BUSINESS ENTERPRISE OUTLINE I.

Business Organizations a) Sole Proprietorship Ultimately flexible i) Formation individual just decides to form No formalities ii) Management- sole proprietor runs the business- No formalities iii) Financial Rights & Obligations Sole proprietor keeps all profits and losses (no protection). Usually a small or modest amount of capital iv) Taxation Pass through all income from business is income of sole proprietor v) Liability to third parties Sole proprietor PERSONALLY LIABLE for all debts of the business vi) Existence Lifetime of the sole proprietor vii) Comments (1) Pass through taxation, flexible management, no formalities are all benefits (2) Personal liability, run by sole proprietor, and limited existence all downsides b) General Partnership i) Formation Consent to form a partnership between parties, Agreement by the partners to participate in a common enterprise for profit. NO PUBLIC FILING NECESSARY by may file a statement of partnership authority. ii) Existence- Without a definite term dissolves upon the withdrawal of any partner OR may be terminated upon dissolution of agreement UPA- dissociation causes dissolution. RUPA- Dissociation causes dissolution if remaining partners elect not to continue iii) Management Default rule one partner/one vote for ordinary business decisions, unanimous vote for extraordinary decisions such as adding a new partner or selling major asset of firm. iv) Financial rights and obligations- EQUAL SHARING OF PROFIT/LOSS, may be altered by contract. Any partner has the power to bind the partnership as a whole v) Taxation pass through taxation vi) Liability general partners are PERSONALLY LIABLE for the DEBTS OF THE PARTNERSHIP (big downside) UNLIMITED LIABILITY vii) Comments (1) Pass through taxation, ability to attract a few partners for capital, and flexibility to contract all good. (2) Prevalent industries that use this are accounting, law and medicine (3) However, liability by all partners for debts of partnership is a big downside risk, GP suck!! (4) MALPRACTICE FOR A LAWYER TO DO THIS NOW c) Limited Partnership i) Formation Filing of certificate with state officials, limited partnership agreement required ii) Duration- lasts as long as the parties agree so SPECIFIC TERM, or absent agreement, until a general partner withdraws iii) Management General partner manages. Control is by general partner with limited partners prohibited from participating in management. ONLY THE GENERAL PARTNER HAS THE AUTHORITY TO BIND THE LP AS TO ORDINARY MATTERS. Limited partners can vote but cannot behind the LP ULPA Uniform limited partnership act- removes control rule and specifics limited partners are limited partners. iv) Financial Rights and obligations Profit/loss determined by agreement; obligations determined by agreement v) Taxation Pass Through vi) Liability to third parties GENERAL PARTNERS PERSONALLY LIABLE FOR DEBTS OF PARTNERSHIP, Limited partners are liable only to the extent of their investment so long as they do not participate in the control of the business. third parties may compel limited partners to satisfy their contribution obligations in limited partnership agreement. vii) Existence- specified terms viii) Comments (1) More protection than general partnership, only general partner is personally liable, but not total protection; pass through taxation All are strengths (2) Limited management; some exposure to liability Weaknesses d) Limited Liability Corporation & Partnership LLC & LLP i) Formation Formal, requires a filing of a certificate or article of organization, creature of statute ii) Duration- Approaching perpetual, varies by jurisdiction

II.

iii) Management Any form of management is permitted (1) Member managed - more like partnership, members have ability to bind the LLC in the same way as partners (a) This is when the LLCs day to day operations are run by a LLC member (2) manager managed- corporate, members have no authority to bind the LLC (a) hire an outside person to manage the day to day issues iv) Financial Rights and Obligations (1) Vary by jurisdiction Provides some shield against liability (2) Obligations for contribution: Vary by agreement (3) Financial structure very flexible v) Liability to third party- Personally not held liable vi) Taxation Pass through taxation vii) Comments (1) Strengths Flexible management, pass through taxation, provides liability shield (2) Weakness Does not provide the vehicle for raising capital (3) Members and managers have a fiduciary duties of care and loyalty depending on manager managed or member managed (4) Member managed- Fiduciary duty is parallel those in a general partnership (5) Manager Managed - only managers have fiduciary duties; a member who is not a manager does not owe anyone a fiduciary duty e) Corporation i) Formation Solely a creature of State statute; filing of a certificate of incorporation & articles ii) Duration- Perpetual, regardless of what happened to shareholders, directors, or officers iii) Management Separation of management and ownership management by board of directions and officers. Significant requirements for annual meetings and special meetings. (1) Shareholders vote on: (a) Election of directors (b) Extraordinary transactions (Mergers, acquisitions, sale of all assets, etc) (c) Amendments to articles (d) Non-binding resolutions and requests for studies by shareholder proposal (2) Very formalized management Officers managements, BOD affairs and business iv) Financial Rights/Obligations (1) Profit/loss sharing: Pro rata based on share ownership (2) No Obligation for contributions (3) Financial structure may have multiple classes of stock and debt (4) Financial structure strictly regulated by state and federal securities law. v) Taxation Double Taxation vi) Comments (1) Strengths Greatest vehicle to raise capital, corporate shield from liability, ability to manage large ventures (2) Weaknesses Double Taxation, Lacks flexibility, Hippie Shareholders Agency a) Agency Relationships i) Principal (employer) Liable to the third party in contracts ii) Agent (employee) Acts on behalf of principal, may legal bind the principal, interacts with 3 rd party iii) Third Party (customer) usually interacts with the agent, Who is an agent? i) The relationship of principal and agent necessarily involve some matter of business, but only that where one undertakes to transact some business or manage some affair for another by authority and on account of the latter, the relationship of principal and agent arises. ii) The Agent can bind the principal legal for actions taken by the agent on behalf of the principal, if the power is expressly or inherently granted to the agent. Fiduciary Obligations of Agents i) Reading v. Regem (page76) Solider in uniform driving truck through war zone for money. RULE: A agent owes a duty of honest and good faith to his principal

b)

c)

ii)

(1) IF an agent acquires an asset for himself, which he obtained solely through opportunity arising as an agent for the principal, then the agent is accountable for that asset or benefit to his principal. General Automotive Manufacturing v. Singer (page 79) Man working as manager of a repair shop and when shop couldnt do the repair he would send it to another companies shop and keep the money if they customer paid over. RULE: Agent has a fiduciary duty to ones principal, a duty of utmost good faith and loyalty as to not act adversely to the interest of the principle.

iii) MAIN POINT OF AGENCY Agent has a duty not to unjustly enrichment himself while using a right, privilege, or opportunity granted to him solely as his position of an agent for the principal. (1) Example Agent watches animal for principle, and uses animal for an event that makes agent money, principle is entitled to the money, because of the agents fiduciary obligation to principle.... (2) Also if Agent fails to disclose all the facts regarding the Agents service to the principle, Agent may be able to avoid violating his fiduciary duty. iv) Comments (1) IF a person achieves fame through personal accomplishments, this could be argued against this duty because they did not gain this opportunity solely through their role as a agent (2) If the principal and agent relationship ends, does the fiduciary obligation end with it? (3) If the agent discloses all the facts surrounding his adverse conduct or potential conflict, the agent may avoid his fiduciary duty to act solely on behalf of the principle. (4) Agent violates his duty of loyalty to principle or Partner in 3 ways (a) Agent receives payment from 3rd party in connection with some transaction between the principal and the third party (b) Agent makes a secret profit from the agency relationship by secretly transacting with the principal (c) Agent uses her position to make a personal profit from someone who has no relationship whatsoever to the principal, while acting on behalf of the principal III. Partnerships- an association of two or more persons to carry on as co-owners a business for profit. a) Characteristics of Partnerships i) Personal liability of partners; limited duration; dissolution on exit of one partner; limited transferability of ownership interests; Pass-Through taxation ii) Partnerships are not a good idea because all partners are liable for one partners acts and only unsophisticated people with no access to legal advice use partnerships. b) Partnership Formation i) 15-202. Formation of partnership; powers ii) Except as otherwise provided in subsection (b), the association of two or more persons (i) to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership, and (ii) to carry on any purpose or activity not for profit, forms a partnership when the persons intend to form a partnership. A limited liability partnership is for all purposes a partnership. iii) Subject to 15-1206 of this title, an association formed under a statute other than (i) this chapter, (ii) a predecessor statute or (iii) a comparable statute of another jurisdiction, is not a partnership under this chapter. iv) In determining whether a partnership is formed under Section 15-202(a)(i), the following rules apply: (1) Joint tenancy, tenancy in common, tenancy by the entireties, joint property, common property or part ownership does not by itself establish a partnership, even if the co-owners share profits made by the use of the property. (2) The sharing of gross returns does not by itself establish a partnership, even if the persons sharing them have a joint or common right or interest in property from which the returns are derived. (3) A person who receives a share of the profits of a business is presumed to be a partner in the business, unless the profits were received in payment: (a) of a debt by installments or otherwise; (b) for services as an independent contractor or of wages or other compensation to an employee; (c) of rent; (d) of an annuity or other retirement or health benefit to a beneficiary, representative or designee of a deceased or retired partner;

(e) of interest or other charge on a loan, even if the amount of payment varies with the profits of the business, including a direct or indirect present or future ownership of the collateral, or rights to income, proceeds or increase in value derived from the collateral; or (f) for the sale of the goodwill of a business or other property by installments or otherwise. (4) A partnership shall possess and may exercise all the powers and privileges granted by this chapter or by any other law or by its partnership agreement, together with any powers incidental thereto, including such powers and privileges as are necessary or convenient to the conduct, promotion or attainment of the business, purposes or activities of the partnership. (5) Notwithstanding any provision of this chapter to the contrary, without limiting the general powers enumerated in subsection (d) of this section, a partnership shall, subject to such standards and restrictions, if any, as are set forth in its partnership agreement, have the power and authority to make contracts of guaranty and suretyship and enter into interest rate, basis, currency, hedge or other swap agreements or cap, floor, put, call, option, exchange or collar agreements, derivative agreements, or other agreements similar to any of the foregoing. c) Partnership by estoppel i) In order to establish a partnership by estoppel, four elements must be proven: (1) Plaintiff must establish a representation, either express or implied, that one person is the partner of anotheri.e., that there was a holding out of a partnership (2) The making of the representation by the person sought to be charged as a partner or with his consent (3) A reasonable reliance in good faith by the third party upon the representation (4) A change of position, with consequent injury, by the third person in reliance on the representation. Partnership Property i) Any asset acquired in the name of the partnership is partnership property (1) A transfer directly to the partnership in its own name (2) A transfer to one or more partners acting in their capacity as partners AND the name of the partnership appears on the transfer document ii) If the partnership is not named, property acquired by one or more partners is partnership property if the document transferring title indicates the buyer was acting in his capacity as a partner iii) Property purchased with partnership funds is presumed to be partnership property Fiduciary Obligations of Partners i) Meinhard v. Salmon (page 105) (1) Joint adventurers, like copartners, owe to one another, while the enterprise continues the duty of the finest loyalty. Many forms of conduct permissible under normal circumstances, are forbidden by these fiduciary ties. (2) Factors to consider: (a) Are the parties joint adventurers or partners? (b) Did one member enjoy an opportunity or benefit coming to him by virtue of the venture? (c) A partner must disclose new opportunities arising out of the current venture or opportunities gained by one partner as virtue of the partnershipDuty of loyalty owed to each other by partners or co-venturers (3) Factors (a) Did the new adventure arise out of the partnership or co-adventure? A nexus of relation!! (b) Did one partner disclose to the other partner the opportunity? Duty may be satisfied (c) Did one partner gain secret profits due to his position in the venture? Or steer an opportunity away for himself? ii) Partners Conduct (1) The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care stated in (b) and (c) of this section. (2) A partner's duty of loyalty to the partnership and the other partners is limited to the following: (a) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity; (b) to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and

d)

e)

(3)

(4)

(5) (6)

(c) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership. A partner's duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. A partner shall discharge the duties to the partnership and the other partners under this chapter and the duties under the partnership agreement and exercise any rights in accordance with the obligation of good faith and fair dealing. Each partner does not violate a duty or obligation under this chapter or under the partnership agreement merely because the partner's conduct furthers the partner's own interest. A partner may lend money to and transact other business with the partnership, and the rights and obligations of the partner are the same with regard to the loan or transaction as the rights and obligations of a person who is not a partner, subject to other applicable law.

f)

Partner leaves Partnership i) A partnership may officially dissolve upon a member leaving, OR a dissociation may occur when a partner leaves where the partner is entitle to a liquidation value of his share on the day of dissociation (1) 29- The dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business (a) Dissolution is not the same as termination ii) Departing partner is still liable on all firm obligations unless released by creditors iii) These default rules may be circumvented by a partnership agreement that lays out the specifics arrangement for when a partner leaves office. Formation of Partnership Agreements i) Generally, partners can contract anything in the agreement; except: (1) May not Eliminate the implied contractual covenant of good faith and fair dealing ii) Courts try to give maximum effect and freedom of contract iii) In forming a partnership, Lawyer must remember to draft a buyout clause (1) Any lawyer who advises people entering into a business venture and who fails to urge the adoption of a buy-sell agreement is guilty of malpractice. (2) Exit strategy is key!! (3) Price and valuation are important considerations hire an appraiser (4) Agreement should provide a mechanism for the appraiser because it is hard to agree during a fight (5) Things to remember in Buyout Clause (a) Trigger events Death, divorce, disability, will to leave (b) Obligation to buy firm other investors, consequences for refusal (c) Price book, appraise, formula, set price, relation to duration, (d) Method Cash, installment, financing (e) Protection against debts of partnership (f) Procedure for offering either to buy or sell iv) Winding up, Dissolution, and termination (1) Different mechanisms for when a partner leaves a partnership v) Sharing of losses (1) Default losses are shared in the same proportions that profits are shared so equally if not sated otherwise, but this may be modified by agreement. (2) Example Where one partner brings money and the other services, and the venture fails. The partner contributing capital is NOT entitled to receive his money because partners were equally sharing profits and losses.

g)

h)

Raising Additional Capital Partnership see page 136-39 i) May be avoided by proper planning & agreement ii) Pro-rata capital requirement additional points buy in. iii) Pro-rata dilution used to make up a shortfall when a partner fails to contribute capital, and it was inserted in the agreement. Use points to represent capital needed.

iv) Penalty dilution Points cost less after the intital funds, used where funds are not suppose to be needed later, but are later requested, provides incentive for partners to contribute more funds; made by agreement. v) Loan agreements Partners make loans to the venture at interests vi) New partners added- General partner may sell new partnerships shares to anyone at whatever price, comparable to stock at an open market. CORPORATION INFORMATION IV. Articles of Incorporation (Certificate) a) Name of the Corporation b) Registered Office and Agent i) Registered office where service of process of will sent ii) Registered agent- Must be filed with the secretary of state c) Capital Structure of the Corporation i) Must specify the securities or shares the corporation will have authority to issue ii) Describe the various classes of authorized shares d) Purpose and Powers of the Corporation i) Just say purpose of corporation. Not as important now a days because of the decline of the ultra vires doctrine. Now able to say to conduct any legal activities e) Size/Composition of Board of Directors i) Many statutes dont require this anymore ii) Also most stautes have gone away of the requirement of having at least three people on the board. f) Voting provisions, membership requirements, management provisions, indemnification provision

V. Constitutes and Terms (1) Corporate Actors (a) Shareholders- they own the corporation, elect board of directors (b) Board of directors- manage affairs, including hiring corporate officers (CEO, CFO) (2) Inside Directors (3) Outside or independent directors (4) Management/officers president and secretary required by statute, may also have numerous others ex: VP, Chief information, Treasurer ect. (5) Corporate Securities (shown below) VI. Financial Rights in Corporation (1) Equity Financing (i) Issuing shares of stock (a) Pay corporations for the shares, each share represents an ownership interest in the corporation and gives the shareholder a bundle of rights and powers (b) Have financial rights to dividends when declared by the board and to a pro rata share of corporate assets on dissolution (c) have the right to elect directors and approve fundamental corporate transactions and liquidity rights that enable them to sell their shares (d) TWO COMMON CATEGORIES common shares and preferred shares (ii) Basic Equity Ingredients (a) Dividends- in the discretion of the directors when to give these out (b) Liquidation rights these are given out by pro rata distributions when corporation closing. The articles specify the amount to be paid in liquidation and the priority of payment. (c) Voting Rights- able to elect the directors and to approve significant corporate transactions proposed by the board (d) Conversion rights- can convert shares to another security in the corporation (e) Redemption rights- gives the shareholder the ability to force the corporation to repurchase the stock. (f) Preemptive rights- allows the shareholder to acquire shares when the corporation issues new shares. This protects exisiting shareholders proportional interests (voting and ownership) in the corporation (iii) Common Shares (a) (iv) Preferred Shares (a) This is senior to common shares as to dividends and liquidation rights, but junior to the claims of debt holders and creditors (2) Debt financing

