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-Chapter 1-

1. Agency-

a. elements:

i. A Voluntary relationship b/n two persons,

i. one, the Principle, has a right to control the conduct of the other

i. the Agent has the power to affect the legal relations of the principle.

Neither a contract nor compensation are required.

a. Principles:

i. Disclosed Principle- The existence and identity of the principal is

known to a third party.

i. Partially Disclosed Principle- The existence of the principal is known

to a third party, but the identity is not known.

i. Undisclosed Principle- Neither the existence nor identity of the

principal is known to the third party.a. Agents-

i. General Agent- A person continuously employed to conduct a series of

transactions for a principal

i. Special Agent- A person employed to conduct a limited number of transactions for a principal

i. Master/Servant- An Agent whose actions are subject to the control of

the principle.

i. Independent Contractor- An agent whose actions are not subject to the

control of the principal.

i. Subagent- An agent hired by another agent who has authority to do so.

• Servant v. Independent Contractor

Servant

• Salary

• Continuous Employment

• Tools furnished by Employer

• Work's on Employer's premises• Unskilled/Supervised Work

• Regular part of Business

Independent Contractor

• Paid by the hour/project

• Works on specific projects, not continuously.

• Tools furnished by Contractor

• Works at Contractor's office/shop

• Skilled/Unsupervised Work

• Nonrecurring business, unique projects

•[1] Gorton v. Doty: D lost b/c she loaned her car to Garst for

transporting P's team, Garst got in an accident, P injured, and D was

held responsible as the Principle, Garst was the agent.• Creditor's control – If a creditor assumes control of his debtor’s

business, he may be held liable as principal for the acts of his debtor inconnection with the business (this includes day to day operations).

Gay Jenson Farms Co. v. Cargill, Inc.: D1 in addition to

loaning funds to D2, also took control of the day to day

operations of D2. both Ds lose.

a. (Contracts) Liability of Principle

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• Actual Authority- express or implied

Express Actual Authority- the statements that the principalmade to the agent, orally or in writing granting power.

Implied Actual Authority- Agent's additional authority inferredfrom the express authority granted.

•[1] Mill Street Church of Christ v. Hogan: P hired

Hogan1 to paint its church. Hogan1 needed and got help from his brother, Hogan2, who broke his leg.

Hogan2 held P responsible for injuries. Hogan had

implied authority to hire Hogan2 because it was

necessary to implement Hogan1’s express authority

as an agent of P to complete the painting. P loses.

• Authority from necessity – an agent has impliedauthority to hire a subagent when such authority isnecessary to implement agent's express authority.

• Apparent Authority- Whenever conduct of a principal causes a third party to believe the agent has authority, the agent will have apparentauthority to obligate the principal.

Three Seventy Leasing Corp. v. Ampex Corp.: A salesperson at Dagreed to sell certain computers to P despite not having beengiven the authority to do so by D. D loses.

buyers belief can bind a principal – A salesperson binds hisemployer if he makes a sale which leads a buyer to believe that asale had been made.

• Watteau v. Fenwick: D authorized Humble as

purchasing agent, but only for specific items, an

authorization which Humble then exceeded. D loses.

• Inherent Authority - (looks at agents status & custom)- Authority of anagent to perform tasks typically performed by that type of agent, evenw/o specific instructions.

incident matters to the agency – When one holds another out as an agent, that agent can bindthe principal on matters normally incident to such agency, even if he was not authorized for a particular type of transaction.agent acting within boundaries – An agent acting within the usual boundaries of his role bindshis principal even if the details of the transaction to which he agrees were not authorized.Ratified Authority- If an agent did not have either actual or apparent authority, the principalmay nevertheless ratify an agent's past transaction. (Principal must have full knowledge of actionstaken)Marital status – Marital status cannot in and of itself prove an agency relationship.Agency by Estoppel (fairness)– the appearance of authority must be shown to have been created by the manifestations of the alleged principal and not solely by the supposed agent.(Contract) Agent’s liability – an agent becomes liable for not disclosing, or partially disclosing,

his status as representative and principles identity. (actual knowledge is the test.)(Torts) Liability to 3rd Parties:

Liability of Agent- Agents will always be liable for their own Torts, no matter where, when,how, or under whose employment their tort happened.Liability of Principal- Generally, the law requires that principals be responsible for all acts of aservant, but not for independent contractors.However, the servant must be in the Scope of Employment:The nature of the job the agent was engaged to perform;Time and space limitations concerning the agent's whereabouts and activities,

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agent's frolics are not in scope of employment

Harm caused while performing duties intended for principal.If force is intentionally used by the servant against another, the use of force is not unexpectable

by the master.Servant v. Independent Contractor – A Party may be liable for a contractor’s torts if heexercises substantial control over the contractor’s operations.

Humble Oil and Refining Co. v. Martin: P injured when a car rolled out of a service stationowned by D. P held D liable for the station operator’s negligence.

Franchisee- Independent Contractor – A franchisee is considered an independent contractor of the franchisor if the franchisee retains control of inventory and operations (the day to dayoperations).Agent Relationship by Franchisor Control - If a franchise contract so regulates the activities of a franchisee as to vest the franchiser with control within the definition of agency, a principal-agent relationship arises even if the parties expressly deny itRestatement (2nd) of Agency 1 – agency is a fiduciary relation resulting from consent of one person to have another act on his behalf. Billops v. Magness Construction Co.: D1 exercised substantial day to day control of its

franchisee, D2. D loses.

Scope of Employment – Conduct of an employee is within the scope of employment even if thespecific act does not serve the employer’s interests if the act was reasonably foreseeable. Ira S. Bushey and Sons, Inc. v. United States: When a drunk Coast Guard seaman turned

wheels on a drydock wall, damaging a drydock owned by P, P sued the Federal Government,

D, for compensation. P wins.

Plaintiff's proof – To recover damages from an employer for injuries from an employee’sassault, the Plaintiff must establish that the assault was in response to the Plaintiff's conduct,which was presently interfering with the employee’s ability to perform his duties successfully. Manning v. Grimsley: When P, while attending an Orioles baseball game, continuesly heckled

the pitcher, D, D pitched a speed ball directly into the mesh screen in from of P. the ball went

through the screen, injuring P, whereupon P sued both D and the Club (D), his employer, for

battery and negligence. D loses.

Liability for torts of independent contractors – Although not ordinarily liable for thenegligence of a hired contractor, liability ensues when the contractor performs inherentlydangerous work (and the liability is absolute where the work is ultra-hazardous). Majestic Reality Associates, Inc. v. Toti Contracting Co.: D1 hired D2 (a gen. contractor) to

demolish a building. The building fell and injured P's neighboring building. D loses.

Fiduciary Obligations – A legal obligation to act for the benefit of another, includingsubordinating one’s personal interests to that of the other person.Breached Agency Fiduciary Duties:

agent making his own profit - An agent who takes advantage of the agency to make a profitdishonestly is accountable to the principal for the wrongfully obtained proceeds. Reading v. Regem: When military authority took possession of bribe money obtained by P

while an army sergeant, P filed a petition for its return, and won.

agent drawing business away – An agent who draws business away from his principal for hisown enrichment is liable to the principal for his profits there from.General Automotive Manufacturing Co. v. Singer: D, a consultant and representative of P,

solicited customers on his own behalf. Had to return $.

Lack of Loyalty – A director’s duty to refrain from self-dealing or to take a position that isadverse to the corporation’s best interest.Abuse of Position- “grabbing and leaving” – Former employees may not use confidentialcustomer lists belonging to their former employer to solicit new customers.

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Town and Country Housing and Home Service, Inc. v. Newbery: Certain employees of P left,

formed a competing company, and utilized customer lists they had obtained from their

former employer. They lost.

CHAPTER 2

PARTNERSHIPS (UPA- Uniform Partnership Act 1914) –

Definition of Partnership- an association of “two or more persons to carry onas co-owners of a business for profit” (a legal entity)Partners v. Employees –

Partners have AUTHORITY AND CONTROL for operating the business.Right to share in PROFITS,Obligation to share LOSSES,ownership and control,combined w/ capital (very important) andheld out as partner to 3rd parties,rights of the parties on dissolution,language of agreement not controlling. Employees –

Employee- Definition is Opposite of Partner no control, no authority…

Who are Partners?

Fenwick v. Unemployment Compensation Commission: beauty shop

employee not given raise but made “partner” w/ profit sharing--

Without control and obligation for losses. is she a partner? NO

Proving Partner status:

Intention of parties;manifested intent (not conclusive);

the right to share in profitsSharing profits is Prima facie proof of partnership,

BUT NOT if received in payment of;

debt by installments,wages of employee or rent to landlord,

annuity to widow or rep or deceased partner,

interest on loan (though amt may change w/

profits),

or for sale of good will of business or other

property by installments.

obligation to share in losses;Ownership andcontrol of property and operations;Conduct toward 3rd parties—

filing partnership income taxes;

how they describe themselves to other parties (i.e.,Unemployment Commission);registration as partnership; and,

rights to assets in dissolution.Investors as Partners

Totality Test- A partnership might be shown by a number of

agreements that otherwise might not be enough, by

themselves, to show a partnership,

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However, sharing in profits is a sensible security for a

loan to a partnership that doesn’t establish a

partnership.

Some Element to the Totality of the Circumstances

Test

title of k;

fixed term of k;sharing any operating costs;

sharing in losses;

shared management;

conduct toward 3rd parties;

partnership name;

p-ship tax return filed;

intentionally shared assets;

Testimony on character of relationship.

Southex Exhibitions, Inc. v. Rhode Island Builders Assocation,

Inc. (p. 102)

Facts: Southex was successor in interest to a contract

with Rhode Island Builder's Association (RIBA). Thecontract described their relationship as a partnership,

whereby Southex was to produce all RIBA home shows

at a particular venue, but that if that were unavailable

RIBA would be able to go elsewhere. The k was five

years and renewable on mutual agreement.

Holding: No partnership existed.

Partnership by Estoppel

Requirements to have a Partnership Estoppel (requiring a

Partnership by law for fairness)

Representation that one person is the partner of another Evidence of the person charged as representing themselves as a

partner.Reasonable Reliance and Good Faith by a third party upon thatrepresentationDamage- A change in position with consequent injury by thethird party in reliance.

Young v. Jones (p. 110)- On the basis of a falsified financial

statement done by a Bahamas Price Waterhouse Firm, plaintiff put

$550k in a SC bank, from which the $ disappeared. Plaintiff sought

to hold PW US Firm liable as a general partner—which licensed PW

Bahamas to use the PW name.

Rule: Partners by estoppel are jointly and severally liable to

all persons who gave credit to the firm.

Fiduciary ObligationsPartners owes each other and partnership a duty of 1) loyalty and, 2)care.

Duty of loyalty

To account for and hold as a trustee the partnership'swell-being.Can't perform in ventures against partnership's goodCan't compete w/ partnership while partnership exists.

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Meinhard v. Salmon (p. 111)[Partner sold subject of P- ship W/out Consulting Partner]- Partner keptopportunity to himself, sold it, and made lots of moneyand left his partner out in the cold.

Rule: Opportunities made available to a partner must be offered to both partners while the

partnership exists (i.e., while the fiduciaryobligation exists.)Furthermore, the managing partner has a greater duty of loyalty to the financing partner.“uncompromising ridigy has been the attitude of the courts of equity when petitioned toundermine the rule of undivided loyalty by the“disintegrating erosion” of particular exceptions.”

Duty of Care- a breach in the duty of care is usually in winding

down, and limited to gross negligence, reckless conduct,intentional misconduct, or knowing violation of law.

Acting in own interest doesn’t necessarily violate duty or obligation.Partner may lend money and transact other business w/the partnership same as non-partners.After Dissolution –Duty of care in winding downlimited to gross neg and reckless conduct, intentionalmisconduct, or knowing violation of law. No duties toformer partners.

Bane v. Ferguson (p. 117)- A law partner

retired, but the firm afterwards dissolved the

firm, which resulted in a termination of his

retirement benefits.

Rule: Partners have no fiduciary duty to former partners (unless unanimously agreed upon).

Grabbing and Leaving (p. 119)Rule: Partners owe each other a fiduciary duty of “the utmostgood faith and loyalty.”Rule: Partner has obligation to “render ON DEMAND true and full information of all things affecting the partnership to any partner.” UPA 20.

Meehan v. Shaughnessy (p. 119)-: Defendant

Partners in a firm should have given 3 months notice

for quiting, but only gave 30 days and also lied to

other partners about their plan to leave.

Rule: When a partner intends to leave a firm hehas an obligation to let his current partners havean opportunity to compete for the clients heseeks to take with him. Rule: Former partners must pay former partnership any profits from clients obtainedthrough the former partnership.

Expulsion of Partner (p. 127)

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Expulsion – involuntary expulsion must be “bona fide” or in“good faith” to not violate partnership agreement (PartnershipAgreement controls).

Lawlis v. Kightligner & Gray (p. 127)- Lawlis was a

drunk senior partner—involved in the partnerships

management. He was given two chances to clean up.

He had signed the partnership agreement which hada "no cause termination." The firm fired him for no

cause.

Rule: The partnership agreement sets out theterms for the involuntary expulsion of partners;P’ship agreement had legal “no cause”termination clause.

Partnership Property (p. 134)- (Ss401)

Rule: Partnership assets owned by entity not individuals. (althoughindividual personal property is owned by the individuals, not the partnership)

A Partner has:

rights in status of being partner in the partnership;interest in the property (a right to share in profits and anobligation to share in losses); andright to participate in management .

Rule Ss26- If a partner sells his partnership interest to anassignee, it does not dissolve the partnership, nor give theassignee a right to management or administration (unlessotherwise agreed by all partners), but only entitles the assigneeto the profits previously accorded to the old partner.

However, although a partner may assign his partnershipinterest to an assignee, he cannot sell his rights as a partner, nor can the new assignee become a partner

without the unanimous consent of all partners.Putnam v. Shoaf (p. 134)-: Frog Jump Gin Company,

partner dies and wife gets his share, she wants out

and gets out. Later assets are found, she wants a cut.

I: Did Mrs. Putnam intend to convey her interestin the partnership to the Shoaf?A: YES, and she did not retain any interest in anadmittedly unknown courses of action to conveyor retain. She can’t participate in new windfall.Rule: Partnership assets belong to the entity notindividuals.

Raising Additional Capital (p. 136-38)

There are partners who initially give capital, and others who givecapital and services.

A Partnership account- a running account of the running balance of

a partner's account.- profits and personal withdraws are shown in

this account

Partnership profits- partners share equal in profits, even if

the partners give initially different amounts.

Loses are shared in proportion to profits.

Rights of Partners in Management (Ss) 307

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Liability- In absence of other arrangements, “all partners are JOINTLYand SEVERALLY LIABLE for acts and obligations of partnership.Management- In absence of agreement to contrary “all partners haveequal rights in the management and conduct of the partnership business"

Majority- “any differences in the course of ordinary businessare decided by a MAJORITY of partners,” (1/2 the partners is

not a Majority)Unanimous- New partners, and extraordinary changes in business require unanimous vote

Business- Each partner has authority to bind the partnership intransactions in the usual course of the partnership business unless the partner has no actual authority and a third party has knowledge of thisfact.

