1. AGENCY...........................................................................................................................

2
I.

I
ntro
2

II.

C
reation of the Agency Relationship
2

III.

T
ypes of Authority (How can an agent bind a principal)
3

IV.

P
rinciples of Attribution
3

V.

A
gents Fiduciary Duties to Principal
4

VI.

T
ermination of the Agency Relationship R3d 3.06 and 3.11
5

VII.

C
onclusions/ Liability to Contract with Third Parties
5

2. PARTNERSHIP.................................................................................................................. 6
I.

I
ntro
6

II.

F
ormation
6

III.

R
elations of Partners Inter Se and to the Partnership

Business Associations Outline

1. AGENCY
I.

Intro
a. Agency relationships create both inward and outward-looking
consequences
i. Inward relates to the relationship between the principal
and the agent and is largely governed by the contracts
between the parties and the law of fiduciary duties
1. The agent is a fiduciary to the principal, the principal
is NOT a fiduciary to the agent
ii. Outward relates to the relationship between the principal,
the agent, and a third party and are governed by various
principles of attribution
b. University of Chicago View on Agency
i. Everything about agency law is in a sense default rules,
that are substituted when parties dont bargain for them
1. Agency law steps in and creates responsibilities and
duties, for people who dont negotiate them
c. Ex: Shareholders elect a board of directors, who appoint officers,
and the officers are agents of the corporation

II.

Creation of the Agency Relationship

a. Definition R3d 1.01
i. Agency is the fiduciary relationship created when (1) the
principal manifests assent to the agent that the agent shall
act on the principals behalf and subject to the principals
control, and (2) the agent assents to the above manifests
consent to act
1. Manifest can be written, oral, or conduct that
suggests this
2. Agencies are consensual, not contractual
b. Three elements that alter the strong presumption that no one has
the right to bind another (consent, benefit, control)
i. A manifests consent
ii. A acts for the benefit of P
iii.A is subject to Ps control
c. U.S. v. Cyberheat
i. The creation of an agency relationship ultimately turns on
the parties intentions as demonstrated by either express
agreement or by inference of their actions
d. Must have legal capacity R3d 3,04, 305
e. Types of Principles and Agents 1.04

i. Disclosed Principal the third party has notice that agent is

acting for the principal and has notice of the principals
identity
ii. Undisclosed Principal third party doesnt know that there
is a principal, and doesnt know the principals identity
iii.Unidentified Principal thirds party knows there is a
principal, but doesnt know who the principal is
III. Types of Authority (How can an agent bind a principal)
a. Actual Authority R3d 2.01
i. Highest form of authority
ii. Focus is on the manifestations between the principal and
agent
1. Agent must reasonably believe that he is acting in
accordance with the manifestations of the principal,
and the principal wishes the agent so to act
iii.Types R3d 2.02(Express, Incidental, Implied)
iv.Castillo v. Case Farms
1. Giving an agent express authority o undertake a
certain act also includes the implied authority to do
all things proper, usual, and necessary to exercise
that express authority
b. Apparent Authority R3d 2.03
i. More complicated than actual authority
i. This is where the action is in the cases
ii. Focus is on the manifestations that have occurred between
the principal and the third party
1. Def: (1)When a third party reasonably believes that
the actor has authority to act on behalf of the
principal, and (2) the belief is traceable to the
principals manifestations must have emanated
from the principal
iii.How to establish apparent authority
1. A reasonable belief by the third party that the alleged
agent is an agent of the principal
2. Some action or inaction by the principal to create (or
fail to dispel) that reasonable belief on the part of the
third party
3. Some showing that the third partys injury could have
been avoided had the alleged principal exercised
control over the alleged agent
iv.Bethany Pharmacal v. QVC
1. It was unreasonable for Bethany to believe that QVC
created an apparent agency in Janis to contract on
QVCs behalf

2. QVC did not stand idly by, they notified Bethany of

the error and made clear that a valid contract could
only be made with a QVC purchase order
IV. Principles of Attribution
a. Ratification R3d 4.01- 4.08 (Authority Granted after the fact)
i. Def: affirmance of a prior act done by another, whereby the
act us given as if done by an agent acting with actual
authority
1. An undisclosed principal can ratify
ii. Things that must be done for a ratification to hold up:
1. 4.03 A person may ratify an act if the actor acted or
purported to act as an agent on the persons behalf
a. An undisclosed principal can ratify
2. 4.04 A person may ratify an act if (a) the person
existed at the time of the act, and (b) the person had
capacity see 3.04
3. 4.05 Timing
a. Cant partially ratify, must ratify the whole
thing
b. Estoppel R3d 2.05
i. Key: (1) Detrimental Reliance, and (2) Principal must have
been in a position to cause the confusion, and could have
easily corrected it
1. This is judged based on reasonableness
c. Imputation of Notice R3d 5.01-5.04
i. Def. of Notice information conveyed to the agent typically
goes upstream to the principal
d. Agency Costs
i. Principal
1. Risk of adverse selection of an agent
2. Agent may shirk, mess up, or not perform optimally,
may also be more risk adverse than P
a. P can try to mitigate these risks by:
i. Incentivizing compensation
ii. Bond the agent
iii.Carefully monitor As behavior
ii. Agent
1. Deadbeat P, might not pay; P might ratchet up
responsibilities and not pay more
V.

Agents Fiduciary Duties to Principal

a. Intro
i. Principals and agents owe duties to each other in an
agency relationship
5

b.
c.

d.

e.

1. P performance of contract obligations, good faith

and fair dealing and indemnification in certain
circumstances
2. A performance of contract obligations, care,
competence, diligence, obedience and disclosure
a. Most important is Duty of Loyalty
i. Agent must act loyalty for the principals
benefit in all matters connected with the
agency relationship
ii. If an A breached this duty, Ps primary
remedies are damages and disgorgement
of profits
Agent is a fiduciary, therefore has a higher degree of
responsibilities than P
i. Ps duties resonate more in contract
Breach of Fiduciary Duty can be used to Reallocate a Loss/
Circular
i. Ex P was attributed with information from the agent, lost
to a third party, then P sues A for breach of fiduciary duty
1. You sue under a breach of fiduciary duty when the P
loses on apparent authority, for violating the
instructions
ii. Ex Third party sues A, and A had actual authority, so A
would turn around and sue P under his duty to indemnify
1. This is only possible when A had in fact actual
authority
Duty of Loyalty
i. Agent cannot take a material benefit arising out of the
position, cannot act on behalf of an adverse party, cannot
compete with the P during the period of agency, cannot
use Ps property for personal benefit
ii. Food Lion v. Capital Cities
1. Undercover reporters were disloyal for promoting the
interests of ABC over Food Lion. Employees are
disloyal when their acts are inconsistent with
promoting the best interests of their employer at a
time when they were on its payroll, or an employee
who deliberately acquires an interest adverse to his
employer
iii.An agents fiduciary duty of loyalty ends the day the
agency relationship ends often non-compete forms try to
address this
Sub-Agents
i. An agent must have actual or apparent agency to create a
subagent
ii. The subagent can bind the original P
6

VI. Termination of the Agency Relationship R3d 3.06 and 3.11

a. Termination of Actual Authority
i. P could die or lose capacity, A could die, or P & A could
have a mutual agreement to end the relationship
1. How P manifests a revocation of the agent or the
Agent renounces the relationship
ii. General Rule: a termination ends actual authority of an
agent
1. R3d death of P doesnt terminate actual authority
unless A knows it
b. Termination of Apparent Authority
i. Termination of any kind does NOT wipe out apparent
authority
1. Apparent authority ends when it is no longer
reasonable for the third party to believe that the
agent continues to act with actual authority
a. P must give notice to third parties to avoid
lingering apparent authority under implied
warranty of authority 6.10
VII. Conclusions/ Liability to Contract with Third Parties
a. Result of relationship depends on whether P is disclosed or
unidentified/ undisclosed
i. Disclosed P Situation
1. Enforce P and third party are parties to the K, only P
can enforce
2. Liability only the P can be liable on the K
a. If P is liable and shouldnt be, he should turn
around and sue A
b. If third party loses against P, Third party should
sue A under Agents Implied Warranty of
Authority 6.10
ii. Unidentified/Undisclosed P
1. Enforce P, A, and the third part are partied to the K
2. Liability third party can sue P or A
a. If third party sues A, and A has actual authority,
A should sue P
b. If third party sues P, and A does not have
actual authority, P can sue A
2. PARTNERSHIP
I.

Intro
a. Positives
i. Partnership is informal and very flexible
7

1. You can work around the default rules and arrange

things among yourselves
2. No formalities are really required to form a
partnership
ii. For tax purposes partnerships are not treated as an entity
partners file individual tax returns (not double taxed like
corporations)
b. Negatives
i. Unlimited liability partners are individually responsible for
partnership obligations
1. Individual responsibility can be satisfied out of their
personal assets
c. Action happens with apparent authority
i. The partnership statutes defines it as ordinary course of
business
II.