(i) Corporation can borrow money (a) can be issued by third party (outside debt) or shareholders (inside debt) (b) Debts obligations by the corporation have to be repaid to principal with interest (c) Unless provided by contract, debt holders do not acquire rights to share in earnings (3) Corporate Earnings (a) Corporation can use funds generated internally by its businesses I. Nature of Corporations a) Essential Characteristics of a Corporation i) Perpetual existence (1) unless otherwise designated in charter/articles/certificate. (2) Or State Dissolution (judicial order, bankruptcy) (3) Shareholder dissolution (vote to dissolve, merger or other combination) ii) Separate existence (1) Is a legal person (2) has its own constitutional rights- Due process for property interest, equal protection and commercial speech. iii) Means Double taxation- taxing of corp dividends and other distributions iv) Limited Liability (1) General shareholders, officers and directors are not liable for third party debts of the corporation. (2) MBCA 6.22(b)- A corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct. (3) Generally, shareholders are liable only to the extent of their investment in the corporation v) Centralized Management Separation of ownership and control, every corporation must have a board of directors that manages the corporation. Only the board of directors acting as a unit can speak on behalf of the corporation or establish policy for the corporation. (1) BOD manages the business, policy and affairs of the Corporation. (2) Officers (President, VP, Treasurer ect.) manage the day to day affairs of the corporation. These people are voted into their positions by the board of directors (3) Directors and officers are agents of the CorpOwe a Fiduciary duty to both the Corporation and the shareholder. (4) Shareholders can vote on many important matters- election of board, sale of all assets, and fundamental changes to articles of incorporation or by-laws, fundamental transactions vi) Passive ownership by shareholders (1) Have limited voice, right to vote on some matters, but in large corporations shareholders effectively have no voice (2) BOD manages affairs (3) Feet vote- Shareholder does not badger management or board when they disagree, they simply sell. vii) Freely Transferable ownership interests Public stock market strengths this right b) Promoters A person who identifies a business opportunity, lays out business ground, drafts articles of incorporation, issuance of certificate of incorporation and organizational meeting to take place to elect the board, aka. forming a corporation as the vehicle for investment by other people. i) Obligations of Promoters to Third parties for Pre-incorporation commitments (1) If a promoter signs a contract, in her personal capacity, and then forms the corporation later, the corporation may unilaterally adopt the contract, but is not required too. (2) Promoter is still liable if she signed for a contract in her personal capacity. (3) Even if corporation adopts the contract, promoter is still held liable unless the third part releases promoter. (a) A promoter can also if the corporation is never made enforce the contract on the other side because he is individually responsible! (i) Promoter will not be held liable if there is a novation agreement which the corporation agrees to take over all rights and duties under the K and the other party releases the promoter from all liability under the K (4) Extent Promoters may bind a corporation Pre-Incorporation (a) De Facto Corporation (benefit) Court may treat a firm not properly incorporated as incorporated, if the organizers (1) in good faith tried to incorporate; (2) had the legal right to do so; (3) acted as a corporation.

(b) Corporation by estoppels (debt or contract) Situation in which the promoter goes out and contracts under the corporations name when the corporation is not yet formed. The other party (1) thought it was a corporation all along (2) would earn a windfall if now allowed to argue that the firm was not a corporation (i) Southern Gulf Marine Co 1. Promoter signed a contract on behalf of the corporation when the corporation was not yet formed a. At the time of signing the contract the promoter is individually liable i. Believes that the corporation will soon form and indemnify him and ratify the contract 2. Other side cannot get out of the contract because the corporation was not yet formed Promoters Obligations to the Corporation i) A promoter owes a fiduciary obligation to the corporation; therefore if the promoter does not reveal a conflict in interest or makes a secret profit off the corporation, the promoter may violate this fiduciary duty. Corporate Veil i) FACTORS IN SHOWING THAT CORPORATE VEIL SHOULD BE PIERCED (1) Must show that there was a failure to observe corporate formalities, and (2) That there was injustice or a similar wrong doing (i) Must be more than just someone not getting paid - KEY (ii) Otherwise this element would be present in every case ii) Usually forming a corporation provides a liability shield to the shareholders, directors, and officers. However, this limited liability shield may be pierced under the proper circumstances. iii) Objective standard: Where a individual stockholders are carrying on a dummy corporation in their personal capacities for purely personal rather than corporate ends. (1) IF the stockholder is conducting the business in his individual capacity, the stockholder may be personally liable. This applies to individual, but also a holding company-subsidiary relationship (2) Factors do determine if the stockholders are doing business in their individual capacity (a) Shuffling of personal funds in and out of the corporation (b) Following of laws, Insurance, Capitalization requirements (c) Failure to maintain adequate corporate records or comply with corporate formalities (d) Commingling of funds or assets (e) Domination of one corporations assets by another corporation (3) Also, if injustice would be promoted, without holding an individual or another corporation liability, the court is more likely to pierce the corporate veil. iv) Test from Illinois state law (1) Unity of interest and ownership that separate personalities of corporation and individual to no exist (2) Fraud or injustice would be promoted by finding a separate corporate entity (a) Injustice where a party is unjustly enriched, party escapes liabilities, skirt legal rules, scheme to bunch assets and liabilities in separate corporations, avoid creditors (b) Injustice does not mean the creditor will not be able to collect or it will be extremely difficult, but to protect the creditor from some conduct amounting to bad faith when a party hides behind a corporate veil. e) Corporate veil When a corporation does not follows corporate formalities and sometimes states require injustice or a similar wrongdoing i) Parent-Subsidiary relationship (1) Pay close attention between the relationships in piercing the corporate veil: Is a sister subsidiary liable for the other subsidiary! Is there a shareholder entity relationship, or a subsidiary / Holding company / subsidiary relationship? (2) Parent subsidiary Piercing the Corporate veil allows the parent to be liable for the subsidiary action, but it does not mean all the subsidiarys controlled by the parent are liable for the actions of one subsidiary (3) Enterprise liability doctrine- disregards multiple incorporations of the same business under common ownership. (a) Pools together assets to satisfy the liabilities of any part of the enterprise, the assets of individual owners or managers are not exposed.

c)

d)

(4)

(5)

(6) (7) (8)

Borrow as much on assets so not a lot of cash And if you do have cash you pay dividends to the partner. Have to do it out of net earnings ect. If do everything right no matter how much it costs to get better and claim.thats all he gets. Dont like it talk to the legislature 1. Walkovsky v. Carlton a. Taxi case b. Court held that the enterprise liability doctrine was present here because Carltons corporations held out to the public as a single enterprise and were artificially separated into different corporations Parent-Subsidiary Piercing the Corporate veil Analysis (a) Corporate Control when a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholder, the corporate form may be disregarded in the interests of justice. (i) Common directors or officers (ii) Common business departments (iii) Consolidated financial statements and tax returns (iv) Parent finances the subsidiary (v) Parent caused the incorporation of the subsidiary (vi) Subsidiary operates with inadequate capital (vii) Subsidiary receives no business except that given to it by the parent (viii) The parent uses the subsidiarys property as its own (ix) Daily operations of the two corporations are not kept separate (x) Subsidiary does not observe the basic corporate formalities, such as separate books and board meetings Failure to Observe Corporate Formalities (a) This includes holding shareholder/directors meetings, issuance of stock, election of directors and offiers, keeping corporate minutes, (i) This is just evidence that the corporation is their alter ego for their own personal affairs Commingling Assets and Affairs (a) Using a corporations bank account for personal expenses Undercapitalization and Purposeful Insolvency CASES (a) Sea Land (i) Own used his corporations as a way to transfer funds to protect them from having to pay their debts 1. The corporation was the controlling shareholders alter ego (ii) Second prong- promote injustice 1. Was intentionally using the corporations as a way to prevent the payments of their debts (iii) Reverse Peirce 1. Go through a person to get to all of their other corporations a. Factors considered in this case= Commingling of funds, undercapitalization and disregard for corporate formalities (b) In re Silicone Gel Breat Implants Products Liabilities (i) Determining whether the subsidiary and the parent company are the same entity (ii) Totality of the circumstances test for veil piercing, 1. Common directors or officers, 2. Common business departments, 3. Parent finances the subsidiary, 4. Parent pays the salaries and other expenses of the subsidiary, 5. Subsidiary receives no business except that given to it by the parent, 6. Parent uses subsidiary property as its own, 7. Daily operations are not kept separate, and 8. Subsidiary does not observer basic corporate formalities (iii) If these elements are met, then the parent company will be directly liable for the debts of the subsidiary

(i) (ii) (iii) (iv)

II.

(9) Limited partnership- general partner being a corporation managed by the limited partners (a) What about a situation of a limited partnership, where only a general partner is liable for the debts of the partnership, and the limited partners create a corporation fulfill the role of general partner. (b) Apply the corporate veil analysis to determine if the limited partners violate the arrangement of liability, because under this arrangement the corporation is solely liable, but if the corporation is a dummy corporation, then the individuals will be liable. (i) Requires a showing that ownership and personal interest were not separate, unity of interests (ii) Promotes injustice or fraud (c) Note: If advising a client facing this situation, have the client request the limited partners sign the contract in their personal capacity. (i) CASE 1. Frigidaire Corp. v. Union a. Two people set up a partnership in which they were limited partners, and the general partner was a corporation that they set up and acted as directors for b. Limited partners are not liable for the debts of the general partner 2. Directors and officers are not personally liable for the debts that they cause the corporation to incur ii) Ways to Prevent Piercing the corporate veil and Enterprise Liability (1) Corporate veil- Respect corporate formalities and take out the minimum insurance (2) Enterprise Liability- Separate books and bank accounts for each corporation, plus careful accounting for supplies, for borrowing of drivers ect. Derivative and Demand Suits a) Shareholder Derivative Actions i) THE BUSINESS AND AFFAIRS OF EVERY CORPORATIONSHALL BE MANAGED BY OR UNDER THE DIRECTION OF A BOARD OF DIRECTORSDelaware state law section 141(a) b) Shareholders can bring either (Eisenberg v. Flying Tiger) i) Direct action, or (1) Shareholder is individually injured and needs to enforce her rights as a shareholder- DIRECT INJURYINJURY TO SHAREHOLDER (a) Wrongful act seen as separate and distinct from corporate injury (b) Denies or interferes with the rightful incidents of share ownership ii) Derivative action (1) Suit on behalf of the corporation to enforce corporate rights that apply to shareholders only indirectly in that it affects the value of their share of the corporation (2) A suit in equity against a corporation to compel it to sue a third party to enforce a right held by the corporation (a) Many states require security for corporate costs for nominal plaintiffs (i) Not Delaware iii) Double derivative actions (1) Shareholder of a parent company suing to enforce the rights of a subsidiary corporation iv) Questions to ask to figure out if its a derivative or direct suit (1) Who was injured? (2) Who will receive the relief? DERIVATIVE SUITS i) Derivative suit seeks to cause the corporation to seek recovery for a wrongful act that depletes corporate assets and thereby injures shareholders only indirectly by reason of the injury to the corporation. (1) Derivative suit is a suit in equity against a corporation to compel it to sue a third party to enforce a right held by the corporation. ii) Allows the shareholder to step into the shoes of the corporation and seek its right to restitution that he could not demand on his own. (1) First, requires the shareholder to demand that the corporation vindicate its own rights, then (test later) iii) The shareholders injury is derivative of the injury to the corporation. (1) Misfeasance or misappropriation of corporate property (2) Enforcement of corporate contracts with 3rd parties

c)

10

(3) Actions against corporate directors for competing with corporation. Appropriation of corporate opportunity (4) Excessive salary suits (Disney) (5) Third party torts against the corporation (6) Correction of false entries in corporate records by directors (a) These are suits that generally enforce fiduciary duties of directors, officers or controlling shareholders - duties owed to the corporation. iv) Derivative Litigation Standing - In order for a shareholder to have standing and bring a derivative action, the shareholder must: (1) Have contemporaneous ownership with breach of fiduciary duty, AND (a) This is so that one does not buy shares to buy a lawsuit (2) Plaintiff must have continuing interest throughout lawsuit. v) The invention of derivative actions led to strike suits, where small shareholders would bring suits simply to recover the legal fees of litigating such a suit. d) Indemnification i) Directors are indemnified against actions against most liabilities, which means the corporation will reimburse them if they are held liable for an action ii) BUT are not indemnified against breaches of duty of loyalty Direct Suits brought by Shareholders i) These are suits brought by shareholders where a wrongful act is seen as separate and distinct from corporate injury, OR ii) Denies or interferes with the rightful incidents of share ownership (1) Interference with the right to vote (2) Interference with preemptive rights (3) Dilution of voting rights (4) Enjoin improper voting of shares (5) Compel dividends (6) Improper uses of corporate machinery (7) Compel dissolution (8) Challenge improper expulsion of shareholders (9) Compel holding shareholder meetings (a) All these issues are generally to vindicate individual shareholders structural financial, liquidity and voting rights. Analysis for Shareholder Derivative Action i) What type of action is being brought Derivative or Direct? (1) Whether the object of the lawsuit is to recover upon a chose in action belonging directly to the stockholders, OR whether it is to compel the performance of corporate cats with good faith requires the directors to take in order to perform a duty which they owe to the corporation, that duty was owed to the corporation and only derivatively to its stockholders. (2) Plaintiff claims that the defendants are interfering with the plaintiffs rights and privileges as stockholders. OR (3) No monetary recovery will accrue to the corporation as a result, mean s direct lawsuit ii) If Direct claim, No demand required: However, a derivative claim usually requires the plaintiff to serve a demand upon the corporation to bring a claim against the third party, BOD decision. (1) If demand is required, then plaintiff must serve a written demand upon the corporation (2) Wait 90 days before filling suit, unless the plaintiff has been rejected by the corporation (3) If demand rejected its a complete bar unless one shows that it was not done in self-interest, bad faith, or uninformed. (a) Cannot argue after demand was made that it should have been excused (i) Advantages of the demand: 1. Servers as a kind of alternative dispute mechanism that requires a challenging shareholder to first exhaust intracorporate

e)

f)

11

2. Allows the court to ascertain whether the board could have acted on the demand (ii) Disadvantages of the demand: 1. Forewarns defendants of an impending suit giving them an opportunity to take evasive actions 2. Demand requirement delays litigation while the shareholder waits for the board to act on the demand 3. Concession that the shareholder thinks the board is capable of addressing the problem iii) Demand may be rejected by any BOD if based on a valid Business Judgment (1) Then shareholder-plaintiff must show the boards response to the demand was self-interested, dishonest, illegal, or insufficiently informed. (a) CASE (i) Grimes 1. Look at the type of recovery if plaintiff wins to determine whether a suit is direct or derivative 2. 141(a) a. The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors b. Board cannot delegate all of its powers out. This would be abdication and violation of fiduciary duties. i. Must retain some powers iv) Demand may be futile (excused) if: (1) Demand is excused because of futility when a complaint alleges with particularity that a majority of the board of directors is interested in the challenged transaction. Director interest may either be self-interest in the transaction at issue, OR a loss of independence because a director which is (disinterested) in a transaction is controlled by a self-interested director. (a) Evidence that even a disinterested director may be solicitous to fellow directors who are being sued. This may be because of personal, professional or social ties to the other directors (2) Demand is excused because of futility when a complaint alleges with particularity that the board of directors did not fully inform themselves about the challenged transaction to the extent reasonable appropriate under the circumstances (3) Demand is excused because of futility when a complaint alleges with particularity that the challenged transaction was so egregious on its face that it could not have been the product of sound business judgment of the directors. (a) CASE (i) Marx v. Akers 1. Futile Demand- demand is made: directors have a reasonable time to analyze demand and reject a. This is what NY statue imposes 2. Universal Demand a. Have to make a demand before a derivative suit not matter what 3. In this case the demand was futile because it fell under the first exemption- the board of directors were interested. v) BOD may combat Demands by forming a SLC (special litigation committee)- DGCL 141(c) (1) The Board of Directors will create a special committee of disinterested/independent directors for the purpose of determining, on behalf of the board, the position that the Corporation shall take with respect to the derivative claims alleged on its behalf. (a) Unless plaintiff can show the committees members were themselves interested or had not acted on an informed basis, the committees recommendation were entitled to full judicial deference under the BJR vi) Plaintiffs rights when BOD refuses Demand; Rights after Demand Refusal (Zapata 2 part test and Auerbach- Can compose and SLC to deal with this) (a) Court will review the independence and good faith of the committee and the bases supporting its conclusions. The corporation has the burden of proving independence, good faith and a reasonable investigation. (b) In re Oracle Corp. Derivative litigation

