· Web viewBASICS OF CORPORATIONS. Closely held v. publicly held. Closely held – 5 or fewer...

Corporations Outline

BASICS OF CORPORATIONSI. Closely held v. publicly held

a. Closely held – 5 or fewer owners (overlap w/ control), no active mkt for sharesII. Forming a Business Entity – Reasons:

a. Liability for protection of owners.b. Set forth an understanding of management/rules.c. Establish change of control/exit/succession proceduresd. Taxes & Investment/Raise Money – easier to do with an established modele. Ownership and profit issues

III. Taxes – important in determining which business form to choosea. Basics

i. Marginal rate (each add’l $ above threshold) v. average rateii. Capital Gains/Losses

1. Long term, taxed at 15% v. short (up to 1 year), taxed at norm rate2. Long term and short term netted separately3. Losses may be carried to offset gains in future years

b. Proprietorship – not a separate taxable entity from owner (Schedule C)c. Unincorp Business Entity – at least 2 owners/partnership – Subchapter K – pass

through taxes to ownersd. C-Corp – double taxed (if distribution made, shareholders taxed)e. S-Corp – created to deal with issue of double taxation. Req’s:

i. Less than 100 shareholdersii. No non-resident or non-individual shareholders

iii. Only 1 class of stockIV. Internal Affairs Rule – foreign courts apply law of state of incorporation

GENERAL PARTNERSHIPI. Governed largely by state statute: Uniform Partnership Act; 1997 Revised UPA –

adopted by 36states, DC, VI, and PRII. Formation

a. Established by default where “2 or more ppl carry on as co-owners of a business for profit” – prima facie case if share profits.

i. UPA and RUPA provide rules for assisting in determ of if established.ii. Estab. whether there was intent or not.

b. Creditors can give some business advice – if too involved, can be seen as partnersIII. Partnership Agreement

a. RUPA – agreement may be written, oral, or implied – doesn’t have to be in writingi. If not in writing won’t reflect all expectations/understandings of partners.

ii. Only reason to have in writing is for statute of frauds issues (Gano v. Jamail)iii. No analogous UPA provision.

b. Default rules (of state statute) apply unless altered by agreement btwn partners.c. Profits – partners share equally in profitsd. Management – each partner has equal right to participate in mngmnt.e. Unlimited personal liability.

i. Liable for act depending on when you entered P-S in relation to when liability-creating event occurred – later/earlier partners not subj. to liability

1


ii. NOW – generally have an exhaustion requirement for partnership’s assets before going after partners personally; prev. did not have exhaustion req.

f. Flow through taxation to partners – partnership preps statement for filing to inform of profits.

IV. Joint Venture – specific venture/specific undertaking – NOT general operation.a. Generally limited time and limited purposeb. Each must have equitable interest in profits; joint sharing of losses commonly

regarded as essentialc. Treated as “general partnership w/ limited purpose” – thus partnership laws

generally governV. Kessler v. Antinora (NJ 1995) – partnership profits

a. K to provide funds to build house; A to build it – profit split, but silent on losses; house sold for a loss.

b. Issue – what sort of entity is formed? Should A have to cover K’s losses?c. Holding – partnership (by default); Not required to cover losses – Cali Rule.d. General Rule – repay capital contribution first; if there is a loss, it should be split

along lines that the profits were to be split (unless agreement specifies otherwise).i. If both parties put in capital, repayment is split into that proportion before

reverting to the profit/loss rule.ii. Might require one partner to pay cash to the other to reach that split

e. CALIFORNIA EXCEPTION (Kovacic v. Reed) – if one party contributes only labor (and is not compensated for it), he does not have to compensate the capital partner.

i. The labor investment is valued equally to the capital investment.ii. Thus, labor investment is losing 100% of its value, while investing partner

only losing a small percentage.iii. If labor partner is compensated, default rule kicks in.

VI. Indemnification & Contributiona. INDEMNIFICATION – UPA S.18(b) & RUPA S.401(c) – partnership must indemnify

partner for payments made and liab incurred in ordinary course of partnership’s business (unless altered by agreement)

i. Obligation of the partnershipb. CONTRIBUTION – if insuffic funds to pay obligations on dissolution, partners must

make up the short fall.i. Creditor may go after indiv partners, but only liable up to their share (RUPA

307(d)VII. AGENCY RELATIONSHIP

a. Definitioni. “Fiduc relationship which results by manifestation of consent by principal to

agent to act on principal’s behalf and subject to his control; and agent consents to act”

1. Manifestation by principal2. Agent’s acceptance of undertaking3. Understanding that principal is to be in control of relationship

ii. As long as legal def. met, agency is present even if parties did not intend one.iii. Relationship is not limited to natural persons (partners to partnership)iv. If not within scope of the business, there is no authority.

b. Principal is liable to a 3d party when agent acts w/: actual, apparent, inherent auth.i. May also arise through estoppel or ratification.

2


ii. Cannot remove authority after the fact and invalidate liability to 3d partyiii. Except, if didn’t have authority, can quickly say “no” to avoid liab – needs to

be before there is detrimental reliance.c. Actual Authority

i. Stems from communication btwn principal and agent – is it reasonable for agent to believe he has authority to act?

1. Can be revoked beforehand2. If after the fact – ratification/estoppel3. May be express or implied (from prior acts)4. If principals words/conduct would leave reasonable person in agent’s

position to believe agent has authority to act, agent DOES have actual authority (hypo – principal left note on wrong desk to do act)

ii. Incidental Authority – authority for agent to engage in acts necessary to accomplish an authorized transaction.

iii. UPA S.9 – Partner Agent of Partnership as to Partnership Business1. Carrying on in usual way of P-S binds P-S, unless acting partner has no

such authority AND 3d party knows he has no such authority2. If not w/in usual scope of business, BUT is within apparent course of

business of other firms in same business, than still falls under S.93. If not in usual business, doesn’t bind partnership unless authorized.4. Certain acts require no authority less than all partners – (see list)

iv. National Biscuit Co. v. Stroud (1959)1. S advised N it would not be responsible for more bread; F bought

more2. Issue – Can acts of 1 partner bind partnership as a whole?3. Holding – YES, each partner has actual authority for the partnership4. Each GP has equal mngmnt authority, within scope of the partnership5. Other partner cannot restrict such authority by notifying 3d party

a. To revoke, must dissolve partnership6. Holds unless partnership agreement states otherwise – RUPA S.303 (if

agreement publicly filed) – no similar UPA provision.7. Outcome would be different if F had been

a. Agent (rather than partner) – can revoke actual authorityb. F might still have apparent auth, unless S notified Nabisco

d. Apparent Authorityi. Arises from manifestation of PRINCIPAL to 3d PARTY – if Principal’s

words/conduct would lead a reasonable person in 3d party’s position to believe agent has such authority (cannot be created by agent)

ii. May be created through agent’s position/title – if not clearly estab, what is industry standard for such position/title.

iii. To dispel, principal must note that not authority exists to the 3d partye. Estoppel

i. No affirmative representation made, but principal contributed to 3d party’s belief OR failed to dispel it.

ii. 3d party must have undergone a detrimental change in position.VIII. Fiduciary Duties

a. UPA S.21 – Partner Accountable as a Fiduciaryi. Every partner must account to P-S for any benefit

3


ii. Applies to all representatives of a deceased partner as well.b. Meinhard v. Salmon (NY 1928)

i. Lease btwn G & S, S enters separate agreement with M – S to operate, M to pay ½ costs. Near end of lease, reversion enters into extended lease; S did not tell M.

