Business Associations – Klein, 3rd Edition

PART I: AGENCY & PARTNERSHIP: BASIC FORMS OF ENTERPRISE ORGANIZATION- AGENCY, PARTNERSHIP,
& LLC

I. Introduction and Agency Law

a. Law of enterprise organization:
i. Agency= simplest=> can be terminated at any time by either the principle/agent.
ii. Partnership=> jointly owned business firms.
iii. Corporation law=> deals w/ the creation and governance of the private legal entities that are the principle economic
actors in the modern world.
b. Forms:
i. Sole proprietorship.
ii. Partnership- can be done through Ks or filing w/ secretary of state.
iii. LLC- Only way to do is file w/ secretary of state.
iv. Corporation- Filing w/ secretary of state.
1. DE has 65% of all corporations formed.
c. Goal= facilitation of voluntary business orgs. to make wealth grown-> use other people’s labor and money!
d. How capital markets work: Shareholders-> Corporations<- Creditors
i. Shareholders get upside (equity), but no guarantee=> much riskier, higher return.
ii. Creditors get a fixed payment=> less risk, less upside (less returns).
iii. Corporation run by Board of Directors-> (hires) CEO.
1. Relationship b/w Board & shareholders governed by state corporate law.
a. Shareholders vote for Board.
II. Objective of Corporate Law – Efficiency
a. Pareto Efficiency- Distribution of resources is efficient when resources are distributed in such a way that no reallocation of
resources can make at least one person better off w/o making at least one person worse off – “Pareto optimal”; “Pareto
efficient” – only when all parties have a net utility gain; Problems:
i. Uses a fixed point for the original distribution of resources
ii. Everything makes at least one person worse off – not possible for courts to make everyone happy.
b. Kaldor-Hicks Efficiency- Deals w/externalities – uncompensated costs imposed on parties w/o their consent-> leads to an
overall improvement in social welfare – if at least one party would gain from it after all those who suffered a loss as a result
of the transaction or policy were fully compensated.
i. Limits – doesn’t say anything about initial distribution of wealth.
c. Coase – 1937 – Nature of the Firm; Costs assoc. w/transactions b/t market participants were substantial; Firms exist b/c
sometimes it is more efficient to organize complex tasks within a hierarchical organization than on a market; Could do
complex tasks on markets but where many steps are involved market transacting is costly b/c might require extensive
negotiation or wasted effort to discover the best prices.
d. Transactions Cost Theory – Owners of various resources commit to some “contractual” governance arrangement, such as the
firm in order to reduce their transactions costs and share the resulting efficiency gains.
e. Agency Cost Theory – Actors affect the interests of other actors in a transaction; sometimes act in their own self-interest
rather than that of the company as a whole.
i. Basic insight – to the extent the incentive of the agent (the person or interest that possesses discretionary power over
some aspect of the principal’s investment in the relationship) differ from the incentives of the principal herself, a
potential cost will arise – “agency cost”
ii. Agency cost – any cost (explicit or implicit) associated w/the exercise of discretion over the principal’s property by
an agent.
iii. Principal aim of corporation law is to reduce agency costs.
*Note – courts rarely use efficiency when justifying their decisions – apply the law, don’t create their own, and when they do
create their own they don’t justify it on extrinsic concepts like efficiency.
f. Life Cycle of the Firm
i. Venture Capital Financing: form LLC/LLP
ii. Go public: IPO (get traded), but have to be reviewed by Chancery.
iii. M&A Activity
iv. Bankruptcy/privatize
III. Agency
a. Shareholders= agency & Board= principle
b. Principal has 3 powers: 1) power to direct, 2) expect, and 3) select.
c. 3 general sources of agency costs:

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 i. Monitoring costs – costs that owners expend to ensure agent loyalty
ii. Bonding costs – costs that agents expend to ensure owners of their reliability
iii. Residual Costs – costs that arise from differences of interest that remain after monitoring and bonding costs are
incurred
d. Definition= Rs3d Agency 1.01– Agency is the fiduciary relationship that arises when one person (a “principal”) manifest
assent to another person (an “agent”) that the agent shall act on the principal’s behalf and subject to the principal’s control,
and the agent manifests assent or otherwise consent so to act. Broken down:
i. Consensual relationship
ii. Principal – grants authority to another to bind her in certain respects
iii. Agent – accepts that responsibility
1. Subject to the agent’s consent, the principal can define or delimit the granted authority in any way she
pleases.
e. Parties’ Conception Does not Control: Agency relations may be implied even when the parties have not explicitly agreed
to an agency relationship.
i. Gay Jensen Farms v. Cargill (1981) –Case about ACTUAL authority. Ps sued when company defaulted on Ks for
sale of grain. D (Warrant) was in a security agreement with the defaulting company (Cargill), provided funds over
the years and had a variety of agency Ks. Ps sue both D and defaulting company.
ii. Rule: To create an agency there must be an agreement, but not necessarily a K b/t the parties – agreement
may result in the creation of an agency relationship even if the parties did not call it an agency and did not
intend the legal consequences of the relation to follow. Control can be inferred though not expressed!
1. Existence of an agency may be proved by circumstantial evidence which shows a course of dealing b/t the
two parties.
iii. All 3 elements of agency exist here – D directed Warren to implement its recommendations, and W acted on D’s
behalf in procuring grain for D as part of its normal operations that were financed by D.
iv. 9 Factors that indicated D’s control – constant recommendations, right of first refusal on grain, inability to act w/o
D’s approval, right of entry onto premises, correspondence and criticism, financing purchases and power to
discontinue financing.
1. Cargill exercised more than nominal control over Warren and was an active participant in Warren’s
operations rather than simply a financier.
v. §14K – one who contracts to acquire property from a 3rd person and convey it to another is the agent of the other
only if it is agreed that he is to act primarily for the benefit of the other and not for himself.
1. Factors indicating a supplier v. an agent are: (1) that he is to receive a fixed price for the property
irrespective of the price paid by him, this is most important (2) that he acts in his own name and received
the title to the property which he thereafter is to transfer (3) that he has an independent business in buying
and selling similar property.
vi. Restatement §8 –(inherent) power to affect the legal relations of another person (P) by transactions with 3rd persons,
professedly as agent for the other, arising from and in accordance with the other’s (P) manifestations to such third
persons
f. Authority
i. Agents acting with authority may bind principals (authority is the starting point for analysis of contract actions).
Authority is also an element in vicarious liability based tort actions against the principal; no need for written/verbal
confirmation, as long as intention of both parties is manifested.
ii. Actual Authority - RS3 §2.01 – An agent acts with actual authority when the agent reasonably believes, in
accordance with the principal’s manifestations to the agent, that the principal wishes the agent to act.
iii. Apparent Authority – RS3 §2.03 – When a 3rd party reasonably believes the actor has the authority to act on behalf
of the principal and that belief is traceable to the principal’s manifestations
g. Liability in Contract
i. RS2d Agency §140 – The liability of a principal to a 3rd person upon a transaction conducted by an agent may be
based upon the fact that:
1. The agent was authorized
2. The agent was apparently authorized
3. The agent had a power arising from the agency relationship and not dependent upon authority or apparent
authority
ii. RS3d Agency 6.01 & 6.02 – When an agent, acting with actual or apparent authority, makes a contract on behalf of
a principal, the principal and the third parties are parties to contract
h. White v. Thomas –White employs Simpson and gives her Power of Attorney to attend a land auction and bid up to $250K for
a 220-acre farm. Simpson wins the auction for the remaining 217 acres with a bid of $327,500. When Simpson realizes that
she had exceeded White’s authority, she agrees to sell 45 acres to other ppl. White “has a heart attack” when he finds out, but
closes on the 217 acres, then refuses to sell the 45 acres. They sue White for specific performance on the 45 acres.

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 i. Court held that in the absence of a principal and any indicia that an agent has authority to engage in a
specific action on the principal’s behalf, the agent does not have apparent authority to engage in such action
merely because the agent asserts she has such authority.
1. Reasonable from the general manifestations of the principal – the court says this was not a reasonable
reliance – big difference between buying and selling; Also, this is real estate=different!
i. Inherent Authority - R2d §161 – a general agent for a disclosed or partially disclosed principal subjects his principal to
liability for acts done on his account which usually accompany or are incidental to transactions which the agent is authorized
to conduct if, although they are forbidden by the principal, the other party reasonably believes that the agent is authorized to
do them and has no notice that he is not so authorized.
j. Estoppel to Deny Existence of Agency Relationship - R3d. §2.05 – A person who has not made a manifestation that an
actor has authority as an agent and how is not otherwise liable as a party to a transaction purportedly done by the actor on that
person’s account is subject to liability to a 3rd party who justifiably is induced to make a detrimental change in position
because the transaction is believed to be on the person’s account, if
i. (1) the person intentionally or carelessly caused such believe, or
ii. (2) having notice of such belief and that It might induce others to change their positions, the person did not take
reasonable steps to notify them of the facts
iii. similar to inherent agency in the restatement 2d, just under another name
k. Gallant Insurance v. Isaac – Gallant (Pr) sells car insurance to Isaac (3rd) through its agent Thompson-Harris (A). Policy
states that any changes would have to be authorized by Pr. 3rd buys new car, which A agrees to insure effective immediately.
A and 3rd agree that 3rd would come in to fill out paperwork. 3rd gets into a car accident & goes to A’s office to fill out the
paper work as planned and also reports her accident. P denies coverage b/c A was not authorized to renew 3rd policy w/o
authorization from P.
i. Court found that the insured could have reasonably believed that the agent had the authority to bind the
policy; An agent has inherent authority to find its principal where the agent acts within the usual and
ordinary scope of its authority, a third party can reasonably believe that the agent has authority to conduct
the act in question and the third party is not on notice that the agent is not so authorized.
ii. The agent had a common practice of binding policies orally in violation of the agreement with principal and
principal accepted so the court finds it to be reasonable
1. Implied authority – the 3rd party can reasonably believe that this is ok b/c they keep doing it even though
it’s against the agreement – Gallant never stopped them in the past
2. Apparent authority – 3rd party had no reason to doubt the agreement/propriety of Thompson-Harris’ actions
given that they were her only contact with Ins. Co. – Gallant had never objected to any of the prior
interactions similar to the one in question
iii. Two-part test: 1) Does A’s power derive from the agency relationship? 2) Could the third party reasonably believe
the A had that authority?
iv. DIFFERENCE btw Gallant and White - Availability of information – buyer had much more ability to collect
information in White than in Gallant. Least cost monitoring – burden on Isaac to monitor insurance agent and
company is too much v. the burden of Thomas checking Simpson’s relationship w/White. Lowering the monitor
costs. Burden on the party who can monitor cheapest.
l. Agency by Estoppel or Ratification
i. Elements of estoppel are customary – Failure to act when knowledge and an opportunity to act arise plus reasonable
change in position on the part of the third person. (Best Buy hypo)
ii. Ratification – accepting benefits under an unauthorized K will constitute acceptance of its obligations as well as its
benefits
m. Liability in Tort: P generally liable if and only if master/servant relationship (not independent contractor) and within scope
of employment
i. RS3 §2.04 – An employer is subject to liability for torts committed by employees while acting within the scope of
their employment
ii. RS3 §7.07(3)(a) – an employee is an agent whose principal controls or has the right to control the manner and
means of the agent’s performance of work
iii. Independent contractor – person who contracts with another to something for him but who is not controlled by the
other or subject to the other’s right to control with respect to his physical conduct in the performance of the
undertaking.
iv. Factors in Rs2d Agency §220(2)(a)-(j) to determine servant v. independent contractor
1. Extent of control the employer exercises over details
2. Whether or not the agent is engaged in a distinct business
3. Type of occupation, whether it is normally done without supervision in locality.
4. Skill required in particular occupation

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 5. Whether the employer supplies the tools necessary
6. Length of employment (longer the length of the employment, the more likely it is a servant relationship)
7. Method of payment (wage v. per job)
8. Whether the work is regular business for the employer
9. Intention of parties
10. Whether employer is in business
v. Rs2d Agency on Principal Liability:
1. Rs2d Agency §215 – Conduct Authorized but Unintended by Principal – where injury ensues as a result of
servant’s act, principal is liable for tort damages
2. Rs2d Agency §216 – Unauthorized Tortious Conduct: Principal may be liable for tortious conduct of
agent, despite the fact that he does not personally violate a duty
3. Rs2d Agency §219 – When Master Is Liable for Torts of His Servants – if servant acts in scope of
employment
4. Rs2d Agency §228 – Scope of Employment:
a. Kind of employment to perform;
b. Substantially within the time and space limits;
c. Purpose, in part at least, is to serve master; and
d. Intentional by servant and not unexpectable by master
5. Rs2d Agency §230 – Forbidden Acts: may be within scope of employment
6. Rs2d Agency §231 – Criminal or Tortious Acts: may be within scope of employment
7. Rs2d Agency §232 – Failure to Act: by servant, may be within scope of employment
vi. Humble Oil v. Martin(1949) – P and his two children were injured when they were struck by a vehicle that rolled
out of a service station owned by D (principal). and operated by S (agent). Evidence showed D exercised control
over S’s operations, but D said it couldn’t be held liable for S’s torts.
1. Rule: A party may be liable for a contractor’s torts if he exercises substantial control over the
contractor’s operations.
2. Rationale – Evidence showed that D mandated much of the day-to-day operations of the station, enough to
justify the trial court’s finding of a master/servant relationship rather than a contractor relationship.
vii. Hoover v. Sun Oil Co. (Del. Sup. Ct. 1965)– Hoover sought to hold franchisor Sun Oil responsible after Hoover
was injured in a fire at a service station franchise operated by Barone.
1. A franchisee is considered an independent contractor of the franchisor if the franchise retains
control of inventory and operations.
2. Test: whether the franchisor retains the right to control the details of the day-to-day operations of the
franchisee. Franchisor influence insufficient.
3. Why the different results?

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 Humble/Sc Sunoco/Barone
hneider
Humble Barone set hours of
set hours operation
of
operation
Schneider Barone could sell non-
sold only Sunoco products
Humble
Products
Humble Barone took title to goods
held title
to goods
that
Schneider
sold on
consignme
nt
Lease was Lease was terminable
terminable once annually
at will
Rent was Barone had “overall risk
“at least in of profit and loss” though
part, based subsidies from Sunoco to
on the ensure competitiveness
amount of
Humble’s
products
sold” and
Humble
paid a big
% of
Shcneider’
s operating
costs (e.g.,
75% of
utility
bills)
Humble No written reports
could required, but
require representative Peterson
periodic visited weekly in an
reports advisory capacity
a. Day-to-day evidence of control is less important than the legal rights of the parties to control –
R3d 7.07
n. Governance of Agency- 3 methods:
i. Contract
ii. Exit rights
iii. Fiduciary duties
1. Duty of obedience – to what the explicit instructions of the principal are (doesn’t cover a lot, can only
instruct so much)
2. Duty of care: (anti-negligence) acting in good faith as a reasonable person would, being informed and not
negligent.
3. Duty of loyalty (anti-cheating) – can’t cheat on the principal; acting in good faith to advance the P’s
interest.
iv. Duties of the Agent to the Principal
1. §8.01 General Fiduciary Principle – an agent has a fiduciary duty to act loyally for the principal’s benefit
in all matters connected with the agency relationship

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 2. §8.02 – Material Benefit Arising out of Position – An agent has a duty not to acquire a material benefit
from a 3rd party in connection with transactions conducted or other actions taken on behalf of the principal
or otherwise through the agent’s use of the agent’s position
3. §8.03 – Acting as or on Behalf of an Adverse Party – an agent has a duty not to deal with the principal as
or on behalf of an adverse party in a transaction connected with the agency relationship.
4. §8.06 – Principal’s Consent –
a. Conduct by an agent that would otherwise constitute a breach of duty as stated in §§8.01-8.05
does not constitute a breach of duty if the principal consents to the conduct, provided that:
i. In obtaining the principal’s consent, the agent:
1. acts in good faith,
2. discloses all material facts that the agent knows, has reason to know, or should
know would reasonably affect the principal’s judgment unless the principal has
manifested that such facts are already known by the principal or that the
principal does not wish to know them, and
3. otherwise deals fairly with the principal; and
ii. the principal’s consent concerns either a specific act or transaction or acts or
transactions of a specified type that could reasonably be expected to occur in the ordinary
course of the agency relationship.
v. Duty of Loyalty –
1. §8.01 – an agent has a fiduciary duty to act loyally for the principal’s benefit in all matters connected with
the agency relationship
2. §8.06 - In certain circumstances, the agent can act as an adverse party as long as there is full disclosure and
fair dealing – real estate is an example of this type of a beneficial relationship with an agent as adverse
party
a. Hypothetical §§8.01-8.06 (pg. 35) – Client just sold his house and the buyer was his own real
estate agent. But the client discovers that the house down the street sold for 50% more through
another agent the next week.
i. Probably could void – not full disclosure under §8.06
vi. Tarnowski v. Resop (1952) – A (Resop) takes $2K “secret commission” from third party (T) on “coin operated
music machine” deal on behalf of P (Tarnowski).
1. Rule – An agent is liable to a principal for the agent’s profits made during the course of the agency;
it is not material that no actual injury to the principal results, or that the principal made a profit on
the transaction.
a. It is also irrelevant that the principal, upon discovering a fraud, rescinded the K and recovered
from that with which he has partied. P’s remedy from agent – secret commission; all costs of
collecting form sellers as damages.
2. Rs2d Agency 407 – If an agent has received a benefit as a result of violating his duty of loyalty, the
principal is entitled to recover from his what he has so received, its value, or its proceeds, and also the
amount of damage thereby caused.
a. If the agent’s wrongdoing requires the principal to sue to recover, the principal is also entitled to
attorneys’ fees from the agent, since the attorney’s fees are directly attributable to the agent’s
breach.
3. Doesn’t he seem to be overcompensated – he gets back more than he suffered?
a. Deterrence rationale – deter agents from engaging in this type of behavior – Signifies the
seriousness of fiduciary duties (duty of loyalty)
vii. In Re Gleeson(1954) – Mary Gleeson dies; Con Colbrook, a close friend and tenant on her land, is the executor and
trustee under her will, which benefits her 3 children. Barely back from the funeral when the lease is up; Con talks
the whole thing over with the 2 competent beneficiaries, leases the land for another year, increases payments by
67%, and finds another tenant the next year. Con files his first semi-annual report; beneficiaries collectively object;
lower court approves report; appeals court reverses.
1. Colbrook discussed the arrangement with the beneficiaries but – §203 - the trustee is accountable for any
profit made by him through or arising out of the administration of the trust, although the profit does
not arise from a breach of trust -> Trustee can’t profit.
a. No (good faith) exceptions – duty of loyalty is stronger for trusts.
2. Guardian of incompetent beneficiary probably brought the action – his fiduciary duty to challenge this
IV. Partnership
a. Partnership Defined - 2 or more parties entitled to the business and its returns
i. All owners are liable as principals and are all agents

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 ii. All are jointly and severally liable for debts (creditor can pick w/e P1 and go after them, and then P1 can go after P2
to get share)
iii. All are equally responsible for control, unless there is some other agreement
iv. Creditor of partnership, once assets have been exhausted, creditors of p-ship stand on equal footing as individual
creditors
b. Governing Laws (see chart on UPA v. RUPA)
i. Revised Uniform Partnership Act (RUPA) (1997)– used in about 2/3 of states.
ii. Uniform Partnership Act (UPA) (1914)– used in 1/3 states, being displaced by RUPA.
iii. Definition of Partnership (UPA §6(1); RUPA §101(6)):“an association of 2 or more persons to carry on as co-
owners a business for profit”
iv. ‘Co-owners’ means:
1. shared control of the business; shared profits of the business
2. No formal creation requirements. Doing business as co-owners results in creation of partnership by
operation of law
c. Meinhard v. Salmon – Meinhard and Salmon are hotel joint venturers. Salmon gets 60% of profits for first five years, then
50-50 for the remaining 15. Losses are split equally. When the first lease is about to run out, Salmon is presented with a new
opportunity: lease the whole block for 80 years. Salmon accepts for his own corporation (Midpoint), without consulting or
informing Meinhard; Meinhard now wants a piece of the action.
i. “Joint adventurers owe to one another, while their enterprise continues, the duty of finest loyalty, a standard
of behavior most sensitive. …A trustee is held to something stricter than the morals of the market place. NOT
HONESTY ALONE, BUT THE PUNCTILIO OF AN HONOR THE MOST SENSITIVE, IS THEN THE STANDARD OF BEHAVIOR.” –
JCARDOZO
1. Cardozo seems to be suggesting a pretty broad spectrum of duty – the offer of the new venture came during
the joint venture where he owed at least a duty to fully disclose to his partner the new venture/opportunity
2. Black-letter law points: motives do not matter in duty of loyalty.
ii. Should have disclosed all related activities – Cardozo leaves open what the rule is, just that lack of disclosure breaks
the duty – is disclosure enough? We don’t know-> about deterrence.
iii. 2 truths from this case
1. If a court cites Meinhard’s language, the D is going to lose
2. If a court cites Meinhard’s “punctilio of honor” language, the D is going to lose badly
d. General Partnership – General partnerships can be organized w/no formalities and no filing – partnership status depends on
the factual characteristics of a relationship between two or more persons, not on whether the persons think of themselves as
having entered into a partnership.
i. Uniform Partnership Act is still the standard as Revised UPA is being adopted
1. UPA §6 – a partnership is an association of 2 or more persons to carry on as co-owners of a business for
profit
2. UPA §7(3) – share of gross returns (revenues) does not indicate partnership b/c that is where wages come
from
3. UPA §7(4) – receiving net profits is prima facie evidence of partnership, unless net returns are interest
payments, wages, rent, etc.
ii. In general, look at 3 things to determine partnership status:
1. control over the enterprise (agency law);
2. profit sharing (UPA §7(4));
3. and intent of the parties
a. UPA §6, also
b. UPA §18(g) – no person can be a member of a partnership w/o the consent of all the partners
iii. UPA §7(1) –Partnership by estoppel- persons who are not partners to each other are not partners as to 3rd parties,
except for p-ship by estoppel (UPA §16)
1. If a person represents itself as being a partner in an enterprise (or consents to others making the
representation) AND a third party reasonably relies on the representation (actual reliance required) and
does business with the enterprise
2. THEN the person who was represented as a partner is personally liable on the transaction, even though that
person is not in fact a partner – somewhat analogous to apparent authority doctrine.
a. UPA§16(1) refers only to those who “give credit,”
b. RUPA §308 expands this to all transactions and case law has made this clear even in the UPA
context
e. Vohland v. Sweet – Sweet does apprenticeship with Vohland the Elder; Elder dies, Vohland Junior takes over and renames it
“Vohland’s Nursery.” Beginning in 1963, Sweet was paid 20% of net profits of nursery. No explicit agreement. Sweet’s 20%
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 share is (erroneously) called “commission.” In 1979, Sweet sues to dissolve partnership – i.e., wind-up, sell assets, and
distribute proceeds. (284,860 x 20% = $65,972)
i. Sweet contributed labor and expertise into a nursery business, from which he took 20% of the profits-> Had been
reinvesting profits in the company for years to build up inventory stock – Sweet wants his 20% of the stock out
1. Vohland is arguing Sweet was on commission, never meant to make him a partner and he never contributed
capital
ii. For purposes of creating a partnership, one partner’s contribution may consist of labor and expertise. A
partnership may be defined as 2 or more persons carrying on as co-owners of a business for profit. No one
element or test exists for identifying a partnership, but, generally speaking, a partnership relation involves
mutual contribution and mutual share of the profits-> the intention to do the acts creating the p-ship that
count, not actually intending a p-ship!
1. Court seems to think that Vohland was creating ownership incentives in Sweet and then not actually give
him ownership
f. Continuing liability of an existing partner
i. Default Rule -> Exiting partner is liable for debts created before leaving
ii. Common law and UPA are sensitive to the exiting partner’s liabilities, but you have to be careful not to allow
partners to go running for the hills when a partnership fails
iii. If you can show that the lender knew the partner was withdrawing and agreed to release that partner, then they will
not hold them liable for those debts
iv. UPA §36.4 – if the retired partner dies, their estate is still liable for all debts prior to departure, but estate can pay off
personal debts first
g. Management and Control- Unless otherwise provided in the partnership agreement:
i. Every partner has a right to participate in the management of the partnership business.
ii. Any difference arising as to ordinary matter connected with the partnership business may be decided by a majority
of the partners, with each partner having one vote regardless of the relative amount of his capital contribution.
iii. Extraordinary matters require approval by all the partners.
h. Authority – every partner is an agent of the partnership for the purpose of its business.
i. UPA- UPA §18(h) – Any difference arising as to ordinary matters connected with the partnership business may be
decided by a majority of the partners; but no act in contravention of any agreement between the partners may be
done rightfully without the consent of all partners
ii. UPA §9(2) – An act of a partner which is not apparently for the carrying on of the business of the partnership in the
usual way does not bind the partnership unless authorized by the other partners
1. Required to object in a timely manner
2. Could do so if the partner had real or apparent authority
3. Construction
iii. Partner has apparent authority for carrying on in the usual way the business of the partnership – unless the partner in
fact has no authority to act for the partnership on a particular matter and the person with whom he is dealing “has
knowledge” that the partner has no authority.
iv. RUPA- Even if a partner’s actual authority is restricted by the terms of the partnership agreement, she has apparent
authority to bind the partnership in either:
1. the ordinary court of the partnership’s actual business
2. business of the kind carried on by the partnership, unless the third party knew or had received notification
that the partner lacked authority.
v. RUPA §303(a)(2) – provides for the filing of a “Statement of Partnership Authority”
1. Grant of authority is conclusive as to third parties even w/o actual knowledge, unless have actual
knowledge that the partner does not have such authority.
2. Limitation not effective unless the third party knows of the limitation or the statement has been delivered to
him.
vi. RUPA §401(j) – An act outside of the ordinary course of business of a partnership and an amendment to the
partnership agreement may be undertaken only with the consent of all parties
i. National Biscuit v. Stroud (1959)– Stroud and Freeman formed a partnership to run a grocery store. Stroud told National
Biscuit that he would not be personally liable for any more bread it sold to the store. Freeman ordered more bread, National
Biscuit delivered it and National Biscuit sued Stroud for payment.
i. Why didn’t Stroud’s letter alert Nabisco that Freeman had no authority?
1. UPA§9(1) Rules of Authority - “Every partner is an agent of the partnership for the purpose of its
business, and the act of every partner, including the execution in the partnership name of any instrument,
for apparently carrying on in the usual way the business of the partnership of which he is a member binds
the partnership, unless the partner so acting has in fact no authority to act for the partnership in the

