BUSINESS ASSOCIATIONS

08/24/2010

- Professor relies on volunteers in class discussion (also cold calling); multiple choice final exam; personal
outlines are permitted and not commercial on the exam;

- Policy themes in this semester – this is a policy based class as compared to economic theory approach

1) What role should corporations play (as a normative question)?

2) What role should democracy play in American govt? Usually, corporations are very hierarchical;
but recently, there has been a change although small.

a. Should boards be more representative of society?

b. Alternatively should we give community groups more of a say in corporate management?
3) What is the role of Federalism in American law? As to competition between state and the national
gov’t.

Partnership Formation:

2 statutes govern partnerships in the US; not all states adopted RUPA (36 states including NJ, CA,
Delaware) but still use UPA (like NY); they are very similar (95%); RUPA makes explicit by using case law
what is implicit under UPA;

i) United Partnership acts - UPA §6(1) (1914)

ii) Revised United Partnership act – RUPA §202(a) (1994, 1997)

UPA §6(1): “a partnership is an association [(1) voluntary agreement, not K, to associate ( like by shaking
hands, it does not have to be explicit)] of two or more persons (or partnerships or corporations like business entities) [(2) at
least two persons] to carry on as co-owners [(5) profit sharing and joint control] a business [(3) must be a
business, not just an investment] for profit (it does not have to generate profit since many of them unfortunately fail)” (4)
anticipation of profit. The intent is found objectively not subjectively.

RUPA: “… the association of two or more persons to carry on as co-owners a business for profit forms a
partnership, whether or not the persons intended to form a partnership.”

Three policy terms we’ll encounter in the course: what role corporations should play in society

- Comparing the two the acts

 RUPA modernizes and updates, and states things that were left for case law in the UPA. But no
policy difference
 Revised act explicitly states the relations of the partners to each other regarding loyalty, due care
and good faith
 RUPA makes it clear that the provisions of the partnership are default rules

Fenwick v. Unemployment Compensation Commission (1945)

Facts- Lady in beauty salon in Newark wants a raise. Owner says he can’t afford a raise but if he makes
more money he’ll share his profits. The papers say that both parties will work in the shop, and that they
are in a partnership, to be terminable at either party’s insistence. Lady quits after a while and
Unemployment wants its taxes saying that the parties were not partners but just employees

Rule – partnership req 2 or more people intending to carry on as co-owners in a business for profit

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Analysis – The following items are needed for a partnership to form:

 Intent
o The agreement is evidential but not conclusive, seems that the owner promised to pay
more in comp if business warranted it
 Right to share in profits
o That exists here
 Obligation to share in loss
o Entirely absent in this case
 Ownership and control of partnership property and business
o Owner kept control to himself
 Community of power in administration of business
o Owner made all the decisions
 Language of the agreement
o Ms. Cheshire is called a partner but is excluded from the ordinary rights of a partner
 Conduct towards others
o Parties held themselves out to UI as Partners but not to the rest of the world
 Rights of dissolution
o Mrs. Cheshire had the same rights as if she had quit
Holding – The court reversed the Supreme Court’s finding that a partnership existed
between prosecutor and his receptionist because the element of co-ownership was lacking.
The agreement was one to share profits resulting from a business owned by prosecutor who
contributed all the capital, managed the business and took over all the assets on
dissolution. Ownership was conclusively shown to be in him.
* So the first four of the UPA were satisfied but not the 5 th criteria; there is no loss sharing but that is not
determinative since all five elements of the UPA can be satisfied; joint control is here a problem;
Cheshire did have right to inspect the books which conflicts with the statement to a bit that she did not
have control; general partners are personally liable for the debt of the partnership which is one of the
main reasons for lawsuits in potential partnerships;

Martin v. Peyton (1927)

Facts – P is a creditor and the D had lent money to a “partnership”, but P says as that they were partners
too. D (explicitly refusing the partnership) had lent Mr. Hall money, to invest in his company ( Respondents
agreed to loan Hall $2.5 million in securities for Hall to secure $2 million in loans ) D does so but insists on three
instruments called “the agreement”, “the indenture” and “the option”. D were to take 40% of the profits but
not to exceed 500k.

Rule – Generally Creditors are not to be found Partners

Analysis – Look at each instrument and see whether they as one or in whole point to the D being
partners with Mr. Hall

 Loaned securities are not to be mingled with the other securities of the firm, and that fund is
always to be maintained at 2M
o This is just a loan agreement so far
 D take out 1M life insurance policy on Mr. Hall’s life till the 2M lent is returned
o This is just ordinary caution
 D to be kept in loop of everything can inspect books, and can veto any business decision
o They cannot initiate txn, only veto them, this is proper safeguard for loan
 All members in the firm assign their interest to the D, and no loan is allowed on each’s interest
o Just prudent securing of D interest in the survival of their loan
 The “Option” allows the partnership to buy into the company later at a given price

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  D can also fire people if they make a bad decision
o This last provision is unusual but not enough by itself to deem this a partnership
Holding – No partnership.

Why did the court care – because there is a creditor, and if they are partners then they are personally
liable.
Policy reasons why the court decided the case in this way – will injecting capital make creditors liable, i.e.
make lenders more likely to lend?
* In partnerships, partners are personally liable for any debt of the partnership while in a corporation
shareholders are liable only up to their investments in the company. In the class, we analyzed each
element of UPA §6(1)! Problem: profit sharing and joint control in order to satisfy joint control: there is a
evidence of profit sharing. There is a fair amount of control of the business by the D. However, D cannot
positively affect the business or propose new ideas. This is a much closer case than the previous one.
Intent is not determinative under either UPA or RUPA, just in RUPA it is more explicitly stated! In the
absence of any agreement, profit sharing is equal but however parties may agree on a different
percentage share.

08/25/2010
The Fiduciary Obligation of Partners: Relationship of partners to each other and to the partnership
Fiduciary duty – P.111 RUPA §404 IMPORTANT: new effort to extend fiduciary duty of loyalty; final
dissolution of a partnership does not unfold right away but there is a “grey” period when accounting
etc… is settled; section 404 seems to require notice + sharing so long as the partnership continues: if the
relationship with the person making the lease, like in the Salmon’s case, there seemed that the partner
competed against another partner which was enough to trigger section 404 b) 1). Two partners cannot
by signing a K decides to circumvent section 404 as to duty of loyalty but certain provisions would be
upheld by the court!

Meinhard v. Salmon
Facts – D and P were in a partnership where they leased a part of a building on 42 nd and 5th for 20 years.
P provides the money and D does the work. They had failure and then success. Then the Owner of the
building approaches D to lease the entire block just before the 20 years are up. D agrees and signs
before term is over but does not tell his partner. Partner sues saying he wants to be included
Rule – Partners owe each other the duty of utmost loyalty, esp when the new enterprise is an extension
and enlargement of the old. Greater loyalty is owed by a
Analysis –

 D took the opportunity in secrecy and silence

 He needed to, at least apprise his partner of the opportunity given by their common venture
o Hence D had to allow P to compete with him
 Since D was the primary person in control of the operation he had a duty of disclosure
o DUTY OF LOYALTY FOR SUCH A PERSON IS GREATER
 Here the subject matter was an extension and enlargement of the old lease
 P to be given half the new lease
Holding – Finds for P
Share in losses equally to be shared but was given to D one more share so that he can continue to be the
manager.
Cardozo calls them a joint venture but what applies to a joint venture will also apply to a partnership, i.e.
more fiduciary duties for a partnership than for joint ventures
Rule – u
Cardozo says that D had a duty to tell P that i) the new offer had come ii) allow him to participate since
the property is the same
Why have this high level of honesty and loyal behavior? – to encourage that people don’t’ have to spend
lots of time watching their back, especially since partners are personally liable for the partnership debts.

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General standard of Partners conduct –
* They are not partners (one has a complete control over the property as a real estate agent while the
other was a textile merchant), they are labeled as “joint co-adventurers.” Joint adventurers are different
than partnerships, also look at p.106. If D leased another property or the same 6 months later, the holding
would be for the D!

PARTNERSHIP PROPERTY:
Putnam v. Shoaf, 1981
Facts - Mrs. Putnam (P) owns a business with the Charltons and sells her share in it to D (Ms. And Mr.
Shoaf), because it has a lot of debt. In exchange for transferring the business she has to put in some
money. After transferring the business, P gets a new book keeper and it is discovered that the old
bookkeeper was embezzling. He is fired and 68k recovered. ½ that amount is given to the Charltons and
P wants the other half is disputed.
Rule – Your interest in a partnership is like a co-tenant, and undivided part of a whole and once you
convey it, you keep nothing of it
Analysis –
P conveyed her property rights in the business, which under section 24 of the UPA is

 Rights in the partnership property

o Is a tenancy right and does not exist absent a partnership
o Thus the co-partner owns nothing but the partnership owns everything,
o The partner owns an undivided interest in the whole
o Thus P had to convey all or none of her partnership status
 Interest in the partnership
 Right to manage the partnership
Holding – Holds for pa; Ms. Putnam did not intend to convey her profit/loss to the D.
Courts decision because P Interest in partnership means that you owe the profits stream not the physical
assets.

# The Appellant is not entitled to the money collected by the business. Although the dishonest
bookkeeping occurred while Putnam was still a partner, Putnam signed over her undivided interest in the
partnership to Appellees. A partner does not personally own any specific property of the partnership and
therefore can not retain any rights to the partnership after she conveyed it to Appellees. If she had an
interest in the money, then she had an interest in the partnership

* P.134 UPA §24; partnership does not mean you can take property with you, instead you have the right
of share of the profit while property belongs to the partnership;
UPA: unanimity: a person becomes a partner only by unanimous decision by all partners; a partner can
sell his/her profit share to someone else but not the management rights;

08/26/2010
PARTNER’S AUTHORITY/LIABILITY
Nabisco v. Stroud, 1959
Facts – D (Stroud) and Freeman” enter into a partnership and open a grocery store. D tells P (Nabisco)
not to sell them bread and that he will not be responsible if bread is sold to them, but Freeman orders
some and they get the bread. Partnership went to bankrupt and Stroud (D) did not want to pay to P as a
creditor for the bread.
Rule –

 Every partner is an agent of the partnership for ordinary decisions, unless the acting partner has
no authority to act AND the person being dealt with Knows this
 All partners are jointly and severally liable for the acts and obligations of the partnership
 All partners have equal rights in the management of a partnership, but any difference between
them may be decided by a majority of the partners
Analysis –

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  Stroud could not restrict Freeman to act since this was an ordinary matter and he by himself is
not a majority
Holding -
Any extraordinary decision will require unanimous approval,
Extraordinary decision would be to cut off the decision making power of a person in a law firm.

Stroud’s argument – had told P not to ship anymore bread hence not responsible, though other partner
ordered it
Argument doesn’t work, as each partner is an agent of the partnership
UPA 18(h) says that the majority of partners have decisions that stick but here it’s a deadlock as its 50/50
split. So ordinary decision need majority, extraordinary decision then need a consensus

Partnerships are run in a very egalitarian way, as opposed to a hierarchical structure in a corporation

What is someone in Stroud’s position to do?

 Draft an agreement allocating decision making to one party

 Arbitration clause for differences

Partnerships cannot make a decision that hurts the rights of a 3 rd party

* Straightforward case; p.140: UPA 18 e), 18 h) …but no act in contravention of any agreement between
the partners may be done rightfully without the agreement of all partners; partnership is very egalitarian
and not hierarchical;

PARTNERSHIP PROFIT/LOSS SHARE

Kovacik v. Reed, 1957,
Facts – P, Kovacik, says he’ll put up 10k, to remodel Kitchens, if D does all the work. They will split profits
50/50. After the accounting they notice that the enterprise is at a loss. P then wants D to contribute to the
loss.
Rule – Partners to share equally in profits and losses, irrespective of how much each contributed, but
when one partner contributes skill and the other labor, neither party is liable for the others loss, i.e. each
looses his own capital → this case is an outlier, holding would not hold today!
Analysis –
Holding – Finds for P
Losses were never discussed; explicit agreement about not sharing is not an essential element of a
partnership.

UPA §§19(a) – Rights and duties in a partnership are to be decided between them subject to the following
rule

a) Each partner is to be paid back his contribution, and share in the surplus, profits, equally, after all
liabilities including those to the partners are satisfied, and must contribute to the losses, capital or
otherwise

§ 40 b) Liabilities to be paid in the following order

I. Creditors other than partners

II. Owing to partners other than for capital and profits
III. Owing to partner for capital
IV. Owing to partners for profits

d) Partners will contribute amount needed to satisfy liabilities

UPA 401(b) expressly states that Kovacik is rejected and that each partner is liable to the losses in
proportion of the partners share of profit
The default, i.e. when there is no discussion of profit sharing, the loss to be split 50/50.

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* This was a voluntary agreement between the parties; it is called a “joint venture” but is very close to a
partnership; the parties never discussed potential losses; UPA sections 18a) and 40 on p.172; in the
absence of the agreement, profit is shared equally while losses are shared the same way like percentage
for profit.

TRANSFER OF PARTNERSHIP INTEREST

Transfer of Partnership interest
Only by agreement by the partners, can sell income stream but cannot transfer management rights
without the agreement of your partners.

8-31-2010
CORPORATIONS I
Role and Purpose:

Overview

1. General partnership
2. Business Corporation
a. Close (Closely held)
b. Public (publicly traded)
3. Hybrids (LLCs and LLPs)
People form general partnerships very easily, sometimes even without the partners knowing about it
hence we need to know about and study it.

Corporations – is subject to double taxation hence partnerships are often preferred

Theories of Corporation –

1. Aggregate (shareholder primacy  maximize Profits for Shareholders); corporation as extension

of interest of shareholders
1. Sees the corporation as an aggregation of the shareholders, i.e. the shareholder as the
center of the corporation
2. i.e. maximize profits for the shareholders
2. Artificial Entity (State legislature primacy  Public Welfare); corporation as a creation of state
1. Entity created by the state, i.e. a privilege,
2. The goal is to promote the public welfare as primary objective of state regulation
3. Real Entity or Separate Entity (Board of directors Primacy)
1. Sees the corp. as a separate (from shareholders) entity to itself, i.e. the Board of directors
gives it its direction i.e whether they want to favor the community or others stakeholders

* Professor said that in real life board of directors of a corporation tries to balance the interest not only of
the shareholders but also customers, community etc… ( although, as a student said, we can make an argument that
these also further the profit).

Internal Affairs Rule – law of the state of incorporation governs the conduct of the corporation
Exceptions

1. Bond posting statute

2. Shareholder inspection Statue

“Race to the Bottom” – William Carey v. Genius of American Federalism (Roberta Romano)
Stakeholders/other constituents influenced by a corporation:

1. Customers or consumers, environment

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 2. Community
3. Employees
4. Governments, local communities
5. Suppliers, independent contractors, creditors (among others, bondholders)

Dodge v. Ford Motor Co. – Aggregate, 1919

Facts – Ford Company is formed and the P, Dodge, invest. Company takes off and makes tons of
money. P starts own business. Lots of special dividends are also released since the company is so
profitable. But a large amount of Profits are kept, for the purposes of i) investing in a new smelting plant ii)
humanitarian work such as reducing the price of cars and improving workers conditions. P sues to get
more of the profits released and not invested saying that the board of directors withholding the special
large dividends was arbitrary since and that profits could not be used as capital.
Rule – Company is required to be run for the profit of the shareholders. Directors have powers to declare
dividend and courts will not interfere baring fraud, misappropriation of funds or not declaring dividends
during items of surplus profits, when such refusal is an abuse of discretion, to constitute fraud or a breach
of good faith.
Analysis – When a company has Assets greater than 132 mil, surplus of 112 mil liquid assets of 54 mil
and had released special dividends for every year and liabilities < 20 mil, refusing to pay dividends seems
arbitrary. The plan to reduce price of cars seems like it might make the company slightly less profitable,
i.e. will diminish the value of shareholders. Ford is definitely altruistic and incidental humanitarian
expenditure of profits is allowed, but the business is to be allowed for the profit of the stockholders, and
that is what the directors must work towards. So the dividends must be released but the investment in the
plant we will not interfere in because of i) the increased capacity ii) expected competition ii) prices may be
increased in the future.
Holding – release the dividends but plant can go forward
Shows the Aggregate theory
Each state has a maximum dividend payable to SH. This is essentially a protection for creditors
* Dodge 1: 10%, Dodge 2: 10%, Henry Ford: 58%, other shs: 22%. Dodge people established also a new
car company. Dispute: how profit should be allocated; Dodge needed money to fund his new company.
Henry Ford, as a majority shs, do owe a duty to other shs while other minority do not and they do not
have fiduciary duty; a majority shs does not have an absolute majority of stocks.

Ligget v. Lee – Brandeis famous dissent, 1933

Chain Store taxes –
Rule - Artificial Entity theory. Corporation can live in Perpetuity, various limitations on the ability to own
stock in other corporation. These holding companies could be limited. Everything changes in the 1900
and states become a lot more lax, because of NJ laws change. He says that the regulating corporation is
part of the police powers of the state.
* The privilege of engaging in such commerce in corporate form is one which the State may confer or may
withhold it as it sees fit. “Race from the bottom”. In 1880’s, 90’s, NJ, among others, was a villain… by
relaxing its laws for corporations; so corporations were just on paper in NJ so were subjects under NJ law
but kept their operations in other states; not where they located but where they are incorporated
(chartered). Woodrow Wilson was to be blamed NJ is not anymore ... because when he was a governor
of NJ he was anti-trust person; in 1913, he made legislation to repeal those permissive law for
corporations so Delaware became one;

1-9-2010
BJR – Business judgment rule – “a presumption that in making a business decision the directors of a
corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in
the best interest of the company” – fiduciary duty

Federalism – will concern ourselves with two kinds of federalism

1) Federalism as competition between states
2) Federalism as interaction between federal regulators and state/local regulators

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A.P. Smith Mfg. Co. v. Barlow, 1953
Facts – Company wants to make philanthropic gifts to Princeton University and other schools but a
shareholder objects. So company asks for a declaratory judgment, saying that such gifts help company by
i) getting it goodwill of locals ii) favorable business operation conditions iii) encourages free flow of well
trained peeps for it to employ.
Rule – Corporations have taken the place of individuals in giving gifts for the pubic good and alteration of
the rights of existing stockholders is allowed when such alteration is in the public policy and the directors
acting in good faith. Statute limitations might exist, such as In NJ can’t be >1% ok with notice. Must be an
reasonable amount, often use 10% of taxable income (p.269 IRC 170b)2)).
Analysis – Does a historic analysis of how Corporations have supplanted Individual donors, plus cold war
is going on and such donations are what we need.
Holding – allows for transfer

 There is a parallel between the courts public policy interest for corporation and Brandeis’s dissent
in Ligget i.e. that as corporations are getting bigger they are to replace the philanthropic giving of
the old school barons!
 Now we rely on the BJR (Business Judgment rule)
 Limitations enunciated by the courts
o No Indiscriminate amounts
o No Pet projects or seeming impropriety
Disclosure and ratification, i.e. disclosure to the board and then not voting yourself, will remove the
problems i.e. allow yo to go to a pet project. Anonymous donations allowed if its an immaterial amount.

Statutes about giving

DGCL 122- Every corporation can make donations for public welfare, or for scientific or patriotic donations
Ca – regardless of specific corporate benefit (very generous)
NY – “irrespective of specific corporate benefit for the public good…” (broadest)
PA – Balance stakeholders and SH in doing its action

Analysis p 268

1) Allows for D to contribute 1,500 to be added onto contributions made by others to P-ton university
2) The holding diminishes shareholder value and increases the likelihood of allowing corporations to
contribute more towards “social programs”
Problem Pg 269 – Problem is that it’s a close friend especially in light of the AP smith limitation of “pet
project”. But disclosure to the board and then not voting will remove the problems (called “disclose and
ratification”)

* Corporations can make and are allowed to give donations by the common law and NJ statute; D:
Princeton as a private institution (non-G) as an important fact at that time because of the communist
threat. Corporations do not need to show specific benefit from giving a donation; corporation should have
a reasonable belief that it may benefit, corporation should show some probable and not a specific belief
there would be some benefit for the corporation; Conflict of interest: mere social relation does not rise to
that level but financial conflict of interest does…

Stockholder derivative suit - A lawsuit filed by one or more of a company's stockholders in the name of
the company. A derivative suit is filed when the firm's management will not or cannot sue in the name of
the company. For example, a stockholder may enter a derivative suit against the firm's chief executive
officer to recover funds from a questionable or an improper act by that officer. Also called derivative suit.

CA – allows a very broad grant of authority

NY – Broadest
Other constituency statures – Corp can act based upon consideration of what the effect of the action is on
other stakeholders such as shareholders, employees, suppliers, customers and creditors and
communities etc. These seem to override Dodge v Ford.

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Shlensky v. Wrigley
Facts – P, a minority stockholder on the cubs alleges that he Cubs not putting on night lights and playing
more night games is causing their operating losses and hence wants damages and an order requiring D
to add night lights at Wrigley (D, majority owner of 80%). 80% owner thinks baseball is a daytime sport and
lights will deteriorate the neighborhood
Rule – Directors are presumed to have acted in good faith and baring a showing of Directors actions
tainted by fraud, illegality or conflict of interest, P in a derivative suit will not prevail (we’ve come away
from Dodge)
Analysis –

 When the directors act they have the authority to act absolutely as long as then acted within the
law and court cannot substitute its judgment for theirs
 When the directors act they are presumed to have acted in good faith baring their judgment being
tainted by fraud
 Considering the affect of light on neighbors can be considered by directors since:
o Considering patron who might not want to come into a poor neighborhood
o Property value of the field might go down if the same for the surrounding areas goes
down
o Motives in complaint has no allegations of fraud, illegality or conflict of interest
 Furthermore the P complaint does not show that the team would have been profitable even if
nights were installed
 P negligence claim also fails since there is no requirement that the directors follow the herd and
install night lights
Holding – finds for D
One reason this case turns out diff form Dodge is the BJR, i.e. the court is overruling Dodge saying that
BJR controls here not the maximization of profits as in dodge (absent fraud etc)
* Directors now have broad discretion to balance all sorts of interest and not like in Dodge’s case and
profit maximization. This is a strong case for the BJR.

Analysis p 279

1) His share price is diminished by anticipated future losses and he also has a negligence claim
which he would not be able to collect on
2) Yes. I think the causal element is what was found missing i.e. the link between the lack of
installing the night lights and its incidental loss
3) I would try to show that
a. He never considered the cost of installing light
b. That his private beliefs and that is what led him to his decision, made the directors make
their decision hence there was a conflict of interest for the directors

§2.01 of the principles of corporate governance

a) Corporate activities should be directed enhancing profit and shareholder gain

b) But the Corporation may ignore a) above to
a. Act in accordance with the law
b. Make ethical considerations for responsible corporate behavior
c. Devote reasonable resources to the public good

Problems pg. 280

1) Very slim since there is no showing of fraud, conflict of interest or illegality.

2) Maybe. Yes she should the causal links between bills making healthier salami and lowering heart
disease is sufficiently attenuated, and if she can show that she should win per Wrigley. The
remedy should be to hold up the status quo. If big profits allowed then she has no cause of
action.

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 09-02-2010
P.189-200
How to form a corporation

 Fill out forms for incorporation – from Sec’y of State

 Adopt bylaws
 Elect a board of directors who will issue stock
 Have to tell the incorporated state who your agent is
 Have to have Inc. in your name
 Have to conform to corporate formalities in order to get the benefits of corporation

Delaware still preferred as a state to incorporate as:

 Delaware courts have developed a very well body of case law that gives a lot of predictability to
potential cases.
 Chancery courts are very sophisticated with very talented judges

Limited Liability and Piercing the Veils

* INC. means incorporated; P.194: there are three separate legal doctrines that the P might invoke in
case like Walkovszky: enterprise liability, respondeat superior (which we’ll not discuss), and disregard of
the corporate entity (“piercing the corporate veil”)! Look for the hypothetical down – Mogul’s case!

Walkovszky v. Carlton, 1966, if not clear, look at: http://en.wikipedia.org/wiki/Walkovszky_v._Carlton

Facts – D’s cab injured P. D is the shareholder in a corporation with 2 cabs under it each with the min
required Liability insurance. D owns many such companies. P alleges that all the corporations are the
same and the he should be able to pierce the veil to reach the personal assets of D.
Rule – Can “pierce the veil” if i) corporation is a subpart of another business (Enterprise theory) and ii)
corporation is a dummy for the stockholders (PCV). Former will result in the larger corporation being liable
but not the SH latter in the individual being liable.
Analysis –

 Cannot hold D personally liable, as there is no allegation that he ran the corporation in an
individual capacity. To hold D personally liable here because he owned several corporations
would also allow holding the individual owner corporations personally liable.
 If there needs to be changes to compensate the P (since each corporation seems to be
undercapitalized) it should come from the legislature changing its min liability insurance laws
(which happened later on)
 No showing that the D was shuttling money in and out each individual corp paying no mind to
formalities of each corp. Nor that the corp that hurt P was a part of a larger corporate body for the
Agency rule
 P is relying on a showing of fraud, but if its not fraudulent for an individual to take out the min
required insurance its not so for each corporation

Dissent – Legislature did not intend the Corp rule to allow people to escape liability is such case. the
rule should be that if a corporation is undercapitalized given the risk of ordinarily carrying out the
business, he may be held personally responsible for any resulting liabilities baring extraordinary
circumstances
Holding – No piercing will be allowed
Piercing the veil is done for:

1. Prevent fraud
2. Equity damages

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Undercapitalization is not sufficient to pierce the veil is the point of this case

Piercing is very hard to do and rare and is easier understood through exceptions to the veil piercing
* Inadequate capitalization and insurance do not break “piercing the corporate veil” but rather lack of
observance of formality (look below!);
ADVICE (important!) for corporation: do not mingle personal and corporate funds, issue stock certificates
(as formality even if the company is small), adopt and comply with the state law and also the bylaws, do
appoint the board of directors, hold regular board and shareholder meetings (at least once a year even for
a small corporation), keep minutes of those meetings, keep financial and corporate records and keep it
from any personal records, comply with statutory capital requirements and insurance requirement even if
it is minimal, …, take funds on the regular basis for salaries etc…, be careful not to withdraw haphazardly
funds or for personal needs (like for the house),
Not a single one would be determinative…

Policy of Limited Liability Company (LLC)–

1) Benefit - In a LLC no problem of looking up your shoulder, i.e. be a passive investor, reduces
monetary oversight cost hence is more efficient
2) Downside – LLC encourages and harmful and unethical behavior, i.e. why reward ppl of draining
profits
a. Undercapitalization issues

Class hypo where numerous ACE Company spilled oil onto the farm
Sue:
Joe Mogul – shareholder, officer, and d; piercing the Corp veil
Tom Mogul - shareholder, officer, and d
Cynthia Mogul – only shareholder

PCV look for:

 Bank account statements of Ace

 Personal Account of Moguls
 Public Statement regarding Corp structure
 Corporate formalities
o Meetings of shareholders
o Bylaws
o Meetings of Directors – minutes
o Certificate of Incorporations
o Stock certificates
 Examine books to see if Joe Mogul is paying out the debts of the corp.

