Corporations, Kraakman, Fall 2012 Harvard Law School

The Law of A enc!

Intro to Agency Agency is the simplest form of joint economic undertaking and is therefore a foundational concept upon which much of corporate law is built. Types of Agency "estatement #$% A enc! 1&01: Agency is the fiduciary relationship that arises when a principal manifests assent to an agency that the agent shall act on the principals behalf and subject to the principals control, and the agent manifests assent or otherwise consents to so act. Agent can bind principal in tort, contract, and even criminal law "estatement #$% A enc! 1&02: sage of the term is not dispositive in determining whether a relationship is one of agency. !"ee also Jensen Farms v. Cargill# "cope and form of agency: "est& #$% A enc! 2&02: "cope of authority includes the things that the principal told the agent to do, as well as anything necessary or incidental to it, as a reasonable person would understand that. o $elegation of authority can differ in scope between a: "pecial agent, who is only empowered for a particular act%transaction, or &eneral agent, who is delegated authority over a series of acts%transactions "est& #$% A enc! 1&0'#2%( 'erception of (rd parties when dealing with an agent: o $isclosed 'rincipal, where (rd parties know that the agent is acting on behalf of a known principal, o 'artially disclosed 'rincipal, where (rd parties know they are dealing with an agent, but dont know whom he%she represents, or o ndisclosed 'rincipal, where (rd parties assume that the agent is the principal. )evel of principals control over the agent can vary, being either: o Employee, wherein the principal e*ercises significant control !and is vicariously responsible for torts committed within the scope of the employees employment, +est. ,.-.# o Independent Contractor, wherein the principals control is limited and the agent e*ercises much discretion/ e.g. building contractor Termination "estatement #$% A enc! $0)( Agency can terminate based on death or cessation of e*istence of the principal or agent, loss of capacity, e*press revocation, or events that lead to the reasonable conclusion that principal no longer assents to agents actions. 0ither the principal or the agent can terminate an agency relationship at any time. If the agency relationship was set up for a term, then actions for breach of contract damages may arise, but in no case will the remedy be specific performance of the agency 1 if one person wants out, there can be no agency. !"ee +est. (.1-!1##

Jenson Farms Co. v. Cargill #when is an agency created% Facts( 2argill contended that it was not the principal for 3arren &rain 4 "eed 2o by virtue of its course of conduct, and, therefore, could not be held jointly liable with 3arren for 3arrens contract defaults with creditors. Holdin ( An agency is created through a course of conduct where the facts, taken as a whole, show that 1# one party has manifested consent that another party be its agent/ ,# the second party acts on behalf of the first party/ (# the first party e*ercises control over the second party. An agency re5uires an agreement, but not necessarily a written contract6 the e*istence of an agency may be proved by circumstantial evidence. 3arren acted on 2argills behalf in procuring grain for 2argill/ 2argill financed this operation/ 2argill e*ercised more than normal control over 3arren !making key operating decisions in a way not typical of a normal financier#/ 2argill loaned money not to benefit from interest but to obtain a source of market grain. Comment 1( Apparent consent 1 manifestation by actions or by the failure to act of an agreement of the minds !or of the ac5uiescence by one party to the will of another#

Comment 2( 3arren was subject to the control of 2argill, as demonstrated by a series of factual findings: +ight of first refusal, inability for 3arren to assume debt without consent of 2argill, 2argill7s right of entry to 3arren, criticism by 2argill over 3arren7s actions, 2argill7s determination that 3arren needed strong paternal guidance6 the 2ourt recogni8es that these are not inherently more than a debtor relationship individually, but together, in light of all the circumstances, it shows an agency relationship. Actual and Apparent Authority *ower to +ind #"est& )&01,)&0$%( 9he Agent has the authority to bind the 'rincipal and the (rd 'arty together in contract. Act-al a-thorit! #"est& 2&01. $&01%: Actions that the principal delegated to the agent, as the agent reasonably believes at the time of the action. 2an be e*press, implied, or incidental !+est. ,.-1!1##. Incidental means that it is necessary or incidental in relation to the task e*pressly authori8ed. Apparent a-thorit! #"est& 2&0$%( Actions a (rd party reasonably believes have been delegated to the agent, based on the manifestations of the 'rincipal !but not claims of authority by the agent#. "ee White v. Thomas. White v. Thomas Facts( 3hite !$# contended that his agent, "impson, did not have apparent authority to enter into a contract for the sale of land to 9homas !'#, and that, therefore, an order of specific performance of the contract was erroneous. "impson had been authori8ed only to buy 1 not to sell 1 land. Holdin ( In the absence of a principal and any indicia that an agent has authority to engage in a specific action on the principals behalf, the agent does not have apparent authority to engage in such action merely because the agent asserts she has such authority. 3hile the declarations of an alleged agent may be used to corroborate other evidence of the scope of agency, neither agency nor the e*tent of the agents authority can be shown solely by her own declarations. Comment( 'urchasing and selling are not so closely related that a third person could reasonably believe that authority to do the one carries the authority to do the other.

Apparent Authority: 9he authority granted to an agent to act on behalf of the principal in order to effectuate the principals objective, which may not be e*pressly granted, but which is inferred from the conduct of the principal and agent. 'rincipal can also be bound by estoppel when (rd party detrimentally relies on e*pectation of agency relationship and 'rincipal doesnt notify them. !+est. ,.-:, ,.-;.# 9his also works as replacement inherent a-thorit!, which +est. (rd abolishes. Inherent Authority Inherent authority is not conferred on agents by principals but represents conse5uences imposed on principals by the law. o Inherent power gives a general A the power to bind a ', whether disclosed or undisclosed, to an unauthori8ed < as long as a general A would ordinarily have the power to enter such a < and the third party does not no! that matters stand differently in this case. +est. ,nd Agency 1;1, 1=.. o +est. (rd Agency does not have provisions e*actly matching inherent authority. Instead, +est. (rd replaces it with estoppel>type rationales, which lead to similar results in cases like "allant v. Isaac. +est. (rd ,.-;. Gallant Ins. Co. v. Isaac Facts( &allant, an insurer, contended that its agent, 9hompson>?arris, did not have inherent authority to bind &allant on an insurance policy issued to Isaac. Holdin ( An agent has inherent authority to bind its principal where the agent acts within the scope of its authority, a third party can reasonable believe that the agent has authority to conduct the act in 5uestion, and the third party is not on notice that the agent is not so authori8ed.

Comment( 9he doctrine of inherent authority gives a general agent the power to bind a principal, whether disclosed or undisclosed, to an unauthori8ed contract as long as a general agent !ould ordinarily have the po!er to enter such a contract and the third party is not on notice that the agent is not so authori#ed . 9his theory has been critici8ed as an unwarranted shift in the traditional balance of monitoring costs between principals and third parties. Inherent authority is e*tra useful when ' is undisclosed !cant look to what the apparent authority is#.

Agency $iability in Tort "est& $rd A enc! 2&0'. /&0/#1%( 0mployers are subject to liability for torts committed by employees acting within the scope of employment, defined in @.-@!,# as subject to employers control !respondeat superior#. 'rincipals liability to (rd party for Agents behavior !A@.-(# results when: Agent acts with actual authority !A@.-.#/ 3hen Agent acts with apparent authority !A@.-B#/ 3hen 'rincipal negligently selected Agent !A@.-:!1##/ 3hen 'rincipal has duty, and Agent does not fulfill it !A@.-;#.

0mployees as used above are to be contrasted with independent contractors. Independent contractors do not cause vicarious liability for the 'rincipal through their torts/ rather, they retain liability themselves. An independent contract is a party undertaking a particular assignment !hile retaining control of the manner in !hich it is e%ecuted. Humble Oil & Refining Co. v. Martin Facts( Cartin was injured when a car rolled out of a service station owned by ?umble. Cartin sought to hold ?umble liable for the station operators negligence. Holdin ( Although a party is not normally liable for the torts of his contractors, said party may be liable for a contractors torts if he e*ercises substantial control over the contractors operation. In this case, ?umble set the hours of the service station, paid some of the operating e*penses, mandated much of the day>to>day operations, etc. Comments( 3hen the party so substantially controls the manner of the contractors operations, the contractor relationship breaks down and a master>servant relationship is formed. According to the +, Agency, a master>servant relationship is one in which the servant has agreed to work and also to be subject to the masters control. An independent contractor, by contrast, agrees to work but is not under the principals control insofar as the manner in which the job is accomplished. In general, liability will not be imputed to the principal for torts of an independent contractor. ?umble is paying a lot of money 1 they are probably engaged in a lot of supervisory work Hoover v. un Oil Co. Facts( ?oover sought to hold franchisor "un Dil responsible after he was injured in a fire at a service station franchise operated by Earone. Holdin ( A franchisee is considered an independent contractor of the franchise if the franchise retains control of inventory and operations. 9he test is whether the franchisor retains the right to control day>to>day operations. ?ere, Earone retained full control of inventory stocked. Comment( $ifferent courts are split as to which factors would lead to a result of vicarious liability. Earone controls his own costs, is more of a real entrepreneur. ?e would be the one more able to prevent the accident in this case.

Tort $iability and Apparent Authority "est& $rd A enc! /&00 1 Comments& It is also possible to be liable for tort under Apparent Authority doctrine. 9he classic case of tort liability in agency cases is fraudulent statements to the market about the status of merger talks. !genc" an# $uties The Agent&s 'uties 1 $uty of care and duty of loyalty "est& $rd A enc! 0&01: An Agent has a fiduciary duty to the 'rincipal "est& $rd A enc! Comment to 0&01. "emed! for +reach of fid-ciar! d-t!( +emedies for breach of fiduciary duty can include tort remedies, invalidation of the transaction, and forfeiture of the Agents benefit !both from the FrealG principal and the second, FillegalG principal. 9he FrealG principal can claim back both benefits.# "est& $rd A enc! 0&02: An Agent has a duty not to ac5uire a material benefit from a (rd party arising from actions taken on the 'rincipals behalf. !Tarno!s i v. (esop#. 1 $uty of loyalty "est& $rd A enc! 0&0$: An Agent has a duty not to deal with the 'rincipal as or on behalf of an adversary in transactions connected to the agency relationship. !Tarno!s i v. (esop# 1 $uty of loyalty "est& $rd A enc! 0&0)#1%( 2onduct that would breach the duties stated above is not a breach of duty when the *rincipal consents, provided that in obtaining the consent the Agent acted in good faith, disclosed all material facts, and otherwise dealt fairly with the 'rincipal6 and the 'rincipals consent concerns activity that could be e*pected to arise in the course of the agency relationship. "est& $rd A enc! 0&0)#2#: An agent who acts for more than one 'rincipal in a transaction between them has a duty to deal in ood faith with each of them, to disclose to each principal that the agent is acting for the other 'rincipal as well, and all other material facts. "est& $rd A enc! 0&02( An agent has a duty to act only within the scope of his actual authority and to comply with all instructions from the 'rincipal. Tarno%s&i v. Reso' !coin>operated game>machiness case# Facts( 9arnowski wanted to buy a jukebo* business. ?e hires +esop, who did no research and but told 9 had discovered a good buy. Actually, the business sucks !but +esop was taking a H,--- secret commission from the business owners to sell their bad business#. 9arnowski paid H11,--- down on the business but discovered that +esops representations were false. 9arnowski rescinded the sale and successfully sued the seller for his money. ?e then sued contending that +esop, while acting as his agent, was liable for the secret commission he collected and for various damages. Holdin ( An agent is liable to a principal for the agents profits made during the course of the agency. o It is not material that no actual injury to principal resulted or that principal made a profit o Also not material that upon discovering the fraud, principal revoked contract and recovered that with which he had parted. 'rincipal has an absolute right to recover all profits made by the agent in the course of the agency. An agent is liable to a principal for the damages caused by the agents breach of his duty of loyalty. o +estatement Agency A.-@!1#: FIf an agent has received a benefit as a result of violating his duty of loyalty, the principal is entitled to recover from him what he has received, its value, or its proceeds, and also the amount of damage thereby caused.G o If the agents wrongdoing re5uires the principal to sue, the principal is also entitled to attorneys fees.

Comment( An agents primary duty is to make profits for the principal.

In re Gleeson Facts( 9rust beneficiaries holding real property claimed that 2olbrook, the trustee, had to account for profits he personally made as a co>tenant of the trust property. Holdin ( A trustee of real property who is also a tenant of the trust property must account to the trust for profits made as a tenant. 9hat 2olbrook acted in good faith is unavailing because he should have either chosen to continue as a tenant or to act as a trustee. )is choice to act as trustee precluded him from dealing !ith himself. Comment( A trust resembles the agency relationship insofar as the trustee has obvious power to affect the interests of the beneficiary. 9he trust differs from agency insofar as the trustee is subject to terms of the trust. 3oint 4wnership and *artnership 'artnership is a way to balance risk and investment to optimi8e opportunity in some instances *artnership Formation and *ropert! "5*A 102 #Knowled e and notice% #Corresponds to 5*A 12%( 9he only relevant part is subsection !f# in which the partners knowledge is deemed to be knowledge of the partnership immediately. "5*A 10$#a%( 'artnership governed by the partnership agreement and defaults in the + 'A. o "5*A 10$ #+%#$%( 'artnership agreement may not unreasonably restrict the right of access to books and records, eliminate the duty of loyalty. 9he entire partnership or a percentage specified in the partnership agreement may ratify a specific act that violates the duty of loyalty, as long as there was full disclosure. o "5*A 10$#+%#'%( 9he partnership agreement may not unreasonably reduce the duty of care/ o "5*A 10$#+%#6%( 9he partnership agreement may not eliminate the obligation of good faith and fair dealing, but the agreement may, within reason, specify standards by which the performance is to be measured/ "5*A 10) #7overnin law%( 9he law of the state where the chief e*ecutive offices are located governs relations among the partners and between the partners and the partnership. ?owever, Fthe laws of this stateG !i.e. + 'A# govern limited liability partnerships. "5*A 201 #*artnership as entit!%( 'artnerships are entities distinct from the partners. "5*A 202 #Formation of partnership% o "5*A 202#a%( Association of two or more persons to carry on as co>owners forms a partnership, whether or not the co>owners intended that. o "5*A 202#c%( 9he following rules apply to determination of whether a partnership was formed !1# Ioint tenancy, tenancy in common, etc. do not by themselves establish partnership !,# "haring of gross returns does not by itself establish partnership, even if the returns arise from commonly owned property. o "5*A 202#c%#$% Sharin in the profits of a compan! leads to pres-mption of partnership unless its in payment of: debt, services as independent contractor, rent, annuity, interest6 !5*A 8/#'%# "5*A 20$ #*artnership propert!%( 'roperty ac5uired by the partnership is partnership property, not individual property of the partners/ "5*A 20' #9hen propert! is partnership propert!%( "5*A 20' #a%: 'roperty is partnership property when it was ac:-ired in the name of !1# the partnership, !,# partners, with an indication in the transfer instrument that its to partner as partner/ "5*A 20' #+%( 'roperty is ac5uired by the partnership if its transferred to the !1# partnership in its name, or !,# partners, with the name of the partnership written in the instrument of transfer/ "5*A 20' #c%( *ropert! is pres-med to +e partnership propert! if p-rchased with partnership assets/ "5*A 20' #d%( 'roperty ac5uired in the name of some of the partners witho-t any of the above indications is presumed to be individual property. Conflict Among Co*+!ners Ioint venture J a circumscribed partnership limited to a single investment project Meinhar# v. almon Facts( Ceinhard and "almon were co>adventurers in a lease on a hotel. 'rior to the e*piration of the lease, "almon 1 without Ceinhards knowledge 1 agreed to lease the same and adjacent property.

Holdin ( "o long as their enterprise continues, joint adventurers owe one another the duty of finest loyalty. "almon here e*cluded his co>adventurer from any chance to compete and from any chance to enjoy the opportunity to benefit that had come to "almon by virtue of his agency. ;issent( 9here was no intent to renew the joint venture after its e*piration6 Comments( As remedy, 2ardo8o awarded Ceinhard one half of the shares in the company less one !because "almon managed it# Dn fiduciary duties between partners: F0ach partner is, roughly speaking, both a principal and an agent, both a trustee and a beneficiary, for he has the property, authority, and confidence of his co>partners, as they do of him. ?e shares their profits and losses, and is bound by their actions. 3ithout this protection of fiduciary duties, each is at the others mercy.G ,artnership Formation 9he partners need not intend to form a partnership for that relationship to be formed. ! 'A @, + 'A ,-,# 5*A 81)#1%, "5*A 8$00 #*artnership +! estoppel%( If a person represents himself as a partner !or consents to others making such a representation#, and a third party reasonably relies on that representation and does business with the enterprise, then the person who is represented as a partner is liable on the transaction, even if not in fact a partner. ! 'A restricts to creditors, while + 'A e*pands to all transactions#

(ohlan# v. %eet Facts( "weet contributed labor and e*pertise into a nursery business, from which he took ,-K of the profits. Holdin : Lor purposes of creating a partnership, one partners contribution may consist of labor and e*pertise. Comments( A partnership may be defined as two or more persons carrying on as co>owners of a business for profit. 'artnership involves mutual contribution. Cutual share of profits creates a presumption6 and in this case, that presumption could not be rebutted by failure to show mutual contribution. sually, partners in a partnership intend to create such a relationship. "uch an intention is not necessary, however. It is the intention to do the acts creating a partnership, not the intention to create a partnership itself that controls. (elationship !ith Third ,arties ?ow do claims on personal property of partners get allocated between personal and partnership creditorsM o 5*A 816: Iointly%severally liable for firm torts/ jointly liable for firm <s/ partners can enter contracts individually !and pledge their personal assets# o "5*A 8$0): Ioint 4 severally liable for both firm torts and <s/ E 9 under 8$0/#d% firm creditors must e*haust firm assets before pursuing a partners personal assets. 3hen a partner departs, it leads to conflict6 he is responsible for firm debts but cannot make decisions about firm actions. o 5*A 8$)#2%, "5*A 8/0$#c%: releases departing partner of partnership debts if court can infer an agreement between the continuing partners and the creditor to release the withdrawing partner o 5*A 8$)#$%, "5*A 8/0$#d%: releases departing partner from personal liability when a creditor renegotiates debt with the remaining partners after receiving notice of the departing partners e*it !passage of time and Fbuyer bewareG mentality# In partnerships, assets whose assets are technically Fprivate assetsG. 'A and + 'A address it slightly differently. o 5*A 826: partnership property is owned by the partners as Ftenants in partnershipG 1 this joint ownership affords to individual partners no power to dispose of partnership property, so it becomes de facto business property !FaggregateG theory# o "5*A 8601<602: straightforward entity ownership !gets rid of the FaggregateG theory that the individual partners own the property#/ partners rights are transferable. If a partner does not own his partnerships assets in any ordinary sense, he nevertheless retains a transferable interest in the profits arising from the use of partnership property and the right to receive partnership distributions. Sellin partnership interest( Eoth the 'A !,;>,@# and + 'A !:-(>:-(# allow the partners to dispose of their financial interest in the partnership to a buyer, limited to profit rights. + 'A also gives the right to demand judicial dissolution. "ince the partner owns those rights, those rights are liable for his personal debt. !+ 'A :-., 'A ,B#. Eut the interest does not include partnerships other rights.