ii. Issue – Does S have a duty to include M in the new lease?iii. Holding – YES, related to their nexus of opportunityiv. Those acting as partnership have undivided loyalty to one anotherv. New lease was incident of the enterprise, which S appropriated in secret,

excluding M from chance to compete from opportunity arising from participation in partnership

vi. Should receive half of lease, with ~1share adjustment to account for S’ mngmnt interest

vii. JV/General Partnership distinction doesn’t seem to matterviii. If G had approached capital partner instead, maybe a diff outcome – S has

greater duty b/c of mngmnt role.IX. Dissociation and Dissolution

a. 3 stages: formal dissolution; winding down; terminationb. Fiduc duties still exist - might even be heightened to avoid looting.c. Also continue to be personally liable during this period (unless altered by agrmnt)

i. Except if P-S continues after dissolution, leaving partner not liab for future acts.

d. Terminates actual authority (except that needed to wind down) – problem is apparent authority (key is to send notice to 3d parties)

e. UPA S.29 – Dissolutioni. Def – change in relation of the partners caused by any partner ceasing to be

assoc in carrying on of the business (refers to personal rel. of the partners)f. Terminology

i. At will – agreement has no specified definite term or undertaking (default)ii. Term Partnership – implicit/explicit agreement by all partners that P-S shall

have definite term for a particular undertaking.1. Statement that goal of partnership is to recoup investment not suffic

to constitute a “term”iii. Rightful Dissolution – w/o violation of the agreementiv. Wronful – in contravention of terms of agreement

1. Dissolving partner must pay damages, for breach of contract.g. Formal Dissolution – Step 1

i. Req’s a formal event.1. P-S to end on set date2. Partner walks away3. Death/Bankruptcy4. Court Order – Key reasons:

a. Breach of agreement/partner conducts self unreasonablyb. P-S can only carry on at a lossc. Indiv partner capable of performing functiond. Lunatic

ii. Partnership can continue after dissolution event1. Have to give accounting to leaving partner – either then or later

4


2. If later, accounting = amount of share (valued at time of dissolution) + (interest on capital OR returns gained from capital)

3. Partners choice – encourage P-S to make accounting when leaving4. Equitable Rule – allows reasonable efforts to make acct’g – can’t find

partner, so put money into escrow/trust5. Generally not made when leaving, b/c ppl for get or it isn’t much at

the time (eg: FaceBook)h. Winding Down – Step 2

i. Close any transactions; distrib assets:1. Creditors, partners (non capital contrib), capital contrib, profits2. Partners personally responsible for contribution to satisfy liabilities3. Selling assets can be piecemeal or as a going concern

ii. Authority/Agency still exists in a limited way.i. Termination – Step 3j. Collins v. Lewis (Texas 1955)

i. C puts up money, L operates cafeteria – goes way over costii. Issue – May court dissolve partnership?

iii. Holding – NO, L hasn’t done anything wrong; but C may walk awayiv. Partners have inherent power of dissolution, but not the rightv. Court will not assist in braking of partnership where partner not fully or

fairly performed agreement – courts as a policy don’t like breaking up P-S1. C did not perform when he stopped his payments to L (no finance cap

in agreement)2. L could perform his role (mngmnt) but for C’s stopping payment.

vi. L not dissolving b/c no incentive1. He has a set cash flow2. Cali Rule won’t apply b/c receiving compensation for his labor, so

would have to repay losses.vii. C could potentially bring suit later, arguing P-S not possible to carry on for

any profit – but that might have to be awhile to avoid appearing as if trying to scuttle the P-S

viii. Case heard under Texas Law, but outcome largely the same under UPA

OTHER BUISINESS FORMSI. Change to a diff structure does not affect liab for acts while done under prev. structure

a. Some states may say that after certain time, that is no longer the case.II. Main Partnership/Corporation trade-off is taxes v. liability.III. LP

a. State statutes generally explicitly link to general partnership law.b. Formation – req’s filing with the statec. Real details of rights/duties/operation is in the partnership agreement (non-public)d. Can withdraw w/o notice, triggering dissolution.e. Statute does not explicitly grant/deny mngmnt rights to LP, but cases hold that LP

may not participate in mngmnt – agreements also tend to deny mngmnt rights.f. LP participates in control, loses LP status: “control rule liability”g. Generally no voting rights, except for major transactions

5


IV. LLPa. General partnership law applicable, when not explicitly alteredb. All partners have right to participate in mngmnt w/o risking loss of limited liability

– provides “peace of mind” insurance for innocent partnersc. Supervisory liability – only liability for acts you engage in and wrongful acts of ppl

you supervise.d. Formation – must fall w/in general def. of partnership, and meet certain formalities

(such as filing with the state and carrying specified insurance funds)V. LLLP

a. Allows for an LP to register as an LLLP.

VI. The Control Rule – lmt’d partner has no liability for debts of venture beyond initial investment, but can lose that protection if they participate in mngmnt.a. Signif litigation on how much activity is necessaryb. Each progression of LP statute, control rule has become more protective of LP – last

version eliminated control rulec. Gateway Potato Sales v. GB Investment Co (AZ 1991)

i. S (GP) told Gateway that GBI (LP) providing the financing and was actively involved in the management – GBI never confirmed, and took it at face value

ii. Issue – Is GBI liable as a general partner, even though Gateway did not directly know of GBI’s mngmnt acts?

iii. Holding – YES, can be (remanded for determination of liability)iv. Threshold question is whether there is authority for the transaction

1. Actual authority – yes, GP’s role to manage affairs2. Apparent authority – no – agent cannot create authority, must come

from partnership (principal)v. Is there liability? 3 rules, under 2 statutes

1. If LP’s participation in control is not substantially the same, then must have actual knowledge of participation in control

2. If there is no actual knowledge of participation, then LP’s control must be substantially the same as GP’s.

3. Participate in control in substantially the same way and signal it to creditor – saying the LP provides funding not suffic b/c that is the LP’s role.

vi. AZ adopts rules 1 and 2.vii. Under current law, when “substantially the same” test is met, direct contact

not req’d. If test not met, then direct contact is req’d.

VII. LLCa. Combines benefits of corporation and partnership – lmt’d liability and pass-thru taxb. Large freedom to arrange internal operations of venture

i. Members can appoint managers – members don’t have authorityii. Can also be “member-managed” – all members have authority

c. Most states allow LLC to be formed by 1 persond. Can unilaterally disassociate at any time, but dissolution req’s a vote.

6


CORPORATIONSI. Formation of a Closely Held Corporation

a. Where to Incorporate – appraisal of 2 factors: cost of incorp and law of state of incorporation

i. Usually comes down to state conducting business w/in and Delawareb. How to Incorporate

i. File w/ state – 4 req’s: agent, #shares, corp name, name of incorporatorsii. Permissive provisions

1. Opt-in (must be put into charter to apply) – lmt’d liab of directors 2. Opt-out – purpose of court

iii. Then must create bylaws (not publicly filed)iv. Restated (articles redone – only need to check one copy)v. Amended – only certain parts redone (need to check all versions)

vi. Signif issue – what to put into articles – trend toward simplification, only put in what is req’d

II. MBCA provisionsa. S 2.02 – Articles of Incorp

i. Must contain – corp name, # shares, street address of office and name of agent, name and address of each incorporater

ii. May contain – name and address of initial directors, purpose of corp, defining powers of managers/directors/shareholders, imposition of personal liab for shareholders, director liability and indemnification

b. S 2.03 – Incorporation: effective when docs filed (concl. proof of proper existence)c. S 2.05 - Org of Corp

i. After incorp, initial dir must appoint managers and create bylawsd. S 2.06 – Bylaws: may contain any provision for managing the business

III. Ultra Viresa. Ashbury Railway v. Riche – beginning of doctrine

i. Corp NOT liable to contrast RR b/c it was “beyond power of corp” – which was to “make or sell, lend, hire”

ii. Doesn’t matter that corp’s shareholders agreediii. Articles of Incorp are public record and should be looked at when doing trans

b. Some courts avoided ultra vires by construing purpose clauses broadly or finding implied purposes – could also use estoppel, unjust enrichment, waiver

c. 711 Kings Highway Corp v. F.I.M.’s Marine Repair Service (NY 1996) – diminish UVi. Casea arguing ultra vires should be dismissed for failure to state a claim

ii. People weren’t checking public record (undermines reason for UV)iii. NY Bus Corp Law S.203 – no act of a corp shall be invaled by fact it was w/o

capacity or power to do such act1. Except:

a. Act brought by shareholder to enjoin corp actb. Act by corp against incumbent or former officerc. Act brought by state AG

d. Sullivan v. Hammer (DE 1990) – Chartable Donationsi. Financial support for museum to be named after corporation’s founder –

settlement for court approvalii. Allows settlement to go through – in making determ, Court should look at

fairness of the case, considering:

