 2) interstate commerce
3) by means of prospectus or communication 4) untrue
statement or omission of material fact 5) By D which knew or
should have known of untrue statement
D will first argue Due Dillegence 11b defense (never
company or issuer)
RULE: What kind of investigation a prudent person in
Ds position with his position, responsibilities,
background, skills, training, access to info would have
made. Escott MUST BE MATERIAL OMISSION OR FACT
Whos Liable: Signors of statement, underwriters,
directors, engineers, appraisers, experts who worked
(but only their portion)
What is reasonable investitation: Look at major terms,
look at inventory, look at Ks, operations, corp minutes,
Non-experts on non-experted portions: After reas.
Invest., had reasonable grounds to believe truth and
did. (person cant say lawyer/can be accountant)
Escott (bowling ally)
Experts for expertised portions (only liable for their
portion): same as above but in eyes of reasonable
expert
Non-expert on expertised portion: No reasonable
grounds to believe false, and subjectively did not
believe to be untrue. EX: relying on accountant. NO
INVEST NEEDED
Damages: Change in price. But can show it didnt hurt
P.
Exemptions from registration statement:
Private placement (priv. offerings), Regulation D
(private placement but put caps and safe harbors to
avoid or reduce required disclosure. Factors: 1)

Number of units, normally small 2) size usually small


3) manner of offering (PRIVATE ONLY, no ads) 4)
number of offerees and their relationship (if they are
tight, dont need much sophistication because prob
have info) If not close, see sophistication (if a lot prob
have access to info and its private placement) . BUT
can be sophisticated no info not PP.
Safe Harbors. To safely ensure private placement
statusand thus
exemption from disclosure requirementsissuers can
look to the
SECs Regulation D.
(1) If an issuer raises no more than $1 million, it does
not need to
register (Rule 504).
(2) If an issuer raises no more than $5 million and sells
to less than
35 people, it does not need to register (Rule 505).
(3) If an issuer raises more than $5 million and sells to
less people,
it does not need to register so long as each buyer
passes various
tests of financial sophistication (Rule 506).
(4) Registration D only exempts the initial sale.
Sarbanes Oxley: Internal controls, PCs must issue report that they understand importance
of establishing internal financial reporting controls, gather info about companies compliance,
managers are resp. for managing, mandates that managers make disclosure about companys
code of ethics. Use

Misrepresentations MADE BY COMP. WHICH ARE EITHR MISSTATEMENTS OR


OMISSIONS or Fraud or Deception
NOTE: IF THIS HAS TO DUE WITH REGISTRATION OR FINANCIAL INFO IN IT, SEE 1933
ACT
Securities Act of 1934: Mostly secondary market (wall st). created SEC.
Companies must file annual statements and quarterly statements

10b insider trading. 12. Registration : public companies must 14: proxy (no action
letter)
Mandatory continuous disclosure for corps who: list securities on national exchange,
own 5 million in assets and have at least 500 holders, file a statement that becomes
effective.
10B5 Under ACT
Company cant make omissions or false representations or use fraud or deceive to
MATERIAL FACTS
Standing: Generally, investors who dont buy hav standing. SEC can also bring.
Investors have implied right to bring private action.
Step 1) Scienter: Intent to deceive or defraud. (state of mind)
Recklesness could satisfy, intent, willful can, but not negligence
Step 2) Causation: P shows Ds misstatements caused damage
No causation where private lies cant affect market price of a company a
broker privately tells a few holders to buy West v. Prudential
In Jordan , court had a tough time because he wouldve sold anyway?
Step 3) Materiality P shows misstatements were material according to a
reasonable investor Basic
Corps dont have to disclose discussion of merger, but if they DO they
cant mislead or be dishonest. Ct held that info about prelim. Merger
negotiations was material Basic vLevinson
Jordan Need to tell about negotiation of merger to employee thinking of
quitting. Note: Cant fire him and then take profit (see Wilkes). Note:
Cant trade on info if not public: see insider trading
Silence: Note, this cant trigger this violation.
Step 4) Reliance is Presumed unless closely held Fraud on the market
theory. Rebuttable presumption that Ps relied. Indirect reliance OK. Ps relying
on efficiency and integrity of the market, and if corp makes false statement, and
stock goes up, they are relying even if they did not read it or did not have time.
P has to prove, but rebuttable presumption in favor of P. Comes from Basic v.
Levenson
Basic v. Levenson (relied on statements that merger was not coming so
they sold)
Private lies dont go to fraud on market because info not disseminated.
West v. Prudential
MUST BE PUBLICLy DISSEMINATED
With omissions, need to show P would have acted DIFFERENTLy
How to rebut: Evidence that P was going to sell anyway Jordan.
Limit : Can show it didnt affect market price threby
eliminating damages or show other factors affected, limiting
damages
Is D arguing that it is merely an option: Put opt. (right to sell security) Call
opt. (right to buy)
10b5 makes it so that an option is a security so s/holders have
standing.
Steps: Do 1-4. For reliance and causation, keep in mind market price for
options is directly responsive to changes in market price for underlying
stock info affecting that price.

o In Deutschman v. Beneficial Corp: Officdrs of beneficial


misrepresented financial health (they were going under).
Deutschman would have paid a lot less. Satisfied.
If youve merely been treated unfairly without misrep, omission, fraud, deceit, other
options
1) Seek Appraisal (Dissenter) rights: Min. shareholders go to ct and ask for ct
appraiser.
2) When merger between parent and subsidiary (253 DGCL: Short form-merger)
and minority think price unfair, do appraisal or sue for duty of loyalty. Cant sue
under 10b5. Santa Fe

Rule 10b-5 and Insider Trading: 1934 Securities ACT


Policy: Trading on inside information (nonpublic information) is such a concern b/c people
make decision to invest based on information Insider at advantage when he can consider
certain information before the public can.