Fraud is not necessarily an element of PCV, undercapitalization standing alone is not sufficient to PCV,
the most common element of PCV is not observing corporate formalities
Tell your clients to protect their personal assets

1. Do not comingle personal and corporate funds

2. Do issue stock certificates (even if you’re the sole SH)
3. Do adopt and comply with the certificate of incorporations and bylaws
4. Appoint a board of directors
5. Hold regular board and SH meetings (once a year if its 1 SH, but don’t’ let 3 years go by without
any meting)
6. Keep minutes of the meetings
7. Keep corp financial records separate from personal records
8. Comply with statutory and insurance requirement
9. Take funds out of the corporation in the form of salary or dividends paid in a regular basis being
careful not to take funds out haphazardly or as needed for personal matters

11
* Discovery: PVC: breaking down horizontal barriers between companies as to show there is no
distinction between the main Mogul and his companies…: bank records and financial statements and
transaction records for each of the separate Aces and Moguls, minutes of the board of directors meetings,
certificate of incorporation, evidence of stock certificate (where are they issued?), tax records of ace, you
want to make sure there are bylaws which are supposed to be followed, profit + loss statement, payments
(as to whether they violate dividend payments laws).

Enterprise liability – 9 Aces (limited liabilities companies)

 Bank records and financial statements and transaction records for each of the separate Aces and
Moguls
 Physical location, phone lines,
 Maintaining the corporate formalities of each entity
 Common Employees?
 Communications between Corporations
 Common managers
* Difference between PVC and Enterprise liabilities:

Analysis p 194

1. See:
a. Enterprise liability – All the corporation are in fact 1 enterprise and all of them should be
liable
b. Agency – The corp that hurt p is an agent of a larger copr and the larger should eb held
liable
c. Piercing the veil, the corp has been set up as a dummy, and thus we need to pierce the
viel as its inequitable otherwise
2.

Sea-land Service inc. v. Pepper Source

Facts – P sells D pepper. When they want to collect the monies owed for it find that the D corp has
dissolved. They bring suit against the Sole owner of D corp and several of other companies he Owns
Rule – Piercing the veil requires a showing that:

1) Exists a unity of interest & ownership showing that there is no difference between the various
entities. Shown by:
1. Failure to maintain corporate records or maintain corp formalities
2. Comingling of assets or funds
3. Undercapitalization
4. One corp using the funds of another
2) Adhering to the fiction of the different corp would sanction a fraud. Fraud requires a showing of
injustice such as:
1. Showing more than a creditors inability to collect
2. Some common sense rule such as of adverse possession undermined
3. Former partners allowed to skirt legal rules
4. Unjust enrichment
5. Parent corp that caused sub liabilities is made able to escape those liabilities
6. Moving assets to a “safe liability free” corp and moving all liabilities into a “bad” corp
Analysis – P is able to show the unity of ownership and interest since the D maintained 1 office for all the
copr, used the funds interchangeable and for himself However the 2 nd portion is harder to show since just
the fact that a P might not get its money is not enough. However there need not be a showing that the D
intended to defraud P.
Holding – reversed and remanded

Upon remand the courts showed the Injustice when it found:

12
 1) Marchese, the owner, engaged in tax fraud and used the business accounts as his personal
accounts
2) Marchese assured that P would get the money form an account and then took money out of the
account to ensure that no monies would be paid.
* Although the previous case Walckovsky is a primary case to focus also look at black letter text on p.196
and four factors look at. States require pretty strong showing of corporate formalities. Difference how to
show PVC and enterprise liability
* Last class we only mentioned briefly limited liability term: enterprise liability and corporate… liability
as two exceptions. Bylaws: foundational document for a privately held corporation; after that, officers
are appointed (not fixed number) like CFO etc… and finally stocks are sold to initial stockholders or
shareholders makes no difference.
We’ll talk mostly about common stock unless different is pointed. Common stock: first attribute is
economic in nature – sh are entitled to receive residual in case of liquidation (after everyone else is paid)
or the corporation is sold; if board of directors allows, dividends are paid to sh. Second attribute is
voting rights as to vote a director of the corporation (one base per share) which is not the same as
partnership where voting right is per person also in case of extraordinary change like certificate of
incorporation change etc…
- Delaware, among other things, has equity court or court of chancery which primarily deals with the
corporate law issues so it does not deal only with equity issues! This is a trial court level and is
comprised of very knowledgeable judges;

9-8-2010
DERIVATIVE ACTIONS:
* Conflict between accountability and management actions;
Individual versus Corporate Actions: p.214-223
Shareholder Derivative Actions
A. Introduction
Shareholder Derivative Suit – LOOK: http://en.wikipedia.org/wiki/Derivative_suit

 Derived form a cause of action that the Corporation only has, its an equitable remedy.
 Shareholder can recover whatever harm the corporation suffered.
 D will be the Alleged corporation and Corporation.
 Any monetary benefit goes to the corp.
 Demonstrates a tension (prevalent in all of business law) between the authority of directors to run
the corp. and the accountability of the Directors to the SH

Cohen v. Beneficial Industrial Loan Corp, 1949

Facts – P wants to sue D, loan corp., alleging mismanagement and fraud over 18 years. P owns less
than 100 shares which is 0.0125% or at least $50k in market value. There is a NJ stature requiring any
small shareholder (less than 5% owner) to put up a deposit to pay for reasonable legal fees for the D.
Rule – States can add in reasonable standards of accountability, liability and responsibility in a
shareholder derivative suit
Analysis –
Constitutionality of the NJ statute

 Back in the day there was barely any protection for shareholders who lost tons of money as the
directors were not held very accountable
o P were held to have no standing at law such cases, hence could not sue
 Equity came to the rescue, allowing the P shareholder to step into the corporations shows and to
demand that the corp stand up for its rights and when the directors blocked this redress, then the
P was allowed to nominally sue the corp.

13
  However this method was abused as suits were brought not to right wrongs but for its nuisance
value and were quickly settled
o Prevent nuisance suits and meritless suits
o Thus the individual shareholders were hurt by both the directors malfeasance and the P
scurrying away with $
 A stockholder who brings a suit derived from the corporation assumes a position of a fiduciary for
the other shareholders, i.e. as a representative of the class of shareholders
o While the SH have picked the directors they have not chosen the class representative
o The Constitution does not require that the state place its litigation and adjudicative
process at the disposal of such a person and the state can add standards to protect the
interest that the P himself claims to protect
 Due process argument –
o No unreasonable use of state power by requiring a fiduciary’s litigation besides the
liability and security are reasonable
 EQ Protection argument -
o Allowing exceptions for 5% or $50,000 in stocks is ok as it can stand in as a measure of a
good faith P

Applicability in fed court

 P argues that the statute is inapplicable in fed court as the NJ statue is one of procedure and not
substantive
o Not true as:
 Without the statute the case would take the same course
 The statute creates a new liability
Holding – The NJ stature applies in fed court
* Board of directors are Ds. Classic claim of breach of fiduciary duty (committed waste, $200m in 1949,
major claim); NJ statute: 5% or $50k or more; The corporation incorporated in Delaware and the law
applied here is Internal Affairs Rule (look below); Delaware has no bond posting statute; bond posting
requirement: substantive rule imposing liability on litigants rather than substantive law of corporate question and so NJ bond
statute applies (kind of Erie doctrine) – do not worry about this since it is a saddle point ; P: equal protection violation that
NJ bond statute imposed – the Court said (rational decision)

Internal affairs rule – says that you use the law of the state of incorporation should governs but there is
an exception for bond posting statutes as was NJ statute in the case above

How to distinguish between a direct and a derivative suit:

Benefits of direct suit -

 P gets the damages

 Direct suits avoid the bond posting statutes
 Demand requirement not needed in a direct suit

Analysis p 218 –

1) Because the SH was not allowed to sue the directors in law as he had no standing. Thus he sued
to get the corporation to enforce its own rights against the directors and when the directors
blocked he was given standing against the directors
2) Moral hazard in that a minority Shareholder can enrich himself at the expense of the majority
shareholders by filing frivolous suits designed only to get settlements

Eisenberg v. Flying Tiger Line Inc. – NY, 1971

Facts – D has a plan to dissolve original company transfer of all the shares of the original company to a
holding company, and create a new company with all the operations. The holding company will “own” the

14
operations company. The plan passes shareholders meeting but the P sues. The case is governed by NY
law §627. D –this is a derivative action and P must put up a security and that SH were only harmed
because the og company was dissolved and thus their injury is derived form the Og company being shut
down. P - says that his action is representative and not derivative as he was deprived of his rights to vote
which belongs to the shareholders per se
Rule – Removing of a contractual right owned by the shareholder (such as voting on operation of the
company) results in a representative (direct) action not a derivative action
Analysis –

 Gordon test – Derivative action when the rights belong to the shareholders or when suits
purpose is to compel directors to perform their duty is too broad because:
o Later NY cases have limited it to its facts such as in Lazar where the SH managed to get
the Co to call a SH meeting
o Legislature was concerned with the Gordon holding and changed the statue
 Here the reorg took away from the P any voice that he had in the previously operating company
 Prior similar case where the P was not required to put down a deposit even though such a law
existed
Holding – Plaintiff does not have to post security because the suit is not a derivative cause of action.
Plaintiff’s suit is to prohibit the loss of voting rights in Defendant corporation. His cause of action is not on
behalf of the corporation or on behalf of all shareholders.
Rule of law: when the injury suffered was personal, rather than an injury of the corporation, the suit
should not be considered derivative for the purposes of requiring a posting of security for opposing legal
expenses.

Analysis Pg 221

1) Eisenberg could only control and be allowed to vote on the operation of the holding company, but
the operation company was one step removed from any control of the shareholders
2) A suit alleging breach of loyalty to the corporation would be a derivative suit as it’s a breach of
duty of loyalty towards the corporation
3) This is the current test (Tooley test) to see whether a suit is Derivative or Direct- 2 part test:
a. Who suffered the harm, corp. or the SH individually
b. Who receives the benefit of any recovery, corp. or the SH individually

If it’s an injunctive relief that is being sought then the action is direct generally as it’d show on the second
prong of the test

DGCL 145(b) - In judgment D pays damages unless court determines that the D is entitled to Indemnity
* It is important to know difference between a derivative and direct suit; Flying Tiger established a
subsidiary company named FTC and then FTC formed another subsidiary called FTL; then, the orginial
Flying Tiger merged with the FTL and then… to FTC to become a holding company so the Flying Tiger
does not exist anymore or actually FTL becomes…; the Court sides with Eisenberg because the suit was
not derivative, his suit is about deprivation of voting rights which is individual to a shareholder; #2) on
p.221 (look above); relatively recent Delaware standard: Tooley Test (look above) – two prong test –
KNOW THIS!! With the Tooley test, the result for the case would be the same;
There are rules in every state – demand before the board of directors before suit can be constituted;
huge complications in looking for derivative suit; that is for tomorrow’s class.

9-9-2010
P.223-238
B. The Requirement of Demand on the Directors

Demand requirement is a very imp procedural requirement necessary before bringing a derivative action
Comes from Statute not CL. Demand is excused if (look at the chart below!):

15
Test for Demand Futility – Both Need to allege with particularity (no conclusory allegations are allowed)

Delaware (from Grimes, p.228) – majority of cases) NY (from Marx case p.235)

1) A majority of the board has a material financial 1) A majority of the Board is interested in the
or familial interest in the challenged txn ( as to challenged txn (transaction); OR
economic benefit); OR

2) A majority of the board is incapable of acting 2) Directors did not fully inform themselves about
independently for some other reasons such as the challenged txn to the extent reasonably
domination or control; OR appropriate under the circumstances; OR

3) The underlying txn is not the product of a valid 3) The challenged txn was so egregious on its face
exercise of business judgment that it could not have been the product of sound
business judgment of the directors

* You need to show only one of these elements for demand… hard for shs to make excusal; independent
directors: do not work for the company per se but are present at the corporate meetings while insider
directors are those that are employed by the corporation. Claims with particularity which is very strict
requirement; without access to discovery shs are able to show the Test elements through Lexis Nexis and
other sources like footnote 11 on p.228 like SEC, books and records of the business (corporate books
and records) as statutory right Delaware Rule 220; public companies have to file avalanche of information
to the SEC.
NY and DE are similar and the Professor did not see different outcomes applying both statutes although
they are not the same. In any case, DE Test is a touchstone for Demand Excusal so we may focus on
that one.
A well advised sh never make a demand on the Board of Directors but rather goes directly to the Court!!
ADR is overstated and it very rarely happens in reality. DE does not need security statute because it has
a very much protective demand requirement! Demand requirement blocks most of sh litigation but usually
1) or 2) under DE statute sh use.
Demand excusal v. demand

Delaware law: Grimes

Particularity

 No conclusory allegation
 Use Tools at hand (Grimes case)
o News story
o Corporate filings with SEC
o Statutory rights to inspect corporate records
Familial Interest

 Personal financial benefit OR

 Family interest

Board incapable of acting independently such as domination

 Ford case, i.e. a very dominant CEO

 Individuals are employed by the company
 Blackmailing the board
 Simply ratifying a txn by the board does not mean that they are no longer independent to look at
the issue anew
 Naming the Directors as defendants is not sufficient to show a lack of independence

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NY and DE is effectively the same standard
1&2 on the DE side merges into number 1 on the NY side
3 on Del is the same as 2&3 in the NY side

Delaware -Test for wrongful refusal – almost will never win

1) A majority of the board has a material financial or familial interest in the challenged txn from
deciding demand; OR
2) Board deciding demand is incapable of acting independently for some other reasons such as
domination or control; OR
3) Rejection of Demand is not the product of a valid exercise of business judgment

Part of where demand comes from is D.G.C.L §141(a)

“the business and affairs of every corporation… shall be managed by or under the direction of a board of
directors

Grimes v. Donald – Delaware, 1996

Facts – P sues corporation because they gave a golden parachute to a CEO plus said that a huge
severance would kick in case of termination with or without cause including “unreasonable interference”
with the Executive doing his job. P sues both to vindicate his rights and derivative rights saying that the
executive is being paid too much and that the board has illegally delegated its function to the executive.
HE made such a demand to the board who answered that they studied the situation with compensation
consultants and a law firm and they are ok with the executives contracts.
Rule –
Analysis –
Difference between Direct and Derivative claims – is the nature of the wrong and the relief requested.
The Due care, waste and excessive compensation claims are derivative and the abdication of duty is a
direct claim

Abdications claim –
o Directors cannot delegate duties at the heart of management of a corp
o The exec pay does not stop the Board from exercising its authority in the future, this was
just a business decision
o BJR applies when a board acts in good faith, unless the facts show that the $ paid for
services received is wasteful or could not be a Business judgment
Demand requirement

 In a derivative suit the SH/P must say that either that the
o Board rejected his pre-suit demand that the board assert the corp claims OR
o Show with particularity why the SH/P did not demand board justification (excuse). This
can be gotten form
 Reasonable doubt that he board can make an independent decision based on
 Majority of board impaired by familial or monetary ties
 Majority of board is unable to act because of domination or control
 The txn being sued for cannot be justified under the BJR
 If SH cannot met the exceptions above he must, after using the “tools at hand” make a demand
on the board
 The purpose of the Demand rule is:
o Exhaustion of intra-corporate remedies (ADR in a way)
o If litigation is needed the corp can control the proceedings (How?)
o If demand wrongfully refused or excused then the SH can control the proceedings
 Policy reasons for Demand rule
o Deter costly baseless suits

17
 oAllow a suit where the Stockholder can articulate particularized fact showing reasonable
doubt that either
 Majority of the board is independent
 Txn is protected by the BJR
Wrongful refusal distinguished from Excuse

 Party making a demand is entitled to know promptly what action the board has taken
 SH refused can use the tools at hand to get the relevant corp records to see whether there is a
basis to assert that the demand was wrongfully refused
 SH is not waiving his right to say that he was wrongfully refused by making a claim
 If demand is made and rejected the board get the presumption of the BJR unless the SH can
create a reasonable doubt with particularity that the board should get the presumption
Application to this case

 A shareholder who makes a demand cannot say that his demand was excused for other legal
theories
 Board gets presumption of BJR
 No particularized allegations to raise a reasonable doubt that the boards decision was not a
product of valid Business judgment
Holding – Holds for Board

Analysis p 231

1) Board can either respond to the demand rejecting it or take up the suit
2) Show with particularity why the SH/P did not demand board justification (excuse). This can be
gotten form
 Reasonable doubt that he board can make an independent decision based on
 Majority of board impaired by familial or monetary ties
 Majority of board is unable to act because of domination or control
 The txn being sued for cannot be justified under the BJR
3) Its still a waste of the boards time and and possible loss to the corporation’s reputation as well.
4) Probably. Depends how deeply involved I was with that decision. You get an outside counsel to
do some investigations
5) Maybe if the failure to show recovery in the embezzlement cannot be justified by the BJR. Yes it
should> we should always give a chance for the Board to give an answer before going to the
courts, kind of a “exhausting administrative avenues” first. Demand should and is required in this
case.

Marx v. Akers - NY
Facts – P brings a derivative suit against IBM saying that the board made waste by awarding excessive
compensation to executives and external directors.
Rule – a
Analysis –
Purpose of the demand requirement

1) Have corporations handle internal matters not courts

2) Protect Board from harassment on issues clearly in the boards discretion
3) Discourage suits by SH for personal gain
 Historically courts have been reluctant to substitute its judgment for the boards
 The methods to balance discretion for Boards and allowing claims by SH is diff by jurisdiction
o Delaware approach
 The two sides of the Delaware approach are disjunctive as once the directors
interest has been established the BJR becomes inapplicable, i.e. BJR is all you
need?
o Universal demand

18
  Always need demand before a derivative suit
 Unless corp would suffers irreparable harm in the 90 days the corp is given to
respond to the demand
o NY approach
 A demand is futile when complaint with particularity says:
 That most SH are interested in the challenged txn. Interest can be self
interest or loss of independence as a director is “controlled”
 Board did not inform itself about the challenged txn reasonable in the
circumstance
 Challenged txn is so egregious that on its face the board did not exercise
sound judgment
 Current case application of NY law
o The matter of the board scratching each other back is not excused since there is no
particularized showing that the majority of the board was benefitted from the executive
pay raises (only 3 got raises)
o The claim of board setting its own compensation as high is upheld as the pay raises for a
majority of directors as financial gain is “interest”
o However the setting of the compensation for the directors is not on its face excessive and
does not fail on its face, hence the suit is dismissed
Holding – Demand Excused for outside directors, not the inside directors

Problems pg 237-238

1) Derivative law suit since P is acting to protect the corp i.e. the injury was to the corp not to the
individual
2) Yes in both NY and De its excused as 3 out of 5 directors are engaged in self dealing
3) Required under DE unless Adams dominated the other board members
4) Where there is no action by boards, such as no voting, then there is likely NO demand
requirement. There is no really conflict of interest but it is hard to decide because the Board does
not do anything here. Demand is probably excused if consciously refused to vote; usually, courts
are deferential to Board of Directors in close cases! We do not really need this for our course.

9-14-2010
P.238-263 SPECIAL LITIGATION COMMITTEES (SLC)
* DGCL section 141 (a), see p. 244 fn 6 (statutory fount of BJR), 144 (c): “Any such committee, to the
extent provided in the resolution of the board of directors … shall have and may exercise all the powers
and authority of the board of directors in the management of the business and affairs of the
corporation.”
Demand Futility Test under Delaware Law – see Grimes p.228
#

A board of directors, when challenged by a shareholder derivative litigation, may appoint an

independent special litigation committee to consider whether the corporation's best interest is to
pursue or terminate the derivative litigation against the directors. The SLC is a last chance for a
corporation to control a derivative claim when a majority of its directors cannot impartially consider the
demand. The board vests its power to determine what to do with the suit to a committee of

19
independent directors. Generally, if the SLC recommends terminating the derivative suit, the court will
defer to the recommendation if the committee shows its members were independent, acted in good
faith, and had a reasonable basis for their conclusions.
Auerbach v. Bennett – NY, 1979
Facts – Ds (Bennett on behalf of General Telephone & Electronics Corporation (GTEC)) corp using
outside counsel finds out that members of its management had bribed foreign leaders and taken
kickbacks. P (Auerbach) institutes a derivative action on this finding. The board then creates a special
litigation committee to form the board’s decision for any derivative suit litigation. The committee was
formed of three disinterested directors who joined the board after the shenanigans were done. Committee
recommends that no action be taken and that the company’s auditors had acted a-ok! Company also said
that no D or anyone had really done anything wrong and to not allow any derivative suits to proceed.
Rule – a
Analysis – Basically follow the BJR, which means that the courts are ill equipped to comment on
Business judgments

 BJR Does not mean the court will not look

o But the court will only look if the committee is independent and don’t have any
relationships which prejudices their decisions
 Nothing in the record showing the above for the three directors
 P says that actions of a committee nominated by a tainted board are tainted and hence cannot be
used to foreclose derivative suits
o Bubkiss since only the board can make decisions for a corp and this board followed
proper screening procedures
 BJR applies when some directors are accused of wrongdoing but as long as the others are
“disinterested and independent”
 The action against the Special Committee has two components
o Were the procedures chose appropriate
 Court can look at this as its about procedures and we know procedure Mo fo, but
still have to stay away from any business judgments
 All a corporate dude has to show is that there was good faith inquiry into all areas
and subjects
 Proof that a restricted, shallow or halfhearted effort would show bad faith, but P
has provided no such proof
 Good faith as:
 Committee engaged as special counsel
 Committee reviewed prior work of the audit committee
 Reviewed transcript of corporate officers being deposed by the SEC
 Interviews with directors
o The decision, based on the chosen procedures and data, not to pursue the derivative suit
claims
 Not to be touched as this is totally what the BJR is all about
Holding – The findings of the special litigation committee forecloses further judicial inquiry

Management reports to Board who pass onto Audit committee. Then P files suit. Then a Special litigation
committee is filed, and the members are disinterested members of the Bd. Committee say to not
recommend litigation for: Cost, PR, too much time taken from Management.
This Court decides about the dismissal of suits: uses a standard of:

 Look at the adequacy of the investigation

 Procedures the committee followed
 Was the committee independent
 Good faith of the committee
 However, will not look at the business judgment of the Bd – NY courts are the most deferential to
the BJR

20
Its the burden of the Corporation to prove the independence of the SLC

First question is demand excused? No because the test below is not fully met with particularized
accusation. Then again today, paying bribes would be a violation of federal law and hence not a product
of BJR, so actually demand would be excused
# Defendants appointed a three-person special committee comprised of members who were not on the
board at the time of the wrongdoing. The committee reviewed the auditor findings and decided that in the
best interests of the company that they should not pursue an action against the Board members.
Wallenstein continued the suit after Auerbach declined, arguing that any committee appointed by the
corrupted directors should be considered interested parties. The court was not convinced that the special
committee was not independent simply because the interested directors appointed them.
* 4 people listed as Ds; there are 15 members of the board of directors; so under prong 1 there is no
basis that the majority of the board does not have a material or financial, familial interest (look at p.228
and Demand Futility Test); also prong 2 is all right; prong 3 is very hard to prove. The SLC was appointed
because at that time there was no clear rule about… Today, the SCL is appointed when directors believe
there is some conflict of interest! Audit committee here: from Wikipedia: “ in a U.S. publicly-traded company, an
audit committee is an operating committee of the Board of Directors charged with oversight of financial reporting and disclosure.
Committee members are drawn from members of the company's board of directors, with a Chairperson selected from among the
committee members. A qualifying audit committee is required for a U.S. publicly-traded company to be listed on a stock exchange.
To qualify, the committee must be composed of independent outside directors with at least one qualifying as a financial expert. Audit
committees are typically empowered to acquire the consulting resources and expertise deemed necessary to perform their
responsibilities.”
Ideally, a member of the SLC is someone from the board but who joined after the wrongdoing appeared!
The Court will not look at the BJR of the SLC as to whether the board made a right economic decision but
would defer to the SLC.

Zapata v. Maldonado – De, 1981

Facts – P, a sh, brings a derivative suit against Zapata corp (fiduciary duty breach). Says demand is
excused. Board forms an SLC, which recommends that the suit be thrown out.
Points –

 Corp exist via the Del Code 141(a) – says that the Bd. is responsible for and controls all actions
 BJR is a judicial creation that presumes propriety of the corp’s actions. It does not create an
authority and does not become relevant till the termination of a derivative lawsuit is dismissed
 3 issues here
o Right of a stockholder to maintain a derivative action
o Power of a SLC to dismiss a derivative suit
o Role of the chancery in resolving Derivative suits
 A Bd. Decision to dismiss a case after demand was made will be respected unless it was
wrongful
o But here demand was never made and the power of the Bd to seek a dismissal is a
threshold question
 §141(c) allows the Bd. To delegate all of its authority to a committee
o Interest taint of a Bd is not a per se legal bar to the delegation by Bd. To a SLC with
disinterested members
 Courts need to balance the foll and BJR is inadequate:
o Boards interest from being pestered by frivolous lawsuits
o Need to preserve the derivative suit to hold the Bd. Accountable
 There are also social reasons to doubt the SLC actions as;
o They are passing judgments on fellow directors
o And there but for the grace of God it could be me
 Bd. need to consider a balance of many factors in order to dismiss a Derivative suit:
o Ethical
o Commercial
o Promotional

21
 o Public relations
o Employee relations
o Fiscal
o Legal
 Courts can do the same analysis:
 So the proper analysis in a case where demand is excused is E&E p.377/78:
o Step 1 – Court sees whether the SLC can prove its independence, good faith and
reasonable of their investigation. If court is not satisfied it’ll allow the suit to proceed, else
move onto step 2
o Step 2 – Court to apply its own business judgment, using the factors noted above,
whether the SLC was independent and had sound basis for its good faith decision. If not
Allow the suit to proceed.

Delaware

1) A majority of the board has a material financial or familial

interest in the challenged txn; OR

2) A majority of the board is incapable of acting

independently for some other reasons such as domination
or control; OR

3) The underlying txn is not the product of a valid exercise

of business judgment

Bd would only form a special litigation committee when demand is excused, i.e. the board is admitting that
the Bd is “tainted” in some way

Difference in the Delaware approach:

 Do the first step as the NY step i.e. the adequacy of the SLC (burden on corp) and if the
o Court will allow Limited discovery at this stage
o If the SLC does not meet its burden then the case continues
 If the SLC meets its burden the Court will use its own judgment relating to the wisdom of
continuing the lawsuit
o This to make sure that the spirit of the law is upheld
 DE courts are less deferential to management
o Two reasons:
 Policy – NY went too far in being deferential to the managers
 Social pressures, i.e. sociological and psychological pressures on the new
directors to be empathetic towards the other directors
 Comes up with a balancing test
o Protect the directors from dismissing meritless suits
o Save the derivative suit
 If the
* Look at p.248 and 244! Look at the note above, the beginning of the class, about section 141 (c): board
may delegate its power to a SLC. Instead on part test of NY ( extremely deferential standard), De Court adds a
second test at the discretion of the Court on p.250: flexing of muscles by the Court to a bit showing its
expertise. Also, p.251: the Court would also, besides the best interest for the corporation, look at the
public policy as well like bribery of the US officials!