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 particular matter and the person with whom he is dealing has knowledge of the fact that he has no such
authority.”
ii. Rule – The acts of a partner, if performed on behalf of a partnership and within the scope of the business, are
binding upon all partners.
j. Assets=liability + equity (capital)
i. Value inventory at cost.
ii. Accounting value does not = market value.
iii. Accrual- taking adjustment in period it is incurred.
1. Amortization= depreciation accrued as well.
k. Capacity to sue and be sued
i. UPA – suit on a partnership obligation must be brought by or against individual partners, it cannot sue or be sued in
its own name.
1. Partners are jointly and severally liable for wrongful acts and omissions of the partnerships and breaches of
trust.
2. Only jointly liable for all other debts and obligations of the partnership – means creditors have to join all
the individual partners in a lawsuit.
ii. RUPA – partnership may both sue and be sued in its own name and partners are jointly and severally liable for all
obligations of the partnership.
1. But adds a new barrier to collecting against an individual partner on such liability.
2. Must exhaust all other remedies before resorting to collecting against an individual partner.
l. Partnership Relations With Third Parties
i. UPA and RUPA Provisions
1. UPA §9 (1) – Act of every partner binds partnership (apparent authority)
2. UPA §12 – notice to any partner on partnership affairs counts as notice to the partnership
3. UPA §13 – where, by any wrongful act/omission of partner acting in ordinary course of business or with
authority of his co-partners, loss/injury is caused or penalty is incurred, p-ship is just as liable as the acting
partner
4. UPA §14 – the partnership is bound to make good the loss where received money is misapplied in scope of
partner’s apparent authority or while in the custody of the partnership
5. UPA §15 – partners are liable jointly and severally for everything chargeable under §13 and §14, and
jointly for all other partnership debts and liabilities
6. UPA §18:
a. B – Partnership must indemnify every partner for payments made and liabilities incurred in the
ordinary and proper conduct of the business. Each partner is an agent of the partnership and all the
other partners.
b. F – No partner is entitled to remuneration for acting in the partnership business.
c. G – No partner can become a member of the partnership without the consent of all the partners.
7. UPA §36: Dissolution
a. Dissolution of the partnership does not of itself discharge existing liability of any partner.
b. Releases the departing partner of partnership debts IF the court can infer an agreement between
the remaining partners and the creditor to release the withdrawing partner.
c. Releases the departing partner of personal liability where the creditor and the remaining partners
renegotiate
8. RUPA §306 Partners are jointly and severally liable on partnership torts and contracts.
9. RUPA §307(d) – Partnership assets must be exhausted before pursuing personal assets.
m. The Rights of Partnership Creditors
i. UPA §15 – Partners jointly and severally liable on partnership torts; jointly liable on p-ship contacts
ii. RUPA §306 – Partners jointly and severally liable on partnership torts and contracts, BUT:
iii. RUPA §307(d) – Must exhaust business assets before pursuing personal assets
iv. Tax advantages – no double taxation like corporation where profits are taxed as corporate profits and then taxed
again as dividend profits – partnerships only get taxed once
1. Businesses are more easily able to claim deductions for business loss rather than personal
n. Personal Liability – every partner is subject to unlimited personal liability for the debts and obligations of the partnership.
i. UPA §15 – partners are individually liable for wrongful acts and omissions of the partnership (such as torts),
breaches of trusts, and for all other debts and obligations of the partnership
ii. RUPA § 306 – partners are liable for all obligations of the partnership.
1. But adds a barrier to collecting against an individual partner:
2. Judgment for a claim against a partner cannot be satisfied until:
9
 a. a judgment on the same claim had been rendered against the partnership
b. a writ of execution on the judgment has been returned unsatisfied.
3. Exhaustion rule – partnership assets must be exhausted before a partner’s individual assets can be reached.
4. Exception – rule does not apply if the partnership is in bankruptcy.
o. Transferability of Interests – parent cannot transfer his partnership interest to make the transferee a member of the
partnership, except w/the consent of all remaining partners.
p. Third Party Claims Against Partnership Property
i. Segregated pool of assets to secure business debts – characteristic of partnerships
1. If didn’t have this, all of the business and personal assets of investors would be available to both business
and personal creditors.
2. Would create a severe problem as the number of co-owners increased
ii. Property Ownership - affords to individual partners virtually no power to dispose of partnership property, thus
transforming this property into de facto business property
1. UPA 25
a. Partnership can hold and convey title to property in its own name.
b. But the property is said to be “owned” by the partners in a “tenancy in partnership.” – partners
cannot dispose of the property individually.
c. Strips away from partners all the usual incidents of ownership, including the right to assign and
the right to bequeath.
2. RUPA §203 – Property acquired by a partnership is property of the partnership and not of the partners
individually.
3. RUPA 501 & 502 – Partnership actually owns property. Partner does retain transferable interest in the
profits arising from the use of partnership property and the right to receive partnership distributions
a. If a partner does not own her partnerships assets in a general sense, she retains a transferable
interest in the profits arising from the use of partnership property and the right to receive
partnership distributions.
b. Two-level ownership structure – Contributors of equity capital do not “own” the assets themselves
but rather own the rights to the net financial returns that these assets generate, as well as certain
governance or management rights.
iii. Partner’s interest can be transferred in most circumstances – get a “charging order” which is a lien on the partner’s
transferable interest that is subject to foreclosure unless it is redeemed by repayment of a debt.
q. When both Partners and Partnership are in Bankruptcy
i. UPA §40(h) & (i)/Jingle Rule – gives the partnership creditors priority over all partnership assets and assigned first
priority to the separate creditors of the individual partners in the individual assets of those partners
ii. 1978 Act/ (§723 (c)) RUPA §807 (a) - the RUPA follows the parity treatment rule codified in §723 of the
Bankruptcy Act of 1978. First administers the estate of the partnership and then the assets of the general partners to
the extent of any deficiency
iii. Jingle Rule (left) v. 1978 Act (right)

iv. The revised rule against jingle rule cuts against the incentives to individualize assets to prevent creditors from
reaching partnership assets.
r. Applicability
i. In ALL cases, partnership creditors get first priority in the assets of the partnership.
ii. For Individual Assets
1. Jingle Rule Distribution applies where:
a. UPA is controlling state law, AND
b. §723 does not apply (ie: partnership is NOT in chapter 7 or the individual partner is NOT in
bankruptcy).
2. Parity Treatment Distribution where EITHER:
a. RUPA is the state law, OR
b. § 723 Applies (ie: partnership is in chapter 7 or individual partner is in bankruptcy).
s. Dissolution and Disassociation
i. UPA
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 1. Dissolution §29 – any change of partnership relations, e.g., the exit of a partner:
a. Rightful dissolution- normally death, incapacity, withdrawal

b. Wrongful dissolution- by express will of any partener (ex. misconduct, breach of K…)
2. Winding up §37 – unless otherwise agreed, last surviving partner may have an orderly liquidation and
settlement of partnership affairs It may also be allowed upon a showing of cause by the court
3. Termination §30 – partnership ceases entirely at the end of winding up
ii. RUPA
1. Disassociation §601 – uses the three terms in UPA, but adds a third term, dissociation, to describe the
termination of a person’s status as a partner.
2. Dissolution §801 – the onset of liquidating of partnership assets and winding up its affairs
a. Winding up: only happens on the occurrence of certain events.
b. Buyouts: mandatory if want to continue the interest.
iii. UPA (1914):

iv. RUPA (1997):

v. Dissolution – 3 issues
1. Ability of partners to opt out of statutory wind-up in a partnership at will (Adams v. Jarvis)
2. How to liquidate assets in a statutory wind-up (Dreifuerst v. Dreifuerst)
3. Limitation of the power to force statutory dissolution and wind-up (Page v. Page)
t. Adams v. Jarvis: Adams, Jarvis, and a third doctor entered into a partnership for the practice of medicine. Agreement
provided that the firm would continue to operate even if one doctor withdrew and that the withdrawing partner would be
entitled to share in the profits for any partial year that he remained a partner, but all accounts receivable were to remain the
property of continuing partners. Adams later withdrew and claimed a right to share in the partnership’s existing accounts
receivable.
i. Court held that a partnership agreement which provides for the continuation of the firm’s business despite
the withdrawal of one partner and which specifies the formula according to which partnership assets are to
be distributed to the retiring partner is valid and enforceable. Adams doesn’t get 1/3rd of accounts rec., but
only his share of profits til end of year.
ii. UPA §38(a) – when dissolution is caused in any way...unless otherwise agreed, may have the partnership property
applied to discharge its liabilities, and the surplus applied to pay in cash the net amount owing to the respective
partners.”
iii. Reasonable that remaining doctors would want to keep control over accounts receivable, but P is entitled to profits
from accounts receivable that were collecting during the year of Ps withdrawal (remanded to determine amounts).

11
u. Dreifuerst v. Dreifuerst– Ps brought suit against their brother (D) to dissolve a partnership in which they were all partners.
D contended that under Wisconsin law he had a right to force a sale of partnership assets in order to obtain his fair share of
the assets in case upon dissolution.
i. Court held that a partnership at will is a partnership that has no definite term or particular undertaking and
can rightfully be dissolved by the express will of any partner.
1. Lawful dissolution gives each partner the right to have the business liquidated and his share of the surplus
paid in cash.
ii. UPA §38(1) – “when dissolution is caused in any way, except in contravention of the partnership agreement, each
partner, as against his co-partners...unless otherwise agreed, may have the partnership property applied to discharge
its liabilities and the surplus applied to pay in cash the net amount owing to the respective partners.” -> So they had
to sell off the property and split the money less any debts.
v. Page v. Page– P sought a declaratory judgment that the partnership he had w/D was a partnership at will which he could
dissolve.
i. A partnership may be dissolved by the express will of any partner when no definite term or particular
undertaking is specified. However, the dissolution of an at will partnership must still be acted upon with
good-faith in accordance with the fiduciary duties owed by each partner.
ii. Appellate court found that the dissolution was in good faith (no evidence to the contrary – no proof that the new
found profits were anything more than temporary) and found that Big Page could dissolve without owing anything
to Little Page.

D. Alterations of the Partnership Form

1. Limited Partnership (UPA §1001)- cannot go after individual assets, only partnership assets. Like general
partnerships, no distinction between general and limited partners, just has a liability shield. Mostly used by service
firms -> law firms, accounting, etc.
a. Partners are divided into two classes – general partners and limited partners
i. General partners – essentially have the rights and obligations of partners in an ordinary
partnership
1. Must have one or more
2. Have unlimited liability for partnership obligations.
ii. Limited partners – normally do not participate in the management of the partnership’s
business and are subject to only limited liability.
1. Liability of a limited partner for partnership debts is limited to the capital she
contributes to the partnership.
2. If limited partners do exercise management powers they risk losing their limited
liability protection as de facto general partners
b. Control test – if limited partners exercise control they can be held liable as a general partner.
i. Rationale – those who can actively shift assets out of the firm, or make risky decisions, should
be held personally liable to prevent opportunism against partnership creditors. Opportunism
concern does not apply to passive investors so we do not hold them liable.
ii. Revised Uniform Limited Partnership Act (1985) – adopts control test but adds the
qualification that a limited partner who participates in the control of the business is liable only to
persons who transact business w/the limited partnership reasonably believing based on the limited
partner’s conduct that the limited partner is a general partner.
iii. Revised Uniform Partnership Act (2001) – no liability for limited partner even if the partner
participates in the management or control of the limited partnership.
c. Two-tier tax treatment for any enterprise with publicly traded equity – Enterprise is taxed on its entity
income, and its investors are taxed again at individual rates.
2. Limited Liability Partnership (LLP)
a. Need to be registered with the state, different states have different requirements.
b. All partners are limited in liability and can exercise control.
c. The partnership itself is limitless, but individual partners cannot be liable after entity is exhausted.
i. Creditors can only rely upon business assets for liquidation.
ii. Limited partners share in profits without incurring personal liability for business debts;
iii. Limits liability only for partnership liabilities arising from DLLPA §1515(b)
1. Negligence, malpractice, wrongful act, or misconduct of another partner.
2. Or an agent of the partnership not under the partners’ direct control.
3. Limited Liability Companies (LLC): best of both worlds-
a. This is the entity of choice today b/c the owners enjoy control and limited liability and the LLC can elect
not to be taxed as a corporation but to have income attributed to its owners to be treated as a partnership.
i. “Check the box” taxation - Allows all unincorporated businesses to choose whether to be taxed
as partnerships or corporation
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 ii. Disadvantages: complex to form (operating agreement), easier to “pierce the veil,” and state
taxes might be applicable, like a corporation, but unlike a partnership.
b. Formation – formed by filing Articles of Organization in state
i. Operating Agreements then set out additional details.
c. Management
i. Member managed – managed by their members, apparent authority is comparable to the
apparent authority of a partner.
1. Each member has the power to bind the LLC for any act that is for apparently carrying
on the business of the LLC in the usual or ordinary way.
2. Even if an action is not in the usual or ordinary way, the remaining members may
confer on a given member actual authority to bind the LLC to an action or type of action.
3. The remaining members may also withdraw the actual authority of a member to take a
certain kind of action that is in the regular or ordinary way.
4. In this case, the LLC will still be bound, but the member may have to indemnify the
company for any losses
ii. Manager managed – managed by managers who may/ may not be members.
1. Rules concerning authority are comparable to those in corporations – i.e. typically the
managers only have apparent authority to bind the firm.
2. Members have no apparent authority to bind the LLC, just as shareholders cannot bind
a corporation.
iii. Default rule – LLC is to be managed by its members – this prevails unless the members agree
otherwise-> some states modify the default rule.

*Big difference b/w LLC/LLP is the default governance structures for the two entities.
->More about protection from each partner.

PART II: THE CORPORATE FORM: THE BASIC CLAIMS ON CASH FLOWS UNDER THE CORPORATE FORM,
INCLUDES VALUATION AND CREDITORS’ RIGHTS

a. Core Characteristics of the Corporate form

13
 Core Ge LL LL Co
Char ner P C rpo
acter al rati
istic Pa on
s rtn
ers
hip
Inve X X X X
stor
Own
ershi
p
Lega X X X X
l
Pers
onali
ty
Limi X X X
ted
Liab
ility
Tran X X X
sfera
ble
Shar
es
Cent X
raliz
ed
man
age
ment
unde
r an
elect
ed
boar
d
iii. These features complement each other and help to raise capital from passive investors for large perhaps risky
ventures.

IV. The Corporate Form

A. Why use the corporate form?
a. Eliminates problem of personal liability for obligations of entities.
b. Entrance/exit becomes a lot easier for ppl.
i. Shares become more fungible->more easily traded-> get a new source of information about the
company w/o having to
c. Prevent minority investors from threatening to dissolve firm.
d. Default provisions in corporate code.
e. More stable and predictable source of law and definition of fiduciary duties.
f. Corporations are publicly traded (for the most part).
B. 5 core characteristics:
a. 1) Legal personality with an indefinite life.
b. 2) Limited liability for investors.
c. 3) Free transferability of share interests.
d. 4) Centralized management.
e. 5) Appointed by investors.
C. Characteristics – make the corporation an efficient form of enterprise organization.
1. Legal personality with indefinite life
a. Corporation is considered a separate person in the eyes of the law
b. Advantages:

14
 i. Makes it easier to sign contracts, closes sales, and take title in its own name.
ii. Enables corporations to own assets, delimits the pool of assets upon which corporate creditors
can rely for repayment.
iii. Reduces the cost of contacting for credit.
c. Indefinite life – enhances the stability of the corporate form – death/departure of a “principal” doesn’t
matter, corporate form remains.
2. Limited liability for investors
a. Implications
i. Shareholders cannot lose more than the amount they invest.
ii. Shareholders unlike the general partner, who is legally a party to all partnership agreements and
is thus liable under them
b. Reasons for having limited liability
i. Simplifies the job of evaluating an equity investment – if not liable on the debts, more likely to
invest.
ii. Encourage risk adverse shareholders to invest in risky ventures
iii. Increase the incentive for banks or other expert creditors to monitor their corporate debtors
more closely
. c. Easterbrook and Fischel – 6 reasons why limited liability reduces the cost of separation and specialization
i. Decreases the need to monitor managers – managers find ways to offer assurances w/o a need
for director monitoring
ii. Limited liability reduces the costs of monitoring other shareholders – don’t need to know who
other shareholders are, don’t need to monitor their assets to pay debts
iii. Gives managers incentives to act efficiently
1. Shares are tied to votes – poorly run firms will attract new investors who can assemble
blocs at a discount and assemble new managerial teams
2. Threat of displacement gives existing managers incentives to operate efficiently in
order to keep prices high.
3. Limited liability reduces the cost of purchasing shares
iv. Makes it possible for market prices to impound additional information about the value of firms
1. W/unlimited liability shares would not be homogenous commodities, wouldn’t have
one market price
v. More efficient diversification – w/unlimited liability would limit the number of shares
1. Limited liability facilitates optimal investment decisions
2. Managers can invest in risky projects w/o exposing the investors to ruin.
3. Increased availability of funds for projects w/positive net values
3. Free transferability of share interests
a. Equity investors in the corporate entity own something distinct from any part of the corporation’s
property – share interest
i. May be transferred together w/all rights that it confers
ii. Allows the firm to conduct business uninterruptedly
iii. Avoids complications of dissolution and reformation
b. This is immediately tied to limited liability – w/o limited liability the creditworthiness of the firm as a
whole could change as the identities of its shareholders changed.
i. Value of shares would be difficult for potential purchasers to judge
ii. Ability of investors to freely trade stock encourages the development of an active stock market.
c. Free transferability is a default provision – can agree to restrict transferability.
d. Serves as a potential constraint on self-serving behavior of the managers of widely held companies
i. If stock market distrusts, share price will fall and it will be more likely that managers will be
replaced.
ii. Anti-takeover defenses that limit the ability of shareholders to sell their stock to would-be
acquirers are controversial b/c they restrict the power of the market to discipline managers.
4. Centralized Management Appointed by Equity Investors
a. Centralized management can achieve economies of scale in knowledge of the firm, its technologies and
markets.
i. Shareholder-designated Board of Directors, not investors, are accorded the power to initiate
corporate transactions and manage the day to day affairs of the corporation.
ii. This causes a problem – investors become rationally apathetic – need to develop rules to ensure
managers will advance financial interests of investors w/o impinging on management’s ability to
manage the firm productively.
b. Formal distinction b/t board and management
i. Initiation and execution – management
ii. Monitoring and approval – board
15
 iii. Distinction serves as a check on the quality of the delegated decision making.
B. Formation
1. Two Basic Types of Corporations
a. Close Corporation – basically an incorporated partnership.
i. Small, so shareholders are likely the officers and directors.
ii. May have features that restrict the transfers of shares or other provisions that conflict with
general corporate status.
iii. Reason for incorporation is tax status rather than raising capital, so usually
do in their own state instead of DE, for ex.
iv. Absence of secondary market for shares.
*Are often controlled corps.
b. Publically-held corporations
*Can be controlled corps, but usually are not.
i. When a single shareholder or group of shareholders exercises control through its power to
appoint the board.
ii. Where there is no such group, control is said to be “in the market,” where anyone can purchase
control by buying enough stock, but until they do, practical control resides with the existing
management of the firm.
iii. Problems occur in self-dealing transactions and protection of minority shareholders’ rights.
1.large company ->main trait is a public secondary market in which the corp’s shares are listed
and traded
2.primary market-> transactions to which the corporation is party
a. eg. issuing or repurchasing shares
3.Secondary market-> transactions to which corp is not a party
a. Eg. A sells to B shares in X corp
4.Public Secondary Market – eg. Stock exchange
2. Choosing Where to Incorporate
a. U.S. Firms not constrained by headquarters, place of business or other operational factors in choosing
where to incorporate.
b. State of incorporation dictates which corporate law rules apply under “internal affairs” doctrine.
i. DE has 50% of incorporations because of favorable laws & almost 25% of DE state budget
comes from corporation fees.
ii. State charges annual franchise taxes ranging from $10 flat fees to $10,000+ based on income,
assets, etc.
c. Mechanics of reincorporation are straightforward: creation of a new firm in the destination state,
followed by tax-free merger of the existing corporation into the new one, requires shareholder approval.
Typical reincorp. Costs are $70,000 in 2000.
3. Incorporation
a. Process of Incorporating
i. Individual called an incorporator signs the requisite documents and pays the necessary fees.
DGCL§107
ii. Incorporator drafts and signs a document called the Articles of Incorporation or the Certificate
of Incorporation. = “charter”
1. DGCL have requirements that have to be in charter.
-> To change, board has to approve w/ majority of shareholders.
-> By-laws can be changed unilaterally.
-> Shareholders can amend w/ majority vote too.
2. State the purpose and powers of the corporation and define all of its special features.
o Be as broad as possible.
o The provision that shareholders get to vote equally.
o Initial directors typically named.
o Other provision that will affect shares.
o Terms of directors.
-> Typically three year terms.
3. Identifies office within the state or an agent in the state upon whom process can be
served.
iii. Charter is filed w/a public official-> Secretary
1. Have to pay a fee when file charter – fee varies by state – DE calculated by how many
shares the corporation is authorized to issue.
iv. First acts of business in a newly formed corporation – take place at an organizational meeting
DGCL §108
1. Electing directors
16
 2. Adopting bylaws
3. Appointing officers
b. DGCL §102: Contents of Articles of Incorporation-
i. (a)Requirements –
1. Must provide for voting stock
2. A board of directors – size and terms, procedures for removal
3. Shareholder voting for certain transactions.
4. Name the original incorporators
5. State the corporations name and business, address
6. Fix its original capital structure…
ii. Beyond the essentials can have any provision that is not contrary to law
ex. cannot opt out of duty of loyalty. DGCL §102(b)(7)
c. DGCL §109: Corporate Bylaws
i. Must conform to the corporation statute and the corporation’s charter
ii. Fix the operating rules of the governance of the corporation.
iii. Can cause tension if shareholders can amend.
iv. Should include:
o What officers will corp. have: CEO, CFO
o Size of the board.
o Establish date of annual meeting.
o Can include features of how board will operate, but default will be majority of
directors.
o Shareholder agreements.
d. Shareholder’s agreements DGCL §218(c)
i. Formal agreements among shareholders – typically address questions such as restrictions on the
disposition of shares, buy/sell agreements, voting agreements, and agreements w/respect to
employment of officers of the payment of dividends.
ii. Voting trust – an arrangement in which shareholders publicly agree to place their shares with a
trustee who then legally owns them and is to exercise voting power according to the terms of their
agreement. DGCL 218(a)
• §111- Jurisdiction by Court of Chancery.
o Issues of internal affairs.
• §112- Bylaws may provide shareholder access to the proxy.
• §113- Proxy expense reimbursement.
o If shareholders win, reimbursement.
• §121- General powers of corporation.
• §122- Specific powers.
o Things you can definitely do.
o (9)- power to make charitable donations.
o (17)- corporate opportunity opt out.
• §123- Corp. power to hold shares in other companies.

C. Role of Board of Directors

1. *DGCL 141(a)(most important provision in Code) – a)”The business and affairs of every corporation
organized under this chapter shall be managed by or under the direction of a board of directors, except as may be
otherwise provided in this chapter or in its certificate of incorporation.”
*Not enough for Chancery Court that a board has officers-want to make sure equity is fulfilled and
fiduciary duty upheld to shareholders.
* Directors have no special duty to follow wishes of a majority shareholder, this is not direct democracy.
Other sections:
• §142: Officers not necessary, officers honorary
o Third time there is a mention of officers and authority.
o Majority of officers have to be independent- cannot work for company or have worked for
company.
o Law holds board accountable, even though they may not have as much power as CEO.
o Role of officers change, especially in times of crisis.
• §144: Interested directors.
o When board can ratify conflicting transactions.
o How to get protection from _____.
17
 • §145: Indemnification and insurance. *Important section.
o Protecting directors from personal liability.
o 3 lines of defenses:
 1) DNO insurance.
• Cover losses and attorneys fees.
• Will not cover for criminal conduct.
• Deductibles, max payout provisions.
 2) Indemnification.
• Statute has limitations- cannot indemnify for bad faith violations.
• Can only protect good faith violations.
 To be personal liable a lot of things would first have to happen: DNO would have to max
out payout, company would have to be insolvent so that it could not indemnify you, and then you
would be “on the hook.”
• Only happened twice: Enron, WorldCom.
• Personal liability very rare.
 3) Court of chancery can:
• Enjoin things before they happen.
• §151: Classes and series of stock.
o Default rule: Each class is able to vote for what affects their class rights.
• §193: Dividends.
o Company doesn’t even have to declare dividends, and when it declares dividends, it doesn’t even
have to pay them.
• §203: Anti-takeover statute.
o If you acquire more than 15% in a DE corporation’s securities, you will not be permitted to merge
with that company, unless you get 85% of board’s approval.
 Prevents hostile takeovers.
• §212: Proxy
o Shareholders may vote by proxy.
• §213: Securing a vote by buying stuff…
o Have to have date and time to fix who is shareholder and who is not.
o Have to buy 60 days before meeting or whatever fixed date.
• §216: Quorum for shareholder action.
o Majority entitled to vote.
o Presents sets of defaults in ___.
 (In contested elections) directors elected by plurality in default.
• §220: Ability to inspect books and records (by shareholders)
o Usually a preview to a lawsuit- get information to survive summary judgment.
• §228: Shareholders acting in lieu of a meeting.
o Very few boards permit.
• §252/253: Merger statutes
o 253- Freeze-out merger.
 If you acquire 90% of company, you get to tell 10% what their share is worth or the
Chancery tells them what it is worth and you buy them out.
• §262: Appraisal action/ review

b. Automatic Self-Cleansing Filter Syndicate Co. v. Cunninghame (Eng. C.A. 1906): A 55% majority group of
the shareholders of the company contended that the company’s board of directors could not override the groups’
vote, made at an ordinary shareholders meeting, to sell the company’s assets, notwithstanding that the company’s
charter required a 75% vote to limit the board’s decision making power.
ii. Rule – Where a company’s charter requires a 75% vote of the shareholders, made as an
“extraordinary resolution” to override a board of director’s decision, a mere majority resolution
made at an ordinary shareholders meeting may not override the board’s decision that is contrary to
the majority’s wishes.
iii. Rationale

18
 1. The governing statute gives precedence to the directors’ decision in this situation, and gives to
the directors the absolute power to do all things other than those expressly reserved to the
shareholders.
2. The director’s power is subject to extraordinary resolutions, so that if the shareholders desire to
alter the directors’ powers, they must do so not by a resolution made by a majority vote at an
ordinary meeting, but by an extraordinary resolution – this is the only mechanism that may be
used to override the minority.
3. There would be no point to require a “special resolution” for removal of directors in the
company’s charter if the company could be sold by majority vote at a general shareholders
meeting over the objection of the board.
4. This rule protects the interests of the minority shareholders.
5. Anyone unhappy with the decision can make a resolution to remove directors, create a
staggered board, or vote in a new board at the next vote.
iv. Note DGCL §271: Sale, lease or exchange of assets; consideration; procedure
1. BASICALLY - you can’t do this. Board of directors must propose the sale of all
assets and then you need a majority of shareholders to vote on it. Shareholders
cannot sell the assets of a company without approval of the board. You would
have to get rid of the directors – mandatory term
2. Structure of the Board
a. Charter sets terms for general structure
i. Default – all member of the board are elected annually to one year terms.
ii. Can classify different types of stock to elect directors
iii. All directors have one vote on matters before the board
b. Board has inherent power to establish standing committees for the effective organization of its own work
i. Committees are usually filled by “independent” directors
ii. Matters that by statutes require board action cannot be delegated to committee
c. Corporation statues generally allow charters to create staggered boards – directors are divided into
classes that stand for election in consecutive years. DGCL §141(d)
i. Shareholders generally oppose staggered boards b/c they enhance management’s ability to resist
hostile takeovers.
ii. Staggered boards are usually not offered for shareholder approval anymore, but they are
standard features of new companies now.
d. Formality in Board Operation
i. Governance power resides in the board of directors, not in the individual directors that constitute
the board.
ii. Legally speaking, only act as a board at a duly constituted board meeting and by majority vote
(unless a supermajority is required on the issue)
iii. Need proper notice of meetings and a quorum (majority of board present & signed resolution)–
bylaws usually specify, state law provides minimum
*Minimum set by statute- DGCL §141(b)
iv. Law’s requirement of a formal meeting is an effort to discourage the manipulation of board
decision making.
v. Directors may not give proxies for others, they must vote personally
D. Corporate Officers
1. Introduction
a. Corporate charter empowers the board to appoint officers and remove them, w/or w/o cause; Board
generally has power to delegate to corporate officers as it sees fit
c. Corporate officers are unquestionably agents of the corporation and are subject to the fiduciary duty of
agents-> VP, CEO, treasurer…
2. Jennings v. Pittsburgh Mercantile Co. (Pa. 1964): D contended that Egmore, D’s VP and Treasurer-
Comptroller, did not have apparent authority to accept an offer for a sale an leaseback, and that therefore P, a real
estate broker, was not entitled to commissions for a sale and leaseback transaction that Egmore seemed to accept but
that D’s board of directors did not.
b. Rule – A corporation’s executive officer does not have apparent authority to accept an offer for a
transaction that for the corporation is extraordinary.
Generally, corporate officers, unlike directors, are unquestionable agents of the corporation and
are therefore subject to the fiduciary duty of agents. Moreover, the board of directors generally
may delegate its powers to the officers as it sees fit. It seems, therefore, that if this case had
involved an ordinary company transaction, rather than an extraordinary one Egmore should have
been deemed to have apparent authority to enter into it. Thus, it seems this case places the burden
on third parties of determining whether a corporate transaction is ordinary or extraordinary.
c. Rationale
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 i. Apparent authority is defined as that authority which, although not actually granted, the
principal:
1. Knowingly permits the agent to exercise or
2. Holds him out as possessing.
ii. Agent cannot by his own words invest himself w/apparent authority.
iii. For a reasonable inference of the existence of apparent authority to be drawn from prior
dealings, these dealings must have:
a. A measure of similarity to the act for which the principal is sought to be bound, and
granting this similarity,
b. A degree of repetitiveness
v. The extraordinary nature of this transaction placed P on notice to inquire as to E’s actual
authority, particularly since he was an experienced real estate broker.
1. Had P done so, he would have discovered that the board never considered any of the
proposals and did not delegate actual authority to accept officers.
E. Financial Structure
1. Capital Structure – Business corporation raises capital to fund its operations
a. Two types of long term claims for this purpose
i. Borrow money through the issuance of debt instruments (loans)
1. Those who buy corporate debt have a contractual right to receive a periodic payment of
interest and to be repaid the money they initially loaned at a stated maturity date.
2. If corporation fails to make these payments, creditor has a legal remedy
3. Creditor can also accelerate payment in case of a default.
ii. Equity claims – selling ownership claims in the corporate entity
1. Common stock – type of claim – fragile legal protections
-> No right to periodic payment, cannot demand return on investment, cannot
tell managers what to do
->Only have a right to vote, can receive dividends when the board of directors
declares so.
2. Legal Character of Debt
a. The loan agreement has great flexibility in design – Can construct to whatever the parties desire as long
as it is within the law
b. Maturity date – issuer of debt will have an obligation to repay at a stated future date.
i. Repayment obligation – principal amount plus any outstanding interest not yet paid by the
maturity date.
ii. If any interest/principal is not paid when due=> bonds in default.
c. Investing as a creditor has a few advantages:
i. Have a legal right to a periodic payment
ii. Priority claim over shareholders on corporate assets if the corporation defaults, and can sue on
the K if not paid on time.
d. Tax treatment
i. Interest paid by the borrower is a deductible; cost of business when the firm calculates its
taxable income
ii. No deduction is available for dividends or distributions paid to the corporations’ shareholders.
iii. Cost of debt is less than equity to a corporation.
3. Legal Character of Equity
a. Common stock – contractual in nature but the law fixes clear default rules on the K.
i. Most important rules – owners of stock can vote to elect directors and that stock carries one vote
per share
ii. Possess control rights in the form of the power to elect the board of directors.
iii. Any deviation from the one-vote per share rule must appear in the charter.
b. Residual claims and residual control
i. After elect the board, common stock owners have residual claim on the corporations’ assets and
income
ii. Board pays the expenses and interest to creditors, whatever is left over can belong to the
stockholders in that it is available for the payment of dividends
c. Preferred Stock – an equity security on which the corporate character confers a special right, privilege, or
limitation
i. Get paid before general stockholders for dividends and liquidation.
ii. Ordinarily does not vote as long as its dividend is current, on certain fundamental matters get a
class vote (meaning they can veto the venture)
iii. DGCL – right must be created specifically in the document creating and defining the preferred
stock
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4. Basic Concepts of Valuation
a. Time Value of Money
i. risk x time x skill= wealth
ii. Depends on the use you have for it or on the value you can get by finding someone who needs
that dollar now for something valuable
iii. Present value – the value today of money to be paid at some future point
iv. Discount rate – tells us how to calculate present values
1. Rate that is earned from renting money out for one year in the market for money; 2. I.e.
discount rate of 10 % means you earn 10 cents for lending $1 for one year.
3. Equations: PV (1+r)=FV
a. FV = PV + r(PV)
b. PV = FV/ [(1+r)^t]
c. PV-expenses (cash flows)= NPV
-> On this one project, what is the value to me today? Present value of all
streams of cash in future minus expenses.
v. Rate of return – the percentage that you would earn if you invested in a particular project
vi. Interest – the money you are promised when you lend out money or the amount you have to
pay if you borrow money.
b. Risk and Return
i. Assessing the uncertainty in investments – probability of success or failure
ii. Expected return – what investor calculates to determine probability of success or failure.
1.= Weighted average of the investment
2. Sum of what the returns would be if an investment succeeded, multiplied by the
probability of success, plus what the returns would be if the investment failed, multiplied
by the probability of failure.
iii. Financial risk – calculating the present expected value of this opportunity
iv. Risk neutral – if all investor cares about it the expected return of the investment
v. Risk averse – volatile payouts are worth less to these investors
1. Most investors are this; demand extra compensation for bearing risk
vi. Risk premium – the additional amount that risk adverse investors demand for accepting higher
risk investments in the capital markets
1. Does not compensate the investor for possible out of pocket losses – even risk neutral
request this b/c failure lowers the ER of the investment.
2. Instead is compensation for the intrinsic unpleasantness of volatile returns to the risk
adverse investors who dominate market prices.
vii. To calculate present values of risky expected future cash flows, we need to discount those cash
flows at a rate that reflects both the time discount value of money and the market price of the risk
involved – this is a risk adjusted rate.
b. Diversification and Systematic Risk
i. Unsystematic risk= risk you can diversify; particular to a company.
1. Ex. Risk that this company will get hit by a computer virus.
ii. Systematic risk= not diversifiable; in the system; risk that will affect every bet in the
portfolio in the same way.
1. Ex. Risk that interest rates will go up/ down.
i. Packaging investments to reduce risk – construction of mutual funds, a diversified portfolio
ii. Risk aversion means that investors are averse only to risks that they actually end up bearing.
iii. So a risky investment held as part of a portfolio that includes other equally risky investments is
likely to be worth more to its owner than if it would be if it were held alone-> Odds are that even
if a few of the investments go bad, most of them will succeed.
v. Diversified across a portfolio that has less total risk than its individual components
vi. Means that risky investments should be priced to reflect the fact that investors need not bear all
the risk associate w/holding a single investment