Common Law/State Law

Blue Sky Laws state laws concerning wrongdoing of insiders; these laws still on the books,
however, w/ Federal Securities law, investors often go to federal law first
Elements of Typical Blue Sky Law: (Goodwin)
1. Nonpublic info can be described as material
o Materiality something that a reasonable investor would rely on
2. Deceit (misrepresentation of some kind)
3. Transaction was direct, not an anonymous trade on the stock market
Goodwin v. Agassiz Insiders purchased stock on stock exchange after learning
about theory of copper deposits in mine. Analysis Info was only the theory of a
geologist, and thus, not material. Transaction was amorphous, nebulous transaction
where seller had no idea who he was selling to. No liability.
NOTE: This case says no fiduciary duty was owed to s/holders. WADE says today
it is otherwise

Classic Theory of Insider Trading


For insider trading liability under 10b-5, the insider must have a duty to corp whose shares
he traded and its s/holders w/ respect to the nonpublic info (info is material), and must breach
that duty (fail to disclose or abstain)
NOTE: Insider with material info remains an insider even when leaving.
1. Materiality 2 factors from 10b-5 (TGS) Corp IS liable
a. Whether reasonable investor would find the fact important in deciding whether
or not to buy or sell a security.
b. Balance test: Anticipated magnitude of the event in light of the totality of the
company activity; and probability that the event will occur
Texas Gulf Sulfur Knowledge of possible existence of rich iron ore mine was
very important and would have affected stock price. Probability was very high
not just an idea; theory; plan and insiders were actually trading on it. Court
determines the info was material.
2. If material Insiders must: (Cady, Roberts & adopted by TGS)
a. Disclose; or
o Often insider owes fiduciary duty to company to not disclose

b. Abstain
Texas Gulf Sulfur 2 guys who traded day before second press release
(confirming findings) were in breach b/c info was not yet released to public. Guy
who traded on day of disclosure also breached because info hadnt been fully
disseminated needed to wait for analysts to look at impact and for investors to
digest info.
Should have waited for press release.
3) Scienter: Must show intent to influence investors or recklessness.
4) Reliance: Must show reliance. Similar as above.
5) Causation: Harm to other investors or shareholders who missed out.
3. People owing this duty include those who owe a fiduciary duty to the other
party to the transaction (Chiarella (SC) limits TGS which said ANYONE with
inside info has this duty)
Must find a fiduciary nexus (a duty of confidentiality) between the person with
the inside information (the insider and tipper) and the other party to the
transaction
Chiarella Worked for a printing co representing the acquirer Thus, owed no
fiduciary duty to s/holders of the target corps he was transacting w/ and
consequently was not liable.
NOTE: Chiarella didnt get to missapropriation
NOTE: Temporary Insiders Accountant, lawyer, or investment banker becomes
temporary insider for information they are exposed to while working for
corporate client. Thus, the temporary insider may be liable under the classic
theory just as an ordinary insider may be.

Tippee Liability under Classic Theory (Can be Breach of Loyalty when Benefit Gained
(Dirks)
Test for determining tipper/tippee liability: (Dirks)
1. Tipper breaches fiduciary duty to the corp by disclosing nonpublic info and the tippee
knows or should know that there has been a breach; and
2. Tipper tips for the purpose of obtaining some sort of personal benefit
Direct or indirect benefit Examples:
o Selling the info;
o Giving the info to enhance ones reputation or standing;
o Giving the info to someone w/ the expectation of receiving a reciprocal
benefit (quid pro quo) or w/ whom the tipper has a personal (or even
business) relationship
If both factors satisfied Both parties liable. Tippee for breaching a fiduciary duty
assumed from the tipper; and the tipper for inheriting the tippees breach (derivative
liability)
Dirks Court found no liability under 10b-5 b/c Secrist (tipper) did not derive
any direct or indirect benefit from the disclosure to Dirks (tippee), he merely
sought to blow the whistle. (NOTE: Secrist may have had some sort of fiduciary
duty as a former employee)
NOTE: If you are in a restaurant and hear info totally unrelated to you, you can
go and invest like crazy and they will only be liable as breach of duty of care.

When they inadvertently tip you, they gain no personal benefit and thus no
tippee liability. Arms length
Common insiders: Lawyers, accountants, professionals inside firms etc all
becomes insiders.
Fair Disclosure: SEC adopted disclosure rules. If someone discloses material
nonpublic info to market pros, they must make it public If they let something slip, must
issue press release. Disclosure must be simultaneous

Misappropriation Theory (Outsider Trading) B/w trader and source (not corp

The classical theory is based on fraud on the other party to the transaction. The
misappropriation theory is based upon fraud by the recipient of the info on the source of the
information.
The misappropriation doctrine supplements the protective sweet of the insider trading
protections for securities. It was designed to protect the securities market from abuse by
outsiders who have access to confidential info, but who owe no obligation or fiduciary duty to
the corps s/holders
Test for determining liability under the misappropriation theory: (OHagan)
o The party exposed to the inside info has:
1. A duty of trust to the source of the inside information; and
Could involve a fiduciary duty or an agreement to hold something in
confidence
Could involve someone writing article for NYT sharing info and they trade
on it.Carpenter
OHagan Had a fiduciary duty to his partners/his firm which had
obligation to its client to not misappropriate (misuse) confidential info.
The rule of the misappropriation theory is: there are some individuals who
are not fiduciaries to the company in which stocks they are trading, but
they might be breaching their fiduciary duty to someone else, and they
will be liable as a result. OHagan has a duty to his law firms client to
keep information confidential. If you have a fiduciary duty to the
acquiring company, and sell in stocks of the target company, you are
liable.
o Under Chiarella he would have no obligation because he has no
fiduciary duty to Pillsbury because he is not their lawyer (he bought
and then sold Pillsbury stock).
o If this rule was applied to Chiarellas facts, whether there is liability
depends if there was a fiduciary duty owed to the acquirer.
Probably would be liable today because he owes a fiduciary duty to
his employer.
SEC adopts Rule 10b-5(2) which provides examples of relationship or
circumstances that impose a duty of trust/confidence for purposes of
applying the misappropriation theory:
a. When the source of the info agreed to keep the info confidential
(look for confidentiality agreement);
b. When the persons involved in the communication had a history or
pattern of sharing confidences; and

c. When the person who provided the info was a spouse, parent, child
or sibling of the person who received the info, unless it is shown
that there was no reasonable expectation of confidence
2. Violates that duty by trading on the info
Fraudulent Trading in Connection w/ a Tender offer