Claims of ,artnership ,roperty Creditors to ,ersons& Individual ,roperty 3in le r-le !old#: 'artnership assets to partnership debt first, personal assets to personal debt first. ! 'A .-# New *arit! "-le: 'artnership creditors get first priority in partnership assets, and are e5ual in personal assets. !@B Eankruptcy Act A @,(, + 'A B-@!a##. )artnershi' Governance "5*A 8$01( 'artner is an agent of partnership "5*A 8$0$( Statement of *artnership A-thorit!: a partnership may file a statement of partnership authority to define what partners and agents are allowed to do on behalf of the partnership. "5*A 8$0/( Actions =! and A ainst *artnership and *artners : both partnership and personal assets are liable for partnership liabilities, but partnership assets must be depleted before personal assets can be targeted. "5*A 8 '01& *artner>s "i hts and ;-ties: 'artners are credited with e5ual shares of the assets and liabilities, e*cept as otherwise specified. 'artners have e5ual rights in the management of the partnership unless otherwise specified !does not matter what they contributed#. o ?mportant: differences arising as to everyday business matters are to be decided by a majority of the partnership. $ecisions outside the ordinary course of the partnership business or decisions to change the nature of the partnership are to be decided by unanimous vote. "5*A 8 '0$& *artner>s "i hts and ;-ties with "espect to ?nformation( 'artnerships shall keep their records at the chief e*ecutive office. 'artners, their agents and attorneys shall have access to the information during ordinary business hours. o 'artnership shall furnish basic information necessary for partners rights and duties without demand, and other information regarding the partnerships business on demand. "5*A 8 '0'& 7eneral Standards of *artner>s Cond-ct: $uty of loyalty, duty of care. "5*A 8 601 and 8602& *artner @ot Co,owner of *artnership *ropert!( +ather, the only transferrable property he has is the right to the profits. !:-,# "5*A 8 60$& Transfer of *artner>s Transfera+le ?nterest( 9he interest in + 'A :-1 is transferrable, but does not carry the right to vote, etc. It only carries the right to distribution, to re5uest judicial determination for dissolution, and accounting upon dissolution, dating back to previous accounting. o 'artnership agreement can restrict transfer even within those limitations. "5*A 8 60'& *artner>s Transfera+le ?nterest S-+Aect to Char in 4rder( 9he interest that the partner owns, as described above, can be allocated to creditors of the partner. *ational +iscuit Co. v. trou# Facts( "troud advised National Eiscuit that he would not be responsible for any bread that the company sold to his partner. Nevertheless, National Eiscuit continued to make deliveries. Holdin : 9he acts of a partner, if performed on behalf of the partnership and within the scope of its business, are binding upon all co>partners. Activities within the scope of the business cannot be limited e*cept by a majority of partners. "troud was not a majority and thus he is bound to Lreemans sale of the bread. Comment( In the absence of a contrary provision in the parties partnership agreement, each partner acts as the agent of the partnership and of each other partner. Dnly acts performed on behalf of the partnership and are consistent with its purposes are binding on other partners. @otes: 9his case illustrates the majority rule that half of a two>person partnership is not a FmajorityG for purposes of making firm decisions within the ordinary course of business. Note: 9he 'A and + 'A provide default provisions for much of partnership agreements, but allow for specific changes by provision in the partnership agreement. 5*A 82#2%: If a partner does something not consistent with carrying on the business of the partnership, its not binding on the other partners unless a majority agrees. 9hird parties should generally ask to see authori8ation by a majority of partners.

'issolution 5*A ;issol-tion !822#: defined as any change of partnership relations, e.g., the e*it of a partner. $oes not necessarily involve winding up. 9indin -p !8$/#: orderly li5uidation and settlement of partnership affairs

Termination !8$0#: partnership ceases entirely at end of winding>up nder 'A, any partner can force a wind>up of the partnership !8$0#1%#. $ifferent from + 'A. 9ron f-l dissol-tion !8$0#2%#: departing partner has no claim on good will value ,imiting 'artner-s right to dissolve under -,A ./01021b2 o 5*A 8$1#1%#+%: a partnership may be dissolved by the e*press will of any partner when no definite term or particular undertaking is specified E 9 5*A 8$0#2%: even though partnerships are terminable at will !unless a definite term is specified%implied#, partners have fid-ciar! d-ties to act in ood faith when dissolving the partnership. 13ee ,age v. ,age2.

'issolution "5*A ;isassociation #"5*A 8)01#: a partner leaves but the partnership continues, e.g., pursuant to an agreement ;issol-tion #"5*A 8001#: the onset of li5uidating partnership assets and winding up its affairs o nder + 'A, disassociation can happen without dissolution. $issolution here means termination. 9ron f-l disassociation !8)02#: can disassociate wrongfully !without an agreement#, but are liable for damages

!#ams v. Jarvis Facts( Adams, Iarvis, and a third doctor entered into a partnership for the practice of medicine. Adams later withdrew and claimed a right to share in the partnerships e*isting accounts receivable. Holdin ( A partnership agreement that provides for the continuation of the firms business despite the withdrawal of one partner and specifies the formula according to which partnership assets are to be distributed to the retiring partner is valid and enforceable. Comments( 'arties had unambiguously agreed that their partnership would not terminate when one of the doctors withdrew from the firm. 2ourt determines that there is no reason why statutory rules relating to withdrawal should here affect dissolution. $octors had agreed that the withdrawing partner would not participate in accounts receivable. In most jurisdictions, matters pertaining to the distribution of partnership assets and continuation after the withdrawal of one partner are dealt with by statute. ?owever, agreements among partners reached at the outset are generally upheld. 9here are three potential ways to divide assets among partners who are dissolving. $ivide the physical property o No longer allowed !5*A $0#1%# "ell the assets to the highest bidder o 9he only remaining possibility. 9his is the default provision granted in 5*A $0#1%& o 'artners normally buy out dissolving property )age v. )age !linen supply business case# Facts( 'age !'# sought a declaratory judgment that the partnership he had with 'age !$# was a partnership Fat>willG that he could dissolve. Holdin ( A partnership may be dissolved by the e*press will of any partner when no definite term or particular undertaking is specified. Comments( 'artnerships are ordinarily entered into with the hope that they will be profitable, but that hope alone does not make them all partnerships for a term and obligate partners to continue until losses have been recovered 9he power to dissolve a partnership must be e*ercised in good faith. Dne partner cannot free8e out another. o A partner holds his dissolution power as a fiduciary o ?e owes his partners duties of good faith and fair dealing in e*ercising dissolution rights

"eneral ,artnership Leatures of a general partnership: !1# a dedicated pool of business assets, !,# a class of beneficial owners !the partners#, and !(# a clearly delineated class of agents authori8ed to act for the entity !the partners#. Limited Lia+ilit! *artnerships( 9he separation between the partnership as an entity and the investors !partners# who finance it can be further increased by adding limited liability as a .th element. $imited liability means that business creditors cannot proceed against the personal assets of some%all of a firms e5uity investors. !Eusiness creditors can only rely on the partnership assets.# The $imited ,artnership )'s are made up of at least one eneral partner, and other limited partners. )imited partners share in profits without incurring personal liability for business debts/ general partner has unlimited liability. )imited partnerships have to be registered !unlike general partnerships# )'s get pass>through ta*ation. $istinguishing between general and limited partners: Dld test: control test 1 limited partners remain passive so are not liable personally. +ationale: those who can actively shift assets out of the firm, or make risky decisions, should be held personally liable to prevent opportunism against partnership creditors. Newer test: "5L*A 8$0$ !1=@;# adopted a Flabel and controlG 1 a limited partner who participates in control is liable only to persons who think hes a general partner. @ewest test "5L*A 8$0$ !,--1# abandons control test entirely 1 limited partner is not personally liable for partnership liabilities even if the limited partner participates in the management and control of the enterprise. +ationale: status>based liability shield.

)imited )iability 'artnership

Limited Lia+ilit! *artnerships !))'s# allow practitioners such as lawyers and accountants, to have the same benefit of limited liability as other businesses. Cost state ))' statutes protect only ne li ence by other partners or agents of the partnership !+ 'A 1:1:!b##. "ome, e.g. NO and CN, e*tend it to contracts as well as tort debts. Cany ))' statutes create a capitali8ation or insurance re5uirement to offset the limited personal liability of the partners. !to offset the risk of not being able to pay tort creditors#

The Cor'orate Form 2haracteristic Investor ownership )egal personality P )imited liability 9ransferable shares 2entrali8ed%delegated mgmt. under elected board &' P P P )' P P P P ))2 P P P P P 2orp. P

A corporations legal characteristics have complementary 5ualities: limited lia+ilit! makes free transferability more valuable !reduces costs associated with transfers of interest b%c value of shares is independent of assets of owners#, free transfera+ilit! permits development of large capital markets, which are also advanced by the presence of centraliBed mana ement .". corporations are regulated by the law of the state of incorporation, not where they do business. 'ublic corporations vs. closely held corporations o Closely held corporations have few "?/ tend to incorporate for liability purposes rather than capital raising purposes/ may drop features of corporate form/ o ,ublic corporations tend to incorporate to raise capital in public capital markets/ adopt all characteristics 2ontrolled corporations vs. corporations w%o controlling "? o Controlled corporations: a single "? or group e*ercises control through its power to appoint the board o Corporations !4control in the mar et: no single "?%group e*ercising control/ but anyone can purchase control in the market by buying enough stock/ while control is in the market, practical control resides with the e*isting management of the firm *rocess of ?ncorporatin , "C=CA #2&01,2&0). ;7CL 102, 10), 100%(

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!1# A person, the incorporator, signs documents and pays fees/ !,# 9he incorporator drafts%signs the articles of incorporation !+CE2A#%certificate of incorporation !$&2)# 1 also known as the corporations charter. $ocument states the purpose and powers of the corp. and defines all its special features !(# 9he charter is then filed with the secretary of state, along with a filing fee/ !.# 9he secretary of state issues the corporations charter, signed by the secretary !:# 9he first acts of business are electing directors, adopting bylaws, and appointing officers !at an organi8ational meeting# Articles of incorporation: state codes set out baselines and defaults, but leave freedom to the 2orporation itself to be set up how it wishes. o Articles of incorporation CAO contain any provision that is not contrary to law, but C "9 provide for votin stock, +oard of directors !incorporators elect initial board#, and SH votin for certain transactions/ name the ori inal incorporators. state corporationDs name 1 +-siness/ set capital str-ct-re o 9ransactional freedom is the overriding concept 1 articles of incorporation can set out any customi8ed features you want, e.g., classes of voting stock o 9he charter CAO establish the si8e of the board or include other governance terms, like procedures for removing directors from office

3hareholders5 Agreements !primarily concern of closely held corporations# Agreements among shareholders are important in close corporations, but not in widely held public corporations. o "hareholder agreements include restrictions on holding shares, buy>sell agreements, voting agreements !;7CL 8210#, etc. 2ourts enforce these agreements when the corporation and its shareholders are all party to the suit relating to the agreement, but not if its only some shareholders. 9hat is why widely held corporations dont deal with this much.

)imited )iability )imited liability is a fundamental part of the 2orporation Advantages: Cakes shares fungible, allowing modern markets. Investors can deal better with risk, which lowers transaction costs of finance.

9ransferable "hares 9ransferability is a default 1 all corporate statutes allow for agreements that bar transfers. Eut often, there must be a clear warning to that effect on the actual stock. !"ee ;7CL 8202#

2entrali8ed Canagement 2entrali8ed management leads to economies of scale, but also shareholder disconnect. $isconnected shareholders cant police the firm. )eads to challenge 1 what can the law do to make the management accountable and the shareholders involvedM o "hareholders elect Eoard of $irectors, which by strong default appoint management. !0.g. ;7CL 1'1#a%#. o Eoard of directors, then, has the responsibility to oversee management, and make decisions that management puts into practice. =oard is the Holder of *rimar! Cana ement *ower( 9he board of directors holds the primary power of the company, not the shareholders. In that sense, the corporation is like a representative democracy rather than a direct democracy.

!utomatic elf.Cleansing Filter "n#icate Co. ,t#. v. Cunninghame Facts( A ::K majority group !'# of the shareholders of Automatic contended that the companys board of directors could not override the groups vote !made at an ordinary shareholders meeting# to sell the companys assets, notwithstanding that the companys charter re5uired a @:K vote to limit the boards decision>making power. Holdin ( 3here a companys charter re5uires a @:K vote of the shareholders, made as an Fe*traordinary resolution,G to override a boards decision, a mere majority resolution made at an ordinary shareholders meeting may not override the boards decision. Comments( &overning statute in this case gives power to directors to do all things other than those e*pressly reserved to shareholders

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 $irectors are agents to all shareholders 1 not just the majority !and the charter is here providing certain protections to the minority#. If the board thwarts the will of the majority, dissatisfied shareholders can attempt to remove it. 3tructure of the 6oard ;7CL 1'1 sets forth the structure and duties of the Eoard of $irectors. 2orporate 2harter sets structure of the board in general terms. 9here are necessary terms, default terms, and allowed changes in the structure and function of the Eoard of $irectors. o o 2harter can set different classes of stock to elect different proportions of the Eoard of $irectors. 4nce elected, ;irectors have d-t! to all stockholders e:-all!&

Eoard has power to establish standing committees for effective organi8ation, and may delegate to these committees. Advisory committees can include non>directors, but decision>making must be done by directors. !9his comes up in the conte*t of "pecial )itigation 2ommittees and Independent 2ommittees in transactions later in the course#. Eoards are only empowered when they meet as boards. Dften, that involves having a 5uorum, issuing proper notice, etc. see, e.g. ;7CL 1'1#+%, which sets the default 5uorum as a majority of the board.

o 9he essential point of this is that 'irectors are not agents of the 2orporation, the board as a group is. Corporate 4fficers, A ents of the Corporation nlike the directors, the 2orporate officers that the Eoard appoints are the agents of the 2orporation. 9hey usually include a president, vice president, treasurer, and secretary, although titles are not important.

Jennings v. )ittsburgh Mercantile Co. Facts( 'ittsburgh Cercantile 2o. contended that 0gmore, Cercantiles Q' and treasurer>comptroller, did not have apparent authority to accept an offer for a sale and leaseback, and that, therefore, Iennings, a real>estate broker, was not entitled to commissions for a sale and leaseback transaction that 0gmore seemed to accept, but which the board did not. Holdin ( A corporations e*ecutive officer does not have apparent authority to accept an offer for a transaction that, for the corporation, is e*traordinary. 0gmores office does not, in itself, indicate that he has been endowed with apparent authority to act on behalf of the corporation regarding an e*traordinary transaction. Comments( Apparent authority is defined as authority that, although not actually granted, the principal 1# knowingly permits the agent to e*ercise or ,# holds him out as possessing. "uch authority emanates from the principal 1 not the agent. 0*traordinary nature of the transaction should have placed Iennings on notice to in5uire as to actual authority The *rotection of Creditors )ierarchy of claims on a corporation&s cash flo! !Core Iunior# 2ommon "tock 05uity 'referred "tock 05uity "ubordinated $ebt $ebt Eank $ebt%Notes $ebt !Core "enior# Cortgage $ebt !secured# $ebt $angers of limited liability: Dwners may misrepresent assets !incentivi8ed by ownerships ability to walk away# 9here are three basic strategies that 2orporate )aw can pursue in order to protect creditors !1# Candatory disclosure rules !,# +ules regulating corporate capital !(# 2reating duties%remedies on 2orporate actors like directors, creditors, and shareholders. Candator! disclos-res help protect creditors insofar as they protect against misinformation. In fact, Federal securities law re5uires e*tensive disclosures for other agency>related problems in corporate law. Eut state law does not rely much on disclosure. Df course, voluntary creditors can re5uire disclosure as a precondition to lending to the 2orporation.

Capital (egulations Some definitions(

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Shareholder e:-it!( 9he difference between the assets and liabilities on the balance sheet. 9he sum of the liabilities and the shareholder e5uity must e5ual the assets. Stated Capital( 9he value of the shares that the stockholders contributed to the company. Ey $elaware and NO law, the company can deplete the stated capital amount, so it is of limited use as a protective implement. Capital S-rpl-s( 05uity that the company has that is not accounted for in the original shareholder stock value. 9his can result from the company issuing stock at a par value lower than the actual issuance price. !If I understand this correctly, the company can also add to this FaccountG by designating operating profits to become Fcapital surplusG.#

Financial 3tatements 9he difference between the !lower# value of liabilities and the !higher# value of assets is "hareholder 05uity, so that the liabilities together with the "hareholder 05uity e5uals the value of the assets. 9he distri+-tion constraints use the figures on the balance sheet to restrict payment of dividends. 'istribution Constraints Easic concept: creditors lend money on the basis of corp. having a certain amount of assets, so corp. should keep those assets available for the creditors. 9hree main dividend tests used as constraints: o @im+le dividends test !;7CL 81/0. @E=CA 610# Oou can choose to pay dividends either from Capital S-rpl-s or from @et *rofits in the current%preceding year. 9he motivation for the Net 'rofit provision is to allow companies on the rise to pay a dividend even absent a 2apital "urplus. Not much protection for creditors because in addition to fle*ibility choosing either capital surplus or net profit, the 2orporation can !1# manipulate balance sheet to avoid losses, !,# Add money to the surplus account from no>par stock e5uity, or !(# !with shareholder vote# lower the par value of stock to create an e5uity FsurplusG. @ew Eork adds the re:-irement that the corporation not +e insolvent and that the dividend not render the company insolvent. 17ote8 if either of these !ere true9 !ould that invo e the fraudulent conveyance doctrine:2

Codern test !"C=CA 8)&'0# No distribution that renders corp. insolvent/ liabilities cannot e*ceed assets/ corps may use the FrealG value of the corp. if book value is too low. 9his tends to undermine creditor protection.

;inimum Capital and Capital ;aintenance (e<uirements Cinim-m capital re:-irements> !at startup of corporation#. o o Neither $&2) nor +CE2A has a minimum capital re5uirement @ot effective because even if corps cannot dip into minimum capital to pay dividends, normal business activity can deplete the capital/ the money is only re5uired when corporation is incorporated, and then it is immediately invested so no longer available to creditors 'ros and cons of these re5uirements: !R# attempts to protects creditors and thereby opens up investment opportunities. !># creditors can protect selves through </ the amount is arbitrary/ it constrains corp. creation

Capital maintenance re:-irement( 9his re5uires that 2orporations not only have minimum capital, but that they eep a certain amount of capital around to cover e*penses. Eut the essential effect of this is to accelerate bankruptcies because 2orporations suffering from cash flow difficulties have to enter insolvency as soon as the re5uired reserves are depleted.