d. Valuing Assets
• NPV calculations for all the year periods-> calculate NPV of a terminal value based on current growth.
• Assets – Liability = $ + NPV future cash flows + NPV terminal value = VALUE OF BUSINESS
i. Discount Cash Flow (DCF) Approach: Requires a prediction of all future cash flows, and a
discount rate to bring those cash flows back to the present to yield a “net present value” (NPV)
2. Steps in the process:
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 a. Estimation of all future cash flows generated by the asset
b. Calculation of an appropriate discount rate
ii. Weighted average cost of capital – weighted average of the cost of debt and the cost of equity
where the weights are the relative amounts of debt and equity in the capital structure
1. Calculating debt is easier, calculating equity is harder.
iii. Capital asset pricing model – built on insight that well-functioning markets will link risk and
return-> Links securities risk to the volatility of the security prices.
e. Relevance of Prices in the Securities Market
i. Socially valuable if the prices of securities reflected well informed estimates based on all
available information of the discounted value of the expected future payments – stock market does
this.
ii. Depends on the quality of information that informs trading, which depends on the integrity of
all the major actors in the market
f. In Re Emerging Communications, Inc., Shareholder Litigation (Del. Ch. 2004): The business
valuation efforts for the plaintiff minority shareholders and the defendant majority shareholder disagreed on
the appropriate inputs for determining ECM’s cost of capital as well as the relevance of market price for
determining ECM’s fair value.
ii. Issue #1 – Is it appropriate to apply a small stock premium in determining the cost of capital
where doing so is shown to be appropriate in a particular case – yes
1. There is finance literature supporting the position that stocks of smaller companies are
riskier than stocks of large ones, and therefore command a higher expected rate of return
in the market.
2. Caselaw also recognizes the propriety of a small firm/small stock premium in
appropriate circumstances.
3. The issue is not whether a small firm/small stock premium is permissible theoretically,
but whether defendants have shown that a premium of 1.7% is appropriate in this
particular case – Ds have here.
iii. Issue #2 – Is it appropriate to apply a supersmall size premium in determining the cost of
capital where although the company is very small it is also insulted from risk through several
advantages – No
1. D justified the supersmall size premium on the basis that ECM is much smaller than
the average companies used for generating accepted data for determining the size
premium – D offers no rationale for using this premium.
2. Although very small, ECM was unusually protected from the hazards of the
marketplace – it was well established, it had no competition, it was able to borrow at
below market rates, and it was cushioned by regulators from extraordinary hazards.
3. D implicitly argued that these advantages were not enough to offset the risk, but D
never argued that explicitly – needed to support this.
iv. Issue #3 – Is it appropriate to apply a weather related premium in determining the cost of
capital where such a premium is unsupported by valuation literature or empirical evidence – No
1. There was no evidence that there would be no insurance coverage for hurricane losses,
and D did not provide enough factual support to show that this should increase the cost of
equity.
v. Issue #4 – Does the market price of a publicly traded stock corroborate fair value where there
are factors that indicate the market price is below fair value – No.
1. Even if traded in an efficient market, market price does not always = fair value.
2. Record shows that ECM’s stock was not traded in an efficient market – b/c the market
price didn’t represent the company’s true value Ds decided to abandon the merger which
caused Ps to bring suit.
3. B/c the majority interest was owned by one individual, the market price of ECM stock
always reflected a minority discount.
4. Market was inefficient b/c material information was withheld from it
5. Therefore the market price did not corroborate the fair intrinsic value.
V. Protection of Creditors
A. Problems & General Safeguards
Limited liability exacerbates the traditional problems of debtor-creditor relationships:
a. Opens opportunities for both express and tacit misrepresentation in transactions with voluntary creditors
– misrepresent assets, walk away if business fails.
b. Limited liability makes it possible and sometimes attractive to shirt assets out of the corporation after a
creditor has extended credit to the corporation – shareholders distribute assets to themselves and leave the
debts w/the corporation.

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 c. Creditors can minimize the costs of such shareholder opportunism by taking security interests in
particular corporate assets or negotiating specific covenants that give them early warning of credit
problems
1. Fraudulent Transfer Act- limitation= only an ex post remedy; fairly loose standard.
2. Mandatory Disclosure
a. Federal securities law imposes extensive mandatory disclosure obligations on public corporations, but no
US state requires disclosure of financial records for creditors.
b. Public issues of debt are themselves occasions for extensive disclosure
c. Credit bureau reports are more useful than financial statements for evaluating credit risks associated with
close corporations
3. Capital Regulation
2. E.g. requiring investors to contribute a minimum amount of capital to the corporation and restricting the
removal of capital from the firm; SE=>minimal capital= legal capital= par value x shares outstanding.
3. Very direct means by which the legal system can attempt to protect against some of the risks that creditors
face.
4. How do you know what is surplus so that you can make distributions to shareholders?
a. Par Stock = if the stock has par value then the stated capital is equal to the number of shares
outstanding times the par value of each share.
Ex. – Corp. issues 1,000 shares with a $10 par value. The stock has a $30 selling price per share.
Corp.’s stated capital will be $10K, and the remaining $20K paid in by shareholders as part of
their orginal investment is the “capital surplus.”
b. No Par Stock = Stated capital is an arbitrary amount that directors decide to assign to the sated
capital account.
Ex. – Corp. issues 1,000 shares at $30 per share issue price, but because the stock is “no par,” the
corp.’s stated capital will be whatever the board decides it should be. If they decide stated capital
should be $5K, then in addition to this $5K the corp. will have $25K of “capital surplus.”

4. Financial Statements
a. Accounting is a standardized methodology for describing a firm’s past financial performance; A= L +
SE
i. Income statement – presents the results of the operation of the business over a specified period.
1. Limitations – account of profit/loss does not reflect the actual amount of cash that a
business throws off (or makes available to its owners) per year.
2. Net profit may differ from the cash available for distribution for a number of reasons
a. Depreciation is a non-cash charge reflected in the income statement; it
reduces net profit but it does not affect the amount of cash that can be made
available that year
b. Does not reflect the amount of case available to the owners.
ii. Balance sheet – represents the financial picture of a business organization as it stands on one
particular day.
1. Limitation - typically reflect historical costs not current market values
a. Book value (the value found on the balance sheet) may therefore differ quire a
bit from the current economic value of an asset
b. A balance sheet might show a value for shareholder equity that is much more
than shareholders could achieve upon the sale of the firm or, more likely in an
inflationary period, a value that is much less than the firm’s market value

2. Divided up into two columns – assets and liabilities

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 a. Assets
i. Current assets (working assets) – constantly cycling through the
firm’s production process – cash, marketable securities, accounts
receivable, inventories, and prepaid expenses
ii. Fixed assets (capital assets) – property, plant and equipment,
buildings, machinery, equipment, furniture and vehicles
b. Liabilities – divided into current liabilities (due within the year) and long-
term liabilities
3. Every element of the corporation’s value must be accounted for by an equivalent debt
or equity claim on the liability column
a. This is done in the stockholders’ equity column.
b. For both legal and accounting reasons, the stockholders’ equity is divided into
3 accounts:
i. Stated capital (capital stock) – represents all or a portion of the value
that shareholders transferred to the corporation at the time of the
original sale of the company’s stock to its original shareholders.
ii. Capital surplus – if the stock is sold for more than its par value.
iii. Earned surplus (retained earnings) – the amounts that a profitable
corporation earns but has not distributed to its shareholders.
4. A comparison of current assets with current liabilities gives a sense of the liquidity (or
the capacity of non-cash assets to be converted into cash)
a. Both current assets and current liabilities are listed in current dollars.
b. Long-term liabilities also tend to be stated in units that approximate real
economic dollars
b. Distribution Constraints
i. NYBC 510 – bars distributions that would render the corporation “insolvent” –
1. “Insolvent”=unable to pay its immediate obligations as they come due
2. Dividends may be paid only out of surplus; they may not be paid out of stated capital
ii. DGCL 170 – nimble dividend exception – directors of a business corporation may pay
dividends either out of:
1. Capital surplus, OR
2. if there is no capital surplus, out of net profits in the current or preceding fiscal year.
3. This is done to permit boards to reward the shareholders of firms that, although not
conspicuously healthy, may be on an upward trajectory
AND: DGCL § 244(a)(4) allows board to transfer out of stated capital into surplus for no
par stock. Also, dividends can be paid from a Reevaluation Surplus, which allows the
firm to adjust its books to reflect that an asset is worth more (in economic value) than the
amount at which they are carried on the books.
iii. California’s two-part distribution test – Corporation may pay dividends either out of its
retained earnings or out of its assets, as long as those assets (on the balance sheet) remain at least
1.25 times greater than its liabilities and the current assets at least equal current liabilities
c. Minimum Capital and Capital Maintenance Requirements
i. An obvious objection to distribution constraints based on accounting categories such as capital
surplus is that they are easily avoided through the expedient of placing trivial sums in the “trust
fund” of legal capital reserved for creditors
ii. But within the United States, statutory minimum capital requirements are either truly minimal
($1,000) or entirely nonexistent
iii. One reason that minimum capital requirements cannot be an effective creditor protection is that
this check, whether it exists, is fixed at the date of organization of the corporation
iv. Even if companies cannot dip into minimum capital to pay shareholders, normal business
activity can easily dissipate a company’s capital, leaving nothing on the books for its creditors
B. Director Liability to Creditors
1. Directors owe an obligation to creditors not to render the firm unable to meet its obligations to creditors by
making distributions to shareholders or to others without receiving fair value in return
a. Delaware Chancery Court has suggested that when a firm is insolvent (but no one has yet invoked the
federal bankruptcy protections), its directors owe a duty to consider the interests of corporate creditors
i. When a corporation is “in the vicinity of insolvency,” its directors in making business decisions
should not consider shareholders’ welfare alone but should consider the welfare of the community
of interests that constitute the corporation.
ii. But that result will not be reached by a director who thinks he owes duties directly to
shareholders only, needs to see the bigger picture.
2. Fraudulent Transfers
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 Fraudulent Conveyance & UFTA §4 – Under this provision (txt below) and §5 a dividend paid either by
an insolvent corp. or under circumstances that leave the corporation with “an unreasonably small capital”
would be fraudulent, and could thus be reclaimed by the creditor on behalf of the corporation.
(a) a transfer made…by a debtor is fraudulent as to a creditor, whether the creditor’s
claim arose before or after the transfer was made…if the debtor made the transfer…
(1) with actual intent to hinder, delay or defraud any creditor of the debtor; or
(2) without receiving a reasonably equivalent value in exchange for the transfer…AND the debtor:
(i) was engaged or about to engage in a business transaction for which the remaining
assets of the debtor were unreasonably small…or
(ii) intended to incur…or reasonably should have believed that he [or she] would incur
debts beyond his [or her] ability to pay as they came due…
a. Fraudulent conveyance law imposes an effective obligation on parties contracting with an insolvent – or
soon to be insolvent – debtor to give fair value for the cash or benefits they receive, or risk being forced to
return those benefits to the debtor’s estate
b. The statute provides a means to void any transfer made for the purpose of delaying, hindering, or
defrauding creditors.
i. Can void transfers by establishing that they were either actual or constructive frauds on creditors
ii. Future creditors who knew or could easily have found out about otherwise vulnerable transfers
cannot void them.
c. Creditors may attack a transfer on two grounds: TEST:
i. Present or future creditors may void transfers made with an “actual intent to hinder, delay or
defraud any creditor of the debtor”
ii. Creditors may void transfers made without receiving a reasonably equivalent value if the debtor
is left with remaining assets unreasonably small in relation to its business or he would incur debts
beyond his ability to pay as they became due or the debtor is insolvent after the transfer
C. Shareholder Liability to Creditors
1. Equitable Subordination – subordination of shareholders debts
a. =Means that the shareholders debt claims against the corporation will not be paid unless and until all
other corporate creditors are paid
i. *The doctrine is rarely invoked outside the bankruptcy context
ii. Effect – loans from the shareholders to the corporation are treated as if they were not loans but
rather invested capital (stock), at least compared to the claims of creditors who are not
shareholders.
1. Usually means that the shareholders’ “loans” to the corporation will not be repaid,
because if the corporation has gone into bankruptcy, typically there will not even be
enough money to pay off the outside creditor’s claims.
2. Dist. piercing corporate veil
a. When corporate veil is pierced, shareholder has to pay the corporation’s
debts.
b. Here, the shareholder’s claims merely get placed behind the claims of
non-shareholder debtors – may lose loans but not liable for corporate debts.
b. Two main requirements for ES:
i. The creditor be an equity holder and typically an officer of the company
ii. The insider-creditor must have, in some fashion, behaved unfairly or wrongly toward the
corporation and its outside creditors
c. Costello v. Fazio (9th Cir. 1958): The trustee in bankruptcy for the bankruptcy estate of Leonard
Plumbing and Heating Supply, Inc., contended that claims against the estate of the company’s creditors,
Ambrose and Fazio, who were also its controlling shareholders, should be subordinated to those of general
unsecured creditors because Ambrose and Fazio had converted the bulk of their capital contributions into
loans and left the company grossly undercapitalized, to the detriment of the company and its creditors.
ii. Rule – Where in connection w/the incorporation of a partnership, and for their own personal
and private benefit, partners who are to become officers, directors and controlling stockholders of
the corporation, convert the bulk of their capital contributions into loans, taking promissory notes,
thereby leaving the partnership and succeeding corporation grossly undercapitalized, to the
detriment of the corporation and its creditors, their claims against the estate of the subsequently
bankrupted corporation should be subordinated to the claims of the general unsecured creditors.
iii. Rationale
1. The corporation was grossly undercapitalized – A&F only left $6,000 in the business,
1/65th of net sales.
2. Clear that the depletion of the capital account in favor of a debt account was for the
purpose of equalizing the capital investments of the partners and to reduce tax liability
when there were profits to distribute
25
 a. F&A acted for their own personal benefit to the detriment of the corporation.
b. Inequitable to permit those shareholder-creditors to share in the assets of the
bankrupt company, in the same parity with general unsecured creditors.
3. Mismanagement and fraud are not required in order for subordination to occur. The
true test is whether the transaction was within the bounds of reason and fairness – A&F’s
actions were not here.
2. Piercing the Corporate Veil
a. Corporation is a legal entity distinct from its shareholders
i. Normally the obligations of the corporation are separate from the shareholders.
ii. Shareholder normally has no liability for corporate debts or other obligations – liability is
limited to loss of her investment.
iii. Under certain circumstances, shareholders can be found liable to corporate creditors – this is
“piercing the corporate veil.”
->But never used against publicly traded co. or on passive shareholders.
-> fairly rarely used in DE corps.
b. Tests for piercing the corporate veil are vague
i. Was the corporate the “alter ego” or instrumentality of its shareholders – two components
1. Evidence of “lack of separateness” e.g. shareholder domination, thin capitalization, no
formalities/co-mingling of assets (“Tinkerbell test” – to be protected, shareholder must
believe in the separation)
2. Unfair or inequitable conduct – this is the wildcard
ii. Lowendahl test (NY): veil-piercing requires
1. Complete shareholder domination of the corporation – failure to treat the corporation
formality seriously: failure to hold meetings, no articles of incorporation, comingling of
funds!
2. Corporate wrongdoing that proximately causes creditor injury.
iii. Another formulation of the test calls on courts to disregard the corporate form whenever
recognition of it would extend the principle of incorporation “beyond its legitimate purposes and
would produce injustices or inequitable consequences”
iv. Cases focus on four factors to determine whether a corporation is so controlled by
another to justify disregarding their separate identities:
1. The commingling of funds or assets
2. Failure to maintain adequate corporate records or comply w/corporate
formalities
3. Undercapitalization
4. Domination and control.
c. Veil Piercing on K Creditors
i. Sea-Land Services, Inc. v. Pepper Source (7th Cir. 1991): When P could not collect a shipping
bill b/c D had been dissolved, P sought to pierce the corporate veil to hold Ds sole shareholder
personally liable.
2. Van Dorn Test – the corporate veil will be pierced where:
a. There is a unity of interest and ownership b/t the corporation and an
individual and
b. Where adherence to the fiction of a separate corporate existence would
sanction fraud or promote injustice.
3. Application
a. There can be no doubt that the unity of interest and ownership part of the test
is met here.
i. Corporate records and formalities have not been maintained,
ii. Funds and assets have been commingled with abandon,
iii. D was undercapitalized, and
iv. Corporate assets have been moved and tapped and borrowed
without regard to their source.
b. Second part of the test is more problematic
i. An unsatisfied judgment, by itself, is not enough to show that
injustice would be promoted – every person trying to pierce the
corporate veil has this.
ii. Promoting injustice means something less than an affirmative
showing of fraud.
iii. Remanded so P could show some form of wrongdoing.

26
 ii. Kinney Shoe Corp. v. Polan (4th Cir. 1991): After a corporation owned by D defaulted on a
building sublease t/P, P sought to hold D personally liable since his corporation was inadequately
formalized and D had not observed any corporate formalities.
2. Rule –Laya test: In a breach of K, the corporate veil will be pierced where a 1)
unity of interest and ownership blends the two personalities of the corporation and
the individual shareholder, and 2) where treating the acts as those of the
corporation alone would produce an inequitable result; 3) (May be applied) Party
assumed the risk.
3. Rationale
a. In this case, it is undisputed that the corporation had no paid-in capital and
that D did not observe any corporate formalities.
b. A third prong of the test may apply where a complaining party may be
deemed to have assumed the risk of the gross undercapitalization where it would
be reasonable for such party to protect itself by making a credit investigation
c. Third prong does not apply here, b/c D failed to follow simple formalities of
maintaining a corporation, he cannot now extricate himself by asserting that
Kinney should have known better.
District Court Circuit Court
Sea Land Pierce – van dorn Don’t pierce –
Service test satisfied remanded for
factual inquiry on
second prong – On
remand it was
Pierced due to D’s
fraud
Kinney Shoe Don’t Pierce – Pierce – third
assumption of prong not
Risk under 3rd applicable here
prong of Laya Test

d. Veil Piercing on Behalf of Tort Creditors

i. Tort creditors of thinly capitalized corporations differ from contract creditors in at least two key
respects.
1. They probably do not rely on the creditworthiness of the corporation in placing
themselves in a position to suffer a loss.
2. They generally cannot negotiate with a corporate tortfeasor ex ante for contractual
protections from risk
ii. Walkowszky v. Carlton (NY Ct. App. 1966): P was run down by a taxi owned by D, sued
stockholder of D who was a stockholder in ten corporations, including the cab company, each of
which had only two cabs registered in its name.
2. Rule – Whenever anyone uses control of the corporation to further his own rather
than the corporation’s business, he will be liable for the corporation’s acts. Cannot
use corporate form to hide from personal liability.
a. Upon the principle of respondeat superior, the liability extends to negligent
acts as well as commercial dealings.
b. However, where a corporation is a fragment of a larger corporate combine
which actually conducts the business, a court will not “pierce the corporate veil”
to hold individual shareholders liable.
3. Rationale – stockholder here was not shown to be conducting business in his own
capacity.
a. Corporate form may not be disregarded simply because the assets of the
corporation, together with liability insurance, are insufficient to assure recovery
b. Not fraudulent for the owner of a single cab corporation to take out no more
than minimum insurance

27
 c. Fraud goes to whether D was “shuttling his funds in and out of the
corporations without regard to formality and to suit his own convenience”
4. Note - Thin capitalization alone is insufficient ground for piercing the corporate veil
ii. Carter-Jones Lumber Co. v. LTV Steel (6th Cir. 2001): Denune, the sole shareholder of
Dixie, a corporation, which had been found to illegally polluted under CERCLA, contended that
his complete control of corporation and its illegal polluting activities was insufficient, as a matter
of law, to trigger veil piercing and impose personal liability on him.
2. Rule – Mere control of a corporation, no matter how complete, is not insufficient,
as a matter of law, to trigger veil piercing.
3. Veil piercing is an equitable doctrine that is not susceptible to satisfaction by a single
list of factors.
a. Otherwise, courts would not be able to act where equity demanded piercing to
avoid injustice.
b. The Federal Court 3 pronged test:
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 as to commit fraud or an illegal act
against the person seeking to disregard the corporate entity
iii. Injury or unjust lost resulted to P from such control or wrong.
c. Even though a corporation could satisfy all the factors in D’s list, it would be
inequitable to shield the corporation’s controlling shareholder where the
shareholding caused the corporation to commit an illegal act, especially if the
shareholder’s degree of control was great and if the harm to third parties was
great.
e. Alternative Remedies
i. Substantive Consolidation (Horizontal veil piercing) – equitable remedy in bankruptcy that
consolidates assets among corporate subsidiaries for the benefit of creditors of the various
corporate subsidiaries
1. The corporate holding company structure is ignored for the purpose of distributing
assets in bankruptcy
2. Because bankruptcy law is federal law, substantive consolidation represents yet
another area where federal law undermines well-established state corporate law doctrine
on veil piercing.
3. If bankruptcy courts regularly collapse entities in an exercise of their equitable powers,
the corporate form will lose its utility as a device for “asset partitioning” and risk
allocation.
4. Substantive consolidation hinders the development of “internal capital markets” that
efficiently allocate capital within firms
ii. Dissolution and Successor Liability
1. Although shareholders can eventually escape all liability through the simple act of
dissolving the corporation and abandoning its assets, it may be more difficult to escape
tort costs by selling the corporation’s assets
2. Doctrine of Successor Corporation Liability
a. The buyer of the liquidating firm’s product line picks up the tort liability of
the seller, at least as the liability relates to the purchased product line
b. Purchasing firm will reduce the offering price by the amount of the expected
liability.
c. Potential liquidator cannot escape liability through sale of the damage-causing
product line and distribution of the proceeds
3. To avoid imposition of successor corporation liability, the purchasing firm must have
no operation identifiable as continuous with the selling firm’s product line.
4. DGCL 278 & 282 – shareholders remain liable pro rata on liquidating dividend for
three years
3. Limited Liability in Tort? - Hansmann & Kraakman, Toward Unlimited Shareholder Liability for Corporate Torts
a. Limited liability in K gives a default term, which does not exist in tort liability.
b. Limited liability in tort can be justified because without it:
i. There would be administrative problems.
ii. Stocks wouldn’t be equivalent prices on the market. (Don’t know if jointly severable how much
other shareholders have)
iii. Research costs would be increased.
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 iv. Managers, not shareholders make decisions.
v. Wouldn’t be able to diversify because of risk aversion.
c. Limited liability in tort cannot be justified because:
i. It creates incentives to mis-invest by externalizing the marginal increase in tort damages caused
by expansion of the firm and creates incentive for excessive investment and gives managers in
publicly traded corporations incentives to assume too much risk.
ii. Too little prevention.
iii. Encourages overinvestment in hazardous activities. (But might give more for the firm to pay!)
iv. Firms are getting very smart about exploiting the limited liability form to shield themselves.
d. Suggested rule is pro rata liability for investors in excess tort damages the firm’s estate fails to satisfy.
i. Timing issue (occurrence or judgment rule? He says claims made rule)
ii. Between two parties, it seems like firms are benefiting at cost of individuals.
VI. Shareholder Voting
A. Role and Limits of Shareholder Voting
1. Shareholders vote on three kinds of matters:
a. Election of directors
b. Organic or fundamental changes – mergers, sales of all assets, corporate dissolutions, charter
amendments.
c. Shareholder resolutions – recommendation desired by a shareholder or group of shareholders, specifying
a change in corporate policy or disclosure. Minimum requirement is $2,000 market value of stock, held for
at least one year.
2. Shareholder Meetings and Alternatives
a. DGCL 211 – Normal meeting.
i. If board fails to call a meeting within 13 months of the last, courts will entertain a shareholder’s
petition and require a meeting be held.
ii. Shareholders may also vote to adopt, amend, and repeal bylaws; to remove directors; and to
adopt shareholder resolutions that may rectify board actions or request the board to take certain
actions
b. Special Meetings – DGCL §211(d) allows board to call a special meeting – harder because no
shareholder option.
i. Some statutes allow the holders of at least 10% of all votes entitled to be cast demand such a
meeting in writing
c. Action by written consent – DGCL §228 provides that any action that may be taken at a meeting of
shareholders may also be taken through written consent of number of shareholders required to approve the
transaction at the meeting.
d. Proxy system – if you can’t attend annual shareholder meeting (ASM) you can still vote by finding a
representative (proxy) who goes to the meeting and votes on your behalf
Shareholders have three basic rights: 1) vote, 2) sell shares, and 3) sue.
• Retail shareholders rights a lot more narrow than institutional shareholders. Primary players (shareholders
who would vote):
o 1) Mutual
o 2) Pension, private, public, union
o 3) Insurance companies- very passive.
o 4) Hedge funds- unregulated.
3. Electing Directors
a. This is the foundational – and mandatory – voting right.
i. Every corporation must have a board of directors, even if the “board” has only a single member
DGCL 141(a)
b. W/o customization in the charter, each share of stock has one vote – DGCL 212
c. Cumulative Voting
i. Each shareholder may cast a total number of votes equal to the number of directors for whom
she is entitled to vote, multiplied by the number of voting shares that she owns.
ii. E.g. Own 10 shares, and there are 5 directors to be elected, get 10 votes for each director for a
total of 50 votes.
iii. Shareholder can then “cumulate” the votes – use all on one person, use some for one person
and some for another, etc.
4. Removing Directors
a. Common Law – Shareholders could remove a director only “for cause”
b. Campbell v. Loew’s Inc. (Del Ch. 1957) – establishes that a director is entitled to certain due process
rights when he or she is removed for cause, although just what these rights include, and who decides when
they are violated remains unclear.
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 i. Fraud or unfair self-dealing is cause to remove a director, but what about abysmal business
judgment
c. DGCL 141(k) – confers broad removal power on shareholders
i. Provides that when the board is classified directors can be removed only “for cause,” unless the
charter provides otherwise
ii. A board cannot adopt a bylaw that purports to authorize it to exercise a removal power over
other directors
d. Unitary v. Staggered Boards
i. Unitary board – all directors are elected annually, shareholders have a clean shot at electing a
full board once a year.
1. Might be able to “pack” the board with new directors, or remove directors without
cause and replace them with new directors
ii. Staggered board – shareholder must win two elections, which can be as long as 13 to 15 months
apart, in order to gain majority control
1. Entrench boards and managers in ways that deter value-increasing hostile takeover
bids.
5. Class Voting
a. Different from classification of the board, which is staggering the board and directors are elected in
different years.
b. Each shareholder class (common shareholders, preferred shareholders, etc.) has to vote as a class. Why
would this make a difference?
i. There are different risk profiles for different classes of shareholders, standing in line in different
places on the corporation’s cash flow. A single project can have different returns for the different
classes.
c. DGCL 242(b)(2) – Class is entitled to a vote on an amendment if:
i. It would increase the number of authorized shares of such class.
ii. Increase or decrease the par value of the shares.
iii. Alter or change the special rights, powers, or preferences of such class adversely.
iv. Note – This is more limited because it is dependent on a change of legal rights.
5. Cumulative voting: (rare)
a. In typical case (w/o cumulative voting) 50+1% wins=> bare majority.
b. W/ cumulative voting, the objective is to give shareholders the ability to have proportional
representation on the board.
i. Ex. 10 board members, 100 shares= 1,000 votes & can divide however you wanted.
ii. Virtually guarantees minority representation in voting.
iii. *Extremely rare for DE corps-> in DE default is 1 share, 1 vote.
B. Proxy Voting
1. Introduction
a. Given the widely dispersed share ownership of most publicly financed corporations, public shareholders
are unlikely to actually attend shareholder meetings
b. As a result, in order to gather a quorum, the board and its officers are permitted to collect voting
authority from shareholders in the form of proxies.
c. General provisions
i. Proxies must record the designation of the proxy holder by the shareholder and authenticate the
grant of the proxy
ii. In most cases, proxy holders may exercise independent judgment on issues arising at the
shareholder meeting for which they have not received specific instruction.
iii. Proxies, like all agency relationships, are revocable unless the holder has contracted for the
proxy as a means to protect a legal interest or property, such as an interest in the shares themselves
j. Registration pursuant to §12 of SEC Act: a proxy solicitation is covered by the SEC
rules if the proxy is solicited concerning stock register under §12 – stock must be registered as per
§12 if: (1) the stock is traded on a national securities exchange; or (2) the company has at least
five million dollars of assets and the class of stock in question is held by at least 500 record
owners. So, the company must file 10-Ks and other regular reports as per the SEC, along with
following the solicitation rules.
k. Proxy information – once a company decides to solicit proxies it must comply with filing
and disclosure requirements. All docs to be sent to stock holders must first be filed with the SEC,
and if they deem it insufficient or inaccurate, the SEC will order revisions. Proxy solicitations
must contain a “proxy statement,” which discloses: (1) conflicts of interest; (2) details of any
compensation plan to be voted on; (3) compensation paid to the five most highly paid
officers; and (4) details of any major corporate change being voted on. If the solicitation is