22
In re Oracle, De 2003
Facts – Oracle CEO and Chairman sell Oracle stocks in a period where the earnings come in lower than
usual, after telling everyone that the sales would be fine. SH launch a derivative suit charging them with
breaching their duty of loyalty by misappropriating inside information and a Good faith violation. Oracle
forms an SLC with outside directors, who are professors at Stanford. The charged CEO and Chairman
are big people in Stanford, that a couple of them worked on SIEPR, a Stanford research institute,
together. SLC says that the D acted fine and that sales came in lower because of a Hockey stick effect.
Rule – Higher burden to be placed on an SLC to show that it is squeaky clean, and even if you associate
with the D dir, that might be enough to impeach your independence
Analysis –
SLC has not met its burden to show that it is Independent

 Because there are substantial ties between the D and the SLC members
 Asking someone to decide a fellow professor is not a small thing
o He would either end up being more strict or less strict, but that is not the point
o The point is that it will affect his decision and absent a showing that they could totally put
this aside, they will not be found independent
Holding – Finds against SLC
* Part of the lesson from this case is not to mislead the Court.

Martha Stewart Living Omnimedia, Inc. v. Stewart – Unlike Demand Excusal, where the Board is
presumed to be independent, SLC has to establish its own Independence.

There was interest by pro

Structural Independence

Inside Outside

Transactional Independence

Inside Outside

9-15, 16-2010
P.310-34 DUTY OF CARE
Generally speaking a SLC will only be created when the shareholder says that demand is excused. It
might also happen if the demand excusal is a close call. If the company disagrees that demand is
excused, its unlikely to form a SLC, they’ll probably ask to dismiss on grounds that demand was not
excused.

Ability of a SLC to terminate a shareholder suit does not mean that the alleged wrongdoers get a free
pass form any penalty. There might be legal violation for which the SEC or DA might file. Also the director
could be demoted or fired.

Shareholder suits are a very effective way to police management, but not the only way.

The standards applied in the Oracle case, i.e. the willingness to look at non-financial stuff (directors play
golf together, or faculty at the same school) only applies to SLC, not for demand cases.

23
 CHAPTER 5: THE DUTIES OF OFFICERS, DIRECTORS, AND OTHER INSIDERS

SECTION 1: Duty of Care

Two major duties that directors owe the corporation:

2. Duty of care (BJR like explained in the Wrigley’s case

3. Duty of loyalty

Kamin v. American Express Company – NY, 1976

Facts – P – minority shareholders of Am Ex. D - Am Ex and 2 directors of Am ex.
Defendant corporation purchased common stock for $29.9 million, and now the stock has a market value
of $4 million. The directors decided to declare a special dividend, giving the shares of stock to the
shareholders. Plaintiff demanded that Defendants sell the stock on the open market and use the $25.9
million capital gains loss to offset other capital gains. The offset would save Defendant corporation $8
million in taxes. Plaintiffs decided not to pursue Plaintiff’s demand, reasoning that the significant loss
would adversely affect the value of Defendant’s stock. Plaintiff then brought suit, classifying the directors’
decision as negligent decision-making.
Rule – §720(a)(1)(A) says that action can be taken against directors for neglect but neglect is not ordinary
negligence. Neglect is neglect of duties not misjudgment its (nonfeasance), is neglect of duties or fraud,
dishonesty.
Analysis –

 In Derivative actions errors of judgment are not enough for equity interference
 Paying dividends is an exclusive province of BJR
o Courts will only interfere in this unless directors acted in bad faith or dishonestly
 Complaint alleging that another course of action is better is not a cognizable course of action
 Negligence of a director does give rise to a cause of action but the neglect has to be gross
neglect
 Directors did consider the moves that P wants but then rejected it, because of an accounting
issue
 There is a hint that the 4 of the 20 directors might have taken a hit to their compensation if the
company was sold instead of spun off, but this claim is highly speculative
Holding – Court will not interfere absent a showing of fraud, oppression, arbitrary action or breach of trust
Even a decision that is economically unsound such as here is going to be protected under the BJR.
* 4 inside and 16 outside directors as Ds (typical for a publicly traded company); classic bad investment,
grossly inflated price; breach of duty by the Board by instead of selling the shares of DLJ, they just
distributed them to the shs which is wasteful according to the P.
Efficient Capital Market Hypothesis (EFCMH) in three basic versions: weak, semi-weak ( most commonly
accepted), and a strong one, look at: http://en.wikipedia.org/wiki/Efficient-market_hypothesis ! Presumption
that the Bd acted in a good faith by the Court (why the P fails); the Court was not obviously convinced by
the economic decision made by the Board but rather there was activities by the Board as to careful
consideration, special meeting etc…

* D.G.C.L. section 141 (a), (c), (e); great importance are audit committee and compensation committee,
also there may be a third, nomination committee. Also ad hoc committee like SLC; maybe special
investigation committee which follows from section 141 (c)!
141 (e): board of directors should fully rely on the corporation’s record… (p.320); also outside lawyers,
investment bankers and others hired by the company; directors must act in good faith and have
reasonable belief that experts have professional expertise in order to get protection of 141 (e). KNOW
THESE STATUTORY PROVISIONS ALTHOUGH WE DO NOT FOCUS THAT MUCH ON STATUTES!!!
Smith v. Van Gorkom – De, 1985
Facts – D, Van Gorkam, who is the CEO of the company. The case involved a proposed leveraged buy-out merger of TransUnion
by Marmon Group which was controlled by Jay Pritzker. Defendant Jerome W. Van Gorkom, who was the TransUnion's Chairman
and CEO, chose a proposed price of $55 without consultation with outside financial experts. He only consulted with the company's

24
CFO, and that consultation was to determine a per share price that would work for a leveraged buyout. D and the CFO did not
determine an actual total value of the company. The court was highly critical of this decision, writing that "the record is devoid of any
competent evidence that $55 represented the per share intrinsic value of the Company."
The proposed merger was subject to Board approval. At the Board meeting, a number of items were not disclosed, including the
problematic methodology that D used to arrive at the proposed price. Also, previous objections by management were not discussed.
The Board approved the proposal.
Judgment: The Court found that the directors were grossly negligent, because they quickly approved
the merger without substantial inquiry or any expert advice. For this reason, the board of directors
breached the duty of care that it owed to the corporation's shareholders. As such, the protection of the
business judgment rule was unavailable. After the court's decision to remand the case back to the Court
of Chancery the defendants agreed to a settlement. The directors agreed to pay $23.5 million in
damages, of which $10 million was covered by insurance with Pritzker then paying the remainder of the
settlement even though he was not a party to the lawsuit.
Criticism: This criticism stems in part from the fact that the court made independent directors
potentially liable for millions of dollars in damages for selling a company for approximately a 60%
premium its market value. Such liability provides a strong disincentive for the best potential directors to
serve on the board, and one would expect such a disincentive to result in worse corporate governance.
Rule – Gross negligence to be the standard to see whether BJR of a board was informed
Analysis –

 BJR turns on whether the directors have informed themselves prior to making a business
decision, i.e. no protection for unintelligent or unadvised judgment
 §3251(b) requires that for mergers directors act in an informed and deliberate manner
 Directors did not make an informed business judgment as:
o Did not inform themselves of Van Gorkoms role in establishing the $55/share price
o Were uninformed as to the true value of the company
o Were grossly negligent in approving the sale after considering it for 2 hours
 8 Del.C. §121(e) - Directors are protected in relying on good faith reports by officers, with report
including informal investigations by corp. officers
o But no report was presented to the Bd beside the foll witch are not really reports
 Van Gorkom’s Oral presentation at the 1st Bd. Meeting
 Not a report as VG was uninformed himself about the essential
provisions of the document he was talking about
 CFO- oral report of his prelim study
 Was immaterial since the statement didn’t purport to be a valuation study
 Bd. Says that they made an informed choice as:
o Spread of 38/share (mkt) and $55/share (offered) means informed choice
 Premium paid by itself does not mean price is fair.
 D and Bd. Knew mkt had consistently undervalued their shares
 No valuation of company was actually done
 Bd. asked no question of how $55/share was calculated, that D had suggested
the $55 price or the price of the 1M to be sold to Pritzker
o Bd. Wanted a 9 day Mkt test period
 No evidence that the firm could be put up for sale
 Or that a public auction was allowed to occur
o Bd. Members were experts
 Dude the Bd. Used the Spread and market test theories above. They have to be
stupid to do that
o Bd. Members relied on Chief Counsel’s advise that they might be sued if they rejected
Pritzker’s proposal
Dissent – Dude the directors are experts and they know what they are doing. So Step!
Holding – Bd breached its fiduciary duty by i) not informing themselves well ii) not releasing all the info
that a reasonable stockholder would need

25
  The reason to have a lockup option is the its costs a lot of money to set up a deal, thus the Lock
up option compensates him for his inability to pursue other deals.
 Zamin and Schlensky might be wise or unwise decision but here SH might be disgruntled, but
the board decision in the VG case is the most basic decision that a Bd. can make i.e. whether
they will still be owners of the company
 There is an argument that the directors might have to take a higher care when they are selling a
company
 Major problems in the courts view
o No formal report about the valuation
o There was not enough consideration paid i.e. only 20 min presentation

Practical effect on the board room of this case – Now there exists all this extraneous process that is
attached such as lengthy documents and a long meetings and creating a paper trail.

Do directors need to get a fairness opinion from an outside party – this is not required by law but it’s a
really really good idea to get one!
* You need a quorum of the board as to majority of directors are present; then, issues are decided by a
simple majority of the votes; Gorkum is a very fact specific case; p.318: BJR definition; stock price did not
have a high volatility (between $35-38); however, the price share was $55; a share can have a higher
price than a market value if it is possible to buy a majority of shares of the company – people pay an
enormous premium for control over the company (in this case 40%). This is one of the most controversial
decisions; Court: there was a nice premium but that was not that much great; Dissent: points out that
directors were highly qualified and experienced (but that was not enough);
- P.328: KNOW THIS De section 102 (b) (7); only for monetary damages for breaches of duty of care but
not for bad faith or breach of loyalty; applies only to gross negligence; shs can still sue directors for
personal liability in case of …

Cinerama v. Technicolor, p.324

- Similar to Van Gorkom above.

- Combo of duty of care and loyalty means the Bd. must disclose to SH all material facts before a
merger vote
- Del SC differentiates the two cases by
o In VG the failure of the Bd. to inform itself rebuts the presumption of the BJR
o Also the Bd. in VG had violated the duty of disclosure

Analysis pg. 326

1) The difference between what the Mkt thinks the company is worth and what you as the
management think its worth
2) VG might have just needed some money for his shares, not the MOST money he could get such
as the Sh might want
3) I think the court just wanted the Bd. to have done its Due Diligence
a. The duty should be one of diligence
b. Probably not much since Pritzker stayed around
c. Who knows?
4) Yes and no. While it’s a good idea to get an independent valuation., still the directors are in the
best position to judge their company’s worth
5) Yes it can accept a first offer but only after doing its DD. But then again the court did seem to
want to see more mkt testing. I have no idea why the sale of the 1M was an issue
6)

Legislative response to Van Gorkom

DGCL §102(b)(7) –A corp. can remove the personal liability of directors for breach of fiduciary duties of a
director. Injunctive suits are still allowed but only applies to Monetary damages

26
Francis v. United Jersey Bank – NJ, 1981
Facts – Lady inherits a director position at a re-insurance form after her husband dies. She becomes
distraught and drinks herself to death while her sons embezzle form client accounts held in trust. After
finding out about the embezzlement she resigns form the bd, her sons are the other two directors, and
then dies in 6 mos. This is a suit by the creditors to collect from her estate the amounts lost to
embezzlement
Issue: The issue is whether Lillian Pritchard is personally liable for negligently failing to prevent the
misappropriation of P&B funds by her sons.
Held: Lillian Pritchard, as a director on the Board, had a duty of care in managing the business. She did not have to
know every detail of day-to-day operations, but she needed to have a baseline understanding of the finances and
important activities. If she did not understand the activities, then she was obligated to consult counsel for advice. Her
absence from the business did not excuse her duties. The court determined that if she did intervene in the dubious
financial decisions of her sons, or at least consulted an attorney or expert, it may have prevented her sons from
fleecing the company. Therefore, her lack of care was a proximate cause of the damages to the company and the
third parties who relied upon the company. Because of the nature of the business (holding assets of third parties),
she was liable to the third parties for any damages.
Discussion: The decision makes it impossible for directors to hide their head in the sand to avoid liability.
The amount of oversight required will depend on the nature of the business, so it will be very fact-specific.
Rule – NJ std of care – Director must discharge her duties in good faith and with diligence care and skill
as an ordinary prudent person in like situation. Also need to show causation, i.e the negligence caused
the loss
Analysis –

- The care required depends on the kind of business with a Bank requiring a lot more diligence
than a others owing to its public nature
- Lack of knowledge of rudimentary
- Duties of directors:
o Gain Rudimentary understanding of business
o Keep informed of corporate activities
o May not shut eyes to corporate misconduct, and then claim that they didn’t’ see the
misconduct
o Must be familiar with the financial status fo the corp.
- Directors immune form Liability if in good faith they:
o Rely on counsel or
o Rely on Written reports created by an independent CPA
- Inspecting a financial statement gives rise to a duty to investigate more if something seems awry
o In such a case a director might be required to seek advice of counsel and take
reasonable means to prevent illegal conduct
- Causation
o Director can let his disagreement know by disagreeing with board and if he agree with
Bd. and the result is loss to another he may be liable for it NJSA 14A:6-12
o D Is liable as:
 She may have cured the issue by Resigning
 Nature of the reinsurance business is such that she held clients money in trust
Holding – for P
9-21-2010
P.336-47: DUTY OF LOYALTY
SECTION 2: Duty of Loyalty – Conflict of Interest (as number one issue)

Duty of loyalty – means that he fiduciary must subordinate his personal/private interest to that of the
corp whenever the two conflict; the other, less important, is duty of care. IDTs: Interested Director
Transactions.

Structural Independence

27
 Inside Outside

Non-independent Independent

Transactional Independence – e.g. approving salary increase for themselves

Disinterested interested

Independent Non-independent

Types of issues, classic scenarios, i.e. interested director transaction IDTs: we don’t have to memorize
them but they are helpful:

1) Dir has a contract with the Corp and that K is at issue;

2) Dir in one company is a SH in another company;
3) Dir is a dir of two different companies
We’ll be focused on DGCL section 144 (a) and know this for the purpose of the course: p.369

Bayer v. Beran – NY, 1944, old one but interesting to ITDs

Brief Fact Summary: Plaintiffs, Bayer et al., filed a derivative shareholder action against Defendant
directors, Beran et al., contesting their decision to pay for radio advertising that employed a director’s
wife. Plaintiffs also argued that Defendants needlessly renew the employment contract of Dr. Henri
Dreyfus. Dr. Camille Dreyfus, president of the company, suggested a $1 million radio campaign built around a radio musical
program. One of the stars of the program is also his wife. The Board approved the campaign, and it has subsequently been
renewed. The Board also continues to approve an employment agreement for Dr. Camille Dreyfus’ brother, Dr. Henri Dreyfus, who
was a co-founder with his brother of the technology behind the company’s products .
Issue: the issue is whether the Board, through Dr. Camille Dreyfus’ ties with his wife and his brother,
breach their fiduciary duty of loyalty to the corporation by approving the radio deal and employee contract
at issue.
Discussion: the court emphasized that business decisions that would not typically merit an analysis
under the normal business judgment rule will undergo more careful scrutiny when there is a conflict of
interest. The duty of loyalty trumps the business judgment rule.
Synopsis of Rule of Law: A director has a fiduciary duty to support the corporation’s interest over his or
her own conflicting interests, and any competing interests renders the business judgment rule
inapplicable.
Analysis –

- Character of advertising, amount to be spent on it and manner to be used are All matters of BJ
and are at the discretion of the board
- Burden is on director to prove Good faith of txn and show its inherent fairness from the
Corp. viewpoint
- Not improper to appoint relatives of officers or directors, but such appointment is subject to the
strictest scrutiny
- But this case is ok as:
o Quality of the show was fine and no assertion that another artist would’ve made the
program better
o No showing that the program is inefficient
o Wife’s contract was on a standard form negotiated between the advert agency her agent
o Her pay was normal
o Wife received no greater prominence or special buildup

28
 o Popularity of the program has increased
- The fact that the program was not discussed in a formal meeting. This is normally bad but ok here
as:
o Directors were mainly executives of the company who worked in close proximity
Holding – Holds for D

 The BJR always has to yield to the Conflict of interest

 Why do the directors who are not married to the wife not get the BJR protection – as Dreyfuss is
the dominating director
 Board action must take place collectively per modern statutes, so what happens in this case, i.e.
the informal decision making, is not ok
 Court has concluded that the decision was a reasonable and fair one
Exception to where a court will accept an informal process:

1) Directors and shareholders are the same party

2) When a 3rd party reliance on the Bd. decision

Difference between Duty of loyalty and duty of care is the difference between doing bad and shirking your
job although the difference has recently become a vague one.
Requires proof by the company of the level of the fairness of the txn.

Board has a duty to act in the best interest of the SH on matters within the scope of relationship

Bayer rule – if disinterested majority of directors ratified K and the complaining party could not prove it
unfair, courts held K valid. Bayer takes it step forward saying that because the as K is fair even though
disinterested directors didn’t approve, it is ok??
* BJR does not apply here because of potential conflict of interest; the company is carrying the burden
to prove fairness, look at p.369 rule 144;
The court would be stricter today as they would not accept that some members of the board of
directors just met in a hallway!

Benihana of Tokyo, Inc. v. Benihana, Inc., Del 2006 NOT IN THE OTHER OUTLINE!
Facts – BOT – Parent company owns most of the stock in Benihana. Owner marries new wife and wants
to give complete control to her. Mgt of D, Benihana doesn’t like this idea and suggest that there might be
a way to sell more shares to dilute the owner’s interest to keep him from stocking the board with his men.
In any case the company also needs to raise capital to fix its restaurants. They float different ideas and all
discuss some terms for a potential stock sale. After this one of the members of the board, Abdo, comes
up and says that a company which he and another control will buy the convertible stock suggested by an
outside party and agreed to the by the Bd. The parties dicker over the terms and Benihana gets most of
the terms that it wanted. P, the owner in Tokyo sues claiming breach of fiduciary duty.
Rule – § 144(a)(1) – Safe harbor for interested tx applies if material facts, relationships and interest of the
K are known to the board who then approve it with a majority of disinterested directors.
Analysis –

- P argues that the safe harbor doesn’t apply as when the board approved the txn, they didn’t’
know that inside board man, Abdo, had negotiated terms for BFC, and Ado knew Benihana’s
position because he was on the Bd.
o Court’s response – we agree that the board needed to know and the record indicates that
it did know
- Abdo violated his duty of loyalty when he used confidential benihana info to negotiate
o Bubkiss as Even if Abdo did know what the Bd’s position was, ther was negotiation and
Bd. ended up pretty much where it wanted to be
- Bd’s primary purpose was to dilute BOT’s voting control

29
 o True that an action cannot be taken for the purpose of entrenchment, but here the
primary purpose was to provide the best financing vehicle which the Bd. believed that it
did
Holding – Finds for D

Txn between DS and the Corp they control

1) Ratification after full disclosure by majority of minority SH  txn valid unless minority SH can
prove unfairness (Shifts burden from dominant SH to minority SH)

* The Court decides despite the clear conflict of interest it was properly ratified; on p.369;
P.346: problem #1) look in the textbook!

9-22-2010
DUTY OF LOYALTY – CORPORATE OPPORTUNITIES P.347/57
Tender offer – is an offer to buy shares at a certain price and a certain number of shares (controlling
interest) usually have to be sold for the offer to kick in

Broz v. Cellular Information Systems Inc (“CIS”) – De, 1996

Synopsis of Rule of Law: The corporate opportunity doctrine holds that an officer or director of a
corporation can take a corporate opportunity if the opportunity is presented to them in their individual
capacity, the opportunity is nonessential to the corporation, the corporation has no expectation for the
opportunity, and they have not wrongfully utilized corporate resources to take advantage of the
opportunity.
Facts – Broz is the Pres and sole shareholder of RFBC. He is also on the Bd of CIS. Another company,
Mackinac, wants to sell a cell license. They approach Broz to find out if RFBC might want to buy it. Broz
says ok, but then tells CIS CEO and other members of the board in an informal setting whether they want
to buy the license. They say no. CIS is also not able to afford the license at that time. At that time another
company, PriCellular, tenders an offer for CIS. Pricellular is also interested in the cell license, and gets an
option to buy it. But the says that the seller can back out if there is another who tenders a larger offer for
the license. RFBC tenders a larger offer and the license is sold to it. PriCellular was eventually successful at
acquiring CIS, but only after several delays and shaky financing. Meanwhile, Defendant outbid PriCellular for the
Michigan-2 license. CIS, now owned by PriCellular, brought this action against Defendant, claiming he usurped a
corporate opportunity belonging to Plaintiff.
Rule – Corporate opportunity is when a director is presented a business offer which the company that
he’s on the Bd of is i) financially able to undertake ii) is in the line of the work that the company is in iii)
and is one in which the corp has an interest in then iv) the director cannot take that opportunity if his self
interest is in conflict with the corp’s interests.
Analysis –

 Broz became of the opportunity but not in his corporate capacity

 The burden is on Broz to show that he kept his fiduciary duties
 The relevant factors in this analysis are:
o CIS was not financially capable of buying the license
o This was in CIS line of business but at the time CIS was getting rid of its licenses and this
particular license was not of interest to CIS at that time
o Only applies when the director takes and opportunity in conflict with the corps interest
 Broz did not take any opportunity that CIS was willing to pursue
o Formal presentation is not need
o Process of what a director should do in such cases:
 Director should determine whether the opportunity rightfully belongs to the corp
 If the director then sees that the corp is not entitled to the opportunity, then he
may take it on himself

30
  Presentation to the board just creates a safe harbor
o Broz was under no duty to consider what PriCellular’s interest might be
Holding – For broz

If Broz had presented formally to the board and then they don’t’ take it then he would have gotten a
complete safe harbor
If the court had found that this case had been a corporate opportunity, then Broz would have to formally
present to the court to get out.

Corporate opportunity is opportunity that:

1) Corp. is financially able to undertake

2) In the Corp’s line of business
3) Is one in which the corp. has an interest or reasonable expectation and is of practical advantage
to it
4) Where the self-interest of the D, be embracing the opp will be bought into conflict with the interest
of the corp.
5) [Whether O or D learned of the opportunity in an individual or corporate capacity] – relevant factor
in the Broz case, is not dispositive
Note that these are factors not elements
* The best possible scenario and advice in this types of cases is to fully disclose all information to the
board members who will then decide if there is a conflict of interest;
Developed in Delaware

Analysis Pg 351!

1. If CIS has the money and hence the were with all, then this would be a CO case!
2. Then he would be stuck since he’d have duties to both companies to tell them of the process.
Broz should tell CIS and then back out
3. I don’t’ see how his being an employee alter the dynamic at all. The law would still require the 3
elements noted above. Same difference. The law as it’d apply to the case above would not
change
4. Probably too much money
5. Yes because PreCellular had not expressed an interest to Broz at that time. Plus the corporation
that broz owes his loyalty to was CIS not Precellular
6.

In re eBay, Inc. Shareholders Litigation – De, 2004

Facts – D are the founders of eBay. Goldman Sachs gives them dibs on all their IPO initial offerings. This
is the days of the Internet irrational exuberance so the stocks increase in value a ton toute suite! eBay
also invests in stocks and thus there is a eBay SH derivative action alleging that the directors took eBay’s
corporate opportunities (relying on the Broz’s case reasoning).
Rule –
Analysis –

 Ebay could have financially exploited the situation

 EBay was in the business of investing
 Investing in other stock was a “significant part of eBay’s business
 D says that if the court finds against them then all corporate investments opportunity is a
corporate investment
o Bubkiss since that is not the case here since here Goldman was offering these share
sales as an inducement to the D to keep getting business from eBay
o Even if we assume that there was no inducement given, and this is not a corporate
opportunity, a director, as an agent, violates his duty of loyalty by taking a gratuity that
belongs to eBay.
Holding – Holds for P

31
# investing in various securities was held to be in a line of business of eBay despite the fact that eBay's
primary purpose is to provide an online auction platform. Investing was in a line of business of eBay
because eBay "consistently invested a portion of its cash on hand in marketable securities." A corporation
has an interest or expectancy in a business opportunity if the opportunity would further an established
business policy of the corporation.

Martha Stewart case – All 4 factors in the Broz cases have to be balanced and no factor is dispositive

Beam case – An activity is in the corporate line of business when the corporation has fundamental
knowledge, practical experience and the ability to pursue

Restatement of Agency §388 – an agent, who makes a profit through txn that he does for the principal,
must return any such profit to the principal
Restatement of Agency §387 – Agent must act in all matters only for the principal’s benefit
- P.356/57 problem we did on a separate sheet of paper look.
- WE MISSED CLASS

9-28, 29-2010
P.357-367, 673-676: duties of dominant shareholders (parent-subsidiary dealings (by far the most
dominant sh problem (parent by definition owns …)!))
C. Dominant Shareholders
Dominant shareholders also owe a duty to the corp. while common shs do not.
Dominant shareholders Definition – SH with the power to exert control over SH voting. They can use
their power over voting to approve or disapprove fundamental issue and to vote for the corp. The problem
is that their vote might cause corp to harm the minority SH. Can elect the board of directors;

 Can be an individual or group of individuals or a corp. as the parent of another company

 If an individual privately owned corp. then more than 50% of ownership (outstanding shares)
might be required
 In a Public company the % owned might be much smaller. Must look out if at least 25% is owned

- Parent company usually appoints a guy to the subsidiary company;

Two kinds whether a parent owns subsidiary:

1. Wholly owned sub

a. No duty of loyalty problems since no minority SH
2. Majority owned Sub

Std of review (minority SH cases): two cases or basic legal structure:

1. BJR – if the minority SH of the sub cannot show that the sub has taken an action that gives
preference to the parent then the court will use the BJR; no conflict of interest even if dominant sh
is involved.
2. Intrinsic fairness test as a more serious: when there is a conflict of interest then the burden is on
the parent to show that the txn was fair. Intrinsic fairness test. But remember that the minority SH
has to show 1st that the txn involved a conflict of interest. P.358: “the basic situation for the
application of the rule is the one in which the parent has received a benefit to the exclusion and at
the expense of the subsidiary.” And it occurs only when a parent, as a dominant figure, is on the
both sides of a transaction with its subsidiary (self-dealing).