Formation
a. RUPA settled on the entity theory of partnerships the
partnership is an entity distinct from its partners
i. at common law/UPA, the partnership was made up of the
aggregate of the proprietors, and was not treated as a
separate business
ii. led to a lot of confusion
1. All partnership property was held by all the partners
as co-tenants, and the withdrawal of any partner
technically led to dissolution of the firm
b. Definition of Partnership 202
i. The association of two or more persons to carry on as coowners a business for profit, whether or not the intent was
to form a partnership
c. Examples where a partnership may or not be me created 202
(c)
i. Joint tenancy/ tenancy in common doesnt by itself even if
they share profits by use of the property
ii. Sharing of gross returns doesnt by itself even if they
have a joint or common right in the property
iii.A person who receives a share of the profits of a business
there is a prima facie assumption that this is a partnership
d. Partnership Property
i. Property acquired by a partnership is property of the
partnership and not of the partners individually
ii. When is property partnership property? 204
1. If it is acquired in the name of:
a. The partnership, or;
b. One or more partners with an indication in the
instrument transferring title to the property of
8

the persons capacity of partner or of the

existence of a partnership without an indication
of the name of the partnership
2. Frequently, how you categorize a piece of property is
important
3. A proactive way to handle these situations is a
written partnership agreement that states your
original capital contributions to the partnership
e. Holmes v. Lerner
i. Held: The oral partnership agreement was sufficiently
definite for enforcement
ii. While profit sharing is evidence of a partnership, it is not
dispositive
III. Relations of Partners Inter Se and to the Partnership
a. Financial Attributes
i. Most important consequence of partnership formation is
that partners are personally liable for all debts and
obligations of the partnership
ii. Issues relating to the financial attributes can be broken
down into
1. How were the profits and losses ultimately allocated
among partners?
2. Who is responsible to pay third parties for partnership
liabilities?
b. Partners Financial and Management Rights
i. Laundry List of Partners Rights 401 (a)-(k)
1. (a)(1) (2) Capital Account
a. Tracks each partners ownership claim against
the partnership
i. His ownership is determined by the
following:
1. Contributions made by each
partner to the partnership
2. each partners share of the profits
or losses from partnership
operations
3. any withdrawals of funds from the
partnership
4. each partners gains or losses upon
sale of the partnership or its assets
2. (b) profit and loss default profits and losses shared
equally
3. (c) reimburse and indemnify the other partners

4. (d) partners can loan money (advance) to a

partnership and be reimbursed for these funds (e)
treated as a creditor
5. (f) equal management rights
6. (g) can use or possess property only on behalf of the
partnership
7. (h) partners are owners, do not get salaries
ii. Take Away from these Rights
1. Partners have certain financial rights, and
management rights, but do not have an individual
property interest
2. Tracks each partners ownership claim against the
partnership
a. He ownership is determined by the following:
i. Contributions made by each partner to
the partnership
ii. each partners share of the profits or
losses from partnership operations
iii.any withdrawals of funds from the
partnership
iv.each partners gains or losses upon sale
of the partnership or its assets
3. Tracks each partners ownership claim against the
partnership
a. He ownership is determined by the following:
i. Contributions made by each partner to
the partnership
ii. each partners share of the profits or
losses from partnership operations
iii.any withdrawals of funds from the
partnership
iv.each partners gains or losses upon sale
of the partnership or its assets
iii. 103 tells you what is mandatory and what can be
contracted around
1. Provides the flexibility that partnership is famous for
a. Cannot take away right to information, and
cannot fool around with fiduciary duties
b. Pretty much everything else is subject to the
partnership agreement
iv.Personal Creditors can make life difficult for partners
1. May even seek dissolution of the partnership
2. 503 Money rights can get personal property
3. 504 by court order, they can take a lien out on
your financial interest in the property
c. Partners Fiduciary Duties
10

I.

i. The only fiduciary duties a partner owes the partnership is

the duty of loyalty and care 404
1. Duty of Loyalty is limited to these 3 ways
a. Self dealing (stealing an opportunity)
b. Cahoots with an adverse interest
c. Cant compete against the partnership
i. Duty of Loyalty cannot be contracted out
2. Duty of Care
a. Conduct showing gross negligence,
recklessness, intentional misconduct, or
knowing violation would violate the standard of
care
i. Partner can modify this provision, but
they are not allowed to unreasonably
reduce the duty of care 103
i. Meinhard v. Salmon
1. Salmon breached his fiduciary duty by entering into a
lease without Meinhards knowledge
2. Partners owe not honesty alone, but the punctilio of
honor is the most sensitive, is then the standard of
behavior
ii. Gibbs v. Breed Abbott & Morgan
1. The attorneys that left the firm breached their
fiduciary duties by supplying their new firm with
private information
Liability of Partners/ Partnerships to Third Parties
a. Intro
i. Partners may be forced to fulfill the obligations of the
partnership to third parties out of their personal funds
unlimited liability to third parties
ii. All partnership liability is joint and several 306 (a)
iii.This is the biggest negative of the partnership form
b. Sections 301 308
i. Partner Agent of Partnership 301
1. Every partner is an agent of the partnership for the
purpose of its business
a. Partner can bind the partnership if the partner
is apparently carrying on in the ordinary course
of partnership business or business of the kind
carried on by the partnership
i. Unless the partner had no authority and
the third party knew it
1. A persons knows a fact under 102
(a) if they have actual knowledge
ii. Transfer of Partnership Property 302
1. Can be personal property or real estate
11

a. Three ways you can take partnership title

i. (a)(1) property is held in the
partnerships name
1. Ex deed is ABC Partnership,
partnership agreement says no
conveyances unless all consent
ii. (a)(2) property held in the name of some
of the partners, with a reference to the
fact that they are partners, but without
the partnerships name readily available
on the deed
iii.(a)(3) property is held in the individual
name of some of the partners, without an
indication that theyre partners or that
there is a firm
b. Then you must do a 301 analysis
i. (a)(1) if there was apparent authority
partnership loses, initial transferee is
protected
ii. (a)(2) if no apparent authority
partnership should regain property from
initial transferee, unless initial transferee
passes it off to another party
1. If second transferee is a bona fide
purchaser, they have no
requirement to trace the
partnership
iii.(a)(3) if there is no actual authority
third party wins because they dont know
whether there was a partnership, no duty
to check when third party is BFP
2. How to Avoid these issues
a. Take title in partnership name
b. Then file whatever restrictions on apparent
authority with the secretary of state and
provide the country recording office with a copy
iii.Statement of Partnership Authority
1. Contains concept that partnership can file with the
secretary of state
a. You can do affirmative and negative things
i. Can state what the actual authority of a
partner is
1. This will be conclusive evidence
ii. Can also file a certificate that rejects a
partners authority

12

1. Ex no one has the power to

transfer real estate unless all three
partners consent
b. 303 (e) a person not a partner is deemed to
know of a limitation on transfer of property in
name of partnership if its on record
i. Allows you to defeat BFP status, and can
cut off the apparent authority of partners
under 302 (a)(1)
ii. This only works for real estate
iv.Liability of a Purported Partner 308
1. Two situations
a. Apparent partner in actual partnership, or
b. Apparent partner with other apparent partners
and no actual partnership at all
v. Partnership Liable for Partners Actionable Conduct 305
1. Partnership will be liable for tortious conduct or
violation of statutes or for some activity if
a. Partner was actually authorized or acting in the
ordinary course of business
2. The partnership is liable if in the course of the
partnership, a partner receives or causes the
partnership to receive money or property of a person
that is not a partner and the money or property is
misapplied by the partner
vi.Partners Liability 306 (Biggest Negative of Partnership)
1. All partners are jointly and severally liable
2. A new partner who joins an existing firm is not liable
for prior debts, unless the partnership agreement
specifies
a. Sec (c) alters the joint and several rule, and
tells you how to become an LLP
vii.
Action By and Against the Partnership 307 (Who do
you Sue?)
1. (a) a partnership may sue, and be sued in the name
of the partnership
2. (b) you can sue all the partners can do it all at once
or sequentially in separate actions
3. (c) if you choose separate actions: if you just sue the
firm, and get a judgment against the firm, you can
only go after the firms assets
a. Cannot get assets of the partners yet, because
they havent had their day in court
4. (d) as a general rule, you are supposed to exhaust
the firms assets first, before you go after an
individual partner
13

a. Exceptions: When the partnership is in

bankruptcy
i. Partnership creditors have priority on firm
assets. Partnership creditors stand in
parity with personal creditors of the
partners personal estate this is how
strong joint and several liability is
b. If both the firm and individual partners are in
trouble
i. Ex one partner gets hit for more than the
partners share, he can try to get
reimbursed under 401 (c)
c. Limited Liability Partnerships (LLP) 306 (c) - 1001
i. Intro
1. Partnerships with one important alteration
2. Obligations incurred while there is a LLP, whether
arising in contract, tort, or otherwise (full-shield LLP),
the partner is not liable solely by reason of being a
partner (still responsible for own conduct) see below
a. Partners are not personally liable for any of the
obligations of the partnership, unless the
partners become personally liable as a result of
their own conduct or have participated in or
supervised the wrongful conduct of another
partner
ii. Formation
1. To convert to an LLP, the vote must be unanimous, or
what the partner agreement says
2. The name of the partnership must end in LLP or RLLP
3. Must file an annual report
4. You can choose a state different than the state of
your operations
II. Dissociation, Buy-Out, Wind Up
a. Intro
i. RUPA does away with the UPA rule that any departure of a
partner causes dissolution of the partnership
1. Under RUPA, the departure of a partner is a
dissociation and their departure may or may not
result in the termination of the partnership
2. Favors cash out rather than liquidate
ii. Types of Partnerships
1. At Will partner can withdraw for any reason, and
has the right to do so, not a breach
2. Specific term/ Definite Undertaking partner can
withdraw earlier than the end of the term because

14

you have the power to withdraw, but you breach the

contract
a. If you were categorized as wrongful, there are
consequences
i. No role in wind up
ii. Owe breach of contract damages
iii.But you still get credit for good will on
cash out
iii.Test Tip: always determine what type of partnership it is,
and whether someone was wrongful
iv.Article 6 defines all dissociations
1. Whether a dissociation results in a buy out of the
dissociated partner and continuation of the
partnership business or a winding up depends on
Article 8
a. 801 lists all the events that trigger a winding
up or liquidation of the partnership
i. The most common dissolution events are
dissociations
2. If a dissociation does not cause the dissolution and
wind up, the disassociating partner must be bought
out pursuant to Article 7
a. The main consequences of Art. 7 are (1) the
dissociated partners interest must be
purchased for the greater of the liquidation
value or the value based on a sale of the entire
business as a going concern without the
dissociated partner; and (2) the dissociated
partners liability and ability to bind the
partnership are terminated
v. In analyzing the effect of dissociation on the rights of the
partners, a key issue is whether the dissociation was
rightful or wrongful and resolution of that issue
depends on the nature of the partnership
a. Generally a dissociation is rightful when it is
accomplished without violating the agreement
between the partners
b. If a partner dissociates in breach of the
partnership agreement, or in a partnership for a
definite term or particular undertaking, before
the expiration of the term or completion of the
undertaking, the dissociation has been
wrongful, and the dissociating partner is liable
to the partnership and other partners for
damages