Partnerships and other partners are liable for acts of any partner within scope of business and certain breaches of trust. National Biscuit Company v. Stroud (p. 142)- Two partners

nearing end or p’ship, one says I won’t be liable for bought

bread, the other buys $171.04 in bread. Ruled- part of

ordinary business.Rule: each partner has power to bind other if w/in“ORDINARY and LEGITIMATE business”

Ratification of Partners Action

Summers v. Dooley (p. 144) trash collectors; Summers hires

help over objections of Dooley (who, although rejecting,

reaps the benefit of Summers hired work). Summers pays

out of own pocket,

now Summers is out of luck, no contribution fromDooley is required.If one owner benefits from another partner’s actions,ratification? A: NO. Rule: Receiving benefits from

unilateral action taken by other partner is NOTratification.

Moren ex rel. Moren v. JAX Restaurant (pg.144): Partner

brought son into restaurant while she finished an extra shift.

Sat him on the counter next to her while she rolled pizza

dough. Remington put his hand in the roller and got it

crushed.

Is P'ship solely responsible, or is the Mother contributorily responsible?Rule: Partner was acting as partner at the same time shewas acting as mother. So, the partnership cannotindemnify her because she was doing her partnership

duty while also doing her motherly duty, of which therewas no controlling rule (in bringing remington into thekitchen).

Without Provision In P-Ship K No Right to Status

Day v. Sidley & Austin (p. 146) A partner in a firm

lost his control over his position as sole chairman in

the firm when the firm merged. He was not part of

the executive committee which made the day-to-day

decisions. The p-ship k had no provision for his

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maintaining of control in that position. He sued for

breach of k, conspiracy, wrongful dissolution and

breach of fiduciary duty.

Rule: Unless otherwise agreed, there is no rightto a status w/in a partnership.The p'ship contract did not give any leverage to

P's status, so P had no ability to control themerger.He knowingly signed a well-defined contract,and partners acted in conformance with thatcontract.For mergers, the partners need only consent bymajority vote to a merger.

Partnership Dissolution (p. 154) (learn to navigate the statutes- see art. 6-8 andSs103)

Introduction - not the same as going out of business (winding up)Disassociation- When one partner ceases to be a partner Dissolution (of the partnership)- When all partners stop acting as

partners- (if a partnership dissolutes, the partnership is not ended untilthe "winding up" of partnership affairs is completed.

Dissolution is caused without violating the agreement:By the termination of the definite term or particular undertakingBy the express will of any partner when no definite termis specifiedBy the express will or all the partners who have notassigned their interests or suffered them to be chargedfor their separate debts, andBy the expulsion of any partner from the business bonafide in accordance with such a power conferred by the

agreement between the partners.Any partner can dissolve a partnership in contraventionof the agreement but would be liable for damagesresulting from this breach of the partnership agreement.Dissolution also occurs through unlawful activity, death, bankruptcy or by court decree.

Winding Up- selling p-ship assets and finalizing all responsibilities.Wrongful Disassociation if:

Breach of partnership agreement, or before definite term completes.(partner will be liable for damages caused by disassociation.)Buy Out (701)- ??????

802b- a partner who wrongfully disassociates cannothave any say in the dissolution.

Partnership at will 101.8- can quit or be fired for any reason

at any time.

To disassociate

Can dissolute the company and take profits,

etc, or

Sell the partnership to others

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Partnership for Term- explicit or implied- when a project or

time period completes.

To disassociate

801.2- if the dissolution was under 601.6-10,

you have to dissolve, or under 602.b you have

to disassociate, or

Otherwise you have the ability to:Can dissolute the company and take

profits, etc, or

Sell the partnership to others

Uniform Partnership Act- (different than the above, and not

as good)

The Right to Dissolve (p. 154)

Owen v. Cohen (p. 154) Partners could not get along in

running their bowling alley. Court dissoluted the

partnership.

Court can decree dissolution whenever:A partner is guilty of acts against business.

willfully or persistently breaches partnershipagreement,Acts so that carrying on business isunreasonable.other circumstances render dissolution equitable.

Collins v. Lewis (p. 157): Partners created cafeteria business.

One P financed, and the other managed. The financing P did

not provide the necessary financing. The cafeteria exceeded

expected cost to start up, and it did not become profitable.

Financing P wanted to dissolute the partnership.

Rule: A partner may not obtain a judicial dissolution of the partnership if his own interference causes the

partnership to be unprofitable.No Dissolving Partnership to Steal other Partner’s Share in

Opportunity

Page v. Page (p. 162): P'ship lost $ for eight years.

When P'ship began making $ after 8 years, the one P

wanted to dissolute. The other P said the P'ship was

for a "term" (a reasonable amount of time to make

back $.

Rules: Partners may dissolute a business any time, butthey at least must wait, in good faith, to dissolute thePartnership until business debts are paid back.

Consequences of Dissolution

Partners of Dissolved Firm Allowed to Bid on Its AssetsPrentiss v. Sheffel (p. 165): 2 partners didn't get

along w/ third. The 2 sought dissolution. The

Partners and held an auction for the P'ship assets.

The 2 bought the assets and continued business w/o

the third.

Rule: A partnership-at-will is dissolved as aresult of a freeze-out (exclusion of a partner

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from the management and affairs of the partnership).Rule: Wrongful exclusion from participation inthe management and control of the firm doesn’t prevent (in equity) the excluding partners from bidding on the assets, or using them in the

purchase. Pav-Saver Corporation v. Vasso Corporation (p. 171)- P

wrongfully terminates P'ship w/ D. P wants patents and

trademarks back, but K allows non-dissoluting party to

continue business, and D can’t continue business w/out

t’marks and patents. D gets Patents and T'marks.

Rules: when dissolution is caused in contravention of the p-ship agreement, the rights of the partners shall beas follows:

Innocent Party's Rights-

right to damages from guilty partner's breach

continue the business, and possess partnership property (w/bond incourt), and pay wrongful dissolver his partnershipinterest minus recoverable damages.indemnify him against all present or future p-ship liabilities.

Wrongfully Dissolving Partner's rights:

To receive value of Partnership interestminus damages to non-breaching party.(good will not calculated)

Note: “if a partner wrongfully w/draws from a partnership, the

p-ship does not necessarily dissolve.If the P'ship does not dissolve, it must buy-out thew/drawing (“dissociated”) partner for an amount equalto his or her share of the value of the assets of the p-ship.( However, there is no reduction for the value of goodwill. )

"Goodwill" = a $ amount for the image the business has in the community and its clients,which good image affects the ultimate profits.This amount of money can be calculated anddivided b/n partners who leave a business.

The Sharing of Losses (p. 177)

Rule – unless otherwise agreed, co-adventurers shareequally in profits and losses. Kovacik v. Reed (p. 177) There was no discussion of

what to do if losses were sustained. Reed contacted K

to say that they lost money. Reed sued Kovicek for

restoration of the money he lost from the failed

venture.

Rules: “Where one partner or joint adventurer contributes the money capital as against the other’s skill

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and labor, neither party is liable to the other for contribution for any loss sustained.Losses are proportionate to shares in profits.

Buyout Agreements

Definition of Buy Out- When a partner has a right to end hisrelationship w/ the other partners and receives a cash payment, or series

of payments, or some assets of the firm, in return for her or his interest inthe firm.“Trigger Events” causing Buy Out

DeathDisabilityWill of any partner

Obligation to buy out versus option

Firm

Other investors

Consequences of refusal to buy

if there is an obligation

If there is no obligation

PriceBook Value

Appraisal

Formula (e.g., five times earnings)

Set price each year.

Relation to duration (e.g., lower price in first five years)

Method of Cash payment

Cash

Installments (with interest?)

Protection against debts of partnership

Procedure for offering either to buy or sell

First mover sets price to buy or sell

First mover forces others to set price.G&S Investments v. Belman (p. 181)- G & S wanted to dissolve the

partnership pursuant to the buy-out provision in their agreement

due to Nordale’s wrongful conduct (drugs and disruption of

residents), but then continued the partnership after Nordale died.

Rule: Death terminates partnership, filing for dissolution doesn’tRule: A p-ship buy-out agreement is valid and binding even if the purchase price is less than the value of the partner interest,since partners may agree among themselves by contract as totheir rights and liabilities.

Jewel v. Boxer (p. 185) After partners, Jewel, Leary and Boxer

dissolved their law firm by mutual agreement, forming two new

firms, they appealed a judgment awarding post-dissolution income,on cases active at the time of dissolution, on a quantum meruit basis.

Rules: Absent a contrary agreement, any income generatedthrough the winding up of unfinished business should beallocated to former partners according to their respectiveinterests in the partnership.Rule: Each partner has duty to wind up and complete unfinished business.

Limited Partnerships (p. 196)

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has two classes of partners (Limited and General)Limited partners-

limited management, andlimited profit sharing Not personally liable (like Gen. Partners), unless theytake part in control of Business.

General Partners- Share equally in:Management, andProfit sharingPersonal Liability. (Joint and Several Liability- to theextent of capital put into the P'ship.)(could become a limited partner by making a corporationof himself as the sole member, and then make thecorporation the general partner.)

Holzman v. De Escamilla (p. 196) –farmers. Limited partners

take active part in business and thus are liable as general

partners.

Rule: Limited partners are NOT liable as general

partners unless they take part in control of the business.Rules: If a limited partner exercises control over the partnership business, he becomes a general partner.

CHAPTER 3 the Nature of the Corporation

Business Organization Choices – Sole Proprietorship

Small, easy, modest capital needsGeneral Partnership

Two or more carrying on business while sharing control and profits.Dissolves upon death, bankruptcy or withdrawal.Can be formed without knowing. Informal no legal documentation

required. Not double taxation- each partner pays their share of taxes from their profits. (can deduct losses)All partners must consent to admission of new partner All partners have equal voice (unless otherwise agreed upon)All partners individually liable for p’ship debts. E.g. law, acting,medicine.Dissolved by death or withdrawal of partner

Limited Partnership

Must have 1) written agreement, and 2) formal document filed w/ state.Lmt partners can provide capital only (not management), then liable for amount of investment.

Tax advantages and limited liability.All general partners have equal voice in control, but limited partners maynot participate in management.Gen partners individually liable for all partnership debts.Limited Partners only liable for their share (unless they actively participate in management, then they are considered General partners)Dissolved w/ death or withdrawal of Gen. Partner, but not of limited partner.

Limited Liability Partnership (LLP)

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Each partner may participate fully w/o becoming personally liable(most states allow LLPs)Each partner may participate fully w/o becoming personally liable

Limited Liability Company (LLC)

Hybrid between corp and partnershipMembers may elect to be taxed as a corp or p-ship. (thus having ability

to avoid double taxation)Can’t raise as much money as corp. Own interests not freely transferable.Member make a written "operating agreement" expressing the form of transferability, votes, selling, etc. (the LLC is bound by this agreement,so members may sue LLC for breach of agreement)Members only liable for the amount of their capital contribution (even if actively manages), (in otherwords, LLC is liable, not individuals, but veilmay be pierced as w/ corps)

Corporation

Taxed as a separate entity (double taxing-- taxes on corporation profits,then again on shareholder dividends) (A sub-chapter S corp. can avoiddouble taxation- each shareholder pays his portion of the taxes for the

corp.)Shareholders may sell stock transferring ownershipShareholders elect board of directors who supervise corp's affairs. Day-to-day control rests on high-level "officers"."Perpetual Existence" (despite deaths, etc.)

Close Corps

Partner like duties to s’holders.?

CorporationsNature of Corporations –

Structure

stockholders , board, and officers are NOT generally liable for debts of the corporation.A Corp. is a legal entity formed under state statute by filingArticles of Incorporation (AOI) w/ proper state office.Stockholders OWN corp.Corp can sue or be sued, own property, pays taxes on its income.Shareholders also taxed on dividends.

Limited personally liability of owners

Shareholder not personally liable for corp. acts, but may become

so through personal acts. (unless otherwise provided for inArticles Of Incorporation)

Corporation is independent of owners

Legal personality distinct from owners (entitled to due process, bill of rights protect corps.)

Separation of ownership and control.Shareholders:

elect board of directors

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Shareholders DO NOT MANAGE day to day affairsgenerallyVote on amendments and bylawsVote on Certain fundamental transactions (mergers)Approval of independent auditor, etc.

Flexible capital structure

Debt v. Equity SecuritiesDebts- bonds held by creditors (who are not owners)Equity Securities- represent units of the corporation(shares)

Shares- The articles of incorporation must state the number of shares authorized. There are Four Types:

Regular Shares- bought and owned???Outstanding shares- numbers of shares sold and notrepurchased.Authorized, but un-issued shares (yet)Treasury Shares- once issued and outstanding, andsince repurchased.

Issuance of Stock Board of Directors prerogativeShareholders only involved if board wants to issue morethan authorized by articles of incorporation.

Rights of Shareholders

Right to receive dividendsRight to inspect books of the incorporationReceive distribution after dissolution issues taken care of.Proportionate shares must be allowed to be bought if new onesissued.Right to file suit for wrongs committed by Corp.

Public Corp. v. Closed Corp. ??? Look in CrunchTime

Degree of ownershipGovernment controlOwnership of Shares

Delaware is main state for Corps??? Look in Crunch Time No minimum capital requirementOnly requires one incorporator Corporation may be incorporatedFavorable franchise tax No corp income tax No sales tax No inheritance tax on non-residence holdersMay have a principle place of business outside of Delaware.

Process of IncorporationFile articles of incorporation (AOI)

Mandatory provisions (2.02a?)Discretionary Provisions

Direct the By-laws 2.06

Organizational Meeting

Adopt bylaws Nominate leadersIssue stock

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Internal Affairs Doctrine

You are governed by the laws of the state where you areincorporated.

Pre-Incorporation Issues

Promoter- person who identifies opportunity and tries to put together theincorporation

Owes fiduciary. Duties to shareholders and those reasonablydepending on corp formationUnless otherwise agreed upon, all persons acting for corporationwhen no corporation is made yet, are personally liable.K’s entered into w/ “corps”, even those w/ defects in formation,will be honored.Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc. -Improper corp. formation. D can’t escape performance of K tofurnish a ship regardless of character of org, unless substantialrights involved. Parties treated like a corp, so legally defined ascorp (unless substantial rights might thereby be affected).Corporation Liability from Promoter's acts-

Rule: corp is only liable for promotor's acts which itadopts (explicitly or implicitly)

The Corporate Entity and Limited Liability –

Default Rule: A shareholder of a corp is not liable for corps acts exceptfor his own acts or conduct, unless otherwise agreed upon.Piercing the Corporate Veil (aka- alter ego)

Rule: If corp. is treated as corp, there is no chance for personalliability (observe corporate formalities- have meetings, officers,minutes, don't mingle funds)Rule: If separate existence of corp is not observed, the law isunclear.