'irector $iability 5niform Fra-d-lent Transfers Act sets up guidelines for the duty that directors have to ensure that assets remain available to creditors. ;-ties to Creditors: $elaware law says that once a company is entering insolvency the $irectors have a duty to the creditors in addition to the shareholders, since at that point there arise conflicts of interest between the

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two groups. !0.g. "hareholders are comfortable with even massive risk, since they have little to lose, but creditors want safety more than anything at that point.# Cre#it ,"onnais +an& *e#erlan# v. )athe Communications Cor' Holdin ( 3hen near insolvency, board cannot consider "? welfare alone but should also consider the welfare of the community of interests constituting the corp. @ote 1: As a matter of policy we always want to be ma*imi8ing the value of the corp. Eut here, ma*imi8ing the firm value does not ma*imi8e what the "? get. 9hree conflicting interests: "?, creditors, and firm as a whole. Ey making the board think about the creditors, we are making them think more about long>term value than short>term "? interests !even though their duty is usually with the "?#. @ote 2( Another case, 7orth American Catholic Educational ,rogramming !also from $elaware# specifically held that a solvent corp. operating in the F8one of insolvencyG could not be sued by creditors asserting a direct claim to their interests as creditors, since the $irectors duties were to the "hareholder rather than the creditors. 9hey did, however, have standing to sue in a derivative capacity. 9his case might contradict the Credit $yonnais holding, or it could be interpreted to mean that $irectors have a duty to the 2orporation 5ua 2orporation rather than to specific constituency groups. Creditor ,rotection8 Fraudulent Transfers Fra-d-lent transfer law( creditor remedy that obligates parties contracting !ith an insolvent or soon to be insolvent corp. to give fair value for assets they receive from the debtor. +elevant acts create causes of action for creditors against transactions on either of two grounds 1 actual intent or constructive intent. o o Act-al intent( ,resent or future creditors can attack transfers made with actual intent to hinder, delay, or defraud a creditor ! L9A .!a#!1##! L2A @# Fven witho-t act-al intent( ,re*conveyance creditors can attack a transfer that was made for value that was not reasona+l! e:-ivalent and left the debtor with remaining assets unreasonably small in relation to its business. !Dr when the debtor should reasonably have seen that he wouldnt be able to pay his debts following the transfer#. ! L9A .!a#!,#, :!a# and !b##. 2ompare L2A .>;. 5S =ankr-ptc! law is the source for most such lawsuits today, and the approach is substantially similar to the L9A% L2A !"ection :.B# and invokes local state law !"ection :..!b##. F-t-re Creditors who knew or should have known about the conveyances cannot void them. !=upet# v. Wolf#

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Fraudulent transfers in $everaged 6uy +uts #L=4s% L=4s involve a li5uidation>type takeover funded by massive borrowing. Ac5uiring group has to borrow so much, that they often declare bankruptcy shortly thereafter. In a way, the target and its management have engaged in fraudulent transfer because shareholders take full payment for securities in what is becoming a debt>ridden company. 9hus, creditors can sue the original board for letting the companys cash go for inade5uate consideration. *otential remedies G 'eople who attempted to profit by pillaging of near>bankrupt company will have to give back all that they profited. Spin offs( Another arguably fraudulent transfer is companies !tobacco%asbestos# spinning off the tort>debt> laden sectors into separate corporations, to avoid having to pay in full. 'rof notes !as with "ea>)and v. 'epper "ource# that diversification is appropriate in allocating risk, but should it work e*>post facto, when the liability is impendingM

3hareholder $iability 9here are two doctrines under which shareholders can be liable for corporate misappropriation of creditors funds. F:-ita+le s-+ordination and Corporate veil piercin F:-ita+le s-+ordination #SH Lia+ilit! G in a wa!% 05uitable subordination protects unaffiliated creditors by moving them up on the debt hierarchy as compared to shareholders%insiders who are also corporate creditors.

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5&S& =ankr-ptc! Code 8610#c%#1%( permits subordination of a debt claim Funder principles of e5uitable subordinationG. 9he principle is usually invoked only in the bankruptcy conte*t o 9wo re5uirements to invoke this doctrine: !1# the creditor has to be an e:-it! holder and typically an officer of the company, !,# 9he insider>creditor must have +ehaved -nfairl! or wron l! toward the corp. and its outside creditors. 'olicy: 3e dont want to use e5uitable subordination as a default rule and we dont want to discourage controlling "? from lending money to corporations when the loan is legitimate, since they are often in better position than third parties to make loans. o

Costello v. Fa/io Facts( 9he trustee in bankruptcy for the bankruptcy estate of )eonard 'lumbing and ?eating "upply, Inc. contended that claims against the estate of the companys creditors, Ambrose and La8io, who were also its controlling shareholders, should be subordinated to those of general unsecured creditors because Ambrose and La8io had converted the bulk of their capital contributions into loans and left the company grossly undercapitali8ed to the determinant of the company and its creditors. Holdin ( 3here, in connection with the incorporation of a partnership, and for their own personal and private benefit, partners who are to become officers, directors, and controlling stockholders of the corporation convert the bulk of their capital contributions into loans, taking promissory notes, thereby leaving the partnership and succeeding corporation grossly undercapitali8ed, to the detriment of the corporation and its creditors, their claims against the estate of the subse5uently bankrupted corporation should be subordinated to the claims of general unsecured creditors. Comments( 2laims of controlling shareholders will be deferred or subordinated to outside creditors where a corporation in bankruptcy has not been ade5uately or honestly capitali8ed, or has been managed to the prejudice of creditors. 05uitable "ubordination is a means of protecting unaffiliated creditors by giving them rights to corporate assets superior to those of other creditors who happen to also be significant shareholders of the firm. 9he critical 5uestion is what circumstances will permit a court to impose this subordinationM 9he first re5uirement is that the creditor be an e5uity holder !and typically an officer or director#. In addition, the creditor must somehow have behaved ine5uitably to outside creditors. *iercin the Corporate veil is an e5uitable form of shareholder liability. 9he 2ourts assert that they will not allow the corporate form to be used to perpetrate a fraud in order to avoid contract or tort liabilities. $ifferent jurisdictions have different tests for determining whether the corporate veil should be pierced, but most tests have two components !1# 0vidence of lack of separateness between shareholder and corporation, and !,# nfair%ine5uitable conduct !which is the wild card in these cases# Criteria for veil piercin ( the criteria for evidence of lack of separateness are vague, but include some factors such as: $isregard of corporate formalities, Cingling of corporate and personal assets, 9hin capitali8ation, "mall numbers of shareholders, Active involvement of shareholder!s# in management $ifferent formulations of the test from different jurisdictions: Han ;orn Test !@th 2ir., applied in "ea>)and#: !1# unity of interest or ownership such that separation between the corp.%ownership cease to e*ist, !,# allowing the corporate fiction would be to sanction fraud%promote injustice. La!a test<Kinne! Shoe: !1# unity of interest%ownership such that separation of personalities between corporation and ownership dont e*ist/ !,# ine5uitable result would occur if the acts were attributed to the corporation alone. =-t theres another optional element !that court can choose to apply#, which is that the defendant might still prevail if he can show that the plaintiff assumed the risk. ea.,an# ervices0 Inc. v. )e''er ource Facts( 3hen "ea>)and could not collect a shipping bill because 'epper "ource had been dissolved, "ea>)and sought to pierce the corporate veil to hold 'eppers sole shareholder personally liable. Holdin : 9he corporate veil will be pierced where 1# there is a unity of interest and ownership between the corporation and an individual and ,# where adherence to the fiction of a separate corporate e*istence would sanction a fraud or promote injustice.

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Comments( In this case there was little doubt that the first prong was satisfied. 2orporate formalities were not maintained. Lunds and assets were intermingled with other holdings of the shareholder. 'epper was undercapitali8ed. "hareholder moved and FborrowedG corporate assets between various corporations without regard for their source. 9he second part of the test is more difficult as an unsatisfied judgment is not, in itself, a sufficient injustice. 9he test re5uires a showing short of fraud but greater than an unsatisfied judgment. @otes: Dn remand, the court found that Carchese had committed ta* fraud, and he had used the corporations to move money around and avoid liabilities for various things. 9he veil was pierced. 'rof. < says that this case was decided wrongly and could have been decided under fraudulent transfer. 1inne" hoe Cor'. v. )olan Facts( After a corporation owned by 'olan defaulted on a building sublease with <inney, <inney sought to hold 'olan personally liable because his corporation was inade5uately capitali8ed and 'olan had not observed any corporate formalities. Holdin ( In a breach of contract, the corporate veil will be pierced where 1# a unity of interest and ownership blends the two personalities of the corporation and the individual shareholder and ,# where treating the acts as those of the corporation would produce an ine5uitable result. Comments( In this case, Industrial !the corporation that held the sub>lease# had no paid>in capital !its only asset was its re> subleasing of the building to 'olan Industries, a second corporation owned by 'olan# and 'olan did not observe any corporate formalities. A third prong may be added to the test where a complaining party may be deemed to have assumed the risk of gross undercapitali8ation !where it would be reasonable for the party to protect itself by making a credit investigation#. 9hough inade5uate capitali8ation is not, in most jurisdictions, considered to be in itself an injustice, here, 'olan had attempted to protect his assets by placing them in 'olan Industries, then interposing Industrial, a shell corporation, between 'olan Industries and <inney. (eil )iercing and Tort Creditors 9ort FcreditorsG do not rely on creditworthiness of a corp. when placing themselves in a position to suffer a loss. 9hey have no opportunity to negotiate e* ante for contractual protections from risk &eneral rule remains that thin capitali8ation alone is insufficient grounds for veil piercing !but that makes tort claims difficult# Wal&ovs&" v. Carlton Facts( 3alkovsky was run down by a ta*i owned by "eon 2ab 2orp. 3alkovsky sued 2arlton, a stockholder of ten corporations, including "eon, each of which had only two cabs registered in its name. Holdin ( 3henever anyone uses control of a corporation to further his own 1 rather than the corporations 1 business, he will be liable for the corporations acts. pon the principle of respondeat superior, the liability e*tends to negligent as well as commercial dealings. ?owever, where a corporation is a fragment of a larger corporate combine that actually conducts the business, a court will not pierce the corporate veil !so long as the corporation has some hope of functioning independently of parent corporation#. ;issent( In re5uiring the minimum liability insurance of H1-,---, the legislature did not intend to shield those individuals who organi8ed corporations with the specific intent of avoiding responsibility to the public. Comments( 9he corporate form may not be disregarded simply because the assets of the corporation !and its liability insurance# are insufficient. If insurance re5uirements are inade5uate, the remedy is with the legislature. It is not fraudulent for the owner of a single cab corporation to take out no more than minimum insurance. ND90: 2ourts often justify disregarding the corporate entity by way of an estoppel argument 1 if its shareholders do not respect the entity, why should the courtM

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9he corporate veil may be pierced even in instances where there has been no reliance on the companys representations 1 such as in cases of tort. As a conse5uence, whether or not creditors have been misled is not of primary importance. Instead, the court will look at the degree to which the corporation is treated as a separate formal entity !as well as the degree to which the corporation could function as a separate entity from the FparentG#.

S-ccessor Lia+ilit! "ince shareholders are not personally liable for corporate torts, firms might capitali8e themselves sparsely so that when something goes wrong, they just dissolve to avoid liability. 2orporate law addresses that. After 2orporate dissolution and the payment of li5uidating dividend to "?, "? remain liable for suits arising during the corp.s life as follows: o ;7CL 82/0, 202: "? remain liable pro rata on their li5uidating dividend for ( years/ o "C=CA 81'&0/#c%#$%: same as $&2), provided that corp. published notice of its dissolution 7oin concerns<prod-ct lines( Euyers will either negotiate for indemnification or just buy the assets but not the going concern. S-+stantive consolidation #horiBontal veil piercin % used in bankruptcy. Its commonly used, but there are some shortcomings to its use. o Its federal law, because its used in bankruptcy, so its an e*ample of federal law trumping state corporate law. o 3hile it may seem right to make the entire corporate FfamilyG suffer, rather than abandon the creditors of one company, there is also merit for the ability of a company to partition its assets in order to allocate risk strategically. Close Cor'orations A @ote on Close Corporations( 2losely held corporations have different characteristics than widely held corporations. "ince the 1=;-s, state law has dealt with this by allowing latitude in the setup of close corporations. 9hese laws often have a different structure characteri8ed by a FunifiedG corps statute, which e*plicitly permits planners to < around statutory provisions through general opt>out clauses ! sing language like Funless otherwise provided in the charterG !see "C=CA 80&01#+%#. $onahue v. Ro## 2lectrot"'e Co. Facts( $onahue, a minority stockholder in a close corporation, sought to rescind a corporate purchase of shares of the controlling shareholder. 9he 2" sold his shares back to the corporation at HB--%share. 9he FcorporationG only offered to pay H,-- per share for the shares of minority holders. Holdin ( A 2" !or group# in a close corporation who causes the corporation to purchase his stock breaches his fiduciary duty to the minority stockholders if he does not cause the corporation to offer each stockholder an e5ual opportunity to sell a ratable number of shares to the corporation at an identical price. @ote 1: Cinority "? are seen as vulnerable b%c their e*it opportunities are limited. 9his case was an e*ample of judicial activism. $elaware later rejected this holding b%c there may be good business reasons for repurchases and we dont want to regulate them too heavily. @ote 2( 9here was no allegation here that the price being paid to +odd was too high. $onahue wanted out b%c there was no way her stock would ever get dividends/ the +odds had better ways !salary# to get money out of the co. mith v. !tlantic )ro'erties Inc. Facts( 3olfson, a minority stockholder acting pursuant to a provision in the articles of incorporation, was able to prevent the distribution of dividends, as a result of which the corporation, Atlantic, had to pay a penalty ta* for accumulated earnings. Atlantic. 3olfson had arranged for the charter to re5uire an B-K "? vote for any corp. action to prevent the other three "? from ganging up on him. 3olfson continually vetoed dividends. Dther "? sue to remove 3olfson as a director and force him to reimburse the penalty ta*es and related e*penses. Holdin ( 3here a closed corporations articles of incorporation include a provision designed to protect minority stockholders, the minority stockholders have a fiduciary duty to use the provision reasonably. ?ere, 3olfson took risks inconsistent with a reasonable interpretation of his duty of utmost good>faith and loyalty ! &LA)#. Comment 1( 9he 5uestion is whether the veto power possessed by a minority may be e*ercised as its holder wishes w%o a violation of &LA) duties. 9he answer is no. Comment 2( After 'onahue and this case, many courts feared that &LA), if left to grow unrestrained, could decrease the value of the corporate form. Easterbroo and Fischel8 Close Corporations and Agency Costs8 Goals of Fi#uciar" ,a% o 9he goal of fiduciary duty analysis is to determine what the parties would have done if they had the low>cost opportunity to address this eventuality in negotiations.

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In closely held corporations, incentives for management action are different in kind from public corporations, and the danger of conflict is greater. 0*ample 1 firing an employee is not necessarily a legitimate management decision in a closely held corporation, it is more likely to be a way to cut a shareholder out of the benefit of owning a share.

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The $imited $iability Company &eneral contours: Internal relations between investors !FmembersG# governed by general or limited partnership law/ Cembers may operate the firm themselves !agency like in &'s# or elect FmanagersG !as in )'s or corps#/ 9he resignation of a member may or may not lead to dissolution/ Cembers must file a copy of their articles of organi8ation with the secretary of state !like )'s# 5nlike limited partners, mem+ers of an LLC enAo! limited lia+ilit! even if the! eIercise control over the +-siness in m-ch the same wa! that a 7* wo-ld& 9he rise of ))2s was largely ta*>driven. p until 1==@, I+" regulations said that ))2 would be ta*ed like a corp. if it had ( or more of the following: !1# limited liability for the owners of the business, !,# centrali8ed management, !(# freely transferable ownership interests, and !.# continuity of life. $uring this era, ))2 drafters tried to fail the corporate resemblance test by lacking both free transferability of interests !putting restrictions on transfers# and continuity of life !by setting ))2 for a term, or re5uiring dissolution with e*it of any member#. "ince 1==@: Fcheck the bo*G regulations. All new unincorporated businesses !&'s, )'s, ))2s, ))'s# may choose whether to be ta*ed as partnerships !pass>through# or corporations !two>tier ta*ation#. I+" +eg. A@@-.!a#: publicly traded partnerships are treated as corporations. )a''as et al. v. T/olis Lacts: plaintiffs !'appas and Ifantopoulos# and 98olis formed Qrahos ))2 !$elaware# for the purpose of entering into a lease. 9he operating agreement !governed by NO law# provided that 98olis would have a right to sublease !subject to additional payments to Qrahos# and that any member of the ))2 Fmay engage in business ventures and investments of any nature whatsoever, whether or not in competition with the ))2G. After a year 98olis bought plaintiffs interests in the ))2 !allegedly to avoid additional rent payments#, making them sign a handwritten certificate representing that they were not relying on any representation by 98olis and that 98olis owed no fiduciary duties to them. ; months later 98olis assigned the lease for a considerably superior price. 'laintiffs allege breach of fiduciary duty and fraud arising out of 98olis failure to disclose, prior to buying them out, that he was arranging a lucrative sale of the leasehold interest. Holdin 1( nder $elaware law, unless the ))2 agreement in a manager>managed ))2 e*plicitly restricts or eliminates fiduciary duties, managers owe those duties to the ))2s members !; $el. 2. A 1B>11-1!c##. Holdin 2( $espite the certificate in which plaintiffs acknowledged performing their own due diligence and waived 98olis fiduciary duties in relation to the assignments, 98olis had an overriding disclosure duty ! duty of loyalty# until the moment the buy>out transaction closed. 9he case cited in the dissent !Centro# does not support the position that the certificate effectively released 98olis, because in Centro plaintiffs knew that the information provided to them was incomplete !i.e., they were la* in protecting themselves#. 7ormal "overnance8 The >oting 3ystem 9he +ole and )imits of "hareholder Qoting !'owers of Eoard v. 'owers of "harheolders# Qery few public companies restrict the boards managerial power in their charters. $efault powers of shareholders: right to vote !board R some fundamental transactions#, right to sell, right to sue. 9he most important factor affecting shareholder voting is the collective action problem. Attempts to create a more active Fshareholder democracyG: - 1=(. "ecurities and 0*change Act: forced disclosure of information to shareholders !"0A A 1.#/ - Institutional shareholder activism: boost in the 1==-s. - Amendment of "02 pro*y rules in 1==,. - 2onclusion: we no longer live in a world of e*treme cases in which collective action costs are either none*istent !because the corp. has a controlling shareholder# or preclusive !because stockholding is highly diffuse#. 0lecting $irectors