30
 by management and related to an annual meeting to select directors, then an annual report
must be included. There is also the anti-fraud rule (SEC Rule 14a-9(a)) and if there is any
fraud in the proxy statement then a shareholder has the implied right to bring a private
action.
l. Proxy Transactions - §14 of SEC Act:
i. Solicitation by Management – if the solicitation is by management, the solicitation of
even one person falls within the SEC rules.
ii. Solicitation by Non-Management – but if the solicitation is by non-management (e.g, it
is by an insurgent faction trying to get its own slate of directors elected to the board), the
solicitation is not covered so long as the number of persons solicited is ten or fewer.
1. Solicitation of 11 or more – But if non-management solicits eleven or more people, the
solicitation falls within the SEC rules even if none of the people solicited actually grants a proxy
to the solicitor.
Solicitation = (a) on oral request for a proxy, even if no proxy card is sent to the person being
solicited; (b) a request (written or oral) not to execute, or to revoke, a proxy solicited by someone
else; and (c) an advertisement (furnishing of a form of proxy or other communication to security
holders under circumstances reasonably calculated to result in the procurement, withholding, or
revocation of a proxy – a newspaper ad urging to give or deny a proxy would be included).
Proxy Contest Costs:
2. Management expenses – corporation may pay for the “bare bones” compliance by
management with federal proxy rules. Thus, costs of drafting and printing proxy cards and of
mailing them to shareholders.
- So long as the contest involves a conflict over “policy” and is not merely a “personal power
contest” the corporation may pay for management’s reasonable expenses. (advertising , retention
of proxy-specialist firms, telephone and private meetings with large holders around the country,
etc.).
3. Expenses of successful Insurgents – if they succeed and control the majority of the board
of directors, they will then likely approve reimbursement of the insurgent’s proxy costs.
- Reimbursement to successful insurgents is allowed if: (1) the contest involved “policy” and not
wasn’t a power struggle; and (2) the stockholders approve reimbursement (Rosenfield). (Former
management before leaving will also likely have themselves paid back.)
4. Unsuccessful Insurgents – They have virtually no chance of having the corporation
reimburse.
2. Proxy Solicitation Expenses – Rosenfeld v. Fairchild Engine & Airplane Corp. (N.Y. Ct. App. 1955): P
brought a derivative suit to have the $261,522 that had been paid to both sides of a proxy contest returned to the
corporation.
b. Rule – Directors may make reasonable and proper expenditures from the corporate treasury to
persuade stockholders of the correctness of the directors’ policy positions and to solicit shareholder
support for policies that the directors believe, in good faith, are in the corporations’ best interest.
c. Rationale –
i. If not, incumbent directors would be unable to defend their positions and corporate policies. As
such, the old board was reimbursed for reasonable and proper expenditures in defending their
positions.
ii. Stockholders also have the right to reimburse successful contestants for their reasonable
expenses. As such, the new board was also reimbursed for its expenditures by the stockholders.
d. Dissent – personal expenses were wrongly included in the reimbursements.
3. Federal Proxy Rules
a. Four major elements
i. Disclosure requirements and a mandatory vetting regime that permit the SEC to assure the
disclosure of relevant information and to protect shareholders from misleading communications
ii. Substantive regulation of the process of soliciting proxies from shareholders
iii. A specialized “town meeting” provision (Rule 14a-8) that permits shareholders to gain access
to the corporation’s proxy materials and to thus gain a low-cost way to promote certain kinds of
shareholder resolutions; and
iv. A general antifraud provision (Rule 14a-9) that allows courts to imply a private shareholder
remedy for false or misleading proxy materials
b. Specific Provisions:
i. Generally
1. Securities Exchange Act of 1934 establishes (among other things) disclosure requirements for
corporations after they have gone public.
2. All public companies are subject to proxy regulation under §14(a)
3. Schedule 14A what you need to disclose in a “full dress” registration statement.
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 4. Bad Old Days (Pre-1992) if a dozen shareholders want to talk to one another about the company
they must file a proxy statement with the SEC, forcing stockholders to act in public, costly,
potentially embarrassing ways. Publicity instills silence.
ii. Disclosure & Shareholder Communication – Rules 14-a-1 – 14-a-7
1. Rule 14a-1 – A proxy can be any solicitation or consent whatsoever; solicitation is any
communication reasonably calculated to result in the procurement of a proxy
2. Rule 14a-2(b)(1) – solicitation that does not seek directly or indirectly to act as a proxy is
exempt from filing requirements
3. Rule 14a(2)(b)(2) – non-management solicitation to 10 or fewer shareholders is exempt
4. Rule 14a-3 – No one may be solicited for a proxy unless they are, or have been, furnished with
a proxy statement containing certain information in Schedule 14A
5. Rules 14a-4 and 14a-5 – Regulate the form of the proxy and the proxy statement, form of the
vote (see short slate problem)
6. Rules 14a-6, 14a-12 – Formal filing requirements for proxy and solicitation materials (sent to
SEC before shareholders)
7. Rule 14a-6(g) – even if exempt, if shareholder owns more than $5 million worth of stock, must
file communication and Notice of Exempt Solicitation after sending out
8. Rule 14a-7 – sets forth the list-or-mail rule under which, upon request by a dissident, a
company must either provide a shareholders list or undertake to mail the dissident’s proxy
statement and solicitation materials to record holders
iii. Town Meeting Rule (Shareholder Resolutions) – Rule 14(a)(8)
1. Requirements –
a. Shareholder must hold $2,000 or 1% of the corporation’s stock for a year ((b)(1));
b. Must file with management 120 days before management plans to release its proxy
statement ((e)(2));
c. Proposal may not exceed 500 words (d); and
d. Proposal must not run afoul of subject matter restrictions.
2. Grounds for excluding proposals from the company’s solicitation materials (14a-8(i)) – burden
on company to demonstrate grounds for exclusion.
a. Not a proper subject for shareholder action
b. One that would require the registrant to violate any law
c. False or misleading
d. Related to redress of a personal claim not shared w/shareholders in general.
e. Related to operations that involve less than 5% of assets, earnings and sales and is
otherwise not significantly related to the corporation’s business.
f. Related to issues over which the registrant has no power to control.
g. Related to conduct of the registrants ordinary business operations not involving
important political or social issues
h. Related to election to the registrant’s board
i. Counter to a proposal to be submitted by the registrant
j. Moot b/c the corporation has already substantially implemented the proposal
k. Substantially duplicative of an earlier proposal
l. Related to the amount of a dividend
m. Substantially the same as a proposal previously rejected by shareholders at a previous
meeting.
iv. The Anti-fraud Rule - Rule 14a-9
1. Materiality – a misrepresentation or omission in a proxy solicitation can trigger
liability only if it is material – there is substantial likelihood that a reasonable shareholder
would consider it important in deciding how to vote
2. Culpability – the SC has not yet determined a standard of culpability
3. Causation and reliance – a plaintiff need not prove actual reliance on a
misrepresentation to complete a Rule 14a-9 cause of action
a. Showing of materiality normally satisfies the causation requirement.
b. Exception – Virginia Bankshares, Inc. v. Sandberg (1991) – if management
or parent owns or controls a majority of the stock, so that it can cause
shareholder approval of the relevant transaction w/o any votes from the
minority, false or misleading statements in a proxy statement will not normally
give rise to liability in a private action by minority shareholders b/c the
transaction would have been approved even w/o their votes.
4. Remedies – the Mills Court contemplated that courts might award injunctive relief,
rescission or monetary damages
4. State Disclosure Law: Fiduciary Duty of Candor
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 a. State law has done little to regulate proxy solicitation by management
i. Traditionally, state law did not go beyond the duty of loyalty (the obligation not to lie to one to
whom the duty extends)
ii. Today – Substantive regulation has disappeared, and the courts have inserted themselves ex-
post to judge the fiduciary duties.
b. Malone v. Brincat (Del. 1998): Involved a long-term fraud in which the directors made (or permitted
the corporation to make) false filings with the SEC and distributed false financial statements to
shareholders.
ii. In affirming its dismissal, whenever directors communicate publicly or directly with
shareholders about the corporation’s affairs with or without request for shareholder actions
directors have a fiduciary duty to exercise case, good faith and loyalty…the sine qua non of
director’s fiduciary duty is honesty.
iii. Any cause of action under Malone requires shareholders to hold onto their shares to limit
federalism conflict because then they are not protected under SEC Rule 10b-5
C. Shareholder Information Rights
1. Shareholders must be informed in order to vote intelligently
a. State law mandates neither an annual report not any other financial statement.
b. By contrast, federal securities law and the rules promulgated by the SEC mandate extensive disclosure
for publicly traded securities
c. Shareholders were recognized to have a right to inspect the company’s books and records for proper
purpose
2. Delaware courts recognize two fundamentally different types of requests
a. The Stock List – discloses the identity, ownership interest, and address of each registered owner of
company stock
i. Proper Purpose for acquiring the stock list is broadly construed, and once it is shown, the court
will not consider whether the shareholder has additional, “improper” purposes
ii. Burden is on the corporation to produce related identifying information – need to keep the list
updated and produce a second list of stock brokerage firms whose stock is registered in the name
of the Depository Trust Co. and to furnish daily trading information
b. Inspection of Books and Records
i. Here a plaintiff may allege the need for very broad access to the company’s records in order to
uncover suspected wrongdoing.
ii. Such a request, however, places the legitimate interests of the corporation at risk – may
jeopardize proprietary or competitively sensitive information
iii. Under Delaware law, this is reflected formally by requiring plaintiffs to carry the burden of
showing a proper purpose and, informally, by carefully screening plaintiff’s motives and the likely
consequences of granting her request.
3. General Time Corp. v. Talley Industries (Del Ch. 1968): General Time refused to provide a list of its
stockholders to Talley, a GT stockholder, contending that Talley had an improper secondary purpose for obtaining
the list.
b. Rule – Where a shareholders desires a list of a corporation’s stockholders to solicit proxies for a
slate of directors opposed to current management, that purposes is proper and sufficient to require
the corporation to provide the list, regardless of the shareholders’ possible secondary motives for
obtaining the list. DGCL §220
c. Rationale
i. It is undisputed that, as a matter of law, the desire to solicit proxies for a slate of directors in
opposition to management is a purpose reasonably related to the stockholder’s interest as a
stockholder, and that therefore, such a purpose is proper when making an inspection request.
ii. Thus, when a stockholder’s status qua stockholder is established, and the stockholder seeks
production of a stockholders’ list for a purpose that is germane to that status, he is entitled to its
production
d. Note – proper purpose is decided on a case by case
D. Circular Control Structures Problem
1. DGCL §160(c) – shares of its own capital stock belonging to the corporation or to another corporation (parent or
otherwise related), if a majority of the shares entitled to vote in the election of directors of such other corporation is
held, directly or indirectly, by the corporation, shall neither be entitled to vote nor be counted for quorum purposes.
a. Prohibits management from voting stock owned by the corporation
b. Rationale - managers are selected by the corporate constituency (investors) w/the strongest interest in
maximizing corporate value
2. Speiser v. Baker (Del. Ch. 1987): P, a 50% owner of common shares of Health Med Corp. and one of its two
directors, contended that the corporation was required to hold an annual stockholders meeting to elect directors. D,
the other 50% owner of Health Med’s common shares and its other director, counterclaimed that Health Med could
33
 not vote its 42% interest in Health Chem, a publicly traded company, at such a stockholders meeting b/c to do so
would contravene a statutory prohibition on the voting of shares “belonging to” a corporation – despite the fact that
Chem. did not hold, even indirectly, a majority of the stock “entitled to vote” in Health Med’s election of directors.
b. Issue #1 - Where a corporation has failed to hold an annual stockholders meeting for the election of
directors, in contravention of statutory law, must such a meeting be held even if it means that one of two
directors will be removed – yes.
i. D’s affirmative defenses allege no wrong to Health Med or its shareholders that will occur by
reason of the holding of Health Med’s annual meeting.
ii. The essence of his defense is that he will likely be voted out of office as a Health Med director
and the company will fall under P’s complete domination – legally, there would be nothing wrong
with that result.
c. Issue #2 - Where a statute prohibits the voting by a corporation of stock “belonging to the corporation,”
may stock held by a corporate subsidiary “belong to” the issuer and thus be prohibited from voting, even if
the issuer does not hold a majority of shares entitled to vote at the election of directors of the subsidiary –
Yes.
i. Counterclaim cites DGCL 160(c) - literal reading of this language does not prohibit the voting
of Health Med’s stock in Chem since Chem through its subsidiary does not hold, even indirectly, a
majority of the stock “entitled to vote” in Health Med’s election of directors
ii. Specifically, the phrase “belonging to the corporation,” when interpreted in light of the statute’s
history and underlying policy, can reach the facts of this case.
iii. The statute is applicable here, where the capital of one corporation has been invested in another
corporation and the investment, in turn, is used solely to control votes of the first corporation. The
only effect of this structure is to muffle the voice of the public shareholders of Chem in the
governance of Chem
E. Vote Buying
1. General rule – shareholder cannot normally sell her vote unless she is selling the stock that goes along with it.
a. Rationale – vote buying violated public policy as a breach of the duty shareholders owed to each
other. This principle maintained that each shareholder voting his own interests was essential to
preserving the interest of the stockholders collectively.
b. In today’s corporate environment this concept has been largely abandoned.
2. Schreiber v. Carney (Del Ch. 1982): Jet Capital, a shareholder of Texas International Airlines, agreed to
withdraw opposition to a merge if it received a loan from Texas International.
Court held that corporate vote-buying is permissible if it does not work to the prejudice of the
shareholders. Shareholder approval precludes voiding this transaction. Vote-Buying is illegal if its
purpose is to defraud or disenfranchise other stockholders. It is also illegal on Public Policy grounds,
because each stockholder should be able to rely on the independent judgment of his fellow
stockholders –like fraud, but as viewed from a sense of duty owed by all stockholders to one another.
c. Rationale
i. No per se prohibition on vote buying in established opinions, though it appears to be uniformly
rejected b/c occurred to the detriment of the non-participating shareholders.
ii. Today, the law is much more lenient towards these types of transactions;
iii. Holding – vote-buying is not void, but rather voidable only. In this instance, shareholder
approval precludes voiding the transaction.
F. Controlling Minority Structures
1. Dual class equity structures – A. single firm that issues two or more classes of stock with differential voting
rights (high vote and low vote stock).
a. This is most popular in the US, other two not used as much.
2. Corporate Pyramid Structure – A controlling minority shareholder holds a controlling stake in a holding
company that, in turn, holds a controlling stake in an operating company.
3. Cross-ownership structures – Linked by horizontal cross-holdings of share that reinforce and entrench the
power of central controllers, voting rights distributed over the entire group.
Oceanic Exploration Co. (p.197)
• Voting trusts= voting trusts are ok. Here, the stockholder gave up his right to vote on all corporate matters
over a period of years in return for “valuable benefits including indemnity for large liabilities.”

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 iv. CA v. AFSCME – SEC certifies questions to the Delaware Supreme Court b/c they’re not certain – not qualified in
Delaware law. AFSCME proposed for inclusion on CA’s proxy statement a bylaw that would require the CA board
of directors to reimburse the reasonable fees of any stockholder that sought to elect less than 50% of the board (i.e. a
short slate) and succeeded in electing at least one director. SEC certified whether this was a proper subject for action
by stockholders and whether, if enacted, it would violate any DE law to which it is subject.
1. The Court held that the bylaw was a proper subject for stockholder action. Answering the second in
the negative, the Court held that if adopted the bylaw would violate state law. The net result is that
the bylaw can be excluded from CA’s proxy statement under SEC Rule 14a-8(i)(2).
2. DGCL §141(a): The business and affairs of every corporation organized under this chapter shall be
managed by or under the direction of a board of directors, except as may be otherwise provided in this
chapter or in its certificate of incorporation.

VII. Fiduciary Standards

A. Introduction – Fiduciary standards play a role in normal governance of a corporation
1. Duty of obedience – fiduciary must act consistently with the legal documents that create her authority.
2. Duty of care – reaches every aspect of an officer or directors conduct:
a. Requires these parties to act with “the care of an ordinarily prudent person in the same or similar
circumstances”
b. Law insulates from liability based on negligence – do this to avoid risk adverse management
3. Duty of loyalty – requires that corporate fiduciaries exercise their authority in a good faith attempt to advance
corporate purposes.
a. Cannot compete w/the corporation, appropriate its property, information or business opportunities and
transacting under unfair terms
B. Normal Governance – Duty of Care
1. General Standards
a. ALI §4.01(a) – A director or officer has a duty to the corporation to perform the director’s or officer’s
functions:
i. In good faith
ii. In a manner that he or she reasonably believes to be in the best interests of the corporation
and
ii. With the care than an ordinarily prudent person would reasonably be expected to exercise in
a like position and under similar circumstance
b. Gagliardi v. Trifoods International (Del. Ch. 1996): Shareholders of Trifoods International, Inc.
brought a derivative action against TriFoods Directors for recovery of losses allegedly sustained by reason
of mismanagement unaffected by directly conflicting interests, the Ds moved to dismiss.
ii. Issue – what did shareholders have to plead to sustain their action?
iii. Rule – to sustain a derivative action for the recovery of corporate losses resulting from
mismanagement unaffected by directly conflicting financial interests, as shareholder must
plead that a director/officer did not act in food faith and/or failed to act as an ordinarily
prudent person would under the circumstances.
c. Not another negligence rule – more adverse to holding directors liable – why?
i. Bear the full costs but receive only a small fraction of the gains
ii. Would discourage officers from undertaking valuable but risky projects
d. Why we have statutory safeguards (indemnification) and judicial safeguards (business judgment rule)
2. Statutory Protections
a. Indemnification –
i. Statutes authorize corporations to commit to reimburse any agent, employee, officer or director
for reasonable expenses for losses of any sort arising from any actual or threatened judicial
proceeding or investigation.
1. DGCL §145(a) - may indemnify for D&O actions in good faith
2. DGCL §145(f) – may indemnify for actions beyond those provided by statute but still
in good faith
3. DGCL §145(c) – success in a legal action requires indemnification for legal expenses,
even if not in good faith.
ii. Limits – losses must result from:
1. Actions undertaken on behalf of the corporation
2. In good faith
3. And cannot arise from a criminal conviction
iii. Waltuch v. Conticommodity Services, Inc. (2nd Cir. 1996): D refused to indemnify P for
legal fees resulting from litigation that arose out of his former employment w/D, P brought suit for
indemnification.

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 2. Issue #1 – Does a provision of a corporation’s articles of incorporation that provides
for indemnification w/o including a good faith limitation violate DGCL 145 – yes.
a. DGCL145(a) limits a corporation’s indemnification powers to situations
where the officer or director to be indemnified acted in good faith
b. DGCL 145(f) does not free the corporation from this good faith requirement.
3. Issue #2 –If the director is successful in his lawsuit should he be indemnified against
expenses (including attorneys’ fees) actually and reasonably incurred by him in
connection therewith – Yes
a. Escape from an adverse judgment or other detriment, for whatever reason, is
determinative.
b. Once P achieved his settlement gratis, he achieve success “on the merits or
otherwise”
c. Accordingly, D must indemnify P under DGCL 145(c) for the $1.2 million in
legal fees he spent defending the private lawsuits
b. Directors’ & Officers’ Insurance
i. DGCL §145(g) - corporation may buy insurance whether or not the corporation would have the
power to indemnify such person against such liability
ii. Why general corp. insurance instead of raising salaries & board fees and letting the directors
buy their own accounts?
1. D&O insurance may be cheaper if the company acts as a central bargaining agent for
all its officers & directors
2. Uniformity may have value in that it standardizes directors’ individual risk profiles in
decision-making, and avoid potentially negative signaling that would arise from directors
having different levels of coverage.
3. Tax law may favor firm wide insurance coverage
4. Corporate purchase of D&O helps disguise the total amount of management
compensation.
3. Framework for Director and Officer Liability
a. Business judgment Rule – presumes that the duty of care standard has been met
b. Waiver of Liability (DGCL §102(b)(7)) – 90% of DE companies eliminate D&O liability for
duty of care violations (“Self insurance” for gross negligence)
c. Indemnification – may indemnify for D&O actions in good faith (DGCL §145(a)) and for those
beyond those provided by statute but still in good faith (§145(g)).
d. D&O insurance – corporation may buy D&O insurance “whether or not the corporation would
have the power to indemnify such person against such liability” (DGCL §145(g)).
e. Reimbursement of Legal Expenses – even if not in good faith, success in a legal action requires
indemnification for legal expenses (DGCL §145(c)).
3. The Business Judgment Rule- (ONLY applies to duty of care)
a. ALI §4.01(c) – A director or officer who makes a business judgment in good faith fulfills the duty under
this section if he:
i. Disinterested - Is not interested in the subject of the business judgment
ii. Is informed with respect to the subject of the business judgment to the extent that the director or
officer reasonably believes is appropriate under the circumstances AND
iii. Rationally believes that the business judgment is in the best interests of the corporation
b. Chancellor Allen: “The business judgment rule in effect provides that where a director is independent
and disinterested, there can be no liability for corporate loss, unless the facts are such that no person could
possibly authorize such a transaction if he or she were attempting in good faith to meet their duty
c. Business Judgment Rule may be rebutted by showing:
i. Fraud.
ii. Conflict of interest – lack of objectivity or independence.
iii. Illegality of action.
iv. Waste – lack of rational business purpose.
v. Gross negligence.
vi. Inattention to mismanagement, management abuse, or monitoring illegality. vii. Lack of
information.
viii. Receipt of improper benefit.
d. Rationale for the BJR
i. Judges should not second guess good-faith decisions made by independent and disinterested
directors.

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 ii. Procedural reason – when courts invoke the business judgment rule, they are converting what
would otherwise be a question of fact into a question of law for the court to decide – Insulates
disinterested directors from jury trials
iii. Substantive reason - Converts the question “was the standard of care breached” into related but
different questions of whether the directors were truly disinterested and independent and whether
their actions were in good faith.
e. Kamin v. American Express Co. (NY 1976): P brought a shareholders’ derivative suit claiming D had
engaged in waste of corporate assets by declaring a certain dividend in kind.
ii. Issue – should the courts interfere w/a board of directors’ good faith business judgment as to
whether or not to declare a dividend to make a distribution – No.
iii. Rationale –
1. Whether or not to declare a dividend or make a distribution is exclusively a
matter of business judgment for the board of directors, and courts will not interfere
w/their decision if made in good faith.
2. It is not enough to charge, as P has, that the directors made an imprudent
decision or that some other course of action would have been more advantageous –
insufficient and cause of action must be dismissed.
f. Miller v. AT&T (3rd Cir. 1974): Shareholders of AT&T brought suit when the corporate directors
forgave a $1.5 million debt owed it by the Democratic National Convention
ii. Rule – The business judgment rule will not insulate directors from liability where it is
alleged they have committed illegal or immoral acts.
iii. Rationale
1. Business judgment rule only applies where there was good faith.
2. Business judgment has no place in the decision to commit illegal acts.
3. Here Ds were charged w/violating campaign contributions laws – prima facie case has
been stated by the complaint.
4. Delaware’s approach to Duty of Care
a. Smith v. Van Gorkom (Del. 1985): Shareholder of a company sued alleging that the board of directors
did not act in an informed manner when agreeing to a merger deal and thus breached their duty of care
ii. Holding – the directors were grossly negligence in their decision making and could not
claim the protections of the business judgment rule; announces gross negligence standard-
BJR does not apply in violation of duty of care.
iii. Unique b/c it holds financially disinterested directors personally liable for the consequence of
their business decision – First Delaware case to do so
iv. Note – may be better seen as a takeover case than a duty of care case.
b. DGCL 102(b)(7) – reaction to Van Gorkom
i. Validated charter amendments that provide that a corporate director has no liability for losses
caused by transactions in which the director had no conflicting financial interest or otherwise was
alleged to violate a duty of loyalty
ii. Only waives damage claims, can still be the basis for an equitable order (such as an injunction)
c. Cede & Co. v. Technicolor (Del. 1993): Takeover entrepreneur acquired Technicolor in a transaction
characterized by arguable breaches of the duty of care by Technicolor’s board of directors.
ii. The Delaware Chancery Court held that Technicolor’s shareholders failed to prove any injury
b/c they had apparently received full value for their stock.
iii. Delaware SupCt reversed –
1. Breach of the duty of care, w/o any requirement of proof of injury, is sufficient to
rebut the business judgment rule.
2. A breach of either the duty of loyalty or the duty of care rebuts the presumption
that the directors have acted in the best interests of the shareholders, and requires
the directors to prove that the transaction was entirely fair.
d. Application at pleadings stage
i. Malpiede v. Townson (Del. 2001) – a complaint must allege a breach of the duty of loyalty in
order to survive a motion to dismiss
ii. McMillan v. Inter Cargo Corp. (Del Ch. 2000): Ps alleged that the target’s CEO agreed to a
low acquisition price so that he could keep his job following the merger
2. Chancery court dismissed the complaint b/c such generic allegations are too easy to
make
3. Unless particularized facts supporting duty of loyalty claims are alleged, the principal
purpose of 102(b)(7) would be denied by allowing such claims to proceed to trial.
e. Emerald Partners v. Berlin (Del. 2001): Arose from a “roll up” transaction – a corporation w/a
controlling shareholder entered into transactions in which it acquired through merger 13 corporations

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 owned or dominated by this controlling shareholder. Minority shareholder in the corporation sued the
corporation’s directors
ii. Eventually only Ds left were the “disinterested” directors, trial court dismissed
iii. Delaware SupCt reversed
1. Holding – the correct standard of review for a transaction in which a controlling
shareholder is interested is objective fairness (aka “entire fairness”)
2. Ds had the burden to prove entire fairness, so it was a mistake for the court to render
judgment in their factor w/o addressing this issue.
iv. Once the Ps have overcome the presumptions of the business judgment rule, DGCL
102(b)(7) offers less protection to defendant directors.
-> If P allegation of gross negligence so that BJR cannot apply, and place burden of proving
entire fairness to Ds (shifts), required to show: 1) fair process and a requirement to prove 2)
fair price.
4. Duty to Monitor
a. Business judgment rule protects boards that have made decisions – now looking at when directors simply
fail to do anything.
i. Director’s incentives are far less likely to be distorted by liability imposed for passive violations.
ii. Actual liability is more likely to arise from a failure to supervise or detect fraud than from an
erroneous business decision.
iii. Issues arise when loss would financially destroy directors and make board service unappealing
to others.
b. Francis v. United Jersey Bank (N.J. 1981): D ignored her duties as a director allowing her sons to
withdraw over $12 million from client trust accounts. Trustees sue for negligence.
ii. Rule - Individual liability for a corporation’s directors to its clients requires a
demonstration that:
1. A duty existed
2. The directors breached that duty
3. The breach was a proximate cause of the client’s losses
iii. Rationale – this is a departure from the business judgment rule
1. The director of a corporation stands in a fiduciary relationship to both the corporation
and its stockholders.
2. Inherent in this role is a duty to acquire a basis understanding of the corporation’s
business and a continuing duty to keep informed of its activities.
3. This entails an overall monitoring of the corporation’s affairs, and a regular review of
its financial statements which may present a duty of further inquiry
iv. Note – directors do not ordinarily owe a duty of care to third parties unless the corporation is
insolvent.
c. Graham v. Allis-Chalmers Manufacturing Co. (Del. 1963): Shareholders of D contended in a
derivative action that the corporation’s directors were liable as a matter of law for failing to take action to
learn of and prevent antitrust activity of non-director employees. => Does not imply BJR!
ii. Rule – A corporate director who has no knowledge of suspicion of wrongdoing by
employees is not liable for such wrongdoing as a matter of law.
iii. Rationale
1. Board may rely on the honesty and trustworthiness of its employees until something
puts the board on suspicion that something is wrong
2. “Absent cause for suspicion there is no duty upon the directors to install and operate a
corporate system of espionage to ferret out wrongdoing which they have no reason to
suspect exists.”
3. Here, it was impossible for the board to know every employee, once board found out
about the improper actions it took sufficient action.
d. Beam v. Martha Stewart (Del. Ch. Ct 2003): P claimed that Martha Stewart’s directors and officers
breached their fiduciary duty by not monitoring her affairs to ensure that they would not harm the
company.
ii. Rule – Directors and officers of a corporation do not have a fiduciary duty to monitor the
personal, financial, and legal affairs of other directors and officers to ensure that their
conduct does not harm the company.
iii. Rationale
1. Only have duty to monitor when have reason to suspect wrongdoing.
2. Nothing preceding her stock scandal that would have given the board reason to suspect
wrongdoing.