SEC Rule 14e-3(a) Vey broad abstain or disclose rule applies only to tender offers Not
limited to those with fiduciary duties. Essentially a strict liability theory (relating only to
tender offers)
Elements:
Anyone trading on the basis of material nonpublic information
Concerning a pending tender offer (ONLY APPLIES to tender offers)
That he knows or has reason to know has been acquired directly or directly from
An insider of the offeror or issuer or someone working on their behalf on the tender
offer
A.

Indemnification
1. Sources of indemnification for fiduciaries: (i) Exculpation provisions in charters (but such exculpatory provisions are
limited by DGCL 102(b)(7)), (ii) indemnification statutes such as DGCL 145, (iii) contractual promises to indemnify in
bylaws, charters, etc. (which may or may not be able to exceed statutory authorization), and (iv) director/officer (D&O)
insurance (which nearly every company buys).
2. Exculpation clauses: DGCL 102(b)(7)(ii) denies exculpation for acts or omissions that (i) are not in good faith, (ii)
involve intentional misconduct or knowing violation of law, or (iii) violate the duty of loyalty
3.

Indemnification statute: DGCL 145 provides the following.


a. Direct suits: 145(a) gives the corporation power to indemnify expenses and amounts paid if (1) the
person acted in good faith and (ii) with the reasonable belief that he was acting in (or not opposed to) the
corporations best interests.
(i) Expenses and amounts paid: Includes attorneys fees, settlements, judgments, etc.
b. Derivative suits: 145(b) gives the corporation power to indemnify expenses only if (i) the person
acted in good faith and (ii) with the reasonable belief that he was acting in (or not opposed to) the
corporations best interests (iii) and the person is not judged liable to the corporation (unless the court finds
the person is fairly and reasonably entitled to indemnification).
(i) If case settles: likely to get expenses reimbursed because not judged liable. But if case goes
to trial and person loses, harder to show good faith.
c. Who decides if acted in good faith, etc. under (a) and (b): 145(d) Distinterested directors,
counsel, shareholders.
d. Reimbursement of expenses: 145(c) obligates the corporation to reimburse expenses if the defendant
is successful on the merits or otherwise. Applies both to direct and derivative suits.
(i) Success on the merits: Settlement doesnt count; dismissal does (Waltuch, 2d Cir. 1996, suit
against dismissed because s employer paid out large settlement).
e.

Advancement of expenses: 145(e) gives the corporation power to advance expenses if . . .

(i) Corporation has power, not obligation to advance expenses, so D / O is going to want
company to contractually precommit or pass bylaws obligating advancement. Precommitment can
even cover cases where the corporation itself is suing the D / O (Roven).
f. Other rights: 145(f) says that 145 is not exclusive of other rights. It is not clear whether this
subsection has any substantive effect at all.
(i) According to the 2d Cir. (not Del.), 145(f) does not mean that a company can indemnify
directors for act not done in good faith a corporation cannot indemnify in ways inconsistent
with the rest of 145 (Waltuch).
(A) That is, the good faith requirement of DGCL 145(a)-(b) cannot be circumvented
under any circumstances.
(ii) Note that a charter provision cannot require the corporation to provide any indemnification
that is greater than the permitted scope of 145.
g. Insurance: 145(g) gives the corporation power to buy D&O insurance, which is useful because it can
cover situations the corporation cannot indemnify directly (e.g., derivative suit liability) and will still pay if
the corporation becomes insolvent.
4.

How 145 plays out in practice:


a.

If wins: entitled to expenses, including attorneys fees, under 145(c).

b.

If settles and must contribute to the settlement:


(i) Reimbursement of expenses not required because not success on merits. 145(c).
(ii) If acted in good faith and with reasonable belief that his actions were not opposed to the
best interests of the corporation, then 145(a) (direct) or 145(b) (derivative) apply.

c.

If settles, makes no contribution to settlement, and case dismissed


(i) Expenses reimbursed under 145(c). That corporation was a co-defendant and made a
settlement payment in lieu of a settlement payment by the defendant not importnat. (Waltuch v.
Conticommodity Servs., Inc., 2d Cir. 1996) (applying Delaware law).

d.

If not successful on the merits:


(i) If direct suit: Corporation has power, but not obligation, to indemnify for both expenses and
amounts paid in settlement, judgment, fine or penalty, provided acted in good faith and with
reasonable belief that actions not opposed to corporations best interests. 145(a).
(ii) If derivative suit: Corporation has power, but not obligation, to indemnify for expenses,
provided acted in good faith and with reasonable belief that actions not opposed to corporations
best interests, and if judged liable, is fairly and reasonably entitled to indemnification. 145(b).
(iii) Under 145(d), the decision about good faith and reasonable belief is made by the directors
who are not parties to the action, or if there are no such directors of if the directors so decide, the
decision is made by independent legal counsel or by a stockholder vote.

5.

Insurance
a.

Directors and officers insurance can insure some items that are not indemnifiable under 145.