12

(i) Finds that the lack of SLC independence despite the composition of it were unnamed board members and its use of reputable outside law firm, because the SLC members had a long standing professional/academic relationship with principal defendants through Stanford University. (2) The court should determine, applying its own independent business judgment, whether the motion should be granted. This would prevent a corporation from providing independence and procedural, but it appears to be violating the spirit of the demand. (a) Interests (i) Corporations can deter meaningful derivative suits away from shareholders (ii) Corporate interest of riding itself of meaningless derivative suits (3) Comments (a) Factors for independence of SLC (SLC has the burden of proof) (i) Question Whether the SLC can independently make the difficult decision entrusted to it? (ii) Outside members on SLC (iii) Compensation, is it extreme? (iv) Material ties, friendship or familial relationships (v) Indirect ties, like clubs or social associations (b) Factors for Reasonable investigation Due diligence (i) Investigation time (ii) Due Diligence (iii) Paper trial report (iv) Meeting minutes and updates (c) Bad Faith (i) Probably a lack of effort, or breach in duty of loyalty in the SLC to the corporation. III. BUSINESS JUDGMENT RULE a) This is a rebuttable presumption that directors in performing their functions are honest and well meaning and that their decisions are informed and rationally undertaken (a) Its presumed that the directors do not breach their duty of care b) Directors and officers will not be personally liable to the corporation for mere mistakes in judgment, so long as their business judgment was not tainted by breach of the duty of loyalty or gross negligence/malfeasance. Also, insulates board from judicial review (1) In practice If a director avoids any conflicts of interest (duty of loyalty issues) and if they have gathered information and thought about their decision, courts will not permit plaintiffs to second guess that decision if it turns out bad. (2) COURTS WILL NOT SECOND GUESS DIRECTORS DISINTERESTED, INFORMED, GOOD FAITH EXERCISES OF BUSINESS JUDGMENT (a) If board just acting stupidly then BJR and they are fine (b) If board does something really stupidthen still BJR and they are fine (c) So stupid there must be something else going on.NOW BJR doesnt protect (i) Gross negligence or breach of loyalty. The directors are allowed to use BJR unless not in good faith, fraud, oppression, breach of trust. ii) BJR Presumption is proven, IF: (1) Acted on informed basis (2) In good faith (3) In honest belief that action was taken in the corporations best interests. iii) BJR is rebuttable, IF: (1) Decision lacks a business purpose (almost anything- Henry Ford); (2) IS tainted by conflict of interest or is otherwise self-interested (3) Is so egregiously bad that it amounted to a no-win decision (very rare); OR (4) Results from an obvious or prolonged failure to exercise oversight and supervision. c) This rule shields directors from personal liability and insulates boards decisions from judicial review i) Reasons for the BJR (1) Encourages risk taking by the board (2) Avoids judicial meddling- Judges are not business experts (3) Encourages directors to serve

13

IV.

(a) If businessmen are exposed to liability they will not want to do the job (b) This encourages qualified persons to serve as directors and take business risks without fear of being judged in hindsight Ways to overcome the BJR a) Fraud, bad faith, conscious disregard of duties, illegality or a conflict of interest (lack of good faith) i) Fraud (1) An example of this is a director who misleads shareholders in connection with shareholder voting (2) Director knowingly disseminates false or misleading information to public trading markets breach a duty of disclosure ii) Conscious disregard to duties (1) Directors who consciously disregard their responsibilities are held liable for violating the duty of good faith iii) Illegality (1) Directors who intentionally approve or consciously disregard illegal behavior by the corporation violate their duty of good faith, even if they were informed and the behavior benefited the corporation (a) Modern courts have felt the tension because approving illegal behavior maximizes profits for the corporation (2) Conflict of interest (a) A director who is personally interested in a corporation action because he stands to receive a personal or financial benefit loses the BJR presumption Role and Purpose of Corporations a) The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors b) Business Judgment Rule Great preference the court gives when it judges decisions affecting the business and affairs of the corporation, the court will not second guess the directors c) Charitable Donations- A.P. Smith Mftg. Co. v. Barlow i) If donations are made reasonably, in good faith, and advances the interests of the corporation, those donations fall within the Business judgment rule. ii) If the charity is one of the directors pet charities, OR a conflict of interests perhaps a duty of loyalty question arises iii) If the donation is unreasonable or excessive, perhaps a duty of care complaint may arise (1) Ultra vires- Of or referring to an action taken within a corporations or persons scope of authority Dividend Policy Henry Ford Case Dodge v. Ford Motor i) It is unlawful for the board of directors to conduct the affairs of the corporation for the merely incidental benefit of shareholders and for the primary purpose of benefiting others, a directors has a fiduciary duty to the shareholders to maximize their profits. ii) BJR still applies (1) All Henry Ford had to do, was give the court a legitimate business purpose for hoarding the cash. If Ford would have stated the case was for a greater capital investment that was in the businesses best long term interest, then the court would probably have respected his business judgment. iii) Moral: Directors cannot openly state their intentions are to conduct the business in a way that is detrimental to the shareholders interests. (1) Dividend- a portion of the companys earning or profits distributed pro rata to its shareholders, usually in the form of cash or additional shares (2) Special dividends- a dividend paid in addition to the regular dividend, usually because of exceptional corporate profits during the dividend period. Wrigley Baseball during the day i) Plaintiff claimed Wrigley was undermining the profits because he refused to have games at night ii) Wrigleys business decision was upheld: (1) Wrigley claimed he was interested in the integrity of the neighborhood. This was a legitimate business interest because the neighborhood affected the long term interest of the business.

V.

d)

e)

14

VI.

(2) Plaintiff failed to provide any evidence that Wrigley violated his Fiduciary duty to shareholders by undermining the profitability of the business. No evidencemust show more than negligence like gross bad faith or recklessness, or fraud, illegality or self-dealing by the directors to overcome BJR. (a) Conflict of Interest- a real or seeming incompatibility between ones private interests and ones public fiduciary duties The Duties of Officers, Directors, and other Insiders a) List i) Duty of Care ii) Duty of Loyalty (1) Duty of Disclosure b) Facets of Duty of Care- Good Faith, Reasonable Belief, Reasonable Care i) 102b7- directors are exculpated of liabilities if its a breach of care. ii) Good Faith- This standard requires that directors be honest, not have a conflict of interest, and not approve or condone wrongful or illegal activities iii) Reasonable belief- a board decision must be related to furthering corporations interests. . This entails the waste standard (1) Waste- - an exchange so one sided that no business person of ordinary sound judgment conclude that the corporation has received adequate consideration iv) Reasonable Care- informed basis and ordinary care standards relate to the process of board decisionmaking and oversight (1) Informed in making decisions (2) Monitor and supervise corporate activities Duty of Care Two Types i) Procedural due care the process used in reaching a decision rational (due diligence) (1) Directors must make a reasonable effort to inform themselves in making decisions (2) Board of Directors may under 141(e) rely upon records, reports and all other material the member reasonably believes are competent. ii) Substantive due care was the actual decision substantively rational? (1) Whether the complaint alleges waste of assets, What the corporation received is so inadequate in value that no person of ordinary, sound business judgment would deem it worth what the corporation paid. iii) Plaintiff can only show board breach duty of care for acting in bad faith (1) THE DESCRIPTION OF BAD FAITH (a) INTENTIONAL DISREGARD FOR DUTIES (i) ACTUAL INTENT TO DO HARM OR (ii) DELIBERATE INDIFFERENCE (b) YOU HAD A DUTY TO ACT AND YOU DID NOT ACT (i) DIRECTOR ACTS WITH THE INTENT TO BREAK A LAW 1. In Re Caremaker Test iv) Comments Duty of Care: (1) American Express holding The plaintiffs disagree with the boards business decision to distribute special dividends instead of taking a corporate tax deduction on a bad investment of shares in a different company they bought: the court holds the plaintiffs have no complaint because: (a) A complaint that an action is not the most beneficial is not enough, must be recklessly or malfeasance (b) Board took board minutes where it consider all possible options (procedural) (c) Directors are entitled to use their honest business judgment on the information before them (2) Van Gorkom (a) Standard for procedural Duty of Care presumption that a business judgment is an informed one; determination of whether a business judgment is an informed one turns on whether the directors have informed themselves prior to making a business decision, of all material information reasonable available to them. No protection for unintellige nt or unadvised judgment [Gross negligence].

c)

15

(b) Factors court thought were relevant (i) Directors had limited knowledge of the boards action (ii) Relied upon one 20-minute oral presentation of proposal and valuation of company, no reports (iii) Failed to read or understand the one document the board of directors had (iv) No formal reports, for the directors to rely on (v) Failed to have adequate valuation process for company in the buyout (vi) Market test failed to safe the directors lack of diligence because the deal was already lock ed up (c) BOD Also failed to disclose all material information such as a reasonable stockholder would consider important in deciding whether to approve the offer. (3) Factors to consider in entire fairness of a transaction Substantive Due Care (a) The timing (b) Initiation (c) Negotiation (d) Structure of the transaction (e) The disclosure and approval by the directors (f) The disclosure to and approval by the shareholders (4) Brehm v. Eisner; In re Walt Disney (a) Plaintiff claim Breach of Duty of Care Substantive Due Care (b) Plaintiffs claim the exchange was so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration. Breach Substantive Care (i) The directors are granted great deference under the BJR, in challenging their substantive decisions. (ii) Court holds in this case: BJR is an absolute bar for reviewing substantive Duty of Care decisions, and only procedural Duty of Care breaches may be challenged (c) In Re Walt Disney (i) plaintiff may rebut the BJR if she shows the directors had either 1 breached their duty of care OR had not acted in good faith. 1. Plaintiff claim the directors were Grossly negligent in approving the agreement 2. Court held the directors adequately informed itself a. Looked at the procedure the directors used surrounding approval of agreement b. Looked at the process the directors informed themselves, determined it was sufficient (ii) Court Defined what is a violation of Good Faith may be, used to rebut BJR 1. Subjective bad faith fiduciary conduct motivated by an actual intent to do harm 2. Gross Negligence Without more is not bad faith, no malevolent intent 3. Behavior between the previous two categories intentional dereliction of duty OR a conscious disregard for ones responsibilities a. Where a director fails to act in the face of a known duty to act (iii) Waste Claim (substantive board decision) 1. Rare case, only where directors irrationally squander or give away corporate assets 2. The BJR will protect the boards decision unless it cannot be attributed to any rational business purpose. 3. Court held the decision did not come close to the high hurdle required to establish waste because the agreement had a rational business purpose. (5) Francis v. United Jersey Bank- duty to monitor (a) Recognized a duty for directors to act honestly, in good faith, and exercise reasonable prudence in the management of business affairs. (b) Facts of the case, defendant held funds for plaintiffs, and therefore was an implied trust. The trust relationship gave rise to a fiduciary duty to guard the funds with fidelity and good faith. She had a duty to monitor the corporation and failed to do so. Had she exercised her duty of care, she could have prevented her sons from looting the company. (c) Duty of monitoring elements

16

Be familiar with the business Know the general financial status of the business Attend board meetings Inquire upon suspicion of wrong doing Use common sene Make sure that the information you are receiving is all the information that you need to be receiving. (d) Plaintiff had a basic duty of care to oversee operations, learn the business and make reasonable attempts to detect and prevent the crime. (i) Plaintiff could have avoided liability if she resigned, or relinquished her duty prior to abuse (ii) Implied trust of holding money played an important role. (6) In Re Caremark International Inc. Derivative Litigation (a) A board may have a duty to install corporate monitoring and reporting systems to detect illegal behavior. Medicare and Medicaid payments and cannot bribe doctor. (b) Claim that directors breached their fiduciary duty of care in connection with alleged violations by Caremark employees of federal and state laws and regulations (c) GOOD Case: Reread the standard of Duty of Care (d) Liability to the corporation for a loss may be said to arise from an unconsidered failure of the board to act in circumstances in which due attention would, arguable, have prevented the loss (e) Duty to assure corporate compliance with external legal requirements. (f) Test applied (i) Directors are liable for breach of duty by failing to adequately control employees, IF: 1. The directors knew, OR 2. Should have known that violations of law were occurring; AND 3. Directors took no steps in a good faith effort to prevent or remedy that situation, AND that such failure proximately resulted in the losses complained (g) They did all this so not liable for breaching duty to adequately monitor d) The Intersection of Loyalty and Good Faith i) Stone v. Ritter (Caremaker is still good law and same rule implemented in this case) BEAN LIKES THIS CASE (1) Derivative suit seeking personal liability for their failure to implement a monitoring system required by a federal banking law. (2) Claiming that if they had better oversight they would have seen bank employees were doing illegal things (3) Standard for director oversight liability (a) Directors utterly failed to implement any reporting or information systems or controls, OR (b) Having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. (4) Court held that the directors had not engaged in a deliberate failure to exercise oversight or a conscious disregard of their responsibilities (a) They implemented a monitoring system that followed the federal rulethe system failure was not enough to show a sustained or systematic failure of the board to exercise oversight. ii) Reaffirms Disney, Good Faith violation may exist if: (1) Directors intentionally act with a purpose other than that of advancing the best interests of the corporation (2) Directors act with the intent to violate applicable positive law, OR (3) Fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. iii) Left the door open other examples of bad faith yet to be proven or alleged iv) Relates the requirement to act in good faith is a subsidiary element, condition, of the fundamental duty of loyalty. A showing of bad faith conduct is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.

(i) (ii) (iii) (iv) (v) (vi)

17

VII.

Explains the standard for good faith violations (1) Only a breach in the duty of care OR loyalty may result in liability, BUT failure to act in good faith may do so, BUT only indirectly (2) Duty of loyalty is not limited to cases involving conflict of interest, BUT it encompasses cases where the fiduciary fails to act in good faith. vi) Comments (1) Directors who fail to act in the face of a known duty, thereby consciously disregarding their duties, violate their duty of loyalty by failing to discharge that fiduciary obligation in good faith. Duty of Loyalty Duty of fiduciary to act on behalf of beneficiary, place beneficiarys interests ahead of the fiduciary. Generally described as a duty to avoid self-dealing or appropriation of opportunities of the principal. i) The agent is liable to disgorge any/all secret profits obtained from a transaction that breaches the duty of loyalty. ii) Directors and Managers iii) 144. Interested directors; quorum (1) No contract or transaction between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because any such director's or officer's votes are counted for such purpose, if: (a) The material facts as to the director's or officer's relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or (b) The material facts as to the director's or officer's relationship or interest and as to the contract or transaction are disclosed or are known to the shareholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the shareholders; or (c) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee or the shareholders. (2) Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors of a committee, which authorizes the contract or transaction. (a) Quorum- 141b a majority of the total number of directors shall quorum for the business transaction unless the certificate of incorporations or bylaws says something else. CONFUSED ON HOW 141 NEED QUORUM BUT 144 DONT NEED? SO JUST WHEN ONE CANNOT HAVE THE FULL BOARD BC THEY ARE INTERESTED THAT THE DIFFERENCE???? iv) Bayer v. Beran POSSIBLE EXAM QUESTION ABOUT THIS CASE. ANSWER THAT DGCL 144 DEALS WITH THIS NOW (1) Used radio advertising for the company (a) His wife was one of the singers (2) Duty of loyalty is triggered when there is a question of self-interest interfering with the interest of the corporation (a) Courts will closely scrutinize a situation where a director or close personal or financial relation stands on each side of the transaction (3) The business judgment rule, yields to the rule of undivided loyalty, NO BJR defense. (4) A conflict between self interest and fiduciary obligation, and any evidence of improvidence or oppression, any indication of unfairness or undue advantage, the transactions will be voided (5) Director dealings with the corporation are subjected to rigorous scrutiny where challenged the burden is on the director not only to prove the good faith of the transaction but also to show its inherent fairness. (6) Test applied: whether the action of the directors was intended or calculated to subserve some outside purpose, regardless of the consequences to the company, and in a manner inconsistent with its interests. (7) Factors considered: (a) The ultimate purpose of the action (b) Money involved, proportionally (c) Quality in exchange, fairness

v)

18

b)