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 3. The duty to monitor arises when there is suspicion of wrongdoing by the
corporation, and, regardless of how closely Stewart is identified with MSO, she is not
MSO.
4. Unreasonable to impose such a duty because monitoring a director’s personal affairs is
neither legitimate nor feasible, and could engender liability for the corporation – Martha
could sue corp. in tort.
e. In the Matter of Michael Marchese (SEC Enforcement Action, 2003): The SEC contended that D, an
outside director of Chancellor who served on Chancellor’s audit committee violated, and caused Chancellor
to violate, various provisions of the Exchange Act and Rules thereunder b/c he failed to adequately monitor
the company’s financial statements.
ii. Rule – an outside director a corporation who serves on its audit committee violates and
causes his corporation to violate, the Exchange Act and Rules thereunder by recklessly
failing to inquire into the corporation’s financials when he has knowledge of facts to put him
on notice that such inquiry is warranted.
iii. Rationale – D recklessly failed to investigate into matters that he knew could be potential
issues and certified the SEC filings anyway.
iv. Note – directors need to be concerned with their duty to monitor and duty of care not only
because of the potential of shareholder derivative actions brought under state law, but also because
of the potential of SEC enforcement actions
f. In re Caremark International Inc. Derivative Litigation (Del Ch. 1996): Caremark, a managed health-
care provider, entered into K arrangements w/physicians and hospitals, often for consultation or research
w/o first clarifying the unsettled law surrounding prohibitions against referral fee payments.
ii. Rule – board of directors has an affirmative duty to attempt in good faith to assure that a
corporate information and reporting system exists and is adequate.
iii. Rationale
1. Directors do not have to monitor the day to day operations of the company, but they do
need to determine whether they are receiving accurate information.
2. Directors need to make a good faith effort to monitor compliance, be aware of major
activities and related issues that could pose a threat to the company
4. Duty of Care After Caremark -> need to show one of the following:
a. Director failed to acquaint themselves with the basics of the business and should have known of a
red flag (Francis, Van Gorkham);
b. Director had notice of a red flag and failed to investigate (Allis Chalmers);
c. Director failed to monitor/institute compliance program regarding important aspects of the firm’s
activity (e.g., compliance with laws that the company is at high risk of violating). Chancellor
Allen says that the duty of oversight includes an affirmative director duty to “assure that
appropriate information and reporting systems are in place.” (Caremark)

C. Conflict Transactions – Duty of Loyalty

1. Introduction
a. Duty of loyalty – requires a corporate director, officer, or controlling shareholder to exercise her
institutional power over corporate processes or property (including information) in a good faith effort to
advance the interests of the company
i. Officers, directors and controlling shareholders may not deal w/the corporation in any way that
benefits themselves at its expense
b. Specific corporate actions over which it may be sensible to limit board discretion:
i. Self-dealing transactions b/t the company and its directors
ii. Appropriations of “corporate opportunities”
iii. Compensation of officers & directors
iv. Relations b/t controlling shareholders and minority shareholders
c. Duty to Whom?
i. Shareholder Primacy Norm - director loyalty is ultimately loyalty to equity investors b/c
shareholders elect the board.
1. Dodge v. Ford Motor Co. (Mich. 1919): Henry Ford rejected shareholder dividends, said he
had an obligation to share his success w/the consumer by lowering prices. Dodge sued claiming
the directors wrongfully subordinated shareholders interests to those of the consumer.
b. Court agreed – affirmed the primacy of the shareholders interests
2. Note – this is one of the few decisions to enforce shareholder primacy as a rule of law.
a. Today the decision would probably be justified on grounds that it would increase long
term corporate dividends

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 b. Situation would only arise if company announced that it was acting in interests of non-
shareholders over shareholders like here
ii. Alternative model – directors must act to advance the interests of all constituencies in the
corporation, not just the shareholders
1. Rationale – State bestows the status of legal entity, including limited liability on the
corporation in order to advance the public interest by enabling the board to protect all
corporate constituencies, not just shareholders
2. A.P. Smith Manufacturing Co. v. Barlow (N.J. 1953): Barlow and other
shareholders of AP challenged its authority to make a donation to Princeton University.
b. Rule – state legislation adopted in the public interest can be
constitutionally applied to preexisting corporations under the reserved
power.
c. Rationale
i. Fifty years before the incorporation of P, the NJ legislature provided
that every corporate charter thereafter granted would be subject to
alteration and modification at the discretion of the legislature
ii. Statute expressly authorizing reasonable charitable contributions is
applicable to P and must be upheld as a lawful exercise of Ps implied
and incidental powers under common law principles
2. Self-Dealing Transactions
a. Black Letter Law – Crunchtime
i. Definition – Self Dealing transaction is one in which 3 conditions are met:
1. Key player and the corporation are on opposite sides of a transaction
2. The Key Player has helped influence the corporation’s decision to enter the
transaction AND
3. the Key Player’s personal financial interests are at least potentially in conflict
w/the financial interests of the corporation.
ii. Modern Rule – courts will frequently intervene in a self-dealing transaction
1. Fairness – if the transaction if found to be fair to the corporation, the court will uphold
it, regardless of whether it was approved by disinterested directors/shareholders.
2. Waste/fraud – if the transaction is unfair that it amounts to “waste” or fraud” against
the corporation, the court will usually void it at the request of a shareholder, even if it
was approved by disinterested directors/shareholders
a. Def. of waste is very restrictive
b. DE – transaction will not be invalidated as constituting waste unless it is an
exchange that is so one sided that no business person of ordinary, sound
judgment could conclude that the corporation has received adequate
consideration.
3. Middle ground – if transaction is not clearly fair or waste, then the presence/absence of
approval by disinterested directors/shareholders will be the deciding factors.
a. If transaction was approved, court prob. will too
b. If not, court prob. will invalidate the transaction.
iii. How to avoid invalidation:
1. Disclosure + Board approval
a. Disclosure: two kinds of info:
1. the material facts about the conflict
2. the material facts about the transaction
ii. When disclosure must be made – courts split
1. Some courts say must be disclosed before
2. Some courts allow ratification after the fact.
b. Board approval – by a majority of the disinterested directors.
i. Director is interested if either:
1. he or an immediate member of his family has a financial
interest in the transaction.
2. He or a family member has a relationship w/the other party
to the transaction that would reasonably be expected to affect
his judgment about the transaction.
3. Also can be interested if an indirect party to the transaction
– i.e. he owns an equity position in the other transaction.
ii. Quorum – majority of the disinterested directors, not a majority of
the total directors.

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 iii. Approval doesn’t necessarily immunize the transaction from attack,
esp. if it is very unfair – but shifts the burden of proof to the person
attacking the transaction.
2. Disclosure + Shareholder Approval
a. Self-dealing transaction will be validated if it is fully disclosed to the
shareholders and then ratified by a majority of them.
b. Disinterest shareholders – courts split about whether the ratification must be
by a majority of disinterested shareholders or merely by a majority of all
shareholders (which could potentially include the Key Player)
3. Fairness – transaction can be validated by showing that it is fair to the corporation.
a. This is dispositive – will suffice even if the transaction was never disclosed.
b. Determined by the facts as they were known at the time of the transaction.

b. State Ex. Rel Hayes Oyster Co v. Keypoint Oyster Co. (Wash. 1964): Coast Oyster Co claimed that
Hayes, its CEO director and shareholder, breached his fiduciary duty to the corporation by failing to
disclose a secret profit and advantage he would fain from the approval of Coast’s sale of oyster beds to
Keypoint Oyster Co. Coast sought disgorgement of such secret profit from Hayes or his company.
ii. Rule – A corporation’s director or officer breaches his fiduciary duty to the corporation
by failing to disclose the potential profit or advantage that would accrue to him if a
transaction involving the corporation were approved.
iii. Rationale
1. Although not every transaction involving corporate property in which a director has an
interest is voidable at the option of the corporation, since such a K cannot be voided if the
director/officer can show that the transaction was fair to the corporation, nondisclosure
by an interested director/officer is per se unfair
2. Hayes needed to disclose at the point where he was voting on the transaction so that
the Coast shareholders and directors could make an informed determination as to the
advisability of retaining Hayes as CEO under the circumstances and to determine whether
or not it was wise to enter into the K.
3. Irrelevant that Coast may not have suffered any direct harm or that Hayes had no intent
to defraud Coast - What matters is that Hayes was not loyal to Coast
c. Controlling Shareholders and the Fairness Standard
i. Corporation law has long recognized a fiduciary duty on the part of controlling shareholders to
the company and its minority shareholders
1. Dominant value (Delaware law) – controlling shareholder’s power over the
corporation and the resulting power to affect other shareholders gives rise to a duty to
consider their interest fairly whenever the corporation enters into a K with the controller
or its affiliate
2. Clearly governs when a controlling shareholder engages in a conflicted transaction
w/the corporation
ii. Control here is determined by a practical test rather than a formalistic one
1. Safe harbors may be created by getting disinterested approval
2. When there is a controlling shareholder, must look at fairness of price and
fairness of process
iii. Sinclair Oil Corp v. Levien (Del. 1971): Sinclair contended that although it controlled its
subsidiary Sinven and owed it a fiduciary duty, its business transactions with Sinven should be
governed by the business judgment rule, and not by intrinsic fairness test.
2. Rule – the intrinsic fairness test should not be applied to business transactions
where a fiduciary duty exists but is unaccompanied by self dealing.
3. Rationale
a. Self dealing - Where the parent company receives some benefit to the
detriment or exclusion of the minority shareholders of the subsidiary; The
business judgment rule applied to transactions where Sinclair did not engage in
self dealing.
c. Sinclair did engage in self-dealing when it forced Sinven to contract with
Sinclair’s wholly owned subsidiary – this was self-dealing and will be subject to
the intrinsic fairness test.
d. Approval by a Disinterested Party
i. Safe Harbor Statutes – DGCL §144(a)(1) – Alternative Interpretations
Deal has to be: 1) approved by disinterested directors; OR 2) approved by
shareholders; AND 3) fair.
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 1. Literal reading - transaction not voidable solely because it is interested if disinterested
board approval or shareholder approval, but court still needs to do a fairness inquiry.
2. Broader reading - not voidable if disinterested board approval or shareholder
approval, i.e., court avoids a fairness inquiry
ii. General Principles – Cookies Food Prod. v. Lakes Warehouse (Iowa 1988)
1. Facts – After Herrig, a majority shareholder in P, turned the company around by
promoting and selling its products through his own distributing company, other
shareholders alleged that he had skimmed off profits through self dealing transactions.
2. Rule – Directors who engage in self-dealing must establish that they acted in good
faith, honesty, and fairness.
3. Rationale
a. Rule is in addition to the requirement that any such transactions must be fully
disclosed and consented to by the board of directors or shareholders, or at least
be fair and reasonable to the corporation
b. Given his hard work on Cookies’ behalf, Herrig’s services were neither
unfairly priced nor inconsistent with Cookies’ corporate interest; Herrig also
provided sufficient information to Cookies’ board to enable it to make
appropriate decisions.
iii. Director Approval – Cooke v. Oolie (Del. Ch. 2000): Shareholders of The Nostalgia Network
(TNN) contended that two TNN directors, Oolie and Salkind (Ds) breached their duty of loyalty
by electing to pursue a particular acquisition proposal that allegedly best protected their personal
interests as TNN creditors rather than other proposals that allegedly offered superior value to
shareholders. Ds maintained that b/c the board’s disinterested directors also voted to approve the
acquisition, their conduct was protected by the business judgment rule’s safe harbor.
2. Rule – an interested director’s vote to pursue a transaction that would be
beneficial to the director at the expense of the shareholders is protected by the
business judgment rule where disinterested directors ratify the vote.
3. Rationale – Any taint of disloyalty is removed by the vote of the disinterested directors
supporting the same deal b/c no incentive to act disloyally and should be only concerned
with advancing the corporation’s best interests
iv. Shareholder Approval - Lewis v. Vogelstein (Del. Ch. 1997)
1. Rule – Unanimous shareholder approval is required to ratify a conflicted
transaction that involves corporate waste.
2. Rationale –
a. Transaction that satisfies the high standard of waste constitutes a gift of
corporate property and no one should be forced against their will to make a gift
of their property
b. Corporate waste entails an exchange of corporate assets for consideration so
disproportionately small as to lie beyond the range at which any reasonable
person might be willing to trade
v. Shareholder Ratification – In re Wheelabrator Tech., Inc. (Del Ch. 1995)
1. Facts – Shareholders of WTI, whose company was bought by Waste Management,
Inc., in a merger transaction brought a derivative action claiming that the WTI directors
breached their duties of care and loyalty b/c 4 of 11 WTI directors were also Waste
officers. The directors contended that approval by WTI’s non-Waste shareholders
extinguished the claims.
2. Rule – A fully informed shareholder vote ratifying an interested director
transaction subjects a claim for breach of directors’ duties of care and loyalty to
business judgment review, rather than extinguishing the claim altogether.
3. Rationale
a. Shareholder ratification shifts the burden of proof to the Ps, whether the
standard is business judgment or entire fairness
b. Where, as here, the conflict of interest involves the directors (rather than the
controlling shareholder), the business judgment standard is applied.
3. Director and Management Compensation
• Two avenues to regulate pay:
o 1. Tax policy- Section 182 of IRC.
 Congress limited the deductibility of e-pay to $1million.
 Problem: everyone wants to get paid $1 to meet deductibility.
• Can only expense performance-based pay up to $1 million!
o Restrict salaries so that people get payment in restricted stock and can only decrease in value.

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o Options are difficult to use as compensation- so companies use packages: part salary part options-> Track
options to stock price.
o Compensation committee negotiates compensation with advice of compensation consultant.

a. Three-part compensation, generally: base salary, annual bonus, stock options

i. Difficult to determine what fair compensation for CEOs – hard to find market price for the
talents.
ii. Compensation is fair and reasonable when the following are taken into account:
1. Relation of compensation to executive’s qualifications, ability, responsibility, and time
devoted.
2. Corporation’s complexity, revenues, earnings, profits, and prospects. (Remember: risk
can’t be diversified so we need to address this in compensation structure).
3. Likelihood incentive compensation will achieve its objectives.
4. Compensation paid to similar executives in comparable companies.
iii. Shareholders or other disinterested directors often ratify the compensation of the CEO and
other board members to provide an extra measure of legal insulation. Two reasons for doing so:
a. Corporations must pay compensation – don’t attract volunteers
b. Courts are poorly equipped to determine fair salaries b/c of the unique
character of particular managers and the wide range of return managers
command on the market.
b. Option Grants – Lewis v. Vogelstein (Del. Ch. 1997)
i. Rule – when determining whether stock option grants constitute actionable waste, courts
should accord substantial effect to shareholder ratification.
ii. Rationale – the one time option grants to the directors were sufficiently unusual as to require
further inquiry into whether they constituted waste – court is saying that these potentially could be
valid.
iii. Note - By assuming that shareholder ratification was informed, the court ruled that transactions
where officers or directors were paid protected that transaction from judicial scrutiny except on
the basis of waste, and that the exchange was best evaluated in light of a proportionality review at
another time
c. Corporate Loans to Officers and Directors
i. DGCL §143 – board may authorize such loans when it finds that the loan or guarantee benefits
the corporation.
ii. Sarbanes-Oxley §402 of 2002 – Prohibits any indirect or direct loans to corporate officers in
publicly traded companies. These prohibitions had disappeared 70 years earlier.
d. Corporate Governance and SEC Regulatory Responses
i. 1993 – SEC enhanced disclosure rules – Three noteworthy elements:
1. Companies had to disclose, in a standardized summary compensation table, the annual
compensation, long term compensation, and other compensation for the top five
employees
2. Required a narrative description of all employment Ks w/top executives and disclosure
of a compensation committee report explaining the committee’s compensation decisions
3. Required a graph showing the company’s cumulative shareholder returns for the
previous five years, along w/a broad based market index and a peer group index for the
same period
ii. Effect of these reforms – increased transparency, wanted to shame corporations into reasonable
compensation for top executives – but the latter didn’t work.
iii. 2006 SEC reforms – requires a single number that captures all compensation for each of the
top executives, as well as improved disclosures on other payouts
e. Disney decisions – erosion of business judgment rule for executive compensation.
1. Disney CEO Michael Eisner needed a President, asked Orvitz who insisted in “downside
protection” to give up his 55% interest in the Creative Artists Agency, took job; Soon realized that
Orvitz was not a good fit for Disney, fired him w/o cause and Orvitz ended up w/$140 million in
compensation total for 15 months of service as President of Disney.
3. Shareholder P’s brought suit on behalf of the corporation, claiming that the Disney directors
breached their duty of care in approving Orvitz’s agreement and that the severance payment was
waste.
a. Ps had to assert that the board had not acted in good faith under DGCL 102(b)(7)
waiver contained in the Disney charter.
4. In October 1998 – Delaware Chancery Court dismissed the complaint as board was made of
independent directors who had no interests in the transaction.

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5. Delaware SupCt reversed in part on appeal, directed that P be given the opportunity to replead.
ii. In Re The Walt Disney Company Derivative Litigation (Del Ch. 2003)
1. Rule – A claimed breach of directorial fiduciary duties will survive dismissal
where it is alleged with particularity that directors have intentionally and
consciously disregarded their responsibilities
2. Rationale – claims survive dismissal.
a. Facts alleged by the shareholders suggest that the directors consciously and
intentionally disregarded their responsibilities, adopting a “we don’t care about
the risks” attitude concerning a material corporate decision.
b. Where a director consciously ignores his or her duties to the corporation,
thereby causing economic injury to its stockholders, the director’s actions
are either “not in good faith” or “involve intentional misconduct.”
iii. In Re The Walt Disney Company Derivative Litigation (Del Ch. 2005)
1. Rule – Intentional dereliction of duty – a conscious disregard for one’s
responsibilities – is an appropriate standard for determining whether fiduciaries
have acted in good faith.
2. Rationale
a. A failure to act in good faith may be shown, for instance, where the fiduciary
intentionally acts w/a purpose other than that of advancing the best interests of
the corporation, where the fiduciary acts w/the intent to violate applicable
positive law or where the fiduciary intentionally fails to act in the face of a
known duty to act, demonstrating a conscious disregard for his duties.
b. Applying these principles here, the shareholders must prove by a
preponderance of the evidence that the presumption of the business judgment
rule does not apply either b/c the directors breached their fiduciary duties, acted
in bad faith, or that the directors made an unintelligent or unadvised judgment
by failing to inform themselves of all material information reasonably available
to them before making a business decision.
c. With regard to the Old Board’s hiring of Ovitz, and the Compensation
Committee’s approval of the OEA, the directors did not act in bad faith, and at
most acted with ordinary negligence – which is insufficient to constitute a
violation of the fiduciary duty of care.
d. Eisner did not act in bad faith – believed his actions were in the best interests
of Disney when he hired Ovitz.
i. He was responsible for termination, not new board, so the new board
can’t be held liable for that.
ii. Eisner was exercising business judgment in firing Ovitz when he did
not meet expectations – taken w/company’s best interest again.
3. Analysis – Court repeatedly notes that Eisner did not exemplify best practices of
corporate governance, what seemed to save him from a breach of duty was his
subjective belief that he was acting in the company’s best interest.
iv. Ps again appealed to the Delaware SupCt, who affirmed
1. Dicta on good faith in Delaware SupCt – Defined a spectrum of behavior for
identifying “bad faith” conduct
a. One end – fiduciary conduct that is motivated by an actual intent to do harm –
classic, quintessential bad faith
b. Other end – grossly negligent conduct w/o any malevolent intent – cannot
constitute bad faith.
c. In between – conduct that involves intentional dereliction of duty, a conscious
disregard of ones responsibilities. Such misconduct is properly treated as a non-
exculpable, non-indemnifiable violation of the fiduciary duty to act in good
faith.
2. But they didn’t reach a conclusion on whether the fiduciary duty to act in good faith is
a duty that can serve as an independent basis for imposing liability upon corporate
officers and directors.
v. DGCL 102(b)(7) – provides that a corporate charter may waive director liability to the
corporation for damages except for, among other things, damages in connection with a breach of
loyalty and for acts or omissions “not in good faith”
• HOLDING: (Black letter law) Good faith is a subjective, rather than objective determination.
o *Mere negligence does not give rise to liability.
o *Gross negligence escapes the BJR, but falls under 102(b)(7).

44
 o *Bad faith does not get BJR OR 102(b)(7).
4. Corporate Opportunity Doctrine
a. Black Letter Law : True fairness test!
i. Issue - when a fiduciary may pursue a business opportunity on her own account if this
opportunity might arguably belong to the corporation - whether a given transaction is interested in
the first instance. Whether opp.=interest.
1. Dist. self dealing cases – issue there is whether the transaction violates duty of loyalty,
not whether it is interested from the start.
2. Rule – A director or senior executive may not compete w/the corporation, where
this competition is likely to harm the corporation.
a. Usually find this even where Key Player prepares to compete while still
employed by the corporation.
b. If compete after he leaves the corporation, not a violation of duty of loyalty,
unless insider is barred by valid non-competition clause. Cannot use trade
secrets.
c. Use of corporate assets (tangible goods, info) – not allowed where:
i. Use harms the corporation
ii. KP gets some financial benefits
3. Approval/ratification – conduct that would otherwise be prohibited as disloyal
competition may be validation by being approved by disinterested directors or being
ratified by the shareholders. Key Player must fully disclose the conflict and competition
he proposes to engage in.
ii. Director/executive may not do so when a business opportunity is found to “belong” to the
corporation – three tests to determine:
1. Interest or expectancy – narrowest protection
a. Corporation has an interest in an opportunity if it already has some K right
regarding the opportunity.
b. Corporation has an expectance if its existing business arrangements have led
it to reasonably anticipate being able to take advantage of that opportunity.
2. “Line of Business” test – broadest protection
a. Opportunity is corporate if it is closely related to the corporation’s existing or
prospective activities.
b. Factors affecting determination:
i. How this matter came to the attention of the director, officer, or
employee
ii. How far removed from the “core economic activities” of the
corporation the opportunity lies
iii. Whether corporate information is used in recognizing or exploiting
the opportunity
3. Fairness test –
a. Court measures the overall unfairness that would result if the insider took the
opportunity for himself.
b. Factors to consider
i. How a manager learned of the disputed opportunity
ii. Whether he or she used corporate assets in exploiting the
opportunity, and
iii. Other fact-specific indicia of good faith and loyalty to the
corporation
4. Factors to consider regardless of the test (in addition to above)
a. Whether the opportunity was afforded to the insider as an individual or
corporate manager
b. Whether the opportunity was essential to the corporation’s well being
c. Whether the parties had a reasonable expectation that such opportunities
would be regarded as corporate.
d. Whether the corporation is closely or publicly held – case for opportunity
stronger if publicly held.
e. Whether the person is an outside director or full-time executive – more likely
to find opportunity w/full time executive.
iii. When May a Fiduciary Take a Corporate Opportunity
1. A fiduciary may take an opportunity if the corporation is not in a financial position to
do so – implies that the corporation has determined not to accept the opportunity

45
 2. Issue – whether the board has evaluated the question of whether to accept the
opportunity in good faith
3. Most courts accept a board’s good-faith decision not to pursue an opportunity as a
complete defense to a suit challenging a fiduciary’s acceptance of a corporate opportunity
on her own account
b. In re eBay, Inc. Shareholders Litigation (Del. Ch. 2004): Shareholders of eBay brought derivative
actions against certain eBay officers and directors for usurping corporate opportunities by accepting from
eBay’s investment banker thousands of IPO shares at the initial offering price.
ii. Rule – Where a corporation regularly and consistently invests in marketable securities, a
claim for usurpation of corporate opportunity is stated where it is alleged that the
corporation’s officers and directors accepted IPO share allocations at the initial offering
price instead of having those allocations offered to the corporation.
iii. Rationale
1. Factual considerations
a. eBay financially was able to exploit the opportunities in question
b. eBay was in the business of investing in securities, as it had hundred of
millions of dollars invested in such investments
c. eBay was never given an opportunity to turn down the IPO allocations as too
risky or to accept them
2. This conduct placed the insiders in a position of conflict with their duties to the
corporation – commercial discount from the bank as a reward for their positions in the
corporation.
3. Reasonable inference that the insiders accepted a commission or gratuity that rightfully
belonged to eBay but that was improperly diverted to them
iv. DGCL §122(17) explicitly allows waiver to corporate opportunity constraints. Many
companies had begun to have “interlocking” boards (i.e. Silicon Valley)
5. Duty of Loyalty in Close Corporations
a. Close corporations typified by small number of stockholders, no ready market for corporate stock, and
substantial majority stockholders participation in the management, direction and operations of the
corporation
i. Minority shareholders are at a disadvantage
1. Majority stockholders to oppress or disadvantage minority stockholders through
“freezeouts”
2. The minority shareholders are not readily able to sell their interests, since there is not a
ready market for such interests, as there is with publicly traded companies.
ii. Easterbrook & Fischel – Strict Standards of Fiduciary Duty
1. Minority shareholders who believe those in control have acted wrongfully may bring
an action for breach of fiduciary duty
2. Fiduciary duties should approximate the bargain the parties themselves would have
reached had they been able to negotiate at low cost
3. Because of the problems with liability rules as a means for assuring contractual
performance, the parties have incentives to adopt governance mechanisms to resolve
problems that cannot be anticipated
b. For Majority Shareholders – Donahue v. Rodd Electrotype Co. (Mass. 1975)
i. Facts – P, a minority shareholder in a close corporation, sought to rescind a corporate purchase
of shares of the controlling stockholder.
ii. Rule - A controlling stockholder (or group) in a close corporation who causes the
corporation to purchase his stock breaches his fiduciary duty to the minority stockholders if
he does not cause the corporation to offer each stockholder an equal opportunity to sell a
ratable number of shares to the corporation at an identical price.
iii. Rationale
1. Purchase by the corporation confers substantial benefits on the members of the
controlling group whose shares were purchased, since it turns corporate assets into their
personal assets
2. These benefits are not available to the minority stockholders if the corporation does not
also offer them an opportunity to sell their shares
3. The controlling group may not, consistent with its strict duty to the minority, utilize its
control of the corporation to obtain special advantages and disproportionate benefit from
its share ownership
c. For Minority Shareholders – Smith v. Atlantic Properties, Inc. (Mass. 1981)

46
 i. Facts – Wolfson, a minority stockholder acting pursuant to a provision in the articles of
incorporation, was able to prevent the distribution of dividends, which made the corporation have
to pay a penalty tax for accumulated earnings.
ii. Rule – Where a closed corporation’s articles of incorporation include a provision designed
to protect minority stockholders, the minority stockholders have a fiduciary duty to use the
provision reasonably.
iii. Rationale
1. Wolfson unreasonable used a provision to protect minority shareholders
2. He was warned of the penalty tax that could result from a failure to declare dividends
but refused to vote for an amount of dividends that would minimize the possibility of
penalty tax
3. The trial judge was correct in protecting the majority stockholders by ordering
Wolfson to reimburse Atlantic for the penalty taxes

STANDARD Delaware RM ALI

OF REVIEW (DGCL BC §5.0
§144) A 2
§8.6
1
Conflict: NO Entire EF EF
Board or Fairness (D) (D)
Shareholder Review
Approval (burden on
D)
Disinterested BJR BJR Reas
Board (Cooke) (P): onab
Approves unless §8.6 le
Controller, 1(b) belie
then Entire (1) f in
Fairness & fairn
VIII. (EF) (See Co ess
Shareholder Cookies) mm (P):
Lawsuits (Burden on ent §5.0
P) 2 2(a)
(2)
(b)
Disinterested BJR (P) BJR EF(
Board Same as P: D):
Ratifies above §8.6 §5.0
2(a) 2(c),
& §5.0
Co 2(a)
mm (2)
ent (A),
1 §5.0
2(b).
Shareholders BJR/Waste Was Was
Ratify (P). Unless te te
Controller, (P) (P)
then EF (P)
(Wheelabra
tor)
A. Direct v. Derivative Claims
1. Derivative suit – an assertion of a corporate claim against an officer or director which charges them with a wrong
to the corporation.
a. This only indirectly affects shareholders – basically two suits in one
i. First suit is against the directors, charging them w/improperly failing to sue on the existing
corporate claim.
ii. Second suit is the underlying claim of the corporation itself.
b. Injury alleged to the corporate interest – implies that any recovery that results should go directly to the
corporation itself.