Proxy Fights
Rooted in SA of 1934. Section 14: regulates solicitation and prohibits from soliciting
outside rules
NOTE: Only covers corps that file under 34 act even if majority owned by its directors

Most s/holders do not attend annual meetings. Management solicits proxies (votes) from
s/holders in order to reach a quorum (minimum number) so for the meeting can take place
and elections held.
Sometimes insurgents seek to take control by electing themselves to the board 14(a)(11). A
proxy fight then ensues in which incumbents and insurgents (challengers) seek to amass
the most proxies.
o The law provides a lot of help incumbents to remain on board and in control.
o Pay: According to 14(a)(11), s/holders can vote, but not binding.
Incumbents can authorize the use of corporate funds (subject to requirements below) to fund
proxy solicitation in advance (Levin v. MGM)
o Win or lose incumbents dont have to shoulder costs
o Cant be personal
o Provides advantage for incumbents to retain control
o Rationale: Directors would not be able to freely answer challenges of outside groups
and in good faith defend their actions and may be at the mercy of wealthy groups
Challengers must shoulder all costs in advance and may be reimbursed if: (Rosenfeld v.
Fairchild Engine & Airplane)
1. The challengers win;
2. Shareholders vote, after full disclosure, to reimburse; and
3. Requirements below are met
o Rationale: Leads to deterrence but that is better than encouraging frivolous attempts
by insurgents who wind up wasting s/holder and corporate resources
Requirements: In both cases, expenses have to be: (Levin & Rosenfeld)
a. Fair (reasonable in amount and incurred in good faith);
Debate as to whether entertainment expenses are reasonable often depends
on circumstances
b. Legal; and
c. Spent in support of policy (not personnel)
Dispute over the best interests policy NOT who is the better man for the jobs
o Levin Expenses incurred by incumbents were fair, legal, and involved policy matters
(how many films to produce each year and what to do w/ those films) Incumbent
board able to use corp funds to solicit proxies in its favor.
Private Actions for Proxy Rule Violations:
This is derivative.

Law: 34 act. Rule 14(a)(9)


Note: Usually in context of mergers because most need 2/3 s/holder approval.
Step 1) false or misleading material ommissions or statements in proxy ratification
material.
o Or omission of material fact that makes any portion of the statement false or
misleading.

MENS REA: Intent or recklessness for outsiders (prob) and negligece for
insiders (prob)
Relief: Rescission, damages, or both.
Policy: SEC Cant bring every claim. Parties have standing. JIC v. Borak
Step 2) Materiality : Lead a reasonable or prudent investor to act or vote a certain way
Borak
o Under merger, ommssion to minority s/holders that 2/3 of board was controlled by
acquirer is material. JIC v. Borak
o In proxy statement for director fees, company showed # of options they had but not
formula to calculate worth. In suit, P lost because that information was not
material. Investors wouldnt change vote if options were worth mad according to
CT. Seinfeld v. Bart
Step 3) Causation:
o 1) Material misstatement in proxy info
o 2) Must show not only defect but that proxy link was an essential link to
accomplishment of transaction Mills v. Electric Auto-lite Co.
Causation was met in Mills because proxy solicitation was essential link to get
merger in.
Step 4) Damages: must cause harm. Recession: rate. Can enjoin merger, uunless proxy is
revised, but only available if action was brought before merger occurred. Even if no
monetary value, attorney fees Mills
o To shareholders: Damages after meger, looking at arms length and fairness, but
difficult. Monetary damages may not be available tominority shareholders if their
votes are not required to authorize.

6. Overview of proxy rules promulgated under 14(a), which authorizes the SEC to regulate solicitation of proxies. Rules
14a-7, 14a-8, and 14a-9 generate the most litigation
a. Rule 14a-2 describes the solicitations to which the rules apply (if shareholder soliciting proxies for
itself)
b. Rule 14a-3 describes the information to be furnished. Shareholders must be given proxy statements
that make certain disclosures and must be filed with the SEC.
(i) Key items that proxy statements must disclose: (i) Conflicts of interest, (ii) details of
compensation plans to be voted on, (iii) compensation of highly-paid officers, and (iv) details of
major corporate changes to be voted on.
c. Mail-or-give-list-rule: Corporations can either send out proxies for the shareholder, or can elect to give
the list of shareholders to the proxy supporters. In either case, the shareholder must pay. Rule 14a-7. This
rule applies in proxy fights.
(i) Corporations usually choose to send the proxies rather than providing the list, meaning that
insurgent group usually must rely on state rules to get mailing lists.
d. Shareholder proposal rule: Describes when a company is required to include a proposal in its proxy
materials. Rule 14a-8.
e. General antifraud rule. Forbids solicitation of proxies containing material misstatements or omissions.
Rule 14a-9.

Shareholder Proposals(meetings)