7


1. Probable validity of claims2. Difficulties in enforcing claims through court3. Collectability of judgment4. Delay, expense, and trouble of litigation5. Amount of compromise6. Views of parties involved

iii. No personal benefit, lack of indep, or gross neg shown – so get BJRiv. If this is UV depends on how purpose clause written – “any lawful purp”v. Defense – gift contributes to goodwill of the corp – speculative at best, but

doesn’t matter b/c of BJR protectionvi. What considerations matter? – geography, entity donated to, indiv’s name in

relation to the corpvii. State statute – allows for reasonable contrib to charity

viii. CL – reasonableness interp and ultra vires.e. Citizens United

i. UV arg for corp making political donations didn’t workIV. Promoters

a. “Person who directly/indirectly takes initiative in founding/organizing” firm – could be a promoter w/o knowing it

b. Owes signif fiduc duty to others in corp – corp may bring suit v. promoter after corp control transfers to subsequent investors.

c. Default Rule – promoter liable for contracts made when no corp exists – unless there is an agreement to look to some other entity for liability.

i. Where performance called for before corp existence, inference promoter intended to be personally liable, and corp not liable on contract unless it explicitly/implicitly adopts contract (McArthur v. Times Printing Co)

ii. Yaki v. Giles – Promoter not liab when 3d party knows corp not exist yetd. Stanley J. Hove & Assoc. v. Boss (S.D.Iowa 1963)

i. Architect signs contract as “By: Edwin A. Boss, agent for a Minn corp to be formed” and checks were made payable to corp name.

ii. Issue – Is Boss personally liable for contract with corp not yet formed?iii. Holding – YESiv. General rule is that indiv personally liable unless 3d party agreed to look

elsewhere for completionv. 4 alternatives

1. Revocable offer on the table and corp has to accept on its own when it comes into existence

2. Best Efforts – promise by promoter to use best effort tot form corp and get it to accept offer

3. Novation – promoter personally liable, unless corp is formed and steps in to assume the contract/obligation

4. Contract formed where promoter remains liable for performance, regardless of corp’s liability (guarantor essentially)

vi. Which alternative used depends on facts of the case.vii. Should look to intent of entire contract – did not intend corp to be solely liab

viii. Thus, Boss personally liable unless P agreed to look solely to new corp (since no duty to P to form new corp) – no revocable offer b/c contract entered into

8


V. Defective Incorporationa. MBCA S 2.04 – Liability for Pre-Incorporation Transactions

i. If acting as or on behalf of corp, and know that there is no corp, then jointly and severally liable for all liabilities created.

ii. Comment – lmt’d liab should be recognized even if corp not formed when:1. Thought docs filed but wasn’t2. Mailed letters but state doesn’t file or refuses to file3. Immediate execution urged and other party knows corp not filed.

b. Robertson v. Levy (DC 1964)i. L submitted docs, but no cert issued; entered lease and began business; cert

later issued.ii. Issue – Can he be held personally liable for obligation entered into before

cert issued?iii. Holding – YES, personally liable.iv. One reason for enacting modern corp statutes was to elim problems inherent

in de jure, de facto and estoppel concepts1. De jure – conform w/ mandatory req’s: you’re a corp2. De facto – defectively incorp but everything else is fine, usually has a

good faith req3. Estoppel – 3d party thinks they’re dealing w/ a corp, but aren’t

v. S139 – if indiv or group assumes to act as corp before cert issued, joint and several liability attaches – bright line rule, elims de facto and estoppel

vi. NOT ALL JURIS FOLLOW THIS BRIGHT LINE RULE.VI. Piercing the Corporate Veil

a. There is a legit obligation, but insuffic corp funds to cover itb. Not all shareholders will be liable – specific shareholders, for specific transaction

i. Reason it’s a phenom for closely held corps, never done for a public companyc. Enterprise or Sibling Liability – corp has no money, but related entities do.d. Factors – no factor necessarily determinative (although first 3 usually more import)

i. Ownership – majority rule: “substantial owner”ii. Undercapitalized – compare assets to liabilities – “sufficient capital” to pay

expected liabilities/obligations1. May have to change over time (expanded corp, industry changes, law)

iii. Failure to observe corp formalities (eg: lack of board mtgs, no corp records)iv. Non-payment of dividendsv. Insolvency of debtor corp

vi. Siphoning/Co-minglingvii. Non-functioning officers

viii. Misrepresentationix. Overlap of directors – can have, but need to act diff when in diff roles

e. Diff btwn tort and contract claims – tort: no voluntary dealingf. Bartle v. Home Owners Coop (NY 1955)

i. B trustee of WB, which is in bankruptcy, and wholly owned by HOCii. Issue – is parent liable for debts of wholly-owned sub?

iii. Holding – NO, if conditions metiv. Original theory – unless fraud, misrep, or illegality, will not piercev. While HOC controlled WB affiars, had outward indicia of sep corps

1. Creditors not misled

9


2. No fraud3. Appear to be engaging in corp formalities4. No act causing injury to creditors of WB5. Overlap of officers directors – happens a lot for subs though6. POLICY – parent corp provides low cost housing for veterans

vi. Piercing generally reserved for preventing fraud/achieving equity – no evidence of fraud, misrep, or illegality here

g. DeWitt Truck Brothers v. W. Ray Flemming Fruit Co (4th Cir 1976)i. Pierce Corporate Veil

ii. Idea of corp is only a theory and courts decline to recognize it when it would extend beyond reasonable and legit purposes and produce injustices.

iii. Proof of plain fraud is not necessary, but is sufficientiv. Main concern is w/ reality and how the corp operates in rel. to D.v. To pierce, need # of factors and an element of injustice/fund. Unfariness

1. One man corp (90% ownership)2. Undercapitalized (5000 shares at $1 each3. No business records/corp meetings (formalities not observed)4. Doesn’t appear corp designed to make any profit5. Very small “risk capital”/capital reserves6. No dividends7. Director a figurehead w/ no fees

vi. If do not pierce, F permitted to retain large amount from corp that doesn’t have any real capital in the venture – also stated he would take care of charges personally.

h. Baatz v. Aarow Bar (S.Dakota 1998)i. DO NOT PIERCE corporate veil

ii. A corp is a separate entity unless there is suffic reason to the contrary – if cont. recognition will “produce injustice and inequitable consequences”

iii. Args for piercing here – no piercing justified1. Personally guaranteed oblig – suggests formalities observed and

trying to support capitalization2. Overlapping ownership – but fails to show how owners conducting

personal business through corp3. Undercapitalized – started w/ only $5K, but had add’l $200K put in4. Failed to observe formalities b/c didn’t indicate it was a corporation

a. Statute req’s name indication – name incl. “inc”b. Mere failure in corp name also will not justify piercing

5. No fraudi. Radaszewsi v. Telecomm Corp (8th Cir 1992)

i. No piercing of corp veil to get to parent companyii. MO law allows piercing when 3 req’s met:

1. Control – complete dominion over finances, operation, and policya. Prong alone not suffic – need to look at how using corp

2. Control used to commit fraud, violate a law, or unjust act violating P’s legal rights

a. Undercapitalization has become a proxy for this3. #1 and #2 Prox cause of injury/loss

10


iii. Courts disregard undercap’d corp b/c justifies inference parent delib/recklessly created business

iv. However, $11M in liab insurance – which satisfies fed regs is suffcv. Further, no distinction on form of money – debt v. equity.