15

c. Most events are not wrongful in partnerships at

will
b. Most Common scenarios that trigger the end of partnerships
i. Partner withdrawals
1. Ask whether this was a partnership at will, or for a
definite term/ particular undertaking
a. If at will dissolution under 801 (1), you are
in wind up unless you can conceive the person
to take a buy-out
b. If for a particular undertaking/ definite term
because 602(b)(2) says its wrongful, you are
in a Ch. 7 buy-out, unless half the remaining
partners decide to wind up within 90 days
i. You are wrongful and owe damages, and
should they elect wind up, you dont get
to participate in the management of it
ii. Partner is a dead beat (personal financial trouble) or
Partner Dies or is declared incompetent
1. Ask whether this was a partnership at will, or for a
definite term/ particular undertaking
2. If at will go into buy-out, not wrongful even though
its a debtor in bankruptcy
a. Policy: partnership at will, you can walk out any
time
3. If for a particular undertaking/ definite term- triggers
buy-out for death (not wrongful)
a. But debtor in bankruptcy or judicial expulsion
would make this wrongful
i. And half the remaining partners could
decide to wind up within 90 days
c. Buy-Out 701 Generally
i. (a) If you are in a buyout, the partnership continues, after
the dissociated partner is bought out at the prince set out
in (b)
ii. (b) the price should be what the dissociated partner should
receive as if there would have been a wind up under 807(b)
1. Must go through constructively as if actual wind-up
occurred and this business sold today and paid off all
its bills
a. Costs are computed as the greater of the
liquidation value (fire sale) or the value of the
business as a going concern (higher value)
without the dissociated partner
iii.(c) after this calculation is made, the wrongful partner must
offset any damages
iv.(d) and indemnify a dissociated partner
16

1. A dissociated partner is liable for anything the

partnership is liable for, while you were a partner and
for the period after you triggered cash out, you could
still be responsible (lingering apparent authority) --for 2 years after the trigger or can file to have it only
be 90 days
v. Policy: put a buyout provision in the contract to avoid this
d. Wind Up
i. 802 Generally Partnership continues after Dissolution
1. (a) partnership continues until wind up is complete,
then the partnership is terminated
2. (b) partners can change their minds, stop the wind up
and continue the business, as long as they have not
hurt any third parties
ii. 803 Who gets to run the wind up
1. If not wrongful, all the partners
iii. 804 Partners Liability to Other Partners after Dissolution
1. Partnership is bound by those thing appropriate for
winding up the business
2. Still have lingering apparent authority, unless you file
805 statement of dissolution
iv. 807 Mechanics of Wind Up
1. Pay off all liabilities
2. Return to partners their capital accounts, if you dont
have enough assets, then they have to contribute in
losses based on their shares in the partnership
ACCOUNTING CLASSES
I. Balance Sheet
a. Intro
i. A snap shot of a specific day
ii. Assets = Liabilities + Equity; Assets-Liabilities=Equity
iii.Every transaction affects at least two accounts to keep the
balance sheet balanced
iv.Very conservative accounting, assets are carried at
historical cost, except marketable securities
Major Categories
a. Assets
Current Assets most liquid, expect to move to cash within one year
v. Cash and cash equivalents can be moved to cash within 3
months
vi.
Accounts Receivable money owed to you and an
allowance for money that you might not get from
deadbeats
vii.
Inventory for most businesses this is a big deal,
stuff you havent sold
17

1. You have to know: (1) how much inventory you have

on hand, and; (2) you have to ascribe a value to it
a. Three different accounting methods under
GAAP
i. Average cost
ii. FIFO (first in, first out) oldest stuff first,
therefore most recent stuff is left at the
end of the year
1. Helps put a high value on balance
sheet, and lower expense = higher
profits on income statement
iii.LIFO (last in, first out) recent stuff first,
therefore older stuff is left over a end of
year
1. This puts a lower value on the
balance sheet, and higher
expense=lower profits on income
statement
viii.
Prepaid expenses mag subscriptions
ix.
Marketable Securities recorded at market price
Fixed Long Term Assets land, property, equipment, etc
i. Original cost depreciation
x. Good will when you buy something and paid more than
fair market value
1. IE buying a patent
a. Liabilities
Current
xi.
Accounts payable
xii.
Accrued payroll
xiii.
Current portion of long term debt Long Term
a. Equity (most important for us)
xiv.
Trying to keep track of two things
1. Capital contributions what you originally invested in
the business
2. Net Income or losses (retained earnings)
xv.
Equation
1. Starting capital + net income distributions = equity
xvi.
In a corporation ask:
1. What did they invest in the business what is the
price they paid the company for the shares of the
stock?
2. What happened in the way of earning want to know
the earning/or loss, if earnings, what is retained in
the business?
a. Corporations have 3 accounts that track these

18

i. The money received for the initial stock

sale is split between the stated capital
account and the capital surplus account
a. Stated Capital
i. Equation: Number of shares issued by the
company x par value per share
1. History: you cant use the stated
capital to pay anything, it was
viewed as a cushion to protect
creditors
2. Companies began lowering the par
value so there would be a surplus
b. Capital Surplus
i. Equation: Number of shares issued x the
excess of the price the company sold
them for over par
b. Retained Earnings
i. Accounts for net income/ net loss
II. Income Statement
a. Covers an entire period of time (usually a year)
i. Reports all the companys revenues and expenses to
determine if there was a profit or loss
ii. Divide net income by number of shares outstanding to get
earnings per share
III. Cash Flow Statement
a. Traces cash in, cash out
b. This figure matches the equity
HYBRIDS
I. Intro
a. Are the result f a search for a business entity that combines passthru taxation, and limited liability
i. General partnership Pass-Thru Taxation when they earn
profit, those profits are allocated to the individual partners
in the year earned, even if the money s not actually
distributed until a later time. Similarly, any losses incurred
by the partnership will be available as tax deductions to
the individual partners.
ii. Corporation Double Taxation corporate profits are taxed
once at the corporate level and again at the level of the
individual shareholders after payments of dividends
II. Limited Partnership
a. Attributes
i. Has one or more general partner who:
1. Manages the business and has unlimited liability
ii. Can add additional investors (limited partners) who:
19

1. Have limited liability, and are passive investors

iii.Must file a certificate with secretary of state
b. Major Issues
i. Someone is still on the hook, namely the general partners
1. To protect himself/themselves general partners
incorporated to insulate personal assets
ii. Requirement of passivity for limited partners
1. A limited partner who takes part in the business,
loses limited liability
c. Classic form or limited partnership
i. One corporate general partner
ii. Many rich limited partners
1. These ended up being tax shelters for rich people,
benefit of pass-thru taxation, offset losses (IS later
limited this)
III. Professional Corporations
a. Intro
i. Until the LLP statutes there was a deeply entrenched
principle that professionals should not be able to
incorporate
1. Lawyers, doctors, dentists, accountants, and
investment banks
ii. Professionals were annoyed that they were forced to
practice in partnerships, that at the time had a worse tax
law for employee benefit plans than corporations
1. So they lobbied to receive a special professional
corporation statue, which they agreed that they
would remain unlimitedly liable for torts (some states
contracts too)
b. Attributes
i. Taxed like a corporation, or it under 100, they can retain
partnership taxation
c. Why didnt they switch to LLPs or PLLCs?
i. In order to convert, they have to go through dissolution
which is a taxable event
1. If the PC has appreciated assets, IE own the building
(bought it at a lower price, worth more now) that can
be a killer tax consequence
IV. Sub S
a. Intro
i. There are different chapters in the IRS code
ii. Sub S is small business corp.
1. They sought limited liability, but pas thru taxation
b. Attributes
i. Is a corporation under state law

20

ii. Must meet certain eligibility requirements and elect Sub S

tax treatment
1. Then the taxation is analogous to Partnership
taxation
a. Cant have more than 100 shareholders
b. All must be US citizens
c. Can only have one class of stock (Big Deal)
V. Limited Liability Companies (LLCs)
a. Intro
i. Is a true hybrid
ii. Has features from partnerships, limited partnerships, and
corporations
1. It is an unincorporated association created under a
special statute (cant call it a partnership or
corporation)
iii.Alternative entity for small businesses
b. Formalities
i. Not incorporated, but filing requirement (is very minimal)
ii. You can choose the state in which you want to be an LLC
iii.Operations agreement
1. Is like partnership agreement
2. DE requires an operating agreement, loose standards
though
a. Policy: LLCs do not have a lot of default
provisions, s the operations agreement should
be very thorough
c. Separate Personality
i. Yes
ii. Series LLCs 18-215
1. New form of LLCs that is hot
2. Within the same LLC if you put notice that the LLC
has the ability to create a series in the certificate of
formation the LLC can create series within the LLC
and segregate off assets in the same series
a. This insulates losses in that series, limited to
that series
3. Must keep separate books and records
d. Separate Ownership + Control
i. Two fundamental Paradigms
1. Manager managed - yes
2. Member managed no
a. This is default in DE
ii. Who has the power to bind?
1. DE each member and manager has the authority to
bind the LLC
a. Usually only managers can bind
21

e.
f.
g.

h.
i.

iii.Distribution of Profits/Surplus
1. Default rule: in accordance with capital contributions
2. Restrictions: assets must exceed liabilities
Limited Liability
i. Yes
Transfer of Ownership
i. Can transfer $ rights only
Duration
i. Big negative
1. If any member wants to resign, dies, bankrupt,
judicially expelled, they have no right to cash out,
and it does not trigger dissolution
2. LLC has perpetual existence therefore these rights
are very similar to a shareholder in a public
corporation
Tax
i. Pass thru unless check the box
ii. Single member LLC disregard the entity
Wrap Up
i. It is less expensive to incorporate than create an LLC
ii. The operating agreements are pretty complex, because LLC
statutes do not have default rules for everything
iii.Older attorneys dont know much about LLCs, new kids on
the block
iv.Case law is not developed, use corporate and partnership
law

CORPORATIONS: ORGANIZATION AND STRUCTURE

I. Intro
a. Corporations are creatures of statute
b. Internal structure Tripartite Government of a Corporation
i. Shareholders elect directors, and directors elect officers to
run the day to day operation of the company
1. Shareholders
a. Have the right to elect the board
b. Right to vote when the statute says they can
(in fairly extraordinary circumstances usually
board initiated)
i. Amendments to the articles of
incorporation and (usually bylaws)
ii. Fundamental transactions such as
mergers and acquisitions
c. May get dividends
d. Can sue when unhappy/ when officers have
breached fiduciary duties