Fraud or Injustice- The court will "pierce the corporate

veil" and hold individuals liable if there is Fraud or Injustice.

Its not necessary for the shareholders to have knowledge of corp.uncomplianceFactors courts will look to

Corp. fomaliites

Mixing personal and corp affairs.Inadequate capitalization (needs to meet reasonablyexpected liability)Was the corp. entity made solely to avoid personallyliabilities.Corp. is solely instrumentality of shareholders

Corp is closely held (studies show there is little or nocorp veil piercing this way- less control, greater oversight.Shareholders held with joint and several liability

Piercing the corporate veil – “to prevent frauds or the achieve

equity”, follows the general rules of agency, when one usescontrol of corp to further his rather than corps business he isliable for corp’s acts by respondeat superior extends to negdealings as well.

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Combine the following piercing doctrine w/ this previous

summary.

Walkovszky v. Carlton – Guy runs 10 taxi cab corps under hisown corp.

Rule: To pierce the veil of a corp, you must particularizethe lack of corp formalities and intermingling of funds.

Rule: Whenever anyone uses control of the corp. tofurther his own rather than the corp.’s business, he will be liable for the corp.’s acts. Upon the principle of respondeat superior, the liability extends to negligentacts as well as commercial dealings. (RespondeatSuperior - Rule that the principal is responsible for tortuous acts committed by its agents in the scope of their agency.)

Sea-Land Services, Inc. v. Pepper Source – Shipments of Jamaican sweet peppers. : When P could not collect a shipping bill because D Corp. had been dissolved, P sought to pierce thecorporate veil to hold the D Corp.'s sole shareholder (M) liable.

Rule: Van Dorn Illinois Test Corp. and Individual must be so intermingled,that there is no separate identity, andCircumstances must be such that adherence tothe fiction of separate corp. existence wouldsanction fraud or promote injustice.

“Some elements of unfairness, something akin to fraudor deception or the existence of a compelling publicinterest must be present in order to disregard thecorporate fiction” Pederson.

Kinney Shoe Corporation v. Polan –

Rule: De Facto corp. doctrine.

A Corp that is partially but deficiently formed istreated as a Corp if:

formed in good faith,had legal right to incorporate, andthought they had legal right toincorporate.

Incorporation by Estoppel-If 3rd party thought entity was corp, andwould earn a windfall if that person wasallowed to argue that the entity was nota corp.

Parent Company Liability – If Corp owns all shares of the common

stock, Parent-subsidiary relationship. Generally, the Parent (shareholder)is NOT liable for the debts of the subsidiary. However, veil can be pierced with enough control, or “negligent undertaking”.

In re Silicone Gel Breast Implants Products Liability Litigation

– Corp veil pierced! Liability found, substantial controlAND name on packaging shows CONTROL. List of control factors. P. 226.Some factors of control are:

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The parent and the subsidiary have common

directors or officers

The parent and the subsidiary file consolidated

financial statements

The parent finances the subsidiaryThe parent caused the incorporation of the

subsidiarythe subsidiary operates with grossly inadequate

capital

the parent pays the salaries and other expensesof the subsidiaryThe subsidiary receives no business except thatgiven to it by the parentThe parent uses the subsidiary’s property as its

own

Does keep separate books.Rule: The totality of the circumstances must beevaluated on determining whether a subsidiary may be

found to be the alter ego to mere instrumentality of the parent corp. Each state requires a showing of substantialdomination.

Frigidaire Sales Corporation v. Union Properties, Inc. – Pattempted to hold the limited partners (Ds) generally liable after Commercial Corp. breached its contract with them. They werelimited partners in Commercial corp and also joint directors for Union Corp. Union acted as the general partner (while they werethe limited partners) for Commercial.

Rule: Limited partners do not incur general liability for the limited partnership’s obligations simply because theyare officers, directors, or shareholders of the corporate

general partner.Application: D only acted in the day to day activities of the corp. D never acted in any direct, personal capacity.D controlled the limited partnership but, they did so onlythrough its board of directors, officers, and agents.

Shareholder Derivative Actions (p. 232)

Direct v. Derivative Suits- two kinds of lawsuits:Eisenberg test to determine which type of suit (two elements):

who suffered the most direct injury? –

if corp à derivativeif shareholder à direct

to whom did D’s duty run?

If corp à derivativeIf Shareholder --> direct

Eisenberg v. Flying Tiger Line- Action by SH on behalf of himself and other SH to enjoin effectuation of a plan of reorganization and merger. argues thatreorganization will unfairly diminish the voting power of himself and other public stockholders by preventingthem from directly influencing the affairs of theoperating company

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Rule: Suit is a direct, not derivative action.Rule: The injury P is complaining of is an injuryto his voting rights and is thus an injury to him personally rather than to the corporation.

Direct suits

Brought by the SH in her own name

c/a belonging to the SH in her individual capacityArises from an injury directly to the SHExamples:

Prevented from exercising voting rightsDividend payment compulsionAnti-takeover defensesCompelling inspectionProtection of minority SHs, esp. in closecorporation.

Shareholders will prefer direct suit over derivative suitDerivative suits

Brought by a SH on corporation’s behalf

c/a belongs to the corp. as an entityArises out of an injury done to the corp. as an entityProcedural Hoops in derivative suits

Contemporaneous ownership (Must be ashareholder when wrong was committed)Some states require a security deposit for expensesusually no jury because it is equitable

Demand requirement- must first make ademand, by which the corporations regainscontrol of the suit and through a speciallegislative committee, terminate the suit.

ExamplesEmbezzlementBreach of due careBreach of duty of loyalty

Excessive compensationSelf-dealingCorporate Opportunity

SHs are harmed secondarily- enough for a SH toallege that challenged conduct resulted in a dropin corp’s stock price

Pro for Derivative Suits

Allows SH to hold directors accountable

Remedy for insider wrongdoing“remedy born of SH helplessness”Insiders are reluctant to turn on their own

Deterrent effectLegal fees

Corp must pay P’s legal fees if there is asubstantial non-monetary benefit (ctliberal in finding those)

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Any recovery goes to corporate treasury,whether by settlement or trial victoryDirectors can’t be trusted to sue themselves

Con for Derivative Suits

There may be a good business reason not to sueWaste of corporation’s time- (Resulting benefit

is usually less than what the corp would havereceived)Risk adverse managers- (Managers will becomeneedlessly risk-adverse to the detriment of thecompany)Strike suits- (Nuisance suits brought for settlement value. Only enriches attys.)Meritorious suits against insider

settled too easilyIndemnification: Corp must reimbursedir’s expenses if successful defense.Mgmt has incentive to settle in ways

that ensure indemnification.Settlement in which dir doesn’t payanything deemed a success

Plaintiff's Requirements in Derivative Suits:Standing - MBCA §7.41 limits standing to shareholders

Must be a holder of an equity security in the companyDoes not include Bondholders or creditors

Contemporaneous Ownership

MBCA §7.42: Must be a shareholder when the suitcommencedMany states require that the SH also must remainthrough final judgment.

MBCA §7.41(1): Must be a shareholder at the time of the alleged wrong.

Exception: If A inherits the stock via operationof law, and original SH had right to sue, then Ahas such right as well

Reasons for rule

Discourages litigious peoplefrom bringing frivolous suits; prevents them from looking for wrongdoing and then buy sharesto support a suitA person who buys after the

wrong with knowledge of it may pay a lesser price and obtain awindfall from corporaterecovery.

Criticism: Contemporaneous ownershiprule would bar p from suit if he purchased the shares after thewrongdoing, even if neither p nor

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anybody else knew of the wrongdoing atthe time of purchase.

Fair and Adequate Representative - MBCA §7.41(2) NamedP must be a fair and adequate representative of the corporation’sinterests

Grounds for challenging p’s fairness or adequacy:

Conflicted interests, e.g., bringing suit for unrelated strategic purposeUnclean hands (approved or participated in thewrong doing)

Security for Expenses statutes

Some states require that the P pay for the reasonableexpenses of a corporation (pre-litigation security) if P’sclaim fails – upheld as constitutional in Cohen (policyfocus on strike suit)Choice of law

Cohen v. Beneficial Industrial Loan Corp. -

USSC

Federal court sitting in diversity appliesforum state choice of lawAll states apply law of the state of incorporation to substantive merits of acase.Federal law governs procedural issues

Substantial or Procedural Test

If it creates a new liability, as well as acondition on standing, then it issubstantive.

Ct found that security statute was substantiveErie Doctrine:

state law for substantive issuesfed law for procedural issues

Demand Requirement

Rule: SH must make a “demand” to the Board of Directors before filing suit

demand asks the BoD to bring a suit or takeother corrective action to redress thewrongdoingDEMAND IS REQUIRED, Unless EXCUSED àdemand is excused when futile

Pro of Demand Requirement

c/a belongs to corporation (Like all assets,

litigation should be under the control of BoD.)SH may have interests diverse from those of corporation. Thus, BoD should have some say.Relieve courts from deciding mattersProvide boards protection against harassmentDiscourage strike suits.The BJR gives the demand requirement teeth(esp. for last two)

Con of Demand Requirement

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Derivative suits are a mechanism of managerialaccountability

There’s a potential for bias b/c dirs can’t be expected to sue themselves

Role of Demand Requirement: serves as a proceduralstep to separate cases in which board is allowed to

control suits from those in which SH (SH atty) controls.Complex lawLaw not uniform state to state

Demand Futility:

MBCA §7.42: No SH may commence a derivative proceeding until… a written demand has been made …and 90 days have expired from the date the demand wasmade … unless irreparable injury to the corporationwould result by waiting for the expiration of the 90-day period.

Implies that demand itself can be waived.

FRCP 23.1: The complaint shall allege “the efforts, if

any, made by the p to obtain the action the p desiresfrom the directors … and the reasons for the p’s failureto obtain the action or for not making the effort.

Implies that only the waiting period can be

waived

Delaware Standard for Demand Futility

Letter must be submitted to BOD statingIdentify wrong doersBasis for wrongful factsHarm caused to corp.Request for remedial relief

Board actions may include:

Refuse demand (BJR- business judgment rule- P must overcome BJR)Accept demand (take care of it on itsown)Demand excused (not made), because itis futile (P doesn't need to demand BODfor anything, b/c it would be futile)

So P must allege particularizedfacts (pre-discovery using the“tools at hand[2]”) creating areasonable doubt[3] that the board is capable of making a

good faith decision on whether to file suit.

Test for excusing demand- 3 ways to prove that the board is disabled by aconflict of interest (need to show onlyone):

Majority of board has materialfinancial or familial interest, or

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Majority of board lacks

independence (domination andcontrol by wrongdoers), or Challenged transaction not the product of valid exercise of business judgment

Std is difficult to prove b/c must pleadin particularity!If you make a demand before you file alawsuit, you will usually lose.

A rational p will file aderivative suit b/f makingdemand b/c the consequencesare trivialIf demand is required, thencourt will stay proceedings andthere’s a slight delay for you tomake demand.

Preserves right to litigate:Whether or not the suitis direct or derivativeDemand futility

In close cases where it isdifficult to decide if direct or derivative, ctr treats case asdirect if P seeks non-monetaryrelief Rule: By making a demand, oneis later precluded from arguingdemand futility

NY standard for demand futilityDemand is Futile if:

Majority of directors interestedin challenged transaction; or Board member has personalstake in challenged transactionAND loss of control becauseanother director has control over him

Directors failed to inform themselves todegree reasonably appropriate; or

Challenged transaction so egregious thatit could not have been the product of sound business judgment of thedirectors.Demand will be excused if a majority of the board is charged with breach of duecare instead of loyalty

Mark v. Akers CB 259 (NY)- alleges a breach of fiduciary duty due to excessive director and

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executive compensation during a period of declining profits

Rule: It is not sufficient to have demandexcused simply because the board is anamed party in the suit.

As a practical matters:

Most derivative cases end up at futilitymotionsIf a P wins the futility motion, D has anincentive to settle

SPECIAL LITIGATION COMMITTEE (SLC)

How SLCs work (Emmanuel’s)When p files suit, the board appoints a supposedly “independentcommittee” of directors to investigate p’s allegations (Seederivative litigation decision tree*)

Committee must be made of disinterested directors (nofinancial stake)If all of the board is implicated, then the board may vote

to enlarge itself and appoint additional directors.Dismissal is usually recommended

Rarely will an SLC find that p’s complaint has NOmerit.It is mostly dismissed because the burden of recoveringoutweighs the merits.

This is done to give the SLC’s decision the protection of the

BJR

SLC Pros-

Screens out frivolous or strike suits at early stageIndependence of SLC will insure good faith

SLC Cons-

There is a structural bias in having a nominally independentcommittee selected by the board that is being accused.Directors will have to face their fellow directors againBoard will not select a committee of independent SLC who aregoing to screw them over.

NY SLC Standard (few states)– Auerbach v. Bennet CB 265- GTE made $11M in illegal bribes – 4 directors personally involved; SH derivative action againstGTE, all directors and outside audit for breach of duties to corp.BoD responds by appointing a SLC

challenged transaction could not have been the productof sound business judgment

- Court assumed demand was excused- SLC concluded no violation and recm dismissal of suit

Look at NY std for demand futility: (Akers)

majority of directors interested, OR directors failed to inform themselves, OR

Rule: P must show that the:members of the SLC were not in fact independent (i.e.,dominated by controlling shareholder accused of wrongdoing) and/or

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that the SLC did not use reasonable procedures inreaching its conclusions (i.e., shallow investigation)The Tootsie Pop Defense

First Tier = illegality (first bribes must be proven)

BJR means court has to defer to SLC:

As long as there was a disinterestedcommittee with reasonable procedures,then the BJR protects the first tier

Second Tier = committee recommendation (thecommittee's decision cannot be scrutinized untilafter passing tier 1.)

Filing Cabinet Analogy

Court can look into the SLC’sfiling cabinet to make sure allthe proper paper trail is there, but can’t read any of the docs(including “smoking gun”

memo)Delaware SLC Std (most states)–

Zapata v. Maldonado CB 270- excessive compensation case.demand not made. demand excused as futile. BoD appoints aSLC which recommends a)new BoD and b) dismissal of case.Look at Del Std for demand futility(Grimes):

Reasonable doubt as to:majority of board has material interest, OR majority of board lacks independence, OR challenged transaction not product of validexercise of business judgment

Holding/Rule:

two–step analysis:Corporation has the burden of proof to show (2things)

independence and good faith of SLC,andinquiry into the bases supporting SLC’srecommendation. (reasonableinvestigation)****

(only where corp. succeeds on step 1)- courtmay go on to apply its own business judgmentas to whether the case is to be dismissed

this makes the Del std different from NY std – in Del court gets

to decide whether there was a reasonable basis for the decisionthis means that the court can look into the cabinet ANDread docs in it!