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0very corporation must have a board of directors !1 or more natural persons# ! ;7CL 81'1#a%# and at least one class of voting stock. nless the charter provides otherwise, each share of stock has one vote !;7CL 8212#a%#. In public corps, most e5uity takes the form of voting common stock !the right to appoint the board is more valuable to common stock investors than to any other class of investors !e.g., bondholders##. Annual election of directors !another mandatory feature#. Eoards can be staggered !classified# or formed of a single class of directors ! ;7CL 81'1#d%#. 2orporate law facilitates the election of directors by creating a fle*ible framework for holding the annual meeting: minimum and ma*imum notice period ! ;7CL 8 222#+%#, 5uorum re5uirement !;7CL 8 21)#, minimum and ma*imum period for the board to fi* a record date ! ;7CL 8 211#c%#. 9his prevents the incumbent board from manipulating so that only a small number of shareholders can attend. Cumulative voting increases the possibility for minority shareholder representation on the board: each shareholder may cast a total number of votes e5ual to the number of directors to whom she is entitled to vote, multiplied by the number of shares that she owns, with the top overall vote getters getting seated on the board !opposite of cumulative voting is se5uential%normal voting# +emoving $irectors At common law, shareholders could remove a director only Ffor causeG. 3hat is a Fgood causeG for these purposes is unclear: fraud and unfair self>dealing certainly are, but what about abysmal business judgmentM ;7CL 81'1#k%: FAny director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directorsG !there are e*ceptions for cumulative voting !k#!,# and staggered boards !k#!1##. '+DE)0C: 9?0 NLI+0AE)0 20D !p. 1:=#. In a staggered board, directors can only be removed for cause. $irectors can propose amendments to corporate charter !;7LC 82'2# !but that doesnt help much#. Qoting stockholders !not board# can always change bylaws ! ;7CL 8102# !and increase si8e of board6 but board might be able to fill seats by default#. Eoard typically cannot remove directors in the absence of e*press shareholder authori8ation, but can petition a court of competent jurisdiction to remove for cause. "hareholder Ceetings and Alternatives In addition to the election of the board at the annual meeting, shareholders may also vote to adopt, amend, and repeal bylaws/ to remove directors/ and to adopt shareholder resolutions. "pecial meetings are called for special purposes !e.g., to vote on fundamental transactions#. In most jurisdictions, it is the only way that shareholders can initiate action !therefore, it is of considerable importance who may call a special meeting#: - +evised Codel Eusiness 2orporation Act !+CE2A# A @.-,: !i# board of directors or a person authori8ed in the charter or bylaws/ !ii# ?olders of at least 1-K of all votes entitled to be cast. - ;7CL 8 211 #d%: only the board or persons designated in the charter or bylaws !no mandatory 1-K provision#. "hareholder 2onsent "olicitations: alternative to special meetings. ;7CL 8 220 !majority of outstanding shares#/ +CE2A A @.-.!a# !less FliberalG: unanimity#. 'ro*y Qoting and its 2osts 0ach stockholder entitled to vote may authori8e another person !signed Fpro*y cardG or electronic communication# to act for such stockholder by pro*y !;7CL 8 212#+%#. 'ro*ies are revocable unless the holder has contracted for the pro*y as a means to protect a legal interest or property. 'ro*y voting does not remedy shareholders collective action problem: !i# costs of soliciting pro*ies are borne by the corporation, but the fact that the board may e*pend corporate funds on its own re>election seems to permit a kind of self>dealing. !ii# 0*penses of insurgent shareholders are not reimbursed unless they are victorious in their pro*y fight !so the incumbent board has a financial advantage#. "02 Fe'ro*y +ulesG !,--@# aimed at reducing the cost of soliciting pro*ies. +ule 1.a>1;. '+DE)0C: DN)O IN2 CE0N9" AN$ 3INN0+" &09 L+00 '+DPI0" !p. 1;,#. Rosenfel# v. Fairchil# 2ngine an# !ir'lane Cor'. Facts( "tockholders7 derivative action against corporation to have returned to the corporation money paid by corporation to reimburse e*penses of rival factions in pro*y fight. Holdin !Iudge Lroessel#: !i# In a contest over policy, as compared to purely personal power, corporate directors have the right to make reasona+le and proper eIpendit-res from the corporate treasury to persuade stockholders of the correctness of their position and to solicit their support for policies which the directors believe, in all good faith, are in the best interests of the corporation. !ii# 9he stockholders have the right to approve reimbursement of successful

1=

contestants for the reasonable and bona fide e*penses incurred by them in any such policy contest. No reimbursement if: !i# money spent for personal power, individual gain, etc. !ii# fairness and reasonableness of the amounts allegedly spent are successfully challenged. Comment( Iudge Lroessels rule: win or lose, incumbent managers are reimbursed for e*penses that are reasonable in amount and can be attributed to deciding issues of principle or policy. Insurgents stand a good chance of being reimbursed only if they win. Eut does this rule fi* right incentivesM 2lass Qoting Its a protection against e*ploitation by the majority: in order to be authori8ed, a transaction needs to be approved by the majority !or such higher proportion as may be fi*ed# of the votes in every class that is entitled to a separate class vote. 2an occur in the normal governance conte*t !special classes electing designated seats on the board# or in voting on fundamental transactions !which raises more interesting class voting problems#. '+DE)0C: 3?0N 9?0 '+0L0++0$ "9D2< '+0L0+" ND9. - Avone* has two classes of stock !: million no par common stock and :--,--- ;K cumulative preferred stock with a par value of H1- million#. 3ants to issue a new class !11K senior cumulative preferred stock#. - According to @E=CL 8 00', preferred have a separate vote when an amendment either subordinates their preference or authori8es a superior preference. nder NO law, Avone* can issue 1 million additional ;K cumulative preferred shares at a large discount and preferred would have no action. - nder $elaware law, preferred can vote if !i# their preference over common is being subordinated or !ii# the aggregate number of shares of their class is being increased. 9hey do not get a separate vote simply because an even more senior preferred class is being issued. !;7CL 8 2'2#+%#2%#. "hareholder Information +ights "tate law mandates neither an annual report nor any other financial statement. Lederal securities law and "02 rules re5uire e*tensive disclosure for publicly traded securities. Codern statutes codify shareholders right of access to information for a proper purpose. $elaware: two types of re5uests: - +e5uest for a Fstock listG: does not contain proprietary information and is easy to produce, thus Fproper purposeG is broadly construed !burden is on company to prove improper purpose#. 9he order will often re5uire the company to also furnish a Fnon>objecting beneficial ownersG list. - Inspection of books and records: more e*pensive/ may jeopardi8e proprietary and competitively sensitive information. 9hese re5uests are reviewed with care: !i# $elaware 1 plaintiffs must show a proper purpose which will be carefully screened/ !ii# New Oork 1 shareholders have a statutory right to access information, unless the company can show that the shareholder lacks a proper purpose. 9echni5ues for "eparating 2ontrol Lrom 2ash Llow +ights Although it is ordinarily good policy to align control !voting rights# with residual returns, this policy is frustrated in capital structures !e.g., dual>class voting# that misalign incentives. 2ircular 2ontrol "tructures ;7CL 8 1)0#c%( F"hares of its own capital stock belonging to the corporation or to another corporation !if a majority of the shares entitled to vote in the election is held, directly or indirectly, by the corporation# shall neither be entitled to vote nor be counted for 5uorum purposes.G 'eiser v. +a&er !2ircular "tructures 2ase# Facts( 9heres a single operating business, 2hem, with four classes of shareholders: public !.-K#, "peiser !1-K#, Eaker !BK#, and ?ealth Ced !.,K#. ?ealth Ced itself is owned by 2hem, "peiser, and Eaker. 2hem, through a wholly owned subsidiary !Cedallion#, owns an issue of ?ealth Ced convertible preferred stock which carries the right to only =K of ?ealth Ceds vote, but if converted into common stock, would represent =:K of ?ealth Ceds vote. 3hile the preferred stock is not converted, "peiser and Eaker control ?ealth Ced. If the stock was converted, 2hem would control Ced and Eaker and "peiser wouldnt be able to use their control of Ced !through 2hem# to vote on 2hem under A1;-!c#. Holdin 1( 3here a corporation has failed to hold an annual stockholders meeting for the election of directors, in contravention of statutory law, such a meeting must be held even if it means that one of two directors will be removed. Holdin 2( 3here a statute !like ;7CL 81)0#c%# prohibits the voting by a corporation of stock belonging to the corporation, stock held by a corporate subsidiary may belong to the issuer and thus be prohibited from voting even if the issuer does not hold a majority of shares entitled to vote at the election of the directors of the subsidiary.

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Hote =-!in 9raditionally, a shareholder could not sell her vote other than as part of a transfer of the underlying share. Now, vote buying is voidable but not void per se. 3hy limit the separation of control rights !the vote# over cash flow rights !the dividends#M 0asterbrook and Lischel: Qoting in 2orporate )aw "omeone who wants to buy a vote !almost always# must buy the stock too/ by attaching the vote firmly to the residual e5uity interest, these rules ensure that an unnecessary agency cost will not come into being. 9ransactions in votes would present difficult problems. )egal rules tying votes to shares increase the efficiency of corporate organi8ation. chreiber v. Carne" Facts( 9e*as International lends over H( million to Iet 2apital !which held (:K of 9e*as Internationals common stock# in return for voting in favor of reorgani8ation merger. 'laintiff !i# alleges vote>buying and !ii# asserts that the loan was corporate waste. Holdin ( 2orporate vote>buying is permissible if it does not work to the prejudice of other stockholders. 9he loan constituted vote>buying, but it had no purpose to defraud or in some manner disenfranchise other stockholders. 9wo principles that appear in $elaware cases dealing with vote>buying: - Qote>buying is illegal per se if its object or purpose is to defraud or disenfranchise the other stockholders. - Qote>buying is illegal as a matter of public>policy. 0ach stockholder should be entitled to rely upon the independent judgment of his fellow stockholders. In this case, however, the agreement was entered into primarily to further the interests of 9e*as Internationals other stockholders, hence the public policy rationale ceases to e*ist. An agreement involving the transfer of stock voting rights without the transfer of ownership is not necessarily illegal and each arrangement must be e*amined in light of its object or purpose. 9oday, many types of derivative financial contracts are available in more or less standard forms that allow the legal owner of shares to trade away the economic risk of an investment while maintaining legal title. )ortno" v. Cr"o.Cell International0 Inc. !&oing further than "chreiber# Facts( Agreement between board of directors and stockholder, to add stockholder to the management slate in e*change for his support in pro*y fight. Another dissident shareholder who loses the pro*y fight sues for illegal vote>buying. Holdin ( It was vote>buying, but not illegal. 9he 2ourt declines to apply the 3chreiber test considering that it would Fresult in creating litigable factual issues about a large number of useful compromises that result in the addition of fresh blood to management slates.G Cro%n 2ma& )artners v. 1ur/ !"eparation of financial rights from voting rights# Facts( 9he insurgents bought from a former corporate employee the economic interest !future cash flow rights# and the right to vote just enough shares to win a pro*y contest. 9he seller retained bare legal title. Holdin ( 9here was no fraud in the transaction, because the economic interests and the voting interests of the shares remained aligned. Eoth were transferred by the 'urchase Agreement. No need to apply 3chreiber !because the votes were bought along with the economic interest# 2ontrolling Cinority "tructures Dther ways to separate control rights from cash flow rights: controlling minority structures or !2C"s#> permit a shareholder to control a firm while holding only a fraction of its e5uity. Eebchuk, <raakman, 9riantis: "tock 'yramids, 2ross>Dwnership, and $ual 2lass 05uity $ual>class share structures !most common in the .".#> single firm issuing two or more classes of stock with differential voting rights. 2ash flow and control rights may be easily separated by attaching all voting rights to the fraction of shares assigned to the controller. "tock pyramids !most popular worldwide#> in a pyramid of two companies, a controlling minority shareholder holds a controlling stake in a holding company that, in turn, holds a controlling stake in an operating company !not popular in " because of ta*ation at each stage#. 2ross>ownership ties> hori8ontal structures. Qoting rights used to control the corporate group are distributed over the entire group rather than concentrated in the hands of a single company or shareholder. 'yramids and cross>ownership are unpopular in the .". due to ta* reasons and reporting re5uirements under the Investment 2ompany Act of 1=.-.

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$ual>class share structures are rare among public companies !in fact, historically NO"0 would not list common stock that did not possess e5ual rights#, although sometimes they might be desirable !e.g., newspapers#. 2urrently, NO"0 proscribes securities that limit the voting rights of e*isting securities, but permits I'Ds of low> vote or no>vote stock that do not control the rights of e*isting stock. 9he 2ollective Action 'roblem A collective action problem e*ists in any voting system where an informed vote is costly. +ecently, some commentators have pointed to hedge funds as a solution to the collective action problem. <aban and +ock: ?edge Lunds in 2orporate &overnance and corporate 2ontrol Incentives for hedge funds to monitor portfolio companies: !i# ma*imi8ing returns to fund investors !and at the same time increasing the fund managers fees#/ !ii# ma*imi8ing absolute returns. nlike mutual funds, hedge funds benefit directly and substantially from achieving high absolute returns. &eneral Iudicial "uperintendence of "hareholder Qoting Lundamental nature of shareholder voting R wide and fle*ible power of management recognition of broad general powers of courts of e5uity to supervise the voting process under a fiduciary standard of good faith. chnell v. Chris.Craft In#ustries Facts( 9he incumbent board strung along the dissidents who were negotiating up to the last minute/ then with only a couple of months left before the annual meeting the board amended the bylaws to advance the annual meeting date by one month and moved it to a small town !e*cuse: avoid the 2hristmas mail rush#. Holdin ( Canagement has attempted to utili8e the corporate machinery and the $elaware )aw for the purpose of perpetuating itself in office/ and, to that end, for the purpose of obstructing the legitimate efforts of dissident stockholders in the e*ercise of their rights to undertake a pro*y contest against management. &iven these ine5uitable purposes, the advancement of the by>law date of a stockholders meeting cannot stand. Ine<uitable action does not become permissible simply because it is legally possible. Comment( 9he above e*presses a most fundamental rule of fiduciary duty: legal po!er held by a fiduciary may not be deployed in a !ay that is intended to treat a beneficiary of the duty unfairly . 9he Lederal 'ro*y +ules Driginate with the provisions of the "ecurities 0*change Act of 1=(. !A 1.!a#>!c##. Lour major elements: - $isclosure re5uirements and a mandatory vetting regime. - "ubstantive regulation of the process of soliciting pro*ies. - A speciali8ed Ftown meetingG provision. - A general antifraud provision. +ules 1.a>1 through 1.a>@: $isclosure and "hareholder 2ommunication "ection 1.!a# of the "0A made it unlawful for any person to FsolicitG any Fpro*yG to vote any FsecurityG under A 1, of the Act without abiding by a long list of "0A regulations. 9he broad interpretation of this rule in +egulation 1.A resulted in actually discouraging pro*y fights as risky and e*pensive. Amendment of the rules in 1==,: limitation of the term FsolicitationG and new e*emptions under +ule 1.!a#>, !releasing institutional shareholders, in limited circumstances, from the re5uirement to file a disclosure form before they could communicate with other shareholders about a corporation#. +ule 1.a>(: no one may be solicited for a pro*y unless they are, or have been, furnished with a pro*y statement containing the information specified in "chedule 1.A. +ule 1.a>1: Fpro*yG> any solicitation or consent whatsoever. +ule 1.a>,!b#: e*emptions: solicitation to less than 1- shareholders/ ordinary shareholders who wish to communicate with other shareholders but do not themselves intent to seek pro*ies. +ules 1.a>. and 1.a>: regulate the form of the pro*y and the pro*y statement, respectively. +ule 1.a>;: formal listing re5uirements. +ule 1.a>B "hareholder 'roposals !the town meeting rule# 0ntitles shareholders to include certain proposals in the companys pro*y materials. +egulation 1.A provides thirteen specific grounds to permit corporations to e*clude shareholder>re5uested matter from the corporations pro*y solicitation materials. Companies that wish to eIcl-de a shareholder proposal enerall! seek SFC approval #Jno,action letterK% . 9o be eligible to submit a proposal, a person must hold H,,--- or 1K for one>year !1.!a#!B#!b#!1##. Cost proposals fall into one of two categories:

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- 2orporate governance. 9o what e*tent can shareholders enact bylaws that limit the range of options open to the board in managing the firmM "02 will not mandate access to the companys pro*y statement if, inter alia, the matter on which shareholder action is sought is not a proper subject of shareholder action under state law. Catters that fall within the ordinary course of business may also be e*cluded. )ess controversial proposals !which are more likely to be included# are bylaw amendments imposing structural reforms on the board. +ule 1.a>B re5uest by the 2arpenters 'ension Lund to ?ewlett 'ackard, re5uesting that the ?' directors initiate a process to amend the charter and bylaws so that directors are elected by majority !rather than plurality# vote !p. 1=;>,--#. ND90 DN 9?0 +I"0 AN$ LA)) DL + )0 1.A>11, 9?0 "?A+0?D)$0+ '+DPO A220"" + )0. August ,-1-: "02 announced the adoption of a +ule 1.a>11!pro*y access at all .". public companies# any shareholder or shareholder group that held more than (K of a .". public companys shares for more than three years would be eligible to nominate candidates for up to ,:K of the companys board seats on the companys pro*y form. Iuly ,-11: $.2. 2ircuit 2ourt of Appeals struck down +ule 1.a>11. April ,-1,: "02 announced that it would permit shareholders to propose pro*y access on a company>by>company basis. - 2orporate social responsibility: shareholders opposition to lawful !but disapproved# activities of the firm. &enerally, +egulation 1.A permits management to e*clude matters that fall within the ordinary business of the corporation. 0mployment>related proposals cannot automatically be e*cluded under the Fordinary businessG e*clusion. 2ase>by>case, analytical approach. A 1.a>B proposal must focus on Fsignificant social policy issuesG and must not seek to micromanage the business in order to avoid running afoul of the ordinary business e*clusion. +ule 1.a>= 9he Antifraud +ule 'ro*y +ule 1.a>=: general proscription against false or misleading pro*y solicitations. <ey elements !established by "upreme 2ourt decisions#: !i# Cateriality/ !ii# 2ulpability/ !iii# 2ausation and reliance/ !iv# +emedies: injunctive relief, rescission, or monetary damages. 1 "ee "cotts "tuff 7ormal "overnance8 The 'uty of Care Introduction to the $uty of 2are $uties of a fiduciary: - $uty of obedience: important in agency, but not in corporate law. - ;-t! of lo!alt!( re5uires that corporate fiduciaries e*ercise their authority in good>faith attempt to advance corporate purposes. - ;-t! of care( re5uires officers and directors to act with Fthe care of an ordinarily prudent person in the same or similar circumstancesG when overseeing the companys operations. It is litigated much less than the duty of loyalty, because law insulates officers and directors from liability based on negligence in order to avoid inducing risk>averse management of the firm. 9he $uty of 2are and the Need to Citigate $irector +isk Aversion According to the A)Is 'rinciples of 2orporate &overnance, a corporate director or officer is re5uired to perform his functions: (i) In good faith. (ii) In a manner that he believes to be in the best interests of the corporation. (iii) 3ith the care that at ordinarily prudent person would reasonably be e*pected to e*ercise in a like position and under similar circumstances. 9he duty of care cannot be subject to liability under a negligence standard. sually, at least gross negligence is re5uired. Gagliar#i v. TriFoo#s International Inc. Facts( $erivative 9riLoods shareholders claim to recover corporate losses allegedly sustained by reason of FmismanagementG unaffected by directly conflicting financial interests. Holdin ( In the absence of facts showing self>dealing or improper motive, a corporate officer or director are not legally responsible to the corporation for losses that may be suffered as a result of a decision that an officer made or that directors authori8ed in good faith. 9heoretical e*ception to this are FegregiousG decisions. "hareholders can diversify the risks of their investments/ they dont want directors to be risk averse. $irectors, however, enjoy !as residual owners# only a very small proportion of any gains of the corporation, whereas their liability would be joint%several for a loss. 2onse5uently, it is in the shareholders economic interest to offer sufficient protection: no liability for loss as long as they act in good faith and meet minimal procedural standards of attention.