22

e. Are entitled to the residual interest in the

assets of the corporation
i. Upon liquidation, shareholders are
entitled o receive the value of the assets
remaining in the corporation after all of
the corporations obligations have been
satisfied
2. Directors
a. Elected by shareholders to supervise/ appoint
the officers
b. Serve for a set term
c. Directors are the shareholders representatives
within the corporation
d. Typically make the major decisions relating to
the operation of the corporation
e. Directors typically have no authority to act as
individuals, instead they act as a collective
board of directors
i. Many issues under corporate law relate to
conflicts between the board of directors
and the shareholders
3. Officers
a. Most senior employees of the corporation
(President, CEO, CFO)
b. Are in charge of the day to day operations
i. Corporate law has little to say about
officers
c. Officers can bind the corporation under an
agency principle
ii. Main Questions
1. What are the relative spheres of authority?
2. When acting in the appropriate sphere of authority,
what are specific procedural rules for taking action?
a. Note: when you challenge something it can be
procedurally or under a breach of fiduciary duty
II. Mechanics of Incorporation
a. Intro
i. From the beginning regulation/ formation of businesses was
left to the states
ii. There was a fundamental distrust of businesses amassing
capital
1. Through the mid-late 1800s, there were not a lot of
corporations
a. No general corporations statute existed, you
had to get a special act of the legislature

23

2. In the Jackson era, general incorporation statutes

came on the scene but they were highly structured
and restrictive
3. Later, NJ had progressive corporations that made it
easy to incorporate, Woodrow Wilson, then gov
stopped this process
a. And DE stepped in and took over the process,
and has ever since
Mechanics
a. Clear name availability
iii.Make sure the name isnt used by another company
1. You can also reserve a name for a period of time
b. File Charter Document
i. MBCA
1. Articles of Incorporation
a. Name
b. Shares (number authorized)
c. Registered office/ agents for service of process
d. Name of incorporators
ii. Delaware
1. Certificate of Incorporation
a. Name
b. Registered office/ agents for service of process
c. Statement of purpose
i. Does not have to be specific to conduct
any lawful business
ii. History: previously there were purpose
and power clauses to the certificate of
incorporation led to lots of litigation as
to whether the corporation acted outside
of its authority - no longer the case
d. Capital structure
i. More specific than MBCA
ii. If more than one class of stock
1. What is the number of shares
authorized
2. And as to each, what is par/ no par
and rights, privileges, or preferred
a. Or you can give the board the
right to determine this (blank
check)
e. Incorporators
i. Required to file certificate of
incorporation and hold a board meeting
f. If power of incorporators cease at filing, must
list initial directors
24

c. Existence begins on filing

d. Initial Organization Meeting
i. As soon as certificate/ articles are files, need an
organizational meeting to complete the formation of the
company
1. Can be held by the incorporator or the initial directors
ii. 5 steps
1. Must adopt the bylaws (comprehensive procedural
rules)
2. If you didnt decide on initial directors, the initial
incorporator appoints the initial directors
3. Also appoints the officers
4. Sell stock
5. If pre incorporation contracts, have the board adopt
these
e. Amending Charter Document
i. It is harder to amend articles of incorporation compared to
bylaws, two step process
1. MBCA
a. (1)Board approval first
b. (2) Shareholders approve by majority of
outstanding stock for quorum. Vote is more
votes than against
2. DE
a. (1) Board approval first
b. (2) Shareholders approve by majority
Theories Undercutting Limited Liability if Problems in Formation
f. Intro
i. Arise in defects of incorporation, because a corporation
was never formed, limited liability never attached
g. Theories
i. Promoters Contracts
1. What happens with respect to contracts made in the
period of time when the investors were getting things
together before the articles of incorporation are filed?
a. IE sign contracts prior to the date of
incorporation, then the company comes into
existence and decided that the preorganization contracts will not be accepted
2. General rule: promoters are personally liable on preincorporation contracts, unless third party grants a
novation
a. Until the company comes into existence, there
is not yet limited liability
i. In practice: you should always avoid preincorporated contracts
25

1. Instead use an option secured with

consideration, then transfer/ assign
the option to the corporation
b. Exception to general rule
i. The third party knew the company had
not been formed and the third party was
rushing the process
ii. Corporation by Estoppel
1. For equitable reasons, the person trying to bring up
the defect
a. The parties need to have consistently treated
the organization as though it were a
corporation; and
b. If one party were allowed to deny the existence
of the corporation, that party would obtain an
unfair advantage or benefit
iii.De Facto Corporation
1. Three requirements
a. Must be a statute under which you could
incorporate
b. A good faith, substantial effort must have been
made to comply with the states incorporation
statute
c. Must have acted like a corporation/ user of
franchise
2. Examples
a. No drafting or filing of articles
i. You lose
b. Articles drafted by an attorney, investors
signed them, but they were never filed
i. You could win
c. Attorney filed the articles but they were
bounced by the sec of state
i. You could win, better argument
3. If the third party proves a De Facto Corporation, the
third party would lose if they went after your personal
assets
iv.Effect of MBCA 204
1. All persons purporting to act on behalf of a
corporation knowing there was no incorporation are
jointly and severally liable
a. This captures all three of these third party
creditor situations, and is intended to eliminate
De Facto corporations, the process is simple, no
excuse for screwing up does not eliminate
corporation by estoppel
26

h. Other Exceptions to Limited Liability (See: Piercing Section below)

i. Capital Structure
1. If you only have a little risk in equity and a big
shareholder loan, creditors will argue that the loan
should be subordinated to the creditors claim
ii. Legal Capital System
1. At pay-in, if a company sold you stock for less than
par value, you could be liable for the difference
between cash paid and par value
a. Also, if you gave property for consideration,
and it ended up being worth less than par, you
are liable for the difference
i. Third party creditor must show that it was
a bad faith transaction
2. At pay-out, if the board pays an illegal dividend, the
board will be liable
a. If a shareholder knew /should have known it
was illegal, he may also be forced to give back
the money
iii.Piercing the Corporate Veil (see below)
III. Capital Structure
a. Intro
i. When you invest in a business as an owner you expect
three things
1. What will be your relative management and control
rights (how much say)
2. What is your income over the life of the investment
(return on investment)
3. What will you get at the end of your investment (net
assets after liquidation)
ii. In a corporation, these things are at issue, but are allocated
by what instrument is used
1. Either
a. Debt
i. Stock
1. What class of stock
2. How many shares/ what price
3. What features
iii.Three ways to bring money into a business
1. Borrow through a loan or venture capital
a. Venture capital firms make investments in a
number of different start ups, not interested in
being long term investors
2. Sell equity instruments (stock)
3. Retain earnings (make money and keep it in the
business)
27

iv.Initial Public Offering (IPO)

1. This is when the venture capital firm seeks to get out
a. Look for a conversion into preferred stock too
2. Here, the initial investors will probably sell some of
their shares to the public
a. Still want to be controlling shareholder, so will
not sell all
v. Preemptive Rights
1. If the company issues more shares, you have the
right to buy a number in the new issue necessary to
retain proportional ownership
b. Types of Stock
i. Common Stock
1. Definition
a. Most basic and junior ownership interest with
residual interest in corporation
i. Most to gain in good times, most to lose
in bad
b. It is possible to have more than one class of
common stock with different rights and
features
2. Voting
a. Votes in proportion to # of shares held
3. Dividends
a. On the number of shares held
i. Dividends are not rights, are
discretionary on part of the board; may
decide instead to retain earnings
4. Net Assets
a. At liquidation in proportion to number of shares
held after payment of liabilities and of
preferences on preferred stock (last in line)
5. Preemptive Rights
a. Generally none, unless expressly granted in
charter
ii. Preferred Stock
1. Definition
a. An ownership on the corp that is junior to debt,
but senior to common stock because of some
preference it enjoys usually a preference as to
dividends when distributed, and to net assets
upon liquidation
b. May be issued in classes or series
c. Rights, privileges, preferences described in
charter, or if blank check preferred by board
resolution
28

2. Voting
a. Usually made non-voting with contingent voting
rights
i. If dividend arrearages, or
ii. If class voting triggered in specified
circumstances
3. Dividends
a. Generally given a dividend preference
b. Are discretionary on part of the board, but no
dividend to common before dividend to
preferred
c. Generally phrased as $ amount or percentage
of par
d. Types
i. Cumulative must pay all dividends
owed before paying out common stock
holders any dividends they owe
ii. Non-cumulative they do not pay
dividends once they are in arrears
iii.Partially if company had earnings and
didnt pay a dividend then it accumulates
1. If no earnings, dividend does not
accumulate
4. Net Assets
a. Generally, given a liquidation reference
b. Usually phrased as dollar amount equal to par/
original purchase price, plus accumulated
dividend arrearages
5. Sweeteners for people who want some protection and
security and some of the growth the common
shareholders may experience
a. Conversion Privilege typically allowed to
convert to common stock from preferred
i. This is a common feature in venture
capital as an exit strategy
1. This dilutes the common stock
2. Ratio must be specified, X shares of
preferred stock will be Y shares of
common stock(anti-dilution clause)
b. Participation Feature
i. As to dividends, liquidation, or both
1. Is very hard to get
2. Preferred would get fixed
preference, then it collects again
with the common stock
c. Redemption Feature:
29

i. If a stock is redeemable at the option of

the company, it is a call = you must
submit to repurchase of your stock
1. Company is likely to exercise
redemption when paying the
dividend becomes cost prohibitive
2. Typically the redemption price
includes a premium
ii. More uncommonly, the company is
required to buy back your shares put
provision
d. Preemptive Rights
i. These usually are not allowed for
preferred stock
iii.Long Term Debt
1. Definition
a. A written unconditional promise to pay on
demand at a specified date with interest until
the fixed maturity date
i. Contractual/ not residual
ii. May take various forms
1. Bonds or debentures
a. Indenture agreement with a
third party and the holders of
the notes
b. We insert a indenture trustee
because the company is
dealing with a lot of people
i. He owes a fid. duty o
the bond holders
c. The company selects the
indentured trustee
d. The indenture agreement
spells out
i. The maturity date
ii. Interest rate
iii.When the interest will
be paid
iv.What are the events of
default
2. Voting
a. Debt is contractual, thus it does not vote
b. However, debt can exercise some control
depending on negotiated covenants