Sinclair Oil Corp. v. Levin – De, 1971, a very canonical case, cited often:
* No matter that only 3% are minority owned;
Facts – P is a minority SH in Sinven, and D (Sinclair oil) is the majority (97%) owner who appoints all the
directors for Sinven. All the directors work for D. P has 2 cause of actions i) that D is bleeding out all

32
money from Sinven through giving out big dividends (the company prevented from being developed further although
they should be happy by getting big dividends in general) ii) usurping corporate opportunities in Alaska etc and iii) D
breached a K with Sinven. TC finds for P on both using a std of intrinsic fairness as opposed to BJR
Rule – the intrinsic fairness test should not be applied to business transactions where a fiduciary duty
exists but is unaccompanied by self-dealing, ie. where the parent co receives a benefit to the detriment or
exclusion of the subsidiary (minority SHs) (p.358)
* Although it was plausible for Sinclair to buy out the rest of the shares, they were already in trouble…
Analysis –
Intrinsic fairness test:

 Std:
o D has burden to prove
o That its txn with Sinven were objectively fair
o Subject to strict judicial scrutiny
 Can be applied in dividend cases
o So if two classes of stock, one owned by parent and another owned by rest and only the
parent gets Dividend, then this would be self dealing and in addition to the Parents
fiduciary duty would trigger the intrinsic fairness test
o Not applicable here as proportional money received by both parties
 Motive is immaterial unless P can show that the dividend pmt here resulted from improper
motives and amounted to waste
 No showing that Parent took business opportunities form sub
This is triggered when:

 Fiduciary duty of one party AND

 Self dealing:
o Self dealing Is when
 The parent through dominance of sub
 Causes the sub to act in a way
 The Parent gets something from the sub to the exclusion of minority SH
o Parent is on both sides of a txn
Corporate opportunity – Bubkiss as only Sinclair had these opportunities, i.e. there was no reasonable
expectancy of getting these opportunities

Breach of K

 Identifies the conflict of interest when the Sinclair made Sinvin contracted with its sub
International then analyze to see if the deal was fair
 P says that D breached a K it had with Sinven with min prices and amounts and requiring pmt
upon receipt
 Sinvens Act of contract with its sub in this case was self dealing as:
o If K was Breached D received benefit with the sub/Minority SH getting nothing
o Late pmt in contravention of the K is bad as is the amount that D did not buy the min
required form the K
Holding – No self dealing in the dividends issue but failure of fiduciary duty in the breach of K issue

Pepper v. Litton std of Corporate fiduciary duty – A director and a dominating SH are fiduciaries. They
have to prove that any txn with the sub is done in good faith and its inherent fairness

* Problems pg 361

2. No the case could have also been decided in terms of Business Opportunities
3. Way:

33
 a. Not to appoint your own board members, i.e. independent directors who can then make a
decision when there is a conflict of interest (you may not want to do that, selfish holder is
ok term, rather appointing some outside board directors (not a majority) so preserving
control of the company) .
b. Buy out the minority SH
c. Seek ratification from majority of the minority SH

Zahn v. Transamerica, 1947: what are obligations of the dominant sh, in this case Transamerica, to the
minority in a majority owned subsidiary?
Facts – D, Transamerica, bought a controlling interest in Axton-Fisher and dominated its board. Then
charter of Axton says that Class A stock can be bought out by the Bd. at a price of $60 plus accrued
dividends. Also the owner of Class A stock could convert to Class B if they wanted to. Bd had no option to
buy Class B stock. The price of tobacco increases and Axton has a mess load of it. So Transamerica
liquidates the company and makes the board buy out the Class A Stock and then self off the tobacco
making a crap load. P says that D had inside knowledge about the tobacco, hence there is a breach of
fiduciary duty here.
Rule – Majority has a right to control but has to watch out for its fiduciary duty for P
Analysis –

 Right to call in the Class A stock was with Bd not SH

 There is a diff between a SH voting as a Sh and as a director
o I.e. as a SH he can vote for his own benefit but as a Director he is a trustee for all SH
 Directors may not take corporate action for personal profit
 If the Bd was disinterested then it could have called in the Class A stock, but not here
Holding – For P
Three options to the Bd. with respect to the Class A shares:

1. Buy them back (they call class A stock) – pay $60/ share and without disclosing the appreciation
of the inventory and then liquidate, resulting in pmt of 60/share and
2. (P): Disclose everything i.e. the appreciation of the tobaccer and call the class A shares on 60
days notice and then any Class A SH who is paying attention can convert to Class B shares
resulting in Class A and class B share equally
3. (D should do): Decline to call (redeem) the Class A shares and t0 simply liquidate the company
(sell inventory) resulting in the Class A SH gets twice as much as the class B SH
Court said that the fair thing would have been to call the Class A shares and disclose. Court said that a
disinterested Bd. would have told the price of the tobbaccer
Three main points of Zahn from Dennis:

1. Its another example of the breach of loyalty by a dominant Sh to a Minority SH

2. Have a basic understanding of the attributes of preferred v. Common stock, esp about common
stock, i.e. voting rights and economic rights and that there are residual claimant in case of
liquidation
3. The Board needs to look out for the class with the greatest risk (who is at the end of the line when
the company is liquidated), when there is a conflict of interest between different groups. In this
case its class A

Two kinds, most common, of stock are common stock (which most companies have) and Preferred stock.
Common stock (we’ll mostly talk about this): voting (limited right to participate in corporate decision such
as mergers etc…) and economic rights. Preferred stock can be preferred based on liquidation or other
ways:
Preferred liquidation stock, means that they trump common stock
Preferred dividend stock, means that get dividend paid to them before the common stock peeps. In
liquidation first come creditors, then preferred, and then common.
Preferred usually has no voting rights but many corp. have chosen to elect some or all of the directors in
the case if some dividends have been met

34
All state requires that the articles of incorporation specify the number and shares that a corp. is
authorized to issue. Bd. can introduce a new class of stock and then they have to go to the SH and get
authorization

Common stockholders has 2 rights

 Voting rights
o Limited right by and is limited to:
 Electing directors
 Voting on major corporate decision
 Economic rights:
o Residual claims on the corp. assets i.e. each share can get
 Dividends (only if the board of directors authorize it)
 If corp. is liquidated they get what’s left after all outstanding claims have been
satisfied (last in line but if the company is successful, common stock holders get
everything that is left over).

A control block – The majority controlling SH

* Professor listed characteristics of each preferred, class A, and class B stocks.

Zetlin v. Hanson Holdings – NY, 1979, p.673

Facts – P is a minority SH and sues the D, controlling majority SH, for selling his controlling interest to
another company at a premium over Mkt price. P says that he premium price should have been available
to everyone.
Rule – Controlling SH may sell their shares for a premium over the Mkt price
Analysis –

 Minority SH has protection from Abuse but not to inhibit legit interest of the majority
 Premium added is the for the controlling interest
 To take this away would be make available only tender offers
Holding – Finds for D
Issue is whether the majority SH can sell their shares at a premium. The Majority can sell at a premium,
but there are a couple of exceptions:

1. When the controlling SH sells to a known looter (seller knows or has a reason to know that the
buyer will loot the corp or will abuse the minority) then there is a duty of loyalty to the minority
2. Sale amounts to a wrongful sale, which appropriates an opportunity that should have gone to the
corp.
* A straightforward ruling! P.673: there are exceptions: cannot sell to a known looter (a reason to know
will abuse minority shs; in addition cannot sell … (rarely happen, and when there is fraud);

P.367-74, RATIFICATION OF CONFLICT OF INTEREST

This is DGCL §144 a) on Pg 369 (look notes in the book) – Effects of ratification of interested directors
transactions (IDTs):

1) Ratification by majority of Disinterested directors after full disclosure  Txn valid unless
Challenger can overcome BJR (Burden on P)
2) Ratification by majority of [disinterested – although it does not say in the statute, it is valid in court!] SH after
full disclosure  Txn valid unless challenger can show waste – look at pg 390 defines waste
(burden on P)
3) No ratification or ineffective ratification --. D must show intrinsic fairness (burden on D)
Interested director counts for the quorum
4) Dominant SH case
There is also ratification of transactions b… controlling shareholders (CS) and Corp. they control:

35
 1) ratification after full disclosure by majority of minority shs → transaction valid unless minority
shs can prove unfairness (burden shifts from controlling shs to minority shs)

Fliegler v. Lawrence – De, 1976

Facts – President of gold and silver company, Agau, buys antimony-mining lease. He offers it to his
company but the company was not economically avail itself of that offer, hence the board of Agau
refuses. He then creates the company, USAC, sells its share and set up a option for Agau to buy the
company if it was successful. USCA is successful and Agau buys it by exchanging its shares for 800k of
Agau shares. The Shareholders ratify this by a vote. P brings suit to recover the 800k shares and asks for
an accounting.
Rule – 8 Del.Ch. §144 – A ratification shifts the burden to the P to prove that the terms of the K are so
unequal to make it a gift or waste
A K between a Corp. and its directors will not be voided if:

1) The material interest of the director is told and the majority of disinterested agrees
2) The material interest of the director is known and yet the Majority of SH vote to ratify it (says that
the majority has to be disinterested SH, even though no so stated in the statue)
3) The K is fair to the Corp.
Analysis –

 D says that the shareholders ratified so they are fine

o Not so since the majority of the SH who voted for the merger were actually the D
themselves. Only a 1/3 of the disinterested SH voted and we don’t’ know what they said
 This statute does not provide immunity, just removes the “interested director” cloud
 However the D have proved the intrinsic fairness of the deal for USAC and thus the price paid for
USAC was fair
Holding – Finds for D; the burden of proof that the transaction was fair was still on the Defendant directors because the
shareholder ratification was not legitimate. Defendants controlled a majority of the shares, and there was not enough proof that
disinterested shareholders voted with the directors. However, Defendants did offer enough proof to demonstrate that the transaction
was fair.

Pg 370 analysis
/

1. As the reasoning of the case shows, it means that it may be void or voidable. But then the
question is who acts to make it void? The courts? The SH? The Bd.? A non ratified K is also void
or voidable, as seen in the prior Radio case. The only difference ratification does is it removes the
cloud of an interested director and shifts the burden of proof to the P
2. Means that if there are other conflicts then it might make it voidable

In re Wheelbrator technologies Shareholder Litigation – De, 1995

Facts – WM, wants to buy WTI. They suggest a merger. WTI board gets some I bankers, lawyers who
agree with the merger, and after a 3 hour meeting the Bd. ratifies the merger. They put out a proxy
statement explaining the merger and the SH ratify the merger. P sues with foll claims i) A breach of duty
of disclosure ii) A breach of duty of care iii) A breach of duty of Loyalty
Rule – a
Analysis –

1) Disclosure claim
a. De law requires the Bd. to disclose all material facts that would have a significant effect
on SH vote
b. P – Bd only deliberated for 3 hours yet said that they had carefully considered all issues
re the merger
i. Bubkiss as no evidence proving this. Furthermore
1. Meeting was attended by I bankers and lawyers who made presentation
re the merger

36
 2. Proxy describes in detail what the Board considered in coming up with
the merger
3. Waste and WTI had a close Business relationship so the Bd new about
the other company and merging before
2) Duty of Care Claim
a. P Concede that if the Bd had made an informed decision the negligence/duty of care
claim will be extinguished
b. Failure of the Bd.to reach an informed choice is a voidable, not void, act.
3) Duty of Loyalty claim
a. There are two kind of ratification issue
i. Interested txn between a corp. and its directors
1. 8 DelCh§144(a)(2) is not voidable if its approved in good faith by a
majority of disinterested SH
2. If approval by informed, disinterested SH then BJR applies and judicial
review is limited to issue of waste with the burden of Proof on P to show
that a fair exchange was not made
3. Same thing happens in the interested txn occurs but is not under §144
ii. Txn between a corp. and its controlling SH
1. Usually about parent- Sub mergers conditioned upon a “Majority of the
minority” SH approval
2. Std of review is Entire fairness with Directors with the Burden of proof
3. But if a “Majority of Minority” SH do give approval, the std is still “entire
fairness” but burden shifts to P
b. P say that the Entire fairness should be applied in this case,
i. Bubkiss since this was not a case of merger with and interested and controlling
SH
ii. Entire fairness requires controlling SH as:
1. Potential for process manipulation by Controlling SH
2. Controlling SH might influence even an informed SH
3. Hence need additional judicial scrutiny
iii. Since no de jure or de facto control by WM over WTI the std is BJR with burden
on proof on P
Holding – finds for D
Ina case of Dominant SH there is an extra possibility of process manipulation and thus will not give the
benefit that results from the waste test.

Problem pg. 374

1. This is a BJR, assuming no link between Flintstone being hired (1 interested +1 disinterested
voted for and 1 disinterested against); although the case could go both ways; but K is ok more;
2. This is an interested director txn and ratification is not effective since majority did not approve it.
Burden on D to show fairness (intrinsic fairness test). This is a classic example of 144 a) 1): there
is no majority to vote (1:1 among disinterested parties) (possible breach of loyalty by Flinstone).
3. As long as both parties vote then there is the BJR. This is not a ratification problem or financial
interest.
4. Answer
a. No lack of quorum since 2/3 of the Bd is there (don’t’ need majority) Need a quorum of
the total bd to show up but ratifying directors can be less than quorum;
b. Flinstone has a burden to prove internal fairness because there is needed absolute
majority of dis-interested board members; someone not voting is like a vote against the
deal!

9-30-2010
P: 375-392, 395-403: OBLIGATION OF GOOD FAITH
SECTION 3: Obligation of Good Faith

37
  DGCL 145 – Only directors who act in good faith can get legal expenses indemnified
 DGCL 141(e) – Only directors who act in good faith reliance on corporate books and records are
fully protected against SH claims
 DGCL 144(a)(1)-(2) – Related party txn are partly insulated from judicial scrutiny if approved by
disinterested SH in good faith
 But Good faith was made into a duty in Cede v. Technicolor which said that in order to rebut
BJR presumption the P has the burden to prove that the Directors breached one of their duties of:
 Good faith
 Loyalty
 Due care
o If P fails to prove that then the BJR attaches
o If P proves that then it is the Directors burden to prove the “entire fairness” of the txn
o BJR – a presumption that in making a business decision the directors of a corporation
acted on an informed basis, in good faith and in the honest belief that the action taken
was in the best interest of the company!!

A. Compensation
2. The reason for talking about this is that the diff between the highest paid and the avg worker has
increased a whole heck of a lot.
3. Lack of performance, i.e. they are getting paid to do a poor job.
4. Encourages risk taking which means short term over long term 0 might have contributed to the

In re the Walt Disney Co. Derivative Suit Litigations – De, 2006

Facts – Disney hires Ovitz upon the insistence of its CEO Eisner. Ovitz does a package deal wherein he
has “downside” protection in case he is fired absent defined causes. IN this negotiation, the head of
Disney’s comp committee, Russell, said that Ovitz would be at the top paid Execs, and that Would raise
criticism. IN Sept Comp Committee met for an hour and approved the txn, and then the Bd. elected him
pres as well. Ovitz doesn’t’ get along with anyone and then, after an unsuccessful attempt at “being
traded” to Sony, is fired and gets a 140M comp. SH files derivative suit with claims against Ovitz and Bd.
1) Claim against Ovitz – Breached his duty of care and loyalty to Disney by negotiating and accepting the
payment 2) Claim against Disney director a) approving the deal with Ovitz b) approving the severance for
Ovitz
Rule –
Analysis –
Ovitz claim –

 Ovitz Breached no claim since he did not become a fiduciary until formal assumed post
 P say that he was a de facto Pres before
o Nein! Because:
 De facto Pres assumes the office under color of election or appointment and is
fulfilling the duties of the office. This did not occur here

Disney Defendants:-

A. Claims from Approving of the K and electing Ovitz as Pres – P says No BJR protection as actions
were grossly negligent OR not in Good faith

Due Care:

a) Treating Due care and bad faith as separate grounds for denying BJR
a. Presumption of BJR can be rebutted if P show that Directors breached duty of
i. Care
ii. Loyalty
iii. Acted in bad faith!

38
 b. No Duty of loyalty claim made, and he TC said no breach on the other two
b) Claim that the Full Disney Bd had to consider and approve K not just he Comp Committee
a. DGCL allows bd to delegate all or some of its powers including exec comp!
c) Empty
d) Comp Committee did not exercise due care in approving K
a. P says that Comp Committee Did not use “best practices” hence breached their duty of
care
b. Need to look at this form a process perspective i.e compare best practice with what
happened
c. Had the Spreadsheet prepare for and had been used and appended to the minutes, this
law suit would not go forward
d. As far as info, the only breach of due care would be if the Committee did not inform itself
that in case of Severance Ovitz would get 40M in cash comp and 92M in Accelerated
Options. Seems that though it was not documented, the Committee was so informed and
the Court can tell because
i. Comp committee had done similar deals for Eisner and Frank well before
ii. The downside protection that Ovitz wanted, was loss of his earnings from CAA
approx 150-200M
e) Other Directors did not exercise Due care in appointing Ovitz
a. This fails if the Bd. was not grossly negligent i.e. were not fully informed
b. Bd. knew that it wanted a person
c. Ovitz was very successful which would lead a reasonable person to think that he’d be
successful at Disney as well
d. Bd. was informed of the key terms of the K

Good Faith:
Three categories of bad faith

1) Subjective Bad faith

a. Fiduciary wants to do actual harm
b. Classic bad faith
2) Fiduciary action because of gross negligence, but not with any malevolent intent
a. This can be a part of Good faith but gross negligence by itself is not enough to make
something Bad faith
b. CL decisions and legislative history say so
3) Intentional dereliction, i.e. a conscious disregard of one’s responsibility
a. This is non exculpable non indemnifiable for 2 reasons
i. We know that this kind is more culpable than gross negligence, and thus should
be proscribed and Good faith is the method to curtail such actions. Some
example of such acts
1. Fiduciary intentionally acts with a purpose other than what’s in the best
interest of the corp
2. Acts with the intent to violate Positive law
3. Fiduciary intentionally fails to act in the face of a known duty
ii. DGCL §102(b)(7)(ii) expressly denies money damages exculpation for acts not in
good faith or which involve intentional misconduct or a knowing violation of the
law

B. Claims from paying the severance to Ovitz

Did board, not Eisner, need to act to terminate Ovitz

 Corp Bylaws are ambiguous as to whether Eisner could dismiss Ovitz

 Extrinsic evidence supports that Eisner as CEO could terminate Ovitz as he’d done so before

Waste Claim

39
  If P has not rebutted BJR cannot get relief unless the txn constitutes waste
 Waste require the P to prove that:
o The exchange was so one side that no business person of ordinary sound judgment
could conclude that that the corp. had received adequate consideration
o Claims are rare and in unconscionable case where the directors irrationally squander
corporate assets
o Waste is a corollary to the idea that where BJR applies, boards decision will be upheld
unless it cannot be attributable to any rational business purpose
 Here the claim is meritless on its face since Disney had to pay its contractual obligations, and
contractual pmt cannot be found wasteful
o The proper analysis is whether the terms of the NFT was so wasteful i.e. So extravagant
as to create an incentive for Ovitz to get himself fired
o Does not work since the Incentives had a rational business purpose, i.e. to induce Ovitz
to leave CAA!
Holding – Finds for Disney

If the P satisfies the burden of proving that the then the entire fairness doctrine kicks in.
One way that one way that the De cases exonerate D of liability, but there is shaming language, such as
using language saying that “you didn’t’ use best practices”
* 10 year litigation case; there was a trial that really rarely happens; there’s a recent move by Congress to
regulate → Dodd-Frank executive compensation: requires at least every three year (not one year), each
public company to disclose information what they paid their executive officers (CEO, CFO, and top five
others); votes are only advisory … will come into effect in 2011 season;
SEC requires ration of the median salary of all of the employees and the CEO (the difference ballooned in
recent years)
- Proxy statement of accuracy to SE (this statement is useful in assessing how management is paid and potential conflict-
of-interest issues with auditors ). Also, p.382/83 rules…Professor: State regulation of executive pay has not
proved to work over time, there has been an increasing discrepancy in payments between CEOs and
others so federal regulation might be a good step in the right direction!

Pg 391-92

1) Brehm v. Eisner – Due care in decision making context is process decision making only
a. Irrationality is its outer limit of the BJR test or show that the decision was not made in
good faith
6) Could have avoided the problem by just being more official, and detailed minutes and other good
documentation as a message from the Disney’s case.

B. Oversight

 Directors don’t need to know everything about the firm on a day to day basis but must have a
o Rudimentary understanding of the firms business and how it works
o Keep informed of the firms activities
o Engage in general monitoring of the corporate affairs
o Regular review of financial statements
 Question remains as to how much rules and procedures are required by the board to ensure that
the employees do not do illegal stuff
 Caremark Case defined the Obligations of the Board
o Board must make put in place reasonable information and reporting systems designed to
them information sufficient to manage that the corporation is complying with the law and
to measure business performance
o This is a good faith duty of the directors

40
Only a sustained or systemic failure of the board to exercise oversight, such as utter failure to assure a
reasonable information and reporting system creates the good faith which is needed for liability.

Stone v. Ritter – De, 2006

Facts – Bank directors face a derivative suit in which the bank ee knew that there might be some illegal
txn taking place and then the back was found by the Federal Reserve and Alabama banking committee
for not having adequate Anti money laundering checks
Rule – Conditions for director oversight liability a) directors utterly failed to implement any reporting
controls b) having implemented such controls they failed to oversee its operations
Analysis – for P
Demand Futility

 Rales std for demand futility was used

o Could the board have exhibited an independent and disinterested Business judgment in
responding to demand at the time of the complaint
 Demand is excused need to see whether the Bd. is interested. If the directors are monetarily
liable per 102(b)(7), which they exculpated for a duty of care violation but not for breach of duty of
loyalty
* This case clarifies doctrinal points where duty of care is subpart of duty of loyalty; classifies what is and
what is not bad faith (procedural gross negligence is not bad faith); on p.399: explains what bad faith is -
READ; also elements to fail to monitor on p.400 READ.

Graham and Caremark

 Graham said that there is no duty for the directors to install and operate a corporate espionage
system absent cause for suspicion
 Caremark – Can’t charge Directors for wrongdoing for assuming that the employees are honest
in dealing with the company
o This is what the directorial std became
 Where a claim of liability for corporate loss is predicated upon ignorance of
liability creating activity only a sustained failure to exercise oversight is an utter
failure to attempt to assure a reasonable information and reporting system exists
will establish the bad faith needed for liability
o Caremark spoke to the third kind of bad faith enunciated in Disney i.e. fiduciary fails to
act in the face of a known duty
o Failure to act in good faith is not in itself sufficient to establish liability, i.e. good faith is
not on an equal footing as Duty of care and loyalty, and failure on the latter two always
results in liability, more is needed in the case of Good faith
 Now failure to monitor is not a duty of care issue its good faith duty issue and put
Good faith under Loyalty.
 So now 2 different kind of duty of loyalty
 Self dealing
 Failure to act in Good faith
o Failure to monitor
o Duty of loyalty encompasses good faith cases
 KPMG found that the Directors did create a method of oversight and then monitored the results of
the systems that they had put in place
Holding – Finds for Directors
Director fail their oversight requirement:

1. Directors failed to implement any reporting or oversight controls

2. Having made such a, consciously fail to monitor it

41
Class Hypo about having a company is clean in every which way except that it has a well reasoned, well
thought out decision to make $0 investment in oversight – bad decision since you need some oversight
and keep up with the oversight. Prior to Caremark, one could have argued that this decision could have
been upheld under the BJR, but now its not going to be a failure of duty of care but as a violation of a duty
of loyalty, i.e. bad faith.

What if there was a violation of minor laws is it ok for the board to make a considered decision to allow
this to continue – After Stone v. Ritter, no such reasoned decision is not going to be allowed,

Pg 403

5. Not following up, i.e. looking at the results of the monitoring system. Have to look at possible
misconduct and an obligation to resolve possible misconduct. The responsibility to monitor this
rests with an audit committee.

Tuesday: P.576-588, Wednesday: 588-600, 607-14, Thursday: 614-18, 623-28

10-5, 6-2010
CLOSELY HELD CORPORATIONS
VOTING ARRANGEMENTS: p. 576 – 600
# The institution most often referenced by the word "corporation" is a publicly traded corporation, the shares of which are
traded on a public stock exchange (e.g., the New York Stock Exchange or Nasdaq in the United States) where shares of stock of
corporations are bought and sold by and to the general public. Most of the largest businesses in the world are publicly traded
corporations. However, the majority of corporations are said to be closely held, privately held or close corporations, meaning
that no ready market exists for the trading of shares. Many such corporations are owned and managed by a small group of
businesspeople or companies, although the size of such a corporation can be as vast as the largest public corporations . Look
more at Wikipedia!
* We discussed differences between closed and public corporations (advantages and disadvantages);
number of votes depends on number of shares someone holds, not like in public corporation …

A closely held Corp (or a closed corp as they are the same) has 2 characteristics

1) Lack of a secondary market (primary is IPO) – you can’t sell your stocks and move on, thus SH
look to govern the company more
a. Desire for active management since they can’t sell out
2) Has a small number of SH but this is not necessary and essential feature (majority of closed corp
are small)

Will look at a couple of voting mechanism

1) Voting for the Bd.
2) Voting for Officers

Definitions:
Proxy/irrevocable Proxy (D.G.C.L. 212 e)) –
• A grant of authority by 1 party to the 2nd party authorizing the 2 nd (holder of the proxy) to act or
to vote shares as a substitute for the 1 st party.
• Proxy is normal proxy
• Irrevocable proxy – a proxy is coupled with an interest usually meaning that the transfer of
authority and the right cannot be taken back

Voting trust (D.G.C.L. 218 a), Wikipedia is a good source)–

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• A statutory mechanism whereby SH (stock holder) formally transfer Stock certificate and the
voting right that accompanies that certificate with them to a trustee
• Pursuant to a trust agreement ( can be in various degrees of specificities, from … up to a complete discretion of
the trustee; can last maximum 10 years as duration ), the trustee votes in a specified way and returns the
dividends to former trust owners or i.e. the “trust beneficiaries” i.e. the ppl who were the SH
• It formally separates the voting rights and the economic rights
• See it a lot in family businesses

Vote Pooling Agreement – D.G.C.L. 218 c)

• Agreement by SH to vote for themselves or their representatives as directors
• Not formal in the sense that it needs to be filed, is more of a K

Cumulative Voting – D.G.C.L. 214

• You id the number of shares times the number of vacancies and a SH can choose to put all their
votes to vote for 1 guy, 2 guys or 3 guys.
• So if have 100 vote split by 30, 30, 40 for director A, B and C
• In the Ringling case
Different classes of common stock and give each SH all of the shares and say that class of Common Stock
can elect a member of the board

Ringling Bros. – Barnum & Bailey Combined shows v. Ringling – De, 1947
Facts – 2 people with Minority Shares enter into a K to combine their shares and vote for certain
directors. There are 7 directors, and they each, if they vote appropriately, can chose 2 Directors of their
own choose but with combining votes they would choose another one (altogether 5). Should they not
agree as to who will be on the Bd., i.e. the 5th director, they K to resort to binding arbitration. In 1947
they cannot agree and the Arbitrator tells them to vote a certain way. Mrs. Haley, one of the contracting
parties, does not follow his instructions, both to adjourn the meeting or vote for the chosen candidate
and P, Mrs Ringling, brings this suit. TC says that the Agreement was valid as a “Stock Pooling
agreement” and that thus a new election for Bd. should be held.
Rule – SH may join together to pool their votes to choose directors
Analysis –
• The K said that the parties were bound to act as the Arbitrator said, but not that the arbitrator
could vote for them
• Also the K did not give the voting rights of one of the parties to another
• Statue does not bar pooling arrangement only pooling trust (is this true?)
• Owning voting stock does not mean that there is a legal duty to vote. And SH may combine to
vote for their common advantage
• Failure to vote as required by the K was a breach of K by Mrs. Haley
• However the Court will not frustrate the other voters by the failure of Mrs. Haley to vote, thus
the election is not invalid
o We will only invalidate Mrs. Haley’s vote, resulting in all choices of Mrs. Ringling to rise to the
Bd. and the one vacancy which we will not decide on
Holding – Mrs. Haley’s votes are nulled and all on Mrs. Ringling’s choice will ascend to Bd. as will Mr.
North’s
Could have given the arbitrator an irrevocable proxy
The Pooling agreement could have been terminated in 10 years or by mutual agreement
Mrs. Haley’s defense for not following the Pooling agreement – says that this is a failed voting trust not a
vote pooling agreement and that there was no irrevocable proxy either.