Practice Point:In Delaware the SH has a much better shot at succeeding in aderivative suit than in NYOn exam for NY corp in Del, apply NY law!

Empirical findings:

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Derivative cases that go to trial: shareholder-plaintiff’s lose 90+% of the timeMost derivative suits settle

Only ½ of settlements entail monetary recovery bycorporation or shareholders

Average recovery < $6 million

90+% of such settlements, legal fees > monetaryrecovery

Derivative litigation has no positive effect on stock prices:Adoption of a § 102(b)(7) liability limitation provision does nothave a negative effect on stock prices (stock prices remainunchanged when derivative litigation brought)

Role and Purpose of Corporations: (pg 283)-these cases deal w/ the BJR.Cts don’t want to interfere in BJR w/out fraud or violation of good faith.Can businesses do other than wealth maximization?

YES, but must be able to articulate business reasons. You mustarticulate PLAUSIBLE business reasons for charity &

beneficence.DUTY OF CARE and the BJR (Business Judgment Rule) – Operational Decisions

A.P. Smith Mfg. Co. v. Barlow 1953 (p. 270)- Fact summary: Dand other shareholders of P corp. Challenged its authority tomake a $1,500 donation to Princeton University.Rule: Corp. can give donation because long history of help tocommunities detailed and good for USA.

Even a tenuous connection to the good of the corp willmake the donation OK. Can’t be a “pet” charity. NOWyou must be able to make claim it will be good for business (and maybe bottom line).

Courts won’t interfere w/ business w/out FRAUD or misappropriation of funds or refusal to declare dividendswhere it is no detriment to business…MBCA § 8.30(a): The Duty of Care : “Each member of the board of directors, when discharging the duties of adirector, shall act: (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interestsof the corporation”

Dodge v. Ford Motor Co (FMC). Ford wants to stop paying“special dividends” to shareholders & build smelting plant.

Holding: Corp can build plant but can’t arbitrarily denydividends.

Rule: You must articulate PLAUSIBLE businessreasons for charity & beneficence. Ford admits hisdecision not based on business reasons.

Standard of review for dividends:

Rule: Generally, distribution of dividends is left to thedirectors' discretion,

Unless there is an abuse of discretion (fraud or breach of duty of good faith)

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Shareholder Primacy: A corporation is meant to primarily benefit the stockholders and the director’senergy should be spent in that regard.

Limits- There are limits on “for the profits of the SH”

Corp must comply with law

Charitable giving is OK if connected w/ business purposes.

Business Judgment Rule (BJR)

BJR Rule- "In the absence of a showing of fraud, illegality or self dealing by the directors, their decision is final and not subject to review by the courts."

Note: BJR is unique in the sense that corporations have a duty tomaximize profits, yet unless there is fraud, illegality or falsedealings, the court will not intervene (duty exists, but it notlooked at!)BOD owe Duty of Care: A standard of conduct, requiring:

Good faith

Reasonable careChapter 5- The Duties of Officers, Directors, and Other Insiders

DUTY OF CARE

BJR and the Requirement of Informed Decision

BJR goes un-scrutinized, unless there is: Fraud

Illegal Conduct

Self-dealing

Egregious misconduct, or Un-informed decision (No protection for an uninformeddecision)

The Obligations of Control: Duty of Care (p. 316)

Kamin v. American Express Company -Kamin (P) brought ashareholders’ derivative suit claiming American Express (D) hadengaged in waste of corporate assets by declaring a certain dividend inkind.Rule: Whether or not a dividend is to be declared or a distribution madeis exclusively a matter of business judgment for the board of directors,and the courts will not, therefore, interfere as long as the decision ismade in good faith.Rule: The business judgment rule allows a director to maintain his dutyof care while exercising business decisions in honestly and rationally;imprudent decisions will not overcome the business judgment rule.Smith v. Van Gorkom- The board of directors (D) of Trans Union

Corporation (D) voted to approve a merger agreement based solely onthe representations of Van Gorkom (D), one of its directors- Smith andother shareholders filed a class action suit against Trans Union and the board.Rule: The business judgment rule shields directors or officers of a

corporation from liability only if, in reaching a business decision, the

directors or officers acted on an informed basis, availing themselves

of all material information reasonably available.

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Rule of abstention: Court will not review substance of decision, but will examine the decision making process (extent to whichBoD made an informed decision.)Alternative Defense in addition to BJR: Under DGCL§141(e), the board may rely on its officer's report. (but they atleast must inquire to the officer's basis of information.)

Brehm v. Disney- Compensation package for Michael Ovitz wasridiculous- 1995 Disney board hires Ovitz as President, salary of $1M, bonus, stock options on 5 M sharesWaste Rule-BJR doesn't protect when there is waste- Transaction that isso one-sided that no business of ordinary, sound judgment couldconclude that the corporation has received adequate consideration(usually arises with corporate compensation, disposition of corp assets,and chartity)Rule: Directors (and members of committees appointed by BoD) arefully protected when relying in good faith on an expert who wasappointed with reasonable care as professional or an expert on the matter Substantive due care (Brehm v. Disney – D liable) v. Process due care

(Van Gorkom – D not liable)Process due care = ctr looks at rational process to decisionmaking, not its merits

irrationality is the outer limit of BJR and functionallyequivalent to wasteirrationality does not mean stupidity, but rather self-dealing (decision is so bad that no one acting in goodfaith would have made it) à rarely occurs

Substantive due care = ctr evaluates the reasonableness of decision (is this the right decision that a reasonable person wouldhave made?)

Egregious board decisions- Directors can only be liable for egregious

decision only where directors acted in bad faith or followed an irrationaldecision making process -

Francis v. United Jersey Bank (p. 349) Lillian Pritchard (D), adirector of Pritchard & Baird along with her two sons, wascompletely ignorant as to the fundamentals of the reinsurance business; ignored her duties as a director; and allowed her sonsto withdraw over $12 million from client trust funds.Rule: BJR does not protect director when directors have failedto exercise business judgment (here the directors failed to act,therefore the BJR does not apply) à where BJR does not apply,duty of care will apply….(supports profs abstention view of BJR)

Rule: Director has an obligation of basic knowledge andsupervision:

Duty to be informed

Read and understand financial statementsObject to misconduct and, if necessary, resignDoes not require a detailed inspection of day-to-day activities

Causation re liability of dissenting directors: Adirector who is present at a board meeting is presumed to

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concur in corporate action taken at the meeting unlesshis dissent is entered in the minutes of the mtg or filed promptly after adjournment.

In re Caremark International Inc. Derivative Litigation (p. 355)-Facts: Caremark, a managed health care company, settled federalcivil prosecution for violations of anti-referral laws (250M). SHs

sued derivatively BoD for breach of duty of care (if the BoD had paid attention, then Dr.s that referred clients would not havegotten consulting contracts). Judicial approval required for derivative settlements.Rule: BJR does not apply b/c there was no action by the board.However, if the issue arose, then they dismissed the idea of taking action, they would be protected by the BJR.

The Supreme Court has said that where there is no basisfor suspicion, directors cannot be liable. (So, thequestion is whether the BoD had reason to believe theyneeded a system.)

Rule: Corp must attempt in good faith to assure a corporate

information and reporting system. (The details are left to business judgment.)

Adequate law compliance program could include:Policy manualTraining of employeesCompliance auditsSanctions for violationsProvisions for self reporting of violations toregulators

ask how could we violate the law, and try to prevent it; but it could be costly

Potential liability for directorial decisions- 2 contexts:

Rule: Liability may be said to follow from a boarddecision that results in a loss because that decision wasill-advised or “negligent.”

The court will only look at the process of theBoD decision and not the substance of thedecision. The BJR protects the BoD

Rule: Liability for failure to monitor- circumstances inwhich a loss eventuates not from a decision but fromunconsidered inaction.Rule: Legally, the board itself will be required only toauthorize the most significant corporate acts or transactions.

Rule: Basically- you only need a system of checks if you have had problems in the past, or you shouldreasonably expect problems from the info you have.

DUTY OF LOYALTY- Directors must act in the best interest of Corp.3 Categories of Conflict-

Self Dealing,Corp. Opportunity,Corp. CompetitionSelf Dealing

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2 Types

Direct Interested director transaction - Director contracts with the corporationIndirect Interested director transaction - Director isan officer of another corporation. When the corporationcontracts with another corporation, then a conflict of

interest exists. (issue: which corp interest does thedirector take into account?)

Elements

Where Director is on both sides of the deal/transaction(where does loyalty lie?)Director influenced the corporation’s decision to enter the transaction, andDirector’s personal financial interests are in conflict

with the financial interests of the corporation.A self-dealing transaction found by the court to be fair, will be

upheld whether or not it was approved by a disinterested boardor not.

If the transaction is so one-sided that it amounts to waste or fraud, the court will void the transactionIf it is neither fair, nor does it amount to waste, the court will probably use director approval and/or shareholder ratification asa factor

Corp. Opportunity- Directors come across valuable deals, and exploitthe opportunity for the directors benefit instead of the corporations.(more below/later)Corp. Competition- Director engages in business venture which seeksto exploit the same market as the corp. (more below/later).Self-Dealing

Bayer v. Beran (p. 368) In order to promote the product,

company created a radio program featuring opera music sung bythe CEO’s wife. Shareholder sued for conflict of interest (this isindirect interested director trans)Rule: In cases where directors enter into personal transactionswith their companies, such transactions are rigorouslyscrutinized and, upon the showing of any unfair advantage, will be voided.Rule: When issues of Loyalty arise, the BJR does not apply.

In other words- Duty of Loyalty considerations trumpBJR protection.

Lewis v. S.L. & E., Inc.- Donald Lewis (P), a shareholder of SLE (D), claimed that its directors (D) had committed waste by

undercharging LGT, a tenant.Rule: The general rule is that directors of a corporation maymake decisions in the ordinary course of business without review by the court- business judgment rule.

However, when the directors have a personal interest inthe transaction, they are no longer immune from review,and must demonstrate that the transaction was fair andreasonable to the corporation at the time it was entered.

Handling Issues w/ interested Director involvement.

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Quorum-

DGCL §141(b): In order to act on a matter,there must be a majority of directors present.Majority = quorumDGCL §144(b): Even if one or more director isinterested in the transaction, his presence will be

counted in determining a quorumApproval of actions

DGCL §141(b):Approval for any transactionmust be had by a majority of directors presentDGCL §144(a)(1):If material facts (interested

party’s relationship or interest in the action)

are disclosed and the board authorizes in good

faith, a majority of the disinterested directors

present is sufficient for approval, even thoughthe disinterested directors be less than a quorum.

this means that interested director mustdisclose his self-interest (b/c for the BJR

to protect the BoD decision, it needs to be informed)means that interested director may vote, but his vote doesn’t count for approval

DGCL §144(a):Participation by the interested party in the meeting that approves thattransaction, including voting, will not by itself void director approval

Once it is shown that a majority of thedisinterested directors have approvedthe transaction, the burden shifts to

person attacking to show that the

transaction was unfair.as a practical matter: interested director is better off abstaining to preventappearance of impropriety.

Forms of presence

DGCL §141(i):If directors cannot all physicallymeet, then hearing each other through thetelephone is sufficient for presence (but note:this means that email, and IM is not sufficient)

Broz. v. Cellular Information Systems, Inc.- Broz (P)utilized a business opportunity for his wholly ownedcorporation instead of a direct competitor, Cellular

Information Systems, Inc. (D) for which he served as amember of the board of directors.Rule: A corporate opportunity is usurped (and director isliable) where:

Corporation is financially able to take theopportunityOpportunity is in the corporation’s line of

business (closely related to corporation’sexisting or prospective activities)

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Corporation has an interest or expectancy inthe opportunity

Interest: A contractual right to property(i.e K right)Expectancy: a reasonable anticipation of an opportunity due to existing business

arrangements (i.e. renewal rights)Embracing the opportunity would create aconflict of interest between director’s self-interest and that of the corporationNote: must have all 4 factors to be called acorporate opportunity and hold a director liable.(In Broz, D didn’t usurp corporate oppty because (2) oppty was not in corp’s line of business.)

Dominant Shareholders

Rule: Generally, shareholders acting as shareholders Do NOT owe oneanother fiduciary duties.

However, controlling shareholders owe fiduciary duties to theminority (cf. vicarious liability- controlling SH could elect BoDwhich could then act as his agent)

Parent and subsidiary corporations (exists when one corp has enoughshares of another corp to control it)

DGCL §123: Corporations can own shares in other corporationsWholly owned subsidiary (Parent owns 100% of shares)Majority-controlled subsidiary (Parent owns 50.1+%)Minority-controlled subsidiary (Parent owns <50%)

Transactions b/w Parent and Subsidiary Corporation: (subject to

Intrinsic fairness test)

Sinclair Oil Corp. v. Levien- Sinclair Oil owns 97% of stock in

Sinven. Minority SHs objected to 3 aspects of Sinclair’srelationship with Sinven.Intrinsic fairness- Places Burden on D to show transaction wasfair to minority

Majority shareholders can get their just benefits, butcannot benefit at the expense of the minorityshareholders.Application:

Dividends: An argument that there is self-dealing in the dividend policy will likely fail if the minority has received a pro rata share,If it satisfies the BJR, the policy is upheld

Preferred v. Common Stock – could haveimproper self-dealing where different dividendsissued to different types of stock

DGCL §141(a)(1) – a disinterested ratification of aconflict of interest transaction involving an interesteddirector has no effect (b/c interested directors must electthe noninterested directors)

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CB 718 fn. 7: having disinterested directors approval isnot dispositive but it is strong evidence that thetransaction meets the test of fairnessRule: The intrinsic fairness test should be applied onlyto business transactions where self-dealing accompaniesa fiduciary duty;

If self-dealing is not present, then the burdenremains with the plaintiff under the business judgment rule.

Rule- Controlling shareholders must make fulldisclosure when they propose a transaction with thosefellow holders.

Common Stock- ownership in co.;generally have voting rights; but no guarantee of dividends; butit gets control usually 1 vote for 1 share (if bankrupt, creditorswill be paid first)

Preferred Stock - like a product that investor bankers create-

class of ownershipgives a stated dividend- a stated amount at a stated timeusually, no control; no voteupon dissolution- they take priority; if co. is liquidated, they get paid first;advantages- you get to participate in the future, but you don’t getto vote; and you some protection that you will get paid out before other shareholder.

Callable Stock (redeemable shares)The co. has the right to buy back the shares

Rule: Majority shareholders owe a duty to minority shareholders that issimilar to the duty owed by a director, and when a controlling

stockholder is voting, he violates his duty if he votes for his own personal benefit at the expense of the stockholders.

Ratification

Fliegler v. Lawrence- Shareholders (P) of Agua brought suit against itsofficers and directors (D) claiming the officers and directors (D)wrongfully usurped a corporate opportunity belonging to Agua and profited thereby. Basically, Agua buys up USAC shares for a buys out;Rule- Ratification of an “interested transaction” by a majority of independent, fully informed shareholders shifts the burden of proof to theobjecting shareholder to demonstrate that the terms of the transaction areso unequal as to amount to a gift or a waste of corporate assets.