30

i. A frequent negative covenant is not

paying dividends to shareholders if they
are delinquent on loan interest payments
3. Dividends
a. Debt is entitled to interest on terms specified/
usually expressed as a percentage on the face
amount of debt (may be floating and
adjustable) and due without regard to financial
performance of company
4. Net Assets
a. Debt has a fixed maturity date
5. Other features
a. Conversion Privilege
i. Set the ratio that says X dollars of debt
can be converted into Y shares of
common stock
1. You might trade off relative to the
interest rate you are offering
b. Redemption Call
i. Allows a company to buy back the loan/
repay it before maturity date
c. Legal Capital (DE ONLY)
i. Intro
1. Defines par value of shares x number of shares
outstanding
2. DE system is fundamentally flawed
a. Historically based on par, when par meant
price, today par has no relationship to sales
price
i. Theory was to protect creditors, but
should have focused on assets
3. MBCA eliminated legal capital
ii. Pay-In Requirements By Shareholders for stock
1. Requirements regarding the nature of the
consideration the company could accept for the sale
of a stock and the minimum floor amount the
company must receive for the stock to be considered
fully-paid and non -assessable
2. Quality of Consideration 152
a. Cash or any tangible property, any benefit to
the corporation, or combination thereof
3. Quantity of Consideration 153, 154
a. Shares must be issued for a value not less than
par as determined by the board
b. For no par stock

31

i. The board must affirmatively state what

the value of the no par stock is, if the
board fails to state the value, the no par
stock will be treated as having a stated
value equal to its full price (worst case
scenario)
ii. No par formula shares issued and
outstanding x whatever the board says
the value is
1. Note: filing fees are higher on a no
par stock
4. Valuation of Consideration by the Board 152
a. In the absence of actual fraud in the
transaction, the judgment of the directors as to
the value of the consideration shall be
conclusive
i. Notwithstanding the reference to actual
fraud, in cases of gross overvaluation, DE
courts have used standards closer to
constructive fraud bad faith, reckless
indifference
5. Liability of Shareholders for Stock Not Paid in Full
162
a. If the stock is ot full paid (company accepted
cash less than par or less than the stated value
of a no par stock; company accepted ineligible
consideration; company accepted consideration
that the board valued as sufficient to cover
par/std. value, but boards valuation not
deemed conclusive), then:
b. Shareholder is liable to third party creditor or
trustee in bankruptcy for the amount necessary
to cover the par/ std. value if company is
judgment proof
i. When you issue stock for tangible or
intangible things problems occur
1. Ex. if someone pays less than par
value transfers land worth $500
for $1000 worth of stock
a. The shareholder may be
liable for the $500 difference
b. However, you must first go
after the company/ and they
must have been determined
judgment free (business
judgment rule)
32

iii.MBCA disregards legal capital system

1. Thinks the best way to go after the board is through
breach of fiduciary duties
iv.Pay Out Requirements
1. As a general rule, board may declare a dividend
170
a. Can only pay a dividend if you have surplus or
nimble dividend
i. Surplus is defined as the excess of net
assets (total assets minus total
liabilities)over stated capital
1. Focuses on balance sheet
ii. Nimble Dividend if no surplus, out of its
net profits for the fiscal year in which the
dividend is declared and/or preceding
fiscal year (focuses on income statement)
2. Dividends can be paid in cash, in property, or in
shares of the companys stock
3. Qualitative Requirements for Stock Dividends 173
a. If you distribute new stock, you have to transfer
from the surplus account to the stated capital
account
i. Why do companies do stock dividends?
1. When they are not in a position to
do a cash dividend, and they dont
want the market to react negatively
for not issuing one
b. Stock split (2 for 1)
i. Company has to amend articles of
incorporation and drop the par value
c. Reverse stock split
i. Where a number of shares are combined
to form one share
d. Note: stock splits involve no transfers from
surplus to stated capital, but are accomplished
by amendment of article changing the par
value.
e. The stated capital stays the same
4. MBCA
a. Concept
i. Do you have more assets than liabilities?
ii. Can you pay your bills as they come due?
1. If not, then personally liability for
directors under 8.33
IV. Limited Liability, Piercing the Corporate Veil, and Related Documents
a. Intro
33

i. Limited liability and piercing the corporate veil have long

been the most controversial topics in corporate law
ii. The availability of limited liability was a major factor in the
decision to seek incorporation for many businesses
1. Positives of limited liability
a. Allows shareholders to diversify risk
b. Allows companies to attract capital from
passive investors
c. Reduces monitoring costs of watching your
agents (owners watching managers)
d. People can freely transfer ownership interest
i. In practice these attributes fit large
corporations, not closely held owners
are locked in, isnt really a market for
them
2. Negatives of Limited Liability
a. Increases the risk of debt holders
i. When the creditor is a contract creditor,
he better take care of himself through
higher interest rates, etc
ii. Tort judgment you cant contract for it,
nothing you could have done to protect
yourself
b. Creates the moral hazard that the company will
engage in riskier behavior
b. Piercing the Corporate Veil
i. Intro
1. This is the big one, except it is a very difficult
argument to prevail on
2. This goes to the very heart of why you choose the
corporate form, makes the shareholder personally
liable
3. Policy: courts fundamentally do this when it is
inequitable
a. Balancing the pluses of limited liability against
its costs, with a heavy presumption favoring
protecting limited liability
4. Are ultimately questions of fact, must argue both
sides
ii. Piercing Analysis
1. Must show
a. Whether corporate formalities were followed
i. Separate bank account, no comingling of
corporate funds, regular meetings of
directors, corporate records

34

b. Most courts then require a showing of injustice

or unfairness to link the wrongdoing to the
harm
i. Two types of common injustice
1. Where the disregard of the
corporate entity has been visible to
a third party and that third party
has reason to be confused about
whether he was dealing with a
corporation or individual
2. Where the shareholder has
disregarded the separateness of
the corporations funds and treated
them as his own or
undercapitalization
2. Also Beleveder Test from Pro-Fab case
a. To determine whether the corporate veil should
be pierced
i. Control over the corporation by those to
be held liable was so complete that the
corporation had no separate mind, will, or
existence of its own
ii. Control over the corporation by those to
be held liable was exercised in such a
manner to commit fraud or an illegal act
against the person seeking to disregard
the corp. entity
iii.Injury or unjust loss resulted to the
plaintiff from such control and wrong
iii.Types of Pierces
1. Shareholders (never happened in a public company)
2. Subsidiaries of parent companies
a. Ex: when a company starts a new line of
business and tries to shield the parent
corporation
3. Enterprise liability
a. Attempting to pierce to get to the brother or
sister company, not parent
4. Reverse Pierce
a. Individual shareholder wants you to disregard
the corporation. Personal creditor wants to get
to the company, not a company creditor
working to get individual
iv.Easterbrook and Fischel on when piercing
1. Happens more often in close corporations than public
a. There has never been a public piercing
35

2. More in tort than contract

3. Usually when undercapitalized
v. Sorries v. Dancause
1. Because Soerries commingled individual and
corporate assets, he disregarded the separateness of
legal entities and therefore the court may disregard
the corporate entity therefore, he was jointly liable
for the damage to a drunk girls car (over served her
at his bar)
CORPORATION: OPERATION
I. Intro
a. Management of a corporation is divided among shareholders,
directors, and officers
b. All operational decisions can be analyzed by asking:
i. Procedurally
1. Did the proper sector of corporate government
(shareholders, directors, and officers) take action?
2. Did that sector follow appropriate procedures for
action?
a. These procedural rules are typically found in
the bylaws
ii. Substantively
1. Does the action raise any issues of breach of
fiduciary duty by directors or officers:
a. Duty of loyalty
b. Duty of due care
i. If so, the corporation may have a cause
of action, which typically will be asserted
by:
1. Shareholder derivative suit
2. Receiver/ trustee in bankruptcy
c. Hierarchy of authority
i. Statute always trumps
ii. Articles of Incorporation
iii.Bylaws
1. Cannot be inconsistent with articles
a. Takes board and shareholder approval
i. However, in many DE provisions, they
permit the board to amend by laws by
itself unless articles or bylaws
otherwise provide
iv.Difference between articles and bylaws
1. It is harder to change the articles because that is one
of the areas where the board must get shareholder
approavl
36

II. Shareholders Sphere of Authority

a. Intro
i. Their sphere of authority is quite limited
ii. Many times they may have only advisory, not mandatory
power
b. Powers
i. To elect the board of directors, who is responsible for
management of the corporation
ii. To vote when the statute specifies that shareholder
approval is required
1. Typically shareholder vote is required for specific
fundamental organic changes
a. Ex: amending articles, statutory merger, sale of
all or substantially all the assets, dissolution
2. In these instances, the statute usually required that
the board initiate the action, approve it first, and then
submit it to the shareholders
a. Some statutes require a higher level of
shareholder approval than usual for
fundamental changes
i. Ex: In DE, the vote of a majority of
outstanding stock is needed for approval,
rather than simply a majority of shares
present once quorum is established
iii.Usually statutes give shareholders the right to initiate
action only in a few select circumstances
1. Ex: amending bylaws, removing a director, (in MBCA)
filling a vacancy on the board
c. Procedures for Shareholder Action
i. Who may call a meeting? (annual=elect board,
special=anything else)
1. Board may call
2. Person authorized in bylaws
3. A single shareholder or group of shareholders of 10%
of the stock may call in MBCA
ii. Notice
1. For annual meeting
a. A statement of purpose is not required,
because everyone should know the purpose is
to elect the board and conduct any other lawful
business
2. Special meeting
a. Must state purpose
iii.Shareholder of record
1. Confirms who gets notice and who gets the right to
vote
37

2. Bylaws may fix or otherwise board may provide

manner of fixing the date
iv.Quorum/Voting
1. Base rule for quorum: a majority of your outstanding
stock
2. Base rule for voting: a majority of the shareholders
present in person or by proxy
3. Super Majority
a. An easy way to ensure that a minority voice is
through supermajority quorum voting
i. In effect gives minority shareholders veto
power over corporate decisions
1. DE supermajority requirements
can be adopted through a simple
majority vote
a. 242 (b)(4) requires a super
majority vote only when an
existing supermajority voting
provision is to be altered,
amended or repealed
2. MBCA - requires any amendment
that adds a greater quorum or
voting requirement, must meet the
same requirement and be adopted
by the same vote
b. Amending or repealing a supermajority
provision
i. DE, depends on whether its in the charter
or bylaws
1. If charter, can be amended or
repealed only by the greater vote
specified
2. If bylaws, can be amended o
repealed by a mere majority
a. Frankino example (wrinkle)
v. Voting for Board of Directors
1. Statute sets the provision for straight voting unless
you opt for cumulative voting
a. Straight voting
i. Shareholders vote number of shares
owned for as many persons are there are
directors to be elected. The board is
elected by a plurality (highest vote
getters)

38

vi.
vii.