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De SC says – remedy is that the votes of Mrs. Haley are thrown out and the rest of the votes given effect
* Edith Ringling 315 as well as Aubrey Halley while John Ringling 370; agreement for 10 years which
could not be revoked unless there was a mutual consent; 1945 there was a fire, many deaths at the
circus… as a backdrop why these two went into disagreement in 1946; because of that disagreement,
North Ringling got opportunity to elect the fifth member of the board; P alleged there was a
manipulation of elections;
Dunn, a person determined by the arbitrator to be the fifth member of the board, did not have an
irrevocable proxy (he also did not have any interest in the corporation) so it could not bind the shs so the voting
agreement was ineffective; but you can have vote pooling agreement which does not have to rise up to
irrevocable proxy to become valid! Even though Halley won in voting (5:3, 2 Halley plus votes from Mr.
Ringling), she brought the complaint because Mr. Dunn was appointed…; by breaching the agreement,
Mrs. Halley’s votes were tossed out and Mrs. Edith Ringling won the voting by 3:3 which was a deadlock!
Ultimately, Edith Ringling sold her shares afterwards.
- Enforcing pooling agreement, you’d add a provision for irrevocable proxy which would prevent
successful attempt to revoke the agreement!

McQuade v. Stoneham – NY, 1934

Facts – P, McQuade, is a magistrate who bought shares in the Giants owning corp. D McGraw, owns 70
shares but majority is owned by D Stoneham. All 3 owners strike a K that Stoneham will be voted Pres,
McGraw Vp, and P Treasure with all of them getting fixed salaries. A board was to be elected, with the
three owners and 4 “disinterested” who were effectively in the control of Stoneham. At a time, the 2 D
refuse to elect P to the board or as treasurer and elect Bondy (another man), because Stoneham no
longer likes P. P brings this suit challenging their actions. TC won’t allow P reinstatement but gives him
damages.
Rule – SH can unite to elect directors, but cannot untie to control the directors have an agreement to
vote in a way that won’t allow directors to change officers, or control any of the directors actions. Sh
cannot agree to impinge on the directors independence
Analysis –
D – K was void as any K which tell directors to Vote for a particular person as an officer is illegal
P =- Agreement amongst directors to keep a man in office cannot be broken as long as the officer is
working in the interest of the corp. So the entire Contract is wrong.
• SH cannot control the judgment of the directors
o Bad faith of the parties does not change this since the court will not look to enforce morals
• Sh may combine to elect directors
• P says he’s looking out for minority SH, but he is the only one complaining
• A trustee would be held to a higher std but D were not P’s trustees. Their duty was to the corp
• Furthermore, the Magistrate was barred by NY law to engage in any other business or
profession. Hence, this was an illegal K.

Concurrence
• Agrees with the second statutory provision
• K was legal since it said that the 3 SH would act with one voice for achieving a particular
purpose, and not to control the action of the directors, but rather to vote them in. True?
Holding – K is void
- What could McQuade have done to protect himself – he could have set up an employment contract
from the board, also a contractual mechanism to give him a buyout.
* Stonehan 1166 shares, McGraw and McQuade each 70, others 1194 = 250 shares. P.586; you would
advice McQuade three options: 1) voting pool agreement, 2) employment contract like 10 years (as long

44
as possible) which is protection for him 3) and the third protection is buyout arrangement (FORM ON
P.173/74)!!! P.591: NY business law 620: how directors should manage corporation…

Clark v. Dodge – NY, 1936

Facts: Defendant companies, Bell & Company, Inc. and Hollings-Smith Company, Inc., were co-owned by Plaintiff (25% of
shares) and Defendant (the remaining 75% of shares). The companies manufactured medicine, the formulae that were known
only by Plaintiff. Plaintiff entered into an agreement with Defendant wherein Plaintiff agreed to disclose the formulae to the son
of Defendant in return for a promise that Defendant would keep Plaintiff as a director and would be entitled to 25% of all net
income providing that Plaintiff was competent in his position. Afterwards, Defendant did not vote Plaintiff in as director,
stopped delivering 25% of the income to Plaintiff. Plaintiff sought reinstatement and money owed from the stopping of
payments and money wasted by Defendant. Defendant countered, citing McQuade v. Stoneham (263 N. Y. 323), that the
agreement was invalid because it required Defendant as a shareholder to usurp the directors’ judgment .
Rule – When the directors are sole SH, a K between them making them vote for certain people as
directors is OK
Analysis –
• NY GCL § 27 says that the business of the corp. is the province of the Bd.
• McQuade said that the SH cannot tell the directors who to vote into as officers
o This provides a simple but arbitrary test
o If a K does not damage anybody, then there is no reason to hold it illegal
• Besides the dicta in McQuade there is no reason to hold this K Invalid
• §27, is negligibly effected
Holding – Finds for P
McQuade court would probably strike down the following:
• Electing Clark as a GM
• Setting dividends and salary
• Setting salary for peeps
So far as it does not hurt 3rd parties an agreement whereby directors pick officers is ok.

Can the Bd. have its decisions interfered with?

Since then the NY Business law has been changed. NY Business Corporation law §620 now says:
1) An agreement between 2 or more Sh may that their votes be voted in a certain way
2) A provision in the certificate of incorporation, otherwise prohibited by law because of
restrictions placed on the Bd. can still be valid if
1. All SH (regardless of whether they have voting powers or not) have authorized the provision
2. If shares are then transferred to people who had notice of or consented to the provision
* We won’t spend too much time on this case but it tells us what happened after the McQuade’s case.
McQuade is struck down in here and the K is upheld because there no shareholders were harmed
(p.590)! No minority shs to object and no harm to public, creditors, future purchasers of stocks…
NY Section 620 as an updated version: which was not the case in here because it was adopted after
these cases – p.591 look! Voting pool agreement and others, look differences… Part a) would be always
valid while at least part b through d would be invalidated if there is a, let’s say, another 3 rd party as an
minority sh here!!!

DGCL §141(a)
a) All business of the corp. should be done by the Bd., but they must take into account any
provision in the certificate of incorporation
- Who has the power now to choose officers?
DGCL §142(b)
b) Officers are to be chosen per by laws or determined by Bd.

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- NY Business Corporation law §715(b) – certificate of incorporation may say that the SH will directly
elect the officers
California Corporations code §312(b) – except as otherwise provided by bylaws, officers to be chosen by
the Bd.
- Note on SH agreements, voting trusts, Statutory Close Corp and Involuntary Dissolution:
Pooling Agreements:
• Agreement where SH commit to electing themselves as Directors
o Not controversial as does not interfere with the obligation of the director to use his “sound
judgment”
• Courts have a harder time as to what to do with SH picking officers, as it deprives directors use
of own judgment
o Modern view in Galler case below says that such agreements are enforceable for closely held
Corp provided that all SH agree by signing.
Voting trust:
• A devise specifically authorized by state statutes
• SH who want to act in concert turn their votes into a trust, where the trustee votes per prior
instructions
• Often used to maintain control of a corp by a family or group
• Generally must be made public 0 DGCL §218
Statutory Closely held Group:
• Allows a corp to elect close corp Status
• Eg. DGCL 342(1) – Allows Closely held status if not more than 30 SH
• 351 – Certificate of Incorp may provide that he SH not the directors will manage the corp.
• Advantage: - Can avoid certain Corp formalities
• Disadvantage – Most of the goals of Close corp. can be done by using bylaws, ancillary
agreements, employment agreements and buy sell agreements
• LLC – Issues of control left to the individual’s choice, i.e. may be member managed as opposed
to manager managed in a corp.

Involuntary dissolution by court:

• Development of provisions allowing for involuntary dissolution
• Can serve as bail outs for SH who have not entered into effective control or buy sell agreements

Galler v. Galler – Illinois, 1964

Facts – Brothers, want to provide for their families until the last passes away. Enter K, which provides for
appointing directors of the company, that the spouse will be able to nominate directors in case one dies,
and a dividend provision. After one brother dies, the other reneges on the deal, and says that best he
can do is allow the dividend be provided. P sues for specific performance. Appeals court finds for D.
Rule – Parties can reach an agreement when there is i) no fraud, ii) no complaining minority interest iii)
no injury to the public or creditors iv) No statutory prohibition v) i.e. reasonable terms
Analysis –
• Close Corp defined as – stock is held in a few hands and it rarely bought and sold
• Policy reasons why detailed SH agreements ahead of time are needed:
o In a closed corp no market for the aggrieved SH to sell his portion
o Without judicial oversight a large minority SH may find himself at the mercy of an oppressive
majority
o Hard to get independent Board oversight free from the personal motivations
• The K does not fail for indefiniteness since Emma’s life expectancy was ascertainable

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Holding – Finds for P and requires specific performance

Would NY come out the same way? – No because Rosenberg didn’t agree, NY requires unanimity
The contract was found valid b/c:
• it did not violate public policy, purpose was valid (taking care of a widow)
• was not of indefinite duration (life of the widow)
• did not violate rights of a minority shareholder (5% ownership)

Though agreement wasn’t unanimous, following factors

o closely held corporation
o no objection by any minority shareholder (the one there was sold out)
o agreement’s terms were reasonable
§ parties didn’t expect agreement to last a long time
§ dividend payout only if company made up to certain amount
§ payment to widow was reasonable amount.
* Check the case on ecasebriefs.com! Very unusual decision for the Court to uphold the K brought not
by a unanimous decision!

10-7, 12-2010
OPPRESSION AND ABUSE: p.607-19, 623-28
There can be squeeze out, because close corporation does not pay dividends because salary and
bonuses are deductible expenses but dividends are not. Thus salaries and benefits and other benefits is
the primary way to provide a return on the investment.
* Freeze out, two parts: denial to participate in the management of the company and second part is an
economic harm (return to investment). Closely held corporations usually do not pay dividends but rather
salaries, bonuses, and retirement benefits.

Wilkes v. Springside Nursing home – Ma, 1976, FAMOUS CASE AS TO FIDUCIARY DUTY
Facts – 4 SH each get 10 chares each and there was an understanding that all 4 would be directors,
participate in management and get salaries as long as they participated equally. No dividends paid. It was
an informal understanding, i.e. a SH agreement. The income received is in lieu of dividends. Then there is
bad blood between the parties after many years. So Wilkes says that he’d leave, and there was a
directors meeting held which took away Wilke’s salary and didn’t re-elect him as director. Wilkes was not
guilty of any negligence
Rule –
Analysis –

 Sh in a close corp. have almost the same duty to each other as that in a partnership i.e. a duty of
utmost good faith and loyalty
 Sh may not act out of avarice, expediency or self interest
 In Close corp. Sh may freeze out minority SH resulting in the minority having to sell at below mkt
value
 An effective freeze out is when minority SH are not given corporate offices and employment in the
corp since this is often one of the main ways ppl are compensated for their partnerships
o Courts have been unwilling to step into internal corporate operation
 Main way ppl get money court of corps is through salaries, bonuses and retirement benefits
 However the majority also have certain right which must be preserve, i.e. “selfish ownership”
which must be balanced against their fiduciary obligations
 Balancing test:
o 1st Majority must show that there exists a legitimate business purpose for its action
 Groups must have some room to maneuver

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  Must have discretion in declaring dividends, merging, establishing salaries,
dismissing directors with or without cause and hiring and firing officers
o 2nd If Majority meets 1 above then it is up to minority SH to demonstrate that the same
purpose could have been achieved in a way that is does not harm the minority as much
 Applying these principles here we see that P was frozen out here and for the sole purpose of
buying his shares below market
Holding – For P
Widely accepted, including NY as opposed to the Wile
Two steps WILKES TEST:

1) Maj SHS have to show a legit business purpose

2) Min has the burden to show that the same objective could have been done in another way.
 In this case there was no showing of any legitimate business purpose. i.e the other Sh were
greedy and men spirit
 Assume that the Majority SH met the Step 1 in this case, how could they have passed under step
2- They could have shown a better way of affecting the same result and being upheld by the court
by paying him dividends
 They could also have created some legal agreements such as a the buyout agreement in page
173-174
 Give each party an employment agreement, so P would not have to appeal to equity, he could
appeal to K law
 Get a written SH agreement
He is a minority since Wilkes is controlled by the other SH
* There was only an understanding between the parties and not employment K or any sh written
agreement like in the Ingle’s case. Salaries were paid out to the parties and no dividends were paid or
return on investment. P was even trying to get a higher price for the piece of the corporation’s property
(no bad faith or negligence that would justify him being kicked out from the job) but in any case the P was
not re-elected as an officer. Wilkes Test (look at above);
If the P was negligent, like did not come to work and so on, so the first prong of the test would be satisfied
but the second part, the P could argue that he could’ve got a lower position in the company or the Ds
could pay him out a fair price of his investment in terms of dividend payments which would buy him out of
the corporation. NY follows the Wilkes case which may be surprising…
- Also, look at p.627: Nixon v. Blackwell, De, 1993 opinion.

Ingle v. Glamore Motor Sales Inc. – NY, 1989

Facts – P buys shares from D and there was an agreement that D could buy his shares out if P stopped
being an employee for any reason. In return P was to be voted a director and employee. After a while D
fires P and buys out all his share. P does not contend that a price paid for his shares were bad, just that
he was protected from being fired despite the lack of any employment K. P says that the buyback clause
was putin in case he died so that the D could keep the shares.
Rule – Dudes an at will employee and gets no obligation of good faith and fair dealing, duty absent
contract
Analysis –

 Must distinguish between duty to Sh and duty to employee

 Corp could always discharge an employee at will
 There was a K between the parties and taking a strict reading that is what happened here
Dissent –

 Majority took a literal reading of the K

 P wants to keep his stock not sell it
 Plus are you really going to tell me that P should be pleased with a return on 96k on a 75k outlay
for 17 to 15 yers
 Read the plain meaning of the K in light of the entire agreement

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Holding – Defendants do no owe Plaintiff a duty to keep Plaintiff indefinitely as an employee as a result of his
minority shareholder status. Traditionally, an employee is an at-will employee if he does not have an employment
agreement that gives a duration for the employment. This situation does not change when an employee attains
shareholder status, especially when there is a provision in the shareholder agreement that allows the majority
shareholder to buy back Plaintiff’s share if he is terminated for any reason. Plaintiff never asserted that the buyback
amount was unfair, and therefore he suffered no harm.
Synopsis of Rule of Law: absent an employment contract, an employee is an at-will employee when his
shareholder agreement provides a buyback provision of his shares if they are terminated for any reason.
* P ends up with 40% of shares of the company; D, Glamore, kept a little over 50%;
NY is one of the most harsh employment-at-will enforced K for whatever reason! Arguments in the case
as to D: separate issues of employment K and fiduciary duty towards minority shs, D squeezed out from
the corporation.
- Next Tuesday: quickly over 623-28, but big thing unit 21; Wed: 467-82; Th: 490-98 plus BB

Smith v. Altlantic Properties – MA, 1981, p.623

Facts – Wolfson has 25% of corp. but institutes a supermajority (80%) to pass anything, i.e. a veto power
in the articles of incorporation. One of the person was that profits kept accumulating because each SH is
in diff Tax bracket and Wolfson is n a higher tax bracket, so much that there is a tax penalty charged
against the corporation because of Accumulated earnings. P want i) Wilson be removed as a director, ii)
Dividends be paid out iii) Wilson pay out the amount of tax penalty for accumulated profit
Rule – Idea that Wilkes ruling does not just apply to the majority, but also to any controlling SH
Analysis –

 Incurred substantial tax penalty and legal expenses because of wolfson’s decisions
 Majority, in case of a deadlock, can normally seek dissolution of corp. with a 40% - what is the
point of FN 6?
 Minority here has an ad-hoc controlling interest
 Refusal to minimize losses to the corporation justifies charging Dr. Wolfson for losses suffered by
Atlantic.
o No relaxation for duty of utmost loyalty and good faith when applied to a minority ad-hoc
controlling interest. Analysis to be done on a case by case basis
Holding –
A Super majority provision, without a way to break the deadlock, is stupid. Have a way out.
The harm to the corporation was the tax penalty; hence the court smacked Wolfson down!
There is a difference between the DE line of cases as applied to the squeeze out.
* Supermajority voting provision (anything over 50%); D claimed he wanted to reinvest the money but the
Court did not believe him. Wilkes kind of cases apply also to minority shs and not only to majority.

Nixon v. Blackwell – DE std, 1992

Has rejected the Wilke’s test and has required SH in closely held corp. to bargain for contractual
protection, i.e. vote pooling agreement, employment agreement. Will not allow a court-imposed buyout
when the party’s have not negotiated one. No judicially created rules for the minority, when the parties
have not negotiated one.

Dissolution: in essence for closed shared corporations: besides breach of fiduciary duty, P can also ask
for dissolution in all 50 states now: court ordered liquidation of corporation assets and distribution of them
to creditors and shs;
It’s a statutory remedy for Minority SH who have been unfairly treated by SH and sometimes for deadlock.
Look at the state of Incorporation and use that states law
4 typical categories:

1) Deadlock Among directors – Minority can seek dissolution (like in Smith)

2) Deadlock among SH – huh? amount or among? I think Among hence changed (like in Smith)
3) Waste of Corporate assets – corp is so paralyzed by inaction
4) Abuse or oppression of minority SH (like we’ve seen in Wilkes)

49
Oppression defined as (NY, NJ also) – Conduct that defeats the reasonable expectations of Minority SH
to management or to get employed by Company; fairly broad definition;

 Since dissolution is such an extreme remedy, many state courts allow the majority to buy out the
minority at fair price. Judges have equitable discretion; Court will step in and help the parties
negotiate a provision. Sometimes this is done even without statutory provision, i.e. the court using
its power of equity
o In DE however, per Nixon vs. Blackwell, courts will not allow dissolution or buy outs,
instead shs are required K protection prior investing into a closed-shared company!

10-12-2010

Federal Securities Law

2 statutes passed during the great depression:

1) Securities act of 1933 – Affects on Primary market transaction (new issues of stocks; wont’ really
study much)
2) Securities exchange act 1934 – governs secondary market transaction (we’ll cover: securities
fraud, and then insider trading, and then proxy… solicitation…)

Purpose:

1) Protect investors
2) Secure public confidence in the integrity of the securities mkt

C. SEC – Rule 10(b); most important Rule 10(b)-5 (look at p. 438 Professor mentioned)

It’s a general anti fraud provision; not only to publicly traded securities but also securities of any kind like
close-shared company!); SEC: chief G agency, 5 agencies consisted of various specialists; besides
protection of interest, also public interest;

Actions that you can bring:

1) Private actions – example the Basic v. Levinson case (individual versus corporation and so)
2) SEC actions – SEC is charged with enforcing (only on civil level and not criminal)
3) Criminal actions - If its US v. Blank then it’s a criminal action as opposed to SEC v. Blank then it’s
a SEC civil action (any willful violation of securities law)
1. When there is a conflict then Federal law pre-empts

Elements of private COA (cause of action) under rule 10b-5 looks like this:

1) Misrepresentation or omission to state material facts… (from p.438)

2) Materiality – what Basic is known for, i.e. is applicable for all 10b actions
1. A fact is material when a reasonable SH considers it important in how to vote (i.e. buy,
sell and hold) but to be seen in the total mix of information.
2. Balance the probability that the event will occur against the magnitude of the event in
light of the totality of the company activity
3. Material facts probability
1) Board resolutions
2) Instructions of I bankers
3) Actual negotiation
4)

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 4. Magnitude
1) In a merger case – Going to be easier for the P to establish
5. Materiality is determined at when the statement is made
3) Scienter
1. Intent to defraud, intent to deceive, recklessness will suffice, i.e. making a statement or
making a statement with reckless disregard of the effect of the material statement ( in
criminal case, there has to be found actual intent and not only reckless!)
4) Reliance
1. Fraud on the market theory - No need to show individualized reliance, just that securities
professionals would have relied on these statements (this is presumed)
2. Corp can rebut this presumption 2 ways
1) Rebutt the fraud on the mkt theory – there is no such thing, things just leak out,
so no one was fooled, i.e. no one relied on the statement or omission
2) Individualized rebuttal – a particular P did not sell based on Mkt price but for
other reasons, kids tuition etc.
5) Loss Causation
1. Loss causation i.e. the Fraud or Misrep did cause the P loss (like decline of the value of
the stock P hold on to it and so on…)
6) In connection with purchase or sale of securities
1. SC has ruled that the P has to have purchased or sold the security ( meaning, thinking of
buying is not enough, the SC narrowed the scope of standing for private actions )

SEC and Fed Govt only need to prove 1-3 above not the -6 which is only required of Private COA

Basic v. Levinson – US, 1988; look at also ecasebriefs if needed!

Facts – Combustion interested in buying Basic but back out because of Anti-trust issues. Then restart
negotiations. Basic Stock is volatile but says that its not being taken over. Then stop stock trading on
NYSE as its being take over. P, are basic SH who sold their stock alleging violation of 10b.
Rule – test noted above in the outline
Analysis –

 A fact is material when there is a substantial likelihood that a reasonable SH would consider it
important in deciding how to vote
 Materiality when the disclosure of the omitted information would be found by the reasonable
investor to have significantly altered the total mix of info available
 P suggests applying the “agreement in principle” test – not material till agreement in principle
made. Policy justification:
o Investors will be overwhelmed by information
 Bubkiss as
 Assumes investors are nitwits
 Purpose of SEC act was to have full disclosure
o Preserve the confidentiality of merger discussions
o Easy bright line test
 Materiality depends on a balancing of probability that the event will occur and the magnitude of
the event
o Mergers Discussion as it deals with birth and death of a company is high magnitude
 Size of companies
 Potential premiums over Mkt Value
o Fact finder needs to look at the indicia of interest as noted by: (Goes to probability)
 Board resolutions
 Instructions given to I bankers
 Actual negotiation between companies
 To be actionable the statement must be misleading
 Reliance (all buyers and sellers between the first material… and the suspension of trading at the NYSE in this case)

51
 o Fraud on the market theory – In an open market Securities are priced on material
information, thus misleading statements defraud stock purchasers, and prove causation
as well
o Fraud on the market theory (P had reliance on the market price; average buyer cannot rely because
he/she did not do market research but rely on sophisticated investors! ) gives rise to a rebuttable
presumption (is an assumption made by a court, one that is taken to be true unless someone comes forward
to contest it and prove otherwise); efficient capital market theory ECMT (semi-strong…)
o Don’t need individualized reliance in a Class action as it’d effectively bar a class action
suit
o D may rebut presumption by:
 Showing that no change in price occurred
 Mkt Makers were privy to the truth about merger discussions
 P would have traded anyway
 Sold shares because of political pressures to sell shares of certain
business
 Antitrust problem
Dissent: Justice White: does not accept efficient capital market theory
Holding – a
Rejects bright line tests and uses a balancing test.
Materiality is determined at when the statement is made
There is no obligation to disclose that they are about to merge, the only duty is if the Corporate does
make a statement it has to be accurate
Advise to Corp officers –

 Don’t say anything i.e. you can say no comment

 If a company makes a lie but the lie is not material can the officers be held responsible? No
because materiality is a necessary element

Judicial Limitation on 10b-5 actions

Standing - Bleu Chip Stamps v Manor drugs – 10b-5 can only be used by buyers and sellers of a stock
Scienter – Person making the false statement did so with intent to deceive, manipulate or defraud
Secondary Liability & Scope of interpretation – no Liability for anyone who aids and abets. Courts
must use 10b and 10b-5 to see the scope of conduct prohibited
* General test out of Rule 10(b)-5 from this case and many others: test for materiality TSC Industry
Standard (any fact that is material that a reasonable sh would consider to buy or sell shares); Speculative
or contingent event that the C adopts on p.443; probability ( here is low) and magnitude (high because of the
merger here) – even a slight rumors about merger negotiation is relevant because of its huge impact; if the
merger has never gone through unlike what happened: the P would be able to establish materiality even
though maybe not for security fraud … Agreement and Principal Test: the Court did not accept this test
here because investors are capable of making their own decisions (the Court do not want to
paternalize). FN 17 p.444 (silence is not misleading and can be permissible so long as is not misleading
statement); Reliance base: look above…
- Rule 10 b) is a Congressional statute and is very broad which gives authority to the SEC which
promulgate rule 10 b) 5); there are other statutory requirements but we’ll not discuss them; disclosure
as soon as possible is the best advice although company officers dislike the idea to disclose information
dealing with preliminary negotiations.