j. CUPCAKE HYPO – SEE NOTES, p23

CAPITAL FORMATIONI. Types of Equity Securities

a. Basicsi. Board empowers corp to authorize/issue shares

1. Authorized – the ceiling, listed in article of incorp2. Issued & Outstanding – amount sold/being publicly held

ii. Share – unit into which proprietary interest in copr is deivided1. May be diff classes w/ diff distinctions, preferences, rights 2. Each share within a class has to have identical rights

iii. 2 fundamental rights – voting and entitled to net assets of corp1. May be in diff classes, so long as both rights authorized and at least

one 1 share of each class is outstandingiv. Distributions

1. Dividend – distrib from current/retained earnings2. Liqidation – distrib at dissolution

v. Voting rights1. Categories: transaction, governance, dissolution2. Fundamental right b/c protects interest vis-à-vis debt holders

b. Common Sharesi. Have both rights, but may be divided into diff classes

ii. Non financial rights – inspect books, sue on corp behalf, right to financial infoiii. Characteristics (as stated by SCT) – right to receive dividends, negotiability,

ability to serve as collateral for debt, confer voting rights, capacity to inc. in value.

c. Preferred Sharesi. Entitled to specific distribution before anything paid to common shares –

“amount of preference”1. Typically a capped value – even when share value increased, amount

of preference may notii. Special rights (varies based on contract)

1. Cumulative Dividends – accumulates year to year and full amount must be paid before anything to common

a. Partially Cumulative – cumulates to extent corp has earnings, and non-cum to extent there is excess dividend preference

2. Voting – preferred usually non-votinga. For protection, usually get to vote on certain things if no

dividend issuedb. Can also give large voting power to ensure person stays in

control (FB example)3. Liquidation Preference

11


4. Redemption Right (Call Option) – option of corp to recall shares at fixed price set in articles of incorp.

5. Put Option – shareholder option to force corp to buy back shares at fixed ratio.

6. Conversion Rights – into common shares at fixed rationa. Reason – amount of preferred dividend no longer greater than

that being received by common.b. Could be “upstream” as well, but very uncommon.

7. Protective Provisionsa. Sinking Fund – req’s corp to set aside funds each year to buy

back portion of preferred – protects conversion priv from dilution

8. Participating Preferred – after specified preference, also get to participate in dividends as a common share

9. Anti-Dilution – in event more shares issued, must first give current holders right to purchase amount that would not dilute their ownership %

a. Right to buy at lower value if priced less than your sharesb. Protection that shares w/ better pref can’t be issued w/o

consentiii. MBCA S 6.30 – Pre-emptive rights and dissolution.

d. Distributionsi. Gottfried v. Gottfried (NY 1947)

1. Action to req Board of closely held corp to pay dividends2. Issue – Has withholding dividends been in bad faith, entitling common

holders to a dividend?3. Holding – NO, need a finding of bad faith and a surplus suffic to pay

dividends4. Dividends generally paid at Board’s discretion, so need court to say

failure to pay was a breach of fiduc duty.a. Mere existence of adequate surplus not suffic to invoke

payment of dividends – need bad faithb. Relevant to bad faith

i. Intense hostility, against minority shareholdersii. Exclusion of minority, from employement

iii. High bonuses, salaries, loans to officersiv. Majority holders subject to high taxes if div paidv. Desire by majority to acquire minority interest.

c. Essential test is if decision dictated by personal interest5. Factors here:

a. Advance made to majority – has been made to directors and sh. for years’ no evidence loans made w/ div policy in mind

b. No weight to 1 dir statement that goal is to freeze minority outc. Recent expenditures of $165K, to retire preferred – essentially

a dividendd. Capital retained to pay down outstanding mortgagee. Dividend paid a few years ago

12


ii. Dodge v. Ford Motor Co (MI 1919)1. Prev policy of paying large dividends; highest profits in history this yr2. Issue – should FMC be compelled to distrib dividends?3. Holding – YES4. Uses Gottfried Rule – surplus + bad faith.5. Clearly had a surplus6. Appears thus to be an arbitrary refusal – req’s justifications –

duplication of planta. Goal was lower cost of cars for consumers – leads to less profitb. Ford – profits should be shared w/ public – 58% ownerc. Is this really bad faith?

7. Had policy of paying dividends – diff outcome if no such policy?

FIDUCIARY DUTYI. Board of Director Basics

a. Usually 10-12 ppl that operates by committee – compensation, audit, nominating (req’d committees if a public company)

b. Inside director v. outside director (preferred b/c of independence/loyalty issues)c. No req directors must be shareholdersd. Personal Liability Protection for directors – director insur, indemnification clauses

II. Statutesa. Del Gen Corp Law S.102(b)(7)

i. Art of Incorp MAY contain provisions limiting or eliminating personal liab of directors for money damages for breach of fiduc duty

ii. Doesn’t apply to suits in equityiii. 4 exceptions

1. Breach of duty of loyalty2. Act not in good faith or is intentional misconduct/illegal3. Act where director derives personal benefit4. Act violates S.174 – deals w/ unlawful dividends and repurchases

iv. Opt-in provision; came as a response to VG.b. Del Gen Corp Law S.144

i. No contract/transaction is void solely b/c of conflict of interest IF:1. Material facts disclosed and board authorizes it by majority of

disinterested directors; OR2. Material facts disclosed/known to shareholders, and they vote; OR3. It is fair as to corp at time it is authorized

ii. Common/interested dir present may count toward quorumiii. S144 only gives BJR presumption – may still have been found to breach

c. MBCA 8.30 – Standards of Conduct for Directorsi. Shall act in good faith and in manner reasonably believes to be in best

interest of corpii. When becoming informed, such manner as person in like position would

reasonably believe approp under circumstanceiii. Shall disclose info material to discharge of duties – unless violates some lawiv. Entitled to rely on performance, info, opinions, reports of ppl listed in sub (f)

13


d. Some states have “other constituency” statutes. – permit not shareholder considerations.

III. Shlensky v. Wrigley (IL 1968)a. No breach of fiduciary duty (failing to install lights at stadium)b. To prove breach must overcome BJR – can be done it 2 ways:

i. Decision was wholly uniformed – processii. So irrational, it was wasteful, and no rational person would do it.

c. Not proven that installing lights would benefit corpi. Not following others lead is not negligence

ii. No allegations other teams turned profit on lightsd. Court says Dodge is irrelevant

IV. DUTY OF CAREa. Smith v. Van Gorkon (DE 1985)

i. Does BJR isolate Board from liability (for breach of duty of care)?ii. NOT HERE

iii. Board must make decision w/ all info reasonably available – if not, then no BJR protection – has to do w/ decision-making process and substance

iv. DE proper standard for BJR is predicated on negligence.v. Here, not an informed decision b/c

1. No study of intrinsic value of corp – no determ if $55 was “fair”2. No director asked CFO for details or why no fairness study done3. Accepted $55 as fair w/o scrutiny

a. Should have gotten other opinionb. Price was in relation to cost of transaction, not stock pricec. Wasn’t fairly put to mkt

4. No questions on tax implications5. Board didn’t know purpose of mtg til got there and only got docs there6. Lasted only 2hr – if couldn’t extend, what could they have done with

that time?7. Why is reliance on CEO a problem?

a. Best person would have been the finance person – CFOb. Person relying on needs to be reliable – “lawyer told us”

insufficc. Could/should have consulted w/o outside experts.

vi. Rejects arg that Board’s collective experience/sophistication is suffi for finding of reasonable decision.

vii. Outcome of case was shocking b/c DE usually pro-corp and pro-mngmntb. Brehm v. Eisner (DE 2000)

i. No breach of fiduc duty – employment contract w/ umbrella paymentii. First Q – check for (Eisner) independence: nothing alleged he would

personally benefit and had several million options of his own to protectiii. Second step – PROCESS