(d) Conformity to industry standards (8) In this case there was no indication that the wife received any personal enrichment from this situation therefore BJR applies v) Benihana of Tokoyo v. Benihana, Inc. (1) IF the material facts as to the directors relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors and the board in good faith, authorizes the contract or transaction by the affirmative votes of the majority of the disinterested directors. (a) The director does not violate her Fiduciary duty of loyalty, if the material interest is disclosed and approved (2) If the material interests of the transaction are not disclosed, the director may still not have violated his duty of loyalty IF the court reviews the entire transaction under an entire fairness standard. (3) Another thing to remember Corporate action may not be taken for the sole or primary purpose of entrenchment. Lewis v. S.L. & E., Inc. i) Deals with the burden of proof the parties face when a duty of loyalty claim is filed regarding directors and an interested transaction. ii) Standard: (1) When the transaction is challenged in a derivative action against the interested directors, they have the burden of proving that the transaction was fair and reasonable to the corporation. (a) This is because when there is a conflict of interest, the BJR is thrown out the window Corporate Opportunities & Duty of Loyalty i) A corporate fiduciary agrees to place the interests of the corporation before his or her own in appropriate circumstances. (1) Objective is to deter appropriations of new business prospects belonging to the corporation ii) Corporate officer presented a business opportunity which the corporation is financially able to undertake, an opportunity in the corporations business and is of practical advantage, or an opportunity of interest or reasonable expectancyif the officer embraces the opportunity and his interest is brought into conflict with that of the corporation, the law will not permit him to seize the opportunity for himself. (a) Financially able to take opportunity? (b) Is the opportunity at corporations line of business? (c) Does corporation have a financial interest or expectancy? (d) Is the opportunity advantageous to the corporation? iii) Factors considered in whether the business opportunity puts the officer in direct conflict with the corporation (1) Is the corporation capable of exploiting the opportunity Financially?? Any other limitations? (2) Is the opportunity in the interest of the corporation Look at facts (3) Did the corporation have an interest or expectancy in the opportunity (a) Interest- something to which the firm has a better right (b) Expectancy- takes something which, in the ordinary course of things, would come to the corporation. (4) Is the opportunity advantageous to the corporation? (5) Embracing the opportunity would create a conflict between directors self interest and that of the corporation .look at facts iv) The director must examine whether the opportunity is rightfully belonging to the corporation. Examining the facts, if the director believes, based on one of the factors articulated above, that the corporation is not entitled to the opportunity, then he make take it for himself. v) To be overly safe, the director could disclose the opportunity to the board, but the law does not require it. Broz v. Cellular Info. System Inc. i) Broz owned a cell phone company and also was on the board of another cell phone company (1) Opportunity came along to Broz in his own individual capacity. He discussed his interest in the opportunity with the company he was on the board for. They were not interested, so he took the opportunity (2) Company that he was on the board for was bought out by another company that was interested in the opportunity. Buy-out company claimed that Broz breached his duty of loyalty by taking the opportunity

c)

d)

19

e)

(3) The court found that there was no breach of loyalty because Broz had discussed this situation with the original corporation and they were not interested in it In Re Ebay, Inc. Shareholders Litigation i) The opportunities offered to directors place certain inside directors in an obvious conflict between their self-interest and the corporations interest ii) Apply the corporate opportunity analysis above: enough available money? iii) If corporate opportunity does not apply, Did the director obtain the opportunity solely through his position as a director at eBay, if so agency law provides an agent owes a duty of loyalty to the principal, eBay may have a right to money through this duty. (1) HYPO: Instead of offering IPO shares, Goldman Saks tries to secure eBay business by offering the directors gift of (a) below market mortgages for up to 12.5 million or (b) sets of TaylorMade r7 CGB MAX Irons. Would these be corporate opportunities under In re ebay? What about under Borz? Dominant Shareholders Duty of Loyalty i) Must have a dominant shareholder Usually a parent-subsidiary relationship, puppet-puppeteer relationship, where the parent controls the subsidiary, and therefore the parent is on both sides of the transaction (1) Shareholder acting as shareholders owe one another NO fiduciary duties (2) Controlling shareholders OWE fiduciary duties ii) Sinclair Oil Corp v. Levien (1) Facts- Sinclair was the parent corporation of Siven. Declared dividends on the subsidiary corporation.this was okay because everyone obtained the dividends.also dividends are BJR. The Parent corp. allocated projects to different affiliates, again projects werent corporate opportunities so parent under no obligation . Only parent got in trouble for was not enforcing contracts which was a detriment to the sub.. (2) If a dominant shareholder controls a corporation, its relationship with the corporation must meet the test of intrinsic fairness. The standard of intrinsic fairness involves both a high degree of fairness and a shift in the burden of proof. (a) Therefore: The burden is on the dominant shareholder to prove, subject to careful judicial scrutiny, that its transactions with the corporation were objectively unfair. (b) This standard will be applied when parent has received a benefit to the exclusion of the minority shareholders of the subsidiary and at the expense of the minority shareholders of the subsidiary. (3) KEY: Looking for a situation where the dominant shareholder receives, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way to benefit the dominant shareholder at the expense of the minority shareholders (4) FACTUAL ANALYSIS iii) Zahn v. Transamerica (1) The majority has the right to control, but when it does so, it occupies a fiduciary relation toward the minority shareholders (2) Facts: There was class A stocks and class B stocks. Class B shares held voting control. Class A shares were entitled to twice as much liquidation then class B. Class A shares could be redeemed by corporation at anytime for 60 dollars. The controlling shareholders had the corporation redeem all the minority shares and then liquidated the corp. so they got paid more. (3) Lesson: A dominant shareholder-Director may not manipulate the companys assets, such as stock, in such a way that the dominant shareholder profits at the expense of the minority stockholder. This action is ok, if it can be proven that the Board of Directors is disinterested, but may be harder if the Board is dominated by the Majority stockholder. (4) Difference: a stockholder is voting strictly has a stockholder versus when voting as a director; THAT when voting as a stockholder he may the legal right to vote with a view of his own benefits and to represent himself only; BUT when he votes as a director he represents all the stockholders in the capacity of a trustee for them; AND cannot use his office as a director for his personal benefit at the expense of the stockholders. (a) Duty differs depending on whether the party is voting as a stockholder OR voting as a director

f)

g)

Ratification

20

VIII.

Claim that shareholder ratification shifts the burden of proof to an objecting minority shareholder, regarding action the corporation takes. ii) This rule does not apply, IF the majority of shareholder votes casted were cast by the directors (dominant shareholders), in their capacity as shareholders iii) THIS rule would apply, if the majority of votes cast were disinterested shareholders therefore there is a factual basis to apply this rule. Indemnification and Insurance a) Indemnification- Payment by a principal to the agent for liabilities incurred by its agent in connection with the agents action on behalf of the principal i) Doing this could create a moral hazardthink health insurance example. b) Reimbursement of legal fees- the payment of those fees after theyve been paid by the claimant c) Advancement- Most statutes permit advance of legal fees upon undertaking i) Undertaking is just a written promise to repay the legal fees if not successful on the merits or otherwise. d) Types of liability may vary; Delaware applies only to liability of a director to the corporation or its stoc kholders for monetary damages for breach of fiduciary duty as a director. i) It is simply the corporations reimbursement of litigation expenses and personal liability of a director sued because she is or was a director. (1) Indemnification rights continue even after director has left the corporation (a) Indemnify if director was successful in defending the action or (b) The director though unsuccessful in her defense, was justified in her actions. e) Damages may be very large, AND expenses of defense can be substantial, even if no damages are awarded f) When is a good time to prohibit a corporation from providing insurance or indemnification to its directors g) Indemnification cant be put directly in the articles of incorporation h) Corporation has the right to insure or indemnity officers, directors, and employees of the corporation in breaches of duty except: i) breach of duty of loyalty, ii) Acts not in good faith iii) For intentional or illegal breaches, or iv) When the person derived an improper personal benefit v) No retroactive liability limitations i) Corporation may pay for legal fees, and also may advance those fees if so approved j) Actions brought by or on behalf of the corporation against a director cannot be indemnified k) Waltuch v. Conticommodity Services, Inc. i) A corporation may not have a clause in its articles of Corporation that contradict or override Delaware Corporate law. ii) Under 145(a) (this is discretionally indemnification) A corporation may not indemnify a director if she acted in bad faith, the burden is on the director to prove she did not act in bad faithor prove her good faith. (1) A corporation shall (dont have to) have the power to indemnify a person from the threat, pen ding or completing, proceeding any admin proceeding, investigating by the SEC derivative action if the person: (a) Acted in good faith and in a manner that is not or not opposed to the best interests of the company and had no reason to think acts were combatful (b) Termination by any proceeding, or plea shall no create a presumption that one did not act in good faith. iii) Under 145(c)- A corporation is required to indemnify its officers and directors for the successful defense of certain claims (legal fees, if successful on the merits) (1) Success if a director was sued, and the suit was dismissed without him paying a settlement or if the defendant was vindicated (settles with no admittance of wrong doing) iv) Under 145(f) permits the corporation to grant indemnification rights outside the limits of 145a.. v) Point of case- A corporation must indemnify certain individual for legal expenses if they acted in good faith. In addition, 145f does not expand corporate power to exceed 145a. l) Citadel Holding Corporation v. Roven i) 145(e) the corporation may pay an officer or directors reasonable expenses in advance discretionary (1) Advancement- is when pursuant the 145 the corporation advances the director money for legal fees. ii) However, under the employee contract, the corporation had a duty to advance legal fees, so long as the party promised to pay back legal fees if it is ultimately determined the agent is not entitled to legal fees.

i)

21

IX.

iii) Holding: right to advancement for legal fees is different than the right to indemnification . m) HPYO: In Delaware have indemnification and you are on the board, and someone takes over company and off the board. But in bylaws says you will be indemnified. New guy says we will not be indemnified anymore but you say it says I can be indemnified for things that I did when I was a directorcan you get away with this? i) In scoon v. troy deleware held a former director does not get indemnification when the board changes bylaws. This is a drafting matter. Put it in your certificate The Limited Liability Company a) Characterizations of LLCs i) Afford some sort of Limited Liability ii) Partner style pass through taxation iii) Require some sort of public fillings, similar to certificate of corporation, varies by state iv) Laws are still developing, pulls precedent and theories from Corporate and partnership law v) Flexible management, by arrangement b) LLC and liability Notice Requirement i) Constructive notice A party is put on notice that it is dealing with an LLC if the companys articles of organization are filed publicly ii) Liability (1) Constructive Notice Applies where a 3rd party attempts to sue a member of a LLC simple due to their status as members or managers of the LLC. (2) When a 3rd party sues a manager or member of an LLC under an agency theory, the principles of agency law apply notwithstanding the LLC Acts statutory notice rules. Takes from AGENCY LAW (a) Comments: (i) A member of an LLC is liable on a contract entered on behalf of the LLC, if the LLC is not fully disclosed. Therefore, unless the member fully disclose they are acting on behalf of the LLC and the identity of the LLC, then the member may be held personally liable. iii) Lawyer tip: (1) If dealing with an LLC, and agent discloses, Ask for personal guarantee if the deal is questionable. LLC Operating Agreements i) This is a creature of contracts members can virtually unlimited discretion to define the terms of their relationship in the operating agreement (1) If dispute arises then one uses theory of contract interpretation. So if something is ambiguous extrinsic evidence is allowed in. (2) Should be put into a written form because if oral then there can be statute of fraud issues. So write it to be clear and percies ii) Permits members to engage in private ordering with substantial freedom to contract to govern their relationship, provided they do not contravene any mandatory provisions of the Act iii) Under LLC, is treated like a limited partner, with the freedom to contract, flexibility. iv) Rule: LLC are given broad discretion to contract the structure of the LLC, and only when no provision is given will the default rules of the act dictate the relationship. OR if a provision is inconsistent with a mandatory statutory requirement. v) Policy of the Act is to give maximum effect to the principle of Freedom of contract and to the enforceability of LLC agreements. vi) Interpretation of agreements may be a problem, the agreements are given its plain meaning of the words, then circumstances will be used to determine intent. Piercing the LLC Veil i) LLCs will be treated no differently than corporations, when it comes to liability ii) If members and officers fail to treat LLC as a separate entity, by converging personal/ownership interest, AND allowing shield of liability would promote fraud or Injustice (unjust enrichment, something more than failure to collect debts.) The LLC will not shield the members from liability. iii) Comments (1) By nature LLCs are more flexible with less Corporate formalities, this effects the analysis Fiduciary Obligation LLC

c)

d)

e)

22

X.

In a LLC, like a partnership, the members have a fiduciary duty to each other (default rule if nothing said about it or its ambigous); members of LLC owe one another the duty of utmost trust and loyalty. Taken from partnership law. ii) However, this obligation may be removed through the LLC operating agreements, and parties my contractual agree that no Fiduciary Obligation exists. f) Judicial Dissolution i) To get this one has to establish that it is not reasonably practicable to carry on the companys business in conformity with its operating agreement ii) TEST (1) The existence should consider in evaluating the reasonably practicable standard (2) The absence of a mechanism in the operating agreement to circumvent the deadlock and (3) The inability of the company to operate, given its financial condition (4) Whether the company is operating within the scope of the business purpose clause in its operating agreement g) Document Inspection Rights i) Members are afforded access only to those documents and other information enumerated in that section, subject to such reasonable standards as may be set forth in the operating agreement. ii) Statutorily qualified by the requirement that the demand for access be for ant purpose reasonably related to the members interest as a member of the limited liability company (1) Agreement can make this more narrow or more broad h) DRAFTING AN LLC i) First, is this a LLC or PLLC (professional limited liability- professional types, dentist, physicians, doctors, attorneys) or L3C (company is for profit but the purpose is for non profit reasons) ii) Name have to make sure its not being used (1) Check State of Michigans Department of Labor & Economic Growth website (2) Google to see if someone else is already using that name (3) Check U.S. trademark website iii) Articles of Organization iv) The Operating agreement (1) ISSUES TO THINK OF.GOOD FOR FINAL (a) Management (i) Rachel day to day operations (ii) Misha wants to slowly move himself into the business (iii) Leah just wants to give money (b) What happens if/when the business fails (c) Distribution/Dividends from the business (d) Payback periods (e) Potential liabilities arising from the business (f) Merger and acquisition (g) Voting rights (h) Operations, who runs it day to day (i) Control over the business (i) Divorce, bankruptcy, death, disability, A member just wants out (ii) Adding new members later to increase capital in business (iii) Selling business (j) Insurance (k) Buying new property (l) Meetings (m) Right of first refusal (n) Employment contracts (o) Amendments to operating agreement (p) Arbitration clause to resolve disputes (q) Shout out provision Disclosure and Fairness a) b) Definition of a Security Two broad Categories

i)

23

c)

d)

A list of rather specific instruments, including stock, notes, and bonds A general, catch all phrases, such as, evidence of indebtedness, investment contracts, and any instrument commonly known as a security. iii) Investment contract - a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party. iv) Economic reality of a particular instrument: (1) Investment contract is a passive investment with a promise of return off profits (2) Investment contract an investor, as a result of the instrument, is left unable to exercise meaningful control over his investment versus a security such as voting rights and control. The Securities Act of 1933 i) Governs the offering and sale of securities to the public ii) Company must file a Registration statement with the SEC with their initial public offering (1) This includes a prospectus which is distributed to prospective investors when the company goes public or makes a secondary offer Registration Process of Securities i) The SEC prohibits the sale of securities unless the company issuing the securities has registered them with the SEC ii) Private vs. Public Offering (1) Four factors relevant to whether an offering qualifies for exemption or private offering (a) The number of offerees and their relationship to each other (b) The issuer, the number of unites offered (c) The size of the offering (d) The manner of the offering iii) Comments (1) Whether the particular class of persons affected need the protection of the Act (2) Exemption questions turns on the knowledge of the offerees (3) The higher the number of offerees, the more likely the offering is public (4) Offerees relationship does offeree have information, sophistication, must be sufficient basis of accurate information upon with investor may exercise his skills. iv) Escott v. BarChris Construction Corp. (1) Ineffective registration statement due to some defective error (2) Test: (a) Did the registration statement contain false statements of fact or omit facts that would prevent it from being misleading. (b) Were the false statements or omissions material (c) Do defendants establish affirmative defenses. (3) Material Test: (a) Maters are material if: facts that the average prudent investor would tend to deter him from purchasing a security are facts that have an important bearing upon the nature or condition of the issuing corporation or its business (4) Objective standard: Would the average prudent investor believe the facts would have an effect on the investors decision

i) ii)

e) f)

Rule 10B-5, Disclosure under the Securities Act & Exchange Act (page 447) 34 Act includes public reporting obligations: i) Governs the trading of stocks ii) This focuses on public reporting and other obligations of a public company and upon secondary trading markets (NASDAQ) iii) Securities Fraud & 10b-5 promulgated thereunder; iv) Ban on Short Swing profits by corporate insiders; v) Annual disclosure of financial information; vi) Quarterly disclosure of financial information vii) Rules for proxy solicitations (1) Cause of actions under this section (a) Material Misstatement or omission in connection with the sale or purchase of any security (b) Insider trading

24

g)