3 part test (summarized) under 144:

ratified by,full disclosure bydisinterested board necessary; but not disinterestedmajority of shareholders.

In re Wheelbrator Technologies, Inc. Shareholders Litigation-Shareholders (P) of Wheelabrator Tech, Inc. (WTI) (D) filed a classaction suit alleging that WTI (D) and its directors breached their fiduciary obligation to disclose material information concerning acorporate merger.

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Rule: A fully informed shareholder ratification does not extinguish aduty of loyalty claim, but it serves to make the business judgment rulethe applicable review standard with the burden of proof resting on the plaintiff stockholder.

FEDERAL SECURITIES LAW

Security- any note, bond, stock, or debenture (backed by nothing but the

companies earning potential), etc. OR "evidence of indebtedness, investmentcontracts, or any instrument commonly known as a security.Securities law issues generate more malpractice cases than any other issues (easyto over look)7 Statutes regulating the securities law industry (we only care about 2)

Securities Act of 1933- mainly deals with primary markets (regulates theofferings and sale of new securities to the investing public)

File w/ SEC- Requires Corporations, wishing to sell securities,to file a statement with SEC (security exchange commission)(very expensive- avg. cost- $943K)Scope is Procedural- Not worried about weather the corp isthriving or not, it's only worried about weather the corp. follows

certain steps so people can have fair chances at the stock.Reporting Requirement- Periodic reporting requirements(yearly, quarterly, special event)- only apply to registeredcompanies (major publicly traded corps.)

Securities Exchange act of 1934- mainly deals with secondary markettrading (inside trading, securities fraud, short swing profits, proxy voting,etc; also includes periodic disclosure requirements)

Created the Securities and Exchange Commission (SEC) – SEC is the primary federal agency charged withadministering various securities lawsSEC is an independent agency – it enforces securitieslaws

SEC promulgates rules and regulations to implementsecurities law more effectively

Purpose of Securities Law- full disclosure and prevention of FraudFull disclosure: make sure that investors have all the information theyneed to make informed decisions

US congress adapted a ‘rotten egg” statute – corporations cansell their rotten stock, as long as they properly disclose it (noinquiry into merits) V. Many other countries have merit based securities regulations(ask whether company is viable and whether its stock ismeritorious)

Prevention of fraud: agency cost problem re disclosure – how to make a

credible bond?There is information asymmetry b/w issuer and investor – how to persuade the investors that disclosure is truthful- have fraud prevention

Disclosure- Requirement to help make sure that investors have all theinformation they need to make informed decisions

Transactional

Registration statement filed with SEC (prospectus andregistration statements filed with SEC)

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Prospectus distributed to investors (requires information to be provided to investors for particular transaction (balance sheet,income statements, directors and officers, use of proceeds, ect)

Periodic

Form 10 (once)Fork 10-K (annual)

Form 10-Q (quarterly)Form 8-K (episodic) – filed upon certain important eventsRequired in connection with any public saleOnly required of registered companies

Selling Securities under the Securities Act of 1933 (focus on primary market!)General Rules: Securities Act prohibits the sale of securities unless thecompany issuing the securities (issuer) has “registered” them with SEC

A security cannot be offered for sale through the mail or by useof other means of interstate commerce unless a registrationstatement has been filed with the SECsecurities cannot be sold until the registration statement has become effective

the prospectus must be delivered to the purchaser before the saleImportant civil liabilities:

See Ss 11(a)1933 Act §11(b3a) – fraud in the registration statement (no fraud inconnection with any disclosure

can’t be used with exempt offerings (because misrepresentationor omission must be in connection to registration statementdue diligence is not an affirmative obligation, but it is generallythe only viable defense to §11(in practice, due diligence isgenerally delegated to lawyers)there is a right of private action!

1933 Act §12 (a)(1) – strict liability for illegal offers and sales;

rescission remedythis makes the decision whether or not required to register thatmuch more important

1933 Act §12(a)(2) – fraud in prospectus or oral sales communicationcan be used with exempt securitiescan be used whether or not security is registeredstd of review: negligence – seller is not liable if he can show thathe did not know, and in the exercise of reasonable care shouldnot have known, of such untruth/omission

Implied private rights of action exists

1934 Act 10(b) and SEC Rule 10b-5 10(b) is the principal anti-fraud provisions of Securities Law

(used to regulate insider trading)1934 Act § 14(a) and proxy rules

14(a) regulates shareholder votingRegulatory Arbitrage in the Primary Market

public offerings can be useful, but expensive. Therefore, congress provides 2 exemptions to the registration requirement:

Some securities are exempt entirely (no need to ever register)Exemptions are Affirmative Defense!

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Exempt Securities- 1933 Securities Act §4(2): §5 shall notapply to transactions by an issuer not involving any publicoffering (non-public offerings)…

Sales to institutional investors- Insurance companies or pension funds -- Such institutions are powerful andsophisticated enough that they will insist on appropriate

disclosure as a condition of saleSales to key employees- E.g., top senior executiveswould have sophistication of company’s affairsAcquisition of closely held corporation- Assuming thatclose held stockholder is sophisticated, the transactionwill be exemptMoney-raising offerings to small numbers of people-

elements"How many offerees – not buyersDegree of sophistication and knowledge aboutthe company’s affairs possessed by the offerees.

Private Placement Exception: Securities Act § 4(2)

Provisions of Section 5 shall not apply to… “transactions by anissuer not involving public offering” – but public offering is notdefined in statute –

Doran v. Petroleum Mgmt Co, Petroleum Mgmt Coorganized a limited partnership to drill for oil. Itcontacted a few people, but only Doran bought aninterest. Doran agreed to assume one of the firm’s debts.The business started losing money and eventuallydefaulted on the note that Doran guaranteed. Doran suedfor rescission arguing Petroleum did not register.Petroleum argues the were exempt and did not need toregister

Private placement test: Four factors are relevant towhether an offering qualifies to the exceptions-

# of offerees (not purchasers) and the

relationship to issuer.

Number must be below 25 “a totalconsistent with a private placement"Relationship to issuer (is the offeree’srelationship to the issuer such that theofferee in the context of the offer is ableto protect himself and look out for hisown interest in the transaction).

broken into:

are these sophisticatedinvestors? – goes to legal and business sophisticationare these knowledgeable

investors? – goes to access toinformation: amount of information required = “theinformation a registrationstatement would have afforded”

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Required from all offerees

(not all investors) !

number of unites offered

size of the offering (how much money is beingoffered)manner of the offering (private means no

general advertising or soliciting)NOTE: Only investors can attempt to rescindthe sale by challenging whether corporation was properly exempt. Corporations are not allowedto do this!

Regulation D safe harbors:rule 504: is an issuer raises no more than $1 millionthrough the securities, issuer may generally sell them toan unlimited number of buyers without registeringsecurityRule 505: if an issuer raises no more than $5 millionthrough the securities, issuer may generally sell them to

up to 35 buyers without registering the securityRule 506: if an issuer raises more than $5 millionthrough the securities, issuer may generally sell them toup to 35 financially sophisticated buyers withoutregistering the securityRegulation D and 4(2) generally exempt only the initialsale!

RULE 10b-5

Exchange Act § 10(b): It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstatecommerce or of the mails, or of any facility of any national securitiesexchange…

To use or employ, in connection with the purchase or sale of anysecurity registered on a national securities exchange or anysecurity not so registered, any manipulative or deceptive deviceor contrivance in contravention of such rules and regulations asthe Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. purpose was to create a “catch all” for any new deceptivedevices that were not already covered by the 1934 Act.

Exchange Act Rule 10b-5: It shall be unlawful for any person, directlyor indirectly, by the use of any means or instrumentality of interstatecommerce, or of the mails or of any facility of any national securitiesexchange,

(a) To employ any device, scheme, or artifice to defraud,(b) To make any untrue statement of a material fact or to omit tostate a material fact necessary in order to make the statementsmade, in the light of the circumstances under which they weremade, not misleading, or (c) To engage in any act, practice, or course of business whichoperates or would operate as a fraud or deceit upon any person,in connection with the purchase or sale of any securitytreat as “thou shall not commit fraud”

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Elements:

Unlawful – for violation of the rule:Justice dept: a willful violation is a felony andthe SEC may prosecute you criminally – 1934Securities Exchange Act §32(a)SEC bring civil action

Private parties allowed: while there is no express private right of action, courts have implied that private rights exist

Judicial nexus – there needs to be a link b/w Congress,the SEC, and interstate commerce

commerce clause was inserted b/c the idea thatcongress could regulate fraud (state law) wassomewhat controversial.interpreted very broadly – if in defrauding your neighbor, you sent a letter confirming sell thatonly states “I sold you” – it is sufficient; evenface-to-face transactions could be included if

you drove in your car, ectTransactional nexus [in connection with the purchase or sale of any security]

any securities – stock and bonds purchase or sale – must be a purchase or seller inorder to have standing ( Blue Chip Stamps CB427 – P did not have standing to sue where

because of fraud he decided not to buy stock)

Only purchaser and sellers have the right tosue/mere right to exercise an option does notgive standingin connection with – fraud only needs to “touch

and concern” a purchase or sale (eg.,misappropriation theory of insider trading – where the fraud on person A taints thetransaction with person B)

Material misrepresentation or omission [untruestatement of a material fact or to omit to state a materialfact]

materiality exists where “there is a substantial

likelihood that a reasonable investor

would consider the fact important”TSE Industries CB 429.

as to contingencies (where possibility of occurrence is important to investors, butnonetheless only contingent): courtsapply a “highly fact-dependent

probability/magnitude balancing

approach” Basic CB 426, 432 probability that event will occur – board resolutions, instructionsto investment bankers, hired

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atty, capital to finance further development, even did insidersstart to buy stock magnitude of event – size of thecorporate entities, how muchmoney will the co make,

potential for premium over mktvalue

so if not material, then can lie about it!!!there is a difference b/w a material

misrepresentation and omission

with omissions, it is permissibleto keep silent so long as there isno duty to disclose (ft.17 Basic

CB 432)most courts rule that there is noduty to disclose until the cohave reached an agreement in

principle (announce only whereagreement as to deal and its basics; prior to such agreementgive “no comment”)USSC rejects this agreement in principal std for determinationof materiality withcontingenciesnote that if “no comment”

follows a denial highly

suspicious (better off adapting ano comment policy to avoid

sending the wrong signal)with material

misrepresentations, you arescrewed!

Reliancereliance is presumed in omission cases(otherwise would be impossible to prove) Affiliated Ute Citizens of Utah v. US (1962)reliance is rebbutably presumed inmisrepresentation cases (otherwise requiringindividual reliance from each member of the proposed P class would prevent Ps from

proceeding with class action)USSC adapts “fraud on the market

theory” – it is presumed that investorsrely on the integrity of the market price(therefore investors need not prove theyhave seen the reliance) Basic CB 433Assume reliance where:

There is a material publicmisrepresentation

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With a stock that is traded in anefficient market (so that stock price will reflect themisrepresentation)

D could rebut presumption of the fraudon the market theory by “any showing

that severs the link b/wmisrepresentation and the market price”Basic CB 435

Market is not deceived: if themarket makers know about themerger, they will set the priceaccordingly (Market maker is a broker who makes the market ina securities – that agent whichmatches buyers and sellers – market maker determines the price at which a particular

transaction will be executed)Corrective statements- there is aduty to correct inaccuratestatements.Specific plaintiffs would havesold anyways (this is bogus b/cno one would depose 3M Ps)

Causation – there are two types of causation:Transactional causation

but for the fraud, plaintiff would nothave invested (or sold, ect)closely related reliance

loss causationakin to proximate causefraud caused the loss (e.g., marketdoesn’t believe the misrepresentation,stock tanked due to market declined)could be very tricky: how do you provecausation where a false statementdenying merger coincides with fall in

market prices for all stocks battle of

the economic expertswhere reliance is presumed, court will alsoassume transaction causation (omissions/fraud

on the market) but loss causation is not presumed (how wouldBasic’s P prove loss causation on remand – seems like the market did not believe the denial b/c the market price went up anyways; provingloss causation may be tricky - perhaps couldargue that if Basic had told the truth, the pricemight have gone up even more; but Comb mighthave also walked out)

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Scienter is requiredscienter is state of mind

- intent to defraud (Sup Ctr)- reckless disregard of falsity of statement (all circuits)-pure intend is not required b/c reckless

may sufficerequired in private party litigation ( Ernst &

Ernst v. Hochfelde, 1976) and SEC actions( Aaron v. SEC , 1980) Negligence is not sufficent

INSIDE TRADING (order of insider Trading info might be backwards)Rule 10b-5: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securitiesexchange,(a) To employ any device, scheme, or artifice to defraud,(b) To make any untrue statement of a material fact or to omit to state a material fact necessaryin order to make the statements made, in the light of the circumstances under which they were

made, not misleading , or (c) To engage in any act, practice, or course of business which operates or would operate as afraud or deceit upon any person,in connection with the purchase or sale of any security.

Insider trading liability is premised on an omission of material fact

Problem: Liability for omission can only be imposed where D had a duty to discloseSilence is not fraudulent absent a duty to speak. Agassiz (state law)Whence comes insider’s duty to speak?SEC v. Texas Gulf Sulpher: first circuit case to deem insider trading illegal!- Exploratory holedrilled; visual assay promising. Based on core sample results, TGS begins land acquisition.President orders drilling be kept secret until it could buy land. Meanwhile, Ees bought stock andcall options and told their friends. When news got out, the company sent a misleading press

release. Four days later, official statement made at 10 AM. At 10:54 AM, news appeared on DowJones ticker. (arguably insider transaction caused increase in stock price!)Rule: where an insider has material nonpublic information, the insider must either disclose it or abstain from trading until material information has been publicly disclosedrationale for rule: the federal inside trading prohibition was intended to assure that “all investorstrading on impersonal exchanges have relatively equal access to material information”a janitor working for TGS who found the geologist memo is covered by the insider trading rulea farmer who realize the TGS is purchasing their land would probably not be covereddo insiders really have an option?

TGS did not have duty to disclose material info before April 12 press release. After April 12, theyhad duty to correct misleading statement (Basic).– see ft. 12 (CB 465)If TGS wanted the information kept confidential, insiders don’t have the right to disclose it –

Agency §365 – cannot use/disclose information that comes to EE in the course of ee-er relations.therefore, it is really a duty to abstain (abstention rather than disclosure ruleWho is an insider?