1. Doesn’t matter it was negotiated outside of Board b/c employment contracts common/standard thing.

2. Board responsible for considering only material facts reasonably available

3. Reliance – consulted w/ compensation expert

14


a. At time was reasonable to rely on expert – may be diff if expert has bad track record.

iv. WASTE claim – look at creation of contract, b/c obligated to pay.1. Must prove that contract so one-sided no one of ord, sound business

judgment could conclude corp received adequate consideration.2. Board’s decision should receive great deference – if substantial

consideration, then contract is worthwhile/not wasteful.v. Case not immed dismissed under S.102(b)(7) b/c argued as bad faith

exceptionc. Brehm v. Eisner (DE 2006)

i. Amended complaint and argues not properly informed of material facts and grossly negligent

ii. Holding – compensation committee approp informed of material facs/potential exposure

iii. Info for Board’s decision derived from 2 sources1. Benchmarked to options prev. granted to Eisner2. Amount of “downside protection” needed to incentive Ovitz – was

leaving a $150-$200M guarantee at other companyiv. Thus had rational business purpose – induce Ovitz to joinv. There are at least 3 categories of behavior that are candidates for “bad faith”

1. Subjective bad faith – motivated by actual intent to do harm2. Lack of due care – action taken w/ gross negligence3. Conscious disregard for one’s duties – lower court used this standard

V. DUTY OF LOYALTYa. Marciano v. Nakash (DE 1987) – self-dealing

i. What is the standard for voiding a self-interested transaction?ii. Holding – S.144 (deal was fair, under CL test)

iii. Q1 – is there an “interested transaction” – YES: N getting interest back from loan, benefit to them and not everyone

iv. Rule was prev. per se voidability – but that overstates CL rule – self-interest transactions have some benefits, so should be subject to fairness eval vis-à-vis not interested members

1. S.144 not exclusive – can always eval under CL intrinsic fairness testv. Q2 – Does S.144 apply? – remove taint of self-dealing and get BJR protection

1. If satisfy S.144(b)a. If majority of disinterested shareholders approve – BJRb. If majority of disinterested shareholders disapprove/reject:

i. Some courts – BJRii. Others – IFT

2. If (a) and (b) fail, eval under (c) – intrinsic fairness testa. No set factors – court looks at terms of deal and decides what

they would do – could they have gone elsewhere for loan? How much did they charge? Fair amount?

VI. DUTY OF OVERSIGHT – part of duty of loyalty.a. In re Carmark International Inc Derivative Litigation (DE 1996)

i. No breach of duty of oversightii. Director liability for breach to exercise apporp attn. may arise in 2 ways:

1. Ill-advised: no system or ineffective system (process issue) – BJR eval

15


a. “Reasonable info system exists” – indicates some lapse okay – how much is a problem (sustained failure)

b. Who has to know? Is 1 of 10 dir okay? (Bates v. Dresser – Pres had info on likely culprit but did nothing – liable, but rest of Board is not)

2. Unconsidered failure to act – know or should know of problem/ignore system (monitoring issue)

a. Legally, Board only req’d to authorize the most signif corporate acts – most corp decisions not subject to director attn.

b. Overrides Allis-Chalmers “red flag” requirement – still exists, but is supplemented

c. Court cites to VG – wants board to have more responsibilityiii. Must also show failure prox cause of losses complained of.iv. Here

1. Nothing supports view directors knew of violation2. No evidence of sustained failure to exercise oversight function3. Fact losses resulted from the violations doesn’t alone create breach

b. Stone v. Ritter (DE 2006)i. Issue – is there a breach of duty of oversight? Good faith?

ii. Holding1. No separate duty of good faith2. Oversight is a breach of duty of loyalty (means it avoids 102(b)(7))3. Caremark is the standard for duty of oversight

iii. Since showing of bad faith conduct is essential to oversight liability, the duty violated is that of loyalty – results in 2 add’l consequences

1. “Good Faith” is not a separate fiduc duty2. Duty of loyalty is not lmt’d to cases involving conflict of interest

iv. Caremark articulated the necessary conditions for oversight liability1. Failed to implement any reporting or info system2. Consciously failed to monitor/oversee operation, thus not informed

v. Here,1. No red flags2. Report showed subst resources dedicated to compliance program and

that there was an overall high degree of compliance.

DEMAND AND DISMISSALI. Aronson v. Lewis (DE 1984)

a. Issue – when is demand excused as futile?b. Holding – when facts ALLEGED W/ PARTICULARITY create a REASONABLE DOUBT

director’s actions are entitled to BJR.c. Demand req’d b/c derivative suit inherently impedes on managerial freedom of dird. Court must apply a 2 step test

i. Are directors interested or non-independent TODAY (at time dismissal would be made); OR

1. Need majority of directors to be interested/not independent2. Must allege reasonable doubt directors disinterested/independent

a. Mere fact named in lawsuit not sufficient

16


b. Some courts – if dir is to be be held personally liable, would be suffic

c. Just b/c dir appt’d to Board doesn’t remove presumption of indep. – might be diff if they’re “beholden” (eg: inside director)

d. Orchestrated trans may not be suffic – depends on typeii. Underlying transaction is otherwise valid use of business judgment

1. Get to trial if can show it MIGHT be wasteful – only need to make it “sound odd” – will get to eval more fully at trail (eg: defenses)

2. Looks at substantial nature of transactione. If determinant were “reasonable interference” conclusory allegations of futility

would be come automaticf. Burden is on shareholder (on corporation in Zapata)g. Duty of care req’s: good faith, best interest of co; informed basis.

II. Zapata Corp v. Maldonado (DE 1981)a. Issue – Can stockholder continue suit over Board’s dismissalb. Holding – YES, if certain steps satisfied.c. Consideration can be broken down into 3 parts

i. Continuing right of stockholder to bring derivative suit – cannot be allowed to invade discretion of Board, but dismissal not determinative if:

1. Dismissal was wrongful (Zapata)2. Making such demand on Board would be futile (Aronson)

ii. When should committee be able to dismiss suit? – Q is one of member disqualification.

iii. Role of Court in resolving conflict1. BJR not the proper standard2. Req’s balancing of many factors – ethical, promotional, PR, employee

relations, fiscal, legal.d. If motion to dismiss derivative suit made (already determ that demand is req’d),

court applies 2 step testi. Independence and good faith of SLC and bases supporting conclusion, AND

1. Burden on corporation to show good processii. Whether to grant motion, relying on court’s own independent business

judgment.1. Have already proven demand futility and lack of independence – thus

likely to err on side of shareholder2. Court considers full circum of suit – though deemed indep in prong 1,

may not be indep in prong 2 – eg: why did you pick her, of all ppl?III. In re Oracle Corp Derivative Litigation (DE 2003) – deals with Zapata

a. Issue – how should director independence be analyzed?b. Holding – not only by financial interest, but also by social interests/concernsc. Economics is not the only consideration that effects personal behaviord. Corp directors normally the sort of ppl enmeshed in social institutions.

i. Such inst have norms that influence behavior – some things “just aren’t done”e. Here,

i. G-M & G were considering serious accusations against fellow board members and professor who they have constant interaction with – tenure probably matters (factors to eval at tenure), any exec position matters (fundraising responsibilities), similar relation at school

17


ii. Board contends unaware of Elision’s relationship – ignorance is unavailing: should have determined that when forming SLC, esp considering the publicit

f. Fact new Board members hired by Board not determinative b/c of presumption of independence (and b/c all appointments made through some prev knowledge)

IV. Beam v. Stewart (DE 2004) – deals with Aronsona. Issue – was demand futile?b. Holding – NO, demand should have been made.c. Directors are entitled to a presumption of good faith, and shareholder must plead

particularized facts.d. To show that demand is futile, shareholder must provide reasonable doubt Board

members disinterestedi. Interest may be shown by demonstrating potential personal benefit or

detriment to director as result of decision.ii. Variety of motivations (incl. friendship) may influence independence, but it

must be of a bias producing nature – most friendships do not rise to that level.

iii. Oracle takes that to an extreme – ppl naturally and always look out for friends

e. Here,i. Martinez – several yrs business rel. and single affirmation of friendship no

raise reasonable doubt about M’s ability to eval demand – maybe if they were “best friends”

ii. Moore -bare social rel do not raise doubt of independence – might be diff if both participated in wedding

iii. Seligman – might have fel obliged by fiduc duty to call publisher and express concern about book b/c of impact on company.