(i) Trading while in possession of material non public information Required Disclosure Obligations i) Public companies that have more than $10 million in assets, OR more than 500 Shareholders ii) Exchange act 10(b) APPLIES TO ANY SECURITYNOT JUST REGISTERED OR PUBLICLY TRADED SECURITIES (1) 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 any facility of any national securities exchange. (a) To use or employ, in connection with the purchase or sale of any security registered on a nationally securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the commission may prescribe as necessary or appropriate in the public interest or for the protection of investors

iii) Rule 10b-5 (1) 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 securities exchange, (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 necessary in 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 a fraud or deceit upon any person, (2) In connection with the purchase or sale of any security. iv) Elements to establish a Fraud Claim: (1) Economic loss (2) Scienter Wrongful state of mind, intent to deceive, manipulate or defraud (3) Proximate cause of the loss by the misrepresentation (4) Material misrepresentation (5) In connection with a purchase or sale of a security (6) Reliance on the transaction v) Comments: (1) A person to; AND (2) Employ any device, scheme, or artifice to defraud; OR (3) Untrue statement of a material fact, OR Omit to state a material fact necessary to prevent such statements from being misleading; OR (4) Engage in any act, practice, or course of business which operates as a fraud or deceit upon any person; AND (5) In the Purchase or sale of any security

vi) Basic Inc. v. Levinson (1) Directors made statements denying the corporations involvement in a merger deal, deal later occurred and shareholders brought a rule 10b-5 claim. (2) Material: (a) An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. (3) To fulfill the materiality requirement: (a) There must be a substantial likelihood that the disclosure or the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available. (4) Test: (a) Materiality will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity (b) Probability/magnitude approach (Merger deals)

25

(c) The information may become material earlier in negotiations, if the deal is larger for the corporation, such as a buyout that results in the death of the corporation, compared to a larger corporation acquiring a smaller one (d) FACTUAL ANALYSIS (5) Factors Magnitude (a) The size of the two corporate entities (b) The potential premiums over the market value (6) Factors Probability (a) Board resolutions, (b) Instructions to investment bankers (c) Actual negotiations between principals or their intermediaries (7) Fraud on the Market Theory 10b-5 Only applies in larger markets, where information is instantaneously factored into the market price (a) A buyer of stocks does so in reliance on the integrity of the market price, so an investors reliance on any public material misrepresentations, therefore may be presumed for purpose of rule 10b-5 (b) One a material misrepresentation is found, the class has found the threshold facts for proving their loss, BUT the directors may rebut the presumption that the misrepresentation did not lead to a distortion in the price of the stock, OR the individual plaintiff traded or would have despite the statements. vii) West v. Prudential Securities, Inc. (1) Fraud on the Market Challenge (a) Assumes that information is public and reaches professional investors, whose evaluations of the information and trades quickly influence securities pricesin this case there were no public disclosures (b) Court held ORAL FRAUDS have not been allowed to proceed as class actions, must be a statement through some instrument of mass communication, to allow disseminated information to flow (2) If the information is NON-Public (not mass communication, but arm lengths transaction) then the fraud on the market doctrine does not apply, no proximate cause of the loss by the misrepresentation (3) Must prove the non-public information affected the price of stock, IF the Fraud on the market doctrine does not apply burden on the plaintiff viii) Random Comments on Rule 10b-5 (1) Standing: Plaintiff must actually buy or sell shares (economic loss) (2) Scienter Requires proof of a state of mind that is the person making the false statement must have made it with an intent to deceive, manipulate, or defraud (3) Scope of Interpretation No implied private right of action against those who AID and ABET violations of Rule 10b-5limits scope of liability. ix) Dura Pharmaceuticals, Inc., v. Brouda (1) Places the burden of proving that the defendants misrepresentations caused the loss for which the plaintiff seeks to recover. (2) Plaintiffs must adequalely allege and prove the traditional elements of causation and lossmust show a causal connection between the misrepresnatation and the inflated purchase price or deflated selling price x) Santa Fe Industries Inc. v. Green (1) Freezing out or Squeezing out of Minority shareholders by the Majority (253 Delaware law) (2) Minority shareholders may have no meaningful market for their shares, because if no dividends are paid, the minority shares are valueless because the shares have no power in the corporations actions (3) Why does Rule 10b-5 apply here (a) Economic loss (b) Scienter Intent to use a scheme to defraud, intent to deceive (c) Causation causal connection between the statement and the loss (d) Material Misrepresentation substantial likelihood to change a reasonable investors mind (e) Reliance Fraud on the market (f) In connection with the sale of a security

26

(4) Under Rule 10b-5, a cause of action exists for conduct alleged must be fairly viewed as manipulative or deceptive within the meaning of the statute (5) Prevents using rule 10b-5 for the breach of corporate fiduciary duty alleged in this complaintabuse of the minority for the gain of the majority. (6) 10b-5 does not regulate transactions which constitute no more than internal corporate mismanagement (7) This case respects that corporations are state law creatures, and Rule 10b-5 will not be used to override state law.therefore, use state law for transactions involving internal corporate transactions xi) Deutshman v. Beneficial Corp., (1) Does the purchase of options, satisfy the requirement of a security under rule 10b-5? (2) Court holds a purchaser of an option contract, satisfies the purchase of a security requirement, and may bring a claim if the other 10b-5 requirements are satisfied) Problems of Control Proxy Fights a) Proxy Statements i) Board selects the date of the stockholders meeting and the record date. This is usually 60-90 days prior to the annual meeting (1) Record date necessary because of the time required to prepare and mail the materials by which proxies are solicited and then to receive and count when response are sent in. (2) Board nominates slate of directors ii) Statements must fully disclose the major issues (1) Proxy statements have to be filed with the SEC but they do NOT mean its approved and that is has been full disclosure b) Proxy Fights i) Insurgents may seek to take control of the firm by electing themselves and their allies to the board ii) Contentions can also arise when issues that require shareholder approval are scheduled for determination at the annual meeting, or a special meeting (1) Amending the articles of incorporation (2) Liquidate the firm (3) Sell all or substantially all of the assets (4) Engage in a merger iii) Proxy a shareholder may appoint a legal representative, also known as the proxyholder iv) Incumbent managers will solicit proxies form the shareholders, and the managers may vote on behalf of the shareholders, so the person with most proxies usually wins v) Proxy Fights An insurgent group tries to oust incumbent managers by soliciting proxy cards and electing its own representatives to the board (1) Many defenses have arisen to fend off tender offers c) Strategic Use of Proxies Levin v. Metro-Goldwyn-Mayer, Inc. i) The right of an independent stockholder to be fully informed is of supreme importance ii) The court concludes that MGMs current management was within its rights when it used Corporate money to fund the management solicitation of proxies and advertised in the papers iii) The court held the action violated no federal statute or S.E.C. rule or regulation (1) Can use corporate funds if reasonable, not excessive or unfair or illegal (a) Required to have a board meeting and elect board every year so its a business judgment to use money for proxy. No one challenges this if there is no alternative slate iv) Suggest to use Duty of loyalty claim to try and circumvent the Management business judge in using corporate funds to solicit proxies (1) PROBLEM ON PG. 525 Reimbursement of Costs - Rosenfeld v. Fairchild Engine & Airplane Corp. i) Management may look to the corporate treasury for reasonable expenses of soliciti ng proxies to defend its position in a bona fide policy contest ii) Test:

XI.

d)

27

e)

(1) When the directors act in good faith in a contest over policy, they have the right to incur reasonable and proper expenses for solicitation of proxies and in defense of their corporate policies, and are not obliged to sit idly by iii) To prevent use: Plaintiff must establish that such money was not spent for personal power, individual gain, or private advantage and in the belief that such money was used in the best interest of the shareholders and corporation (1) Its shareholders money and incumbents get it if they stay in power and if they dont, the new guys cannot get paid UNLESS shareholders say okay. (a) Fighting personalityno reimbursementfighting policy yes reimbursement Regulatory Scheme on Proxy Fights i) Courts construe the concept of solicitation broadly ii) Each person who solicits proxies must furnish each shareholder with a proxy statement iii) Management has the choice of either mailing the insurgent groups material to the shareholders directly and charging the group the cost, OR it can give the group a copy of the shareholder list and let it distribute its own material.. iv) Economics of Proxy fight: (1) Due to high expense, tender offers may be more appealing because investor can obtain all the profits of improvements accompanied in increased share price, whereas proxy control does see the same potential, but less capital requirement for proxy fights v) Private Actions for Proxy Rule Violations (1) J.I Case co. V. Borak (a) Court found a private right of action under 27 to bring suit for violations of 14(a) (b) Under securities act cannot make false or misleading statements in proxy statements (c) Holds: Private parties have the right to bring claims for deceptive proxy statements, because false and misleading proxy statements are prohibited under 14(a) of the Securities Exchange Act. (d) Test for implied right under 14a-9 (i) Merger was approved at the meeting by a small margin of votes (ii) Would not have been approved but for the false and misleading statements in the proxy solicitation material (iii) Case stockholders were damages thereby (2) Mills v. electric Auto-Lite Co. (a) Issue: What causal relationship must be shown between such a statement and the merger to establish a cause of action based on the 14a-9 violation? (b) Test for causal relationship (i) Where the misstatement or omission in a proxy statement has been shown to be material: that determination embodies a conclusion that the defect was of such a character that it might have been considered important by a reasonable shareholder. (ii) Required that the defect have a significant propensity to affect the voting = material defective is one that a reasonable proxy voter would find substantially affect how he votes (c) 2nd issue: How should the court handle a remedy after a merger has been complete, is setting aside the merger in the best interests of the shareholders as a whole? (i) The relief that is to be granted is one that, the court concludes, from all the circumstance s, is the remedy that would be most equitable to do so. (ii) Flexible, factors considered: 1. Difficult of unscrambling the egg 2. Can damages be proven 3. Fairness of the merger terms (d) 3rd Principal: Private shareholders who are successful in derivative lawsuits, and furnish a benefit on the corporation and all shareholders, shall be award attorneys fees in such a suit the plaintiff was successful in establishing a cause of action. (i) QUESTION 2 ON PG. 542 POTENTIAL EXAM QUESTION (3) Seinfeld v. Bartz (a) Did not inform the shareholders how much the stock option was worth (b) What SEC rule 14a-9 prohibits: (i) Prohibits solicitation of a proxy by a statement containing either:

28

(c)

(d)

(e) (f) f)

1. A false or misleading declaration of material fact, OR 2. An omission of material fact that makes any portion of the statement false or misleading Material is: (i) A fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote Does not have to change a vote, Just establish a substantial likelihood, that under the circumstances, the fact would have actual significance in the deliberations of the reasonable shareholder. Court held: B-S valuation method is not material STOCK, OPTION, CALL AND PUT

Shareholder Proposals Lovenheim v. Iroquois Brands i) Case about shareholder worried about geese feed ii) A corporation may refuse to allow information concerning shareholder proposals to wish to be included in proxy materials being sent in connection with the next annual shareholders meetings iii) Focuses on Rule14a-8 (1) A proposal that relations to operations which account for less than 5 percent of the issuers total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the issuers business (2) Cannot omit a proposal in a proxy statement IF: (a) State is related to operations that account for greater than 5 percent of total assets (b) Statement relates to greater than 5 percent of its net earnings and gross sales for its most recent fiscal year, OR (c) Statement is not otherwise significantly related to the issuers business iv) Does significantly related, relate to a significant ethical or social significance?? v) Rule: The last significantly related to the issuers business is not limited to economic significance, and this is an objective test, so the door is open (1) BEAN THINKS THIS IS WEIRD. SEC referees shareholder proposals i) Rule 14-a8- A shareholder is able to propose issues to be put into the proxy statements ii) If management believes a shareholder proposal can be excluded, it files a notice with the SEC that the firm intends to exclude the proposal. iii) If the SEC staff agrees, it will issue a so called no action letter, which simply states that the staff will not recommend that the commission bring an enforcement proceeding against the issue if the proposal is excluded. iv) Losing party can in theory seek judicial review by the U.S. circuit court of appeals, but these reviews are rare. The NYCERS v. Dole Food Company, Inc. i) The shareholder request the corporation evaluate the impact of various health care reform proposals being considered by national policy makers on the company ii) Dole sent a letter to the SEC, asking for a NO action letter because Dole believe it could leave the could exclude the proposal from its proxy statement iii) A corporation may omit a shareholder proposal from its proxy statement for a number of enumerated circumstances: Corporation has the burden to show that a proposal fits within an exception (1) Ordinary Business Purpose Where the proposals involve business matters that are mundane in nature and do not involve any substantial policy or other considerations (a) This exception does not apply to because it doesnt deal with Doles benefits package (b) Test: Would the proposal have a large financial consequence on the corporation (2) Insignificant Relationship Where proposal relates to operations which account for less than 5 percent of total assets at the end of its most recent fiscal year; (2) AND, for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, AND, is not otherwise significantly related to the registrants business (a) This doesnt work here because health care impose large costs on company

g)

h)

29

i)

(3) Beyond Power to Effectuate Where the proposal deals with a matter beyond the registrants power to effectuate (a) It simply proprses that dole study something! Not beyond effectuate Austin v. Con. Edison Co. of N.Y., Inc. i) Shareholder wanted to add a proposal to the proxy statement, which would allow workers to retire earlier ii) Corporation puts forward to exclusions to exempt the shareholder proposal: (1) Proposal deals with a ordinary business operation (2) Proposal deals with redress of a personal claim or grievance or designed to benefit to the proponent, or to further a personal interest iii) SEC normally grants No Action Letters for the exclusion of proposals dealing with company pension proposals iv) This matter is one of collective bargaining between the corporation & employees, collective bargaining is always a ordinary business operation. AFSCME v. AIG ???????? i) raises the question of whether a shareholder proposal requiring a company to include certain shareholdernominated candidates for the board of directors on the corporate ballot can be excluded from the corporate proxy materials on the basis that the proposal relates to an election ii) Court Held: hold that a shareholder proposal that seeks to amend the corporate bylaws to establish a procedure by which shareholder-nominated candidates may be included on the corporate ballot does not relate to an election within the meaning of the Rule and therefore cannot be excluded from corporate proxy materials under that regulation iii) Exception, for allowing a corporation to exclude the shareholder proposal on a proxy statement (1) the town meeting rule if the proposal relates to an election for membership on the companys board of directors or analogous governing body iv) Rule: Court held proposals that amendments to corporate bylaws are non -excludable under the town meeting rule, in relation to an election CA, Inc. v. AFSCME i) Shareholder proposal recommend that the corporate bylaws be amendment so that a group of stockholders(nominators) who nominated a director for election on the board may be reimbursed for reasonable expenses related to his election on the board ii) Current law: gives the board of directors the discretion to reimburse the cost of expenses in this scenario, BJR iii) Court held, shareholders are entitled to amend the corporate bylaws, but limited by: shareholders statutory power to adopt, amend or repeal bylaws is not coextensive with the boards concurrent power and is limited by the boards management prerogatives under Section 141(a)may not interfere with the boards ability to manage the business affairs of the corporation.BJR iv) Test to apply to see if proper: (1) the scope or reach of the shareholders power to adopt, alter or repeal the bylaws of a Delaware corporation, and then (2) whether the Bylaw at issue here falls within that permissible scope. v) Section 102(b)(1) contemplates that any provision that limits the broad statutory power of the directors must be contained in the certificate of incorporation.11 Therefore, the proposed Bylaw can only be in CAs Certificate of Incorporation, as distinguished from its bylaws. Accordingly, the proposed bylaw falls outside the universe of permissible bylaws authorized by Section 109(b) vi) Rule: Whether or not a bylaw is process-related must necessarily be determined in light of its context and purpose. Factual analysis, is a substantive change or procedural change to the boards discre tion vii) Even if found procedural (which is acceptable), the bylaw proposal is improper if it conflicts with corporate law: (1) whether the Bylaw would violate any common law rule or precept viii) Test: consider any possible circumstance under which a board of directors might be required to act. Under at least one such hypothetical, the board of directors would breach their fiduciary duties if they complied with the Bylaw. presumption that the Bylaw is valid and, if possible, construe it in a manner consistent with the law. ix) The proposed bylaw was invalid because it interfered with the boards ability to fully discharging their fiduciary duties to the corporation and its shareholders, and therefore violated 141(a)

j)

k)

30

XII.