Although s/holder proposal are likely to be voted against, they serve the purposes of bringing
about awareness and forcing companies to confront/defend certain issues. These two factors
both serve social justice, and other social groups will buy shares just to be able to submit a
proposal to bring light to an issue.
WHATS GOING ON: COMPANY WANTS TO EXCLUDE PROPOSAL FROM PROXY
MATERIALS: THEY CAN IF EXCEPTION
Most companies go to SEC and ask to exclude. If they can, SEC will send no action
(meaning they dont take action)
Common occurrences : Often to remove takeover defense measures (green mail, poison
pull), not to appoint CEO as chairman of board, proposal to make board more or less
indepdent, to link director pay to performance.
SEC Rule 14a-8 Town Meeting rule that allows for any security holder who holds (2k in
MV or 1% of companys security and didnt get rid of it) to submit a proposal for action at a
forthcoming meeting of security holder along with a statement of no more than 500 words in
support of the proposal to be included in the proxy statement.
If mgmt opposes: Must file proposal and reasons for opposing with SEC who
Reviews.
EXCEPTIONS to Rule 14a-8: GRONDS TO EXCLUDE BURDEN ON CORP
1. 14a-8(i)(5) Relevance
Proposal must be relevant to operations involving at least 5% of the companys
total assets, net earnings, or gross sales, OR be otherwise economically and
significantly related to the corps business
Otherwise significantly related serves as an exception to the exception
(can exclude proposals related to matters involving less than 5% of
assets, earnings, or sales) with respect to matters of social and ethical
significance (i.e., not limited to issues of economic significance)
Lovenheim v. Iroquois Brands
o Rationale: Although forcing companies to devote time and
resources to confronting something w/ little present financial or
other effect, certain behavior (animal cruelty in Lovenheim), if
taking place, could be devastating from ethical and public relations
standpoint down the line
2. 14a-8(i)(8) Relating to An Election
A proposal was non-excludable b/c it involved a proxy access bylaw change
proposal relating to election procedures IN GENERAL rather than a SPECIFIC,
upcoming election AFSCME v. AIG (shareholders wanted to amend AIG bylaws
to require AIG to publish the names of shareholder nominated board candidates).
Aftermath
a. Current state of law 14a-8(i)(8) amended to allow the board to exclude
any proposal that relates to a nomination or an election for membership
on the companys board or analogous governing body or a procedure for
such nomination or election
o Now applies to procedures as well as elections
3. 14a-8(i)(7) Management Function (company will tell SEC they are denying
proposal)
Bylaws are controlled by s/holders and directors but proposals shall not take
away discretion of the board. Not in the s/holders province to compel the board
to do something because board has fiduciary duty to exercise their reasonable
business judgment CA, Inc. v. AFSCME
Proposals cant be ecluded if it involves a strategic decision

CA v. AFSCME S/holder proposal to reimburse reasonable expenses


incurred by challenging directors was proper matter for s/holder action
(under Del 109); however, the language of shall reimburse violates
the prohibition (under Del 141(a)) against contractual arrangements
that commit a board to a course of action that would preclude them from
fully discharging their fiduciary duties to the corporation. Allocation of
funds is generally something within the boards discretion and this is not
something that the shareholders can mandate that the board do. Cannot
remove board discretion.
o If it is advisory and doesnt require the board to act, it can usually
be included.
o The shareholders power is not coextensive with the boards power
to manage. The shareholders power is limited by the boards
management power under Del 141(a))
14a-8(i)(1): Not a proper subject for action by shareholders (ex: demanding business
to stop purchasing foie gras violates 141(a) and fiduciary breach) Note if 141(a)
violated, 14a-8(i)(2) is violated.
1) Improper under bylaws if inconsistent with law or articles of incorp
2) ORDERS THE BOARD: Cant unless in certificate of incorp.
Other exclusions to EXCLUDE SHAREHOLDER PROPOSAL

(1) Improper under state law: If the proposal is not a proper subject for
action by shareholders under the laws of the jurisdiction of the company's
organization;

NOTE to paragraph (i)(1): Depending on the subject matter, some


proposals are not considered proper under state law if they would be
binding on the company if approved by shareholders. In our
experience, most proposals that are cast as recommendations or requests
that the board of directors take specified action are proper under state
law. Accordingly, we will assume that a proposal drafted as a
recommendation or suggestion is proper unless the company
demonstrates otherwise.

Class Notes: 1 of the most common ways to find their proposals excluded.
When a proposal orders directors to do something, instead of
recommending the directors from doing something, then gets excluded.
Note that proposal does not have any mandatory effect. Bd does not
have to do; it just gives them an idea of what shareholders want. What is
wrong with a proposal in demanding bd to do something? These are not
decisions that shareholders get to make. Management or affairs is to be
only undertaken by bd of directors NOT shareholders.

(2) Violation of law: If the proposal would, if implemented, cause the company
to violate any state, federal, or foreign law to which it is subject;

NOTE to paragraph (i)(2): We will not apply this basis for exclusion to
permit exclusion of a proposal on grounds that it would violate foreign law
if compliance with the foreign law could result in a violation of any state or
federal law.

(3) Violation of proxy rules: If the proposal or supporting statement is


contrary to any of the Commission's proxy rules, including Rule 14a-9, which
prohibits materially false or misleading statements in proxy soliciting materials;

Class Notes: (3) violation of proxy rules. If you have shareholder proposal
that had material misleading statement/omission can be excluded

(4) Personal grievance; special interest: If the proposal relates to the


redress of a personal claim or grievance against the company or any other
person, or if it is designed to result in a benefit to you, or to further a personal
interest, which is not shared by the other shareholders at large;

Class Notes: personal interest of shareholder can be excluded under (4).

(5) Relevance: If the proposal relates to operations which account for less than
5 percent of the company's total assets at the end of its most recent fiscal year,
and for less than 5 percent of its net earning sand gross sales for its most recent
fiscal year, and is not otherwise significantly related to the company's business;
[This was at issue in Lovenheim case]

(6) Absence of power/authority: If the company would lack the power or


authority to implement the proposal;

(7) Management functions: If the proposal deals with a matter relating to the
company's ordinary business operations;

Class Notes: (7): Deals with management functions if proposal relates to


ordinary bus operations, then it can be excluded b/c not proper subject for
shareholders action. It is officers who make ordinary bus decisions. This is
simple corporate governance matter. (can be excluded under (i)(7) or (i)
(1))

(8) Relates to election: If the proposal relates to a nomination or an election


for membership on the company's board of directors or analogous governing
body or a procedure for such nomination or election; [at issue in AIG case]

(9) Conflicts with company's proposal: If the proposal directly conflicts with
one of the company's own proposals to be submitted to shareholders at the
same meeting.

NOTE to paragraph (i)(9): A company's submission to the Commission


under this section should specify the points of conflict with the company's
proposal.