1933 Act §16(a) and (b):Officers, directors and 10% shareholdersRule 10b-5:TGS director - yesTGS secretary - yesTGS geologist - yes

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janitor - yesfarmer hypo - noWhen can an insider trade? - Insiders must wait until the information is effectively disclosed ina manner sufficient to insure its availability to the investing public (at that time a broad tape) – to prove that market knew at that time refer to market maker or the specialist in stock Materiality –

TGS rule – “whether a reasonable man would attach importance” to the information (this isdifferent from the modern test)Modern rule – “whether there is a substantial likelihood that a reasonable investor wouldconsider the omitted fact important in deciding whether to buy or sell security”re contingent facts: probability/magnitude balancing (Basic)factorsnature of the informationCompany responseMarket response (brokers’ opinions)Conduct of the insidersPractice of the industry was to buy on one good sampleBalance probability that event will occur against the anticipated magnitude of the event in light of

the totality of the company activityINSIDER TRADING– WHY DO WE CARE?

There are two kinds of inside trading:

classical insider trading: Director/EE has fiduciary duties both to entity and investors; and thentrades with a investor based on material nonpublic informationoutsider insider trading (misappropriation) – a trading employee (no relationship with entityor investor) trades both types of illegal – but why?: to keep current law we need a theory with normative power, aswell as positive ability to predict what will happen in the future (theory that has both justificatoryand explanatory power)or should be just repeal illegality of inside tradingEconomic Analysis of Inside Trading

DeregulationDeregulatory arguments:(1) market efficiency(2) executive compensation argumentsRegulation

Regulatory arguments:(1) fairness(2) property rightsTHE MODERN DISCLOSURE OR ABSTAIN RULE

There are essentially two options to regulating insider trading (IT):as in CL, think of IT as self-dealing so that IT becomes part of the same problem of corporate opportunity, OR

treat IT as problem of securities fraud – that there is informationasymmetrydon’t analyze these as though one is wrong and the other is right. Just ask what is the purpose of securities regulations? What are we trying toachieve

Different kinds of inside trading:Classical IT : involves insider who owned fiduciary obligations to boththe corporation and the investor with whom they tradeBut with time, more sophisticated IT developed:

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Chiarella - USSC – use of nonpublic market information- Facts:D worked for a printer that was charged with printing financialdocuments and he used information that he deduced from thedocuments to buy stock in target company. No relationship at allwith target company. Client was the buyer company, notcompany whose stock he traded. --> D only had market

informationRule: The mere possession of nonpublic market

information does not create a duty to disclose. ( Note:departs from TGS in which “fairness and equal access toinformation” is the key.) -> equality of access does notsurvive Chiarella

Market information v. Inside InformationInside information: originates withinthe firm and relates to the firm’s earning power or assets (e.g., earnings, products,assets, plans and the like)Market information: is everything else

note that nothing in the opinion distinguishes b/w the twoDuty to disclose or abstain arises from a

relationship of trust and confidence between

parties to the transaction.Who is an insider past Chiarella and Dirk:

Exchange Act § 16(b): Officers, directors, and

10% SHs

Rule 10b-5: - Those with fiduciary duties

Janitor is an Eee, thus agent, so subjectto insider trading liability.Farmer not someone whom investors

would place trust and confidence, notagent, no fiduciary relationship.Hypo: Acme Mining and XYZ Corp arenegotiating a merger. During negs,material nonpublic info about Acme isdisclosed to XYZ. Merger negs fail.XYZ then begins buying stock on theopen mrkt in anticipation of making ahostile takeover bid for Acme. Liability? No. (Dirk FN 22)– arms lengthrelationship does not imply anobligation or an expectation of

confidentialityConstructive Insiders (Dirks FN 14):

Obtain material information from theissuer withan expectation on the part of thecorporation that the outsider will keepthe disclosed information confidentialand

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the relationship at least implies such aduty.

Tipping – Dirks v. SEC : ∆ received a tip from Eee that corporation

was engaging in fraud. Investigated and learned more about fraud. Thentried unsuccessfully to get the NY Times to write about it. Dirks tells hisclients about his investigation into corporation; clients sold. Eventually,

media and SEC action caused stock to collapse and fraud was exposed.In most tippee chains, all the tippees trade. Here Dirk did not, but his clients didTipping:

When an insider tips and outside tippee (not a fid or an

agent of corp; complete stranger) who tips another

tippee who tips another tippee (aka tipping chain)In general, the tippee’s liability is derivative of thetipper’s, “arising from his role as a participant after thefact in the insider’s breach of fiduciary duty”

Rule: A tippee can be held liable only when:Tipper breached a fiduciary duty by disclosing

information to the tippee[6], ANDFor a tippee to be liable:

tipper must have breached a fiduciary

duty

tippee knew or should have known of

breach

The tippee knows or has reasonto know of the breach of duty.

Note: In “tipping chain,” knowledge ismore attenuated at Tippee 2, 3, etc.Also, you can have a tipper who breaches, Tippee doesn’t know of

breach, so he’s not liable.Pecuniary gain; enhanced reputation

that will translate into future profits;

or gifts.

Liability arises for either making the tip or

for insider trading – the fact that D tippedwithout trading is irrelevant if all the other conditions are satisfied.

Could have tipper liability withouttippee liabilityHere tipper was a whistle blower anddid not get any personal benefit

Penalties:Administrative hearings against Ds under the SEC’sdirect regulation (brokers, dealers, etc.)Equitable relief in civil case brought by the SEC:

Injunctions; e.g., forbidding violater from beingemployed in the securities industryDisgorgement of profitsTreble money sanction under ITSA



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Criminal indictment: 20 yrs jail and up to $5 mill finefor individuals and $25.5 mill for corp Ds per count(Exchange Act § 32 makes it a felony)Private suits--rare

MISAPPROPRIATION

Misappropriation: based on breach of a fiduciary duty not to the co in

which you trade, but to the source of informationNeed for misappropriation theory: b/c Chiarella premised IT on a

relationship of trust and confidence, it left a big gap in law could IT

without facing any consequence USSC came up with

misappropriation theory to save the day

U.S. v. O’Hagan: ∆ /partner of a law firm who took info from other

attys working on Grand Met’s hostile take over of Pillsbury. ∆ bought

Pillsbury stock. (note that ∆ is not liable under Dirk b/c Dirk’s abstain

theory requires fiduciary duty to the entity whose stock are being

purchased and ∆ had none..)

Rule: A fiduciary’s undisclosed use of information belonging to

his principal, without disclosure of such use to the principal, for personal gain constitutes fraud in connection with purchase or sale of a security and thus violates Rule 10b-5

O’Hagan should have disclosed to both law firm andGrand Met (b/c he owes fiduciary to both).Grand Met might have approved O’Hagan’s buyingstock, so that it could squirrel away the stock intofriendly hands (warehousing). In theory, if Grand Metand law firm had approved, O’Hagan would not have been liable.Public policy: We want to encourage wide participationin the securities markets. Although informationaldisparity is inevitable, investors would hesitate toventure their capital in a market where trading based onmisappropriated nonpublic information is unchecked bylaw.

Significance: Anyone who misappropriates confidentialinformation from anyone can be liable for trading on thatinformation.Chiarella would have been decided differently. Sup Ct hadrejected misappropriation theory b/c it hadn’t been presented to jury, but Burger dissenting said that it was misappropriation.

SWING PROFITS

Law- statute has two primary sections:SEA § 16(a) - “Every person who is directly or indirectly the beneficial owner of more than 10 per centum of any class of any equity security . . .OR who is a director OR an officer of the issuer of such security . . .within ten days after the close of each calendar month . . . shall file withthe Commission . . . a statement indicating his ownership at the close of the calendar month and such changes in his ownership as have occurredduring such calendar month”

only SH are subject to the 10% requirement

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SEA § 16(b) - “any profit realized by [such beneficial owner, director, or officer] from any purchase and sale, or any sale and purchase, of anyequity security of such issuer . . . within any period of less than sixmonths . . . shall inure to and be recoverable by the issuer”

In the event the corporation doesn’t sue for recovery under 16(b), there exists a provision allowing a shareholder to sue the

beneficial owner, director, or officer derivatively on behalf of thecorporationSOL = 2 yrs

SEA § 16(b) – “This subsection shall not be construed to cover anytransaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase, of the security involved”

SH must have 10% for both purchase and sale. The transactionthat places one over the threshold is not a matchable one(Provident Securities)Directors/Officers are subject to § 16(b) if they are an officer or director at the time of either the purchase or the sale

Analysis of 16(b):

This is a form of SL if you violate the rule, you are liable irrespectiveof intent or purposeParties affected:

16(b) only applies to insiders (no misappropriation issues) thatare:

shareholders with more than 10% of the stock beneficial owners - directly or indirectly havethe power to dispose, vote, ect

officers (no 10% requirement)Statutory officer – prez, CEO, CFO, ect and Anyone who exercises significant policy makingfunctions

directors (no 10% requirement)16(b) is narrower than 10b-5:

smaller group of insiders than under 10b-5no tipping liability, no misappropriation liability, noconstructive insiders16(b) applies only to companies that must register under the 1934 Act

10b-5 applies to any security to any company(public or private) v.

16b only applies to publicly held co & only

applies to equity securities (stocks, or securitiesconvertible to stock)

Sale and Purchase:16b applies whether the sale follows the purchase or viceversa

therefore shares are fungible

it is irrelevant for analysis when you bought or sold the same stock so long as it meets the 6 mthand other requirements; the fact that the sharesyou sold are not the same ones that you bought

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is irrelevant so long as there is sufficient stock tomatchIf a trader sells 10 shares of stock and buys back 10 different shares of stock in the same companyat a cheaper prices, he or she is still liableHypo:

1/1- Buy stock @ $91/2 - buy stock @ $111/3 – sell stock @ 10

trader can’t argue that he lost money because he

sold the 1/2 stock so long as we could match

the 1/1 and 1/3 transactions, trader is liable for the difference 11 – 10 (see also maximizing)

The sale and purchase must occur within six months of each other

Recovery:

Any recovery goes to the companyshareholders can sue derivatively, and a shareholder’s

lawyer can get a contingent fee out of nay recovery or settlementcourts interpret the statute to maximize the gains the

company recovers:hypo:

12/31 – buy stock @ 51/1- Buy stock @ $91/2 - buy stock @ $111/3 – sell stock @ 10

courts will max corporate recovery:first will use 12/31 price 10 -5then, any residual will go to the next

transaction that will yield most liability,and so on

A court will not imply step transactions: A 10% SH can sellenough shares to go below 10% threshold, and then in a separatetransaction freely sell the rest without being subject to 16b – Reliance Elec v. Emerson Elec. CB 491- USSC

Facts:6/16 - E buys 13.6% of dodge8/28 - E sells some shares; reducing holdings to 9.96%9/11 - E sells remainder

Issue/Holding:

Was the 6/16 purchase a “matchable” purchase?

– USSC doesn’t answer Assuming that it was a matchable purchase, canit be matched with 9/11 sale? - No, because Ewas not a 10% owner on 9/11

What is a matchable transaction:

Officers and directors are subject to § 16(b) if they arean officer or director at the time of either the purchase or the saleShareholder:

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In a purchase-sale sequence, the transaction bywhich the shareholder crosses the 10% thresholdis not a matchable purchase. Only purchaseseffected after one becomes a 10% shareholder are matchable -

Foremost-McKesson v. Provident Sec CB 493- USSC

Facts:9/20

Prov acquires debentures convertible into > 10%of Foremost stock This is not a matchabletransaction because places Prov over top

9/24Prov distributes some debentures to shareholdersPotentially matchable transaction

9/28Prov sells remaining debentures Potentiallymatchable transactionIs2

22. Issue: Can we match 9/20 acquisition with 9/24disposition?

Holding: NO

HYPOS: CB 503-504B is the CEO of a company registered with SECthat has 1M outstanding shares of stock

CB 1(a)1/1 purchases 200K shares @ 10 Don’t worryabout % because B is CEO5/1 sells 200K shares @ 50

Liability:

because B is the CEO, 16(b) applies toall of his transactiona purchase occurred within 6 months,and B owes (200K)($50) - (200K)($10)= $8M

CB 1(a) variationYears ago purchases 200K shares @ 10 Don’tworry about % because B is CEO1/1 sells 200K shares @ 505/1 buys 200K shares @ 10Sale/purchase v. purchase sale distinction notimp

Liability: because B is the CEO, 16(b) applies to all of histransactiona purchase occurred within 6 months, and Bowes (200K)($50) - (200K)($10) = $8M

CB 1(b)1/1- purchases 200K shares @ 10 Don’t worryabout % because B is CEO5/1- sells 110K shares @ 50

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5/2- sells 90K shares @ 50Liability: because B is the CEO, 16(b) applies toall of his transactionA purchase and two matching saleoccurred within 6 months, and Bill

owes:(200,000)($50) - (200,000)($10) =$8,000,000The percentage of shares Bill owns isirrelevant because he is an officer CB 1(c)

1/1- purchases 200K shares @ 10 Don’t worryabout % because B is CEO5/1- sells 110K shares @ 50 Resigns5/2- sells 90K shares @ 50

Liability:

RULE: Officers and directors aresubject to § 16(b) if they are an officer

or director at the time of either the

purchase or the sale

Despite the fact that B was not onofficer on the 5/2 transaction, becausehe was on officer during the transactionson 5/1 & 1/1, they are matchable with5/2A purchase and two matching saleoccurred within 6 months, and Billowes: (200K)($50) - (200K)($10) =

$8M Note: it works the other ways as well (if

he gets hired after the sale) rules are

designed to max liabilityRene is an investor with 200K shares of publiccorp stock that she has held for several years.She is not an officer or a director (therefore needthe 10% threshold):

CB 2(a)Years ago purchases 200K shares

She is now a 10% holder (200K/1M) =20%

Not a matchable transaction because places over threshold

1/1- Sells 200K shares @ 50She loses 10% hold

5/1- Buys 50K shares @ 10

She gets 10% not a matchabletransaction (Provident Securities)

5/2- Buys 110K shares @ 10Potentially matchable transaction

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Liability: RULE: “This subsection

shall not be construed to cover any

transaction where such beneficial

owner was not such both at the time of

the purchase and sale, or the sale and

purchase, of the security involved”

R is not liable because was a 10 percentshareholder when she sold, but not whenshe bought either block

CB 2(b) Years ago purchases 200K sharesShe is now a 10% holder (200K/1M) = 20% Not a matchable transaction because places over threshold1/1- Sells 200K shares @ 50 This was made at atime when she was 10% SH!!!!!!- matchabledespite fact that it causes her to lose 10%5/1- Buys 110K shares @ 10- She gets 10%

(110K/1M) not a matchable transaction

(Provident Securities)5/2- Buys 50K shares @ 10- Potentiallymatchable transaction

Liability:Yes, because could match the 1/1 and5/2 [sell/buy]Accordingly, she is liable for her gainon 50K shares: ($50 x 50K) – ($10 x50K) = $2M

CB 2©- Years ago purchases 200K shares- Sheis now a 10% holder (200K/1M) = 20%not a matchable transaction (Provident Sec)

1/1- Sells 110K shares @ 50- She loses10% hold – still matchable?1/2- Buys 90K shares @ 50- She gets

10% not a matchable transaction

(Provident Securities)5/1- Buys 300K shares @ 10-Potentially matchable transactionLiability:Renee was not a 10 percent shareholder when she bought her stock.Accordingly, we cannot match a purchase with her sale of her first 110K

shares, and she is not liable.CB (4) – Suppose an investor has convertibledebentures

Years ago purchases 5K sharesdebentures- convertible into 100shares/debenture- She is now a 10%

holder 5K debentures = 500K shares

she is treated as owner of more than

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10% of equity -> not a matchabletransaction3/1- Buys 100 debentures @ $800-Matchable4/1- Sells 100 debentures @ $900-matchable

Liability: she is liable for her $10,000 profit on the purchase and sale of the100 debentures.