10-13-2010
467-482; then 490-498 in addition to a case on the BB; the following Tuesday, p. 483-490
Insider Trading and the Use of Inside Information
Theories of Insider Trading

52
 1) From rule 10(b)(5) – Classical Theory (in TGS case): Disclosure or abstain rule (“Classic theory”)
2) From rule 10(b)(5) Misappropriation (O’Haggan case)
3) Exchange rule 14e-3 (tender offers)
4) Tipping (most complex)

Policy justifications to allow insider trading–

 Its compensation for insiders and doesn’t’ hurt people with long positions
 It’s an additional method for insiders to disseminate information to the mkt

Goodwin v. Agassiz – Mass, 1933

Facts – In March, D Agassiz (president of the Cliff Mining Company) and MacNaughton (just a Michigan resident not
D), learn about a geologist's theory that there would be copper deposits in an area. In May, Cliff Mining
closed down an unsuccessful exploration. Also in May, D bought 700 shares of Cliff Mining Co. on the
Boston Stock Exchange. P, Goodwin, learned that exploratory operations, in newspapers, had closed and
sold his shares which are the shares D bought. Only D had knowledge about the geologist’s theory. D did
not disclose because D wanted to buy nearby land. D also was director of another company…
Claims he would not have sold shares if he knew about the geologist's theory P sells his stocks at the
exchange.
Rule – Dir. have no duty to SH under the common law; although today … ( the Court made distinction about
fiduciary duty for corporation and shs)
Analysis –

 When Directors seeks to buy shares without disclosing material facts courts will scrutinize
 Director had duty to Company
 No duty to set forth their plans, i.e. was still in its nebulous stages
 D made no representations to anybody
Holding – a
Factors the court found relevant in exonerating D

 Legal reasons for the Courts decision

o Speculative
o Directors do not have a fiduciary duty to stock holder
o Since no face to face txn
o There was no duty owed to the existing shareholders, then how can there be a duty to
people who do not even owe the stock
 Social policy reason for Courts decision
o Directors would also harm cliff mining company with disclosure
o Restriction on trading since people are handcuffed form exploiting information

BUT THEN COMES ALONG THE FOLLOWING CASE AS A BIT SURPRISING FOR CORP: there is a
duty of directors not to purchase stocks from the corporation shs when directors have material facts
others do not have:
SEC v. Texas Gulf Sulphur Co., 1969
Facts – In early November TGS drills an exploratory drill showing high mineral content but keeps the
results secret. TGS stops exploratory drilling and buys surrounding land. While buying several TGS
employees and their tippees bought TGS stock and options. On April 11 the news of the potentially large
mine gets into the newspapers. On April 12 a press release from TGS said the news reports were false
and there was no conclusive data on the mine. On April 16 an official statement from TGS announced
they had found a mine of at least 25 million tons. Company says that the statements made were not
fraudulent.
Rule –Directors should disclose or abstain if they come across material information
Analysis –

53
  Anyone with material inside info (doesn’t have to be a director or management) must either
disclose it, or not trade on it
 Congress no longer to allow insider to use inside information as a sort of compensation
 Material Inside information
o Reasonably certain to have a substantial effect on the market price of the security, i.e.
will make a reasonable investor buy/sell hold
o Balance Probability of event and the magnitude of the event
o Application to the case
 It was material as it was a bug find and they had to know it’d affect mkt price
 D bought tons of shares and options. They HAD never bought options before so
they knew it’d affect mkt shares.
 D might trade after a reasonable waiting period i.e. wait till it appears in a wide circulation
 Purpose of act is to protect the investing public
Holding – Remands fto see whether a reasonable investor would find the information material
Court says, all the SEC has to show that the information would influence mkt actions
Cases against individual defendants for insider trading
Assessed materiality suing foll:

 The call option was never bought by these people before, plus these were short term calls, i.e.
that he prices will go up dramatically in the short term
 The drilling was unusually good
When can insiders trade - TGS says that the information has to be disseminated i.e. publicly available, i.e.
reasonable waiting period

Directors should disclose or abstain if they come across material information

 Based on the trust, i.e. duty between the directors and SH with whom they are trading
 So the imp question is does the D owe a duty to the person with whom they are trading (always
ask yourself this question at a 10(b)(5) cases

Reasons why TGS did not disclose the information

 Because they wanted to buy up the surrounding land and wanted to keep the prices down.
 Why was there no duty for TGS to tell the landowners to disclose, i.e. you cannot affirmatively lie
to people
* This is a civil action brought by the SEC unlike the previous private action case; D mislead press
release; D: press release was not really deceptive and such deception if existed was not in connection
with purchases with the stocks since …; Call: option to purchase stocks at a fix price for a limited time
period.
There’s no any specific time period but you have to wait until info is fully disseminated; you have to give
people not in privity not only to see info but also to absorb them! Usually and typical is 48 hours after
public announcement which is probably more than needed so company directors might be in a
disadvantaged position.

10-14-2010
Chiarella v. United States, 1980
Facts – Tender offer stuff going to a. D figures out what the offer is, i.e. which company is going to be
bought. D had a specific duty not to use the stuff. D bought and later sold at a higher price shares.
Rule – Need a Duty to violate, not a general duty not to use info
Analysis –Here Chiarella at best had a duty to his Er, but not to the SH or to the market in general
Holding – a
We’d expect that Chiarella would be held responsible under 10(b)(5) but the SC says not guilty of insider
trading because he had no duty, i.e. have to have a relationship of trust
Court said that Chiarella had a Duty to his employer, i.e. the company that is buying the shares, not to the
acquiring company.

54
Shows that the breaching party has to breach a duty between the insider and the trading partner
Famous for undercutting the parity of information concept in TGS
* Tender offer (we’ll cover in detail later in class) is invitation by a bidder (tender offerror) to shs of the target
company to submit to tender their shares for purchase by a bidder at a specified price. Right at the
announcement of the offer, share price of the acquiring company goes up so that’s why it attracts scrutiny
by the SEC and others. Mergers are often friendly acquisitions but tender offer does not have to since
there’s no requirement of friendliness with the board of directors.
D made only $30k and he was not a sophisticated trader but anyway the SEC opened an investigation
where D, by negotiating, gave back $30k and subsequently got fired by his employer. Later, D also got
convicted under criminal charges under Rule 10b)5) which is the first criminal prosecution in history of the
U.S. under insider trading. D was not an insider and he only violated his job policy rules. D was a blue
collar guy and had fewer resources to defend himself like other CEOs etc…;
Chiarella implications: D had material information; his conviction is overturned but he still is in personal
trouble by paying his lawyers, lost his job, returned profits made; Court compared TGS and this case –
TGS owed duty to corporation and shs while in this case Chiarella did not owe the duty to anyone except
indirectly to through his employer to the acquiring company! There was no trust and confidence, which is
required for liability, between the D and shs of the traded company (no fiduciary duty); no corporate
insider. SO CHIARELA IS NOT LIABILE UNDER CLASSICAL THEORY BUT TODAY THERE ARE
OTHER THEORIES HE MIGHT BE CRIMINALY LIABLE FOR LIKE: RULE 14e)3), misappropriation and
one more…
- WHEN CLASSICAL THEORY APPLIES AND WHEN MISAPPROPRIATION APPLIES FOR THE
EXAM!!!
- Current policy is that an insider trader violator need to pay back three times as much as profit that
person gained.

US v. O’Hagan, 1997
Facts – D firm reps a client who was planning a tender offer for Pillbury. D buys shares in Pillsbury. He
was also was embezzling money from the clients and firm.
Rule –
Analysis –

 Classical theory arises from Duty of insiders and their agents (temporary fiduciaries)
 Misappropriation theory
o Fraud is committed when a person misappropriates confidential info to trade thereby
breaches his duty of loyalty and confidential to the principal by removing form the
principal exclusive use of that info
 Duty is to the sourse of the information, nto to a trading party
o Security must be bought or sold
 14e – Pg 495
o Applies to tender offers
o Only for tender offers
o Offeror must have taken substantial steps to commence a tender offer
o Applies to anyone in the employ or an agent of the Oferror
o No duty requirement
Holding – a
O’Hagan owes no duty to Pillsbury, the target.
Court says that there was no Duty to Pillsbury, but says that he misappropriated – saying that you owe a
duty to the source of the information, i.e. to the company. So here D owed a duty to the law firm and to
the acquirer.
No if he had traded on this information and told his fellow partners, and the acquiring company, it would
not be unethical and not illegal.
One of the reasons some people objected to this decision was the fear that in essence it was criminalizing
a workplace rule.
Rule 14-e i.e. a separate section of the exchange act i.e. not 10(b)(5) this is a specific section dealing with
tender offers

55
14e-3 –

 Forbids trading, sweeping because it dispenses with the duty requirement i.e. duty with either the
source or the trading partner.
 Not triggered till Offerror has to have taken substantial steps (which is defined pretty broadly).
 Only applies to tender offer (i.e. not to mergers)
 Does not apply to other sensitive information such as drug approval
 SEC enacted this to overcome the ruling of Chiarella
 Ginsburg takes a very broad discretion approach to SEC’s ability to bring such an action

Two new ways that the SEC is trying to close down loopholes

1) Rule 10(b)(5)(1) – responded to an argument that said that SEC must show that the D used the
info not just that they had the info.
1. Makes it clear that just possession of the Insider trading info is enough
2. Some affirmative defenses to exist
1) If an individual has a trading plan, i.e. I’ll sell stocks at a specific price, at a
specific time. Buthtis is very narrow, i.e. has to set the date and the amount
traded
2) Rule 10(b)(5)(2) – About more informal information, i.e. info that you get form family. That kind of
information can allow a cause of action under misappropriation. Responded to the Chessman
decision
1. This rule specifies 3 situation where the person has a duty of trust
1) If you have a contract to keep something secret, if you then trade on that info
then its misappropriation
2) If you have a pattern of trading with your best friend
3) Duty exists when someone gets certain info from a spouse, child, parent or
sibling (this is a presumption, which can be overcome by showing that you
betrayed your family all the time)

* The D did not owe duty to the target corporation but to his client’s corporation! The prosecutor would
rely on both 14e)3) and misappropriation in prosecuting the D. Also p.494. For the next Tuesday:
problem solving day and for Wednesday Dirck case

10-19-2010
All these are rules promulgated by the SEC; theories of Insider Trading coming from Rule 10b)-5):

1) Classical theory comes from the Exchange Act section 10(b) became the SEC promulgated rule
10(b)(5)
1. Usually people look at prong a and c for prohibitions
2) Misappropriation comes from the Exchange Act section 10(b) became the SEC promulgated rule
10(b)(5)
3) SEC Rule 14e-3 comes from Exchange act Section 14(e) and was a response to the Chiarella
case – tender offer.
4) Tipping
So if in an exam she will say a SEC rule and we have to know what rule is implicated
- Keep in mind when a person is seeking help from a professional, like a lawyer or doctor, those people
are just treating …; no violation under the classical theory;
- P.497: Rule 10b5-2 which names three non-exclusive situations; SEC tried to extend the rule behind the
classic case; also note 10) on p.498. about Rule 10b5-1

MINE: Hypo: if a second patient eavesdrop info from the first patient and the doctor and subsequently
trade on that info, the second patient is not liable under the classical theory, and he does not own a duty
to disclose or abstain …

56
A priest owns the same duty like a doctor like a psychiatrist!

Hypo 1 – Company in data storage, and Alice studies data storage, and she has decided that Company A
is well positioned to receive a large K in the near future. If Alice buys the stock and the company gets the
deal, will Alice be censured?
Answer – no, as she has no duty to anyone, nor has she misappropriated the info. The reason for the
duty based jurisprudence is to encourage the kind of behavior that Alice just did

Hypo 2 - what if the Company officer does the same as Alice above
Answer – He owes a duty to the buyer of the shares, per the classical theory

Hypo 3 – Officer Archie on a public company tells Bill that the company has falsified its financial
statement. Bill does nothing and then sells the stock, the fraud does come to light. He defends himself on
the ground saying that he would have sold the stock for his child’s education
Ans – under 10(b)(5)(1) he would be liable where the govt does not have to show that he traded, the only
affirmative defense is that he had a premade plan to sell, i.e. set amount to sell on asset date, before he
got the news!

When its insider trading, do a step analysis where you go down number 1, classical theory, 2)
Misappropriation 3) SEC Rule 14e-3.then 4) timmping. I.e. see if it fits classical test first!

Hypo 4 – Shrink is treating a Ceo, and the Ceo gets comfort and session, and then sells his shares in the
Ans – not violating Classical theory since he has no duty to the Company but he is Misappropriating the
information per 10(b)(5)(2)!

Hypo 5 – patient 2 in Shrinks office hears the orig patient 1 telling the shrink about the stock going down.
The patient then sells his share
Ans – Not under classical theory since no duty to the company, no fiduciary duty to the patient 1, and how
does he know

Hypo 6 – same as above but about a tender offer

Ans – She under 14e-3 applies since it s a undisclosed tender offer coming from an employee, even
though there is no duty. But if she does nto know where the info is coming form

Hypo - CEO goes to a priest tells him all the bad stuff he does, and then the priest sells his shares in the
stock.
Ans – Still owes a confidentiality duty, misappropriation

Hypo 7 – 2nd parishioner finds out from parishioner 1 and then sells his stock
Ans – No duty under the classical theory and no duty under Misap or under 10b52, no history of trust and
confidence, no rule 14e-3 as to tender offer. BUT under 10b5-2: SEC would prosecute the parishioner …!

Hypo 8 – Airline passenger leaves confidential documents while leaving and the other one picks up
confidential passenger and sells stock
Ans – No Duty to first guy and no classical duty, and no misappropriation ( he is just a stranger on the plane – no
mutual expectation of confidentiality). But if it’s a tender offer ( which is an extreme example where people make most
money…) then a duty is created but not for merger which is different than a tender offer!

Hypo – Cat burglar breaks into the office of J&J, and while looking sees a memo showing a major
breakthrough and takes on his cell and orders stuff from his broker. Does he have a 10(b)(5)
Ans – No classical – not insider, No under Misap – No relationship or trust or confidence!

* We’ve got a handout for this class with problems!

10-20-2010

57
 Tipping

Dirks v. SEC, 1983

Facts – Dirks is a securities analyst, received material non public info from an inside employee (Secrest)
talking about fraud at his company. Discovered that it was fraud, went to WSJ, but they don’t’ publish it
because they did not believe him, he does get his clients to listen to him, who liquidate 16 M by selling
shares. Then the fraud is uncovered. But Dirks does not trade.
Rule –
Tippee’s duty is derivative of the insiders duty
Tippe knows or should know of Insiders breach
Insider Must gain form disclosure for there to have been a breach
If Insider no breach then no derivative duty
Breach of Duty when there is a direct or indirect personal benefit to the insider
How to see what is a benefit

 Was there any financial gain to secrest?

o But doesn’t have to be an immediate benefit, it can be a delayed benefit
 Can be a quid pro quo, i.e. you give the tip and expect to get something later on.
o Can be the continuance of an affair
Not a personal benefit

 Desire to expose fraud

Analysis –a
Holding –
Question is what happens when an outsides trade
Secrist – Tipper
Dirks is the 1st tier tippee
Dirks is also tipper #2

Constructive insider – Someone who get confidential from an insiders, such as a lawyer working on the
See footnote 14 for a list of people
Can dirks be considered a constructive insider Footnote 14– No, no relationship of Confidentiality,
Securities analysts are supposed to be independent, but rather he is a Tipee, rather than an accountant
or a lawyer who is a constructive insider.
Dirks has no Fiduciary duty to Equity Funding
Did Secrist do anything some wrong – Court says no because he did not use the info for his own personal
gain

Dirks test for Tipping:

Tippee liability –

1. Did the Original tipper breach a duty by disclosing the info?

a. Breach of duty when there is a personal gain to the tipper
2. Did the tippee know or should have known that the info was obtained in breach of duty?

Tipper liability –

1. Did the D breach a duty by discussing the info and gaining a personal benefit?
2. Was it foreseeable that the tippee in question would trade?

Hypo – Your client give out a hot tip from an insider, and you represent the client, what would you say?

1) The tipper didn’t’ get a personal benefit

58
Hypo – Barry Switzer, a football coach, at a track sees a CEO that he knew. At some point Switzer
overhears the CEO say that the company might be overtaken. Switzer buys in.
IS Switzer an insider or a constructive insider – No, so no classical theory; only casual acquaintances so
no misappropriation; so the only issue left is tipping
CEO got no benefit, so no benefit so no breach of duty of loyalty;
* Still a standard case;
PROXY next, read p. 521-531 for the next week; PROXY access new developments!

I PUT NOTES INTO ANOTHER, INNIS, NOTES FROM HER! 10-26-2010

PROBLEMS OF CONTROL
Proxy Fights
Acquisition of Control
1. Proxy fights for control of board of directors
2. Mergers
3. How tender offers are used to conduct hostile takeover

Strategic and economic aspects of Proxy Fights

Shareholder voting
- get to vote only on specified topics; otherwise day-to-day management is conducted by company
- certain specified major events in a corporation’s life, after such events have been proposed by
BoD (dissolution and liquidation of assets)
- changes to articles of incorporation
- vote for directors
o default rule is the whole slate of directors will be elected every year
o in fact, companies have classified boards – some subset up for election every year –
helps incumbent manager stay in power, but also costly
o it can be hard and take a long time/ cycles of election to get control of board by voting
in the directors you like
o for an election to occur, certain requirements – have to have a quorum: a majority of
outstanding shares that are entitled to vote (not majority of shareholders – one vote per share
(not one vote per partner, like in partnerships)
o present in person or by proxy (voter can appoint someone as their agent)
o most voting is done by proxies
o certificate of incorporation can increase number of quorum to 100% or reduce it to
1/3
o Voting is done by plurality, not majority (largest number of votes, up to maximum
number of vacancies)
 One implication is often very unpopular directors get elected
 Management will only propose slots that are open for voting
 There’s been a push to get majority voting, but generally still plurality

- Proxy regulations come both from federal and state law

- What about hold-over boards that are intentionally not getting a quorum, for example,
homeowners’ association?

P. 525 PROBLEM
- Incumbent directors hire a PR firm to help find shareholders trying to get elected on the board
(because disagree with business strategy) (see Levin case below)
- What if the decision involves hiring one of the shareholders’ brother  this is starting to look
more like an interested director situation
- friendship (“soft” conflict) doesn’t create conflict of interest (courts say director fights don’t
involve conflict of interest, as trying to employ business strategy that involves a director’s brother)

59
Levin v. MGM, NY, 1967
Facts – There are two competing groups trying to win a proxy fight for the board of directors (one groups
is the incumbents [O'Brien] and the other is the insurgents [Levin]). O'Brien is using MGM resources to
solicit proxies. Levin seeks a court injunction (temporary and permanent) to stop O'Brien from using MGM
resources and stop him from voting the proxies he obtained and he seeks damages on behalf of MGM
($2.5 million)
Rule – Bd. can get reimbursed for Proxies if

1) Sums were not excessive and

2) SH fully informed.
3) Fight is not personal but for the better direction of the corporation (promotion of
business policy).
4) Soliciting proxies is a BJR issue
5) Expenses may not be excessive (as to constitute waste) and must be
reasonable.
Fight is not personal but for the better direction of the corporation (promotion of business policy).
Is this a purely power contest or is it an effort to inform shareholders about a policy dispute. Can’t be
extravagant or wasteful

Rosenfeld v. Fairchild Engine and Airplane Corp - NY

Facts – Attny, brings derivative suit to compel the return of the cost to both sides of a proxy fight. Dispute
was over the benefits package for a former director. Old Bd. got kicked out, and new Bd. reimbursed
which was ratified by SH.
Rule – When it’s a policy dispute then the amounts spent by the incumbent is reimbursable, but not when
it’s a personal power struggle. SH can ratify this.
Amounts must be reasonable
Generally as a right the incumbents can get reasonable reimbursement
Insurgents get reimbursement if they win and get SH ratification (because they do not get the
presumption of validity that the old boards gets)
Analysis –a
Holding – a
Majority sees no conflict on interest and
As a general rule, Courts view policies that promote management communication with SH to be more
important than a conflict of interest (a soft Conflict)
There is an analogy to political campaigns i.e. communicate to the SH, communicate to the populace
However Dissent says that yes the general rule is that when dispute over a policy dispute its reimbursable
and when it’s over a personal dispute then it shouldn’t be reimbursed makes sense, but the reality of the
situation is that its impossible to distinguish between personal v. Policy distinction.
Generally as a right the incumbents can get reasonable reimbursement
Insurgents get reimbursement if they win and get SH ratification (because they do not get the
presumption of validity that the old boards gets)
Nobody gets reimbursed when the courts find the pmts were unreasonable
SH carries the burden to show that the Proxy cost was unreasonable
The difficulties of this cases, is that it’s about a director getting paid, but the court still looks at it as a
policy question not a personal issue question
Courts usually do not consider proxy fights to be interested director

Pg 531 problem

Start by asking whether this is a policy issue or a personal issue, But since courts seem to see most
things as policy, so as long as it’s a purely a personal power contest, the court will say that you can spend
this money. Then ask if it’s a reasonable cost.
Geddis can only get reimbursed only if the SH ratify it

Federal Rules of Proxy fights

60
  Proxy rules are a hybrid of State law and Federal law. Reimbursement (Rosenfeld above) is a
state law issue
 Proxy statements are a federal Law issue
o Need to be prepared when the are looking for SH vote
o SH can have a say in the way the corp. is run, is by giving out proposals to be included in
the proxy cards
o 14(a)(8) was made easy to communicate with SH, i.e. so that the SH can easily
understand the rules
 SEC is like a referee in these proposal actions, i.e. referee between SH and
other Company
 2 ways Company to rejects SH proposal:
 Procedural defects
o Must be $200
o Can’t be 500 words
o Q 2-4
 Other basis – Q 9
o 13 grounds for exclusions
 SEC referees, gives an action or no action letter
 If no action letter then SH can go to the ask the commission (usually will
not happen), then go to a District court for review
 Two categories for SH proposal
 Social justice – Lovenheim case
o Brought by church group, NGO, labor unions
 Corporate governance
o Pension plans, Institutional investors
o Tend to do well
o Eg:
 Say on pay – allow SH to have their say on the pay for
peeps (execs)
 Non binding – since the BJR gives the Directors
say
o Improper under the law, ie. SH cannot
say on things that are under the gambit
of the Directors
 Majority voting for directors instead of plurality
 Eliminate Classified Boards and have annual elections
(so that take over of companies have less of a proxy…
missed this
 Proposal for repeal of takeover defenses
 All proposals are non-binding, hence Q1 says to phrase the question as non
binding.
Lovenheim v. Iroquois Brands Ltd.
Facts – P, wants to include a proposal to have the corp. study the use of pate making methods. SEC
goes against him since not enough economic effect.
Rule –
A proxy proposal need not be entered if it accounts for:

1) LT 5% of assets in the prior Fiscal year OR

2) LT 5% of net earnings and gross sale Fiscal year OR
3) Not significantly related to Issuers Business
1. Can Consider ethical and Social significance f related to the Company’s
business
Analysis –a
Holding – a

61
Court agrees with him under rule 5, i.e. relevance, because it is deemed otherwise significant, i.e doesn’t’
have to be exclusively economic.
Is still the general rule i.e if you can show that there is a social moral, reason for your proposal, the fact
tha tits part of a small portion of the corp’s earning, it will not be excluded.

For Wednesday
Review AFSCME case and read the SEC summary for the proposed Rule 14a-11
www.SEC.gov/news/press/2009/2009-116.htm

10/08/09
SEC RULE 14a-8(i)(8) overruled the AFSCME case, but note that the old blackboard copy of the rule 14a
did not reflect this and Dennis has posted a new version. And that is one of the reason there is a new rule
proposed which we will be discussing today

Proposed Rule 14a-11

Pros Cons

- clubbiness among Nominating committees, and Impedes proper functioning of the Bd. by allowing
the new rule allows true outsiders to have a chance special interest or a single interest D’s

Decrease proxy fights since now you’d have the 3 Discourages innovation and risk taking on board
or 5 percent

Increase SH voice, level playing field with respect Damages to SH value because ownership
to costs threshold is too low and Holding period too short

Limited to substantial SH and 1 year holding Distractions to mgt team

requirement – restrained approach

Increase board accountability Nominating SH don’t have a Fiduciary duties to

corp and to other SH where as directors on
nominating committees do

May help minority SHS

Encourages investment in companies by holding

board accountable and facilitates the ability of SH
to vote poor Directors out of office.

NOMINATING DIRECTORS have to be outside directors, cannot be inside directors

* the Dodd-Frank Act has changed the balance of power between shareholders and company management by providing a process in which
shareholders can require the inclusion of their nominations to the board of directors in proxy statements in the form of new Rule 14a-11 pursuant to the
Securities Exchange Act of 1934.

AFSCME v. AIG
Facts – AFSCME, P, proposed a question for the AIG proxy statement that would change the bylaws to
allow shareholder nominated directors on proxy statement in certain circumstances. AIG asked the SEC
whether there would be any action if they excluded the proposed question under Rule 14a-8(i)(8) (related
to an election). Division issued a no action would be taken by SEC. AFSCME sues seeking court order
compelling AIG to include the proposal
Rule – A Sh may not ask to include proxy information relating to election, but charging bylaws to establish
a procedural by which SH nominated candidates does not fall within this rule
Analysis –a

62
Holding – a
NY statute on Pg 558

Pg 555 Problems
1. Exclude it
A. – No because you have to propose that the SH recommend this does not do that
B. Probably okay under Lovenheim
C. Inside council will say that this violates inside strategic decision. Plus it also says that the company
shall produce, so is it okay under state law?

Crane v. Anaconda - NY
Facts – Crane, P, places a tender offer for Anaconda, D, stock. P requests D's SH list. P owns no shares
of Anaconda. D refuses. P buy 2.35M shares and requeste list. D offers to mail the prospectus for P. P
wants list for a targeted tender. Using NY Business law 1315, filing an affidavit saying its request is for a
proper request. Bubkiss says D as not proper purpose
Rule – When State statutes require proper purpose, the desire to take control the company is a proper
purpose
Analysis –a
Holding – a
Internal affairs rule does not apply when the NY state has a law allowing its residents to file such a
Don’t’ worry about the NY business law statute just the one on pg 561, the Honeywell case
Have to declare that it’s not soliciting for an improper purpose
Court equates the economic welfare of the SH with that of the

State ex rel. Pillsbury v. Honeywell, Inc.