(10) Substantially implemented: If the company has already substantially


implemented the proposal;

(11) Duplication: If the proposal substantially duplicates another proposal


previously submitted to the company by another proponent that will be included
in the company's proxy materials for the same meeting;

(12) Resubmissions: If the proposal deals with substantially the same subject
matter as another proposal or proposals that has or have been previously

included in the company's proxy materials within the preceding 5 calendar


years, a company may exclude it from its proxy materials for any meeting held
within 3 calendar years of the last time it was included if the proposal received:

(i) Less than 3% of the vote if proposed once within the preceding 5
calendar years;

(ii) Less than 6% of the vote on its last submission to shareholders if


proposed twice previously within the preceding 5 calendar years; or

(iii)Less than 10% of the vote on its last submission to shareholders if


proposed three times or more previously within the preceding 5 calendar
years; and

Class Notes: Proposals that have been given in the past but have never
had much support.

(13) Specific amount of dividends: If the proposal relates to specific amounts of


cash or stock dividends.

Note on SEC oversight/procedure of s/holder proposals:


If a corp believes a proposal can be excluded, it may file w/ the SEC stating that it
intends to exclude the proposal, the SEC then:
If in agreement files no action letter saying it would not recommend
commission bring enforcement proceeding
If not in agreement notify issuer that SEC may bring enforcement action if
proposal is excluded
Intermediate approach tell issuer that would be excluded as currently drafted,
but can be revised as follows
o Either side who loses can ask commissioners to review staff decision
o Proponent of the proposal may still bring suit even if SEC does not take action

Closely Held Corporation (35 or fewer shareholders)


Hobby Lobby: Best interest of the corporation. Want corporation to avoid heavy fines. Q: What
advice would you give to the Sc in relation to Sc in citing this decision? BJ is relevant if one of
the shareholders in the family had challenged the other members (by incurring penalties and
bringing litigation). Dissenting family member could have said a breach, negligence, etc. But
this is a different question. If a corp is a person as per citizens united, they should have a first
amendment right as to what speech they have. On the other end, when there are numerous
shareholders, how do you ascertain this? Why if a corp gets special treatment with liability
should it be a citizen in regards to rights?
Wade: The essence of a corp is it seperateness from its shareholders. It is a distinct legal
entity, with its own rights, obligations, different from the rights of shareholders. Relates to

piercing: if an individual shareholder gets to relyon te separate existence of corp to shield


himself from liability, then that should end the inquiry. Shouldnt get to choose.
Abuse of Control (state law, normally closely held)

Since CHCs are similar to partnerships, s/holders have a fiduciary duty of utmost good faith
and loyalty to each other because they control board of directors. By contrast, s/holders in
large public corps owe no duties to one another unless there is a dominant s/holder
Test for breach of duty of loyalty to minority shareholders: (Wilkes)
1. Whether the action taken further a legitimate purpose; and if so,
Burden on controlling s/holders
NOTE: Controlling shareholder can be someone with 25% stake but total
veto power (i.e 4 shareholders all w 25% but they need >80% of the vote
to pass anything) (preventing freezeout)
o See Smith v. Atlantic Properties (similar to fisk ventures with veto
provision)
Wolfson in Smith ran wouldnt agree to pay dividends to
other 3 shareholders. Eventually, that had negative tax
consequences. He breached duty of loyalty by having no
plan and making taxes come.
But, didnt all 4 not agreeing cause tax penalty?
2. Is there an alternative means to accomplish that purpose that would be less harmful to
the minority s/holders interest (i.e., less harmful (least restrictive) alternative)
Burden on minority s/holder
o Wilkes (mass) Termination of Wilkes for objecting to Quinns purchase of corp
property because price was too high did not further a legitimate business purpose (and
thus, didnt have to reach second prong). Wilkes was competent in his salaried
position. Other members cannot just fire him.
i. Distinguishing Ingle: 1) Ingle was NY 2) Ingle had specific sholder K with specific
buyout, Wilkes had oral understanding to keep job as long as loyal. 3) Wilkes,
original investment in corp, held shares for a long time, Ingle employee first, just
bought shares 4) Wilkes did not get fair price, Ingle did 5) but werent
expectations the same? 6) dissent in Ingle says buyout prov. Was there in case
Ingle left
Remedies for breach Reasonable Expectation Test: (Brodie)
1. What were s/holders reasonable expectations?
o What did the shareholder reasonable expect to get out of being a shareholder?
2. Were s/holders reasonable expectations in share of ownership frustrated?
o Brodie By freezing out Ms. Brodie, she was excluded from corp decision
making, access to corp info, and ability to sell her shares. She was receiving no
dividends and no salary.
3. Determine what remedy would vindicate Ps interests? (remedy has to comport with
the plaintiffs reasonable expectation of benefits from stock ownership in the
corporation)
In freeze out, restore minority s/holder as nearly as possible to the position she
would have been in had there been no wrongdoing
Forcing a buyout of ones shares is not a proper remedy (Creates artificial market
UE)
o Brodie Reasonable expectation was role of director and/or officer and salary
similar to what her husband was receiving (and maybe a dividend)