1. Result: if any shareholder or groups

have 51% of stock they may elect
all the members of the board
b. Cumulative voting (ADD FORMULA TO BOOK)
i. Shareholder votes number of shares
owned for as many persons that there
are directors to be elected, all of which
may be cast for a single candidate or
distributed among 2 or more candidates
as a shareholder sees fit
1. Result: by allowing a shareholder to
cumulate or block votes,
cumulative voting is designed to
provide the holder of a substantial
minority interest with the
opportunity for representation on
the board
2. Recent developments
a. Shareholders dislike that the highest vote
getters win (in plurality system), so they sought
to have statutes amended
i. Companies responded that they were
scared that this would lead to unresolved
situations/ instability
1. This argument won, however
a. Both statutes amended the
provision regarding
resignation, limited to public
corporations
i. MBCA 10.22, when a
plurality results in the
election of a director
with a highly negative
vote, the director shall
serve 90 days until the
company decided who
will maintain the
position
ii. DE 805 (b) a company
can ask a director to
resign if they dont get
a majority vote
Remote Participation
1. Used in small closely held companies
Action without meeting
1. Must have unanimous written consent
39

viii.

Shareholder Inspection rights

1. There are certain books and records that you have an
unqualified right to see, for everything else, you must
establish a purpose to see them
a. MBCA is a little more shareholder sensitive
b. DE will question what you want to see, and
your purpose

III. Proxies
a. Intro
i. One mechanism to promote responsibility in managers of
public corporations is found in the federal securities laws
ii. Historically state law had very few provisions on proxies,
and there was no federal regulation on the sale of
securities
1. In response to 1928 stock market crash, Congress
passed the 1933 and 1934 Acts
a. 33 Securities Act
i. Transactional in nature
ii. When companies issue securities to the
public, they have to file a registration
statement, applies to IPO and any other
offerings
iii.Focus is on disclosure
1. Many exemptions for small
companies
b. 34 Act
i. Regulates the secondary resale market
(companies whose securities are traded
on exchanges, broker/dealer transactions,
the exchanges where the deals are taking
place
1. Interested in continuous disclosure
a. Demands a lot of information
2. Require annual 10 K, quarterly 10Q,
and in connection with every
meeting of the shareholders, when
management solicits proxies
information must be provided
c. Through these two acts, you are assured of
ongoing disclosure
iii.The purpose of federal proxy regulation is to provide
shareholders with the information necessary to make
informed decisions when voting
iv.MBCA 7.22 and DE 212

40

1. Usually the only provisions are an outer limit on

duration, and revocable unless coupled with an
interest
b. Mechanics
i. Anytime a proxy is initiated, certain materials must be
disclosed (process is very expensive)
ii. Sec 14(a) of SEC Act regulate
1. Any proxy solicitation
a. Unlawful for any person o use ISC or the mails
to solicit a proxy in respect of securities
covered by the 1934 Act (companies with
securities traded on an exchange, or
companies with securities traded on NASDAQ if
greater than 500 shareholders and more than
10 MM in assets)
iii.Sec 14 (a)(3) (a)(15) (what goes in it)
1. Must give background of nominees and attendance
record
2. Executive employment compensation
3. Related transactions disclose any conflicts of
interest between nominees and the company
a. Ex:
4. Must be filed 10 days before mailing
iv.Are shareholders contesting the proxy?
1. If so, the company is required to turn over the
mailing list or do the mailing for them at the groups
expense
a. Companies would prefer to NEVER give up the
shareholder list
2. 14a-9 creates liability provisions for material
misrepresentations or omissions in the proxy
statement
a. Note: Liability concerns drive the preparation of
proxies
v. Proxy process is tilted in favor of management
1. Regulation 14a-8 Shareholder Proposals
a. Allows shareholders to ask a company to put a
shareholder proposal in the companys proxy
materials when he wants to propose an action
i. Obviates the expense and logistics of
sending it out themselves
ii. Management doesnt like these, they
want control over the agenda
b. Eligibility requirements

41

i. Have to own at least $2,000 worth of

stock, or one percent of outstanding
shares, whichever is less
ii. And must have owned the shares for at
least one year prior to submitting a
proposal
iii.Have to give the company 120 days
before companys proxy statement
c. Generally two types of shareholder proposals
i. Socially responsible/ social activist
ii. Corporate governance
1. Ex: seeking an advisory vote to:
a. Split chairman/ CEO, or ask
for cumulative voting
b. Add to the list of people who
have the power to call
meetings
c. Get rid of poison pills
iii.New Type: governance proposals that are
not advisory, but instead propose bylaw
amendments
1. Mgmt claims this interferes with
their sphere of authority and would
exclude it under management
functions exception
a. After AFSCME case, argue
that the bylaw is procedural
rather than mandating the
board to act
2. Regulation 14a-8 Question 9
a. Historically the SEC has allowed management
to exclude a shareholder proposal 9 (ii) lists
reasons, such as
i. Improper under state law
1. Must be advisory
ii. Violation of law
iii.Dealing with management function
iv.Dealing with elections
c. Hot Issues
i. Dodd Frank Bill, Congress passed new regulation that
mandated the SEC to do three things
1. Companies have to obtain an advisory vote from
shareholders on executive compensation
2. Companies have to obtain an advisory vote from
shareholders on how often they want to be asked
about advisory votes on compensation (frequency)
42

I.

a. Statutes says at least every 6 years

3. If proxies are solicited in the context of a merger or
acquisition, there has to be a lot of info provided
about golden parachute arrangements
Directors Sphere of Authority
a. Intro
i. Board is entrusted with management and affairs of
corporation
ii. MBCA 8.01 (b) all corporate power shall be exercised by
or under the authority of the board, and the business and
affairs of corp. managed by or under the direction of, and
subject to the oversight of the board (subject to any
limitations in articles or shareholder agreement under
7.32)
iii.DE 1.41 (a) the business and affairs of copr. shall be
managed by or under the direction of a board of directors
(except as otherwise provided by statute or it its cert of
incorporation)
1. The exceptions are related to closely held
corporations to divide authority
a. Closely held corporation
i. Shareholders often decide to vary the default rules because
the number of shareholders is small, highly tailored
arrangements allocating control are often feasible
b. Shareholder agreements
i. Intro
1. One of the most common methods of allocating
control in a closely held corporation is to set up a
simple contract arrangements among the
shareholders
a. Usually to provide protection to minority
shareholders, because majority shareholders
exercise control through default rules in the
statute
i. Usually they seek vote-pooling
agreements
1. Obligates shareholders to vote
together as a single block
2. Scope and enforcement questions
a. You cant dictate how a director is going to act
c. Voting Trusts
i. When a shareholder transfers title to a voting trustee and
the shareholder then becomes the beneficiaries of the
voting trust

43

1. Shareholder keeps financial rights, but gives voting

rights to the trustee (legal title to the shares is
transferred from shareholder to the voting trustee)
ii. Were created to overcome irrevocable proxies
1. Unlike proxies, where the shareholder retains
ownership but simply directs the proxy holder to vote
the shares, in a voting trust legal title is transferred
iii.Purpose
1. Generally to ensure continuity of management and
consistent voting
iv.Courts traditionally didnt like these, but allow them with
certain restrictions
1. Disclosure
2. Limits on duration
d. Scope
i. More modern statutes like the MBCA , have things that
statutorily let you go into a scope that wouldnt have
traditionally been allowed (DE does NOT have this)
1. 7.32 (a) two or more shareholders can provide for
the manner in which they will vote their shares by
signing an enforceable agreements
a. Effective even though it is inconsistent with one
or more provisions on the MBCA
b. Can eliminate board all together or restrict its
powers
c. Can have shareholders decide if they want to
declare dividend
d. Decide who can be the officers and their terms
e. Can split up the voting power
f. Statutorily allows shareholder agreement to
alter the normal distribution of authority
2. 7.32 (b) Conditions to be Effective
a. Valid for 10 years unless otherwise determines
b. All shareholders must sign on
c. Must be noted on each stock certificate
e. Procedures for Board Action
i. Size of the Board
1. Specified or fixed in the manner provided by the
articles or bylaws all corporate statutes allow you to
have a variable range board
a. Ex: anywhere from 3 to 20 as determined from
time to time by board resolution
i. You cannot know if you have a quorum
until you know the size of the board
1. The fact there is a vacancy does
not change the size
44

ii. Term
1. Generally from annual meeting to annual meeting
a. Exceptions
i. Resignation
ii. Removal
iii.Vacancies
iii.Classifying the Board/ Stagger
1. If the board is classified you can stagger so only a
portion is up for reelection
a. This is commonly employed in public
corporations
i. Reasons:
1. Mgmt says continuity, but the real
reason is to make it harder on a
hostile tender offer
2. If a board is classified, the director can only be
removed for cause not without cause
iv.Place/ Notice of Meetings
1. Regular meeting (listed in bylaws) no notice
2. Special 2 day notice
v. Quorum/Vote
1. Base Rule
a. You need a majority (greater than 50%) of the
number of fixed, or number specified within the
prescribed range
i. MBCA 8 person board, you need 5 for a
quorum; if 9 person board, need 5
ii. DE basically same as MBCA
2. You may vary the base rule in the article or bylaws
a. Cant go lower than 1/3 though, unless its a
one person board
3. Note: you cant break quorum by leaving because
you dont like whats happening at the meeting
vi.
Vote
1. There is no concept of proxy for boards
2. Base Rule: Once a quorum is established, need
majority, may vary the base rule, but not go lower
vii.
Resignation
1. Term is a year unless you give written resignation to
the company
a. Can also resign ahead of time and give an
effective date
2. Note: there has been a shift toward asking directors
who do not receive a majority vote to resign
viii.
Removal By Shareholders