47
 c. Has many special procedural hurdles designed to protect the board of director’s role as the primary
guardian of corporate interests.
d. Examples – most cases brought against insiders for breaches of fiduciary duties
i. Suits against board members for failing to use due care
ii. Suits against an officer for self-dealing
iii. Suits to recover excessive compensation paid to an officer
iv. Suits to reacquire a corporate opportunity usurped by an officer.
e. Costs/benefits
i. Benefits – May confer value on the corporation (i.e. firing bad manager) and add value by
deterring future wrongdoing
ii. Costs – Direct costs of defense and possibly prosecution, indirect costs of insurance, lost
profits, loss of efficiency because officers are preoccupied, bad publicity, etc.
2. Direct actions – normally brought as class actions= gathering together of many individual or direct claims that
share some important common aspects.
b. Injury alleged is to the personal interest.
c. Examples:
i. An action to enforce the holder’s voting rights.
ii. An action to compel payment of dividends
iii. An action to prevent management from improperly entrenching itself (e.g. to enjoin the
enactment of a “poison pill” as an anti-takeover device)
iv. A suit to prevent oppression of minority shareholders
v. A suit to compel inspection of the company’s books and records.
d. Company plays no role, shareholders/attns get paid; take money out of the co…
3. Commonalities b/t the suits:
a. Require Ps to give notice to the absent interested parties
b. Permit other parties to petition to join in the suit
c. Provide for settlement and release only after notice, opportunity to be heard, and judicial determination
of fairness of the settlement
d. Successful Ps are customarily compensated from the fund that their efforts produce.
4. Tooley v. Donaldson, Lufkin & Jenrette (Del. 2004): Suit was brought by minority shareholders as a direct
(class) action alleging that the board had breached a fiduciary duty to them by agreeing to a twenty two day delay in
closing a proposed cash merger.
b. Chancery court dismissed – said the potential claim only belonged to the corporation.
c. Del. Supreme Court affirmed the dismissal, but re-stated the test for derivative v. direct
i. TEST – the issue must turn solely on the following questions:
1. Who suffered the alleged harm (the corporation or the suing shareholders) AND
2. Who would receive the benefit of any recovery or other remedy (the corporation
or the stockholders individually)?
ii. Holding – no claim was stated by the complaint b/c the shareholders had no individual right to
have the merger occur at all.
5. Gentile v. Rossette (Del. 2006) – illustrates the malleability of the direct/derivative distinction; CEO and director
of SinglePoint came up w/a scheme to increase their debt ratio, completed this w/o notifying the minority
shareholders of the primary purpose. Minority shareholders brought suit against CEO & director.
b. Chancery Court granted summary judgment for D, Ps claim was solely derivative and Ps lost standing
when company merged.
c. Delaware SupCt reversed – held that the Ps claim was both direct and derivative
i. Found a direct claim from an extraction from the public shareholders, and a redistribution to the
controlling shareholder, a portion of the economic value and voting power in the minority interest.
ii. Public shareholders harmed in the same way that Ds directly benefited.
B. Attorney’s Fees & Incentives to Sue
1. When all investors hold small stakes no one investor has a strong incentive to invest time and money in
monitoring management
2. Change the incentives if award attorney’s fees
a. “Common fund” theory – courts usually award the Ps attorneys a reasonable fee for bringing a
successful derivative action.
i. Under this theory the fee is paid out of the amount recovered on behalf of the corporation.
b. Ps attorney gets nothing when a derivative suit is dismissed b/c there is no recovery and no benefit
c. When it succeeds on the merits or settles the corporation is said to benefit from any monetary recovery or
governance change, but company also pays the fees
d. Differing modes of compensation
i. DE awards percent of total award

48
 ii. Federal Courts use lodestar method to include costs expensed and risk (this prevents
premature settlement problem)
3. Fletcher v. A.J. Industries (Cal. App. 1968): P requested attorneys’ fees for successfully settling a derivative
suit.
b. Rule – Even though the corporation receives no money from a derivative suit, attorneys’ fees are
properly awarded if the corporation has substantially benefited from the action.
c. Rationale – extension of the common fund theory – “substantial benefit” rule
i. If the corporation received a substantial benefit from a derivative action, even though non-
monetary, recovery of attorney fees should be allowed.
ii. Here there was a restructuring of corporate management, a restriction on the authority and
voting rights of the majority shareholders, possible future monetary awards, and the saving of
excessive salary paid to the former Treasurer – these were substantial corporate benefits
C. Standing for Derivative Suits
1. Underlying assumption – screening for qualified litigants increases the quality of shareholder litigation.
2. FRCP 23.1 – Delaware also follows – standing rules for derivative actions
a. P must be a shareholder for the duration for the action
b. Contemporaneous ownership rule – P must have been a shareholder at the time of the alleged wrongful
act or omission
c. P must be able to fairly and adequately represent the interests of shareholders, meaning in practice there
are no obvious conflicts of interest.
d. Complaint must specify what action the P has taken to obtain satisfaction from the company’s board or
state w/particularity the Ps reason for not doing so.
3. Demand Requirement of Rule 23: Black Letter Rules
i. Demand on the board is excused where it would be “futile,” which exists if the board is accused of
having participated in the wrongdoing.
ii. Delaware – Demand futility test
1. Demand will not be excused unless P carries the burden of showing a reasonable doubt about
whether the board:
a. Was disinterested and independent or
b. Was entitled to the protections of the business judgment rule (i.e. acted rationally after
reasonable investigation and w/o self-dealing)
2. This is difficult to get – must plead facts showing either part with great specificity, plead duty
of loyalty instead of due care.
iii. Demand Required and Refused – result depends on who D is:
1. Unaffiliated third party – P will almost never be able to pursue his suit after the board has
rejected it.
2. Suit against insider – P has a better chance of having board refusal overridden, but must show
either that:
a. The board somehow participated in the alleged wrong
b. Directors who voted to reject the suit were dominated or controlled by the primary
wrongdoer.
b. Levine v. Smith (Del. 1991): GM shareholders filed shareholder derivative suits against GM’s directors,
challenging the buy-back of GM stock from Ross Perot, its largest shareholder, and others, on the grounds
that Perot and the others were wrongfully paid a premium to stop criticizing GM and that the GM directors
approving the buy back could not have acted independently. The Chancery Court dismissed, rejecting the
shareholders’ claims of demand futility and that the GM directors lacked independence.
ii. Rule – To withstand dismissal of a derivative action, a P shareholder claiming demand
futility or wrongful demand refusal must allege particularized facts that overcome the
business judgment rule presumption.
iii. Rationale
1. Where demand futility is asserted, two related but distinct questions must be
answered:
a. Whether threshold presumptions of director disinterest or independence
are rebutted by well pleaded facts
b. Whether the complaint pleads particularized facts sufficient to create a
reasonable doubt that the challenged transaction was the product of a valid
exercise of business judgment
2. Chancery court properly applied the test here –
a. Shareholders did not plead sufficiently particularized facts to show that GM’s
outside directors were so manipulated, misinformed and misled that they were
subject to management’s control and unable to exercise independent judgment

49
 b. Shareholders’ allegations more appropriately related to the issue of director
due care and the business judgment rule’s application to the challenged
transaction
c. Pre-suit Demand: Is the traditional equity rule of pre-suit demand the best way to adjudicate the board’s
colorable disability to claim sole right to control the adjudication of corporate claims?
ii. ALI – said no – rule of universal demand
1. P would be required to always make a demand and if she was not satisfied w/the
board’s response to her demand she should institute suit.
2. If Ds sought dismissal of the suit, then the court would review the board’s exercise of
business judgment in making its response.
iii. Delaware SupCt – rule of universal non-demand
1. Infers that whenever a P does make a pre-suit demand, she automatically concedes that
the board is independent and disinterested w/respect to the question to be litigation
2. If independence is conceded by making demand, then the only prong of the Levine test
that the P is left is the second prong, which asks whether bad faith or gross negligence
may be inferred from the decision itself.
3. Practical effect of this rule is to discourage pre-suit demand
d. Rales v. Blasband (Del. 1993): Blasband, first a shareholder in Easco Hand Tools, and then a
shareholder in Danaher Corp., which acquired Easco as a wholly owned subsidiary, contended that demand
was excused in a double derivative action he brought b/c the Danaher board could not impartially consider
the merits of his derivative action (relating to improper use by the Easco board of the proceeds from sales
of its senior subordinated notes) w/o being influenced by improper considerations.
ii. Rule – In a derivative action where demand excusal is asserted against a board that has
not made the decision that is the subject of the action, the standard for determining demand
excusal is whether the board was capable of impartially considering the action’s merits w/o
being influenced by improper considerations.
iii. Rationale
1. Levine test is inapplicable here b/c inapplicable the Danaher board did not make the
decision that is being challenged
2. Court must determine whether or not the particularized factual allegations of a
derivative stockholder complaint create a reasonable doubt that, as of the time the
complaint is filed, the board of directors could have properly exercised its independent
and disinterested business judgment in responding to a demand
3. Here board was interested b/c federal court had ruled that Blasband had pleaded facts
raising at least a reasonable doubt that the Easco’s board’s use of proceeds from the note
offering was a valid exercise of business judgment
iv. Note - two other situations where this test would apply and Levine would not
1. Where a business decision was made by the board of a company, but a majority of the
directors making the decision have been replaced, AND
2. Where the subject of the derivative suit is not a business decision of the board
v. Note – Board of directors must respond to demand in 2 steps:
1. Directors must determine the best method to inform themselves of the facts relating to
the wrongdoing and weigh legal and financial considerations in responding. It must also
investigate reasonably if necessary.
2. Board must weigh alternatives. Including internal action and commencing legal
proceedings.
D. Special Litigation Committees : of independent directors to investigate question of whether to dismiss suit
a. Varies by jurisdiction
i. Divide b/t those that follow Delaware – Zapata case below – give a role to the court itself to
judge the appropriateness of a special litigation committee’s decision to dismiss a derivative suit.
ii. Those that follow NY – Auerbach v. Bennett – if the committee is independent and informed,
its action is entitled to business judgment deference w/o any further judicial second guessing.
2. Zapata Corp. v. Maldonado (Del. 1981): Maldonado has initiated a derivative suit charging officers and
directors of Zapata w/breaches of fiduciary duty, but 4 years later an independent investigation committee of two
disinterested directors recommended dismissing the action.
b. Rule - Where the making of a prior demand upon the directors of a corporation to sue is excused and a
stockholder initiates a derivative suit as detrimental to the corporation’s best interests, the court should
apply a two-step test to the motion:
i. Has the corporation proved independence, good faith, and a reasonable investigation
1. If no, then court will deny corporation’s motion and allow case to proceed.
2. If yes, go on to next step.

50
 ii. Does the court feel, applying its own independent business judgment, that the motion
should be granted – may but don’t have to apply this step.
1. Court can strike a balance between legitimate corporate claims, as expressed in a
derivative stockholder suit, and a corporation’s best interests, as expressed by an
independent investigating committee
2. Look at whether there would be a just result in letting suit proceed despite step 1, how
compelling corporate interest is in dismissal of a non-frivolous lawsuit, interests of
law/public policy.
3. If the court’s independent business judgment is satisfied, then it may grant the
corporations motion subject to any terms/conditions it sees fit.
3. In re Oracle Corp. Derivative Litigation (Del. Ch. 2003): Oracle Corp’s SLC moved to terminate a derivative
action brought on Oracle’s behalf, claiming it was independent.
b. Rule – SLC does not meet its burden of demonstrating the absence of a material dispute of fact about its
independence where its members are professors at a university that has ties to the corporation and to the Ds
that are the subject of a derivative action that the committee is investigating.
c. Rationale
i. Independence turns on whether a director is for any substantial reason incapable of making a
decision with only the best interests of the corporation in mind – focus on impartiality and
objectivity.
ii. SLC has not shown it is independent here – ties are so substantial that they cause reasonable
doubt about the SLC’s ability to impartially consider whether the trading defendants should face
suit
iii. Burden of establishing independence lies w/the corporation.
4. Joy v. North (2nd Cir. 1982)- Citytrust’s SLC recommended the dismissal of a derivation action brought in
federal court under diversity jurisdiction. The federal court determined that under state law it was required to review
the committee’s decision.
b. Rule – a SLC’s recommendation regarding the termination of derivative litigation must be
supported by a demonstration that the derivative action is more likely than not to be against the
interests of the corporation.
c. Rationale
i. Court’s function is to weigh the probability of future benefit to the corporation, not to decide the
underlying litigation on its merits
ii. Factors the court should weigh include attorney’s fees, out-of-pocket expenses, time spent by
corporate personnel on the litigation, and non-discretionary indemnification, but not insurance that
has already been paid for
iii. If after the court weighs these factors it finds a likely net return to the corporation that is
insubstantial relative to shareholder equity, it may take into account two other items as costs
1. Impact of distraction of key personnel by continued litigation
2. Potential lost profits which may result from the publicity of a trial
d. Dissent – majority goes beyond the Zapata standard, judges shouldn’t make business judgments.
5. Settlement by Special Litigation Committee – Carlton Investments v. TLC Beatrice International Holdings,
Inc. (Del. Ch. 1997): The Chancery Court review a SLC’s proposed settlement of a derivative action on behalf of
TLC.
b. Rule – A proposed settlement negotiated by a SLC is to be reviewed under the two-step approach
set forth in Zapata, involving, first, a review of the SLC’s independence, good faith, and
reasonableness of its decision, and, second, a discretionary business judgment review of the
settlement’s merits
c. Rationale
i. Court cannot decide the merits of the particular claims, only looking at merits of the settlement.
ii. Here, applying the first step of the Zapata test, the SLC and its counsel proceeded in good faith
throughout the investigation and negotiation of the proposed settlement; the conclusions reached
by the SLC, which formed the basis for the amount of the proposed settlement, were well
informed by the existing record; and the proposed settlement falls within a range of reasonable
solutions to the problem presented
iii. This should be enough to support the settlement, but if undertaking the second Zapata step is
necessary, with the court exercising its own court’s conclusion is that this settlement represents a
reasonable compromise of the claims asserted
d. Note – court uncomfortable w/exercising business judgment here – courts ordinarily should not exercise
such business judgment except where doing so will protect shareholder welfare.

51
Class: Transactions in Control (p. ?-441)
• Controlling blocks of stock:
o Selling at a premium.
• If control is sold, minority shareholder does not have control.
• Don’t have a minimum control %.
o Cases where 30-40% is the threshold; lowest seen is 10% in sale of corporate office.
• Subject to fiduciary duties.
o Market” Rule
 Absent looting of corporate assets, conversion of a corporate opportunity, fraud or other acts of bad faith, a
controlling stockholder is free to sell, and a purchaser is free to buy, that controlling interest at a premium
price
o 3 main exceptions:
 Collective Opportunity (Perlman case)
 Selling a corporate office
 Looting (Harris)
Pearlman
• Rare cases where sale of control resulted in a loss of opportunity to the company.
Harris v. Carter
• Controlling shareholder has a duty to investigate the buyer in some circumstances, but not an affirmative duty.
Williams Act- Attempts to make takeovers fairer to the target’s shareholders, by reducing the pressure upon them to make a quick
decision and by ensuring that all shareholders will be treated equally.
• In response to where buyer “lightening ray” offers.
• To control tender offers.
• 4 characteristics:
o 1) Filing requirements.
o 2) Substantive regulations for offers themselves.
 20 days that offer must remain open.
• Early Warning System (§13(d)) – Act requires anyone who purchases more than 5% of the stock of a publically held company
to disclose that fact promptly to the SEC.
• Tender offer= an offer of cash or securities to the shareholders of public corps. in exchange for their shares at a premium over
market price.
o SEC did not define tender offer, but has an 8-factor test: (Brascan Ltd.)

52
  Solicitation – An active and widespread solicitation is made o the target’s public shareholders;
 Percentage – The solicitation is for a substantial percentage of the stock;
 Premium – The offer to purchase is made at a premium over the prevailing market price;
 Firm Terms – The terms of the offer is contingent on the tender of a fixed number of shares (and is perhaps, though
not necessarily, subject to a fixe maximum number that will be purchased);
 Limited Time – The offer is open only for a limited period of time;
 Pressure – The offerees are subjected to pressure to sell their stock; and
 Public Announcements – The buyer publically announces an acquisition program, preceding or accompanying his
accumulation of stock.
• If there is a Tender Offer – The Act requires comprehensively regulates tender offers. It does this in 3 ways:
o General Disclosure (§14(d)(1)) – The Act requires comprehensive disclosure by any bidder of the bidder’s identity,
financing, and plans for the company is the bid is successful.
o Anti-Fraud Provision (§14(e)) – prohibits “any fraudulent deceptive, or manipulative” practices in connection with a tender
offer.
o Terms of the offer (§14(d)(4)-(7)) – governs the substantive terms of the tender offer, e.g., duration, equal treatment

IX. Mergers and Acquisitions

A. Introduction
1. Among the most important transactions in corporate law are those that pool the assets of separate companies into
either a single entity or a parent company and a wholly owned subsidiary.
a. Law of M&A transactions provides (relatively) quick and inexpensive ways to reform the portioning and
management of corporate assets
2. Sources of Value in these transactions
a. Economic Sources of Value – economies of “scale,” “scope,” and “vertical integration”
i. Economies of Scale – result when a fixed cost of production – such as the investment in a
factory – is spread over a larger output, thereby reducing the average fixed cost per unit of output
ii. Economies of Scope – mergers reduce costs not by spreading costs across a broader range of
related business activities
iii. Vertical Integration – arises by merging a company backward, toward its suppliers, or forward,
toward its customers
b. Other sources of value – tax, agency costs, and diversification
i. Tax Benefits – Corporations w/tax losses may prefer to find a wealthy merger partner instead of
setting off its own losses.
ii. Agency Costs – can replace an underperforming management team when buy control.
iii. Diversifying a company’s business projects – also increases corporate value, maintains year-
round gain.
3. Opportunistic motives for Transactions
a. Squeeze out merger – controlling shareholder acquires all of a company’s assets at a low price, at the
expense of its minority shareholders
b. Merger that creates market power in a particular product market and thus allows the post-merger entity
to charge monopoly prices for its output
c. “Mistaken” mergers – occur because their planners misjudge the costs involved.
4. Evolution of Merger Law
a. Almost non-existent until 1890, at first needed unanimous shareholder approval.
b. Then corporate statutes were amended to allow majority shareholder approval, providing they were
recommended by the board.
c. Now – Mergers require shareholder and board approval.
i. DGCL §251(b) – Mergers require vote on part of both the target and the acquiring company
except when the acquiring company is much larger. (whale-minnow) Rationale: May result in
dilution of acquirer’s stock.
ii. DGCL §271 – Sales of substantially all assets require shareholder vote of target, but not
acquirer (regardless of size). Rationales: There is no change in management of the acquirer or
dilution of shareholder vote. Target is likely to be dissolved upon the sale.
iii. Dist. two statutes – agency problem is more severe in the former – shareholder approval is
required in transactions that change the board’s relationship to its shareholders most dramatically.
B. Transactional Forms
1. Introduction
a. Three principle legal forms of acquisitions
i. Acquirer can buy the target company’s assets
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 ii. Acquirer can buy all of the target company’s stock
iii. Acquirer can merger itself for a subsidiary corporation w/the target on terms that ensure
its control of the surviving entity.
b. In each of the three transactional forms, the acquirer can use cash, its own stock, or any other agreed-
upon form of consideration
2. Statutory Merger – DGCL §251 – follow procedures set up in the state corporation statute
a. Explanation
i. One corporation merges into another w/the former (“disappearing” corporation) ceasing
to have any legal identity, and the latter (“surviving” corporation) continuing in existence.
ii. After the merger, the surviving corp. owns all of the disappearing corp.’s assets and is
responsible for all of the disappearing corp.’s liabilities.
iii. Ks b/t the disappearing corp. and third parties are now b/t the surviving corp. and the third
party.
iv. Shareholders in the disappearing corp. are now shareholders of the surviving corp.
b. Process under DGCL 251
i. Acquiror & Target boards negotiate the merger. Board gets initiation and approval.
ii. Proxy materials are distributed to shareholders as needed (see below)
iii. T shareholders always vote (§251 (c))
iv. A’s shareholder vote unless outstanding increases by <20% surviving corporation’s charter is
not amended, and security held by surviving corporation’s shareholders will not be exchanged or
modified. (too insignificant) (§251(f)),
1. DGCL §251 does not protect preferred stock with right to a class vote unless there is a
charter amendment (§242(b)(2))
2. This is only when amendment alters the format rights of preferred stock, not when it
reduces economic value.
v. If majority of shares outstanding approves, T assets merge into A, T shareholders get back A
stock. A gets T liabilities.
vi. Certificate of merger is filed with the secretary of state.
vii. Dissenting shareholders who had a right to vote have appraisal rights
3. Asset Acquisition
a. Process – DGCL §271
i. Once again, the boards of the two firms – A and T – negotiate the deal.
ii. But now, only T’s shareholders get voting and appraisal rights if substantially all are sold
(because only T is being bought)
iii. Transaction costs are generally higher because title to the actual physical assets of the target
must be transferred to the acquirer. But acquiror may do this if they feel shareholders won’t
approve.
iv. After transfer, selling corporation usually liquidates the consideration received (e.g. cash) to its
stockholders.
v. Liabilities are not necessarily assumed
b. Katz v. Bregman (Del. Ch. 1981): In Ps action against D, the CEO of Plant Industries, to enjoin the
proposed sale of the Canadian assets of Plant, P contended that a sale of substantially all the assets of the
corporation required the unanimous vote of the stockholders.
ii. Rule – Under Delaware law the decision of a corporation to sell all or substantially all of
its property and assets requires not only the approval of the corporation’s board of
directors, but also a resolution adopted by a majority of the outstanding shareholders of the
corporation entitled to a vote.
iii. Rationale
1. Here, the proposed sale of Plant’s Canadian operations would constitute a sale of
substantially all of the assets of Plant as presently constituted
2. Under Delaware law, an injunction should issue preventing the consummation of such
sale at least until it has been approved by a majority of the outstanding stockholders of
Plant, entitled to vote at a meeting duly called on at least 20 days’ notice
iv. Note – represents a court taking up the tools at hand to reach a result that it thought fairness to
shareholders required
c. Thorpe v. CERBCO (Del. 1996): CERBCO stock in Instituform constitutes 68% of CERBCO’s assets.
Public shareholders want CERBCO to sell its controlling interest in Instituform, controlling shareholder
wants to sell its controlling interest in CERBCO and block the deal.
ii. Delaware Supreme Court holds that sale of CERBCO’s stock in Instituform would constitute a
sale of substantially all of CERBCO’s assets – requires a shareholder vote – controlling
shareholder can veto the transaction.

54
 iii. Test – The need for shareholder approval is to be measured not by the size of the sale
alone, but also on the qualitative effect upon the corporation. Thus it is relevant to ask
whether a transaction is out of the ordinary course and substantially affects the existence
and purpose of the corporation
3. Stock Acquisition
a. The purchase of control by an acquirer is merely a shareholder transaction that does not alter the legal
identity of the corporation
b. To acquire a corporation in the full sense of obtaining complete dominion over its assets, an acquirer
must purchase 100% of its target’s stock, not merely a control block
c. Compulsory Share Exchange – RMBCA §11.03/Stock-for-Stock Acquisition
i. T shareholders give up T shares and get back A shares
ii. Difference between the statutory merger and the compulsory share exchange is that T corp.
keeps it separate existence
iii. In a regulated industry, where corporation cannot legally own assets outside of industry,
corporation can do it indirectly through this, and this is a liability shield.
iv. RMBCA 11.03 – Share Exchange Transactions
1. This is a tender offer negotiated with target board that becomes compulsory after
approval by shareholders.
2. At time 1, A Corp exchanges shares of A for T shareholders’ shares.
3. At time 2, A shareholders and T shareholders own A.
4. A completely owns T.
a. Must be for ALL shares to be a full-fledged acquisition, otherwise it is just a
shareholder transaction.
b. Benefits because eliminates SEC regulations.
c. Some states have short form merger statutes which allow a 90% shareholder
to cash out minorities unilaterally. DGCL §253
d. Can’t be done in Delaware. But they have provision for a “two step merger”
i. Boards of Target and Acquiror negotiate 2 linked transactions in a single package.
ii. Tender offer for most or all of the target’s shares at an agreed price which T’s board
recommends to shareholders
iii. Merger between target and a subsidiary of the acquiror which is to follow the tender
offer and remove minority shareholders who failed to tender. (Usually at the same price as
tender offer). If for cash, this is “cash out.”
4. Merger Generally
a. A merger legally collapses one corporation into another
b. In most states, a valid merger requires a majority vote by the outstanding stock of each constituent
corporation that is entitled to vote.
c. The voting stock of the surviving corporation is generally afforded statutory voting rights on a merger
except when 3 conditions are met:
i. The surviving corporation’s charter is not modified
ii. The security held by the surviving corporation’s shareholders will not be exchanged or
modified
iii. The surviving corporation’s outstanding common stock will not be increased by more than 20
percent
d. The rationale for this exemption is that mergers satisfying these conditions have too little impact
on the surviving corporation’s shareholder to justify the delay and expense of a shareholder vote
5. Triangular Mergers
a. Used to shield A from the liabilities of T – do this by merging into a wholly owned subsidiary of A.
b. Forward Triangular merger –
i. A creates a subsidiary for the purpose of the transaction, S had no assets except shares of stock
in the A.
ii. T is then merged into S, and T shareholders get the shares of stock in A.
iii. S is the surviving corporation
c. Reverse Triangular Merger
i. Same facts as above, except that S merges into T, so that T is the surviving corporation that is a
subsidiary of A.
ii. Cheapest and easiest method of transfer because both preexisting operating corporations are left
intact. Stock purchases have costs but are much simpler.
iii. DGCL §11.03(g)(3) – only if it is keeping T shareholders in place will there be a 20% vote
exemption.
d. Two Step Merger

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 i. e.g. tender for $35, and once acquirer gets 51%, rest cashed out for $25 – two-tiered front loaded
offer
ii. Could attack in State Court as self-dealing and unfair, though probably unsuccessful because
1. Majority of stockholders (51%) tendered and approved the transaction
2. No requirement that both steps offer equal price
iii. Could attack in Federal Court as manipulative under 10b-5 (or by 14(e) of Exchange Act,
which forbids manipulation in connection with tender offers)
iv. What is the benefit of the two-step reverse triangular over one-step?
1. Speed, as soon as tender offer is complete, you own company.
2. With one-step, must file proxy materials, shareholder vote
6. De-Facto Merger
a. Some US court have accorded shareholder voting and appraisal rights to all corporate combinations that
resemble mergers in effect.
i. This is a functionalist approach
ii. Counterargument to this approach - corporations exist as entities because certain formal steps
are taken
b. NO De-Factor Merger in Delaware – Hariton v. Arco Electronics, Inc. (Del. 1963)
i. Facts – D sold all of its assets to Loral Corp. in exchange for Loral common stock. P, a
shareholder in D challenged the transaction as a de-facto merger.
ii. Rule - A corporation may sell its assets to another corporation even if the result is the
same as a merger without following the statutory merger requirements
iii. Rationale
1. No interaction b/t assets and merger statute, as long as one or the other is followed
correctly, doesn’t matter if action is illegal under the other.
2. The theory of de facto merger can only be introduced by the legislature, not the courts
3. Cannot distinguish this transaction b/t one where no dissolution of the selling corp. is
required b/c Arco continued in existence.
4. Rationale of de-facto merger doesn’t apply in DE – no right to appraisal, P knew that
D could sell at any time.
iv. Note – this approach is the minority rule
v. Criticism of this approach – Since the merger procedure is authorized to achieve the result
sought by Arco, it seems unfair to allow the use of another device to obtain the same result
indirectly in order to deny the protections given to minority shareholders under the more direct
approach
Statutory Merger Asset Acquisition Share Exchange
(DGCL §251, RMBCA (DGCL §271, RMBCA (RMBCA §11.03)
§11.02) §12.01 -.02)
T Voting Yes – need majority of Yes , if “all or substantially Yes – need majority
Rights shares outstanding all” assets are being sold of shares voted
(DGCL §251(c)), or (DGCL §271(a)) or no (RMBCA §11.04(e))
majority of shares “significant continuing
voted (RMBCA business activity”
§11.04(e)) (RMBCA §12.02(a))
A Voting Yes , unless <20% No (though stock Yes , unless <20%
Rights shares being issued exchange rules might shares being issued
(DGCL §251(f), require vote to issue new (RMBCA §11.04(g))
RMBCA §11.04(g)) shares)
Appraisal Yes if T shareholders Yes under RMBCA if T Yes , unless stock
Rights vote, unless stock shareholders vote, market exception
market exception unless stock market (RMBCA §13.02(a))
(DGCL §262, RMBCA exception (RMBCA
§13.02) §13.02(a)(3)); No in
Delaware , unless
provided in charter
(DGCL §262(c))