Perhaps injunction to prevent majority from blocking the minoritys


position
o Wilkes Salary that Wilkes would have received had he not been terminated
Ways to avoid issues:
1. Employment with shares that has contract that sets grounds for termination
Employee doesnt acquire fiduciary protection against being fired simply
because he is a minority s/holder Ingle
Ingle NEW YORK at will employment doctrine overrides strict good
faith when buy-back provision in s/holder agreement is premised on
termination for any reason. No right to employment, and no fiduciary duty
to terminate only for cause. The sequence of starting as an at-will
employee and then becoming a shareholder was material. If his argument
was that he wasnt treated fairly in terms of the money he received for
shares, he would have went to ct and they would have appraised it.
(dissenting from transaction). Appraisal/dissenters rights.
**Remember if he hadnt signed agreement, may have been more
like Wilkes
o ******Q: Enron documentary: Did the board members of
Enron breach a fiduciary duty. And if so, what duty?
o Duty of care requires due consideration/ investigation/ and
deliberation. They did not do that here. Failure to
investigate, failure to deliberate. Need to finsh by saying
that they were grossly negligent!
o How about duty to monitor? Dont want to show this
because it is a much higher standard to prove good faith.
Q:: Andy fastow when he did business, he chose for many of the
special entities limited partnership business forms. Many of the
rest of the partners were limited liability. Was limited partner
form the best choice of business organization. If not, why not,
and what would you have chosen? Entities were limited
partnerships, how do you protect Fastow when he can be
responsible for all the debts? Limited partnerships (LLPS), def
varies from state to state. What about a corporation? Not the
best answer because corps have centralized control and he wants
control! Takes away flexibility.
Q Why did Ingle lose his case?
o
2. Some sort of buyout (buy-sell) agreement
If a minority s/holder is termination/frozen out, corp has buy out his shares
When M. Sholder has K that terminates stock when employee quits
Corp must Disclose or abstain from trading on MATERIAL, non-public
info. (see above under insider trading)
In Jordan: if you quit, get book value, but merger was in place. Corp
didnt tell him and got excess because he sold before successful merger.
Jordan wouldnt have quit had the company disclosed or abstained.
(these are Wilkes duties) : good faith.
Contrary to INGLE!
Opportunistic fireing triggers Wilkes
Can agree to trigger and price when agreement entered

Exception relating to employment at will contract in NEW YORK An


employee doesnt acquire fiduciary protection against being fired simply
because he is a minority shareholder Ingle

Mergers and Acquisitions: Friendly transaction negotiated between acquiring company and
the acquired.

2 Ways to do this:
1) 2/3 vote of shareholders of both companies vote for merger
2) Sell assets of acquired company and surviving company has
assets of acquired company.
Result: one company ceases to exist and everything is transferred to the
survivor.
Once Merger, Dissenting Shareholders Always get Dissenting Rights

Right of shareholders if they dissent from or disagree with particular


transaction under state law

Courts will determine value of their shares

Judicial proceeding to appraise value of shareholders shares

DE shareholders of companies in DE do not get appraisal rights for asset


sales; shareholders of companies in DE do get appraisal rights for mergers

PA shareholders get appraisal rights in both asset sales and mergers

Asset Sale
o

one company sells its assets to another company

If company a sells its assets to company b, then in return for assets can give 1) $, 2)
shares in company b, or 3) combo of both

Once A sells to B, all it has is its name and $/stock it got for its assets. In these
cases, after A sells assets, it will liquidated. Then A will give $/shares, to the A SHs.

Farris v.Glen Alden Corp: List small but sells to GA in exchange for GA stock. Then, list
liquidated and distributed GA stock . This was done to avoid appraisal rights because PA
didnt have appraisal rights for asset selloff. Ct called this a de facto merger and
abolished this asset sell off without appraisal rights. PA NEED APR. RIghts
Harrington v. Arco : Same transaction as Farris: involved asset sale (did it instead of
merger) and Delaware ct said that this is perfectly ok to choose one over the other. NO
APPRAISAL RIGHTS IN DE
Both methods of amalgamation are of equal dignity because any other approach,
parties are never certain of the outcome. No defacto merger in most jurisictions
including NY.

Freezeout Merger: Normally, remedy for merger or sell out is to have court determine fair
price. But another remedy

Majority Rule: It is ok to freeze out minority shareholers, but must do so in


accordance w/ Weinberger
w/ 1) fair price : usually independent evaluations, investigation, etc.
2) fair dealing. Need full disclosure of COIs, merger agreement, etc. Need to
bargain for price.
o Weinberger rule. Does not require legit. Business purpose to freezeout.
Here, there were conflicted directors. Not fair dealing by not disclosing
conflict. Also, not fair price because the company should have bargained
more for minority shareholders.
o Other bases: Not just misrep ofr fraud. Can be broader notions of procedural
fairness and fair dealing.
Minority Rule: (Coggins was for cash-out merger)
o 1) Legit Business Purpose: (Cant be personal) Coggins MASS Rule
o 2) Fair Price:
o 3) Fair Dealing:
Note: Relief: Normally dont force people back in, give damages as if
merger was undone and corp back together.

Takeaway: Remedies for minority shareholders (and no such thing as de-facto merger)
1) Appraisal rights (In DE and NY, they are extreme right rights because cts. Dont want
everyone to do it. So they give it when there is a merger, but not asset sale. In PA, they
give rights for both).
2) Weinberger remedy
3) K Right to get a certain level, see Rabkin. There, minority shareholders had right
to get certain price per share per K.
De Facto Non-merger

Rauch v. RCA: Where parties structured a merger but plaintiffs wanted to call it an
asset sale followed by redemption. Essentially, DGCP251 allows during a merger for
a company to reissue stock or to give a cash out. In this case, if I was a
redemption, Ps wouldve gotten 100 a share, not 40. IT IS WHAT THE PARTIES
CALL IT. Corporaitons have equal dignity to choose how they structure. THIS IS
THE OPPSOSITE OF HARRINGTON
LLC Merger: (merger of llc into a corporation)

BACKGROUND: LLCs can have board of managers, have centralized management,


etc.
Rule: Managers still have fiduciary duty of loyalty. In VGS Inc. v. Castiel, C owned
75% and S owned 25%. Q served on board as per C. Q and S try to go behind Cs
back and form LLC to become majority.
o Majority of LLC can take members off board without notice or meeting etc.
If C had notice, he would have blocked merger by remoing Q from board of
managers. DGCL 404(d) allows actions requiring consent to be taken w/o
meeting, but remember they cant be surreptitious.

Must provide notice and give shareholder opportunity to


protect his interest.