MANAGEMENT AND CONTROL OF THE CORPORATIONI. Officers

a. MBCA S 8.40b. Officers appointed by Board – DE and MBCA only req that someone take minutesc. Roles of officers must be incl. in the bylaws

II. Function of Officers – MBCA S 8.41III. Lee v. Jenkins Brothers (2d Cir 1959)

a. Y enters into pension contract with Leeb. Issue – does Yardley have authority for this contract?c. Holding – NOd. General rule is that Pres has authority to bind the company by acts arising in usual

and regular course of business, but NOT for contracts of extraord. nature.i. Lifetime employment contracts generally met w/ hostility

ii. BUT pension contracts usually eval’d by a different standard b/c1. Board control not impeded2. Agreement is beneficial, necessary, and reasonable3. Common fringe benefit

iii. Whether there is apparent authority for the transaction is a question of fact – depends on nature of contract, officer negotiating contract, corp’s usual

18


manner of conducting business, size of the corp, circum giving rise to the contract, reasonableness, amount involved, & who the 3d party is.

iv. In certain cases, contract may be so important that outsider would normally supposed only Board could authorize it.

e. Here,i. Actual auth – nothing shows there is express authority or any reasonable

belief that Y can enter the contractii. Apparent – employment decisions tend to eminate from Pres office – look at

size, too large to be normal.iii. Courts generally more concerned about tenure – pension diff b/c about

money.f. Could have become valid with ratification after creation of contract.

IV. Relations between shareholder and director – SHAREHOLDER AGREEMENTSa. Shareholder agreements disting from pooling agreement b/c involve things not

central right of Board, and thus not presumptively valid.b. 4 spheres of shareholder rights

i. Electing/removing board members – majority vote movement & “holdover rule”

ii. Amend articles/bylawsiii. Fundamental changes – JV, merger (usually up or down vote, not details)iv. Conflict of interest transactions (S.144)

c. Everything else left to discretion of Boardd. MBCA S 7.32 – Shareholder Agreements

i. Agreement shall be set forth in articles of incorp/bylaws and approved by ALL shareholders at tme of agreement OR in written agreement signed by ALL shareholders and made known to corporation

ii. Subject to amendment only by all shareholders at time of amendment.iii. Valid for 10 years unless agreement states otherwiseiv. Existence of agreement shall be conspicuously noted on front/back of each

certificate for outstanding shares. – if made after issued, recall all shares to include note.

1. Failure to note agreement will not invalidate it.2. Purchaser who didn’t now of agreement at purchase, shall be entitled

to rescission right – knowledge assumed if on shares though (either 90d after discovery or 2yr after purchase)

v. Agreement ceases to be effective when corp becomes public.vi. Agreement that limites discretion of Board als relieve Board of related liab

vii. Shall not be usedto impose personal liab on any shareholder.e. McQuade v. Stoneham (NY 1934) – traditional theory

i. Failure to keep promise to use best efforts to keep McQuade as Treas.ii. Issue – was replacing McQuade illegal? Can shareholders make an agreement

to vote for particular persons as director?iii. Holding – replacing McQuade not illegal; can make contract – if can do it as

an individual shareholder, then can do it as a group.iv. Shareholder agreements should be eval’d provision-by-provision, based on

the normal rights of the shareholders.v. Stockholders may thus combine to elect directors.

19


1. Here, the minority shareholders M claims to be protecting are not complaining of his discharege.

2. Stoneham & McGraw’s duty was to corp and shareholders – they’re under no legal oblig to deal righteously w/ McQuade.

3. A contract that precludes board members from changing officers, salaries, policies, or retaining indiv except by consent on contacting parties is illegal

4. **Norm shareholder right is for election of Board members, NOT execs or officers.

f. Galler v. Galler (IL 1964)i. Case is a signif development in closed corporation law and special legislative

treatmentii. Had shareholder agreement to ensure financial security of dependents ant

that if either brother died, their wife would take their place on the Board – suit for shares repurchased in violation of agreement

iii. Issue – is agreement void by public policy?iv. Holding – NO, enforce agreement (accounting should be made)v. Shareholder agreements often necessary for protection of those financially

interested in closely-held corporation – protection from majority can often only be achieved w/ a detailed shareholder agreement.

vi. Shareholder agreements for closely held corps have prev been upheld when:1. There is no apparent public injury2. Absence of complaining minority3. No apparent prejudice to creditors.

vii. Since parties to the action (when a closely held corp) are complete co-owners, no reason why exercise of power and discretion of director canot be controlled by valid agreement.

viii. Here, objections to the agreement1. Duration – although lifetime is not exactly ascertainable, there is no

statutory or public policy which would invalidate agreement on such grounds

2. Election of certain persons – similar agreements have been upheld before, assuming no complaining minority; silence on removal assumes that Board still has that power.

3. Purpose (provide maintenance for immed family) – no inherent evil in purpose and minimum earned surplus req protects corp and 3d party

4. Salary Continuation Agreement – limited for corp/3d party protection; usually a UV issue, but no complaining minority.

g. Shareholder Agreement Analysisi. S 7.32 – okay if everyone signs and follows other guidelines

ii. McQuade – 4 spheres of shareholder rightsiii. Galler – if have certain pre-conditions it’s okay (closely held corps)

VOTINGI. MBCA S. 7.28 – Voting for Directors, Cumulative Voting

a. Unless otherwise noted, directors elected by PLURALITYb. Have right to cumulative voting only if provided for in the Articles of Incorp

20


c. May not be voted cumulatively at meeting unless:i. Mtg notice conspicuously states that such voting is authorized; OR

ii. Shareholder gives notice of intent less than 48hr before mtgII. MBCA S 7.30 – Voting Trusts

a. May confer trustee the right to vote or totherwise to act for them by signingin agreement setting out provisions; effective on date first shares conferred – valid for 10 years unless extended by written consent and sent to corp office (binds only the signing/renewing parties)

III. MBCA S 7.31 – Voting Agreements (Pooling Agreements)a. Open ended agreement to vote together – not specifics.b. Presumptively valid

IV. Ringling Bros (DE 1947)a. Issue – should voting agreement be followed?b. Holding – YESc. Nothing in agreement allows one party to exercise the voting rights of another

i. Arbitrator has no right to enforce decision, but is only enforceable if one of the parties wills it

ii. Thus, the actual voting of Haley’s shares frustrates the agreement and should not be treated as partial performance

d. No specific enforcement for pooling agreements unless agreement gives a roadmap or has its own enforcement mechanism – b/c agreement open-ended that parties will vote together.