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C. Structuring the Transaction – many different factors to consider
1. Timing
a. Speed is almost always desirable in acquisition transactions
b. Different types of transactions
i. All cash, multi-step acquisition is usually the fastest way to lock up a target and assure its
complete acquisition
ii. All case tender offer may be consummated 20 days after commencement under the Williams
Act.
iii. If stock constitutes any part of the deal, the two-step structure generally does not provide a
significant timing advantage because the stock to be issued generally must be registered with the
SEC pursuant to Rule 145 of the Securities Act.
iv. Most deals using 100% stock are structured as one step direct or triangular mergers
c. Title Transfers
i. Title transfers not a matter of concern in a merger since all assets owned by either corp. vest as a
matter of law.
ii. In sale of assets may result in substantial cost and delay.
iii. Thus reverse triangular mergers are the cheapest and easiest methods of transfer
iv. Stock purchases entail stock transfers and the corresponding costs of documentation but are
simpler than asset purchases.
d. Regulatory Approval –varies w/type of transaction – Try to choose a structure that minimizes the cost of
obtaining regulatory approvals or consents needed to close the K.
e. Voting and Appraisal Rights
i. Sometimes condition transactions on shareholder approval or provide appraisal rights
ii. Weary of these transactions because they can slow down the process.
2. Lawyer’s Role in Deal Structuring
a. Barrier – Different expectations about the value of the company
i. Lawyer Response: Build in contingent payments: “Earn-out” or “Clawback”
b. Different time preferences
i. Negotiate timing of payments
c. Asymmetric information: the “Lemons” problem
i. Representations and warranties will facilitate the due diligence process by forcing the disclosure
of all the target’s assets and liabilities.
ii. Covenants – tool for controlling risk, i.e. Pledge by target to use its best efforts to cause merger
agreement to close, Board will recommend approval of the merger
iii. Parties will typically indemnify each other for any damages arising from any misrepresentation
or breach of warranty – Allocates burden of undiscovered noncompliance to the party making the
representation
d. Imperfect information
i. Negotiate “to the seller’s knowledge” versus “to the best of seller’s knowledge” versus “to the
best of seller’s knowledge and after diligent investigation.”
ii. Due Diligence – acquiring reliable information about the target through SEC filings, financial
statements.
D. Taxation of Corporate Combinations
1. Basic Concepts
a. Taxes levied on income in the US, which includes gains in value of investments
b. Gain – calculated as the excess of the new amount realized on sale over the taxpayer’s adjusted cost
basis.
i. Adjusted cost basis – cost after reduction for the depreciation or amortization charges made
against the asset’s cost in calculating annual income taxes.
ii. Realization of gain – generally occurs when an investment is sold
iii. Recognition – refers to the legal rules that determine whether taxes will be due at the time the
gain is realized.
2. Tax Free Corporate Reorganizations
a. Subsection 368(a)(1)(A) – excepts statutory mergers in which a sufficient proportion of the
consideration is stock
i. Must meet 3 additional requirements in addition to being a merger under state law:
1. Business purpose, not merely a tax avoidance purpose for the transaction
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 2. Satisfies a community of interests test
3. Satisfies the continuity of business enterprise requirements
ii. Can be accomplished in triangular form
b. Subsection(a)(1)(B) – exempts transactions where at least 80% of all shares of voting stock (and 80% of
each class of nonvoting stock) of Target are acquired in exchange solely for voting stock of the acquirer.
Includes boot to the extent of 20% of the total.
c. Subsection 368(a)(1)(C) – exempts reorganizations in which A acquires assets solely in exchange for
voting stock of A – 3 common forms:
i. A acquires substantially all of Ts assets in exchange for its voting stock - 90% of the fair value
of Ts net assets and at least 70% of Ts gross assets constitutes the acquisition of substantially all
Ts assets.
ii. Forward triangular merger form. – A’s subsidiary acquires substantially all of Ts assets in
exchange solely for voting stock of A.
iii. Forward triangular merger in which T merges into S and Ts shareholders receive only A voting
stock.
d. Qualification under 368 means that there is no recognition of gain by sellers except to the extent they
receive “boot” (any non-voting stock consideration)
E. Appraisal Remedy
1. Appraisal Process
a. Every U.S. jurisdiction provides an appraisal right to shareholders who dissent from qualifying corporate
mergers.
i. Most states provide appraisal for shareholders who dissent from a sale of substantially all of the
corporation’s assets.
ii. Half states, an amendment to the corporate charter gives rise to an appraisal.
b. Quid pro quo for getting rid of unanimous shareholder approval requirement, but now markets are very
liquid so mainly this remedy is used in non-publicly traded firms or transactions which shareholders have
structural reasons to believe consideration may not be “fair value.” (i.e. there is a controlling shareholder)
(GS feels this is never justified in an arms length transaction.)
c. DGCL §262 mandates appraisal only in connection with corporate mergers and only in certain
circumstances.
i. Shareholders get notice of appraisal right at least 20 days before shareholder meeting §262(d)(1)
ii. Shareholder submits written demand for appraisal before shareholder vote, and then votes
against (or at least refrains from voting for) the merger §262(d)(1)
iii. If merger is approved, shareholder files a petition in Chancery Court within 120 days after
merger becomes effective demanding appraisal §262(e)
iv. Court holds valuation proceeding to determine the shares’ fair value exclusive of any element
of value arising from the accomplishment or expectation of the merger §262(h)
v. No class action device available, but Chancery Court can apportion fees among plaintiffs as
equity may require §262(j)
2. Market-Out Rule – DGCL §262(b)
a. Always get appraisal rights – §262(b)
i. statutory merger, less than 2,00 shareholders (privately traded)
b. No appraisal right – §262(b)(1) don’t get appraisal rights if your
i. Shares are market-traded, or
ii. Company has 2,000 shareholders; or
iii. Shareholders not required to vote on the merger
c. Appraisal rights apply if – §262(b)(2)
i. merger consideration is anything other than shares in surviving corporation or shares in third
company that is exchange-traded or has 2,000 shareholders (with de minimis exception for cash in
lieu of fractional shares)
3. The Nature of “Fair Value”
a. The appraisal right is a put option – an opportunity to sell shares back to the firm at a price equal to their
“fair value” immediately prior to the transaction triggering the right.
b. 2 dimensions of appraisals
i. The definition of the shareholder’s claim (i.e. what it is specifically that the court is supposed to
value) AND
ii. the technique for determining value
c. Different ways to determine value –
i. Value as minority shares, that is, apply a minority discount – least desirable for dissenting
shareholders
ii. Value as pro rata claim on going concern value, that is, no minority discount but no claim on
the benefits of the deal.
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 iii. Value as pro rata claim on going concern value, including the benefits from the deal – most
desirable for dissenting shareholders
d. In Re Vision Hardware Group, Inc. (Del. Ch. 1995): Minority shareholders pursuing their appraisal
remedy contended that the debt of Better Vision should have been valued at its face value rather than at the
deep discount at which it was purchased by Trust Company of the West, the acquirer in the merger that
cashed out Vision’s public shareholders.
ii. Rule - The debt of an imminently bankrupt corporation should be valued at face value
rather than at discounted value paid by an acquirer as part of a transaction that will keep
the company from declaring bankruptcy
iii. Rationale –
1. In an appraisal proceeding, shareholders are entitled to the fair value of their shares,
without accounting for any element of value arising from the accomplishment or
expectation of the merger, on a going-concern basis, free of any minority discounts
2. However, in this case, it is more appropriate to view Vision on a liquidation basis b/c
w/o the TCW proposal and its effectuation, Vision was a going concern heading
immediately into bankruptcy and, unless new credit was made available, liquidation
3. Therefore, under the particular circumstances of this case, the appropriate valuation of
the company’s debt is the dollar value of the legal claim that that debt represented
4. Shares value was no greater than the amount paid in fact.
X. Transactions In Control
A. Introduction
1. Exchanging or aggregating blocks of shares large enough to control corporations.
2. Buyers are willing to pay a premium for this – why?
a. Premium is a payment for “private benefits of control”
b. Buyers believe they have a superior business plan that will increase the value of the stock in their hands
– attempt to drive up the price of their stock, pay premium for it.
3. Investors can acquire control in two ways – both raise issues
a. Purchase of a Control Block – Can purchase a controlling block of shares from an existing control
shareholder
i. Incumbent controller will demand a premium over market price.
ii. Can get premium through larger private benefits or by putting the company’s assets to more
profitable uses.
iii. Makes regulatory measures have two effects
iv. Mitigates the risk of opportunistic transfers of control to bad inquirers
v. But also could hinder the efficient transfer of control to acquirers who will use company assets
in more profitable ways.
b. Purchase of Public Shares – purchase the shares of numerous smaller shareholders – tender offer
i. Similar tradeoff b/t preventing bad transfers and hindering good ones
B. Purchasing a Controlling Block of Shares
1. Seller’s Duties – three issues: 1) extent to which the law should regulate premia from the sale of control; 2)
Law’s response to sales of managerial power that occur w/o transferring a controlling block of stock; 3)
seller’s duty of care to screen out potential looters.
2. Regulation of Control Premia
a. Different Tests
i. Common law rule – “market rule” – sale of control is a market transaction that creates rights
and duties between the parties, but does not confer rights on other shareholders.
ii. Alternative – “equal opportunity rule” – minority shareholders would be entitled to sell their
shares to a buyer of control on the same terms as the seller of control.
b. Zetlin v. Hanson Holdings, Inc. (N.Y. 1979)
i. Facts – When D and the Syvestri family sold their controlling interest in Gable Industries for a
premium price, P, a minority shareholder, brought suit contending that minority shareholders were
entitled to an opportunity to share equally in any premium paid for a controlling interest.
ii. Rule – Absent looting of corporate assets, conversion of corporate opportunity, fraud or
other acts of bad faith, a controlling stockholder is free to buy that controlling interest at a
premium price.
iii. Rationale
1. Minority shareholders are entitled to protection against abuse by controlling
shareholders, but not to inhibit the legitimate interests of other stockholders.
2. For this reason that control shares usually command a premium price – added amount
an investor is willing to pay for the privilege of directly influencing the corporation’s
affairs.

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 3. P basically arguing that cannot get control unless offer to all shareholders – this is
contrary to current law.
c. Perlman v. Feldmann (2nd Cir. 1955)
i. Facts – After D sold his controlling interest in the Newport Steel Corp., P and other minority
stockholders brought a derivative action to compel accounting for, and restitution of, allegedly
illegal gains accruing to D as a result of the sale.
ii. Rule – Directors and dominant stockholders stand in a fiduciary relationship to the
corporation and to the minority stockholders and beneficiaries thereof.
iii. Rationale
1. When the sale of a control block necessarily results in a sacrifice of an element of
corporate good will and consequent unusual profit to the fiduciary who has caused the
sacrifice, he should account for his gains.
2. Need not be absolute certainty that a corporate opportunity is involved, only a
possibility of corporate gain is necessary to trigger the fiduciary duty and recovery for
breach of that duty
iv. Dissent
1. As a dominant shareholder, D did not have a duty to refrain from selling the stock he
controlled – majority fails to specify the fiduciary duty that is being violated.
2. Record shows that D did not receive excess value for his stock, b/c a controlling block
is worth more than ordinary stock.
v. Note – this case dealt w/steel transactions during wartime – violated fiduciary duty b/c premium
was based on belief that steel shortage was an attempt to divert a corporate opportunity
d. Easterbrook & Fischel – Defense of Market Rule in Sales of Control
i. Sales of controlling blocs of shares – good example of transactions where the movement of
control is beneficial.
1. Premium price – unequal distribution of the gains
2. But this unequal dist. reduces the costs to purchasers of control, and increases
incentives for inefficient controllers to relinquish their positions.
ii. Some commentators say there should be a sharing requirement
1. “equal opportunity” rule – entitle minority shareholders to sell their shares on the same
terms as the controlling shareholder
2. These proposals would stifle transfers of control - people may not consent to the sale
of a controlling block, bidders may have to buy more than necessary, causing transaction
to be unprofitable.
3. Minority shareholders would suffer w/the decrease in management improvements.
iii. Perlman v. Feldmann – suggests that the gains may have to be shared in some
circumstances – had special circumstances here
1. Problems w/this treatment:
a. Court’s proposition that an corporate opportunity was extracted – unless the
price of the shares plummeted, it could not be extracting enough to profit.
b. Source of the premium is the same source of gains for the shares after the
buyer installed new managers and furnished a more stable market for the
products.
2. Not always as fortunate as shareholders in Perlman – have “looters” – take the $ and
run, one time transaction.
a. Hard to detect them in advance.
b. System should deter looters through heavy fines/imprisonment, not through
preventative remedy.
e. Delaware rule - Simple sale of a controlling block of stock, unconnected to any corporate activity,
is free of any duty to minority shareholders.
i. But these are rare – often need corporate action to facilitate the sale of a control block, and
whenever corporate board takes action, should do so when it believes that it is beneficial to the
corporation.
ii. In Re Digex Inc. Shareholders Litigation (Del. Ch. 2000)
1. Facts – Acquirer first approached the board of the partly held subsidiary of the
controller w/a lucrative offer. Controller arranged to sell itself to the inquirer in lieu of
selling the subsidiary, thereby excluding the subsidiary’s minority shareholders from a
premium, obtained a waiver of DGCL 203.
2. Rationale – failure to extract something in exchange for the waiver might violate the
board’s burden to show entire fairness because it is of value. Waiver must be for the
benefit of the corporation and all its shareholders, not just its controlling shareholder.
This shows that market rule doesn’t necessarily always work in practice.
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 3. Sale of a Corporate Office
a. Issue – sale of relatively small block of stock in a widely held firm at a premium by the CEO or
managing directors who simultaneously promise to resign.
i. Problematic b/c giving control w/o making them buy the appropriate amount of stock.
b. Carter v. Muscat (N.Y. 1964) – board of the Republic Corp. appointed a new slate of directors as part
of a transaction in which the company’s management sold a 9.7% block of its stock to a new “controlling”
person at a price slightly above market.
i. Despite a shareholder challenge, the court upheld the re-election of new directors at the annual
shareholders meeting.
c. Brecher v. Greg (NY 1975) – court found that paying a premium for control while only purchasing 4%
of a company’s outstanding shares is “contrary to public policy and illegal”

4. Looting – controlling shareholder may not sell his control block if he knows or suspects that the buyer
intended to “loot” the corporation by unlawfully dividing its assets.
a. Harris v. Carter (Del Ch. 1990)
i. Facts – Harris and other minority shareholders of Atlas Energy Corp. and his associates
committed a breach of fiduciary duty by negligently selling control of the corporation to a group
who looted it.
ii. Rule – A majority shareholder may be liable if he negligently sells control and such sales
damages the corporation.
iii. Rationale – When a corporate fiduciary’s action may foreseeably harm the corporation
his negligent acts causing such harm are compensable – applies negligence standard to
corporate context.
b. Note – Harris is the majority view – negligence is sufficient for looting.
i. Minority view – Levy v. American Beverage – in that case actual knowledge of the buyer’s
wrongful intentions was required for liability
ii. Excessive price alone is not ordinarily enough to put seller on notice that the buyer is a looter –
factor to be considered, but not determinative.
C. Tender Offers - an offer of cash or securities to the shareholders of a public corporation in exchange for their shares at a
premium over market price
1. Williams Act regulates tender offers
a. Purposes
i. Sought to provide shareholders sufficient time and information to make an informed decision
about tendering their shares and to warn the market about an impending offer.
ii. Also intended to assure shareholders of an equal opportunity to participate in offer premia & to
discourage hostile tender offers on the margin
b. Four Principle Elements
i. “Early warning system” – section 13(d) – alerts the public and the company’s managers
whenever anyone acquires more than a 5 percent of the company’s voting stock.
1. Basic Rule (Rule 13d-1(a)) – investor must file a 13D report within 10 days of
acquiring 5%+ beneficial ownership.
2. Rule 13d-1-(b) gives Partial exemptions for qualified institutional investors and
passive investors who only need to file within 45 days of year end.
3. Updating requirement (Rule 13d-2) – must amend 13D promptly on acquiring
material change (~ +/- 1%)
4. Key Definitions – “beneficial owner” means power to vote or dispose of stock (13d-
3(a)); group is anyone acts together to buy, vote, or sell stock (13d-5(b)(1))Each group
member deemed to beneficially own each member’s stock.
5. §13e-3 – Mandates strict disclosure when insiders plan to go private and force public
shareholders out of the company.
6. §13e-4 – Requires companies to make disclosures when tendering for their own shares.
ii. General Disclosure – Section 14(d)(1) – mandates disclosure of the identity, financing, and
future plans of a tender offeror, including any plans for any subsequent going-private transaction.
iii. Anti-Fraud Provision – Section 14(e) – anti-fraud provision that prohibits misrepresentations,
nondisclosures, and “any fraudulent, deceptive, or misrepresentative” practices in connection w/a
tender offer.
iv. Rules that regulate the substantive terms of tender offers
1. §14d-7 – Shareholders who tender can withdraw while tender offer open
2. §14d-10 – Tender offers must be made to all holders; all purchases must be made at
the best price
3. §14e-1 – Tender offers must be open for 20 business days
4. §14e-2 – Requires target’s board to comment on the tender offer.
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 5. §14e-5 – Bidder cannot buy “outside” tender offer
2. Wellman v. Dickinson (S.D.N.Y. 1979) – Court offered Eight factor Test to determine if it was a tender
offer:
a. Active and widespread solicitation
b. The solicitation is made for a substantial percentage of the issuer’s stock
c. A premium over the prevailing market price
d. The terms of the offer are firm rather than negotiable
e. Whether the offer is contingent on the tender of a fixed minimum number of shares
f. Whether the offer is open only for a limited period of time
g. Whether the offerees are subjected to pressure to sell their stock
h. Whether public announcements of a purchasing program … precede or accompany a rapid
accumulation.
3. Brascan v. Edper Equities Ltd. (S.D.N.Y 1979): Brascan, a Candadian company traded on the American Stock
Exchange, contended that Edper violated section 14e of the Williams Act when Edper acquired 24% of Brascan’s
stock over two days. Brascan claimed that this acquisition constituted a de facto tender offer and that Edper
therefore violated provisions requiring the announcements of further purchases.
b. Rule – The mere acquisition of a large portion of a company’s stock by itself does not constitute a
tender offer for purposes of section 14e of the Williams
c. Rationale – Conduct Edper engaged in is not what is commonly understood as a tender offer, all Edper
did was acquire a large amount of stock in open market purchases.
i. Edper’s conduct meets only one of 8 criteria for a tender offer:
1. Calling for active and widespread solicitation of public shareholders – this is clearly
not met
2. Calling for a larger accumulation of stock – is met
3. Calling for a premium over the prevailing market price is met, but only to a slight
degree.
4. Calling for firm offer terms, rather than negotiable terms, is not met.
5. Calling for the offer to be contingent on the tender of a fixed minimum number of
shares – met only to a slight degree
6. Calling for the offer to be open only for a limited period of time – not met.
7. Calling for the offerees to be subjected to pressure to sell their stock was not met.
8. Calling for public announcements of a purchasing program preceding or accompanying
a rapid accumulation – not met.
ii. Edper did not violate section 14e of the Williams Act
4. The Hart-Scott-Rodino (HSR) Act Waiting Period
a. Gives FTC & DOJ the proactive ability to block deals that violate the antitrust laws.
b. Minimum waiting period before closing a transaction §18a(b)(1)(B) – vary by transaction
i. Cash tender offers – acquirers must wait 15 calendar days after filing before closing
ii. Regulated open market purchases – acquirers must wait 30 days after filing
iii. Mergers, asset deals, and other negotiated acquisitions – both parties must wait 30 days after
filing
iv. may be extended for another 30 days (10 days for cash tender offers) if DOJ or FTC makes a
Second Request (§18a(e)(2))
c. Who must file – §18a(a)(2)
i. The acquirer in all deals > $212 million
ii. An acquirer with assets or sales > $106 million and a target with assets or sales > $11 million
(or vice versa), if the deal involves assets or securities > $53 million.
d. Corporate law importance – waiting periods it imposes before a bidder can commence her offer
i. Must be disclosed immediately to target companies, and bidders may not close a deal until the
relevant waiting period has elapsed.
D. Freeze-outs
1. Black Letter Rules
a. Freeze-out – transaction in which those in control of a corporation eliminate the equity ownership of the
non-controlling shareholders through legal compulsion.
b. Context in which a freezeout is likely to occur:
i. Second step of a two step acquisition transaction – A buys 51% of T’s stock then eliminates the
remaining 49% of shareholders through a merger.
ii. Where two long term affiliates merge – the controlling parent eliminates the publicly held
minority interest in the subsidiary
iii. Where the company goes private – insiders cause the corporation or its underlying business to
no longer be registered w/the SEC, listed on a stock exchange or actively traded over the counter.
c. General rule – in evaluating a freezeout courts will usually:
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 i. Try to verify that the transaction is basically fair AND
ii. Scrutinize the transaction especially closely in view of the fact that the minority holders are
being cashed out (as opposed to being given stock in a different entity)
d. Techniques for carrying out a freeze-out
i. Cash out merger – insider causes the corporation to merge into a well funded shell, and the
minority holders are paid cash in exchange for their shares, in an amount determined by the
insiders.
ii. Short Form Merger – If A owns 90% or more of T, then T can be merged into A w/all of Ts
holders paid off in cash.
iii. Reverse Stock split – outsiders end up w/fractional shares and the corporation can compel the
owners to exchange them for cash.
e. Federal Law on Freezeouts
i. SEC Rule 10b-5
1. If there has been full disclosure, then P is unlikely to convince the court that the rule
has been violated, no matter how “unfair” it may seem.
2. But if the insiders concealed or misrepresented material facts about the transaction then
the court may find a violation
ii. SEC Rule 13e-3 – requires extensive disclosure by the insiders in the case of any going-private
transaction, can be liable for damages or an injunction
f. State Law on Freezeouts
i. General test – in most states must meet at least the first prong and possibly the second:
1. The transaction must be basically fair, taken in its entirety, to the outsider/minority
shareholders.
2. The transaction must have been undertaken for some fair business purpose.
ii. Basic fairness – most courts require:
1. A fair price
2. Fair procedures by which the board decided to approve the transaction
3. Adequate disclosure to the outside shareholders about the transaction.
iii. Business purpose – sometimes cannot put through a transaction even if pay a fair price b/c sole
purpose cannot be to eliminate the minority stockholders.
1. Esp. likely to be applied when transaction is a going private one.
2. DE has abandoned this requirement.
2. Cash out Merger Cases
a. Weinberger v. UOP, Inc. (Del. 1983): Claiming that a cash-out merger b/t UOP and Signal was unfair,
P a former minority shareholder of UPO brought a class action to have the merger rescinded. Directors of
UOP were also directors of Signal, and study said $24 should be offered for shares, but Signal only offered
$21 w/o informing shareholders of the study.
ii. Rule – When seeking to secure minority shareholder approval for a proposed cash-out
merger, the corporations involved must comply w/the fairness test:
1. Fair dealings – imposes a duty on the corporations to completely disclose to the
shareholders all information germane to the merger and
2. Fair price – requires that the price being offered for the outstanding stock be
equivalent to a price determined by an appraisal where “all relevant non-
speculative factors” were considered.
iii. Rationale – This acquisition was not fair b/c no fair price, was lower than was study by
directors admitted was fair, dealings were not fair b/c was no negotiations and no disclosure about
the study w/the higher price.
b. Rabkin v. Phillip A. Hunt (Del. 1985): buyer of control block had K w/the seller that if the buyer
completed a cash-out merger within 12 months of purchasing control, it would pay the minority
shareholders no less per share than it had paid to acquire its control stake. Buyer waited a little more than
12 months and cashed out the minority at a lower price. Minority shareholders claimed a breach of
fiduciary duty instead of getting an appraisal b/c waited longer on purpose.
ii. Court permitted the non-apprasial attack to proceed.
c. Cede v. Technicolor, Inc. (Del. 1996): Merger arose out of a two-step, arm’s length cash merger
between a corporation controlled by Ronald Perlman and Technicolor, a public company w/no controlling
shareholder
ii. Court of Chancery found that Perlman did not owe a fiduciary duty to pay a fair price to the
minority shareholders in the second step merger
iii. Del SupCt – reversed
1. Perlman had a burden to establish that the price paid to minority shareholders
was fair and that the burden could not be satisfied by looking at the results of a
negotiation with the Technicolor board.
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 2. Appraisal remedy – P could simultaneously pursue an appraisal action and his claim
for breach of fiduciary duty.
iv. Note – Holding makes clear what Rabkin implied:
1. When there is a claim that the D owes fiduciary duties to public shareholders (i.e.
parent-subsidiary merger, two tier cash out merger) – appraisal is not the exclusive
remedy
2. But where there is a straight cash or stock merger between firms w/no shared
ownership interest, complains about price alone must be relegated to appraisal.
d. Fairness remedy still predominates – why?
i. Appraisal may not be available because of the “market out” provisions
ii. Action claiming breach of fiduciary duty can be brought before the merger, which provides the
P the opportunity to request a preliminary injunction.
iii. Suits for breach of fiduciary duty can be brought as class actions – leverage
3. What Constitutes Control – Kahn v. Lynch Communication Systems, Inc. (Del. 1994)
a. Facts – After Lynch’s board approved a controlling shareholder’s per share tender offer for its minority
shares, P sought to enjoin the cash-out merger and recover monetary damages.
b. Rule – A shareholder owes a fiduciary duty if it owns a majority interest in or exercises control
over the business affairs of the corporation.
c. Rationale
i. Despite is 43.3% minority shareholder interest, Alcatel exercised control over Lynch by
dominating its corporate affairs
ii. A controlling or dominating shareholder standing on both sides of a transaction bears the
burden of proving its entire fairness, which can be established by showing that negotiations were
conducted at arm’s length and that there was no compulsion to reach such an agreement.
iii. Chancery Court should not have shifted this burden to P.
4. Special Committees on Independent Directors in Controlled Mergers
a. Assuming a properly constituted, diligent and well advices special committee of independent directors
approved a transaction – courts treat it in two ways:
i. Treat the special committees as that of a disinterested and independent board, which merits
review under the deferential business judgment rule.
ii. Continue to apply the entire fairness test, even if the committee appears to have acted
w/integrity, since a court cannot easily evaluate whether subtle pressure or feelings of solidarity
have unduly affected the outcome of the committee’s deliberation.
b. In Re Western National Corp. Sharholders Litigation (Del. Ch. 2000)
i. Facts – shareholder Ps attacked the fairness of a merger between Western National and
American General. Value was $29.75 per share, preannouncement market price was $28.19.
Shareholders attacked the deal as unfair.
ii. Court granted SJ for Ds, held that since business judgment rules applied to judicial review of
the case, since in the court’s view, American General was not a controlling shareholder.
5. Controlling Shareholder Fiduciary Duty on the First Step of a Two-Step Tender Offer
a. A controlling shareholder who sets the terms of a transaction and effectuates it through his control of the
board has two duties:
i. A duty of fairness to pay a fair price.
ii. A duty under both corporate law and federal securities law to disclose all material information
respecting the offer.
b. In Re Pure Resources Inc Shareholders Litigation (Del. 2002)
i. Facts – Unocal Corp. owned 65.4% of Pure Resources, Inc., and wanted to take it private via an
exchange offer by which Unocal hoped to acquire the balance of Pure’s shares in exchange for its
own stock. Minority shareholders believed the offer was inadequate and coercive, and therefore
subject to entire fairness review. They also contended that Unocal and Pure’s board of directors
had not made adequate and non-misleading disclosure of material facts relating to the offer.
ii. Rule – a tender offer made by a controlling stockholder (to be followed by a short-form
merger) is coercive to the extent it includes in its definition of a “majority of the minority”
shareholders affiliated with the controlling stockholder as well as management which has
incentives that are different from those of other minority shareholders, but is not subject to entire
fairness review where the other aspects of the tender offer are non-coercive and full disclosure has
been made.
iii. TEST - To accomplish this, the law should consider an acquisition tender offer by a
controlling shareholders non-coercive only when:
1. It contains a non-waivable majority of the minority provision
2. A short form merger will take place immediately after the controlling shareholder
obtains more than 90% of the shares and
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 3. The controlling shareholder has made no retributive threats.
c. The Tender Offer Roadmap
i. Offer cannot be coercive: Our law should consider an acquisition tender offer by a controlling
stockholder non-coercive only when
1. It is subject to a non-waivable majority of the minority tender condition
2. The controlling shareholder promises to consummate a prompt §253 merger at the
same price if it obtains more than 90% of the shares; and
3. Controlling shareholder has made no retributive threats
ii. Target board independent directors must have role: the majority shareholder owes a duty to
permit the independent directors on the target board free rein and adequate time to react to the
tender offer, by (at the very least):
1. Hiring their own advisors, providing the minority with a recommendation as to the
advisability of the offer, and
2. Disclosing adequate information for the minority to make an informed judgment
iii. Details of fairness opinion must be disclosed “Stockholders are entitled to a fair summary of
the substantive work performed by the investment bankers”

Summary of DE law on Freeze-Outs: In light of Weinberger and later cases decided under it:
A. Entire Fairness Rule: A freeze-out transaction, as well as any other transaction in which
insiders are on both sides of the transaction, will be sustained only if it is “entirely fair,” as
measured by fair procedures, fair price, and adequate disclosure (Weinberger).
B. Burden of Proof: Under some circumstances, the burden of proof can shift to the plaintiff to
show that the terms of the transaction were unfair. For this burden-shifting to occur, however,
all of the three following things must happen:
1. Approval by a majority of minority – A majority of the minority shareholders must vote to approve the transaction
(Weinberger).
2. Disclosure – The D’s (insiders trying to sustain the transaction) must carry the burden of showing that they made adequate
disclosure of the transaction (Weinberger).
3. Arm’s Length Process – There must be a simulation of an arm’s length process, in which representatives of the minority
and the majority negotiates. Usually, this will be by a committee of independent directors, who negotiate with the majority-
holder (Kahn).
C. Damages: Plaintiff/shareholders attacking the fairness of a freeze-out or other merger
transaction, even if they win, will normally have to be content with a monetary recovery equal
to what they would have gotten under appraisal (Weinberger). This means that the Ps will
usually not be able to get an injunction, and will not be able to recover in a class action for all
the frozen out shareholders (including those who didn’t request appraisal). Therefore, a P will
normally have to comply with the appraisal statute (e.g., by giving notice, prior to the merge,
that he dissents) before he will even be allowed to attack the transaction on grounds of
unfairness.
1. Fraud or Overreaching – On the other hand, an injunction and class action damages will apparently still be available if the
Ps prove fraud, misrepresentation, or gross and palpable overreaching (Rabkin injunction against freeze-out allowed if P
can show “overreaching” by the majority).

F. Hostile Takeovers
1. Introduction
a. Works as a powerful market mechanism for displacing bad managers
i. If a corporation is badly managed, its share price will decline relative to others in the industry,
making it profitable for a new group to make a tender offer and bring it into more efficient
leadership.
ii. Control contests are profoundly unpleasant for incumbent managers
b. Law opened 2 avenues for initiating a hostile change in control
i. Proxy contest – the simple expedient of running an insurgent slate of candidates for election to
the board
ii. Tender offer – the even simpler expedient of purchasing enough stock oneself to obtain voting
control rather than soliciting the proxies of others
c. Black Letter Law
i. State regulation of hostile takeovers – DGCL 203
1. Prohibits any business combination b/w the corporation and an interested stockholder
for three years after the stockholder buys his shares.
2. Anyone who buys more than 15% of a company’s stock is covered.