Takeovers

Dealing w/ hostile form of corporate takeover. Typically, acquirer bypassed the directors and
makes offer directly to s/holders through a tender offer Offers premium over market value
if sufficient % of shares are tendered
Can also bypass board and have shareholders through proxy try to mess with corps
directors
Can also do a slow creep and buy stock on open market and gain share to influence
directors. Chef
Numerous tools available to Board to thwart takeover attempts power derived from Del
141(a) (power to manage business gives Board power of defense) & Del 160(a) (broad
authority for corp to deal in its own stock)
Tiers:
1 Tier: No limit on shares willing to take, but he wants 51%. Offers for 60 when trading
at 50. You can tender and get 60, or refuse and watch the price (freeride). If deal fails,
keep what you have.
2 Tier: Buy 51% of everyone that tenders stock for 65 (front end) and thereafter merge
firms and pay 55 to the remaining back end %49.
What happens: 1) you tender and go through. Get 65 for at least %51 of stock
(more if less tender) and $55 for the rest. 2) Dont tender and deal goes through.
You will receive back end $55 for all stock. 3) Deal does not go through: maybe
rival company bids stock up real high.
Reason: Meant to prevent one tier (free ride policy) where no one tenders hoping
company becomes more profitable because eveveryone scared of getting
screwed in 2 tier.
Defense Mechanisms:
Greenmail buy corporate raiders shares (IRS now imposes 50% tax penalty
on Greenmail)
In Cheff the corporation got Holland bank to buy only the Maremont
shares. They offered $20 for shares worth $14, so the shareholders bring
suit.
Alternative: Issue dividends or buy shares from shareholder who want to
sell.
Poison Pills anything that kills your corporation. A triggering event that is
going to make the corporation less valuable so that the acquirer will no longer
want to acquire it.
Could be certain rights granted to s/holders to acquire equity or debt
securities
White Knight A person or corp that rescues the target and makes competing
tender offer
No-shop Agreement Stipulation prohibiting a target corp from seeking other
offers
Cancellation Fee requires acquirer to pay large fee to White Knight
Lockup Option Gives White Knight option to buy valuable crown jewels at
far below market value if raider gains control Revlon

Self-tender Company purchases its own shares (Now illegal if offered to select
s/holders only) Unocal

Analysis
Board can take a number of defense mechanisms to ward off a hostile takeover attempt
BJR protection does not apply right away to boards actions. There is enhanced scrutiny.
o Directors have to satisfy higher burden to get BJR protection b/c of fear of
COI/entrenchment Cheff
Test to determine whether board acting reasonably, and thus, higher burden satisfied
o Court analyzes whether board (Unocal Duties Expansion of Cheff):
1. Acted in good faith (actions motivated by genuine concern for the corp);
2. Conducted a reasonable investigation in assessing the takeover bid; and
3. Balancing Whether action taken was reasonable in relation to the threat posed
o If factors met, higher burden satisfied & directors receive BJR protection (subject to
trad. BJR exceptions)
Cheff Court determined that board acted in good faith and conducted a reasonable
investigation (did own investigation; contacted outside firm; considered Dunn &
Bradstreet report which characterized Maremont as a corp raider), and thus, decision to
pay off Maremont was protected as a valid business decision. Maremont was going to
change their business strategy that was working (i.e., by liquidating the company).
Unocal Selective treatment in making self-tender was reasonably related to the
perceived threat of a coercive two-tiered tender offer (NOTE: SEC outlawed self-tender
offers unless offered to single s/h or all)
o The board passed the enhanced scrutiny test and got BJR because it was acting
in the shareholders best interests and not to entrench themselves.
However, when sale or break-up is inevitable, the boards obligation changes from defending
the corp (unocal duties) to getting the best possible offer for shareholders (dont need to
seek competing price) Revlon Duties:
1. Triggered when dissolution or break up is inevitable (active bidding process) or when in
response to a hostile bid, company abandons long term strategy and looks for a
friendly bidder to break up company Revlon
o Corp initiates sale
o Corp seeks alternative transaction in response to bidders offer (Revlon)
Lock-up provision is an acknowledgement of an imminent break-up. You
want to foster bidding, not eliminate it.
o Corp abandoning strategy and business model through lockup provision
(Revlon)
Revlon Only issue was price. Board had fiduciary duty to get best possible
price and subsequent defense measures no shop, lockup, and cancellation fee
to white knight were not reasonable
Analysis changes if other issues such as acquirer would change business
model, etc.
Merger: If a merger is in place, and negotiations are ongoing, to fend off a rival
bid, the COMPANY may make a tender offer and is not forced to investigate new
offer. When sale or breakup is not inevitable, company can use its best
interest and make tender offer (shareholders lose). Time INC Doesnt fit in
either category.
REVLON DUTIES NOT TRIGGERED HERE BECAUSE NO
CHANGE IN POWER
2. Triggered when control of the corp is to be sold QVC

Paramount v. QVC Sale would change control from fluid aggregation of


public shareholders (disperse and fragmented ownership) to dominant s/holder.
Different from Time Warner When this happens, it triggers Revlon
Important if dominant s/holder plans to change business model or if such
control in the hands of one person and thus unfettered discretion to take
such actions as sell off assets, dissolve, merge elsewhere, etc. would be
against the public interest
No shop: Paramount board would not discuss any business combo with 3 rd
party unless the parties offer was not subject to financial contingencies,
and paramount board decided that its fiduciary duties required it to talk to
the 3rd party.
Termination fee: If negotiated deal falls through (Viacom and paramount),
Paramount would pay Viacom 100 million.
NOTE: There can be a conflict of interest because people can lose their
jobs. Because of this, business judgment rule is not implicated.
HEIGHTENED LEVEL OF JUDICIAL SCRUTINY.
Lyondell v. Ryan: Board of Lyondell gets offer from Basell. Reject first offer
within very short time. Board was very sloppy. Derivative suit by shareholders.
While they were sloppy and disinterested, they were exculpated from liability for
duty of care. Only liable if duty of loyalty but they werent because of no bad
faith (business judgment)
Remember, as long as they bargain for fair price, DONt NEED TO SEEK
COMPETING OFFERS

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