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Comment( )aw protects corporate officers and directors in many statutory and judicial ways: !i# indemnification of costs incurred by reason of corporate activities ! ;7CL 8 1'6#/ !ii# liability insurance/ !iii# business judgment rule/ !iv# authori8ation to companies to waive director liability for acts of negligence or gross negligence !and seemingly recklessness# !;7CL 8 102#+%#/%#. 9his case offers a policy justification for the EI+. Iudicial 'rotection: 9he Eusiness Iudgment +ule 2ore idea: 2ourts will not second>guess ood,faith +-siness decisions made by directors and officers, and will not impose liability for even stupid business decisions so long as the director or officer #1% had no conflict of interest when he made the decision. #2% athered reasona+le amo-nt of information +efore decidin , and #$% did not act wholl! irrationall!& G Traditional =3" 1amin v. !merican 23'ress Facts( "hareholder brings a derivative suit against the directors of American 0*press alleging that their decision to distribute the shares American 0*press holds in another corporation to shareholders as a special dividend is a waste of corporate assets. 'laintiff contends that the sale of the shares on the open market instead would have resulted in substantial ta* savings to shareholders. Holdin ( Lor the directors. 'laintiff makes no claim that the directors engaged in fraud or self>dealing, but merely claims that some other decision would have been wiser. It is not enough that the directors made an imprudent decision/ more than imprudence or mistaken judgment must be shown. ?ere, the evidence shows that the directors considered the ta* advantages of selling the stock rather than distributing it, but were worried that this path would hurt the corporations reported earnings. Comment( 3hether or not a dividend is to be declared or a distribution made is e*clusively a matter of business judgment for the board and the courts will not interfere as long as the decision is made in ood faith. nderstanding the Eusiness Iudgment +ule 9he clearest e*isting definition is probably the one given in the A)Is 'rinciples of 2orporate &overnance !A ..-1!c#: a decision constitutes a valid business judgment !and gives rise to no liability for ensuing loss# when it !1# is made by financially disinterested directors or officers !,# who have become duly informed before e*ercising judgment and !(# who e*ercise judgment in a good>faith effort to advance corporate interests. 9he $uty of 2are in 9akeover 2ases: mith v. (an Gor&om !gross negligence actionable before A1-,!b#!@# Facts( Qan &orkom !chairman% 20D of 9rans nion 2orporation/ near retirement age and willing to sell his shares prior to retirement#, with little outside advice !no investment banker, no outside lawyer# and little advice from senior staff, set about to arrange a merger agreement with a 'rit8ker family entity. "hareholder sues alleging breach of duty of care. Holdin ( $irectors had been grossly negligent in their decision making !failing to inform themselves ade5uately# and therefore could not claim the protections of the EI+. 9hey were found liable for damages because they did not obtain the highest possible price from the takeover bidder, even though the sale price was substantially higher than the stock had ever previously traded, and even though there was no apparent taint of self>dealing. Comment 1( Qan &orkom is an e*ception to the usual rule that if theres no taint of self>interest, and at least some attention paid to directorial responsibilities, the EI+ will shield the directors for liability for their decision. Comment 2( 9he case shows that process is e*ceptionally important in obtaining the benefits of the EI+. $irectors who were grossly negligent in their decision making will lose the protection of the EI+. Comment $( 3as there a pseudo>(evlon, take>over type rationaleM @4TF( +ational belief and EI+ 1 courts will only evaluate the underlying merits of transactions that are egregious on their face. Dtherwise, emphasis will be placed on the rationality of the directors belief !was there a rational reason to e*plain their course of conduct# 1 not on the rationality of their decision. Additional "tatutory 'rotection: Authori8ation for 2harter 'rovisions 3aiving )iability for $ue 2are Qiolations Immediate reaction to Qan &orkom: !i# rise in the level of premia charged by insurance companies for director and officer liability policies/ !ii# ;7CL 8102#+%#/%: possibility to eliminate or limit liability for losses caused by negligent or grossly negligent !or likely reckless# transactions in which the director had no conflicting financial interest or otherwise was alleged to violate a duty of loyalty. Conflict Transactions( 9he $uty of )oyalty 9he duty of loyalty re5uires a corporate director, officer, or controlling shareholder to e*ercise her institutional power over corporate processes or property !including information# in a good>faith effort to advance the interests of the company. $uty of loyalty comes into play when there are conflicts in the transaction

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9he "hareholder 'rimacy Norm "hort answer: directors owe loyalty to the corporation as a legal entity. $irector loyalty to the corporation is, ultimately, loyalty to e5uity investors. Core than a legal rule it is an implicit value, although it has been recogni8ed as a rule in the case $o#ge v. For# Motor Co: Facts( $odge brothers !holding 1-K of Lord shares# sued to force Lord to declare a dividend out of a large pool of earnings retained to fund new projects and to FfinanceG price reductions on Lord products. Lord alleges obligation to share its success Fwith the publicG. Holdin ( A corporation is organi8ed for the benefit of stockholders, not for charitable purposes. Lord wrongfully subordinated shareholder interests to those of consumers by holding back dividends. Comment( A boards decision today to use retained earnings to fund investments, price reductions, or even increased employee wages would easily be justified as a device to increase long>term corporate earnings. A 5uestion of loyalty would arise only in the odd circumstance that the board claimed to advance non> shareholder interests over those of shareholders !like Lord#. A different conception of duty of loyalty: directors must act to advance the interests of all constituencies in the corporation, not just the shareholders. !.) mith Manufacturing v. +arlo% Facts( Action brought by corporation for judgment declaring its contribution to 'rinceton niversity to be within its powers, wherein defendants asked for judgment declaring the contribution to be a misappropriation of corporate funds. Holdin ( 9here is no difficulty in sustaining, as incidental to their proper objects and in aid of the public welfare, the power of corporations to contribute corporate funds within reasonable limits in support of academic institutions. "uch e*penditures may likewise be justified as being for the benefit of the corporation. Comment( 9here is no suggestion that the donation was made indiscriminately or to a pet charity of the corporate directors in furtherance of personal rather than corporate ends. It was made in reasonable belief that it would aid the public welfare and advance the interests of the plaintiff as a private corporation and as part of the community in which it operates. 2onstituency "tatutes 9he 5uestion of directors loyalty had much more economic import in the hostile leveraged buyout transactions of the 1=B-s than in cases of charitable contributions. &iven the e*perience of 1=B-s transactions, managerial advocates turned to the rationale that directors owe loyalty to the corporation, understood as a combination of all its stakeholders 1 creditors, shareholders, managers, workers, suppliers, and customers. $elaware has not adopted a constituency statute. elf.$ealing Transactions A self,dealin transaction is one in which three conditions are met:

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A key player !officer, director, 2"# and the corporation are on opposite sides of a transaction 9he <ey player has helped to influence the corporations decision to enter the transaction 9he <ey 'layers personal financial interests are at least potentially in conflict with the financial interests of the corporation

2ourts will fre5uently intervene to strike down !or award damages for# self>dealing transactions. In most states, the approach to self>dealing transactions is as follows: Fairness( If the transaction is found to be fair to the corporation, the court will uphold it. 9his is true regardless of whether the transaction was ever approved by disinterested directors or ratified by the shareholders 9aste<Fra-d( If the transaction is so unfair as to amount to waste or fraud, the court will usually void it at the re5uest of a stockholder, even if the transaction was approved by a majority of disinterested directors or ratified by shareholders o In $0, a transaction will not be invalidated as constituting waste unless it is Fan e*change so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received ade5uate considerationG If the transaction does not fall into either of the two above categories 1 its not clearly fair but not so unfair as to amount to waste or fraud 1 the presence or absence of director approval and%or shareholder ratification will make the difference.

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9here are three different ways that a proponent of a self>dealing transaction can probably avoid invalidation. !1# ?e may show approval by a majority of disinterested directors, after full disclosure/ !,# he may show ratification by shareholders, after full disclosure/ and !(# he may show that the transaction was fair when made. ;isinterested ;irectors( A transaction may not be avoided by the corporation if it is authori8ed by a majority of the disinterested directors after full disclosure of the nature of the conflict and the transaction o 9wo kinds of info must be disclosed: material facts about the conflict and material fact about the transaction o 2ourts are split about when this disclosure must be made. "ome courts re5uire it to be made before the transaction. Dthers all ratification after the fact Shareholders( A self>dealing transaction will be validated if it is fully disclosed to the shareholders and then ratified by a majority of them. o 2ourts are split about whether the ratification must be by a majority of disinterested shareholders !majority of the FminorityG# or merely be a majority of all shareholders. nder CE2A AB.;(, a majority of disinterested shareholders must approve. Fairness( A self>dealing transaction can be validated by showing that it is, under all the circumstances, fair to the corporation. "uch Foverall fairness: will suffice even if the transaction was neither approved by the disinterested directors nor was ratified by shareholders. In most states, the approval of shareholders or disinterested directors will ND9 immuni8e a transaction from judicial review for gross unfairness. In $0, however, authori8ation by disinterested directors or shareholder ratification will immuni8e even an unfair transaction from judicial review. According to the $0 "upreme 2ourt: FApproval by fully>informed disinterested directors under ;7CL 81''#a%#1% or disinterested stockholders under ;7CL 81''#a%#2% permits invocation of the EI+ and limits judicial review to issues of gift or waste, with the burden of proof upon the party attacking the transaction.G ;arciano v. 7a ash. In short, director or shareholder approval is beneficial because it impacts both the burden of proof and the standard of proof o Standards of *roof( 2" is interested party 1 entire fairness $irector or officer is interested party 1 EI+ !a director>approved or shareholder> approved transaction will only be overturned if the unfairness is so great that it amounts to fraud or waste# =-rden of proof( In most states, director or shareholder approval shifts the burden of proof. 3ithout approval, the burden is on the <ey 'layer to show fairness. Dnce there has been approval, the burden shifts to the person attacking the transaction

9he $isclosure +e5uirement Qalid authori8ation of a conflicted transaction between a director and her company re5uires the interested director to make full disclosure of all material facts of which she is aware at the time of authori8ation. $elaware courts re5uire all material information relevant to the transaction. tate e3 rel. Ha"es O"ster Co. v. 1e"'oint O"ster Co. Facts( In the light of 2oast Dysters cash flow problems, Qerne ?ayes !director, ,(K shareholder, and 20D of 2oast Dyster# convinces the board to sell two oyster beds and suggests 0ngman !2oast employee# to form a new corporation !<eypoint# to buy them. ?ayes own family corporation, ?ayes Dyster, helps <eypoint with financing, in e*change for which ?ayes Dyster receives :-K of the e5uity in <eypoint !this occurs after the 2oast board votes to sell, but before 2oast shareholders approve the sale#. Holdin ( In 3A, nondisclos-re +! an interested director or officer is, in itself, a +reach of fid-ciar! d-t!& It is not necessary that an officer or director of a corporation have an intent to defraud or that an injury result to the corporation for an officer or director to violate his fiduciary obligation in secretly ac5uiring an interest in corporate property. Comment( ?ayes obligation to divulge his interest arose from the possibility, even probability, that some controversy might arise between 2oast and <eypoint. In all fairness, 2oast shareholders and directors were entitled to know that their president and director might be placed in a position where he must choose between the interest of 2oast and <eypoint. 0isenberg: "elf>Interested 9ransactions in 2orporate )aw 3hy isnt fairness of price enough without full disclosureM Answer: 2ourts dont want to have determine what was a fair price.

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ND90" DN $I"2)D" +0 DL 2DNL)I290$ 9+AN"A29IDN" +e5uiring a fiduciary to disclose raises the 5uestion of what must be disclosed beyond the simple fact of self>interest. $elaware courts re5uire all material information relevant to the transaction. 0arly +egulation of Liduciary "elf $ealing 1Bth>1=th centuries: courts would uphold a contract if it was !i# fair and !ii# approved by a board composed of a majority of disinterested directors after !iii# full disclosure. Cid>,-th century: safe harbor statutes !embodying earlier charter provisions that sought to ensure that interested transactions would not be void per se#. Iudicial +eview of "elf $ealing 9oday: 9he )imited +ole of "afe ?arbor "tatutes "afe harbor statutes initially sought to permit boards to authori8e transactions in which a majority of directors had an interest. Cost .". jurisdictions now have them. ;7CL 8 1''. @E=CL 8 /1$. Cal& Corp& Code 8 $10& "o long as it is disclosed, a transaction is not voidable FsolelyG because it is interested. 9he transaction will stand if approved by a majority of the disinterested directors or a majority of disinterested shareholders or it is fair !the most followed interpretation 2ookies Lood#. Another possible interpretation !broad#: never voidable if fully disclosed and authori8ed or approved in good faith or if it is fair. Coo&ies Foo# )ro#ucts v. ,a&es Warehouse Facts( Cinority shareholders of closely held corporation filed derivative action alleging that majority shareholder !?errig#, by ac5uiring control of the corporation and e*ecuting self>dealing contracts, breached his fiduciary duty to the company and fraudulently misappropriated and converted corporate funds. Holdin ( 9he satisfaction of disclosure alone does not prove that a director has met the duty of loyalty/ it merely precludes the court from rendering the transaction void or voidable outright. ;irectors who en a e in self,dealin m-st esta+lish the additional element that the! have acted in ood faith, honest!, and fairness& 9his re5uires not only a showing of Ffair priceG but also a showing of the fairness of the bargain to the purposes of the corporation !i.e., benefit to the corporation#. Comment 1( ?aving found that the compensation ?errig received from the agreements with 2ookies was fair and reasonable, the 2ourt is convinced that ?errig furnished sufficient pertinent information to 2ookies board to enable it to make prudent decisions. Comment 2( $irectors who engage in self>dealing must establish that they acted in good faith, honest, and fairness. Self,dealin transactions m-st have the earmarks of arms,len th transactions +efore a co-rt can find them to +e fair or reasona+le& 4ne potential wa! to esta+lish fairness is to show approval +! disinterested +oard #theoretical -nderpinnin of law concernin self,dealin % Iudicial +eview 3hen 9ransaction ?as Eeen Approved by a $isinterested Cajority of the Eoard Coo&e v. Oolie Facts( 'laintiffs allege that two 9NN directors breached their duty of loyalty by electing to pursue a particular ac5uisition proposal that best protected their personal interests as 9NN creditors, rather than pursue other proposals that offered superior value to 9NNs shareholders. Holdin ( 9he fact that two disinterested directors voted to pursue the disputed proposal removes the alleged taint of disloyalty. nder ;7CL 8 1''#a%#1%, the Co-rt will appl! the +-siness A-d ment r-le to the actions of an interested director, who is not the maAorit! shareholder, if the interested director f-ll! discloses his interest and the maAorit! of the disinterested directors ratif! the interested transaction& Comment( 9he disinterested directors vote leads to the presumption that interested directors acted in good faith. "hareholder +atification of 2onflict 9ransactions A)I, 'rinciples of 2orporate &overnance A :.-,!a#!,#!$#: 9he power of shareholders to affirm self>dealing transactions is limited !i# by the need to protect the disinterested minority of shareholders/ !ii# by the corporate FwasteG doctrine. ,e%is v. (ogelstein nanimous shareholder approval is re5uired to ratify a conflicted transaction that involves corporate waste. 3aste entails an e*change of corporate assets so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade. In re Wheelabrator Technologies0 Inc. !Interested $irector, approval my majority of shareholders#

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Facts( "hareholders of 3heelabrator !39I# brought a derivative action claiming that 39I directors breached their duties of care and loyalty because . of the 11 39I were also officers of the company that ac5uired 39I. $irectors contended that approval by 39Is non>conflicted shareholders e*tinguished the claim. Holdin ( "tockholder ratification does not automatically e*tinguish a claim for breach of the directors duty of loyalty. +ather, its operative effect has been to change the standard of review to the EI+ !for conflicts involving directors#, with the burden of proof resting upon the plaintiff. Comment( Interested transactions between the corporation and its controlling shareholder are evaluated under an entire fairness standard of review. 9he 2" has the burden of proving that the transaction was entirely fair. 9he need for this higher level of judicial scrutiny is triggered because the participation of the 2" raises a strong concern that the 2" may manipulate the process6 If the transaction is conditioned upon approval by a Fmajority of the minorityG stockholder vote, and such approval is granted, the burden of demonstrating entire fairness shifts to the plaintiff. $ifferent 9reatment for 2ontrolling "hareholdersM - 2ontrolling shareholders also owe a fiduciary duty to the company and its minority shareholders. - 2ontrol in this conte*t should be determined by a practical test rather than a formalistic one: !i# "hareholder holding less than :-K of the voting power may have a fiduciary duty by reason of the e*ercise of corporate control/ !ii# "hareholder holding more than :-K will probably owe such duty, even if not e*ercising control. 1ahn v. ,"cnh - 2onflict between the controlling shareholders fiduciary duty !prevails in conflict transactions# and his entitlement to sell and vote in his own interest. !2ontrolling shareholder dilemma 1 $ige3# inclair Oil v. ,evien !parent>subsidiary 1 same logic as controlling shareholder cases# Facts( $erivative action brought by minority stockholder of subsidiary !"inven# against parent corporation !"inclair# to account for damage sustained by subsidiary on grounds that parent !as result of dividends paid by subsidiary, most of which went to parent company# denied industrial development to subsidiary. Holdin ( The intrinsic fairness standard sho-ld not +e applied to +-siness transactions where a fid-ciar! d-t! eIists +-t is -naccompanied +! self,dealin & "elf dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent received something from the subsidiary to the e*clusion of, and detriment to, the minority stockholders of the subsidiary. Comment( In this case, a proportionate share of dividend money was also paid to minority stockholders6. "incalir usurped no business opportunity belonging to "inven. ?ence, EI+. Weinberger v. 4O)0 Inc. Facts( "ignal, which was majority shareholder !:-.:K# of D', sought, and ac5uired, remaining shares of D' by merger transaction including payment of cash to minority shareholders of subsidiary for their minority shares. Cinority shareholder, on behalf of class of all subsidiary shareholders who had not e*changed their shares for merger price, challenged the transaction as a breach of the D' boards fiduciary duty. Holdin 1( A minority shareholder may successfully challenge the approval of a cash>out merger that was approved by the majority of the minority shareholders if he can demonstrate that the corporation failed to comply with the fairness test in securing approval. Holdin 2( 9here were common "ignal> D' directors participating, at least to some e*tent, in the D' boards decision>making processes without full disclosure of the conflicts they faced. 9here is no Fsafe harborG for such divided loyalties. 3hen directors of a $elaware corporation are on both sides of a transaction, they are re5uired to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain. Comment 1( 9wo basic aspects of fairness: )) Lair dealing: timing, initiation, structuring of the transaction/ its disclosure/ how the approvals of the directors and the stockholders were obtained. 9here was no fair dealing here !time constraints, little bargaining, failure to disclose the report prepared by "ignal> D' common directors to outside D' directors and minority stockholders#. "tockholders vote was not an informed one, and, conse5uently, their approval was meaningless. )) Lair price: economic and financial considerations. Lairness in5uiry is not a bifurcated one as between fair dealing and price: all aspects must be e*amined as a whole since the 5uestion is one of the entire fairness. 9raditionally, the remedy of the minority shareholders has been restricted to appraisal rights ! ;7CL 8 2)2#. ?owever, courts may occasionally give the minority shareholders the right to bring a class action for damages or an injunction if the terms of a short>form merger are dramatically unfair.