Facts – D, Honeywell, produced munitions for the US government used in the Vietnam war. P against the
war and wanted to stop the production of the munitions so buys 100 shares to influence D’s Affairs by
communicating with other SH. Used DE statute Sec. 220 to demand the shareholder ledger, and corp.
records dealing with weapons and munitions
Rule –
Analysis –
Holding –
SH can get access to the SH list and the Corp has the burden to show that the inspection is for an
improper purpose for Inspecting a SH list
SH can get access to the records and the list SH has the burden to show that the inspection is for an
proper purpose
So harder for SH to get books and records than SH list.
This is so as its disruptive to the Corporation. Plus there are confidential business records
But for the list of the corp. then let the SH have the list as saying that
Proper purpose has to relate to investment returns, i.e. economic returns must the primary purpose, and
the secondary purpose can be neutral (social conscious), but can’t be improper (steal trade secrets)
Note that an improper means harmful, i.e. not that it’s not proper1

11-2-2010

B. Freeze outs
* Classic merger (aka statutory merger, see section 255); for corporation in De, we need as lawyers to
look at constitution of both corporations. Look at the notes at Innis Traditional/Classic merger! It requires
most work for the lawyers under classic merger.
Triangular merger: Consideration like cash or … forward and reverse triangular merger (just a formal
difference). The point of this merger; shell is a company or corporation that exists without assets or independent
operations as a legal entity through which another company or corporation can conduct various dealings ; two main points of

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this merger is to limit shs votes and to limit liability by the Alpha company since a new entity Shell would
assume all liabilities of Beta corporation in forward merger.
There are other merger techniques which we’ll discuss them in probably less extent; Freeze out is usually
two step acquisition (we’ll see in Weinberg).
For a merger need the following

 Need a plan for executing the merger (articles of merger)

o State the consideration for the acquiring amount
 Plan must be approved by the Bd of each company
 Plan must be approved by the SH of each company
o Done by submitting a proxy statement
 File the articles of merger with the appropriate State companies

Note that this is very similar to the formation of a corporation

Triangular merger

 This is a 3 way merger

 Alpha creates a shell which
o If shell merges with the target and the shell disappears its called a reverse merger
o If target merges with the shell and the target disappears its called a forward merger
 Don’t’ have to deal with the Alpha SH, i.e. don’t’ need their approval
o Shell has only 1 SH, Alpha who needs to approve

Freeze out merger –

 Done as a two step process

o 1st – tender offer to gain more than 50% of the target company
o Cash out merger where the remaining SH gets cashed out

Weinberger v. UOP Inc. – De, 1983

Facts – Signal tenders an offer to buy 50.5% of UOP at $21/share and this is oversubscribed since the
market price is $14. It then elects 6 members to the 13 board members for UOP, and after UOP’s CEO
retires, chooses his replacement. Two years later Signal still wants to invest and settles on taking over
UOP, and Signal’s CEO, ask its CFO, and Planning VP to work up numbers to see whether they will buy
the company. All three are Directors on UOP. They come up with a number saying up to 24/share would
be ok for Signal, but they tender offer of between 20-21. CEO of UOP, Crawford, does not object, and
gets Lehman Bros to do a feasibility study on the price but only gives them 4 days to do the study and
they come back with price of 21. UOP Bd. considered the proposal, financial statement, mkt price info,
and budget info and the Lehman study, but not the Signal CFO study. Signal’s Directors Abstain but say
that “they would have voted yes”, rest of Bd. Approves. Merger ratified in Sh meeting 2.5 mos later with
52% of minority voting for merger. At 21/share.
Rule –

 In a freeze out merger P must allege specific acts of fraud, Misrep, or other misconduct showing
unfairness
 1st P must show some basis for invoking fairness doctrine
 Then Majority must show via a preponderance of evidence that txn was fair
 But when ratified by majority of minority, burden shifts back to P to show that txn was unfair to
minority
 However the party relying on the vote must always show that the Material facts were disclosed
 Remedy per DGCL §262
Analysis –

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  Primary reason to find against D is that the CFO report was not disclosed to UOP and only used
for the benefit of Signal
o The diff in price between 21 and 24 was 17M to the minority
 If UOP had Fully disclosed everything they would be ok or if UOP had appointed its outside
directors to have an arms length negotiations with Signal this would be strong evidence of
fairness, especially in a parent – Sub context
 Disclosure (complete, not adequate) of material fact is required, and Material fact is defined as
information as a reasonable Sh would consider important deciding whether to sell the shares
 Since no Arms length transaction, signal could nto escape because their directors did not totally
abstain
 When Directors on 2 bd. they are held to a std of utmost good faith and most scrupulous fairness
of bargain
 Fairness has 2 aspects which must be examined in whole, but in a non fraud case the price is the
preponderant consideration
o Fair dealing
 Issues of:
 When Txn timed,
 How Initiated,
 How structured,
 How negotiated,
 How disclosed to directors
 How approvals obtained
 Includes Duty of candor
 Imposed on non officers who are privy as well
 Application to this case
 How did merger evolve
o Totally initiated by Signal under strict time constraints,
o Structure set up by Signal with no negotiations
o All conflicts resolved in Signal’s favor
o Minority given impression that Lehman study was careful, but it
was hurried
o Most imp the price of 24 was withheld
o Fair price – economic and financial considerations
 Must include relevant factors of
 Assets
 Market value
 Earnings
 Future prospects
 Anything affecting intrinsic value of stock
 Valuation method used need not only be the Delaware block or weighted
average method, but can use other generally accepted techniques
 8 DGCL 262(h) says Fair value to be determined all relevant factors
except the result of the merger
 Fair value includes any damages
o Damages –
 In case of fraud Chancery has full discretion and can use:
 Equitable
 Monetary
 And Recissory damages
 Should be based here on the fair dealing and fair price – So what are damages in
this situation?
o Business purpose test is not to be used
Holding – Finds for P

65
Signal wants to buy out the rest of the SH because then you don’t’ have to deal with the SH, i.e. their
annoyance. You owe no duty to them and can do what you want to.
Legal standard being applying is the duty of loyalty
Test is:

1. Fairness
a. Fair Dealing (Signal Flunked the fair dealing part, i.e. rushed bargaining, decision, plus
candor since material information was not given)
i. Negotiating
ii. Candor
b. Fair Price
i. No specific method, but use whatever method is available

Questions Pg. 710

2. They do owe loyalty to both Companies and really should have recused themselves
3. Should have
1) Used arms length bargaining,
2) Keep Signal people on UOP board out, isolate them from the txn
3) Independent committee to study the offer and give them all the resources to
negotiate, and
4) Hire an independent Investment Banker and give them time to do a thorough
study and Independent Counsel
5) Have a vote and make sure that the Sh know everything that the UOP directors
know.

Hypo - If report had been disclosed in Weinberger (as the most glaring thing that was done in this case),
would that have won the case for the Signal and UOP directors? – No that just shifts the burden onto the
plaintiff.
The question is, would the price fail the fair price analysis?
But there was no negotiation, it only shows that it was a right price, but it would still be a conflict of
interest (band-aid solution)

* Classic and statutory merger and triangular merger we’ll talk and then Weinberg case.
Weinberg: UOP 7 out of 13 board members controlled by Signal since they acquired 50.5% of the UOP
shares but wanted to get remaining ones (49.5%) in the absence of any other investment opportunities
at the time; P.336 in E&E good! Entire Fairness test: fair dealing and fair price; conflict of interest,
question of ethics which the Court seems to care about;
Problems p.710: 1) there is no duty to maximize price for the shs but there is a duty of loyalty. So Signal
made an error by assigning Arledg-Chiritea (members that sat on the both boards) to do report; so they,
Signal, were basically entrapped. 2) look above also;
For Wed: p.733-755 (Cheft + Uncal), Thu: 755-766 (Revlon)

11-3-2010
TAKEOVERS
The Fiduciary duty of care and loyalty are the bedrock of all Corp law.
Corporate law is the balancing the need to protect the Directors authority and it hold them accountable.

Should the response to a takeover bid be a decision for the board of directors or for the SH?
Delaware courts have looked at this more as an issue for the Bd. not the SH in general, but there are
some small exceptions (will discuss next week)

66
The proper role for Corporation in US society under the three theories:

6) Aggregate Theory (focuses on corp. as property owned by shs) – Maximize

profits
7) Artificial Entity Theory (corp. as creation of state)– State has the power i.e.
should be with the state legislature to enhance the general public welfare
(including SH as a constituency)
8) Real or Separate Entity theory – The Corp is a separate entity controlled
besides shs and… also by the BD, where the corp is allowed to balance the
interest of the SH and various other entities (workers, residents, creditors,
customers etc… anyone who is affected – holistic approach)

When we talk about takeover law we’re talking about the law of takeover defenses, i.e. what kind of
defenses a Bd. can take without violating their duties to existing SH

Questions to consider when looking at such decisions.

1) Is there a conflict of Interest between the SH and the incumbent managers in a takeover context
2) How much discretion should the Courts give managers in deciding whether to resist the takeover. (i.e.
should the courts apply the BJR or the fairness standard or develop some other standard?
3) What types of responses of strategic responses are proper, i.e. how far can the managers go to resist

4) Should directors be able to consider the interests of non SH stakeholders ( anyone that is affected by a
corporation like the employees’ families, suppliers, customers, community, and others ) and to what degree and under what
circumstances

Why Directors might want to fight

1) The bid is too low

2) They want to keep their jobs
3) Pride of ownership issue, i.e. they spent their whole lives building the company
and don’t’ want to let it go
4) Watching out for other stakeholders (employees, creditors)
1. Consider Motives of looter for the benefit of the creditors, i.e. protect the
creditor.
* Takeovers defensive action occur because: 1) policy change not in interest of corp; 2) hold out for a
higher bid; 3) financial interest: self-interest (incumbent managers can be pushed out by new guys) –
outside directors fees perks while inside directors compensation; 4) psychological self interest: ego –
being in control, family or similar kind of sentimental attachment, loss of political and social capital; 5)
national interest: concern re country of origin; 6) fear of liquidation 7) concern for employees; 8) hurt to
managerial reputation; 9) procedural change not in best interest of corporation; 10) environmental
concerns as to harm to community affected by a takeover;
3) and 4) do not seem like Court would justify, i.e. improper as to perpetuate themselves in office.
- Revlon duty …

Cheff v. Mathes – De, 1964

Facts – Takeover dude, Maremont, wants to takeover Holland Furnace Company and change its sales
policy. Company sales had been going down. Directors believe that its sales policy is good and decide to
buyout the shares from Maremont at a premium over market Price. Derivate SH suit seeks to bar the
Holland repurchase of Shares owned by Maremont. Holland defended by saying that they had a unique
Business model and Maremont would ruin their company.
Rule –

 If Bd. acts on sincere belief that buying out dissident SH is needed to maintain proper business
practice, the board is not liable.

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  But if Bd. acts solely to perpetuate itself in office then the use of corp. funds is improper
 Burden is on the directors to prove that the purchase is in the corporate interest
o The greater the “self dealing interest” of a director the greater the std of proof required of
the directors to show their good faith and reasonable investigations
 Honest mistake of judgment is reasonable at the time of the decision is ok
 Pecuniary gains to be considered material
 Just being a substantial SH is not enough of a gain since all SH would share the
benefit of going to the Substantial SH
 Buyout premium price is ok since attributable to control premium
 BD actions which show its good faith and reasonable investigations:
o Direct investigation
o Receipt of professional advise
o Personal observations of Maremont’s actions and explanation of corporate purpose
Analysis –a
Holding – Finds for Bd.
How much discretion should the Courts give managers in deciding whether to resist the takeover. (i.e.
should the courts apply the BJR or the fairness standard or develop some other standard? –
Court here says:

 There is a conflict of interest but not as high as self dealing, so the fairness test will not apply
o Yet there is a conflict of interest
 So their test is to see if there was:
o Bd. has burden to prove that there was reasonable grounds to believe that there is
dangerous grounds to see a danger to corporate policy
 Satisfied by showing good faith and reasonable investigation
o Once this above threshold is met then the BJR applies – the test is called a Threshold
BJR
o If you cannot meet the threshold then it’s the inherent fairness std.
Note that Maremount tender offer never really got off the ground
Greenmail – When a Company purchases back the stock owned by a potential acquirer, at a premium
over market.
* Publicly traded company where shares had Maremont and his wife; the company had branches in many
states;
Had the Court found a hard core financial interest than inherent fairness standard which did not happen
here but BJR;

Procedure for conducting a tender offer.

Williams act – regulates tender offers?
4 elements

1. Anyone who singly or as part of a group acquires 5% of a stock of a company must identify
himself with the SEC (to prevent the creeping tender offer as Maremont was doing in Cheff
above)
a. After acquiring the 5% the acquirer has 10 calendar days to give notice, and during that
10 days you can still continue to acquire shares
2. Anyone making a tender offer must file a disclosure document (this is expensive to do) which
reveals
a. The source of their funding,
b. The identity of the purchaser and
c. What the acquirer plans to do with the company
3. Acquirer who raise his price, must raise it for any stock already tendered (stocks already
received)
4. Acquirer must hold the tender offer open for 20 business days and any one who tenders may
withdraw their stock during that period

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Hypo – Freddie wants to make slasher movies and wants to acquire a chainsaw company

1) Freddy secretly buys 40% of Texas chainsaw, before filing with the SEC. Result - OK as long as
he files within 10 days
2) Can Freddy and each of his pal buy 4.99%. - No since you’re buying as a group
3) Can Freddy file his offer on Friday noon, and keep it open till Monday morning – no since he has
to keep it open for 20 days
4) Freddy only wants 51% only, and accepts stock on a first come first serve basis – No, you have
to accept shares on a pro rata basis.
5) Start with low price then raise the price – yes he can do that but then has to give the same price
to everyone

Unocal Corporation v. Mesa Petroleum Co., De, 1985

Facts – Mesa, who owns 13% of Unocal, makes a 2 tier front loaded tender offer for Unocal at 54/share
in cash for the first 37% and Junk bonds for the last 50%, which was substantially subordinated. Unocal’s
Bd. with 8 outsiders and 6 insiders meet and get presentations form Goldman Sachs, that the company is
worth at least 60/share. The outside directors meet as a committee and recommend to the Bd. to reject
the Mesa offer but do not suggest any defensive measures. Bd then meets a week later and approves a
defensive buy back of shares at 72/Share, which would i) bar Mesa from getting this and ii) that the tender
would only kick in when Mesa had bought his first 50% of shares, then they change it to say that they will
buy 50M in shares anyway. They finance the company, and makes the company less desirable. Mesa
sues saying that Unocal’s mesa exclusion violates its fiduciary duty to Mesa.
Rule – If Disinterested Bd, acts in good faith, and with due care, absent abuse of discretion, its decision
will be upheld as an action in good faith and gets the BJR. And can Discriminate against a shareholder in
carrying out a reasonable corporate policy.
Analysis –

1) Does the Board have the power to take this defensive action?
1) Board has power under DGCL 141(a) – to see to the Business and affairs of
the corp
2) Board has power under DGCL 160(a) – to deal in its own shares
2) Thus the directors can selectively purchase shares as long as it is not done to entrench
themselves in office.
a. Bd gets BJR as long as Conflict of interest in a case where there is a conflict of interest
Bd. has a burden to show
1) Reasonable grounds for thinking that there was a danger from the takeover
2) This burden is satisfied by showing good faith and reasonable investigation
3) This is enhanced when outside directors act per this std
3) Defensive measure to come within the BJR, must be Reasonable in relation to the threat
a. A reasonable Directors analysis of the threat can include considering:
1) Inadequacy of the price
2) Nature and timing of the offer
3) Questions of the illegality
4) Impact on other stakeholders such as creditors and customers
5) Risk of non consummation
6) Quality of securities offered
b. Here the threat was that 54/share was not enough
1) We know 2 tier offers are coercive
2) Plus Mesa dude is a known greenmailer – as found by the TC
3) Bd. said that its specific objective was to defeat the inadequate Mesa offer and
if it worked to provide its SH value at 72/Sh in senior debt
1. Mesa’s Participation would thwart these goals as:
a. Allowing mesa to participate in it would subsidize his effort to buy
at 54/share

69
 b. Mesa cannot, by definition, fit in the class of SH being protected
form its own coercive and inadequate tender offers
4) Selective Repurchases have been authorized before, this is just the first time that we’re applying
it to a greenmailer
Holding – a
Enhanced Scrutiny – Unocal test

A. Did the Directors have reasonable grounds for believing a danger to the corporate policy existed?
a. Were they motivated by a good faith concern for the welfare off the corporation and its
SH
b. Did they conduct a reasonable investigation
B. Were the Defensive measures reasonable in relation to the threat posed
C. If you satisfy this then you get a BJR
Here they held the good procedural steps in addition to doing all the step above
* UNOCAL TEST: for defensive measure (as basic test which is still valid today as to takeovers):
Threshold showing by Ds: 1) they have reasonable grounds for believing there is a danger to corporate
policy and effectiveness. D satisfies 1) by showing a) good faith to protect the corporate enterprise and b)
reasonable investigation. 2) Responsive action is reasonable in relation to threat posed. If Ds show 1+2,
then BJR.
“Self-tender” offered by the corporation; death security …; discriminatory nature against Mesa: it’d only be
offered others excluding Mesa and only if Mesa’s offer goes through; the point is that shs would stop
selling at $54 hoping they’d sell it to the company’s higher offer $72 but …; then, the corporation bought
50 mil shares at $72 incurring large debt while Mesa was not able to afford to buy at that price and Mesa
sued claiming a breach of fiduciary duty by the BD since Mesa is a sh – breach duty of loyalty ( the company
picks its favorites) in this case (the other duty is duty of care which is not the case here). Mesa was engaged in
greenmailing (two-tire offer…);

Poison pills is a term referring to any strategy, generally in business or politics, to increase the likelihood
of negative results over positive ones for a party that attempts any kind of takeover. It’s extremely
effective measure, as compared to the greenmailing which is not, for takeovers!!
IRS has taken away a lot of defensive measure:
Greenmail taxed at 50%
Poison Pill – most popular defensive strategy is the one in the Revlon.

Analysis Pg 755

1) No still get judicial review, since still need reasonable in relation to the threat
2) Skip
3) Yes they would since directors can look at other stakeholders and the threat posed to them.

Two tiered offer – has a front end and a back end

Front end – usually a tender offer
Back end – Same money, but different in amount or quality of security tendered, usually a cash out
merger
Held t

Revlon v. Forbes Holdings, Inc. – De, 1985

Facts – Pantry Pride, P, makes hostile offer for D, Revlon, at $45. D Bd. meets and rejects offer after
getting advise from I Bank that $60-$70 was a better price for the company in pieces and mid 50’s as a
whole. Bd. Consists of 14, with 6 Snr managers, 2 significant stockholders, 4 with Business dealings with
Revlon, leaving 2 independent Bd. members. D takes defensive measures and repurchases 5M shares of
its 30M outstanding shares and issues Note Purchase Rights (“Rights”) that let SH trade shares for 1 note
with $65 face value, Earning 12% maturing in a year. Rights become active if another company buys
more than 20% of the shares but at lower than $65/sh. Revlon can buy back the rights at 10 cents a
share. P ups its offer to $47.50. Bd. then buys up 10M shares by issuing notes, and covenant that Revlon

70
with not incur more debt, sell assets or pay dividend unless approved by independent Directors. P
increases Offer to 42. The Bd. authorizes negotiating with other peeps and deal with D2 Forstmann, is
reached. Terms are $56/Sh, Management will buy shares using their golden parachutes, Revlon to waive
Notes covenants. D2 intends to sell off the company. Then the creditors threaten suit against Revlon
since they are breaking their covenant. P increases bid, then says that it’ll bid a fraction more than D2. D2
agrees to final deal with Revlon at 57.25/Sh with terms: i) Discounted price on a couple of units of Revlon
ii) No shop provision iii) 25M cancellation fee iv) Notes to be supported by D2. Bd. agrees to the deal. P
sues to enjoin the deal. TC for P.
Rule – i) When a company is being sold for its pieces the fiduciary duty of the Bd. is ensure that the Sh
get the max money, and ii) consideration of other stakeholders is to be done to the extent that it is
rationally related to the Sh value
Analysis –
Bd. Action not to get the same deference as since the majority of the directors are not outsiders.
Rights plan

 Main point is whether the rights action was reasonable and what was its purpose
 Bd. Found that the $45 was inadequate, as a price for a “bust up takeover” (buying and selling
the company for its parts), upon advise form Lazard
 This was done to protect SH from a takeover at a price below market
 These seem action done in good faith and upon reasonable investigation
 All this made moot by the fact that the Bd. Ended up buying out the rights.
10M Share repurchase

 Bd Acted in good faith when it said that the P offer of $47.5 was inadequate and its responsive
defensive actions were also reasonable
Decisions after $53 Pantry Pride offer and Bd. Authorization to look for another buyer

 At the $53 a share offer it was obvious that the Bd was up for sale
 At this time the Bd. duty changes form preservation of a corporate entity to the maximization of
the value for SH
o Directors are now to become auctioneers charged with getting the best price for the
company
Lock up with D2 Fortsmann

 Directors made support of the Notes, as they were subject to a suit by the Notes creditors, an
integral part of their deal with Fortsmann
 Selective dealing to fend off a hostile bidder is not a proper objective when the company is being
broken up
 Revlon cannot show good faith by preferring the Notes creditors, whose rights are fixed by
contract, over the Sh, to whom they owe a duty of Loyalty
 Consideration of other constituencies is inappropriate when company getting auctions
 Note holders were ok, since they were accepted by creditors on an understanding that covenants
could be waived if there was a purchase of the company at a fair price
 Lock up not per se illegal
o Since “white knights” will only come if they get some compensation to cover their costs
o However lock ups that draw in bidders (when the company is being auctioned) are ok, not
those that end an active auction
 No Shop Provision is not per se illegal
o Not permitted when the Bd.’s duty is to sell to the highest bidder
 Fortsmann was dealt with preferentially throughout the entire deal and given all negotiating
advantage
 Cooperation from management
 Access to financial data
 Access to the Bd. to present its proposals directly

71
 o Favoritism to a White knight is ok, when fending the corp, not when its being auctioned
off.
Holding – Finds for P
Point of a golden parachute is to incent the managers to be more neutral in the case of a takeover.
Proportionality test – Was the defensive measure a showstopper, i.e. make it impossible to take over the
company. In this case the rights offer was such as to raise the price. I.e. it’s not a defensive strategy that
is pushing people away form a deal.
Court doesn’t’ really say when a bust up becomes inevitable, just that it occurred here.
Unanswered question form Revlon

1) When does the auctioning duty come into play? Is it when the company is put up for sale?
Answered in the next cases
2) What does maximize price mean? – Does it mean that the Revlon Management just steps out of
the way?

More than 30 states have rejected the Revlon holding that it is inappropriate to consider the interest of
non SH stakeholders when there is a CIC.
* How did it change BD duty – part II and III or the Court’s argument ( p.760 to 766); Poison pill here is mute
because …
What does maximizing price mean? Should Revlon be passive, assume affirmative duty to find a better
buyer? We don’t know …; we’ll know more about cases coming up. These are the most difficult cases to
understand so pay close attention;
FOR TUESDAY through 776! And then Paramount case 776-790 and then from p.793

Paramount Communications v. Time Incorporated, Del 1989

Facts – Time, a journalistic public company, with a modern Board, i.e. heavily outside directors, wants to
expand into entertainment, hence want to look for potential partners. They create a committee to consider
corporate strategies in the 90’s. Think of joining Warner, but then it doesn’t pan out because of tax
consideration. Time only wants to merge with Warner if it can maintain Board control as a way of
mainlining their journalistic integrity. Time wanted to do all cash or a cash plus securities deal (makes it
clear that Time is in charge). Finally work out a deal that the Warner CEO will leave in 5 years. The other
issue is the share trade price with Warner hoping for a .45 per Time share. End up getting .465 giving
62% of the New company. Defensive measures set up, including i) automatic share exchange (kind of like
a cancellation fee, i.e each company can take advantage of an increase at price. Both boards approve the
merger. Then Paramount comes in with a bid for Time at $175/share contingent upon cancellation of the
Warner merger. Time board sends a strongly worded letter to Paramount, saying that the 175 is
inadequate and as disturbing Time’s culture. Now defensive measures put into thwart Paramount such as
it’s two tier securities and cash acquisition (Since its not a takeover, i.e. no new stock being issued which
would require Time’s SH approval, but a merger for cash, there would be no need for SH approval. The
fear being that the Sh would prefer the $175 deals from Paramount hence veto the merger). Paramount
raises its offer to $200, but the Time Bd. rejects it saying that the Warner merger gives it better value.
Rule – a
Analysis –
P Revlon argument – Since time was up for sale when it i) 62% of the combined company going to the
WB ii) Discussions with WB was outing it up for sale

 Ch court rejects that there was no CIC, since there was no shift in control as the market, was fluid
and un-aggregated
 Del SC agrees but adds:
o Revlon duties are triggered when
 Company initiates a bidding process for itself, or a bidding break up
 Or if in response to a takeover it abandons its long term strategy and seeks
another transaction seeking a break up
Unocal claim – Broken up into two pieces, pre Paramount Bid and post

 Pre Paramount Bid

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 o Court applies the BJR
 Paramount Bid On
o Court acknowledges that the Bd found that the price was too low. Paramount bid at the
last moment was poor, i.e. when the SH have the proxy votes and trying to vote. So the
Bd. was trying to protect them.
Holding – a

First the Board of both companies have to merge.