May be okay in amending the Certificate of Incorporation, But a shareholder may not offer a shareholder proposal that interferes with a statutory right, OR interferes with the Boards duty to exercise its fiduciary duty to the corporation and shareholders.manage the affairs and business of the corporation Shareholder Inspection Rights a) Generally corporate financial records for public companies are available from the SEC disclosure filings required under the Exchange Act b) Close corporations generally do not have a publicly disclose their financial statements c) 220: Inspection of books and records A stockholder of record will have the right to inspect the stockholders list for any proper purpose (1) Written demand under oath (2) Required by a stockholder of record (not stock held in street name through a broker) (3) Stating a proper purpose Crane Co. v. Anaconda Co. i) Under rule 14a-7, a shareholder has the right to force the corporation to either: mail your proxy materials to the shareholders and bill you for the costs, OR to give you the shareholder list instead ii) This section deals with the battle over shareholder identity, federal law does not grant any laws, but state laws may grant such a right. iii) Generally state corporate laws provide shareholders have a right to inspect certain corporate books and records, but generally Close corporations do not have to publicly disclose their financial statements. iv) With Stockholder list, the Corporation bears the burden of proving that stockholder does not have a proper purpose: (1) Improper purpose includes: (a) IF the stockholders seeks the list to well them to marketers, give it to creditors, or use it for political purposes, BUT seeking list to solicit proxies OR for purposes of valuing the investment are Proper v) Crane vi) A corporation attempting to purchase a large stake in Corporation B, requested the shareholder identity on the theory Corporation B had a fiduciary duty to its shareholders to hand over the list. vii) Corporation B rejected request to view the shareholder list, but offered to mail the materials viii) Corporation A purchased a large stake in Corporation B, and then attempted to exercise a known common law right to inspect corporate records ix) Court Held: A shareholder desiring to discuss relevant aspects of a tender offer should be granted access to the shareholder list, UNLESS it is sought for the purpose inimical to the corporation or its stockholders, AND the manner of communication selected should be within the judgment of the shareholder. (1) This right is derived from the shareholders beneficial ownership of corporate assets and the concomitant right to protect his investment x) Principle this right to view corporate assets should be liberally construed in favor of the stockholder whose welfare as a stockholder may be affected (tender offer) xi) The corporation trying to prevent access to the shareholder list must prove: (1) Sustains the burden of proving an improper purpose.. e) State Ex Rel. Pillsbury v. Honeywell, Inc. i) Plaintiff wanted access to the shareholder list because he wanted to solicit a proxy involving the corporations involvement in manufacturing cluster bombs for the Vietnam war. ii) Proper purpose test applies..The court held the proper purpose must be germane to this interest as a shareholder, with some concern with investment return iii) Plaintiff stated the only reason he purchased stock was to solicit the proxy and influence the company to stop manufacturing the cluster bombs iv) Court Held: A shareholder has a purpose germane to his economic interest as a shareholder, such as to solicit a proxy to influence the corporation to improve the value of the company or long term well being.not to affect a political or social question Sadler v. NCR Corp. i) Plaintiff sought the NOBO list, list of beneficial owners who do not elect to have their names removed, i)

x)

d)

f)

31

(1) NOBO list- a list of beneficial owners of shares who do not elect to have their names removed from the list. (2) CECE records of how many stocks the wall street companies hold for their investors ii) CEDE list, identifies the brokerage firms and other record owners who bought shares in a street name for their customers.brokerage firms must compile a NOBO list at a corporations request iii) Issue the court answers is whether a shareholder may request a corporation compile a NOBO list, and handover the shareholder list. iv) Court construed the shareholders rights generously and held: permit a qualifying shareholder to require the compilation and production of such a NOBO list v) Reasoning: The management in power would be able to defeat the proxy, by simply denying the NOBO list, which contains a majority of the stock holders, and for each non answered proxy, it would count as a vote for the incumbent management, thereby the incumbent manage had all the access it needed, so the NOBO list is required to protect the interest of the shareholders. g) Shareholder Voting Control Problems of Control i) Stroh v. Blackhawk Holding Corp. (1) Principal proprietary rights conferred by the ownership of stock may consist of one or more of the rights to participate (a) In control of the corporation (voting rights) (b) In its surplus or profits (dividends or liquidation rights) (c) Distribution of its assets (2) The rights to earnings and the rights to assets the economic rights may be removed and eliminated from the other attributes of a share of stockonly the man agement incident of ownership may not be removed (3) Principal A corporation may establish different class of stock that allow a shareholder to maintain control of the corporation with a smaller amount of capital investmentthere is nothing wrong with a corporation that develops a scheme to maintain control through varying stock classes. Closely Held Corporations Introduction i) Closely held corporations are corporations with a small number of shareholders, varies by state statute (1) DGCL specifies max. 30 (2) Articles of incorporation must say that its a closed corporation (3) Restriction on stock transfer (4) Management by stockholders ii) Closely held corporations have special rules because of the special relationship shareholders usually have with the corporation. iii) This is a firm organization (1) Having relatively few shareholders who are often family (2) Significant shareholder participation in the operation of the business (3) Firm is the primary source of income for the shareholders, usually because they hold officer or other employment positions with the firm (4) Illiquidity of shares iv) Public corporations organizations are (1) Have thousands of shareholders who are unrelated except through their common ownership of the firm (2) Shareholders are passive investors, not active managers or employees of firm (3) The firm is not primary source of shareholders income (4) Shares are freely transferable v) Masachusetts: shareholders in a closely held corporation are like partners and owe each other fiduciary duty of loyalty, good faith, candor (1) Shareholders many not act out of avarice in derogation of loyalty to other shareholders (a) Test for improper freeze out (i) Minority please and proves prima facia case of breach of duty of good faith by majority (ii) Control group must demonstrate a legitimate business purpose for its actions (iii) Burden shifts to minority to demonstrate a less harmful alternative vi) Delaware:

XIII.

a)

32

(1) Shareholders do not owe each other fiduciary duties. If the minority needs protection, they must bargain for that protection prior to investing vii) Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling (1) Parties had an agreement to vote together, when voting for board of directors, and if a dispute arose, the parties agreed to settle the dispute through an arbitrator (2) Stockholders my be agreement in writing deposit capital stock of an original issue with or transfer capital stock to any person or persons, or corporation or corporations authorized to act as trustee, for the purpose of vesting in said person or persons corporation or corporations, who may be designated Voting Trustee or Voting Trustees, the right to vote thereon for any period of time determined by such agreement, n. (3) Moral: Voting trusts or stock pooling agreements are allowed! (4) Statute authorizes vesting for the right to vote for a limited period of time. (5) Shareholders may lawfully contract with each other to vote in the future in such way as they, or a majority of their group, from time to time determine (6) In this case, the agreement did not authorize the arbitrator to cast the votes for the deadlocked party, but to resolve the deadlockprobably lawyer malpractice, need a more clear voting agreement (agreement did not construe as creating powers to vote each others shares, no party was justified to empower to other to vote their shares.) (7) The provision must pass a reasonable analysis (a) Does the agreement enable parties to take unlawful advantage of the outsider shareholder (b) Offend a rule of law OR public policy of the state viii) McQuade V. Stoneham (1) Facts: P and D had an agreement that they will use their best endeavors to elect eachother and keep themselves on the board. (2) Stockholder agreements to vote are enforceable, UNLESS found void as to offend a rule or public policy (3) Rule: Voter agreements may not control the directors in the exercise of the judgment vested in them by virtue of their office to elect officers and fix salaries (4) Rule: Directors may not by agreements entered into as stockholders abrogate their independent judgmentnot interfere with the BJR!! (5) Agreements to vote may not place limitations on the power of directors to manage the business of the corporation by selection of agents at defined salaries (6) Contract is also void is if violates the public policy or law of the statehere it contravenes local law ix) Clark v. Dodge (1) Facts: Clark was the only one that knew the formula to the medicine and was going to tell the son for the promise that get net income from corporation. Giving out to many dividends so not getting all money was entitled to. (2) Logical and practical test (a) If the enforcement of a particular contract damages nobody not even, in any perceptible degree the public-one sees no reason for holding it illegal, even though it interferes with the BJR (3) Close Corporation application (a) Where the directors are the sole stockholders, there seems to be no objection to enforcing an agreement among them to vote for certain people as officers (4) In this case, an agreement may be valid even where there is a conflicting statutory requirement or it violates the BJR, which allows the directors to manage the business and affairs of the corporation. .. (a) Agreement must harm no one (b) Beneficial agreement really like insurance for both parties, protect both shareholders (c) SP granted because employment compensation is main source of investment return DIFFERENCE BETWEEN McQUADE AND DODGE M was designed to protect minority shareholders that were not party to the agreement C has no minority shareholders, the rule is unnecessary x) Galler v. Galler

33

(1) Brothers owned a corporation and each owned 50/50 of the stock. (2) Shareholders entered the agreement with the intent for the support and maintenance of their immediate families (3) Policy for enforcing agreements is that minority shareholders are more venerable to abuse than minority shareholders in the public corporation because no market exists to sell the shares, and minority shareholders may be squeezed out of their economic benefit of the corporation (4) Agreements between shareholders in close corporations will be upheld even though goes against corporate norm, Unless: (a) There is a complaining minority interest appears (b) fraud or apparent injury to the public or creditors is present (c) clearly prohibitory statutory language is violated (5) Factual analysis under the circumstances xi) Ramos v. Estrada (1) Case of a shareholder voting agreement for use in close corporations (2) Shareholders in a close corporation will enter in voting agreements to prevent certain abuses such as limiting the transferability of stock in the company to ensure the company does not pass into the control of persons whose interest might be incompatible with the interests of the company and of the stockholders. b) Shareholder Voting Control i) Corporate Control (1) Issue various class of stocks, such as preferred class of stock, which allows a group to shareholders to maintain control (2) Board of Directors controls the voting processif a plaintiff challenges Blasius standard (a) Plaintiff must demonstrate the boards primary purpose was to interfere with or thwarting the exercise of a shareholder vote, (b) If plaintiffs fails to carry burden, boards decision is judged under the BJR (c) If plaintiff carries the burden, the board must present compelling justification for their action to interfere with the shareholder franchise ii) Close Corporations (1) Principle issue for shareholders in closely held corporations: oppression of minority shareholders and minority shareholders attempting to avoid this. iii) Tools to avoid oppression of shareholders through sharing control (Know these, use week 9 game plan) (1) Various stock classes (2) Supermajority voting requirements on certain issues (3) Prohibition on director interference with shareholder vote (4) Cumulative voting (5) Class voting (6) Voting Trusts (7) Irrevocable proxies (8) Vote pooling agreements (9) Shareholder agreements (10) Involuntary dissolution & forced sale agreements STOCK STUFF i) Cumulative voting- means each share carries a number equal to the number of directors elected ii) Straight voting- means that each share gets one vote for each director (1) Majority can defeat cumulative voting by amending articles of incorporation to stagger the election of directors so that fewer directors are being elected each year iii) Class Voting (1) The articles of incorporation divide shares in to classes and give each class a specific number of directors (a) Problem: Must plan and draft for contingency of holder of class dying and creating vacancy iv) Voting trust (1) An agreement among shareholders under which all of the shares owned by the parties are transferred to a trustee, who becomes the nominal, record owner of shares.

c)

34

(a) Disfavored: courts have issues about the separation of the vote from the stock. (i) Loss of control (ii) Still possible for board oprress (b) Advantage- no possibility of shareholder deadlock, since everybody puts their shares in the trust and trustee votes v) Irrevocable proxy (1) Generally shareholder proxies are revocable at any time (2) Irrevocable proxy permanently separates vote from the stock (a) Courts dont like this (i) They require that the irrevocable proxy also be coupled with an interest in the corporation vi) Shareholder Agreement (1) Enforceable if agreements just to elect parties to agreement to board positions (a) Usually unenforceable if they contain additional directions to board vii) Quorum (1) In order for shareholder to take action, there must be a quarom at the meeting (a) This is a majority of the shareholders entitled to vote (i) Votes casted in favor > votes casted against - MBCA (ii) Decisions must be approved by the vote of a majority of the shares present. DGLC viii) Pre value minimum price at which shares may be sold (1) Specific in articles of incorporation ix) Stock Split (1) Effected by changing par value through amendment to articles (a) Ex: par value cut 1 dollar to 50 cents (b) New shares issued on 2-1 basis x) Entrenchment affect? d) Abuse of Control - Closely Held Corporations i) Key things for small corporations when organizing legal person to go forwardthink of exit strategy! ii) Freeze-out is: (1) Majority takes action designed to isolate the minority from the financial benefits they would ordinarily have received from the corporation (2) Factual Analysis of the circumstances Must prove bad faith in a plan to freeze out minority, excessive compensation in and of itself is not enough iii) iv) Wilkes v. Springside Nursing Home, Inc. (1) Closely held corporation where the friendships between the shareholders deteriorated, and one of the active shareholders was forced out of the corporation management and cut off to all corporate economic benefit (2) Stockholders in close corporations must discharge their management and stockholder responsibilities in conformity with this strict good faith standardThey may not act out of avarice, expediency or self interest in derogation of their duty of loyalty to the other stockholders and to the corporation. (3) When a minority stockholder in a close corporation bring suit alleging a breach of good faith duty owed to them by the majority, the court must analyze the action taken by the majority stockholders in the individual case.The court will examine the business purpose advanced by the majority, THEN it is open to the minority stockholder to demonstrate that the same legitimate objective could have been achieved through an alternative course of action less harmful to the minor itys interest.. (4) Court must weigh the legitimate business purpose, if any, against the practicability of a less harmful alternative (5) Factual analysis (a) Legitimate business purpose (b) Wrongful conduct by minority v) Ingle v. Glamore Motor Sales, Inc. (1) Plaintiff was a shareholder and an employee at the defendants corporation.

35

(2) Plaintiff signed shareholder agreement, that stated any stockholder shall cease to be an employee of the corporation for any reason, shall have the option, for 30 days to repurchase all of the shares of stock then owned by such stockholder(buyout agreement). (3) Court distinguishes a majoritys duty to a minority shareholder v. the rights an employee has in an at will employment relationship (4) In the case of a buy-back shareholder agreement, the majority upheld the agreement, and repurchased the shares at the agreed to pricesince the plaintiff had to right to employment, the buy -back agreement did not violate the majoritys duty of loyalty or good faith (5) Consider (a) If the plaintiff argued the price was unfair or violated his good faith in oral understanding (b) How about if the majority failed to exercise the buy-back option (c) Agreements show a clear intent and reasonable expectation of partysif you make your bed, you are going to sleep in it.ensure you bargain a decent buy back agreement, OR dont complain (d) Courts will not rewrite K if one gets the short end of the stick

vi) Brodie v. Jordan (1) Facts: P wife of husband who owned shares from working there dealing with the day to day operations. He died, when she asked for information about the company she was refused. (2) Stockholders in a close corporation owe one another a duty of utmost good faith and loyalty (3) Stockholders violate this duty when they act to Freeze out the minority (4) Freeze outs are: (a) Majority stockholders ruse to declare dividends, drain of corporations earnings through bonuses and salaries, high rent to their properties, deprive minority of employment opportunities, corporation to sell its assets at an inadequate price to the majority sharehol ders. (5) These examples all frustrate the minoritys reasonable expectations of benefit from their ownership of shares. (6) Case deals with Remedies: (a) Was the plaintiff entitled to a forced buyout of her shares by the majority (b) Remedy should restore the minority shareholder whose benefits which she reasonable expected, but has not received because of the fiduciary breach. (7) Court has broad equitable powers to fashion remedies for breaches of fiduciary duty in a close corporation (8) Must determine: (a) Minorities reasonable expectations of ownership (b) Whether such expectations were frustrated (c) If so, which means will vindicate the plaintiffs interests (9) Factual analysis vii) Smith v. Atlantic Properties, Inc., (Case looking at minority breaching fiduciary duty to majorityrefusing to accept an idea to avoid tax liabilities) (1) Defendant inserted a shareholder agreement provision that provided veto power to any one of the shareholders by requiring basically unanimous approval for corporation decisions (2) The failure to act lead to tax penalties assed by the IRS (3) The Corporation incurred substantial penalty taxes and legal expenses largely because on shareholder reused to approve a declaration of dividends, which would have avoided the penalties (4) Issue is: Did the shareholder violate his fiduciary power by using the veto powered agreed upon (5) Even if a shareholder bargains for protection through a shareholder agreement: the shareholder may not act recklessly in running serious risks which are inconsistent with any reasonable interruption of duty of utmost good faith and loyalty. (6) If a shareholder uses his veto power, seems he must have a reasonable business reason for such decision, AND causing reckless losses to the corporation will not provide such a justifiable business reason, especially if the reasons are for personal benefit. (7) This is a dead lock casecorporation cannot do anything. And if deadlock minority has duty of good faith and loyalty. viii) Nixon v. Blackwell