PUBLIC OFFERINGSI. Statutes

a. ’33 Act – deals w/ registration, offer and sales (based on disclosure)b. ’34 Act – regulates all other aspects of public tradingc. Blue Sky Laws – state statutes

II. IPO Processa. Statutory Reqs

i. Registration w/ SEC, req’d by ’33 ct1. S.5 – disclosure docs (incl. prospectus, R424)2. Info does not have to go to investors (get some info when purchase)

ii. If something wrong w/ disclosure, firm has STRICT LIABILITY1. Other ppl on agreement (underwriters) have liability capped at share

allotment2. They can defend based on due diligence (varies by expert/nonexpert)

iii. After disclosure, subject to ’34 Act – periodic reporting, req’s to register on an exchange

b. Offering – “firm underwritten public offering” – sell to underwriter, who sells to investors (may have multiple underwriters)

c. Stages of Registrationi. Pre-filing: 30d prior to filing

1. File prelim registration (red herring) – used until final registration at effective date

2. Problem of “conditioning the mkt” – construed broadly.

21


a. Prohib against selling efforts; can’t do anything differentlyb. IPO more likely to be seen as conditioning b/c of large lack of

public infoc. “Tombstone ad” – cannot editorialized. If violate “gun jumping” then everyone deemed to have

rescission right.e. Statute of lim – 2 yr after discovery, 5yr total

ii. Waiting: filing until it is declared effective1. Registration may be changed2. Selling Activities – “testing the mkt”, go on “road show” – investor

meetings with potential buyers, but can’t actually sella. Can be made binding as soon as company goes public though.

iii. Post-effective1. If purchase shares, get final prospectus2. Liab for misstatements in filings (have back-and-forth w/ SEC in

‘waiting period’ but they aren’t req’d to comment)III. SEC v. Ralston Purina Co (SCT 1953)

a. S4(2) of ’33 Act exempts transactions by issuer not involving any public offering from the registration req’s of S.5

b. D made authorized but unissued common shares avail to “key employees”c. Issue – is class of employees considered “public”?d. Holding – YES, private offering is one made to ppl considered able to fend for self

i. To be public, an offer need not be made available to the whole worlde. Design of ’33 Act is to protect investors by promoting full disclosure

i. Thus, exempt transactions are those which ther is no need for disclosure since those ppl have the same info that would be made avail to public.

ii. Since it depends on info, any motive is irrelevantiii. Regulation D helps define who is deemed to be sophisticated enough

1. Usually depends on money though, not age or position.2. Also need to think about resale – quicker resale a problem.

SECURITIES FRAUDI. Definition – material misstatement in connection w/ security – doe not apply to

decision not to purchase.II. Materiality Tests

a. TSC – Material if person would consider it important, that would alter total mix of information. (wouldn’t necessarily affect action taken)

b. Basic – probability/magnitude for contingent eventIII. Rule 10b-5

a. By use of interstate commerce, mails, or any facility of a national security exchange, illegal to

i. Employ any device, scheme, artifice to defraudii. Untrue statement of material fact or to omit to state a material fact necessary

in order to makd statements not misleading.iii. Act/practice/course of business which operates or would operate as fraud

deceitb. In connection with purchase or sale of security.

22


IV. Materialitya. Basic v. Levinson (SCT 1988)

i. 3 public statements denying merger, then announces it laterii. Issue – what is the standard of materiality (for prelim negotiations)?

iii. Holding – probability/magnitude, in light of totality of company activityiv. Info is material if “substantial likelihood that reasonable shareholder would

consider the info important in making a decision”1. A lie alone is not suffic and silence alone is not actionable – info is not

made material by virtue of a public statement denying it.2. There is no req to disclose ongoing negotiations w/ another company.

v. Probability – look at indicia of interest in transaction at highest corporate level (Board resolutions, instructions to I-Bankers, actual negotiations)

vi. Magnitude – size of corp entities, potential premium over mkt value, significance of transaction to securities issuer

b. SEC v. Texas Gulf Sulphur Co (2d Cir 1968)i. Drilling discovery, keep quiet to facilitate acquisition of land area; some stock

purchases made and coll options issued; during time, corp denied findingii. Issue – what constitutes insider trading?

iii. Holding – material, non-disclosed facts.1. Judged at the time the order is placed.

iv. Trading alone not enough – has to be material as well1. Size of transaction can be indicative of materialness2. Can safely trade when public fully digests info – may take longer for

more technical infov. R10b-5 req’s same access to same info for everyone

1. Rule applicable to anyone possessing info, even if not an isider2. If someone cannot disclose the info, then they are banned from

trading on it.3. Restrained only if the info is MATERIAL – “essentially extraord in

nature and which is reasonably certain to have a subst effect on mkt price.

vi. Disclosure of info is only effective when it has been fully absorbed – news release merely the first step.

vii. Here, major indication of materialness is importance attached to the resultsviii. Issuance of stock options –ppl receiving the shares have a duty to inform the

issuing committee of their find/that shares are too low.V. Breach of Duty

a. Chiarella v. US (SCT 1980) – TRADITIONAL THEORYi. Worked at printer, was able to deduce names from blank docs

ii. Issue – does person who learned from confidential docs of corp takeover violate S10b if he fails to disclose before trading?

iii. Holding – NO, trading must be in violation of some duty1. Duty can extend beyond fiduciary duty and cover employees2. “Constructive insider” - attorney, accountant, consultant.

iv. Obligation to disclose info is held by virtue of position, arising from existence of relationship of trust and confidence

v. Not every instance of financial unfairness constitutes a violation of S.10b – it requires a prior relationship to make the activity fraudulent.

23


vi. Here, Chiarella owns a duty to the printer and the acquirer, but not the target firm that he acquired shares in – no rel. of trust and confidence with the target firm.

b. US v. O’Hagan (SCT 1997) – MISAPPROPRIATION THEORYi. Issue – is someone who trades using confidential info misappropriated in

breach of their fiduc duty to the source of the info?ii. Holding – YES, have a relationship of trust and confidence w/ the source

establishing a fiduciary duty to that source.iii. S10b reaches any deceptive device in connection w/ purchase/saleiv. Trading on non-public info qualifies as a deceptive advicev. If you misapprop confidential info for trading purposes, you are in breach of

duty owed to the source of the info.vi. Full disclosure to source of the info of an intent to trade forecloses liability

under the misapprop theory b/c disclosure removes the deception.VI. TIPPEE LIABILITY

a. Dirks v. SEC (SCT 1983)i. Issue – Did Dirks violate anti-fraud provision by not disclosing info? How do

you breach by passing info?ii. Holding – NO

iii. Can only be held derivatively liable – someone else must breach their duty to hold you liable – because tippee has no relationship to shareholders

iv. First, must use TSC/Basic to check if info is material.v. Only person w/ fiduc duty to shareolders is Secrist

1. Didn’t trade – so not directly liable2. Mere passing not enough – must have:

a. Established duty (relationship of trust and confidence) to corp (trad) or source (misapprop)

b. Pass was in violation of that duty.c. Pass was for personal benefit – can be reputational, kickback

for more business, as a gift – inherently incl. expectation that tippee will trade on the info.

vi. Once there is a violation, everyone downstream is liable – by not checking upstream that the tip is clean, you assume liability

vii. Here, there is no actional be violation1. Dirks has no fiduc duty to shareholders, so not directly liable for trade2. Took no action to induce shareholders to place confidence in him3. No expectation from source that info would be kept confident, so not

liable through misapprop theory.4. No violation by Secrist, so not dervi liable – no pass for personal

benefitb. US v. Chestman (2d Cir 1991)

i. Issue – do family links create fiduc relationship of trust and confidence?ii. Holding – NO, rel. req’s independent relationship of trust and confidence

iii. First step is to determine if info is material – it is.iv. Chestman dos not have a fiduc relationship with the shareholders so cannot

be held directly liable, and no expectation from source he would keep it quiet so no misapprop theory

24


v. Can only be held derivatively liable. – if can get one person liable for a pass, then can get Chestman b/c he knows of family relationship and thus that the info was prob wrongfully attained

1. Start with Ira – duty to corp, but not passed for benefit, no breach2. Shirley – duty to Ira (they usually discuss such matters), and maybe to

corp, but not pass for benefit.3. Breach in pass btwn Susan and Keith

a. Is there a rel. of trust and confidence btwn Susan and mother – might have been, but pass was not for personal benefit.