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SIn a footnote, the 2ourt intimates that D' might have been okay if they had appointed an independent negotiating committee of outside directors to deal with "ignal at arms length. It would have helped the transaction meet the fairness test. Approval by a Eoard Cinority of TIndependentT $irectors Assures the appearance as well as the reality of a fair deal. 9wo important aspects: - Dperation: properly charged by the full board, composed of independent members, and vested with the resources to accomplish its task. - 0ffects: shifts the burden from the defendant to the plaintiff !who must show FunfairnessG or violation of EI+ in a controlled transaction#. "9AN$A+$ DL +0QI03 !burden of proof# Neither board nor shareholders approve $isinterested directors authori8e !beforehand# $isinterested directors ratify !after# "hareholders +atify $&2) A 1.. 0L !$#/ Eut see "iliconi* EI+ !'#/ 2ooke/ but see 2ookies !0L, if controllerM# EI+ !'#> same as above EI+ % 3aste !'# +CE2A A B.;1 0L !$# EI+ !'# A B.;1!b#!1# 4 2omment , EI+ !'#/ A B.;,!a# 4 2omment 1 3aste !'# A)I A :.-, 0L !$# +easonable belief in fairness !'#/ A :.-,!a# !,#!E# 0L !$# 3aste !'#

Corporate 4pport-nit! ;octrine 3hen may a fiduciary pursue a business opportunity on her own account if this opportunity might arguably belong to the corporation !;einhard#M 2hief 5uestions: whether an opportunity is corporate and whether a fiduciary may nevertheless justify pursuing the opportunity in a personal capacity6 has a fiduciary breached her duty of loyalty in taking the opportunityM $etermining 3hich Dpportunities TEelongT to the 2orporation ( tests: - FIpectanc!< interest test #narrowest protection to the corporation%( the e*pectancy or interest must grow out of an e*isting legal interest, and the appropriation of the opportunity will in some degree Fbalk the corporation in effecting the purpose of its creationG. - Line of +-siness( any opportunity falling within a companys line of business is its corporate opportunity. - Fairness test( multiple factors. 3hen Cay a Liduciary 9ake a 2orporate DpportunityM - Eoards good> faith decision not to pursue an opportunity. - ?owever, theres no obligation to present an opportunity to the board/ its only effect is a Fsafe harbor.G - ;7CL 8122#1/%: every $elaware corporation has a power to F+enounce, in its certificate of incorporation or by action of its board of directors, any interest or e*pectancy of the corporation in, or in being offered an opportunity to participate in, specified business opportunities or specified classes or categories of business opportunities that are presented to the corporation or 1 or more of its officers, directors or stockholders.G 9ransactions in 2ontrol 3hy are buyers willing to pay a premium for controlM - Its a payment for Fprivate benefits of controlG - Euyers might have a superior business plan that will increase the value of the stock in their hands !Fpublic benefits of controlG#. 9wo ways to ac5uire control: !i# 'urchasing a controlling block from an e*isting controlling shareholder. !ii# 'urchasing the shares of numerous smaller shareholders. 'olicy concerns in either case. "ales of 2ontrol Elocks 9he +egulation of 2ontrol 'remia

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- In the ."., minority shareholders do not have a right to sell their shares alongside the controlling shareholder, nor a right to sell their shares back to the company !as in mergers#. - Eebchuks market rule: Fsale of control is a market transaction that creates rights and duties between the parties, but does not confer rights to other shareholders. Illustrated by 5eitlin v. Hanson Hol#ings0 Inc. !New Oork 1=@=#, p. .,1, where New Oork 2ourt rejects e5ual opportunity rule: FAbsent looting of corporate assets, conversion of a corporate opportunity, fraud or other acts of bad faith, a controlling stockholder is free to sell, and a purchaser is free to buy, that controlling interest at a premium price.G - ?owever, proponents of minority shareholder interests !looking, amongst others, at )erelman v. Fel#mann case# defend the idea of according minority shareholders a claim on control premia. )erlman v. Fel#mann Facts( "tockholders7 derivative action to recover from former dominant stockholder !and principal officer# alleged personal profits resulting from sale of controlling stock, with conse5uent right to control distribution of product !steel products at time of steel shortage due to the <orean 3ar#, to end>users of corporate product. Holdin ( 3here dominant stockholder and principal officer of steel corporation, at time of steel shortage, sold controlling stock to steel users, together with conse5uent right to control distribution of steel, he was accountable to minority stockholders to the e*tent that the price paid represented payment for right to control distribution. Comment( A director who is also a dominant stockholder stands, in both his aspects, in a fiduciary relationship to the corporation and to the minority stockholders, and his responsibility as a fiduciary includes dedication of his -ncorr-pted +-siness A-d ment for sole +enefit of corporation in an! dealin s that ma! adversel! affect it& In this case, Leldman had the burden of proving that the sale of stock, with its incident right to control distribution of products, had not deprived corporation of any opportunity for gain. If there was possibility of corporate gain !Leldman could not prove there wasnt#, minority stockholders were entitled to recover. A $efense of the Carket +ule in "ales of 2ontrol 0asterbrook and Lischel: 2orporate 2ontrol 9ransactions Eenefits of the movement of control: new officers, new plans, new working arrangements, etc. 9he premium price reduces the costs to purchasers of control and therefore increases the number of beneficial control transfers. ?owever, numerous commentators argue for some form of sharing re5uirement: !i# 9heory that control is a Fcorporate assetG. !ii# F05ual opportunityG rule !offer to controlling shareholder must be e*tended to all shareholders6 deterrence to looters because looters, at least in theory, have nobody off which to free>ride#. 2riti5ue of 'erelman: Cinority shareholders would suffer under either rule, as the likelihood of improvements in the 5uality of management declined6. 9hat said, the market rule may allow looters to dominate over efficient buyers in certain circumstances6

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@ormal 7overnance( The ;-t! of Care

3tatutory Techni<ues for $imiting 'irector and +fficer (is E%posure "tatutory power to indemnify losses 4 statutory authority allowing purchase of insurance for directors%officers offers most reliable protection Indemnification most statutes prescribe mandatory indemnification rights for directors%officers 4 allow for broader elective indemnification rights. o Authori8e reimbursement for reasonable e*penses%losses of any sort !includes attorneys fees, investigation fees, settlement amounts, sometimes judgments# related to actual or threatened suits )imits: losses must result from actions on behalf of the corp. in good faith 4 cant arise from a criminal conviction. ;7CL 81'6#a%, #+%, #c% Waltuch v. ContiCommo#it" ervices0 Inc.

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Facts: 3hen $ refused to indemnify ' for legal fees resulting from litigation that arose out of his former employment with $, ' brought suit for indemnification. 9he former lawsuit had ended in a settlement where ' was dismissed from suit with no settlement contribution. Holdin : 1# A provision of a corporations articles of incorporation that provides for indemnification without including a good>faith limitation runs afoul of a statute that permits indemnification only if the person acted in good faith6 even if the statute allows the corporation to grant rights in addition to indemnification rights. o $&2) 1.:!a# Udiscretionary indemnification powerV prohibited indemnification if he had acted in bad faith regardless of whether $s indemnification provision didnt re5uire good faith. ,# 9o the e*tent that a director, officer, employee, or agent of a corporation has been successful on the merits or otherwise in defense of any action, he shall be indemnified against e*penses !including attorneys fees# actually and reasonably incurred by him6 0scape from adverse judgment or other detriment is determinative. 'irectors and +fficers Insurance 'rovisions authori8e corps to pay premia on $4D liability insurance #"C=CA 80&6/, ;7CL 81'6#f%% +easons to have corporate !not individual# insurance: o o o o 2ould be cheaper if company acts as central bargaining agent niformity standardi8es individual risk profiles 9a* law favors firm>wide coverage !$4D insurance is deductible# $4D might under>invest in insurance if left to themselves

The 'uty of Care in Ta eover Cases A note on mith v. (an Gor&om 9he first $0 case to actually hold financially disinterested directors personally liable for breach of duty of care for the conse5uences of the boards business decision. )ed to immediate revision in the statutory law. Additional 3tatutory ,rotection8 Authori#ation for Charter ,rovisions Waiving $iability for 'ue Care >iolations +eaction to mith v. (an Gor&om6 $ramatic rise in the level of premia charged by insurance companies for $4 D liability policies 0nactment of ;7CL 8102#+%#/%( validated charter amendments that provide that a director has no liability for losses caused by transactions in which the director had no conflicting financial interest or otherwise was alleged to violate a duty of loyalty !so long as there was good faith# $uties of Care an# Cor'orate Malfeasance 7 What is +a# Faith from a $ut" of Care )ers'ective The 6oard5s 'uty to ;onitor8 $osses ?Caused? by 6oard ,assivity ?f decision deflected<no decision made @4 =3" Francis v. 4nite# Jerse" +an& Facts( '4E was a family firm w%. directors. Lather died 4 sons engaged in shady dealings. Lirm went bankrupt. Eankruptcy trustee brought suit against Crs. 'ritchard for breach of duty of care. Crs. ', although a director, was not active in the business 4 knew virtually nothing about its affairs !never attended meetings, read books, etc.#. Holdin ( )iability of a corporations directors to its clients re5uires a demonstration that 1# a duty e*isted, ,# the directors breached the duty, and (# the breach was a pro*imate cause of the clients loss. Ey virtue of a directorship, one has the power and responsibility to prevent losses and to deter wrongful action by other insiders. Crs. ' breached the duty of care 4 was the pro*imate cause of the loss. "easonin : A director should ac5uire at least a rudimentary understanding of the business of the corp. Eecause directors are bound to e*ercise ordinary care, they cannot set up as a defense lack of the knowledge needed to e*ercise the re5uisite degree of care. 9his case was pre 1 $&2) A1-,!b#!@#6 this provision would have covered both actions and omissions $irectors are only immune from liability if, in good faith, they rely upon the opinion of counsel for the corp. or upon written reports setting out financial data concerning the corp. and prepared by an independent public accountant, or upon financial statements%books%reports of the corp

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 If statements reveal illegal course of action, a director has a duty to object and, if the corp. does nothing to correct the conduct, to resign Analysis in cases of negligent omissions calls for determination of the reasonable steps a director should have taken and whether those steps !ould have averted the loss 2ausation may be inferred where you can conclude that the failure to act would produce a particular result, and that result has followed. @4TF: 9his case reflects the majority view that there is a minimum objective standard of care for directors. $irectors cannot abandon their office but must make a good>faith attempt to do a proper job. Graham v. !llis Chalmers Manufacturing Co. Facts: $ pled guilty to price>fi*ing charges and paid huge fines. "? brought derivate suit against officers to recover fines on behalf of the corp. 's argued that directors breached their duty of care in failing to install controls to prevent the violations. Holdin : $irectors win. Absent cause for suspicion !a Fred flagG#, there is no duty upon directors to ferret out wrongdoing which they have no reason to suspect e*ists. @ote( 9he analysis depends on the circumstances !structure%nature of corporation included#: if a director recklessly trusts an untrustworthy employee or neglects his duties as director or willfully ignores wrongdoing, then the liability is on him. In the Matter of Michael Marchese 8 2C enforcement action9 Facts: 9he "02 contended that Carchese, an outside director of company who served on companys audit committee violated and caused the company to violate carious provisions of the 0*change Act because he failed to ade5uately monitory the companys financial statements. "es-lt: Carhcese violated the 0*change Act by recklessly failing to in5uire into the corporations financials when he had knowledge of facts to put him on notice that such in5uiry was warranted. )ack of action is seen as reckless here because Carchese had knowledge of potential problems but failed to make further in5uiries. @4TF( sometimes, lapses of statutory%administrative standards of business conduct are treated as criminal matters !e*. 0nvironmental statutes# Drgani8ational "entencing &uidelines offer powerful incentives for firms to put compliance programs in place, to report violations of law promptly, and to make voluntary remediation efforts In re Caremar& International Inc. $erivative ,itigation Facts( 2aremark was subject to the Anti>+eferrals 'ayment )aw. 9hey had an ethics guidebook, an internal audit plan, and a toll>free confidential ethics hotline implemented to ensure compliance. ?owever, lower level managers engaged in misconduct that led to H,:- million in penalties. "? filed a derivative suit seeking recovery from the board, alleging breach of duty of care. Holdin ( A board of directors has an affirmative duty to attempt in good faith to ensure that a corporate information and reporting system e*ists and is ade5uate. "easonin ( Eoards must assure themselves that info and reporting systems e*ist in the organi8ation that are reasonably designed to provide to mgmt%board timely, accurate info sufficient to allow mgmt%board to make informed judgments re: business performance and compliance w%law. o 9he )0Q0) of detail of the system is a matter of business judgment Necessary for the board to e*ercise a good faith judgment that the corp.s info%reporting system is ade5uate o Dnly a sustained or systemic failure of the board to e*ercise oversight will establish the lack of good faith thats a necessary condition to liability SClarification of Caremar 3tandard > tone v. Ritter: Caremar articulates the necessary conditions for director oversight liability: o !a# the directors utterly failed to implement any reporting or information system, or

o !b# having implemented such a system, consciously failed to monitor its operations, thus disabling themselves from being informed of risks or problems re5uiring their attention. According to 3tone9 knowled e is re:-ired( Imposition of liability re5uires a showing that the directors knew that they were not discharging their fiduciary obligations. Note: Sar+anes 4Ile! 8'0'( re5uires that 20D of firms regulated under "ec. 0*change Act of 1=(. periodically certify that they have disclosed to the companys independent auditor all deficiencies in the design or operation, or any material weakness, of the firms internal controls for financial reporting.

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In re Citigrou' Inc. harehol#er $erivative ,itigation Facts( "? brought suit against $4D claiming breach of fiduciary duties by failing to monitor and manage the risks faced from problems in the subprime lending market 4 for failing to disclose e*posure to subprime assets. 2orp. was unable to pay investors 4 had to sell assets at fire sale prices. Holdin : 2itigroup wins. 9he discretion granted $4D for ma*imi8ation of "? value on the long term affords the opportunity to take risks without fear of personal liability/ also free from liability if risk results in loss. "easonin : ' frames the suit as a Caremar claim, but court rejects its use in monitoring business risk Instead uses the fiduciary duty of care and the +-siness A-d ment r-le o Locuses on the decision>making process rather than on a substantive evaluation of the merits of the decision o +isk is part of the game6 just because the decision raised red flags of risk does not mean Caremar %3tone implicated. EI+: presumption that in making a business decision the directors acted in an informed basis, in good faith 4 in the honest belief that the action was taken in the best interest of the company standard of gross negligence o Eurden on the ' to rebut this presumption o Absent an allegation of interestedness or disloyalty, the EI+ prevents the court from second guessing directors decisions if they were the product of rational process 4 the directors availed themselves of all material and reasonably available info. @=no!ingA >iolations of $a! Miller v !T&T Facts( "? suit against A949s board, alleging that A949 is refusing to collect on a loan made to the $N2 during the election. "? claim that this is an illegal campaign contribution, in violation of federal law/ directors ought to collect debt or be personally liable. Holdin ( 9he EI+ doesnt protect directors from liability for illegal acts. "easonin ( o 3here the decision not to collect a debt owed by the corp. is itself alleged to have been an illegal act, different rules apply o "? are within the class for whose protection the statute was enacted the alleged breach of that statute should give rise to a cause of action @4TF( $istinction b%w knowing violations of law and duty of care: think about a board that deliberates with the utmost care to authori8e an action that they know to be illegal. under ;iller, EI+ will not immuni8e their decision from judicial scrutiny.

FIec-tive Compensation
Introduction Main social goals of cor'orate la%6 8Goals of Cor'orate ,a%9 o Facilitation of coo'erative economic activit" o 2fficient re#uction of agenc" costs 2reating incentive systems that link managers personal interest with corporate wealth is problematic: o $ifficult to identify the best signals of production o Attributing that production to different members of the management team is complicated o 9hose paid in relation to a certain metric will have incentives to game the system The Challenge of E%ecutive ,ay "ince most 20Ds sit on the board, setting compensation is a form of self>dealing. o 0stablish mechanisms to emulate an arms length negotiation !e*. 2ompensation committee# 2ontroversy re: composition of pay: instead of basing pay on corporate performance, salary is often insensitive to company performance o Agency problem: a fi*ed salary is unlikely to do enough to induce a manager to accept risky projects that may be beneficial from a long>term "? perspective. Alternative: incentive compensation based on performance of individual managers !or of the co. as a whole# 1 though this can create additional agency costs as managers are more willing to break rules to earn more H when incentives are higher for them 9hese days most of 20D compensation is in the form of e5uity !W half is salary and bonus#

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A 6rief )istory of E%ecutive Compensation in the -3 1=@-s>B-s: 20Ds paid salary R bonus little if any incentive to ma*imi8e value for the "? increased agency costs at the e*pense of "? wealth ma*imi8ation and overall corporate value 1==-s: performance>based pay mainly based on stock and stock>option compensation reduced agency costs and private benefits of control !looting the company hurt their ultimate take>home pay# o +eason for the shiftM Internal +evenue 2ode stated that 20D compensation over H1 million !and compensation of other top officers# couldnt be deductible to corporation unless it was performance>based compensation Accounting rules: stock options werent an e*pense to the company under LA"E rules, so it didnt affect 0'" 4 '0 ratio o "hortcomings of shift: Inde*ed options were virtually none*istent, so e*ecutives could profit substantially if the overall market went up regardless of how they performed within their industry Dption re>pricing was common, which represented a windfall to e*ecutives 1==-s>,---s: overall growth of 20D pay o globali8ation of product 4 capital markets o hire of outside, superstar 20Ds o "02 regulatory changes mandating public disclosure of e*ecutive compensation !had the opposite of the intended effect# Dnce pay was disclosed, there was a race to the top !every company wanted the most glit8y 20D# +ecent regulation: o ,--,( Sar+anes 4Ile! 8$0'( if a company must restate financial filings made to "02 as a result of e*ecutive misconduct, the 20D and 2LD must pay back any bonuses, incentive> or e5uity> based pay and%or any trading profits reali8ed in the 1, months after the incorrect financial info was disclosed. Also imposes up to 1- years imprisonment for knowing violation and up to ,- years for willful violation. o ,-1-: ;odd,Frank 826'( publicly listed companies that restate their financial statements due to a material noncompliance with reporting re5s must seek repayment form any current or former e*ecutive officer of any incentive>based compensation !including stock options# paid during the ( yr period prior to the restatement date note: eliminates the re5 of misconduct to trigger clawbacks also regulates golden parachute compensation through mandated disclosure of e*ecutive compensation arrangements upon solicitation of "? votes for approval of C4A, consolidation or sale of assets Are -3 CE+s ,aid too ;uch: "? advocates attack many common features of top e*ecutive compensation, including its overall level, its form, the procedures used for setting compensation, and the common sweeteners in compensation contracts, such as golden parachutes that reward e*ecs for standing aside gracefully in the sale of their companies 9here are cases of abusive 20D pay 4 social costs in the form of resentment, jealousy, and anger +ebchu& an# Frie#6 )a" Without )erformance6 Overvie% of the Issues Aims to show that the pay>setting process in " public companies has strayed from the arms length>model Canagerial power has played a key role in shaping e*ecutive pay 4 has resulted in considerable distortions that has resulted in costs to investors and the economy has led to compensation schemes that weaken managers incentives to increase firm value and even create incentives that reduce long>term firm value Llawed compensation arrangements have been widespread, persistent, systemic 4 have resulted from structural defects in the underlying governance structure that enable e*ecs to e*ert considerable influence over their boards +engst Holmstrom6 )a" Without )erformance an# the Managerial )o%er H"'othesis6 ! comment Argues that Eebchuks premise that negotiations should be arms length is misguided: he speaks from the perspective of a closely held family business, and suggets that they want to AQDI$ arms>length bargaining o ?e prefers to err on the generous side o ?as found that e*ecs dont like the use of relative performance evaluation o 0*perimenting with incentive design can have unintended conse5uences 2ompensation is sensitive and thus shouldnt be conducted at arms>length/ benchmarking and staying within norms can help overcome aggressive 20D demands