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 3. Net effect – anyone who buys less than 85% of a Delaware corp. cannot for three years
conduct a back end merger b/t the shell he uses to carry out the acquisition and the target
therefore:
a. Cannot use the target’s assets as security for a loan to finance the share
acquisition
b. Cannot use the target’s earnings and cash flow to pay off the acquisition debt.
ii. Defensive Maneuvers
1. Pre-offer techniques – shark repellants – generally must be approved by a majority of
the target’s shareholders. Examples:
a. Super majority provision – may amend articles of incorporation to require that
more than a simple majority of the target’s shareholders approve any merger or
major sale of assets
b. Staggered board
c. Anti-greenmail amendment – prohibit the paying of greenmail to discourage
any hostile bidder bent on receiving greenmail.
d. New class of stock – second class of common stock and require that any
merger or asset sale be approved by each class then the new class can be placed
w/persons friendly to management.
e. Poison pill – try to make bad things happen to the bidder if it obtains control
of the target, making the target less attractive
i. Call plan – gives stockholders the right to buy cheap stock in certain
circumstances. Contain “flipover” provision that is triggered when an
outsider buys a certain amount of the target’s stock. Holder of the right
can then acquire shares of the bidder at a cheap price.
ii. “Put” plans – if a bidder buys some but not all of the target’s shares,
the put gives each target shareholder the right to sell back his remaining
shares in the target at a predetermined fair price.
iii. Shareholder approval is not generally required.
iv. Can be implemented after a hostile bid has emerged.
v. Most have been upheld, only where it has the effect for foreclosing
virtually all hostile takeovers it is shut down.
2. Post-offer techniques
a. Defensive lawsuits
b. White Knight – target finds itself a white knight who will acquire the target
instead of letting the hostile bidder do so.
i. Often given a lockup – some special inducement to enter into bidding
process
ii. Crown jewel option – e.g. of special inducement – option to buy one
of the target’s best businesses at a below market price.
iii. Lockups are the type of anti-takeover device that is most likely to be
invalidated, esp. if used to end, rather than create an action.
c. Defensive acquisition – target takes on a lot of debt to make itself less
attractive.
d. Corporate restructuring – restructure to raise short term stockholder value.
e. Greenmail – buys the bidder’s stake back at an above-market price, usually in
return for some agreement where the bidder agrees not to attempt to re-acquire
the target for a number of years
i. Most courts seem to allow this
f. Sale to friendly party – may sell less than controlling block to friendly party
who won’t tender to a hostile bidder.
g. Share repurchase – buy back shares from the public if insiders hold a
substantial but not controlling stake
h. Pac Man – target may tender for the bidder
iii. Delaware response to defensive maneuvers
1. Business judgment rule – target and its management will get the protection of the
business judgment rule under the following circumstances:
a. Reasonable grounds
i. Board and management must show that they had reasonable grounds
for believing that there was a danger to the corporation’s welfare from
the takeover attempt.
ii. May not use anti-takeover measure to entrench themselves in power
– must be protecting shareholder’s interests, not their own.
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 b. Proportional response – must show that the defensive measures they actually
used were reasonable in relation to the threat posed.
i. Cannot be preclusive – have the effect of foreclosing virtually all
takeovers.
ii. Cannot be coercive – forces management solution on the
shareholders.
c. Reasonable investigation – must reasonably investigate the hostile bid.
2. Decision to sell the company – once target’s management decides that it is willing to
sell the company, courts give enhances scrutiny to the steps the target board and
managers take.
a. Management and the board must make every effort to obtain the highest price
for the shareholders
b. All would be bidders must be treated equally.
c. If management is interested, have to be careful not to favor them.
3. Sale of Control – enhanced scrutiny given to transactions in which the board sells
control of the company to a single individual.
a. Only where the target is merging into a friendly controlled acquirer that
enhanced scrutiny will be triggered.
b. If target is merged into a friendly acquirer that is already held by the public at
large w/no single controlling shareholder or group, there will be no enhanced
scrutiny.
4. Board may just say no – If board has not previously decided to put the company up for
sale or dramatically restructure it, then the board basically has a right to reject unwanted
takeover offers.
2. Defending against Hostile Takeovers – Cases
a. Unocal Corp. v. Mesa Petroleum Co. (Del. 1985): Mesa was a stockholder in Unocal attempting a
takeover that Unocal’s directors tried to fight by making an exchange offer from which Mesa was excluded.
ii. Rule – A court will not substitute its own judgment for that of the board of directors of a
corporation that has decided to fight a takeover attempt by one of the shareholders in the
absence of showing that the decision was primarily based on some breach of the directors’
duty.
iii. Rationale
1. No duty owed to a stockholder in a corporation that would preclude the directors from
fighting a takeover bid by the stockholder if the board determines that the takeover is not
in the best interests of the corporation
2. Selective exchange offer was reasonably related to the threats posed (inadequate and
coercive two-tier tender offer) and fit within the directors’ duty to ensure that the
minority stockholders receive equal value for their shares
b. Unitrin v. American General Corp. (Del. 1995): American makes a hostile takeover bid, Unitrin’s
board resists by installing a “morning after” pill and repurchasing 20% of its shares. Share repurchase
increases Unitrin directors’ stake from 23% to 28% and gives the board a solid veto power over a freeze-
out transaction (due to 75% vote requirement for transactions with a >15% shareholder.)
ii. Chancery Court finds a threat of “substantive coercion” and upholds the pill as proportionate to
the threat, but strikes down the repurchase as disproportionate under Unocal.
iii. Delaware Supreme Court reverses “if the directors’ defensive response is not draconian
(preclusive or coercive) and is within a ‘range of reasonableness,’ a court must not substitute
its judgment for the board’s.”
iv. Re-articulation of Unocal Proportionality requirement
1. Second step of Unocal is a two-part inquiry:
a. Was defensive tactic “coercive” or “preclusive” and if not,
b. Does it fall within a range of reasonableness.
2. Defendant directors have burden of showing proportionality.
a. If D succeeds, then burden shifts to P to show breach of fiduciary duty (i.e.
entrenchment, lack of good faith, or being uninformed)
b. If D fails, it gets final opportunity to show entire fairness of the transaction
c. Moran v. Household International, Inc. (Del. 1985): Household International adopted a poison pill as
a general anti-takeover device, as opposed to a response to a particular threat.
ii. Rule – a corporation may adopt a poison pill as a general anti-takeover device as opposed
to a response to a particular threat.
iii. Rationale
1. When corporate directors prove that they had reasonable grounds for believing that a
danger to corporate policy and effectiveness existed, and that a defensive mechanism
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 adopted was reasonable in relation to the threat posed, the deferential business judgment
rule will be applied as the level of scrutiny to the directors’ decision
2. Whether the response is to a particular threat or a general threat is of no great relevance
3. Here, the Chancery Court found that the majority of Household’s board was concerned
about a two-tier tender offer takeover and that the defensive measures taken were
reasonable
d. Smith v. Van Gorkom (Del. 1985): The board of directors of Trans Union Corp. voted to approve a
merger agreement based solely on the representations of D, one of its directors.
ii. Rule – The business judgment rule shields directors or officers of a corporation from
liability only if, in reaching a business decision, the directors and officers acted on an
informed basis, availing themselves of all material information reasonably available.
iii. Rationale –
1. The director has a duty to the corporation’s shareholders to make an informed business
decision regarding a proposed merger before it is subjected to shareholder approval
2. Subsequent shareholder ratification does not relieve the director from this duty, unless
their approval is also based on an informed decision.
3. In this case, the directors breached their duty of care by failing to conduct further
investigation as to the proposed merger, and by submitting the proposal for shareholder
approval without providing them with the relevant facts necessary to make an educated
decision
e. Revlon, Inc. v. MacAndrews and Forbes Holdings, Inc. (Del. 1986): Solely to prevent a hostile
takeover, the board of Revlon granted Fortsmann certain lock up options
ii. Rule – A board of directors cannot grant lock up options solely to prevent competitive
bidding for a corporation
iii. Rationale
1. When it appears that an active bidding contest for a corporation is underway, the board
of directors, whose duty is to the shareholders, is under an obligation to do what it can to
maximize the sale price for the benefit of the stockholders
2. A lock-up is not necessarily illegal, and when it is done to prevent a takeover which
would be detrimental to shareholders, it may be employed
3. Where, however, the lock-up has no effect other than to prevent competitive
bidding, thus depressing the stock’s price, the lock-up works not to benefit the
shareholders, but rather it burdens them
4. Here, it has not been shown that the lock-ups were designed to do anything other than
stifle competitions, and this was improper
iv. Note – initial tender offer for Revlon was low, and the court did not argue w/the board’s early
defensive measures b/c they drove up the price of the stock.
f. Paramount Communications v. Time, Inc. (Del. 1989): Paramount contended that anti-takeover
measures enacted by Time’s directors in response to its tender offer were invalid b/c Paramount’s per-share
offer amount was fair market value.
ii. Rule – A board of directors’ efforts to prevent a takeover via a tender offer will not be
invalid merely b/c the takeover offer constituted fair market value.
iii. Rationale –
2. Under Revlon, a directorate is under a duty to maximize shareholder prices only when
it is clear that the corporation is “on the block,” meaning when a sale is a foregone
conclusion.
3. Time was not the object of a bidding war, and was not effectively up for sale, which
would have triggered a duty under Revlon on the p arty of Time’s directors to maximize
per-share-value.
4. This being so, for the business judgment rule to attach, the rule under Unocal is that a
directorate may oppose a takeover if:
a. There are reasonable grounds for believing that a danger to corporate
effectiveness and policy exist and
b. The defensive measures adopted are reasonable.
5. A court should not, under Unocal, substitute its judgment for that of the corporation’s
as to what is a “better” deal is.
a. First prong – Time’s board had decided, after long deliberation, that the
Warner deal was in the best long term interest of the corporation. Had reason to
worry about Paramount
b. Second prong – Time’s response to the threat was reasonable – carried
forward the pre-existing transaction in modified form.
g. Paramount Communications v. QVC Network, Inc. (Del. 1993)
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 i. Facts – The Paramount board approved unusually restrictive contractual provisions to prevent
unsolicited tender offers from interfering w/their intention to transfer control of Paramount to
Viacom.
ii. Rules
1. A change of corporate control or breakup of the corporation subjects directors to
enhanced scrutiny and requires them to pursue a transaction that will produce the
best value for stockholders
2. A board of directors breaches its fiduciary duty if it contractually restricts its
right to consider competing merger bids.
iii. Rationale
1. A judicial determination must be made as to whether the board’s decision-
making process was reasonable, and whether the board’s actions were reasonable
given the existing circumstances.
a. By selling the controlling interest in Paramount to Viacom, the majority
shareholders in Paramount would lose the ability to guide the corporation
through the selection of directors
b. Therefore, the fiduciary duties of the directors require that they endeavor to
assure that the shareholders receive the greatest possible value for their interests
2. Solicitation of competing bids for the corporation is a reasonable method to ensure that
shareholder interests are properly valued
a. The board was under a duty to inform itself of all realistic options that might
maximize the position of the shareholders
b. In this case, the Paramount board entered into highly restrictive contracts
which prevented it from considering other offers – preventing it from fully
informing itself.
3. Poison Pills
a. Types of Poison Pills
i. “Flip Over” Pill –
1. Gives target shareholders other than the bidder the right to buy shares of the bidder at a
substantially discounted price. (after freezeout)
2. Allegedly derived from DGCL §157“Every corporation may create and issue … rights
or options entitling the holders thereof to purchase from the corporation any shares of its
capital stock.” Emphasis added.
ii. “Flip In” Pill
1. Might be illegal in California
2. Gives target shareholders other than the bidder the right to buy shares of the target at a
substantially discounted price.
iii. “Chewable” Pill – Pill disappears if fair price criteria are met (e.g. fully-financed, 100% offer
for a 50% or more premium over current market price).
iv. “Slow Hand” Pill
1. Illegal in Delaware but legal in Maryland, Virginia, Pennsylvania, and Georgia
2. Pill that may not be redeemed for a specified period of time after a change in board
composition.
v. “Dead Hand” Pill
1. Illegal in Delaware but legal in Maryland, Virginia, Pennsylvania, and Georgia
2. Pill that may only be redeemed by the “continuing directors” so hostile board that is
elected in a proxy fight cannot redeem the pill for a stated period of time. Another case
ruled that current directors cannot restrict power of future boards.
3. Delaware said it was illegal because it created 2 classes of directors without necessary
charter authorization and unduly conditions rights of shareholders to elect new directors.
vi. “No Hand” Pill
1. Illegal in Delaware but legal in Maryland, Virginia, Pennsylvania, and Georgia
2. Pill that may not be redeemed by current or future boards for the life of the pill
(usually ten years).
b. Implementing a “Flip In” Poison Pill
i. The flip-in is a provision in the target company's corporate charter or bylaws.
1. The provision gives current shareholders of a targeted company, other than the hostile
acquiror, rights to purchase additional stocks in the targeted company at a discount rate.
2, These rights to purchase occur only before a potential takeover, and when the acquirer
surpasses the "kick-in" or threshold point of obtaining outstanding shares (usually 20 -
50%).

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 ii. No potential acquiror or other shareholder will risk triggering a poison pill by accumulating
more than the threshold level of shares because of the threat of massive discriminatory dilution,
making it prohibitively expensive to obtain control through purchase. The threshold level therefore
effectively sets a ceiling on the amount of stock that any shareholder can accumulate before
launching a proxy contest.
iii. Four steps:
1. Rights plan adopted by board vote. Shareholder vote not necessary as long as the board
has the requisite provision in the charter allowing it to issue blank check preferred stock.
2. Rights are distributed by dividend and remain “embedded” in the shares.
3. Triggering event occurs (it never does) when prospective acquirer buys >10% of
outstanding shares. Rights are no longer redeemable by the company and soon become
exercisable.
4. Rights are exercised. All rights holders are entitled to buy stock at half price – except
the acquirer whose right cancelled.
iv. In friendly deal, target wants to ensure that rights are not triggered, so it redeems the pill
v. Poison pill can be good in that they allow company to defend against hostile bidder (can veto
tender offer); can be bad because they deter potential bidders from value-creating transactions
c. “Dead Hand” Pills
i. Core idea – a pill cannot be redeemed by the “hostile” board that is elected in a proxy fight for a
stated period of time.
1. Can take a variety of forms
2. Radical idea – permit a board to limit the ability of shareholders to designate those
with board power
ii. Carmody v. Dell Brothers (Del Ch. 1998)
1. Delaware’s first case dealing w/dead hand pills
2. Held that such a device was invalid because:
a. it created two classes of directors without the necessary authorization in the
company’s charter and
b. it unduly conditioned the rights of shareholders to elect new directors.
iii. Mentor Graphics Corp. v. Quickturn Design Systems (Del Ch. 1998)
1. Facts – No discrimination b/t old and new directors. Delayed redemption provision -
provided that, while generally the board had a redemption power, it had no such power
for 6 months following the election of a new board (or a majority of new directors)
2. Chancery Court - Struck down the pill based on a Unitrin/Unocal analysis. No abstract
threat to the corporate made reasonable the imposition on the shareholders’ right to have
fully functioning directors in place.
3. Del supCt – affirmed but did not invoke the Unocal/Unitrin principle
a. Was based on the statutory interpretation of directors’ power
b. Present board did not have the authority to restrict the power of future
boards to exercise their managerial judgment.
c. Rationale raises interesting questions – other things such as standard
contracts restrict the power of future boards
d. Mandatory Pill Redemption Bylaws
i. Requires the board of directors to redeem an existing pill and to refrain from adopting a pill
without submitting it to shareholder approval.
ii. Present two controversial issues
1. Is a bylaw that mandates the board to exercise its judgment in a particular way a valid
bylaw?
a. Most leading Delaware firms have opined that a mandatory bylaw would
constitute an invalid intrusion by the shareholders into the relam protected by
section 141(a) of the DGCL
b. Delaware courts haven’t reached a conclusion on this issue
2. Whether managers must include in the company’s proxy solicitation, materials
respecting any such proposal.
a. Questions are related, if it is invalid, SEC is not going to require certification.
iii. Unisuper v. News Corp. (Del Ch. 2005)
1. Facts – The News Corp. board of directors contended that an alleged agreement it had
made w/shareholders to permit a shareholder vote on poison pills was unenforceable as a
matter of law b/c it was inconsistent w/the grant of managerial authority to the board and
b/c it would require the board to refrain from acting when the board’s fiduciary duties
required action.

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 2. Rule – A K b/t a corporation’s shareholders and its board of directors to permit a
shareholder vote on defensive measure is not invalid as a matter of law
3. Rationale
a. The agreement here gives power to the shareholders, and not a third party, so
it is saved from invalidation under the statute – shareholders are ultimate holders
of power in the corporation, and exercise right to vote to exercise control.
b. Board doesn’t disable its fiduciary powers by granting power to the
shareholders – shareholders should be able to fill a particular gap in the
corporate K if they want.
c. When the shareholders, as principals, make explicit the corporate K on a
given issue, the directors, as agents, must act in accordance with the amended
corporate K, there is no longer the need for the gap filling role performed by the
fiduciary duty analysis.
4. Closing the Deal
a. Lock-up – any contract, collateral to an M&A transaction, that is designed to increase the likelihood that
the parties will be able to close the deal
i. Two major categories
1. Asset lock-ups – create rights to acquire specific corporate assets that become
exercisable after a triggering event, such as a target shareholder vote disapproving a
merger or a target board’s decision to sign an alternative merger agreement
2. Stock lock-ups – options to buy a block of securities of the target company’s stock at a
stated price
ii. Termination fees are often justified as necessary to compensate a friendly buyer for spending
the time, money, and reputation to negotiate a deal with a target when a third party ultimately wins
the target
1. Courts approve reasonable payments
2. Boards of the target and acquiring companies see unique benefits from the favored
transaction that the target’s shareholders may not recognize, and that these boards
therefore wish to minimize the possibility that a third party might break up the deal
iii. In determining whether a lock-up is consistent with the board’s duties in a Revlon transaction,
courts will weigh such considerations as how early in the process the lock-up was given and the
value-enhancing nature of its specific terms
iv. Buyers rights under “deal protective” provisions are commonly triggered by:
1. Failure of the board to recommend a negotiated deal to shareholders in light of the
emergence of a higher offer (thus employing a “fiduciary out,” which is discussed in the
next section)
2. A rejection of the negotiated deal by a vote of the target’s shareholders
3. Later sale of assets to another firm
b. “No Shops/No Talks” and “Fiduciary Outs”
i. For acquirers in corporate mergers, the legal requirement that the target’s shareholders vote
approval introduces an irreducible contingency into merger contracts – a second bidder might
offer a price before the shareholders vote and the deal closes
ii. Buyers protect against this risk in two ways
1. Seek a large lock-up, as described above
2. Seek certain covenants from the seller that will protect their deal
a. Ex: not to shop for alternative transactions or supply confidential information
to alternative buyers
b. To submit the merger agreement and no other agreement to the shareholders
for approval
c. To recommend that shareholders approve this agreement
iii. When a better deal arrives before the shareholder vote, can the target’s board continue to
recommend the less attractive original deal without violating their duty of loyalty? Or face
contractual damages?
1. “fiduciary out” clause – if some triggering event occurs, then the target’s board can
avoid the contract without breaching it
5. Shareholder Lock-ups –
a. Omnicare, Inc. v. NCS Healthcare, Inc. (Del. 2003)
i. Facts – Omincare sought to acquire NCS Healthcare. Genesis Health Ventures had made a
competing bid for NCS that the NCS board had originally recommended, but then withdrew the
recommendation and instead recommended that the shareholders accept the Omnicare offer, which
was worth more than twice the Genesis offer. However, the agreement b/t Genesis and NCS
contained a provision that the agreement be placed before the NCS shareholders for a vote, even if
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 the board no longer recommended it. There was also no fiduciary out clause in the agreement.
Pursuant to voting agreements, two NCS shareholders who held a majority of the voting power
agreed unconditionally to vote all their shares in favor of the Genesis merger, assuring it would
prevail. Omnicare challenged the defensive measures that were part of the Genesis transaction.
ii. Rule - Lock-up deal protection devices, that when operating in concert are coercive and
preclusive, are invalid and unenforceable in the absence of a fiduciary out clause
iii. Rationale
1. Apply Unocal, not Revlon b/c no sale of control or break up.
2. First prong – the Genesis defensive measures were unreasonable and not proportionate
to the threat – left NCS w/no alternative transaction
3. Second prong – defensive measures were both preclusive and coercive, and, therefore,
draconian and impermissible - completely prevented the board from discharging its
fiduciary responsibilities to the minority stockholders when Omnicare presented its
superior transaction
4. Defensive measures – the voting agreements and the provision requiring a shareholder
vote regardless of board recommendation – when combined to operate in concert in the
absence of an effective fiduciary out clause are invalid and unenforceable
iv. Dissent
1. NCS board’s actions should have been evaluated based on the circumstances present at
the time the Genesis merger agreement was entered into – before the emergence of a
subsequent transaction offering greater value to the stockholders
2. The lock-ups were reached at the conclusion of a lengthy search and intense
negotiation process in the context of insolvency, at a time when Genesis was the only
viable bidder
3. Under these facts, the NCS board’s action before the emergence of the Omnicare offer,
reflected the actions of “a quintessential, disinterested, and informed board” made in
good faith, and was within the bounds of its fiduciary duties and should be upheld
4. Any bright-line rule prohibiting lock-ups, such as the one put forth by the majority,
could, in circumstances such as those faced by the NCS board, chill otherwise
permissible conduct
b. Orman v. Cullman, (Del Ch. 2004)
i. Facts – Through dual class structure Cullman family owns controlling interest in General Cigar
since IPO in February 1997. January 2000 Swedish Match agrees to buy out minority shareholders
of General Cigar at $15.25 per share cash, such that Swedish Match would own 64% and the
Cullman family would own 36% of General Cigar (with Cullmans still retaining control).
1. Merger agreement contained:
a. No breakup fee
b. A fiduciary out that allowed General Cigar to consider an unsolicited superior
proposal
c. A class vote of the A and B shares separately
d. A majority of the minority approval (effectively) from the Class A
shareholders
2. Cullman family agreed to vote their controlling interest for the Swedish Match
transaction and against any alternative acquisition proposal for 18 months after any
termination of the merger.
ii. Chancery court upholds shareholder lockup: “In Omnicare the challenged action was the
directors’ entering into a contract in their capacity as directors. The Cullmans entered into the
voting agreement as shareholders… Unlike Omnicare, the public shareholders were free to reject
the proposed deal, even though permissibly their vote may have been influenced by the existence
of the deal protection measures.”
6. State Anti-takeover Statutes
a. First Generation of anti-takeover statutes
i. Addressed both disclosure and fairness concerns
ii. Was generally limited to attempted takeovers of companies w/a connection of the enacting
statute
iii. E.g. Illinois Business Takeover Act of 1979
1. Required any offer for the shares of qualifying target companies to be registered w/the
secretary of state, after which the offer entered a 20 day waiting period and then become
registered unless during that period the secretary called a hearing to adjudicate the
fairness of the offer.
2. Secretary had discretionary power to call hearing, but was required to do so if
requested by the target’s outside directors
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 3. Would deny if offer failed to provide full disclosure or was inequitable and would
impart fraud and deceit
4. In 1982 – Supreme Court struck down this Act as preempted by the federal Williams
Act & in violation of the Supremacy clause
b. Second generation of statutes then attempted to avoid preemption by the Williams Act by maintaining an
appropriate balance between the interests of the offerors and the targets within the overarching policy of
investor protection.
i. E.g. “Fair price statute” – deters coercive two tier takeovers by requiring that minority
shareholders who are frozen out in the second step of such a takeover receive no less for their
shares than the shareholders who tendered in the first step of the takeover.
1. Typically achieved by requiring a high supermajority vote to approve a freeze out
merger unless it provides a “fair price”
ii. E.g. “control share statute” – resists hostile takeovers by requiring a disinterested shareholder
vote to approve the purchase of shares by any person crossing certain levels of share ownership in
the company that are deemed to constitute “acquisition of control”
1. Ohio enacted a statute in 1982 that became a model for other states
2. Indiana enacted a statute that varied the model by allowing the bidder to cross the
relevant ownership thresholds without obtaining shareholder approval but w/an automatic
loss of voting rights.
a. The offeror could regain voting control upon gaining approval from a
majority of disinterested shareholders.
b. Statute was upheld in case below
iii. CTS Corp. v. Dynamics Corp. of America (1987)
1. Facts – Indiana enacted a statutory scheme requiring shareholder approval prior to
significant shifts in corporate control.
2. Rule – A law permitting in state corporations to require shareholder approval
prior to significant shifts in corporate control is constitutional.
3. Rationale – Corporations are creatures of state law, and states are free to formulate
policy regarding the internal operations of corporations, provided they do so in a non-
discriminatory manner, which is the case here.
c. Third Generation Anti-takeover statutes (1987-2000)
i. Followed logically from the SupCt holding in CTS that state antitakeover legislation is
consistent w/both the Williams Act and the Commerce Clause if it allows a bidder to acquire
shares, even if it makes such acquisition less attractive in some circumstances.
ii. “Business combination statute” – aka moratorium statute
1. Prohibits a corporation from engaging in a “business combination” within a set time
period after a shareholder acquires more than a threshold level of share ownership
2. Some statutes allow merger to proceed if a statutory fair price is paid
3. DGCL 203 – its moratorium statute
a. Meant to deter “junk bond” financed “bust up” takeovers by preventing
acquirers from getting their hands on the assets of target firms
b. Two “outs” that may affect the planning of an acquisition
i. Statute’s restriction does not apply if the bidder can acquire 85% of
the outstanding voting stock in a single transaction.
ii. Its restrictions do not apply if after acquiring more than 15% but less
than 85%, a bidder can secure a 2/3 vote from the remaining
shareholders (other than itself) as well as board approval.
c. Defines the term “business combination” narrowly so as only to cover
transactions between the target and the bidder or its affiliates.
iii. Disgorgement statute – PA and Ohio
1. Mandate the disgorgement of profits made by bidders upon the sale of either stock in
the target or assets of the target.
2. Any bidder who acquires a fixed percentage of voting rights, including (in some acts)
voting rights acquired by proxy solicitation, is subject to this statute.
3. Under PA statute – any profit realized by a controlling person from the sale of any
equity security of the target within 18 months of becoming a controlling person belongs
to the target.
4. Ohio statute – more circumscribed – provides safe harbors to management proxy
solicitations.
iv. Redemption Rights Statute – Allows shareholders to bring an appraisal action not merely for
freeze out mergers but also whenever a person makes a “controlling share acquisition,” defined as
acquisition of 30% of a corporation’s stock.
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 v. Constituency statutes
1. Allow (or in some states require) the board of a target corporation to consider the
interests of constituencies other than the shareholders when determining what response to
take to a hostile takeover offer.
2. Deter takeovers by releasing directors from some of the fiduciary constraints imposed
by caselaw, allows the board to use broader justifications.
3. Example of Indiana’s statute
a. Alters the content and judicial scrutiny applied to director’s duties.
b. Rejects Delaware’s imposition of enhanced scrutiny and instead referred
solely to “good faith exercise of business judgment after reasonable
investigation” as the measure of a directors duty.
7. Proxy Contests for Corporate Control
a. Schnell v. Chris-Craft Industries (Del. 1971)
i. Facts – Ds managing directors amended the bylaws in accordance w/the new DGCL, advancing
the date of the annual stockholders meeting.
ii. Rule – Inequitable action does not become permissible simply b/c it is legally permissible.
iii. Rationale
1. There is no indication of any prior warning of management’s intent to amend the
bylaws to change the annual stockholders’ meeting date.
2. Rather it appears that management attempted to conceal this action as long as possible.
3. Stockholders may not be charged with the duty of anticipating inequitable action by
management and of seeking anticipatory injunctive relief to foreclose such action.
4. Until management changed the date of the meeting, the stockholders had no need of
judicial assistance.
iv. Dissent – in view of the length of time leading up to the immediate events that caused the filing
of this action, the lower court was correct that the application for injunctive relief came too late.
b. Blasius Industries, v. Atlas Corp. (Del. Ch. 1988)
i. Facts – The Board of Directors of D sought to prevent P from obtaining shareholder approval of
its plan to enlarge the board by voting to expand the board to give control to an insurgent group.
ii. Rule – A board of directors may not enlarge the size of the board for the purpose of
preventing a majority of shareholders from voting to expand the board to give control to an
insurgent group.
iii. Rationale
1. Shareholder franchise is the ideological basis for directorial power.
2. The only legitimate reason why a select group of persons can control assets not
belonging to them is a mandate from those who do control the assets.
3. Consequently, any effort made by the directors to frustrate the will of the majority,
even if taken for the most unselfish of reasons, must fail.
4. Any attempt to frustrate shareholder voting cannot stand up to a challenge
c. Notes on Schnell and Blasius
i. Judicial review under these cases is perhaps the most exacting under corporate law –
unequivocally reverses the business judgment presumption – director action that interferes with
the voting process is presumptively inequitable.
ii. But these two cases do not always apply – since manipulations of the voting process can be
characterized as “defensive” courts may apply the Unocal test to them (less demanding)
iii. In both instances directors have the burden to establish compliance w/a relative standard
iv. Differences b/t Unocal and Blasius review
1. Blasius requires a very powerful justification to thwart shareholder franchise for an
extended period – But a week or two may allow a less compelling justification
2. Time Warner opinion seems to authorize a target board to take defensive action of the
company is threatened by “substantive coercion” (which basically means the company
knows best) – this excuse cannot be used under Blasisus review
d. Hilton v. ITT Corp. (D. Nev. 1997)
i. Issue – whether certain defensive actions by the ITT board in response to a Hilton takeover
attempt constituted a violation of fiduciary duty.
ii. Facts – ITT board tried to reorganize w/o shareholder vote to prevent takeover by Hilton. Hilton
said action was to protect the incumbency of the board and constituted a breach of fiduciary duty.
iii. Court first determined that the ITT board could reasonably conclude that Hilton’s offer was
inadequate. Then considered whether the defensive action was preclusive or coercive – said it was
both – the new provision would preclude current shareholders from exercising a right they
currently possess – to determine the membership of the ITT board.

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