45

1. Generally can remove a director with or without

cause
a. This takes a special meeting of shareholders
and must state this is the purpose of the
meeting
2. What vote do you need?
a. MBCA whatever the regular quorum and
voting requirements are
i. Exception: If cumulative voting is
authorized, if votes against removal
would be sufficient to elect director
cumulatively, then removal fails
b. DE need a big vote
i. The majority of the outstanding stock
1. Also has cumulative exception
ix.
Vacancies
1. Can be created in many ways resigns, dies, removal
by shareholders, can also increase the board
a. If the size is specified in the articles, it will take
an article amendment, not easy
i. Usually has to be board initiated and
approved, then the shareholders get to
vote
ii. If the size was not controlled by the
article, but it is in the bylaws, in most
cases, either directors or shareholders
could change the size of the board
2. Unless the articles provide otherwise, vacancies can
be filled by:
a. MBCA
i. Shareholders
ii. Board, and board can fill even if less than
a quorum
b. DE
i. Doesnt say anything about shareholders
filling vacancies
1. DE cases law states that newly
created directorships can be filled
by shareholder vote or by the board
x. Action without Board Meeting
1. Must be unanimous written consent (MBCA and DE)
a. Lots of routine type matters are completed this
way
xi.
Board may Divide into Committees
1. You cannot delegate fundamental organic changes to
a committee (IE M/A)
46

a. But boards do a lot of things by committee

2. MBCA requires approval by a majority of all
directors or the number of directors required by the
articles or bylaws under quorum and voting rules
3. DE board may create committees with normal
quorum/ majority
IV. Officers Sphere of Authority
a. Serve at the will of the board
i. Can be removed at any time by board, subject to contract
rights
b. Few statutory provisions because governed largely by rules of
agency law
Minority Oppression of Shareholders Close Corporations
I. Intro
a. Traditional corporate laws contemplate centralized control in the
board of directors and the majority rule
i. But close corporations are categorized by shareholder
participation in management and by the lack of public
market for their shares
1. Therefore, under traditional corporate laws minority
shareholders are vulnerable to harm at the hands of
the majority
1. Ex: a majority shareholder may terminate the
minority shareholders employment and refuse to pay
dividend
a. Thus he is cut off from any financial benefit
from his equity investment; he might attempt
to exit, but the absence of a public market for
the shares, and the presence of a maj
shareholder who has manifested hostility may
foreclose this option unless the minority
shareholder is willing to see to the majority,
however given the circumstances, the price
would not reflect value
a. DE does not believe that there should be any special, judiciallycreated rules to protect a minority stockholder of a closely held
corp
i. He made a business judgment decision to buy into such
minority, and on what terms
I. Remedy? see MBCA, not DE
a. Buyout
i. MBCA permits the corporation or shareholders to purchase
the shares of a shareholder petitioning for dissolution
b. Wind up

47

i. MBCA allows the court to appoint a receiver or custodian to

wind up and liquidate the corporation
SHAREHOLDER DERIVATIVE SUITS
I. Concept
a. Shareholder stands and asserts the corporations cause of action
i. Names corporation as nominal defendant, along with the
names of directors and officers
b. Originally courts wanted to incentivize these actions, therefore
they granted attorneys fees
i. This led to the implementation of procedural hurdles (tough
for shareholders)
1. Requirements (MBCA 7.40, DE 327)
a. Must be an owner of the stock at the time the
transaction took place that you are suing about
i. must also keep ownership while the
litigation is going on
b. Must bring a demand on the Board
i. If management is entrusted with control
of the company, they should be the ones
to decide if they should sue
ii. Next, have to show that you made a
demand, and they refused, or the
demand may be excused as futile
1. DE case law states what the
plaintiff must establish to show
demand futility
a. In misfeasance, you have to
show either that the majority
of directors were conflicted/
disinterested and not
independent; or that the
transaction was not a part of
the BJR
2. In either case, the company can
use a mechanism where the board
creates a special litigation
committee of independent directors
and charge them to determine
whether it is in the best interest of
the company to sue
a. They always decide against
suing
b. And the court used BJR to
decide whether the

48

committees decisions should

prevail
FIDUCIARY DUTIES
I. Duty of Care
a. Intro
i. Requires that each member of the board shall act (1) in
good faith and (2) in a manner the director reasonably
believes to be in the best interest of the corporation
(MBCA 830(a))
a. Due care analysis
i. Must establish
1. Duty (there is always a fiduciary duty)
2. Breach of the Standard of Care
a. In most jurisdictions, the standard is that the
director should exercise the kind of care that a
person in a like position under like
circumstances
b. Judged on gross negligence
i. This is where plaintiffs typically lose
3. Causation
a. Must prove what they did caused the damage
4. Damage
b. Business Judgment Rule
i. When a director is sued based on violating the duty of care,
the director is often entitled to the BJR (only used if there
was a decision)
1. Provides protection for directors from lawsuits which
might seek to challenge the business judgment of
those directors
a. Directors are allowed to be wrong or to make
mistakes and still have the protection of BJR
2. It is a presumption in favor of the director/defendant,
that a court will not second guess a decision and find
a director liable for a decision that looks bad
retrospectively
a. A court will presume that the director:
i. Acted in good faith
1. Not fraud, illegally, or had a conflict
of interest
ii.Made an informed decision of all relevant
information that was reasonable available
iii.
Hand an honest belief that it was in
the best interest of the company
b. Because this is a presumption, the plaintiff
must disprove one of these
49

ii. The Decision Making Context

1. Smith v. Van Gorkom
a. Before this case, most DE BJ cases held as long
as you did not have (1)bad faith, and (3) honest
belief, the court would not look into whether it
was an informed decision
b. VG introduced informed decision and said you
must satisfy all three presumptions
i. Held: Board was grossly negligent
because they were not adequately
informed about:
1. VGs approaching Pritzker and
putting a price on the table
2. The intrinsic value of the
company (very controversial)
a. Therefore the directors were
liable to the company for the
difference in price
c. After VG, Boards will be sure to get a fairness
evaluation of their company and not meet for
such a short amount of time
d. There have not been many cases following VG
where directors have been held to violate the
BJR
2. Exculpation Clauses (another hurdle for shareholders
to sue the corporation)
e. Post-VG, DE and the MBCA enacted legislation
that permits companies to include exculpation
clauses in their certificate of incorporation
i. Allows corp. to eliminate director liability
to the corporation for certain types of
breaches, including breach of due care
(gross negligence)
1. May NOT eliminate bad faith,
willful intentional criminal violations
and loyalty breaches
f. this led to many good faith claims and the
courts began to struggle as to whether a duty
to act in good faith is a separate fiduciary duty,
or part of the duty of care, or part of all the
directors fiduciary duties
i. Stone, Disney, and Caremark answered
these questions
1. Settled that there is no
independent duty of good faith
50

a. Affirmative Defenses to Duty of Care Violation

ii. A violation might not result in liability if the Board can show
(entire fairness standard) that the transaction was
beneficial to the corporation, that it was fair, or that there
were no damages
iii.In order to use the BJR, there is a minimum level of care
that must be met to show that an informed judgment was
made
1. But, if the transaction is judged to have been fair
even though good business judgment was not
exercised, then there is no liability

a. The Oversight/Monitoring Context Failure to Act

iv.Intro
1. Part of the duty of care is to be informed about what
is happening within the corporation and to provide
oversight
a. The BJR has no role in a case of inaction
by the company
i. Because there has been no judgment
2. These cases arise where employees of the
corporation have engaged in illegal activities, and the
corporation is forced to pay large penalties to the
government or judgments/settlements to third parties
arising from those illegal activities
v. Situations in which a board is accused of failing to act,
often involve failing to detect, protect, or stop Caremark
Claims
1. Standard
a. The directors utterly failed to implement any
reporting or information system or control; or
b. Having implemented such a system, failed to
monitor or oversee its operations, thus
disabling themselves from being informed of
the risks or problems requiring their attention
c. In either care, imposition of liability requires
showing that the directors knew that they were
not discharging their fiduciary obligations
i. Directors dont have to do a perfect job,
but they do have to do their job and in
order to do their job, they must be
informed
Duty of Loyalty
b. Intro

51

i. Any time a director participates in a transaction involving a

conflict of interest the duty of loyalty is implicated
1. A conflict of interest exists when the director knows
that at the time he is asked to take action in a
potential transaction, he or a person related to him
(1) is a party to the transaction or (2) has a beneficial
financial interest in the transaction; and then
exercises his influence to the detriment of the
corporation
ii. The duty of loyalty requires that fiduciaries put the
interests of the corporation ahead of their own interests
iii.Courts scrutinize loyalty cases more than due care
iv.Types of loyalty claims
1. Self Dealing: A transaction between a director or
officer and a corporation which the director/officer
serves (on both sides of the transaction)
d. Called interlocking directorate
2. Corporate Opportunity
c. Policy
i. At common law, any conflict of interest made a contract
void
ii. Now courts tolerate conflicts of interest because the
benefits of such transactions are often high
1. To prohibit all conflict of interest might sharply limit
who would be willing to serve as a director of a public
company
iii.Try to identify bad transactions and separate then from
good
d. Procedure
i. If you bring a duty of loyalty claim, the company will try to
cleanse
1. Cleanse the Conflict (DE 144, MBCA 8.60-.61
e. The transaction is cleansed if:
i. The transaction is disclosed and
approved by a vote of a majority of the
fully informed, disinterested directors
(the ones who do not have the conflict)
ii.The transaction is disclosed and ratified
by the informed shareholders
1. DE disinterested shareholders
iii.
The transaction is shown to have
been intrinsically fair to the corporation
f. If you satisfy one of the procedural mechanisms
(1 or 2), the court will say that the director met
his initial burden of proof,

52

i. Therefore plaintiff has the burden to

prove it is unfair
g. If the company does not cleanse, they will have
to prove fairness
e. Corporate Opportunity Doctrine
i. Intro
1. Is a subset of the duty of loyalty
2. Stands for the principal that an officer or director of a
corporation may not take, for personal gain, an
opportunity like a business venture or a new
opportunity or discovery, in which the firm has a
property right, and use it for his own advantage
without first offering it to the corporation
ii. What is a corporate opportunity?
1. Line of Businesses Test (Guth v. Loft)
h. How did the director find out about the
opportunity, was it in his capacity as director?
Did he notify the company?
i. Was the company financially able to undertake
the opportunity?
j. Was it in the companys line of business, in
which the company has an interest or
expectancy?
k. Was the interest of the director in conflict with
that of the corporation?
2. Argue the facts
iii.Go through cleansing steps
1. However, cleansing rarely occurs in the corporate
opportunity context
iv.Result if successful
1. A constructive trust on the license for the benefit, will
have to give it back to the corporation
CORPORATE COMBINATION
I. Intro
a. There are three major modes to buying and selling a business
i. Statutory merger/ consolidation
ii. Share Purchase/ Tender Offer
iii.Purchase of all or Substantially all the Assets
b. This is an area where form triumphs over substance
i. Generally the acquiring company selects the mode
1. Offers the consideration
a. Cash, securities (usually stock of acquiring
company), or even property; or a combination
of these