Bainbridge Hypo;6/16- 13.2% purchase @ $ 10- cant’ use because places you over 10% (ProvidentSecurities)6/19- buy + 3.3% @ $10- Yes 10% -Potentially matchable8/28- sell 6.6% @ $11 (takes you downto 9.9%)- Yes was 10 % - potentiallymatchable

LINK 6/19 and 8/289/11- sell the remainder @ 20- Below10% - Not Matchable (Reliance)Liability: she is liable for her $10,000 profit on the purchase and sale of the100 debentures.

Summary of Rules:USSC interpretation of 16b has been remarkablyrigid: intended as a bright-line statute, yetdraconianIs there a sale/purchase OR purchase/sale within6 mths – If yes, go on

Order is irrelevant: sale/purchase or purchase/salerule applies to any sale (tender, stock, open mkt,ect)Is it by a director or a SH?Directors and Officers need not satisfy the 10%requirement (10% rule applies only to peoplewhose only link is stock ownership)

Officers and directors are subject to §16(b) if they are an officer or director atthe time of either the purchase or thesale

So if gets hired after sale, or if gets fired before still liable

With beneficiary SH - “this subsectionshall not be construed to cover anytransaction where such beneficial owner was not such both at the time of the purchase and sale” –

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only purchases effected after one becomes a 10% SH arematchable!!!!!

if you are 10%shareholder, you can go below 10%, pay your

liability and sell the restfreely

but sales that reduce your holdings to below 10% arematchable!

Max gains for corporationBottom line: most of time, an insider can’tsell/purchase OR purchase/sell within 6 mthswithout violating 16b [except qualifiedcompensation plans which are not covered by16(b)]

Indemnification and Insurance

Liability Limitation Statutes – DGCL § 102(b)(7) provides that a corp’sarticles of inc may (but need not) contain:

A provision eliminating or limiting the personal liability of a director tothe corp or its SHs for monetary damages for breach of fiduciary duty asa dir. Provided that such provision shall not eliminate or limit the liability of a

dir: For any breach of duty of loyalty to corp or its SHs;

For acts or omissions not in good faith or which involveintentional misconduct or a knowing violation of law;

liability for unlawful dividends;or for any transaction from which the dir derived an improper

personal benefit only applies to directors, not officers (BJR applies toboth)

although officers also are subject to a duty of

care, they are denied exculpation by charter provision Arnold v. Society for Savings Bancorp – if D isboth a director and an officer, a §102(b)(7)

provision applies only to actions taken solely inhis capacity as a director

only eliminated monetary liability, it does not eliminate equity remedies(class actions)

the effect of the statute is to wipe out monetary liability for breach of fiduciary dutiesdistinguishes self dealing (improper personal benefit) from duty of care

Indemnification Statutes:At CL, corporate EEs were entitled to indemnification for expensesincurred on the job, including certain legal liabilities, but directors werenot. Today, most states have statutory provisions covering the authorityor obligation of a corporation to indemnify officers and directors for any

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damages they might incur in connection with their corporate activitiesand for the expenses of defending themselves.Different situation where directors might be subject to liability

Claims by third parties (i.e. director hits pedestrian withcompany car)Claims by shareholders (for injury to the corporation)

Claims by EEs (i.e. sexual harassment, ect)Claims by customers (i.e. sale of harmful drugs)Claims by competitors (i.e. violations of anti-trust laws)Claims by governmental agencies

Indemnification is important b/c even though the risk of liability might be remote, the amount of damages and the expenses incurred to litigatethe claim could be substantial, especially in proportion toofficers/directors’ wealth.

Delaware law:

Coverage:

§145(a) – indemnification for third party actions - expenses,

judgments, fines, and amounts paid in settlement where the

officer acted in good faithgood faith + believed in the best interest

§145(b) – indemnification for derivative suits allowed but for expense only (more narrow than a)where D is found liable to the corporationonly with judicial approval

* requires good faithMandatory v. Permissive Indemnification

§145(c) – the corporation must indemnify a director or officer who ‘has been successful on the merits or otherwise” in thedefense of the action.

if successful mandatory indemnification

if not successful discretionary* doesn’t require good faithAdvancement of expenses

145(e) allows a corporation to advance expenses to the officer or director provided the latter undertakes to repay any such amountif it turns out he is not entitled to indemnification.

Sacrbane –Oxley prohibits loans by corporation toofficers and directors. Some think this provision mayaffect advancement of expenses - Sacrane – Oxley may preempt 145(e)?!?

Purchase of insurance by corporation authorized - §145(g)

Indemnification by agreement allowed: a corp can K for protection

above that of the statute145(f) authorizes the corporation to enter into writtenindemnification agreement with officers and directors that go beyond the statute: statutory indemnification rights “shall not bedeemed exclusive of any other rights” to indemnification created by “bylaw, agreement, vote of the stockholders or disinteresteddirectors or otherwise”

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if statute is silent by agreement, the parties can

provide for indemnification145(f) clearly authorizes indemnification agreementsmandating payment of expense that the statute merely permits145(f) clearly authorizes indemnification agreements

mandating advances145(f) likely allows indemnification of certain expensesnot contemplated by the state (i.e. for expense beyondthose of atty fee) Whether a provision could mandate indemnification in asituation which statutory indemnification is not permited? - Waltuch

Waltuch (P) v. Conticommodity Services, Inc (D). Waltuch (P) wasthe VP and chief metal trader for Conticommodity (“Conti”). Waltuchsues Conti for indemnification of §2M for legal expenses incurred indefending himself for his alleged fraud and manipulation of the silver market (Cornering a market is manipulation and is against CFTC rules)

against civil lawsuits ( P had incurred 1.2M in expenses and wasdismissed from suit with no settlement contribution; Conti paid $35M insettlement)

CFTC enforcement proceeding ( P incurred 1K in legal

expense before he settled - paid 100K fine and 6-month ban onfuture Ks)Conticommodity’s articles of inc provided the corp shallindemnify and hold harmless each of its incumbent and former dirs, officers, Ees and agents…against expenses actually andnecessarily incurred by him in connxn with the defense of anyaction, suit or proceeding threatened, pending or completed, inwhich he is made a party, by reason of his serving in or having

held such position or capacity, except in relation to matters as towhich he shall be adjudged in such action, suit or proceeding to be liable for negligence or misconduct in performance of dutyHELD: Indemnification rights may be broader than those set

out in the statute, but they can’t be inconsistent with the

scope of the corp’s power to indemnify, as delineated in the

statute’s substantive provisions. consistency rule

OUTCOME: Waltuch not indemnified per agreement. Where thestatute requires good faith, as it does in both sub a and b, anagreement that purports even by implication to authorizeindemnification for bad faith conduct is inconsistent with thestatute’s scope.

Good Faith: (thinking back on the truck hypo)Interpreting CA law, 4th Cir. has held that a dir or officer who intentionally participates in illegal activitycannot be deemed to have acted in good faith even if theconduct benefits the corp.Thus, no indemnification.

Fees on Fees

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If an officer or dir is obliged to sue the corp seekingindemnification, is a prevailing officer or dir entitled notonly to indemnification of atty fees incurred in theunderlying litigation but also those fees incurred in theindemnification suit?

Baker: NY indemnification statute bars recovery

of “fees on fees.” But the NY statute authorizescorps to provide indemnification of fees on feesin bylaws, employment Ks or through insurance.Stifel Financial Corp: Del. says that an attyrepresenting a former dir who is being deniedstatutorily authorized indemnification must seek compensation from his client or remainuncompensated, a result inimical to the interestsof the former dir and contrary to the express purpose of § 145 to protect dirs from personalliability for corporate expenses. Indemnificationstatute should be broadly interpreted to further

goals it was enacted to achieve.CHAPTER 6 Problems of Control (p. 539)

Proxy Fights (p. 539)

Proxy: shareholders may appoint an agent to attend the shareholder meeting and vote ontheir behalf. That agent is the shareholder’s “proxy holder,” sometimes simply called theshareholder’s “proxy” (or “proxy card”).Proxy Card: Incumbent managers at large firms solicit other shareholders for proxystatus, asking the other shareholders to sign a proxy card which will allow the managersto vote on their behalf.Proxy Fight: “Proxy fights” result when an insurgent shareholder group (a group of shareholders who want to wrest control of the company away from the reigning Board)

tries to oust incumbent managers by soliciting more proxy cards than the incumbentmanagers, then electing themselves and their allies to the Board.Strategic Use of Proxies

Levin v. Metro-Goldwyn-Mayer, Inc.

Rule: Incumbent directors may use corporate funds and resources in a proxy

solicitation battle (proxy fight), if 1) the sums are not excessive and 2) the shareholdersare fully informed.In this case, element 2) was satisfied because the incumbent managers sent letters to allthe shareholders which itemized the major costs which they intended to spend on the proxy fight, including $15,000 or a law firm, $5,000 for a public relations firm, and gavean estimated total of the entire cost: $125,000. Element 1) was satisfied because those

expenses were reasonable and very small in amount compared the firm’s annual grossincome of $185,000,000.“Fully informed”

SEC rule 14a-9 prohibits solicitation of a proxy by a statement containing either:a false or misleading declaration of material fact, or an omission of a material fact that makes any portion of the statement false or misleading.An omitted fact is “material” if there is a substantial likelihood that a reasonableshareholder would consider it important in deciding how to vote.

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Reimbursement of Costs

Rosenfeld v. Fairchild Engine & Airplane Corp.

Rule: In a contest over policy, corporate directors have the right to make reasonable and proper expenditures from the corporate treasury for the purpose of persuading thestockholders of the correctness of their position and soliciting their support for policies

that the directors believe, in good faith, are in the best interests of the corporation.Application: The incumbent mangers properly spent $106,000 out of the firm’s treasuryon a proxy fight, but they lost. After the fight was over, they spent another $28,000 onturning over control, which was also reasonable, so the new Board reimbursed the oldBoard for $28,000. One shareholder, alone, had a problem with this, so he sued for themoney to all be returned to the firm’s treasury, but it turned out that he was just a stupid jerk, because this was all kosher. Notes on the Regulation of Proxy Fights (p. 547)Soliciting Proxies- “Soliciting” proxies includes merely asking for other shareholders tohelp in obtaining a list of all the shareholders for the purpose of soliciting proxies(Studebaker Corp. v. Gittlin). However, only shareholders who are actually soliciting

proxy cards are required to file with the SEC; the other shareholders who merely help bycampaigning or helping obtain a list of shareholders do not need to file with the SEC(SEC rule 14a-2).Proxy Statement- People who solicit proxies must furnish each shareholder with a“proxy statement,” including any conflicts of interest and major issues that he intends toraise at the shareholder meeting, and the current managers must also give an annualreport. Everybody who solicits proxy cards has to file a copy of all these letters with theSEC (SEC rules 14a-3, 4, 5, 6, 11).Rule 14a-7 says that when an insurgent group wants to solicit proxy cards, the incumbentBoard has two choices: 1) The incumbents can mail the insurgent group’s letters to all theshareholders for them and charge the insurgent group for that cost; or 2) The incumbentscan give the insurgent group a list of all the shareholders and make the insurgents mailthe letters themselves. Usually the incumbent group does #1, because that keeps the listof shareholders confidential.Private Actions for Rule Violations

J.I. Case Co. v. Borak

Rule: Where a federal securities Act has been violated, but no private right of action isspecifically authorized or prohibited, a private civil action will lie and the court is free tofashion an appropriate remedy. The Securities Exchange Act has an implied private causeof action for individuals damaged by violations of the Act. This means that plaintiffs arenot limited to state law relief (which often requires that the plaintiff post a large $ bond), but instead may seek relief in federal courts for violations of this federal law.Mills v. Electric Auto-Lite Co.

Rule: when a proxy solicitation is misleading, and then a shareholder gets hurt by thatsame vote, the causal connection between the shareholder’s damage and the misleading proxy statement will be presumed. The shareholder doesn’t have to prove that he wouldhave voted a different way but for the misleading proxy solicitation.Seinfeld v. Bartz

Rule: Valuations of option grants to outside directors are not material information whichmust be included in a corporation’s shareholder statement to solicit proxy votes. Such

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valuations are not material as a matter of law. An omitted fact is “material” if there is asubstantial likelihood that a reasonable shareholder would consider it important indeciding how to vote (SEC rule 14a-9).Shareholder Proposals

Lovenheim v. Iroquois Brands, Ltd. -

Rule: A shareholder proposal can be significantly related to the business of a securitiesissuer for no economic reasons, including social and ethical issues, and therefore may not be omitted from the issuer’s proxy statement, even if it relates to operations whichaccount for less than 5% of the issuer’s total assets.By the way, the issue should have enough social/ethical import that it would have asubstantial effect on a reasonable shareholder’s decision, and ideally thereby affect thevalue of the company to a degree of more than 5% if the shareholders knew about it.Analysis- Lovenheim is a member of PETA. He only bought the shares in the first placeso that he could be a shareholder so that he could advertise the animal cruelty in thecompany’s proxy materials to get people to sell and hurt the value of the company. That’sTenacious D.

The New York City Employees’ Retirement System v. Dole Food Company, Inc.Rule: Corporations may omit shareholder proposals from proxy materials only if the proposal falls within an exception listed in Rule 14a-8(c). The general rule is that ashareholder notifies the corporation of his intention to introduce a proposal at the annualmeeting, the corporation is required to include that proposal within its proxy materials(SEC Rule 14a-8(a)).Exceptions: 14a-8(c): When a firm does NOT need to include a shareholder proposal inits proxy statements:[i](5) - “if the proposal relates to operations which account for less than 5% of the

(firm’s) total assets at the end of its most recent fiscal year, and for less than 5% of itsnet earnings and gross sales for its most recent year, and is not otherwise significantlyrelated to the (firm’s) business.”[i](6) - “if the proposal deals with a matter beyond the (firm’s) power to effectuate.”[i](7) - “if the proposal deals with a matter relating to the conduct of the ordinary

business operations of the (firm).” There is an exception to this exception. In this case,the court found that the issue of which health care plan to support held significantfinancial implications for the firm, thus removing the proposal from the category of ordinary business matters. Austin v. Consolidated Edison Company of New York, Inc.