36

(1) A stockholder who bargains for stock in a closely held corporation can make a business judgment of whether to buy into such a minority position, and if so on what terms (2) The tool of good corporate practice are designed to give a purchasing minority stockholder the opportunity to bargain for protection before parting with consideration. It would do violence to normal corporate practice and our corporation law to fashion an ad hoc ruling which would result in a court imposed stockholder buy-out for which the parties had not contracted. ix) Jordan v. Duff and Phelps, Inc. (1) Shareholder sold back stock in a closely held corporation when there was a pending sale of the defendant firm and would have made his stocks worth much more (2) Rule: In close corporations, when a majority purchase their own stock must disclose to sellers all information that meets the standard of materia lity (3) Materiality: (a) A substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder AND would have been viewed by the reasonable investor as having significantly altered the total mix of information made available. (4) Close Corporations have a fiduciary duty to disclose material facts when buying back their own stock (5) The firm may have negotiated a term, that it did not have to disclose all material facts, or contracted away this duty (6) 10b-5 requires that a director must disclose or abstain, but in a close corporation arrangement.the director does not have the option to abstain if the corporation is buying back its stock.therefore, under 10b-5 and close corporations the corporation must disclose all the material facts before the purchasing of their stocks (7) For damages; Jordan must prove causationOr because of the omitted material disclosure, Jordan missed out on the opportunity, therefore he must prove he would not have sold the company if he had known of the possible tender offer WITH FAMILIES GET BUYOUT ARRANGEMENT Control, Duration, and Statutory Dissolution i) Situations where minority shareholders have been treated unfairly by majority shareholders, and are seeking court order dissolution in certain circumstances and general equitable powers of the courts ii) Alaska Plastics, Inc. v. Coppock (1) Plaintiff is seeking a forced buyback of her shares of the closely held corporation (2) Majority shareholders are in a position to squeeze out minority shareholders at unreasonably low prices because there is no market for minority shares of a Closely held Corporation (3) Methods to buy back minority shareholders at fair value EXIT OPTIONS FROM A CLOSE CORPORATION (a) Articles of inc. or bylaws provision that provides for the purchase of shares by the corporation contingent upon the occurrence of some event, such death of shareholder or transfer of shares (b) Shareholder may petition the court for involuntary dissolution of the corporation under state statute (i) Showing illegal, oppressive, fraudulent, wasteful conduct (ii) Liquidation is reasonably necessary for the protection of the rights and interests of the complaining shareholders (c) Some significant change in the corporate structure, such as a merger, the shareholder may demand a statutory right of appraisal (d) A purchase may be justified as an equitable remedy upon a finding of a breach of fiduciary duty between directors and shareholders and the corporation or other shareholders. (4) Involuntary dissolution and Liquidation is AN Extreme REMEDY (a) Involuntary liquidation requires a showing of illegal, oppressive or fraudulent or alternatively, constituted a waste or misapplication of corporate assets by the majority shareholders (5) Where a majority or controlling shareholder takes advantage of a special corporate benefit, the fiduciary duty owed to other shareholders required that the corporation offer such benefit equally (6) These incidental benefits bestowed upon the controlling shareholders may be construed as Constructive Dividends (7) FACTUAL ANALYSIS = equal benefit IF special benefits exist for majority

e)

37

(8) Notes: (a) Courts may also grant involuntary dissolution and liquidation for two other scenarios (i) Deadlock among directors 1. Directors must be evenly divided and therefore unable to make corporate decisions 2. The shareholders must be unable to resolve the deadlock 3. The deadlock must threaten irreparable injury to the corporation or advantage of the shareholders (ii) The Deadlock must threaten irreparable injury to the corporation or prevent the business of the corporation from being conducted to the advantage of the shareholders (iii) Shareholder Deadlock: 1. Shareholders must be evenly divided 2. Because of their division the shareholders must be unable to elect a board of directors for two years running (b) Courts are reluctant to order liquidation absent compelling circumstances- Oppression, Fraud, Deceit (c) Oppression Conduct that substantially defeats the minority shareholders reasonable expectations (d) MORAL As a lawyer, MAKE SURE TO INSERT PROVISIONS TO DEAL WITH THESE ISSUES iii) Haley v. Talcott (1) Restaurant caseHaley head of day to day, Talcott financed and then made the land be an LLC and both guaranteed on the mortgage (2) Plaintiff is seeking dissolution of the LLC because it is not reasonable practicable to carry on the business in conformity with the limited liability company agreement. (3) Relationship established by contracts, but clearly meant to be a joint venture (4) This involves a shareholder stalemate or deadlock: (a) Shares were spilt evenly, so the status quo continues (5) Absent intervention by the court, the plaintiff is stuck in the deal, with no recourse (6) Rule: A member or manager may seek and receive a decree of dissolution of a LLC whenever it is not reasonably practicable to carry on the business in conformity with the LLC agreement (7) 3 pre-requisites for a judicial order of dissolution - TEST (a) The corporation must have two 50% stakeholders (deadlock) (b) Stockholders must be engaged in a joint venture (c) They must be able to agree upon whether to discontinue the business or how to dispose of its assets (8) What about where an exit provision exists through the LLC agreement? (a) That would dominate if it could apply equitable, however in this case the provision only allows either party to leave voluntarily, and it provides no insight on who should retain the LLC if both parties would prefer to buy the other out (b) The exit mechanism fails as an adequate remedy because it does not equitably effect the separation of the parties. iv) Pedro v. Pedro (1) The court was proper in awarding the difference between a buyout agreement and the fair market value of those shares (a) If the fair value of the shares is greater than the purchase price for the buyout as calculated from the formula in the SRA, the difference is the measure of respondents damage resulting from having been forced to sell his shares in the company (2) The reasonable expectations of a shareholder are those at inception and develop during the course of the shareholders relationship with the corporation and with each other (here: implied lifetime employment contract) (3) Reasonable expectations (may be) a job, a significant place in management, and economic security for his family (4) Must ascertain the intent of the parties to the employment contract (a) Consider the written and oral negotiations of the parties (b) The parties situation

38

(c) The type of employment (d) The particular circumstances of the case (5) In closely held corporations, a reasonable expectation by the employee-owner that his employment is not terminable at will v) Stuparich v. Harbor Furniture Mfg., Inc. (1) Plaintiffs sought involuntary dissolution of the corporation claiming damages for fraud, conspiracy, and negligence.. (2) Liquidation is reasonably necessary for the protection of the rights or interests of the complaining shareholder or shareholders (3) Involuntary dissolution is a drastic remedy that should be appropriately limited. (4) Factors do determine if t is reasonably necessary to protect the interests of the minority shareholders through involuntary dissolution (a) How is the plaintiff injured (b) Is there an alternative method to remedying this injury (c) Are any fiduciary duties being violated (d) Majority shareholders who run the business are protected by the BJR for decisions they making regarding the operation of the company.must should a breach in fiduciary duty of loyalty, like the majority getting a benefit the minority does not have the ability to receive

f)

g)

h)

Transfer of Control Closely Held Corporation i) Frandsen v. Jensen-Sundquist Agency, Inc. ii) Plaintiff and defendant has an agreement that gave the plaintiff the rights to first refusal. Also had a tag along clause in it. If I refuse to buy with my right to first refusal then you have to buy our stocks and bring us with. iii) This was an agreement giving the plaintiff the first right to buy the stock, if it was offered for sale, BUT in the transaction the corporation selling its principal asset, not its stock iv) There is a difference between the sale of shares of stock and a merger v) A minoritys right to first refusal allows a minority shareholder from coming under the control of an undesired controlling interest because if the majority shares are offered for sale; the minority has the first opportunity to purchase the shares vi) However, in the case of a merger, these concerns are not relevant because all the shares will be purchased, not just the majorities shares vii) This clause prevents a new controlling shareholder from getting power, and squeezing out the minority shareholder on the cheap viii) Court pulls out a doctrine stating that rights of first refusal are to be interpreted narrowly, canons of construction ix) If you desire to have the right to purchase upon a merger offer, must clearly contract for that right Merger: Target shareholders get cash or other value and only one of the corporations involved survives. i) Acquiror/surviving entity gets all assets and all liabilities of the surviving entity. ii) Sales tax avoided iii) There may be other tax implications iv) Licenses in the surviving entity remain valid, but licenses in the non-surviving entity may be invalidated. Sale of assets: target shareholders remain but their corporations will have only the case or shares or other value which the acquiring co. exchanged for the assets sold. Acquiror has the purchased assets. i) Sales tax may be due ii) Other accounting and tax implications iii) Any time the majority sells its control, the minority shareholders essentially get a new partner and are subject to a new master Zetlin v. Hanson Holdings, Inc. i) Rule: Absent looting of corporate assets, conversion of a corporate opportunity, fraud or other acts of bad faith, a controlling stockholder is free to sell, and a purchaser is free to buy, that controlling interest at a premium price. ii) The controlling share of a closely held corporation commands a price premiumthe added value an investor is willing to pay for the privilege of directly influencing the corporations affairs. iii) See examples of potential problems on 698

i)

39

j)

V.

Essex Universal Corp. v. Yates i) Defendant purchased about 25% of a public corporation, and as part of the deal the seller was to deliver 8 of the 14 board of director positions because under the corporate charter resigning board members could select their replacement ii) The issue is whether this contract is on its face void? iii) Normal Rule: It is illegal to sell corporate office or management control by itself (but here there was 28.3% of the stock also) iv) The test the court develops is that: If the buyer was contracting to acquire a majority of stock (in reality) then there is no reason why the contract should not similarly be legal, as to a purchase of actual majority v) Test: (1) The burden of proof is on the party attacking the legality of the transaction, thus the party must prove the block of stock in question did not carry the equivalent of majority control. Must prove the existence of circumstances which would have prevented the buyer from electing a majority of the board of directors in due course k) 262 of Delaware Code i) If in minority and you think that the price thats being offered is not fair or adequate Delaware says well you dont have to take the dealyou can get an appraisal, go to court to appraise ones shares ii) I think you will find Delaware is so unhappy with this provision that its hard for anyone to come out ahead.Its expensive to do thislitigation, banker, (1) Cant get an appraisal if its listed on the stock exchange. (2) Cant get one if merger doesnt need stockholder approval (3) cant get one if shares received have similar characteristics (4) Appraisal is available if holders are required to except anything than shares of stock of surviving iii) Who gets appraisal (1) Merger (a) MBCA- shareholders of target entitled to vote (b) Del 262- all shareholders of targetm usually acquiror shareholders unless: (i) Whale-minnow merger (Farris) OR (ii) Market out- under present Delaware law appraisal is not availableif the shares relinquished are 1. Listed on a national securities exchange 2. Held of record by more than 2000 stockholders and 3. if the shares received have similar characteristics (2) Short form merger (a) Shareholders of subsidiary only (b) Sale of seller only iv) Appraisal Procedure (1) Dissenting shareholders must (a) Give written notice of intent to dissent before shareholders meet (b) Vote against proposition (2) Corporation must notify dissenting shareholders of their appraisal rights (3) Dissenters must tender share to corporation and demand payment (4) Dissenters must then sue for appraisal (5) Dissenters bear all the costs and only receive payment after final order. Mergers, Acquisitions, and Takeovers a) Introduction i) Statutory mergers mergers through a merger agreement and state law (1) Merger agreement- drafted by the parties, which prescribes the treatment of the shareholders of each corporation ii) Practical mergers mergers that do not use statutory procedure (1) Company buys stock from the shareholders directly to gain control and then do a short form merger of the companies iii) Short form merger Companies gains 90% of shares in another corporation, it can merger without a vote

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b)

iv) Acquisition- obtain all the assets of the company and give them stock in your company. This way you do not acquire liabilities like one would in a statutory merger Farris v. Glen Alden Corporation i) Under Penn. State corporate law, a shareholder does not have a right to dissenters or appraisal rights when the corporation acquires all or substantially all of the property of another corporation by the issuance of stock, securities or otherwise shall not be entitled to the rights and remedies of dissenting shareholders ii) So the court must find a way to justify the transaction as a Merger to allow dissenter rights iii) De Facto Merger: (1) A transaction between two corporations, one corporation dissolves, its liabilities are assumed by the survivor, its executives and directors take over the management and control of the survivor, AND, as consideration for the transfer, its stockholders acquire a majority of the shares of stock of the survivor, then the transaction is no longer simply a purchase of assets or acquisition of property, BUT a merger iv) Since the court found a merger, the dissenting stockholders were entitled to appraisal rights v) After this case, the Penn. Legislature abolished the De facto merger doctrine. Hariton v. Arco Electronics, Inc. i) Involves 271 of Delaware corporate law, where a selling corporation sells all of its assets in consideration of the buying companies shares of stock, and then the shares are distributed to the shareholdersAfter the sale has been completed the selling corporation is dissolved, so the same result is accomplished as by a merger (1) In Delaware, a shareholder does not have dissenter and appraisal stemming from his corporations sale of all of its assets ii) Plaintiff argues in this case for a De facto merger, which would give arise to appraisal rights iii) Delaware courts deny the de facto merger argument, and hold that the Corporations have the right to this procedure under 271 Freeze Out Mergers Weinberger v. UOP, Inc. i) Cash out merger between the majority owner, Signal, and UOP, corporation ii) Rule: (1) Burden is of the plaintiff attacking the merger to demonstrate some basis for invoking the fairness obligation (2) Where a corporate action has been approved by the majority of the minority shareholders, the burden entirely shifts to the plaintiff to show the transaction was unfair to the minority.BUT the burden clearly remains on those relying on the vote to show that they completely disclosed all material facts relevant to the transaction. iii) Test thought iv) What may the minority demonstrate to force the majority shareholder to prove that the transaction was fair. (1) Behavior suggesting a breach of duty of loyalty (2) Transaction is approved by uninformed majority of minority shareholders, then controlling party bears the burden of proving by preponderance of evidence that the transaction was entirely fair. (3) However if minority is informed, burden stays with the plaintiff to prove unfairness of the transaction v) Note: Board of directors in this case had a duty to both Signal stockholders and UOP minority shareholders.sticky situation vi) Why were UOP minority shareholders uninformed? (1) Failed to disclose a study that showed the price range Signal would pay for UOP, and those directors had a fiduciary standard (2) This showed a $3 per share price increase was still good for Signal and greatly increased the value of UOP shareholders value.court found this omission material (3) Complete candor is required for minority shareholders are to be considered informed vii) When directors are on both sides of a transaction, they are required to demonstrate their utmost good faith and inherent fairness of the bargain.. viii) Fairness (1) Fair Dealing (2) Fair Price ix) Fair Dealing (1) Study of price was not disclosed, is all information available Duty owed

c)

d)

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(2) Time constraints?? (3) Who initiated the deal? (4) What were the negotiations? Where there any? (5) Fairness opinion?? (6) Disclosure of the process to shareholders x) Fair Price (1) Comparative analysis of other merger premiums (2) Discounted cash flow analysis (3) Earnings potential of UOP (4) Any techniques or methods which are generally considered acceptable in the financial community and otherwise admissible in court.requires consideration of all relevant factors xi) In a case of fraud, misrepresentation, self dealing, deliberate waste of corporate assets, or gross and palpable overreaching are involvedcourt has power to fashion any form of equitable and monetary relief as may be appropriate xii) The real question in freeze out merger: Can the plaintiff show a breach in duty or loyalty or that the minority vote on the merger was uninformed of all the material facts surrounding the merger. e) Coggins v. New England Patriots Football Club, Inc. i) Massachusetts take on freeze out mergers ii) Test (1) Business purpose Requires a showing of a legimate business purpose (If a purpose, must show fairness) (2) Fairness Test In the totality of the circumstances was it fair to the minority shareholder iii) Business purpose test (1) A director of a corporation violates his fiduciary duty when he sues the corporation for his or his familys personal benefit in a manner detrimental to the corporation (2) Because the director standing on both sides of the transactionshe has the burden of showing that the transaction does not violate fiduciary obligations (3) Business factors (a) Any personal benefit gained my director (majority shareholder) (b) Legal duties (c) Financial gain for corporation (4) Assume Delaware fairness test iv) Remedies under the circumstances a remedy where the interests of the corporation and of the plaintiffs will be further best Rabkin v. Philip A. Hunt Chemical Corporation i) The issue here is whether appraisal are the only source of remedy available to minority shareholders who have been frozen out. ii) Because of the fair dealing prong in the Weinberger test, valuation is not always the cause of an inherently unfair transaction.the procedure under which the transaction was completed may be unfair and in this case appraisal rights may not provide relief. iii) Holding: In a case, where a majority shareholder violates the fair dealing prong of the Weinberger test, for matters of procedural fairness.Appraisal rights are not the sole remedy iv) Stockholders may claim that the price being offered is the result of unfair dealings!!!! De Facto Non-Merger Rauch v. RCA i) Plaintiffs are claiming a merger is actually a redemption of their class A stock, which entitles them to $100 per share instead of the $40 they received ii) Court: conversion of shares to cash that is carried out in order to accomplish a merger is legally distinct from redemption of shares by a corporation. iii) Redemption preferred stock may be subject to redemption by the corporation at its option or at the option of the holders of such stock or upon the happening of a specified event..in this case the preferred stock was subject to redemption by the corporation iv) Plaintiff may have sought appraisal rights if she believed the transaction was unfair. LLC Merger VGS, Inc. v. Castiel

f)

g)

h)

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i)