4. Pass to Chestmana. Keith and Susan usually don’t discuss such matters – marriage

is only a general confidence, and insider trading req’s specific consequences.

b. Was she trying to get an agreement for Keith? – maybe, but to be sufficient the agreement has to go both ways, not unilateral

c. Rules post-Chestmani. Rule 10b-5-1 – knowing possession of info while trading is suffic, not req’d

that it be shown they actuallyused the infoii. Rule 10b-5-2 – non-exclusive list of 3 situations in which person has duty of

trust and confidence1. Mutual agreement to maintain info in confidence – can’t be unilateral2. History, pattern, practice of sharing confidences, such that recipient

knows or should reasonably know that person expects confidencea. Nature of exchange not relevantb. But if can show that don’t discuss this info, then rebuts rule

3. Bright line rule for presumption of trust and confidence if receive from spouse, parent, child, sibling.

a. Can rebut if show don’t discuss such things.d. SEC v. Cuban (NDTex 2009)

i. Issue – did Cuban have a duty to corp to keep info quiet? Can duty be created by agreement?

ii. Holding – No duty to keep the info quiet; can be created by agreement, but Cuban didn’t have one.

iii. No reason why duty cannot arise by contract – would prob form an even stronger duty

1. But req’s 2 agreements ; non-disclosure and non-use (otherwise no duty not to use/trade on the info)

2. Reason by R10b-5-2 does not create the req’d duty – deals only w/ confidentiality (related to tipper/passer liability)

iv. No agreement was created here1. “Can’t sell” statements only indicate a misbelief that he cannot trade,

not an agreement not to trade2. The expectation cannot be unilateral: no contention that CEO

expected Cuban not to trade on the info v. Circuit Split

1. 5th cir – need non-disclosure AND non-use agreements2. Other courts – only need agreement “not to tell”

e. See HYPO in notes.

25


TAKEOVER MOVEMENTI. Cash Tender Offer

a. Buy shares of target company either on open mkt or by making offer to shareholders – public invitation to “tender” shares to bidder, usually at 15-20% premium; usually mailed or posted as ad

b. Usually comes w/ conditions that not req’d to purchase unless necessary amount is tendered

c. Signif modified by 1968 Williams Acti. Req’s disclosure by bidder if acquiring 5% or more, but need not be made in

advance (no later than time announce tender offerii. Set bidding urles

1. Must remain open for minimum of 20 business days2. Shareholder can w/draw during that windo3. All shareholders must receive highest price paid4. If oversubscribed, all shareholders have shares purchased pro-rata

iii. Target company cannot be passive: 3 options to shareholder on which offer to take

1. Recommend option2. No opinion/remain neutral – maybe a suggestion they’re all good3. Unable to take a position (harsher than #2)

iv. Goals of Act1. Slow down process to give shareholder full info and target time to

respond2. Assure all shareholders treated equally.

II. Rule 14e-3 – cannot purchase/sell if you have material, non-public info about a tender offera. No duty requirementb. Trader and tipper liability

III. Leveraged Buyouta. Aggressor (mngmnt, other corp, raider) purchases all or most of the outstanding

stock for a premium (enough to get a controlling stake)b. Financed through loans, and structured such that the debt usually ultimately

becomes the target’s obligation.c. Proceeds of the debt used to purchase the target’s shares.d. Generally not possible to get 100% of shares, so might engage in secondary merger

IV. Takeover Defensesa. Generally accepted justifications

i. Offered price too low and doesn’t reflect true valueii. Aggressor has reputation for unsound fiscal policy

iii. Cannot meet debt w/o using target’s assetsiv. In shareholder’s best interest to remain independentv. Mngmnt already embarked on long-term plan to improve profits/stock price

vi. Violates some lawvii. Unfair to shareholders by coercing them

b. Panter (7th Cir 1981) – cause DE courts to reject simplistic application of BR for a “more balanced analysis” (b/c board seen as inherently interested

26


V. Unocal Corp v. Mesa Petroleum Co (DE 1985)a. Mesa seeks to purchase 51% of shares, and then issue “highly subordinated

securities for th restb. Unocal defense by issuing “exchange offer” – If Mesa gets 51%, rest of shares can be

exchanged for $72/share – would result in Mesa owning 100% of a debt-awashed corp

c. Holding – Reasons for exchange offer valid and reasonably related to threats posedd. Can’t analyze breach under normal BJR b/c managers generally inherently biased

b/c jobs on the line – econ motivation could overcome normal judgmente. Thus, need heightened rule for Board’s fiduciary duty when Board is responding to a

takeoverf. 2 part test

i. Reasonable ground to believe threat to corp policy or effectiveness (something the court will recognize)

ii. Response reasonable to perceived threat (usually about proportionality)g. Generally as long as doesn’t completely preclude takeover, court says its okay.h. Dir’s duty not unbridled authority – must analyze nature and effect, including:

i. Inadequacy of price offeredii. Nature and timing of offer

iii. Legalityiv. Impact on non-shareholder constituenciesv. Risk of non-consummation

vi. Quality of securities offeredvii. Basic stockholder interest

i. Here, objective was to make sure remaining stockholders get fair value if takeover goes through, and excluding Mesa necessary to definition of defense

VI. Revlon Inc. v. McAndrews & Forbes Holding (DE 1986)a. Holding – actions to fight off initial low bid value was okay; but ultimately choosing

lower offer was a breach – estab a new principleb. Once in Revlon, Board cannot consider other constituencies.c. Once break-up become apparent/inevitable, duty of Board changes from

preservation of corp entity to maximizing corp’s value at sale for shareholder benefit

i. R’s arg that it took lower offer in consid of other corp constituencies has limits in that it must be “rationally related” to corp

ii. However, such concern inapprop in action among active bidders.d. When does Revlon zone commence?

i. Board’s response (10M share repurchase) – NO, b/c takeover not inevitableii. Deal w/ FL (lock-up) – YES

iii. If entire posture is a defense, can probably manage to stay in Unocal.VII. Paramount v. Time-Warner

a. Paramount offering larger amount for tender offer than Warner, arguing for Revlonb. Court – not in Revlon b/c company (Time) is going to continuec. Case is important in determining when Revlon is triggered.

VIII. Paramount v. QVC a. Paramount agrees not to shop around for other buyersb. Court finds Revlon duties were triggered

27


IX. Barbarians at the Gatea. Once company targeted, escalation happens really quickly – why need to test the

mkt (VG)b. Defenses to takeover

i. Lock-up – lock company or part out s that its not part of transaction: keeps ppl in the transaction, stalls the transaction, and makes it more expensive.

ii. Scorched Earth – sign agreements w/ others that if takeover happens, company parts get sold off

iii. Management Buyout (what Ross tries)iv. Shark repellants (in charter to make takeover harder to do)

1. Staggered Board terms2. Supermajority for mergers3. Fair price provisions – any 2d step merger needs a “fair price”

v. Green Mail – says will do a takeover (to cause price to go up), but doesn’t and instead sells for profit

vi. Poison Pill1. Can be triggered by diff types of takeovers, depending on how written2. At time of takeover, convertible securities go to common stock at a

high ration, with a right to repurchase at a vey low price3. Makes takeover impossible – higher price and lot more shares4. Can only be de-activated by pre-takeover mngmnt

a. Bidder goes to Board and offers incentive to remove pillb. Lawsuit against Board that not removing pill is a breach of

duty b/c in shareholders best interest for transactionc. Why would company get involved at all? – becomes subject to fiduc duty attack

i. Doing what they think in best interest of shareholderii. Req’d to act under the Williams Act

1. Freedom to deal with who they want2. Can’t make false public statements, but not req’d to give everyone the

same infoiii. Changing bids elongates the 20 business day period.

d. Is Board in movie in Unocal or Revlon?i. Eval at the time Board makes defensive move – diff defensive moves might

require diff analysis.ii. Seems like Board is in Revlon – never trying to repel takeover

iii. Is starting to entertain offers acknowledging a takeover’s inevitability?1. If issue is to protect corp, then in Unocal2. If no restriction on what buyers can do, then in Revlon

iv. Important distinction b/c if still in Unocal, can consider other constituencies.e. Board ultimately took lower offer – is that a breach?

i. Fear that Ross could not consummate.

28

Date post:	26-Jan-2020
Category:	Documents
Upload:	others
View:	0 times
Download:	0 times

· Web viewBASICS OF CORPORATIONS. Closely held v. publicly held. Closely held – 5 or fewer...

Documents