Take home message - As a general rule an agreement for a stock/stock merger for 2 public companies
pursuant to a strategic plan do not trigger Revlon duties to maximize returns to SH.
Total Shift in control can be seen as a merger however when a Smaller comp is bought out, and if one of
the management is being forced out, then its like the company is being sold, and Revlon duties attach.
* Pretty independent board with 75% outside directors; millions of shares publicly shared; Time worth
almost twice as much as Warner but offered to give .465 or 3.3% more than …; after the merger, 62% of
shs became in ownership by the Warner shs; full board and shs of both companies must approve the deal
(proxy, informing shs); clause: no shopping around while the merger is ongoing (negotiation with
companies C, D etc…) – typical in these situation; Paramount came with an all cash offer only for Time
which is $50 more than the current market price; Time: company’s culture and integrity, Warner is a better
fit, journalistic heritage, and also the price was inadequate with all which the Court deferred to as well;
- Time recast its offer from stock to stock offer to first 51% cash for shares in the rest, second tier, cash-
out merger: no-cash securities at $70 (it’s not coercive unless for example it’s backed up with junk bonds
with so-called faced value); Time would incur in this case billions of dollars of debt; Time created New
Time where Warner would merge as a triangular merger, where Warner shs would own shares of Time
but New Time would be a wholly-owned subsidiary of Time; Warner shs have to vote and Time, although
not a constituent party is a sole shareholder of New Time, will vote for approved merger; Time shs would
not be able to vote for the merger (billions of dollars) but because Time issued huge amount of new stock,
under the first stock-for-stock option, the Time shs needed to be asked for the merger! But under the
second offer which eliminated stock offer also eliminated Time shs approval! BJR gives the Time board
discretion to maximize profit for shs; Unicon rule would apply besides BJR for the Court!
Paramount offered went up from 175 to 200 dollars; C: something sneaky was going on since Paramount
offer came two weeks before the shs approval after merger negotiations has been ongoing for 2 years.
C: before Paramount, no takeover and no conflict of interest so BJR governs even if the merger turns out
to be disastrous; after the Paramount offer was revealed, the world of Unicon two prong test kicks in – tow
separate suits: Time shs since the think 200 dollars was a good deal and the Paramount suit; Unicon
argument: the board was right that the offer was a treat to the company’s effectiveness and ignorance of
the benefit of the merger etc…, so the first prong was satisfied; in addition the response to the treat was
not coercive even though shs deprived to vote but in fact all defensive measures do not preclude
Paramount to buy both Time Warner (which was insane at the time because the new merged entity was
colossal); …; then Revlon case kicks in: even though 62% of the merged company would be owned by
the Warner, there is not change of control in Time because 62 % of those people are unaffiliated with
each other (there are many of them) which was before and after the merger as the same and therefore no
Revlon duty for the Time board.
- As a general rule stock-for-stock exchange between two public companies pursuing strategic vision or
plan does not constitute sale of change of control and therefore not trigger Revlon duty to maximize … to
shs! This is a huge revelation

* For next Tuesday 11-16: skip pp. 790-793, SKIM only Omnicare p.793-811, but focus on to read cts p.
823-836
- P.775 3):
Paramount Communications Inc. v QVC Network Inc., Del 1994
Facts – 15 directors are on Paramount’s Bd. including 11 outsiders. Viacom Controlled by Redstone who
owns almost 85% of the company. Paramount studies and then wants a merger with QVC. Tentative
agreement breaks down over price. QVC wants to buy Paramount. Paramount and Viacom do due
diligence including Lazard for Para.
1st agreement is a merger with a combo of Viacom stocks and cash offered. Viacom insists on:

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  No shop provision with 3rd party offer is real and Directors have a fiduciary duty out.
 Term fee of a 100M
 Stock Option – Viacom can buy 20% of Paramount’s shares at 69.14 if no merger at a set price
o Includes a Put feature letting Viacom Sell to Paramount the 20% at Market collecting a
profit of the diff between Market and Put price
o No max amount set hence profit to Viacom form Put could reach unreasonable levels
QVC tenders for $80 a share, in QVC stock and cash. Para does a due diligence by seeing which
company makes more sense for it to merge with. QVC then files an action enjoining merger with Viacom
and gives a 2 step tender offers with 51% at cash and the second tier with stock valued at current stock
price but who know what the cost will be when the merger comes through. Viacom and Para renegotiate
but only price increased to 80 in a two-tier offer with cash for the1st 51% and stock and bonds for the rest.
The No shop, Term fee and Option plans not really changed. Diller wants an auction process, but Para
says its not being auctioned and that it has contractual duties to Viacom. Viacom ups its 2 tier to $85 and
QVC then to $90. Para Bd. decides that QVC offer not in its best interest, as QVC offer excessively
conditional plus Booze Allen says that merging with Viacom better for them. Trial Ct finds for QVC.
Rule –
Analysis –
Enhanced judicial scrutiny triggered by:

 Change in control of Corp.

 Adoption of defensive measures in response to a threat of a takeover
Significance of a CIC

 Need to uphold stockholders vote meaning something

o Since minority SH can be deprived of a continuing equity with a cash out merger (how
does this work)
 In a Viacom deal transfer will occur from a fluid aggregation of unaffiliated SH to becoming
Minority SH, whose effective voting position will go to Majority single entity, which can then
effectively:
o Elect directors
o Cause a break up of Corp
o Merge with another
o Cash out Public SH
o Amend Certificate of Incorporation
o Sell out Corp’s assets
 Once control Shifts current Sh will have no leverage to demand another control premium
o Thus current Sh should get a good control premium and/or protective devices
Obligations of Directors in a CIC

 In a CIC situation Directors must reasonably get the best value possible for SH
 There is no blue print to accomplish this but Bd should compare the alternatives available and
consider:
o Fairness and feasibility
o Financing of the offer
o Risk of non consummation
o Bidders identity
o Bidders business plans for the Corp and its effect on SH
 Goal is always to see what is the bet reasonably available value for Sh
Enhanced Judicial Scrutiny in a CIC case

o The scrutiny is triggered by

 Threatened diminution of SH voting power
 An asset is being sold (such as a control premium)
 Impairment of SH voting rights

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 o The Judicial Tests key features are:
 Adequacy of decision making process
 Reasonableness of directors action in the circumstances
 Court should keep in mind the complexity of the directors task
 Decision of D has to be reasonable, not perfect
Distinguishing Revlon and TW

 Revlon
o Break up doesn’t have to be present and become inevitable
o Can occur when Bidders make similar offers
 Then Directors cannot play favorites
 Time Warner
o Facts were diff as there TW would be owned by a fluid aggregation of Unaffiliated SH
before and after
 Hence no voting powers issue
o Txn consummated was not a merger but buying of Warner
 Para Misread Time Warner since maximization of Sh value duties arise in 2 cases
o CIC
o Break up of Corp.
o This arises since the deal with Viacom will shift the control to a controlling Sh Viacom
Breach of Fiduciary Duties by Paramount
Obligations of the Directors:

 Paramount Directors, since they had decided to sell control of the corp. had a duty to:
o Critically examine Viacom merger and QVC deal
o Act in good faith
o To obtain and act on material info available
o Negotiate in Good faith with Both Viacom and QVC
 Paramount D says that No shop stopped them from seeking alternatives
o Bubkiss as any provisions that is inconsistent with a Directors fiduciary duties are
unenforceable
Breach of fiduciary duty by Paramount Board

 Deal with Viacom Provided a modest control premium to SH

 Sale of CIC plus Defensive measures plus disparate treatment of bidders triggered judicial
scrutiny
 Stock Option plan was draconian
 Term fee made paramount less attractive to others
 No Shop stopped them from considering others even though QVC had expressed and interest in
Paramount
 QVC’s offer gave the Directors opportunity to renegotiate with Viacom, but they didn’t.
Holding – For QVC
Revlon duties are triggered the moment that the Viacom merger started.
The defensive provisions here were bad for maximizing the value of SH.
Whys is the court so tied into the CIC analysis getting higher duties?
- because this is the one chance that they have to get a control premium for their shares, since any future
bidder will only go to Redstone to

Std of performance for the Para Directors:

 Directors must get the price reasonably available

So the question is then do you need to have an auction – No since there is no Blueprint, but an auction is
a good way. But you do have to do an objective comparison of the analysis.
Role of the court i.e. the Unocal test softened test

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 1) Adequacy of the decision making process
2) Reasonableness of the Directors actions (has to be reasonable, not perfect)

REVLON Duties to maximize value for SH apply when:

1) There is a CIC (new added), i.e. if its sold to a dominant SH (even if its an effective control, i.e.
small amount of Shares)
2) Company is put up for sale
3) When a Bd. adopts a strategy that makes the break up inevitable

Protective statutes

ALI’s §602 Action of Directors that blocks Unsolicited Tender Offers

a) Board can take a reasonably response to blocking a tender offer

b) In considering whether an action is a reasonable response
1. Bd. can consider matters relevant to the best interest of the SH including, legality of offer,
Corporations economic prospects
2. Bd. Can consider other stakeholders
c) A person challenging the action of a Bd. has the burden to prove that Bd. action were
unreasonable
d) Directors who authorize actions under a) above are not personally liable unless their conduct
violates the BJR

Subsequent Delaware Developments

Unitrin v. American General Corp., 1995

 Court Approved a Defensive Repurchase allowing it if it was not draconian

o Draconian means nto coercive or preclusive
Carmody v. Toll Bros

 Dead Hand Poison pills – Pill could only be redeemed by directors who approved it
 Struck down by Ct as:
o Per De Statutes Directors have the power to Control corp.
o Disenfranchised Sh who might want to elect a Bd. to remove the pill
o Dead hand pill was preclusive and coercive
 Preclusive – Added deterrent effect made takeover very expensive
 Coercive – Pill Forced Sh to re-elect directors so that they could have a Bd. that
could fully execute its full statutory power
Mentor Graphics v. Quickturn Design – SC decision briefed here only

 No hand pill invalidated

 No Hand Pill said that a new Bd. could not approve a sale to another Corp for 6 mos ostensibly to
give them time to study it
 141(a) requires any limitation on the Bd. authority to be set out in the certificate of incorporation
o No hand pill would stop them from doing this for 6 mos
o Esp in the fundamental are of negotiating a sale of the corp.

11-16-2010
Tuesday 11-16: skip pp. 790-793, SKIM only Omnicare p.793-811, but focus on to read cts p. 823-836

Omnicare, Inc. v. NCS Healthcare, Inc. – De, 2003

Facts – NCS is in financial trouble and is looking for a buyer but no one wants to buy. Bd. has 4
members, 2 inside and 2 outside. In this case, class A share are one vote per share while class B is 10
votes per share – in other respects, both shares are identical. The Inside members own Class B stock

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with gives them voting control of the company. NCS Defaults and a Creditors Committee is formed.
Omnicare, asks to buy D in Bankruptcy, at 270M, which gave Noteholders some money and SH none.
Genesis, who had lost a bidding war to Omnicare, contacts D, but insist on an exclusivity agreement and
lock ups in any potential transactions. D, forms an committee of outside Board members, to deal with
Genesis, but the full bd. retained legal control. Genesis offers to take up most of the Credit obligations
and give 20M to SH. By now NCS is starting to do better. Merger is done on effectively these terms and
Genesis gets an exclusivity agreement. Omnicare then comes back in and says it’ll pay off all the debt
and pay $3/Share. D can’t talk to Omnicare because of the exclusivity agreement with Genesis and then
Independent Board considers the risk of loosing the Genesis bid. Genesis then ups its bid and i) agrees to
pay off all the debt, Agrees to give more of its stock in its Stock for stock portion of the deal, and lower the
termination fee to 6M, but that an agreement had to be approved by midnight the next day. The
Independent committee and the full Bd. agree to the merger, and to authorize the voting agreement,
whereby the CEO and Chairman had to agree to vote for the merger even if the bd. later changed its
mind. Omnicare then files a suit seeking to enjoin and makes a tender offer at $3.5/share. Bd gets a
waiver to discuss deal with Omnicare who then irrevocably commit to the transaction. Then the Bd
withdraws its recommendation that SH vote for the genesis deal, but the Genesis agreement says that the
Bd. must put this up for vote even if they disagree.
Rule – Defensive measures cannot be draconian (preclusive or co-ercive) or limit the Directors fiduciary
duties
Analysis –

 Ordinary decision to enter into merger that doesn’t not involve a CIC gets BJR but when CIC is
involved there applies an enhanced Judicial Scrutiny
o Enhanced Scrutiny when:
 Defensive measures in a hostile Takeover proposal
 Enters into a CIC and starts and active bidding process
 Here deal Protection Devices require enhanced Scrutiny
o Conflict of interest arise when the Bd. prevents them form exercising SH their rights to
vote
o SH ability to reject a txn has an inverse relationship to the strength of the devices to
protect the transaction
o Hence deal protection devices get enhanced scrutiny
 Test:
o Had reasonable grounds for believing that a danger to the corporate policy existed (threat
here was loosing the Genesis deal)
 Satisfied by acting in good faith and reasonable investigation
o Defensive response was reasonable in relation to the threat posed. Two step analysis
that the measures were not:
 Coercive – Aimed at forcing onto the SH a Management sponsored
alternative to a Takeover
o When the Bd. or another party causes the SH to vote in favor of
the txn for a reason other than the merits of the txn.
 Preclusive – Deprives the SH the right to receive all tender offers or
precludes a bidder from seeking control by fundamentally restricting
proxy contests.
 If either are met then the defensive measures are draconian and not permissible
 Application of the test:
o Here the following defensive measures were Coercive:
 The section 215(e) – requiring vote even if Bd. does not recommend txn
 Absence of a fiduciary out clause
 Voting agreements
o Hence it was mathematically impossible for Omnicare to succeed.
 The defensive measures are unenforceable not only because they are coercive, but also because
they left the Directors unable to perform their fiduciary duties to minority SH
 The BD does not have the power to accede to a Lock up

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  Bd. by not negotiating a fiduciary out clause, removed itself when it’s judgment was really
needed, i.e. when a superior offer came in.
 Defensive measures cannot be draconian or limit the Directors fiduciary duties
Holding – Finds against Genesis.
Takeaway, exclusivity provision adopted by a bd to protect a merger must withstand Enhanced scrutiny
Greater extension of the Unocal std, even when the Merger txn does not result in a CIC.
In this case the deal protection is unreasonable because it results in a fait accompli, since it is preclusive
and coercive
Here the court found the combination of the three measures to be preclusive and exclusive since it
accomplished a fait accompli
You can’t lock up an agreement so much that there always has to be an out clause.
Even when there is no Revlon duties the Board must be abel to get out of the deal

Why Revlon duties do not apply

Short answer –

 SC assumes that Revlon duties dos not apply, whether or not the Revlon Duties were triggered –
assume arguendo

Longer answer

 Court of Chancery decision says Revlon only applies when there is an active bidding process, but
they quickly tied themselves to the deal with Genesis, and that is why that aspect of Revlon did
not apply
 Bust up of company – wasn’t’ an issue at all
 When there is a CIC, and Company controlled by 2 dominant SH, and assuming that they were
working in concert, because here this is snot a CIC because there is movement from being a
Dominant SH scenario to becoming a dominant aggregation of Unaffiliated SH, hence the
formalistic CIC does nto matter
Who knows why the Delaware SC didn’t get into this, perhaps they thought the arguments were weak,
perhaps they wanted to tet to this other issue

Bankruptcy does not count as a bust up since the directors did not want bankruptcy and the attitude of the
directors is what you need to focus in on

Anti-Takeover Regulation (State v. Federal)

Williams act- Did the Williams Act preempt state regulations about takeovers

So long as state Legislations does not change the basic neutrality

1. Alter the Williams Act basic neutrality btw tender offers and basic management
2. Impose burden that would conflict with the Williams act regulations
The state statute will survive judicial scrutiny

Since tender offers have a national impact the Illinois statute was unduly burdensome
So the 1st attempt to regulate met with failure

2nd generation statute was the control Share acquisition act which survived in the CTS case

 Bidder acquires a company and it could not vote those shares over

3rd generation statute (Moratorium statute)

 Popular in DE and Ny

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  Follow the Indiana
 Don’t’ restrict a bidder to acquire, just prohibit merger
 Is an effective anti takeover device as it stops the acquirer from using the assets of the acquired
company to finance the takeover
 Exception when tis a friendly takeover
 Other condition when the moratorium can be called off when you buy 85% of the target shares,
then no moratorium

CTS Corp v. Dynamics Corp of America, US, 1987

Facts – Indiana has a law saying that any corporation incorporated in Indiana and with Indiana
shareholders, must get approval of majority shareholders in order to for another corporation to acquire
control of it
Issue – Dynamics says that the act authorizing this violates the commerce and Williams act
Analysis –
Majority

a. You might think that this is a conflicting state regulation regimes, i.e. diff laws in diff states this is
not a question here as
i. Historic prevalence of state regulation of business means if congress wanted to preempt
such regulation it would’ve by now.
ii. We need to have corporations governed by one jurisdiction and historically this has
been in the state where it is incorporated
b. Statute in question is not discriminatory as it affects internal and external acquisitions the same
way. Just cause it happens to fall on an external business more does not establish the claim that
it discriminates
c. Pike balancing tests – Ct of appeals invalidated on the pike test shouldn’t do so as the balance
comes out in the local interest, i.e. corporations created in the local interest
d. Dynamics says that Tender offers should be encouraged as its better allocation of resources in
the hands of managers better able to use them
i. SC responds – Constitution does not require the state to subscribe to any economic
theory so we won’t second guess the legislature
Scalia – concurring

e. Likes all of the ideas except for the Pike Analysis

i. Not an area for the Judiciary to balance this
White – Dissent

f. Undermines the Williams Act which preempts the Indiana Statute

g. Burdens the market in interstate ownership esp if other staters follow Indiana’s lead
h. Indiana admits that part of its decision is Motivated by protecting Indiana corporation. Any law
that permits majority to stop minority (including out of staters) to sell to an out of state tender
offer is interference in Commerce clause

Class notes:
CTS Corp v. Dynamics Corp of America
Facts -
Statute operation – If a corp meets certain Indiana related qualifications then if there is an acquisition of
control share then you can get the economic benefit but not the voting benefit, unless you make a request
and then you have to get a majority of the pre existing disinterested Sh to a. Interested Sh are acquirer,
Officer or insider Director can exercise

If you buy the shares and the SH say no, then the company can buy them back but they don’t’ have to.
Good for Acquires in a way since normally acquirers want the SH the right to vote on the acquisition, so
you remove the BD. from the decision
Posner says that he market for takeover was an interstate nature and hence the states were interfering
with National and international owners

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If Posner’s holding was upheld then a slippery slope would result and the states would have no control
over

Court says the primary purpose of the act is to Protect the SH of the Indiana

 But the it also protect companies headquartered in Indiana

 Court says that its there to protect SH form the 2 tier front end loaded offer.

Study it because it’s about federal state

It’s a very states right decision in the area of corporate law pg. 830 para b
* p.830: very pro-state statement by the Court: “No principle of corporation law and practice is more
firmly established than a State’s authority to regulate domestic corporations, including authority to
define the voting rights of shareholders.”

11-16-2010
Wed, read the first three cases under LLC
Limited Liability Company

Formation

LLC

 Resembles general partnerships

 Provides some liability shield though
 Investors are called members
 May be managed by members or by managers (like a corp.)
 Requires paperwork foiling with a state agency plus fees and taxes
 Advantageous tax treatment
o Taxed once as opposed to corps.
o Members can have losses flow through to their personal income tax returns

LLP

 Requires filing with the state

 Limited liability for torts (negligence and other similar misconduct) but not for contractual debts
o Few states provide protection from both

LLC provides 3 attractive features:

1. Partnership like Tax treatment, i.e. the business is not taxed, just the distribution is taxed
2. Limited Liability
3. Flexibility in internal management of the business

There is a lot of diversity in practicing since the Unified act was passed in 1995, hence all states have a
hodgepodge of statutes because all states passed this before this act was passed

How to form an LLC:

 Have to file a document with Sec’y of state

o The foundational document is like the corporation’s articles of incorporation, kept simple
 Most of the stuff is added in the operating agreement

Management structure:

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  Whether LLC will have a centralized structure (corp) or a decentralized one (partnership)
o The beauty is that you can elect for yourself,
o Can decide if you want a member managed LLC or a manager managed one
o Default rule is the Partnership model
o Default rule is that your voting is proportional to the percentage of profits you get.
o Can make the members more passive if you take the manager managed model
 Particular LLC statute are pretty bare bones
o Hence need to get lawyers to develop contractual structure

Waste, Water & Land, i.c. d/b/a Westec v. Lanham, Col, 1998
Facts – Ds, Lanham and Clark are a managers and members of a LLC and Clark goes and K’s with
Westec to do some engineering work for them. Gives his Business card to Westec which has Lanham’s
Address, which was the principal for PII, The company’s name was not on the card but PII, the short
name of the company was. And oral agreement between Clark and Westec was reached. Westec does
the work and bills but is never paid and sues the members individually and as a company. Lower court
finds for P. Appellate reversed saying that filing the articles of organization gave Westec constructive
notice of status as an LLC.
Rule –

 Agent is personally liable for a K when the existence AND identity of the principal are not fully
disclosed
 Notice requires that the parties use the word Limited Liability Corporation or LLC as part of their
names
 LLC opens 2 bases for individual liability of members
o Alleged improper action
o Failure to observe the formalities coupled with a wrongful act
Analysis –

 Notice of Agency exempting liability only apply when they are sued as a LLC, not as managers or
members
 When 3rd party sues a manager or member under an agency theory then ageny law applies
 Agency theory
o Agent is personally liable for a K when the existence AND identity of the principal are not
fully disclosed
 Brad interpretation of Constructive notice would allow fraud as then Lanham could mislead 3 rd
party to think that he was personally liablerrrrrrrrrrrrrrrrrrrrr
 Notice requires that the parties use the word Limited Liability Corporation or LLC as part of thei
names
 LLC opens 2 bases for individual liability of members
o Aleged improper action
o Failure to observe the formalities coupled with a wrongful act
Holding – Finds for Westec

- Must provide notice to 3rd parties

Operating Agreement

Elf Atochem North America, Inc. v. Jaffari, Del, 1999

Facts – P, Elf, becomes a member with Malek Inc. Owned by a man Jaffari, in a LLC called Malek LLC.
Then Elf, Jaffari and Malek Inc. enter into an agreement for the governance of Malek LLC. Elf would be
30% owner and distributor for the product and Jaffari would manger and CEO of Malec LLC. The
agreement has a forum selection clause in CA and an arbitration clause. Elf and Jaffari have a falling out
and Elf Sues in Chancery court, derivatively and for itself. Chancery finds for Jaffari saying that it had no
jurisdiction given the forum selection clause.

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Rule –
Analysis –

 Policy of the act is to allow parties the freedom to K, i.e. broad discretion in drafting partnership
agreements
o Who will manage
o Establish classes of members
o Voting procedures
o Procedures for meetings
 Statute fills in when members agreement is silent
 Only an inconsistency with statutory mandatory provision will result in invalidation of agreement
o Only those protecting 3rd parties are such agreements
 De will allow Derivative suits in the name of LLC, but only when the agreement allos it
Holding – For Jaffari, arbitration will be held in Ca
The derivative suit is statutorily determined
There is default jurisdictional language in the De statute
The Ct is very deferential to the operating argument as a K.
De is a leading jurisdiction because of De respects your freedom of K.
Court also shows the preference for ADR.
Hence there are two policy issue highlighted here, i.e. the public policy preference of De:

1) Freedom of K
2) Preference of Arbitration
Q is what other statutory provisions you could you not waive:

11-18-2010
* I’m not sure if we covered Kaycee, the following case, check!
Piercing the Veil

LLC Statutes about PCV

4 ways the statutes fall -

1. Wyoming - Those that say nothing

2. Montana – Use Corporate principles
3. Colorado – Other wrong plus failure to follow LLC formalities pg. 285
4. Unified Limited Liability Act – mere failure to follow formalities will not be the basis for PCV Pg.
297

Other factors courts tend to look at:

 Comingling of assets (personal use)

 Ambiguity in their identity, i.e. whether they hold themselves out to the world as LLC or not

Kaycee land and Livestock v. Flahive - Wy

Facts – Flahive has a K with Kaycee to use the surface of his property and leaves it Contaminated. P
wants to pierce the corporate veil to get to D’s assets.
Rule – Same rules apply to piercing the LLC veil, which is a remedy at equity, as to Corporations
Analysis –

 Wy statue is short, establishes minimal requirement and was made before much was known
about LLC
 Since piercing the veil is a remedy at equity, the lack of statutory authority should not be
considered a barrier to its application
 Moreover, CL doctrine is not found to be abrogated absent unambiguous language in a statute

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  Every state that has enacted piercing eh LLC veil, has used the Corporate mechanism
 However the list of factors for Piercing the viel in an LLC context are not identical, and the
determination should be fact specific
Holding – Finds Piercing allowable and DC to make a fact specific determination on whether Piercing is
equitable in this context
* ONLY 103 IN INNIS OUTLINE!!!
ULLCA section 103 (b)
(b) the operating agreement may not: (2) eliminate the duty of loyalty…, but the agreement may: (i)
identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly
unreasonable,…”
Del. LLC section 18-1101(c)(2): “(c) To the extent that, at law or in equity, a member or manager or other
person has duties (including fiduciary duties) and liabilities relating to a L-L-C or to another member or
manager:… (2) The member or manager’s or other person’s duties and liabilities may be ex … or
restricted by provisions in a L-L-C …”

Fiduciary Duties

McConnell v. Hunt Sports Enterprises - Oh

Facts – Hunt and McConnell along with others form CHL, and LLC, to bring Hockey to Columbus Ohio.
They negotiate with city to get an arena with the city but it’s shot down in a referendum. Then Nationwide
says that it’ll build an arena and lease it to them. Hunt disagrees with the terms. Then nationwide goes to
McConnell to get a lease okayed. McConnell does, NHL agrees to open a franchise. McConnell files suit
seeking a declaratory judgment. Hunt files suit in NY. Lower court files for McConnell.
Rule – In a LLC fiduciary duties, such as not to compete apply, but can be limited by the agreement
document
Analysis –
K Interpretation – K is unambiguous in stating that the members may compete with one another.
Fiduciary duties –

 Fiduciary duties exist in relationship where special confidence and trust is placed in the integrity
and fidelity of another and there results a position of superiority or inferiority
o Normally this precludes competition
Tortious interference –

 Exists when a person induces another to not get into a business relationship with a 3 rd party
 No evidence the McConnell acted in a secret manner
 McConnell said he’d lease if D didn’t
 McConnell got the lease after he was approached by Nationwide
 Nationwide only approached McConnell after being rebuffed by D
 Plus McConnell had a right to Compete with D
P’s breach of K claim

 No evidence that D was Operating member of Party

 If anything the breached the K by representing themselves as such
Holding – Finds for P

Other models for Fiduciary duties

1. De Model
a. Bare boned
b. Freedom of K
c. Wants members to develop agreement about various issues
d. A member or managers Fiduciary duties and liabilities may be expanded or restricted by
provisions in an LLC Operating Agreement

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 i. B
2. Uniform Limited Liability Company act
a. Effective operating Agreement
i. Op Agreement may not eliminate the duty of loyalty, however Op agreement may
ID certain duties to be overwritten if not manifestly unreasonable
ii.

Corporate duties are mandatory

While Partnerships and LLC duties are not, i.e. can be somewhat changed

Dissolution of LLC

New Horizon v. Haack

Facts – Haack, was part of a corporation and personally signed for a gas card for her company. Its
ambiguous whether she signed as herself or as a representative. Her company, Kickapoo valley freight,
fell in arrears and several times she told the card people that she’d make payments. She also said that
her brother and member of her LLC had suffered a breakdown hence she might have to sell the
company’s asset. She never paid P, who sued in small claims court. Small claims court found since she
had been taxed as a Partnership, btu was never able to offer conclusive proof that they had formed a
partnership she was a partner and hence personally liable.
Rule – Dissolve a company by i) filling articles of dissolution (Optional?) and ii) giving written notice to
known creditors with information regarding the filling of claims
Analysis –

 Being taxed as a partnership for tax purposes is not dispositive to treating her as a partner or
piercing the corp veil
 However D is liable since she didn’t’ properly dissolve
 She was part of LLC as she testified and showing that the dpt of revenue recognized Kickapoo as
an LLC
 However you have to sheild your member from liability upon dissolution
 Filing of dissolution is optional however Creditors have to be notified and are first in line to get the
dough
 Creditors must be paid out of corp. assets before the members can collect
Holding – Holds for P, Incorrect dissolution
Take home –

 Members of LLC, unlike partnerships are not personally liable for the debts of the LLC
 Hack is still liable but not on the PCV charge but because of the Dissolution statute
o Insufficient procedure for following the procedure
 Take home – there are procedures of procedures for dissolution
o Then distribute the assets as Statutorily required
 Here the court was not clear as to what assets remained

Q3 – The statute says that she has to payout the $500 to the creditor but nothing over the assets received
in distributions

REVIEW
Wed: Dec 1st: 1-2:30 pm and Mon: Dec 6th: 1:30-3 pm if you have any question for the professor!

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