The form in which the majority of directors used to Merger the LLC into a new Corporation were sound through Delaware law ii) The court found the majority of directors violate their duty of loyalty to the LLC, Castiel, a fellow director and a majority shareholder iii) Factors played in equity (1) Castiel went from having a 75% stake in the LLC, to 37.5% in the Corporation (2) Castiel lost his majority voting power (3) Castiel was voted out of his position on the board of directors (4) After the merger he was effectively excluded from the day to day operations of the Corporation upon which he originally founded (how about equity) iv) Equity looks to the intent rather than the form. Intent to steal management of the firm v) Directors in a LLC owe a duty of good faith and loyalty, so it can be argued.look at the facts of the scenario vi) NO BJR for a breach in the duty of loyalty VI. Takeovers a) Cheffs v. Mathes i) Cheff was Holland Furnaces CEO and was facing a hostile takeover from Maramount through the acquiring of stock ii) Holland furnace used corporate money and assets to borrow money to purchase the Shares that Maramount (hostile actor) acquired in an attempt to gain control, thereby eliminating the perceived threat of a hostile takeover, purchased 155,000 shares from Maramount iii) Under 8 Del.C. 160 a corporation is granted statutory power to purchases and sell shares of its own stock iv) The claim is that the stock purchases were improperly centered upon perpetuation of control (directors control) (1) Analogies proxy funds to inform shareholders are ok, but using corporate funds for selfish purposes such as the directors to perpetuate themselves in office v) RULE: If the board were motivated by a sincere belief that the buying out of the dissident stockholder was necessary to maintain what the board believed to be proper business practices, the board will not be held liable for such decision, even though hindsight indicates the decision was not the wisest course. However, if the board has acted solely or primarily because of the desire to perpetuate themselves in office, the use of corporate funds for such purposes is improper. vi) Test: (1) Did the board satisfy their burden of proof showing reasonable grounds to believe a danger to croproate policy and effectiveness existed by the presence of the Maraemont stock ownership: Reasonable fear (2) Factors: (a) Fear of the directors of possible takeover and liquidation of the Corporation (b) Any Dealings between the parties (c) Actions by the hostile party (d) Reputation of the opposing party (3) Once a reasonable threat is established, actions are proper when made in good faith that the corporate interest was served, b) Greenmail i) IS the purchase by a corporation of a potential acquirers stock at a premium over the market price ii) IRS applied a 50% tax rate to greenmail transactions Van Gorkom i) Read Case Procedural Duty of Care.Must cross the Tees and Dot the Is Unocal Corporation v. Mesa Petroleum Co. i) The Unocal Board tried to block a two-tiered take offer from Mesas Boone Pickens, Pickens offered the first 37% of shares tendered $54 in cash, while the remaining shares would be cashed out with junk bonds purportedly valued at $54 ii) The Unocal Board approved a measure that if Mesa acquired 49% of the shares, then Unocal would offer debt securities for the remaining shares valued at $72

c)

d)

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iii) The issues are: (1) Did Unocal board have the power and duty to oppose a takeover threat it reasonable perceived to be harmful to the corporate enterprise, AND (2) Is its action here entitled to the protection of the business judgment rule iv) Because of the fact the BOD may be acting in their best interests, there is an enhanced duty which class for judicial examination at the threshold before the protections of the business judgment may be conferred v) Test: (1) Does the board have the power: (a) Does the Delaware Statute authorize the Board to take this defensive action, OR (b) If OK under the Delaware Statute, does the Corporate Charter place any limits on this Defense Measure (2) Did the board have reasonable grounds for believe that a danger to the corporate policy and effectiveness existed? (a) Factual analysis of the circumstances Pickens was a greenmailer (b) Directors may satisfy this burden by showing good faith and reasonable investigation (3) Was the defense reasonable in relation to the threat posed (a) Good Faith? (b) What was the primary purpose, entrenchment is not allowed (4) Reasonable investigation, procedural duty of loyalty Van Gorkom vi) If the board meets this test, then the boards action is entitled to protection under the business judgment rule vii) Factors to determine if a Defensive measure is reasonable in relation to the threat posed (1) Inadequacy of the price offered (2) Nature and timing of the offer (3) Questions of illegality (4) Impact on constituencies other than shareholders (5) Risk of nonconsummation (6) Quality of securities being offered junk bonds (7) The basic stockholder interest at stake viii) Once the boards actions are entitled to the BJR, the only chance of disproving the boards decision is through a showing of fraud, breach of a duty, or bad faith which would have been used in the previous analysis ix) Summary; (1) Defense measures used to defeat a Hostile offer: (a) Does the board have the authority to take this action under the Corporate law and Charter (b) If yes, Then.. (c) Did the board have reasonable grounds for believing that a danger to corporate policy and effectiveness existed (i) Board must show good faith in the perceived threat, AND reasonable investigation or procedural Duty of Care in determining the threat is legitimate (ii) The action must be in reasonable relation to the perceived threat and primary purpose not for entrenchment, AND board must show reasonable investigation (d) Once this standard has been met, the Boards decision is given a presumption of the BJR, and will be difficult to overturn x) See Page 779 Poison Pills Also, SEC banned the discriminatory offers not made to all shareholders, no selective treatment allowed

e)

Revlon, Inc. v. MacAndrews Perelman i) Revlon took defense measures in regard to a hostile offer from pantry pride. ii) This case is broken into two separate parts: (1) First part, the board was taking measures to defeat a hostile takeover, so the Unocal principles applied (2) Second part, once it became apparent the breakup of the company was inevitable, the company was on the action block iii) Standard from Unocal: (1) When exercising its power to forestall a hostile takeover, the boards action are strictly held to the fiduciary standards of Unocal, which require the directors to determine the bests interests of the

44

corporation and its stockholders, and impose an enhanced duty to abjure any action that is motivated by considerations other than a good faith concern for such interests iv) Upon, the realization that the company would be broken up, the Boards duty changed, the boards duty changed from preservation of Revlon as a corporate entity to the maximization of the companys value at a sole for the stockholders benefit. This altered the boards responsibilities under the Unocal standards v) The directors role changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sales of the company. vi) Duty turns to maximizing the value to the shareholders, including a duty of loyalty and duty of care vii) The SOLE DUTY IS TO MAXIMAZIE PROFIT FOR SHAREHOLDERS, when the company is put on the auction block viii) Does the boards action have a benefit of maximizing profit for shareholders, or does it have a destr uctive effect by locking up a deal, or eliminating the bidding process ix) The Board must take action to obtain the best possible price for their shareholders f) Paramount Communications v. Time Incorporated i) Deals with a merger of Time and Warner, then at the last second Paramount steps in with a $175 cash offer for Time, and the ensuing battle between the Paramount Board and the Time Board over the cash offer or merger with Warner ii) The Time board rejected the higher price Paramount Offer, by stating the Warner deal offered: (1) Greater long term value for the stockholders (2) Paramount offer did not pose a threat to Times Survival and its culture iii) The court found that the time Warner deal did on constitute a Change of control, and therefore did not trigger Revlon duties to maximize the gain of shareholders. iv) Three times that Revlon Duties may be envoked: (1) When sale or merger of the company results in a loss of control or corporate change (2) Corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear breakup of the company (3) Response to a bidders offer a target abandons its long term strategy and seeks an alternative transaction involving the breakup of the company v) If a boards defense measures to a hostile takeover or tender offer are found to constitute only a defensive response and not an abandonment of the corporations continued existence, Revlon duties are not triggered, though Unocal duties attach vi) Was the revised merger agreement a defensive measure in order to protect against the paramount offer, YES then apply the Unocal Standard vii) Threats that may be posed to a corporation in a Tender offer: (1) Value concern over price and method of payment junk bonds (2) Long term strategic benefit of the deal (3) Risk or uncertainty of the deal (4) Offer meet the corporate objectives or needs viii) The Board of Directors have the fiduciary duty to manage a corporate enterprise including the selection of a time frame for achievement of corporate goals Paramount Communications v. QVC Network i) Deal with bidding offers for paramount from QVC and Viacom ii) Paramount inserted various defensive measures in its merger agreement with QVC, including a No-Shop Clause, A Termination Fee, and A Lock Up fee iii) This case was brought by QVC, alleging Paramount Board failed its duty: iv) A court will subject the directors conduct to enhanced scrutiny to ensure that it is reasonable, when there is approval of a transaction resulting in a sole of control, OR the adoption of defensive measures in response to a threat to corporate control v) When Shareholders must approve action my majority vote: (1) Election of directors; amendments to the certificate of incorporation; mergers; consolidations; sales of all or substantially all of the assets of the corporation; and dissolution. vi) In this transaction, paramount a public corporation had no dominant shareholder, but after merger with Viacom the Paramount shareholders would be subject to the control of a majority shareholder in Redstorm, therefore the Paramount shareholders lose the right to affect the outcome of voting rights

g)

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vii) Therefore, the Paramount directors had an obligation to take the maximum advantage of the current opportunity to realize for the stockholders the best value rea sonable available viii) The Revlon Duties are raised when sale of control exists: (1) Directors have an obligation to reasonably seek the transaction offering the best value reasonable available to the stockholders (versus time where the control was not shifted) ix) Factors to consider in determining the best shareholder value: (1) Evaluate the entire situation and the consideration being offered (2) Try to quantify the value of the offers, and make a comparison of alternatives if feasible x) Test: Board must inform themselves of all material information reasonable available, the directors must decide which alternative is most likely to offer the best value reasonable available to the stockholders. xi) Features of enhanced Scrutiny test: (1) Determination regarding the adequacy of the decision making process employed by the directors, including the information on which the directors based their decision, AND (2) A judicial examination of the reasonableness of the directors action in light of the circumstances then existing, (3) Directors have the burden of proving they were adequately informed and acted reasonably. (4) Just looking for a range of reasonableness, but not a perfect decision xii) Revlon when a board ends an intense bidding contest on an insubstantial basis, that action cannot withstand the enhanced scrutiny which Unocal requires of director conduct (1) May not play favorites, where bidders make similar offers, or dissolution or break up of the company is inevitable xiii) Also have the duty to seeking the best value reasonable available for stockholders where there is a pending sole for control xiv) RULE: (1) To the extent contract provisions, or defensive merger agreement terms, are inconsistent with the Board of Directors Fiduciary duties under Delaware law xv) Because control was already decided to be changed, Board of Directors had a duty to seek the best reasonable value available to the stockholders xvi) Court held, the actions taken by the Paramount Board was not reasonable, no shop, lock up and termination fee: (1) These provisions inhibited the shareholders from receiving the maximum value through a bidding process, and therefore were a breach of the directors duties h) Notes on Page 816 i) Defensive measures by an independent board are permissible if not Draconian, which means that it is not coercive or preclusive. ii) Defensive measures that deprive some board of directors of power, or disenfranchise shareholders are not allowed iii) Any provision that limits a boards ability to act or not act in a fashion which is inconsistent w ith exercise of fiduciary duties, it is invalid and unenforceable. Omnicare, Inc. v. NCS Healthcare, Inc. i) Bidding war over a NCS, which was under bankruptcy and was trying to recover for its debt holders and also shareholders ii) Genesis initial started to negotiation with NCS or the purchase of the company, but Genesis refused to be a stalking horse, and ant an exclusivity agreement, which NCS agreed too iii) Omnicare jumped into the deal, and made a better offer to purchase NCS iv) However, due to the risk of scaring away Genesis, and the uncertainty of the Omnicare deal, NCS decided not to negotiate with Omincare, but use its offer as leverage with Genesis v) A shareholder voting agreement with Genesis, between NCS board members and genesis, ensured the merger agreement would pass a shareholder vote, even if the board withdrew its approval of the merger agreement vi) Omnicare then sweetened the deal for NCS, and the board withdraw its approval of the Merger agreement, but the voter agreement still existed vii) BJR, and certain circumstances where the court will subject the directors conduct to enhanced scrutiny to ensure that it is reasonable, before the BJR is applied to their decisions.

i)

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(1) When a board adopts defensive measures in response to a hostile takeover proposal that the board reasonable determines is a threat to corporate policy and effectiveness (2) Revlon duties when the board enters into a merger transaction that will cause a change in corporate control, initiates an active bidding process seeking to sell the corporation, makes a breakup of the corporate entity inevitable. viii) A merger agreement, with no change of control, is not subject to the enhanced scrutiny ix) Rule: defensive devices adopted by the board to protect the original merger transaction must withstand enhanced judicial scrutiny under the Unocal standard of review, even when that merger transaction does not result in a change of control x) Features of enhanced scrutiny (1) Adequacy of the decision making process employed by the directors, procedural duty of care (2) Examination of the reasonableness of the directors action in light of the circumstances when then existing. xi) The reasonableness test should decide whether the directors decision was, on balance, within a rang e of reasonableness. xii) Unocal test: (1) Directors must demonstrate that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed, REQUIRES the directors show they acted in good faith after conducting a reasonable investigation. (2) Second part requires the directors to demonstrate that their defensive response was reasonable in relation to the threat posed REQUIRES a two stop analysis (a) Directors must establish that the merger deal protection devices adopted in response to the threat were not coercive or preclusive (b) Demonstrate that their response was within a range of reasonable responses to the threat perceived xiii) Coercive, is aimed at forcing upon stockholders a management sponsored alternative to a hostile offer xiv) Preclusive, deprives stockholders of the right to receive all tender offers or precludes a bidder from seeking control by fundamentally restricting proxy contests or otherwise xv) If defensive measures are either preclusive or coercive they are draconian and impermissible xvi) A vote may be nullified by wrongful coercion where the board or some other party takes actions which have the effect of causing the stockholders to vote in favor of the proposed transaction for some reason other than the merits of that transaction xvii) Therefore the voting agreement was Draconian and coercive because they accomplished approval for some other reason that the merits of the transaction xviii) If the board had negotiated a fiduciary out clause to protect NCS stockholders, then the transaction may have been solvedThe board disabled itself from exercising its own fiduciary obligations at a time when the boards own judgment is most important xix) Defensive measures may not be draconian, they also cannot limit or circumscribe the directors fiduciary duties j) Hilton Hotels Corp. v. ITT Corp i) Offer by Hilton, ITT rejected, and took action to split of company into various entities AND classified or staggered the board into three classes with each director serving for three years, also required 80% vote to remove directors without cause and 80% to overturn the classified board ii) Inserted a position pill that if Hilton obtained 50% holdings, a $1.4 billion tax would become due, which Hilton would be responsible for 90% iii) Unocal/Blasius Standard: (1) In assessing defensive action by a target corporation board of directors in a takeover context, the Court should evaluate the boards overall response, including the justification for each contested defensive measure, and the results achieved thereby.where all the target boards defensive actions are inextricably related, the principles of Unocal require that such actions be scrutinized collectively as a unitary response to the perceived threat. iv) Where an acquirer launches both a proxy fight and a tender offer, it necessarily invokes both Unocal and Blasius because both tests recognize the inherent conflicts of interest that arise when shareholders are not permitted free exercise of their franchisein certain circumstances, the judiciary must recognize the special import of protecting the shareholders franchise within Unocals requirement that any defensive measure be proportionate and reasonable in relation to the threat posed.

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v)

These cases drawn a distinction between the exercise of two types of corporate power: (1) Power over the assets of the corporation, AND (2) The power relationship between the board management and the shareholders vi) The board has power over the management and assets of a corporation, but that power is not unbridled, the power is limited by the right shareholders to vote for members of the board vii) Unocal requires the two questions: (1) Does ITT have reasonable grounds for believing a danger to corporate policy and effectiveness exists? (2) Is the response reasonable in relation to the threat? viii) If the defensive measure touches on the issues of control, the court must examine whether the board purposefully disenfranchised its shareholders ix) The proportionality requirement, the nature of the threat will set the parameters for the range of permissible defensive tactics under the second prong of the Unocal test. x) The defensive measures, must not be preclusive or coercive (Draconian), it must be within a the range of reasonableness xi) The ITT directors action is preclusive because it will leave ITT shareholders no choice but to accept the Comprehensive plan and a majority of ITTs incumbent board members for another year. Preclusive xii) A classified board is ok, as long as it is adopted in a proper manner, through a charter amendment, changes in the bylaws or through shareholder vote, it is permissible. AND xiii) The board cannot undertake such action for the primary purpose is to disenfranchise the shareholders in light of a proxy contestthus if a classified board could normally be adopted, it may not be done so for the primary purpose is to disenfranchise ITT shareholders xiv) Factors to determine if ITT board actions were taken with the primary purpose of sustaining control (1) Timing (2) Entrenchment (3) Stated purpose xv) Because shareholders only have two options: (1) Sell, OR (2) Replace the Board xvi) Interference with the shareholder franchise is especially seriousany action that disenfranchises the shareholders is impermissible k) CTS Corporation v. Dynamics Corporation i) See CaseDeals with Preemption, Commerce Clause, and Dormant Commerce Clause

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