53

c. Tax, Securities Law, and Anti-Trust Law all play a major role in this
process
i. Tax
1. If the acquiring company (A) pays cash, the receivers
(B), must pay tax
a. Must pay difference between what they initially
paid and the purchase price
2. If A uses stock or a mixture, with the stock
predominating, then it is possible to structure the
deal as tax-deferred
ii. Fed. Securities
1. If the corporations mechanics require a shareholder
vote, the proxy rules apply
a. In a merger and purchase of assets you need a
shareholder vote, but you do NOT is a tender
offer
i. Williams Act requires the acquiror to
transfer materials to the shareholder
comparable to the kind included in proxy
statements
2. If the company uses stock as consideration, 33 Act
requirements apply
a. Must register the stock, or show exemption
b. And many other requirements
d. Shareholders Sphere of Authority
i. Many statutes begin with the assumption that the
acquirors shareholders get to vote, but there are many
exceptions that take it away
1. Board runs the management of the company,
therefore buying a company is a subset of their
powers
ii. Focus is more on the shareholders of the company being
acquired
II. Statutory Merger/ Consolidation
a. Mechanics
i. A identifies B as a company they want to buy
1. They have to pay something for it, likely more than
what B is publicly trading for (premium)
a. This can be cash, securities, or property
(language is broad)
2. Mergers are cooperative deals, the target get
company need to open up all the books and records
3. Must file articles of merger with secretary of state
a. Must include key information: what did you pay,
amend the articles etc.
b. Once article of merger is filed, B disappears
54

i. Because all of its assets and liabilities are

transferred to A
ii. Bs shareholders get what was paid as
consideration
1. Stock or money usually (B stock is
gone)
ii. Board Approval
1. The two boards must approve the merger
iii.Shareholder Approval
1. Assumption that shareholders of both companies
must approve the merger
2. MBCA default is normal quorum, but most
jurisdictions require a higher vote; DE requires a
majority of the outstanding stock
a. Exception: Short form merger (parentsubsidiary merger) between A and a subsidiary
controlled 90% by A
1. The subsidiary does not get
approval rights, but do get
appraisal rights
b. In general, the board likes to avoid shareholder
votes
3. This process takes time because the board must
solicit the shareholders, send proxy materials, and
receive approval
a. Exception to Shareholder Approval
i. Small scale merger
1. If it is an all cash deal, then As
shareholders do not need to
approve it
2. All stock deal unless he issuance
of stock results in greater than 20%
dilution of As shareholders, they
dont get to vote
iv.Appraisal Rights
1. The B shareholders who dont like the price can
challenge the price in court
a. They are asking the court to make a valuation
call
b. In most jurisdictions, you can NOT bring this as
a class action, must bring it on your own
2. The statute gives these rights, but does not make it
easy
a. You must write the corporation ahead of time
before the shareholder meeting and say that
you are against the merger
55

b. Companies also HATE appraisal rights

3. Policy Q: where a statute has appraisal rights, are
appraisal rights the only way to complain about the
transaction?
a. Companies assert this is the only way, but will
courts?
4. Major Exception
a. Market-out clauses
i. Theory if the consideration in the
merger is a publicly tradable stock, if you
dont like it, sell the stock
ii. A willing buyer will determine the worth
in the market
b. Analysis of Advantages and Disadvantages of Mergers
i. Advantages
1. Ease of transfer of:
a. Control
b. Consideration
c. Assets
ii. Negatives
1. Assumption of all liabilities both known and unknown
2. Start out with the assumption that As shareholders
have voting rights
a. But there are many exceptions
3. Appraisal rights
iii.Note at any time after the merger, A can create a new
shell subsidiary drop down and place all Bs assets and
liabilities there
c. Triangular Merger
i. Attempting to get the positives of merger and circumvent
the negatives
ii. Formation
1. A creates a new subsidiary and funds the subsidiary
with the consideration it will pay B
2. As soon as As sub comes into existence, then the
merger is effectuated between As sub and B
3. A now owns B as a subsidiary
a. After the deal As subs assets will be:
i. Bs assets and liabilities
ii. A owns 100% of As sub
b. This insulates the liabilities, by putting them in
the subsidiary
c. Also, when the merger is voted on by As sub
and B
i. A as a company votes

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4. this process avoids As shareholders right to vote,

and appraisal rights
a. this is allowed because of the broad language
the statutes use regarding permissible
consideration in a merger
III. Share Purchase/ Tender Offer
a. Intro
i. This is the one mode of organization that does NOT require
cooperation of the target company Bs board is
completely out of the picture
b. Formation
i. A makes an offer directly to Bs shareholders to buy their
stock
1. If A gets enough to accept, A will end up owning a
controlling percentage, if not all
1. A becomes the parent and B is the subsidiary
ii. No proxy solicitation required
1. However Congress enacted the Williams Act
a. A disclosure statute with procedural rules
designed to curb abuses
i. IE offer must be open for a certain
amount of time, and give shareholders a
chance to change their mind, also if you
get more shares that you ask for, you
must buy them pro rata
iii.Tender offer can be for all or for a controlling percentage
1. Can condition it any way they want
c. Mechanics
i. Generally As board can do this without shareholder
approval; As shareholders are usually not in the picture,
except if there is dilution of 20% in the MBCA
IV. Purchase/ Sale of All or Substantially All of the Assets
a. Intro
i. Start out with the idea that boards sell assets routinely
ii. However, a sale of substantially all triggers approval
iii.What is substantially all?
1. Generally sales in excess of 75 % of the assets
2. DE uses case law
b. Mechanics
i. A contracts for which of Bs assets and liabilities they want
1. Can shape it in any way they want in return for
consideration to Bs shareholders
ii. As shareholders are not involved
1. No vote or appraisal
iii.No filings required, just close the contract

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iv.In most cases, B liquidates and goes out of business by

distributing its consideration to the shareholders
v. Appraisal Rights
1. In D, no appraisal rights, even to Bs shareholders
a. Most other jurisdictions give Bs shareholders
appraisal rights with exceptions
vi.
Notes: there is quite a bit of case law under
successor liability
1. Who do you sue 5 years after the sale for asbestos or
something?
a. Try to convince court to get A on the hook
i. Assert this was a defacto merger A is
really just a continuation of B, but this is
almost always a loser in DE
2. You could also do this triangularly or as a drop down
merger
V. Recap
a. You can pick any of the three modes and achieve the same result
b. Even if you follow all the appropriate procedural mechanics, at
the substantive level, there are questions of fiduciary analysis
Substantive Issues: Fiduciary Duties
I. Freeze Out Merger By Controlling Shareholder Entire Fairness
Standard
a. When a majority shareholder forces the minority shareholders to
sell their stock in a merger with an entity owned by the majority
shareholders, enabling the majority shareholders to acquire
100% control of the company
i. There are often used following a tender offer to eliminate
shareholders who did not tender
ii. Also used when a controlling shareholder/s want to own all
of the company
1. Note: these transactions are usually constructed as
triangular mergers
b. Conflict of Interest
i. These transactions involve a conflict of interest and must
be evaluated by the Entire Fairness Standard
c. Entire Fairness Standard
i. Two basic aspects, fair dealing and fair price, and all
aspects must be examined as a whole (from DE 144)
1. Whether an independent committee was appointed
to negotiate on behalf f the minority shareholders
2. Whether the committee was in fact independent and
whether they had true bargaining power

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3. Whether the price paid to the minority shareholder

reflected the value of the entire company, or whether
it was based on a minority discount
4. Whether a thorough and complete fairness opinion
was prepared
5. Whether the transaction was approved by a majority
of the minority shareholders
ii. Post Weinberger, any time a controlling parent decides to
subsume the subsidiary through merger, they should
appoint a special committee of independent outside
directors to examine the transaction (from footnote 7 of the
case)
II. Defending Against Hostile Takeovers
a. Intro
i. Any company that has a depressed price worries about a
hostile tender offer
ii. Court believes that in every tender offer, the board is
pulled in two directions
b. Fiduciary Duties in Takeover Defenses
i. Unocal Test Intermediate Scrutiny between BJR and
entire fairness standard
1. The Board must show that it acted in good faith and,
after reasonable investigation, concluded that a
danger existed to corporate policy and effectiveness;
and
2. The action taken by the Board must have been
reasonable in relation to the threat posed
3. Test Tip: make sure to discuss whether the measure
taken was reasonable, or within the range or
reasonableness
ii. In Unocal, the court found that a self-tender to purchase
shares from its shareholders was in good faith and its
response was proportional
c. Defensive Tactics
i. Greenmail
1. Payment to a potential aquiror to incentivize them t
leave the company alone, usually occurs when a
person has started to acquire a significant portion of
shares in a target company
ii. White Knight
1. Is a company that is sought by a target company to
avoid being acquired by the hostile bidder, this
rescues the target company
i. Poison Pill
1. The concept involves creating a device which
multiplies the rights of shareholders (triggered at
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some point in a hostile takeover) so that a person

who did acquire the company would find that the
increased shareholder rights made the takeover so
expensive that it would not be feasible
a. Ex: if another outsider gets 15% of the target
companys stock, then the shareholder rights
kick in usually the right to purchase stock at a
bargain/ below market price
2. Note: these pills never get triggered, you dont
acquire a company when a pill is in effect, you may
however negotiate to get rid of it, when the hostile
offer becomes more friendly
iii.Staggered/ Classified Board
1. Sometimes a company will create a staggered board
with a large number of directors whose terms expire
in different years
2. This type of structure would mean that it could take
several years for a hostile bidder to elect new
directors
iv.Golden Parachutes
1. Extremely lucrative termination package for a
companys senior executives, which is typically
activated if the executive is terminated or otherwise
loses his position within the company
v. Pac-man Defense
1. The target company launches a hostile takeover on
the bidder in an effort to acquire control of the
bidder, rather than let the bidder acquire control of
the target
vi.
Crown Jewel
1. If the target company is targeted only because of one
part of the business, you sell it to someone else
vii.
Share Repurchases
1. Saw this in Unocal, a company offers to repurchase
its own shares at a premium
III. Change of Control Transactions Revlon Duties
a. Revlon Rule
i. As long as a target company is fighting off a takeover, then
the Unocal Test is the proper test to evaluate its actions;
BUT
ii. As soon as the board of the target company is aware that a
takeover is imminent; THEN
iii.The Boards sole responsibility is to get the highest price
for the shareholders

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