Rule: In attempting to exclude a shareholder proposal from its proxy materials, the burden of proof is on the corporation to demonstrate whether the proposal relates to theordinary operations of the company.It’s not so much that the information would hurt the company’s value, it’s that it could

hurt the company’s value, and the directors have a duty to protect that value for theshareholders.(First thing to review in Chp. 6- everything else before may not be on the exam.)Shareholder Inspection Rights- Federal law does not provide a shareholder with access tothe shareholder list, but does not prohibit access to the shareholder list, either. Althoughan incumbent Board may elect to mail an insurgent group’s proxy materials for them,

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thus keeping the shareholder list confidential, the insurgent group may be able to obtainthe shareholder list under state law.General Context:

in the process of bringing a derivative suit, DL law requires particularized pleadings in thecomplaint in order to excuse demand; the get facts before discovery, SHs use inspection rights -“the tools at hand”

to get the names and contacts of fellow SH (so as to conduct own mailing)while fed rules allow the corp to mail out proxy material without disclosing it proxy list, SH wantthe list for strategic “target mailings”there is nothing in the federal proxy rules that require a corp to give SH a SH list.Policy Concerns:

Shareholders have a legitimate interest in using the proxy system to hold the board accountable Nobody wants a junk mail distributor to get access to the shareholder list or a competitor to getaccess to the corporations’ trade secrets and other proprietary informationThere are trade secrets and confidential records that should not be open to inspection by anyshareholder In addition to the federal requirements for disclosure, there are state CL and statutory

rights to inspection

Delaware statute - CB 562§220(b) - Shareholder must make a written demand setting forth a “proper purpose”

A proper purpose is one reasonably related to such person’s interest as a stockholder (to preventuse of inspection rights to harass or use in hostile takeovers)§220(c) – allocates the burden of proof in accordance to the info requested

If shareholder only seeks access to the shareholder list , the burden is on the corporation to showthat shareholder is doing so for an improper purposeIf shareholder seeks access to other corporate records, burden is on shareholder to proverequisite purpose.sometimes, corporations will purposefully deny access to information (even when they know thatSH is legally entitled)Determining proper purpose

Proper purposes Evaluation of investment To determine whether there has been mismanagement (if there are some initial grounds for reasonable suspicion)To determine whether the stock’s market price currently reflects intrinsic valueTo determine why dividends are not being paidTo investigate other aspect of the corporation’s financial conditionThe desire to deal with other shareholders as investorsSoliciting proxies, even if hostile to management (as long as shareholder can show a motivationto maximize value)Crane v. Anaconda CB 558 NY – Crane announced a tender offer for Anaconda stock, andasked for a SH list. Anaconda refused list. HELD: communicating with other SH about offer was

a proper purposeRule: A shareholder wishing to make a tender offer to the other shareholders should be permitted access to the company’s shareholder list, unless the shareholder list is soughtfor an objective adverse to the company or its stockholders. The NY statute permitsaccess to qualified shareholders on written demand accompanied by an affidavit statingthat the inspection is related to the business of the company and that the shareholder hasnot sold a shareholder list within the previous five years.Improper purposes

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Pursuit of only social and/or political goals unrelated to the corporation (non-economic purpose)Pillsbury v. Honeywell CB 561-Minn: P lacks proper purpose for requesting info b/c purposewas solely on Pillsbury’s pre-existing social and political views rather than an economic interestDL requires “as an interest of a SH” – but P admitted his only purpose was to end the war.

Rule: In order for a shareholder to inspect shareholder lists and corporate records, theshareholder must demonstrate a proper purpose relating to an economic interest.“ suit might be appropriate when a SH has a bona fide concern about the adverse effects of abstention from profitable war contracts on his investment in Honeywell”

If he had wanted to save the company from bad publicity, π would have won

therefore, as long as one can assert that there is a meaningful economic interest, that will sufficeseven if the economic interest is secondary!Contrast with SH proposal where ethical or social significance alone is OK Which List

Record list: List of the depository trust in which the stocks are heldCEDE Street name list: List of the brokers who trade in stocks placed in depository trust (givesID of brokers, but not actual SH)NOBO (nonobjecting beneficial owners) list: Actual beneficial owner who does not mind beingcontacted (this is what you want!!! Gives the names of SHs)

Sadler v. NCR CB 564- 2nd Circ.- Rule: A state may require a foreign (out-of-state)corporation with substantial ties to its forum to provide resident shareholders access to itsshareholder list and to compile a NOBO list (nonobjecting beneficial owners), in asituation where the shareholder could not obtain such documents in the company’s ownstate of incorporation.AT&T (a NY corp.) wanted to take over NCR (a MD corp.). Although AT&T couldn’tget NCR’s shareholder list under MD law, AT&T could get NCR’s shareholder list under NY law. So, AT&T asked Sadler (a NY resident who owned shares of NCR) to get NCR’s shareholder list under NY law, and then give the list to AT&T… and AT&T andSadler got away with this scam. but note that absent an exception, the internal affairs doctrine prohibits a state from applying its

corporate governance laws to corporations incorporated elsewhereNY law gives any shareholder of a non-NY corporation doing substantial business in NY the

right to a NOBO list;

Under NY law, if a NOBO list is required to put both sides in a proxy contest on equal

footing, the corporation may be required to compile the list if it does not already have one

The problem is that NCR had CEDE list, but not the NOBO list ctr said too bad, go and get it!

Note: DL law only requires preparation of CEDE list (not NOBO list)

Shareholder Voting Control: common stock, which represents equity and ownership

interests, can be properly understood as consisting of a set of two distinct rights:economic rights

receive dividends (distribution of profits) when and as declared by the B.O.D.residual claim on assets in liquidation

voting rights:elect directorsapprove some extraordinary mattersPacking Rights ( MBCA is a very liberal approach. Other states are much more limiting)- Look this Up!!MBCA §6.01(a) – the articles of incorporation must prescribe the classes of shares and thenumber of shares of each that the corporation is authorized to issueMBCA §6.01(b) – the articles of incorporation must authorize:

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at least one class with unlimited voting rightsat least one class with residual claim

these may be the same, but need not bethis reflects that there are two distinct economic andvoting rights.

MBCA § 6.01(c) - Authorizes nonvoting stock and other

variants on one share-one vote (discretionary)Voting Rights: shareholders vote at:

meetings:annual – where B.O.D. is elected (see MBCA § 7.01)special – emergency issues that can’t wait till annualmeeting (i.e. merger)

Who may call a special meeting:MBCA §7.02(a) - a corporation shallhold a special meeting of shareholders:

§7.02(a) (1) on call of itsB.O.D. or the someoneauthorized to do so under the

bylaws (usually chair of directors or secretary of corp),OR §7.02(a) (2) shareholders actingtogether may call a specialmeeting

default rule- at least10% of the vote holders(note that we arecounting holders of shares, notshareholders!)

articles of incorporationmay affix a lower % or a higher percentage notto exceed 25%demand must be inwriting

most state track the MBCA inrequiring a provision for somenumber of shareholderscritique of MBCA: onlyflexibility is in the requisitenumber of shareholders;

corporation has no right to takeaway SH’s right to call special

meetings could be

problematic with hostiletakeovers

DGCL § 228(a) – allows you to repealthe shareholder’s right to call a specialmeeting and eliminate danger of takeover

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Action without meeting (aka written consents):MBCA §7.04- written consent my be used onlywhere all of the shareholders agree (must beunanimous)

rationale: if some SH dissent, theyshould have the opportunity to have a

meeting at which they get to talk othersinto changing their mind

DGCL § 228(a) - action by consents okay if same # of shares consent as would be needed ata meeting. (prof thinks this is a more soundapproach

Meeting Rules:

MBCA default rules

Extend to which default rules may be varied

Quorum for a meeting

Quorum= A majority of the

shareholders entitled to vote MBCA §

7.25(a) (count shares, not people)hypo: A = 51; B = 35; C = 14 shares

A alone sets quorum b/cmajority sharesB + C are not a quorum b/c nomajority of shares (even if majority of people)

§7.25(a) V. §7.27 – articles of incorporation mayrequire smaller OR larger quorum§7.25(a) says “unless the articles provideotherwise”7.27(b) “articles of incorporation can provide for

a greater quorum” – nothing said for lesser Comments to sections clarify:7.27(a) is a special authorization for a super majority voting right OR quorum7.27(b) is for amendmentsOnce you have a Quorum, to approve

corporate action MBCA § 7.25(c) the yes

must exceed the nos

Hypo: 1000 outstanding shares; 800

present for meeting quorum; Vote is

395 yes, 394 no, and 9 abstainThe proposal has passed b/c yes>no

(abstains don’t count)So proposal passes even though majorityof shares did not approve & majority of present shares did not approveMost decisions can be made by the voteof a majority of the shares present at themeeting in person or by proxy andvoting on the issue

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MBCA 7.25(c) – the articles of incorporationmay require only a greater, not a lesser , number of affirmative votes

State of Wisconsin Investment Board v. Peerless System Corp.

Rule: A shareholder need not attend a shareholders’meeting and record an objection in order to challenge the propriety of the vote.Rule: Where the primary purpose of an adjournment of ashareholders’ meeting is to ensure passage of a proposal byinterfering with the shareholder vote, corporate directors breach their fiduciary duty of loyalty.Peerless’ wrongdoing on this issue was that Peerless didnot inform all of its shareholders that, although Peerlesshad called for the adjournment on the other issues,shareholders could still vote on the controversial “proposal2.” Peerless did this just to interfere with the voting turnout,and that action interfered with the vote, and it was illegal.

Stroh v. Blackhawk Holding CB 573- IL

Rule: A corporation may prescribe whatever restrictions or limitations it deems necessary in regard to the issuance of stock, provided that it not limit or negate the voting power of any share.Illinois law merely requires that every share have the samevoting power. In this case, Blackhawk got around the law by diluting the economic value of the stock rather than thevoting power, keeping 3,000,000 cheap shares with onevote each for themselves, and offering only 500,000expensive shares with one vote each to the public. Still, this

is okay because it conforms to the letter of the IL law: thatevery share have the same voting power.terminology:

Stock split:used to increase the number of stock outstandingwithout changing anything else about thecompany which is still worth the same (donewhen stock price is too high – odd lots areexpensive!)effected by changing part value throughamendments to articles (here par value cut from$1 to 50¢ and new shares issues on 2-1 basis

Policy: Why Shareholder Voting Rightsshareholders ‘own’ the corporationunsure shareholder wealth maximization (rising tide liftsall boats)shareholders have most to loseauthority v. accountability

rational apathy – why should I bother to beinformed (when cost is higher than pol)

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TransferabilityCONTROL IN CLOSE CORPORATIONS

Close Corporation- a corporation in which the stock is held in a few hands, or in a few families,and wherein it is not at all, or only rarely, dealt in by buying or selling” (Galler v. Galler)no secondary market for sharesA controlling shareholder usually actively participates in the day to day management of the

businessPotential Decision-making Problems in Close-CorporationsDeadlock (2-2)Oppress (3-1)

Shareholder Agreements

Solutions to Problems in Close Corps.

Voting Trust/ee: Shareholders relinquish their voting power to a“voting trustee”: The trustee:

becomes the nominal (name only), record owner of sharesoften agrees to cast the votes in a prescribed way (via

trust agreement), (i.e.- to elect certain stockholders to the board).Is responsible for distributing any dividends to beneficialowners of the shares.Pro-

The shareholders retain economic interest in the businessEliminates the possibility of deadlock among

shareholders (since all the shares are held bytrustee – who is a fiduciary of the SH)

Con-loss of control

duration (most states limit to ten years)The law doesn’t like them Imposes onerous

limitationsMost statutes require public disclosure of thetrust’s terms so that the existence and terms willnot be hidden from other shareholdersIf no limit, trust is invalid Nearly all states require a writingstill possible for board to oppress (trustee elects board, board may fire SH, ect)

Vote pooling agreement (VPA): Agreement in which two or more shareholders agree to vote together as a unit on certain or

all matters.Shareholder Agreements

Voting Agreements b/n shareholders are okay.Shareholder agreements which restrict director action are more strictly scrutinized, b/c directorshave more info and need to act independently.

Directors owe duty to corporation, notshareholder.

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Ringling Bros:Cumulative Voting: # of Shareholder's votes = (# of board vacancies) x (# of shares owned)

may cast all votes for one (or more) members of the BoD

Ringling and Haley families factions had a written

agreement under which they were to vote together, andin the case of a deadlock, an arbitrator would decide.

Rule: A group of shareholders may lawfullycontract to vote in any manner they determine.

SH agreements relating to limitations on the B.O.D. discretion

very common- agreements may includerequirement of certain person as officers,specify compensation and/or dividend policy;require SH approval of board action, ect.

General RULE: Agreements that substantially fetter thediscretion of the board are unenforceableMcQuade v. Stoneham and McGraw- McQuade and McGraw

(both had small equity interest in Giants) agreed to elect/keepeach other as officers at specified salaries. McQuade was firedand sued for specific performance

HELD: Ctr says that agreement invalid because boardmust be able to exercise its own business judgment (indeciding how to vote)Directors must exercise their independent business judgment on behalf of all SHIf Directors agree in advance to limit that judgment, thenSHs do not receive the benefit of their independence.Agreement is therefore void as against public policy

Rule: A contract is illegal and void so far as it

precludes the Board of directors from changingofficers, salaries, or policies, or retainingindividuals in office, except by consent of thecontracting parties.Problem: This is inconsistent with the basic principle of freedom of contract. However, contracts should not beallowed if there is some kind of externality. In this case,minority shareholders who are not part of the agreement.

Clark v. Dodge- Where there are NO minority SH, youCAN limit board of directors w/ agreement b/n themselves.

Rule: Where the directors are also the sole

shareholders of a corporation, a contract betweenthem to vote for specified persons to serve asdirectors is legalThe difference between this case and McQuade isthat in McQuade, the directors had a duty to protectthe interests of the whole company, which includedother shareholders. In this case, Clark and Dodgewere the whole company, so no one else could be

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adversely affected by their agreement to protecteach other.

Gallar v. Gallar (CB 598)- Brothers agreed to pay certaindividends each year and to pay, in the event either should die, aspecified pension to a widow.

Rule: In a close corporation, shareholder management agreements are valid, includingagreements to elect directors, absent a complainingminority interest, fraud, apparent injury to the public, and apparent injury to creditors.Application:

the agreement did not have an unreasonabledurationcompany was to pay dividends only if it hadsufficient earned surplusdeath benefit was reasonable

Rationale: An investor in a close corporation “often has

a large total of his entire capital invested in the businessand has not ready market for his shares should he desireto sell. He feels, understandably, that he is more than amere investor and that his voice should be heardconcerning all corporate activity. Without a shareholder agreement, specifically enforceable by the courts,insuring him a modicum of control, a large minorityshareholder might find himself at the mercy of anoppressive or unknowledgeable majority.

Ramos v. Estrade (p. 632)-

Rule: Voting agreements binding individualshareholders to vote in concurrence with the

majority constitute valid contracts.This rule is applicable even though BroadcastGroup did not qualify as a closely held corporation.

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