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Judicial (evie! of Compensation8 The $a! of 'irector and +fficer Compensation "? or disinterested directors often ratify compensation to give e*tra legal insulation, but compensation agreements are not subject to ordinary law of director conflicts. o Instead, courts apply the JwasteK standard to e*ecutive pay challenges, where FwasteG is considered to mean the absence of any consideration 1 an e*ceedingly deferential standard of review In re The Gol#man achs Grou' harehol#er ,itigation Facts( "? charge that that &oldmans business strategy of linking the total compensation of employees to company performance led to growth through e*treme leverage 4 was thus not in the best interest of the "?. Holdin ( Eecause the complaint lacks a particular pleading that an individual was engaged in transactions so unconscionable that no rational director could have compensated them, the ' has failed to raise a reasonable doubt that the compensation decisions were not the product of a valid business judgment "easonin ( +ejects 's claim that the board acted in bad faith when approving the compensation scheme o 9he court notes that ' is not claiming that that they failed to employ a metric but is instead arguing for a different metric 2ourt employs the EI+ to determine that the board need only reasonably inform itself/ as such, there was no gross negligence in choosing a metric 's assertions did not raise a reasonable doubt that &oldmans compensation levels were the product of a valid business judgment Uin determining whether there was wasteV o 9he court notes there should be no finding of waste, even if the fact finder would conclude e* post that the transaction was unreasonably risky The 'ela!are Courts5 Approach to +ption "rants ,e%is v. (ogelstein 8:9 Facts( A one>time options grant to directors was unusual. Holdin ( 3hen determining whether stock option grants constitute actionable waste, a court should accord substantial effect to shareholder ratification. 9he court cannot conclude that no set of cats could be shown that would permit the court to conclude that the grant constituted a reasonable e*change. Need for trial. 7+TE on Corporate $oans to 'B+8 ;7CL 81'$: the board may authori8e loans of corporate funds to $4D when it finds that the loan or guarantee benefits the corporation Sar+anes 4Ile! '02( prohibits any corporation traded on a national e*change or NA"$AX, or the subsidiary of such a corporation, from directly or indirectly e*tending any credit to a $4D of the corporation The 'isney 'ecision In re The Walt $isne" Com'an" harehol#er $erivative ,itigation Facts( New 'resident brought in. 20D, 2LD, 4 &2 heavily involved in negotiations, but other board members only partially informed. $isney market capitali8ation goes up by H1 billion !...K# on announcement. Dne year later, board votes to terminate contract without cause due to poor performance. +eceives a H1.- million severance package under the terms of his employment agreement. "? bring derivative suit alleging waste and breach of duty of care. Holdin ( Intentional dereliction of duty 1 a conscious disregard for ones responsibilities 1 is an appropriate standard for determining whether fiduciaries have acted in good faith. 3ith respect to hiring new 'resident, the board did not act in bad faith and was at most ordinarily negligent under EI+, ordinary negligence is insufficient to constitute breach of duty of care. 3ith respect to firing the president, 20D had the power to do so and the board was under no duty to act !has a right but not a duty to remove officers#/ 20D was acting in good faith. "easonin : "tandard for determining whether the fiduciary acted in good faith: intentional dereliction of duty, a conscious disregard for ones responsibilities 9he court notes that the 20Ds actions were pretty bad and not good for the co., but were made in good faith b%c they were taken with the subjective belief that his actions were in the best interests of the co. !acting swiftly and decisively to hire Dvit8# EI+ process: o 'resumption of EI+ creates presumption of good faith o In order to overcome that presumption, ' must prove act of bad faith by a preponderance of the evidence that presumption of EI+ does not apply b%c: 9he directors breached fiduciary duties,

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 Acted in bad faith !conscious dereliction#, or Cade an unintelligent or unadvised judgment by failing to inform themselves of all material info reasonably available !ordinary negligence is not enough# o If ' rebuts presumption, the burden shifts to $ to prove entire fairness @4TF( where a director consciously ignores his or her duties to the corporation, thus causing economic injury to its "?, the directors actions are either not in good faith or involve intentional misconduct. 2learly Ead Laith !non>indemnifiable#: FLiduciary conduct motivated by an actual intent to do harmG 'robably Ead Laith !non>indemnifiable#: 2learly not Ead Laith !indemnifiable 1-,!b#!@##:

FIntentional dereliction of FLiduciary action taken solely duty, conscious disregard for ones responsibilitiesG by reason of gross negligence and w%o malevolent intentG

'ost>$isne"0 the formal structure of director liability for inattention: !1# Cere director negligence 1 lacking that degree of attention that a reasonable person in the same or similar situation would be e*pected to pay to a decision6 doesnt give rise to liability. o EI+ forecloses liability and permits dismissal at motion to dismiss stage. Gagliar#i & 1amin !,# Lacts that establish gross negligence may be the basis for a breach of duty finding and result in liability for any losses that result. (an Gor&om. o ?owever, under 8102#+%#/%, this liability can be waived through a shareholder approved amendment to the corporate charter !(# Fabandonment of officeG 1 e*treme level of inattention, where a court determines a lack of good faith !rests in part on breach of duty of loyalty# Francis o not protected from liability either under the EI+ or a corporate waiver

ND90: tone v. Ritter clarified a 5uestion left open in the $isney litigation, namely that the duty of good faith isnt an independent duty: Dnly the duty of care and the duty of loyalty can directly lead to liability, whereas the duty of good faith can only do so indirectly $uty of good faith can be seen as a higher level of abstraction 1 according to 3tone v. (itter it is really a violation of duty of loyalty when a duty of care violation rises to the point of bad faith

Shareholder Laws-its
'istinguishing 6et!een 'irect and 'erivative Claims !1# $erivative suit o An assertion of a corporate claim against an officer or director or third party, which charges them w%a wrong to the corporation +epresents two suits in one: !1# against the directors for improperly failing to sue on behalf of the corporate claim and !,# the underlying claim of the corporation itself o $irectors technically owe loyalties to corp. itself, so these are suits alleging breaches of fiduciary duties !e.g., self>dealing cases#/ also, allegation of loss of value of co. as whole o "? are only indirectly harmed o +0C0$O: b%c claim is corporate, recovery goes directly to corp. itself 1 but 's legal fees are recoverable o "pecial procedural hurdles !L+2' ,(.1# designed to protect boards role

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!,# $irect%class actions o A gathering together of many indiv or direct claims that share common aspects o 2laim is to recover damages suffered by individuals directly b%c they are "? !impaired voting rights, dividend payments, securities violations# 1 e.g., >an "or om !alleged lack of ade5uate consideration b%c company sold for too little# o 9hese are suits usually arising under federal securities la!s o +0C0$O: recovery goes to plaintiffs

Toole" v. $onal#son0 ,uf&in & Jenrette0 Inc. Facts( Cinority "?s brought suit as a direct%class action alleging that board had breached a fiduciary duty to them by agreeing to a ,,>day delay in closing a proposed cash merger. !$eprivation of time value# Holdin ( "uit dismissed. "? had no individual right to the merger at all. Dnly direct claim that could have been brought was for breach of contract. "easonin ( 9est for distinguishing b%w direct and derivative: !1# who suffered the alleged harm !the corp. or the suing "?#/ !,# who would receive the benefit of any recovery or other remedy !the corp. or the "? individually# 3olving a Collective Action ,roblem8 Attorneys5 Fees and the Incentive to 3ue 2ollective action problem: no single investor has a strong incentive to invest in monitoring mgmt. 9he law must construct an incentive system to reward small "? for prosecuting meritorious claims attorneys fees. 'laintiffs attorney receives nothing when derivative suit is dismissed. 3hen suit succeeds on merits or settles, corp. benefits from any monetary recovery or governance change resulting from the litigation. Eut the corp. also generally bears bulk of litigation costs on both sides> must pay ' a sum for FcostsG that ranges from very small to (-K. Fischer v. !J In#ustries !substantial benefit rule# Facts( "? derivatively sue the companys directors, alleging that Qer ?alens domination and Calones e*cessive salary damaged the corp. 9he suit settles. 9he settlement !a# reduces Qer ?alens influence over the board, and !b# removes Calone as treasurer, and !c# refers all monetary claims to arbitration. 9he settlement provides for attorneys fees only if arbitration yields a monetary award, but 's attorneys apply for fees anyway. Holdin ( F"ubstantial benefitG rule: the successful ' in a "? derivative action may be awarded attorneys fees against the corp. if the corp. received Fsubstantial benefitsG from the litigation, although the benefits were not FpecuniaryG and the action had not produced a fund from which they might be paid. "easonin ( Qariation of the Fcommon fundG doctrine: can still award attorneys fees to a successful ' from a common fund, but the e*istence of a fund is not a prere5uisite of the award. Fsubstantial benefit:G Ceets the standard if the results of the action maintain the health of the corp. and raise the standards of fiduciary relationships and of other economic behavior, or prevent an abuse which would be prejudicial to the rights and interests of the corp. or affect the enjoyment of protection of an essential right to the "? interest. 2an recover attorneys fees either under a settlement or a final judgment in 's favor ND90" on Agency 2osts 's lawyers may initiate strike suits: suits w%o merit brought to e*tract a settlement by e*ploiting the nuisance value of litigation and personal fears of liability 2orporate $ may be overeager to settle because they bear at least some of the burden of litigation !e*. "itting through depos# but not of settling 3hen managers face personal liability, pressure on both sides is too settle too soon%in a way that helps them escape personal liability Attorney incentives> awarding K of recovery amount may cause them to settle too soon, but paying hourly rates may cause them to spend too much time litigation relative to likely settlement outcome 3tanding (e<uirements 'remise: screening for 5ualified litigants increases 5uality of "? litigation Qarious standing re5uirements: F"C* 2$&1 !which $el. follows#, "C=CA 8/&'1, AL? 8/&02 F"C* 2$&1(

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o o o

' must be a "? for duration of action ' must have been a "? at time of alleged wrongful act%omission !dont want ' to Fbuy lawsuitsG# ' must be able to Ffairly and ade5uatelyG represent interests of "? !no conflicts of interest#

o ' must specify what action he has taken to obtain satisfaction from the board !forms the basis of the demand re<uirement, see below# or state reason for not doing so 6alancing the (ight of 6oards to ;anage the Corporation and 3hareholders5 (ights to +btain Judicial (evie! Issue of whether a "? can take a corporate claim out of the hands of the board against their will arises when: o A company moves to dismiss a derivative suit on the ground the ' has made a pursuit demand on the board but the board refused to bring the suit 2ourt must decide whether or not to defer to the boards business judgment o 9he ' doesnt make a demand on the board on the ground that the board couldnt e*ercise disinterested business judgment 2ourt must rule on the 's validity of e*cuse for not making the pre>suit demand o 9he board seeks to terminate a derivative suit at a later point in litigation, after the suit has already survived the companys initial motion to dismiss o In connection with settlements of "? suits, especially in the rare case where a derivative case is settled over the objection of a derivative '

Delaware Derivative Suit Tree

(oard re+uses &relaxed' ()* (Levine Speigel) #orporation ,rings suit Suit proceeds S"# recommends dismissal or settles S"# re+use Demand excused (e.g Rales! #ase continues %o S"# #ase continues Demand Suit re$uired dismissed (e.g. Levine! Zapata two-step (e.g. Carlton!

P makes demand

(oard does not

P doesnt make demand => Aronson/ Levine two-prong test

The 'emand (e<uirement of (ule C/ 9raditional rule that a derivative complaint must allege w%particularity the efforts, if any, made by ' to obtain the action he desires from the directors or comparable authority, or the grounds for not doing so. U'emand futility testV: In determining demand futility in $0, the court must decide whether: o o ,evine v. mith $irectors are disinterested and independent/ D+ 9he challenged transaction was otherwise the product of a valid e*ercise of business judgment.

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Facts( +oss 'erot becomes &Cs largest "? and gets on &Cs board. 'erot then publicly critici8es company while on board. 0ventually &Cs board pays 'erot H@., million for his &C stock, notes, and his agreement not to wage a pro*y contest or to publicly critici8e &C. A (>person committee and the full board approve the deal. 3ithout making demand, "?s bring a derivative action claiming fiduciary breach, and argue that re5uesting &Cs board to take action would have been futile. Holdin ( "? lose under the Aronson demand futility test "easonin ( 9he premise of a "? claim of futility of demand is that a majority of the board has a financial interest in the transaction or lacks independence%failed to e*ercise due care 1 on either showing its assumed that the board cant e*ercise its power to pursue derivative claims directly. Lor prong !1# a ' must show that the board is either dominated by an officer%director who is the proponent of the challenged transaction or that the board is so under his influence that its discretion is sterili8ed. Lor prong !,# ' must plead particulari8ed facts creating a reasonable doubt as to the Ysoundness of the challenged transaction sufficient to rebut the EI+ presumption !gross negligence%recklessness that decision was not informed# o @4TF( this case converts the Aronson test from FandG to ForG in terms of what ' must accomplish ND90 on 're>suit $emand 2omparison of $emand Lutility Approaches o AL?( rule of universal demand: ' must make demand/ if demand is refused and "? continues, court will review board motions to dismiss under the EI+. o ;elaware: rule of universal non>demand: in practice, demand is rarely made due to 'iegel v. +untroc& !1==-# presumption, and court screens based on two>part Aronson%)evine test: ' must establish 0I9?0+ that directors are interested%dominated D+ must allege facts that create a reasonable doubt of the Ysoundness of the challenged transaction. 3piegel8 assumes that a ' who makes a pre>suit demand concedes that the board is independent%disinterested/ thus, if suit is then brought, only second prong of Aronson test is left to prove Rales v. +lasban# Facts( ', first a shareholder of 0asco then a shareholder of $anaher !which ac5uired 0asco as a wholly>owned sub# contended that demand was e*cused in a double derivative action he brought because the $anaher board could not impartially consider the merits of his derivative action !relating to improper use by the 0asco board of the proceeds from sales of its senior subordinates notes# without being influenced by improper considerations. Holdin ( In a derivative action where demand e*cusal is asserted against a board that has not made the decision that is the subject of the action, the standard for determining demand e*cusal is whether the board was capable of impartially considering the actions merits without being influenced by improper considerations. ?ere, demand is e*cused because court deemed that the board could not have properly e*ercised its independent and disinterested business judgment in responding to the demand. "easonin ( $ouble derivative suit: "? of a parent corporation seeks recovery for a cause of action belonging to the subsidiary corporation 3here there is no conscious decision by directors to act or refrain from acting !as here#, the EI+ has no application. As such, Aronson cant be applied where the board that would be considering the demand didnt make the business decision that is being challenged in the derivative suit. 9his scenario occurs when: o A business decision was made by the board, but a majority of those directors have been replaced o 9he subject of the derivative suit isnt a business decision of the board o 9he decision being challenged was made by the board of a different corporation ;irector interest( A director is considered interested when he will receive a personal financial benefit from a transaction that is not e5ually shared by the "?/ and also where a corp. decision will have a materially detrimental impact on a director, such that the director will be influenced by adverse personal conse5uences of the decision. 3pecial $itigation Committees

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 9here is no basis in positive law !statute# for a procedure under which a court, upon motion of a special committee of disinterested directors !")2#, may dismiss a derivative suit already under way, but many state courts adopted such a procedure under pressure of increased suits. ")2 is not triggered in every case !unlike demand re5uirement# Iurisdictional divide: $elaware !Dapata# gives a role to the court itself to judge the appropriateness of a ")2s decision to dismiss a suit, vs. other jurisdictions !NO# that apply a rule that, if committee is independent and informed, its action is entitled to EI+ deference w%o judicial second>guessing 5a'ata Cor'. v. Mal#ona#o Facts6 ' files a derivative suit. $emand is e*cused, and four years into the litigation, the Zapata board appoints two new independent directors who serve as an ")2. 9he ")2 investigates the action 4 recommends dismissal. X: when !if at all# should a ")2 be permitted to cause litigation, properly initiated by a "? in his own right, to be dismissedM Holdin ( 9wo>"tep 9est: Lirst, the 2hancery 2ourt should in5uire into the independence and good faith of the ")2 and the bases supporting its conclusions !corp. has burden of proof#. o If doesnt meet this standard, then deny corporations motion o If meets this standard, the court has discretion to move to the ne*t step !not re5uired to do so# "econd, the 2hancery 2ourt should determine, applying its own independent business judgment, whether the motion should be granted. In re Oracle Cor'. $erivative ,itigation Facts( $erivative complaint alleges insider trading by four Dracle directors !( have ties to "tanford#. Dracle appoints , independent professors from "tanford to the board as a two>person ")2 w%complete authority to respond to the litigation. +ecommend not pursuing litigation. ' challenges the independence of the ")2. Holdin ( Applying the Dapata two>step test, the ")2 has the burden of showing independence. 9his burden was not here met. "easonin ( ")2 bears the burden of proving its independence. ")2 has not proven its independence b%c of the substantial ties to "tanford. 2ourt isnt 5uestioning the subjective good faith of the committee members. Jo" v. *orth Facts( In a diversity case, the court predicted that 2onnecticut would adopt the Zapata approach to derivative suits and, e*ercising its business judgment, rejected a ")2s motion to dismiss. Holdin ( 3here the court determines that the likely recoverable damages !discounted by the probability of a finding of liability# are less than the costs to the corp. in continuing the action, it should dismiss the case. !direct costs imposed on corp. by litigation [ potential benefits# 2an take into account: attorneys fees, other out of pocket e*penses, time spent by corporate personnel preparing for trial, indemnification, impact of distraction of key personnel, potential lost profits from publicity of litigation 2ant consider: e*istence or none*istence of insurance 2ant take into account Fsoft>factorsG such as deterrence 'ossible alternative to Dapata: more rigorous effort to ensure independence of directors on ")2 "ee Cichi an Laws 8'60&110/, 8'26 3ettlement and Indemnification 3ettlement by Class (epresentatives 'arties are strongly driven to settle in derivative suits $4D generally have a right under a companys bylaws to the indemnification of reasonable defense costs, including any amounts paid if the action settles. Eut if an action goes to trial, theres a risk of personal liability that can be indemnified only w%court approval. 9rial imposes uncompensated risk $4D insurance coverage will typically e*clude losses that arise from fraud%self>dealing, while settlement allows the proceeds of the $4D insurance policy to be used 3ettlement by 3pecial Committee Although rare, ")2s might be established to take control of derivative suits in order to settle them

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Carlton Investments v. T,C +eatrice International Hol#ings0 Inc. Facts: suit for breach of fiduciary duty, corporate waste, fraud, and conspiracy. 9he company appoints an ")2, which eventually negotiates a settlement. ' objects to the settlement. Holdin ( 9he settlement is D<. nder step , of Zapata, the result reached has to be FirrationalG or FegregiousG for a court to overturn the ")2s judgment. "easonin ( 9he judge here is uncomfortable with the court e*ercising own business judgment/ courts should not make such judgments but for reasons of legitimacy and for reasons of "? welfare. As a general rule, in evaluating a proposed settlement, no substantive determinations are made concerning disputed facts or merits of the claim/ instead, a determination is made re: whether the settlement is fair and reasonable in light of the factual support fro the claims When are 'erivative 3uits in 3hareholders5 Interests: A derivative suit can increase corp. value in two ways:

!1# It may confer something of value on the corp. !recovery of past harms inflicted/ governance change that prevents bad managers from inflicting harm in the future# !,# It !or the threat of one# can deter wrongdoing that might otherwise happen in the future 9here are two costs of derivative suits:

!1# 9hey impose direct costs of litigation !,# 9hey impose indirect costs on the corp. and its "? 1 directors must be compensated e* ante for their e*pected litigation costs !$4D insurance#

Transactions in Control
A $efense of the Carket +ule in "ales of 2ontrol Easterbroo and Fischel8 Corporate Control Transactions ND90: $0) 2ourts 4 the 2ontrollers +ight to a 2ontrol 'remium " courts still treat the simple sale of a controlling block f stock, unconnected to any corporate activity, as free on any duty to minority shareholders, E 9 such sales are rare sually, a controller re5uires corporate action of some kind !from a waiver of A,-( to info disclosure by the firm# and this may provide a doctrinal hook on the part of the board to try helping the minority benefit from the control transaction In re $ige3 Inc. H ,itigation Facts( An ac5uirer first approached the board of a partly held sub of the controller with a lucrative offer. 9he controller said it would block such a transaction by refusing to vote for it in its selling the sub. 9hus were the minority shareholders of the sub deprived of the opportunity to reali8e a one>time premium for their shares. Holdin ( 2ontroller was entitled to use its voting power as a shareholder to block a deal between the sub and the ac5uirer. A shareholder in e*ercising its voting power may do so in its own interests. @4TF( 9he holder was nevertheless held to have violated a duty of fairness to minority when, in the course of selling, it pressured the subs board to waive the applicability of $&2) A,-( !which prevents a party who purchases control of a $0 corp. from pursuing a cash>out merger to eliminate the minority for a period of ( years unless the companys board approves e* ante#. 9he board can only waive for the benefit of the whole corporation. In re $el'hi Financial Grou' harehol#er ,itigation Facts( + was the controlling shareholder of $elphi, because he owned about 1(K of the stock. 9he stock he owned was preferred stock that gave him ten votes per share. 9he charter re5uired that in the event of a sale, all the shareholders be

.1

treated e5ually. Eut when the situation arose, + refused to approve the merger, conditioning his approval on an amendment to the charter that allowed him to get more for his share. Holdin ( 9hough + retained voting control, he sold his right to a control premium to the 2lass A stockholders via the charter. A corporate charter, along with its accompanying bylaws, is a contract between the corporations stockholders. Inherent in any contractual relationship is the implied covenant of good faith and fair dealing. A party breaches the covenant by taking advantage of its position to control implementation of the agreements terms. "easonin ( ?ere, however, injunctive relief is denied in favor of allowing stockholders to choose between going along with merger or seeking damages down the road. 3ale of Corporate +ffice S"ale of control is D</ sale of office is not D<S $ooting $uty to "creen Against "elling 2ontrol to a )ooter Harris v. Carter Facts( ' and other minority shareholders of Atlas contended that $ and his associates committed a breach of fiduciary duty by negligently selling control of the corporation to a group who looted it. Holdin ( 3hen the circumstances would alert a reasonably prudent person to a risk that his buyer is dishonest or in some material respect not truthful !a looterM#, a duty devolves upon the seller to make such in5uiry as a reasonably prudent person would make, and generally to e*ercise care so that others wont be harmed. A majority shareholder may be liable if he negligently sells control to someone who damages the corporation "easonin ( 2ontrolling "?s owe a fiduciary duty to the corp. A "? has to take care when e*ercising the right to sell shares. 9he right is limited and has conditions. Tender +ffers8 The 6uyer5s 'uties An investor who wants to buy control in a widely held corp. !no controlling "?# has to aggregate shares of many small "?s via tender offer: offer of cash or securities to the "?s of a public corp. in e*change for their shares at a premium over market price. o Note: the investor also has the option of approaching the largest of the small "?s singly

Sec-rities FIchan e Act of 12$'< 9illiams Act of 12)/ regulates cash tender offers 1 buyer must provide sufficient time%info to "?s to make an informed decision about tendering their shares, and to warn the market about impending offer. o o 9he Act does not define Ftender offer.G Lour elements of the Act: !1# 0arly 3arning "ystem, 81$#d%: re5uires disclosure whenever anyone ac5uires more than :K of companys stock !alerts the public and the companys managers# +ule 1(d>1: o !a# must file 1($ report w%in 1- days of ac5uiring :KR beneficial ownership o !b# allows certain 5ualified institutional investors to file a shortened 1(& report w%in .: days of years>end o !c# permits passive but non5ualifying investors to file a 1(& report w%in 1days of ac5uiring holdings +ule 1(d>,: must amend 1($ and 1(& annually or promptly on ac5uiring 1-RK of an issuers shares +ule 1(d>:: 1(!d# group defined as multiple "? who get together to coordinate their votes or buy%sell stock !,# &eneral $isclosure, 81'#d%#1%: re5uires tender offeror !who would own more than :K of any class of stock# to disclose identity, financing, and future plans, including any subse5uent going>private transactions !(# Anti>Lraud 'rovision, 81'#e%: prohibits any fraudulent, deceptive, or manipulative practices in connection w%a tender offer !.# 9erms of the Dffer, 81'#d%#'%,#/%: governs the substantive terms of the offer, e.g., duration, e5ual treatment.

.,

 +ule 1.e>1 mandates that tender offers be left open at least ,- business days. +ule 1.d>1- re5uires bidders to open their tender offers to all "? and pay all who tender the same Ybest price. Also 7ote8 SFA of 12$'( o "02 +ule 1(e: "02 +ule>Caking Authority over Issuer "elf>'urchases: issuer must provide "? info relating to reasons for purchase% source of funds% number of shares to be purchase% method of purchase%etc. +ule 1(e>1: an issuer that has received notice of tender offer must not purchase unless the issuer has first filed a statement to the 2ommission with relevant info +ule 1(e>(: specifically re5uires e*tensive disclosure by the insiders when they propose a going>private transaction 2overs any transaction in which stock will no longer be registered under 1(. Act 2overs any company that will be removed from a national e*change Applies to going private transactions and mergers of long>term affiliates Cust disclose: o 'urpose of the transaction o +eason for the particular structure o $iscussion of benefits and detriments o 3hether they think its fair or unfair to unaffiliated security holders +ule 1(e>.: dictates filing, disclosure, dissemination of tender offer 4 the manner in which it is filed +emains open for ,- days 4 1- days from notice of increase or decrease of percentage of securities being sought )ists instances where securities rendered can be withdrawn o "ections 1. !d#>!e#: 1.d>1: scope 4 applicable definitions 1.d>,: commencement of a tender offer !1,:-1 am date of published offer# 4 pre>commencement communications 1.d>(: filing and transmission of tender offer statement 1.d>.:dissemination of tender offers to security holders !newspapers, mail, stock lists# 1.d>:: use of stockholder lists: subject company must make concerted efforts to notifying%mailing tender offer materials 1.d>;:disclosure of info to security holders 1.d>@: additional withdrawal rights !right to withdraw deposited securities# 1.d>B: e*emption from statutory pro rata re5uirements !when they get more securities than they wanted# 1.d>=: recommendation by the subject company !not rec. when the tender offer hasnt commenced or if filed under 1.d>=# 1.d>1-: e5ual treatment of security holders: prohibits tender offer unless open to all members of the class 1.e>1: unlawful tender offer practices: make untrue or omit statement of material fact engage in fraudulent, deceptive, manipulative acts 1.e>,: position of subject company: within 1- days, must either reject%accept, remain neutral, unable to take position 1.e>(: transaction on the basis of nonpublic info: illegal to do this

*art ?H
From >an "or om to (evlon

.(

 9he boards entrenchment interest can affect not only its takeover defenses but also its choice of a merger%buyout partner >an "or om originally seen as an aggressive articulation of the boards duty of care, but later recogni8ed as a precursor to takeover cases and especially (evlon @4TF( 2ourts generally refuse to e*amine the reasonableness of decisions made by disinterested directors in the boards regular decision>making process/ >an "or om was a jolting break from tradition. 9he <raak recommends looking at it not as a director negligence case but rather as the first in a line of cases constructing new standard for judicial review for change in control transactions such as mergers.

3ale*Type Transactions Asset sale and li:-idation o 9 board approves sale of all or substantially all assets to A. 'roposal approved by majority of shareholders of 9. 9 then conveys assets to A and receives consideration from A. o sually, 9 then dissolves and distributes consideration in a li5uidation distribution !according to shareholders proportional ownership# Stock Sale<Tender 4ffer o A buys stock from each shareholder of 9. After A controls all or a majority of 9s stock, it may cause 9 to be 1# dissolved with assets distributed to stockholders in proportion to ownership or ,# merged into A with remaining holders of 9 receiving compensation o Tender 4ffer: 2ommon form of stock sale in which A publically announces its desire to buy all or a majority of shares offered to it by 9 A =-K majority shareholder can simply cash out a minority unilaterally !short>form merger# "ome states allow for a plan of e*change !a tender offer negotiated with the target board of directors that, after approval by a majority of shareholders, makes it compulsory for minority shareholders to sell# o =ack,end mer er: Dnce A gets control of 9 by ac5uiring enough shares, it can conduct a back>end merger. 9hough this would re5uire a vote by 9s board and shareholders, such a vote would be a mere formality due to As majority interest in 9. Eack>end mergers limited by ;7CL 820$ !if you ac5uire between 1:K and B:K in your tender offer# Cajor differences between asset sale and tender offer o Eoard of 9 must approve a sale of assets. It need not approve a tender offer. o "ale of substantially all assets must be formally approved by a majority vote of 9s shareholders !;7CL 82/1. "C=CA 812&02# o In asset>sale deal, A gets 9s business without any remaining interest on the part of 9s shareholders. In tender offer, A may be left with some 9 holders holding a minority interest. o In an asset sale, A escapes 9s liabilities. In a tender offer, A takes 9s liabilities along with its assets. Approval for 3ale*Type 'eals Asset sale 9arget side: 9s board of directors must approve and, in most states, 9s shareholders must approve by a majority of all votes that could be cast 1 not just a majority of votes actually cast !CE2A re5uires just a majority of votes actually cast when 5uorum is present# o ND90: Not every sale of assets triggers this obligation. "hareholder approval is re5uired if all or substantially all of 9s assets are being sold +C2A: shareholder approval re5uired when 9 would be left without significant continuing business activity !+C2A A1,.-,# Ac5uirer side: As board must approve but As shareholders need not Tender 4ffer( 0ach holder of 9 decides whether to sell his stock to A. No approval by 9s board is necessary. o 1at/ v. +regman

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Facts( Eregman, the 20D of 'lant, embarked on a course of action to sell 'lants 2anadian assets. 9he 2anadian facility was its only income producing facility. 9he purpose of the sale was to improve 'lants balance sheet. It would have disposed of appro*imately :1K of 'lants total assets that produced .:K of its income. Holdin ( nder $0 law, the decision of a corporation to sell all or substantially all of its property and assets re5uires not only the approval of the corporations board but also a resolution adopted by a majority of the outstanding shareholders entitled to vote. 'reliminary injunction granted. Comment( 6ut !hen is a sale @substantial:A

Thor'e v. C2R+CO !$0 "upreme 2ourt# Holdin ( 9he need for shareholder approval is not determined by the si8e of the sale alone. It is relevant to ask whether a transaction is out of the ordinary course and substantially affects the e*istence and purpose of the corporation.

Hollinger0 Inc. v. Hollinger Intl !2hancery 2ourt# Holdin ( "ubstantially all under ;7CL 82/1 means essentially everything.

'ra!bac s to Asset Ac<uisition Qery costly and time consuming !title transfer is difficult# "uccessor )iability: when the assets at issue constitute an integrated part of the business, courts have identified circumstances in which a purchaser of assets may become responsible for associated liabilities o 9riangular form transactions can lessen the risk of successor liability ;erger*Type Transactions Stat-tor! Cer er( Ey following procedures set out in state corporation statutes, one corporation can merge into another. 9he disappearing corporation ceases to have legal identity. 9he surviving corporation continues in e*istence. o After merger, Ac5uirer !A# owns all of 9argets !9# assets and is responsible for all of 9s liabilities o 2ontracts between 9 and third party are assumed by A Stock Swap !stock>for>stock e*change#: A makes separate deal with each holder of 9, giving stock of A in e*change for stock of 9 o 9raditionally, holders of 9 are free not to participate o "ome states allow 9 to enact a Fplan of e*changeG !with approval of board and majority of shareholders# that makes participation mandatory Trian -lar #S-+sidiar!% Cer ers( o Lorward triangular merger A creates a subsidiary for purpose of the transaction. 9 is then merged into subsidiary. Qery similar to stock swap e*cept all minority interests in 9 are eliminated. Also, A does not need to engage in shareholder vote. o +everse triangular merger A forms subsidiary and subsidiary merges into 9. 9 survives as a subsidiary of A. Advantageous if the survival of 9 would result in contract rights or ta* advantages 2heapest method of transfer because both pree*isting operating corporations are left intact o Eeneficial because they preserve the liability protection of separate incorporation Approval for ;erger*Type 'eals Stat-tor! Cer er o =oard approval( Eoards of both A and 9 must approve

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o o

Holders of T( ?olders of 9 must approve by majority vote !e*cept in short>form merger# Holders of A: ?olders of A must approve in most circumstances. ?owever, under $0 law and C2EA, any merger that does not increase the outstanding shares of A by more than ,-K need not be approved by As shareholders. nder $0 law, preferred stock and common stock do ND9 vote separately !$&2) A,:1# "pecial voting re5uirements can be established in corporate charter !$&2) A,-(# Short,form mer er( If A owns =-K or more of stock of 9, 9 may be merged into A without approval of shareholders of either corporation "hort>form merger limits minority to appraisal rights in most cases !e*cept where the short form merger was Fdramatically unfairG see Weinberger#

Timberjac ;erger Agreement Linnish company +auma>+epola wanted, through its $0 subsidiary +auma Ac5uisition, to buy the American company 9imberjack A makes tender offer to 9. Dffer is contingent on @-K of shares being tendered at H,:%share. o A can go forward with deal unilaterally with any amount of shares between :-K and @-K o "econd step is merger between companies !with cash>out at H,:%share, the same price offered in tender offer# 3hy structure a deal this wayM 3hy not a mergerM o Cakes the vote from target entity very easy o According to legal formalities, A was not a controlling shareholder when the merger was negotiated6 but it is at the time of the vote Appraisal !Not available in asset sales# Appraisal rights give a dissatisfied shareholder a way to be cashed out of his investment at a price determined by the court to be fair. o Cer ers( In nearly all states, a shareholder of either company involved in a merger has appraisal rights if he had the right to vote on the merger. o Short,form mer ers( Cinority shareholders of the FsubsidiaryG in a short>form merger get appraisal rights even though they would not get to vote on the merger. 3ithout conflicts of interest, most arms length mergers should achieve something close to market price Appraisal most needed when there is a potentially interested party According to $0 "upreme 2ourt !"lassman v. -nocal E%ploration#, appraisal is the e*clusive remedy of minority shareholders cashed out in a 826$ short>form merger o Asset Sales: In most states, shareholders of a corporation selling substantially all of its assets also get appraisal rights ND9 the case in $0 If the selling corporation li5uidates soon after sale and distributes cash to shareholders, there are usually no appraisal rights !C=CA 81$&02#a%#$%# o *-+licall! traded eIception( Cany sates !including ;7CL 82)2# deny appraisal to publically traded companies. "o does the C=CA 81$&02#+%. $&2) restores appraisal remedy if target shareholders are re5uired to accepted as consideration anything other than 1# stock in surviving corporation, ,# shares traded on a national e*change, (# cash in lieu of fractional shares, or .# some combination of 1>( o Carket>Dut 'rovisions $&2) denies appraisal to targets held by more than ,,--- registered holders. It also denies appraisal to shareholders not re5uired to vote on the merger !e.g. preferred who have no vote#, "hareholders in a privately traded firm with fewer than ,,--- holders will always get appraisal rights in a merger if they are re5uired to vote "hareholders in a public company with more than ,,--- shareholders have no appraisal rights in a stock>for>stock merger !because the stock is considered highly li5uid# Eut these same shareholders can get appraisal rights when cash is the consideration !clearly not a li5uidity concern6 a value concern# 3hy do appraisal rights not function as a check on value in stock>for>stock mergersM <raak>man thinks the system is whack>man.

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 'olicy justification: o A minority shareholder ought not be at the mercy of a shareholder vote that is either controlled or potentially manipulated by an interested party o Appraisal may be easier to show than breach of fiduciary duty: 'laintiff need only establish that he properly dissented from transaction. Lairness claims v. Appraisal o Lairness claims can be brought as opt>out class actions. 9here are also broad remedies available in a fairness claim. o In appraisal action, plaintiff is only entitled to pro rata share of fair value of company without regard to any gain caused by the merger or its e*pectation o 'ost>Weinberger 9he fair value to which a dissenter is entitled includes a fair share of synergy gains made available in the merger !or from an alternative merger partner# 9his makes sense if the appraisal remedy is understood as a protection against self>dealing Although appraisal now provides basically the same measure of recovery as an entire fairness or fiduciary claim !and an appraisal does not re5uire a finding of breach of fiduciary duty#, fairness actions still predominate Carket>out rules 2lass action considerations Qaluation methods o Cost courts use the F$elaware blockG method to value an appraisal. 9his method considers 1# the market price just prior to the transaction, ,# the net asset value of the company, and (# the earnings valuation of the company. 9he court then combines these factors as it chooses. o In $0, however, courts will now accept any valuation techni5ue used by professionals in the finance industry !Weinberger#. At present, the discounted cash flow method is most common. o $iscounted cash flow tries to work out the value of the company today based on projections of how much money it will make in the future. $2L analysis says that a company is worth all the cash that it could make available to investors in the future. It is described as FdiscountedG because cash in the future is worth less than cash today. $e Lacto Cerger $octrine o "ome " courts have adopted a functionalist approach to mergers and have accorded shareholder voting and appraisal rights to all corporate combinations that resemble mergers in effect. 9hese courts have reasoned that when a de facto merger has the same economic effect as a de jure merger, shareholders should have the same protections. o 2ounter>argument: Lormalism permits people to accurately predict the legal conse5uence of their activities 1 functionalist counter>argument to de facto merger doctrine o $0 takes the formalistic approach 1 each provision of the $&2) is said to have Fe5ual dignityG and Findependent legal significanceG Hariton v. !rco 2lectronics0 Inc. Facts( Arco 0lectronics, Inc. sold all of its assets to )oral 2orporation in e*change for )oral common stock. ?ariton, a shareholder in Arco, challenge the transaction as a de facto merger. ?ariton contended that the transaction was in substance and effect a merger and that it was not fulfilled in accord with the merger statute !thereby depriving plaintiff of appraisal rights# Holdin ( In $0, a corporation may sell its assets to another corporation even if the result is the same as a merger without following the statutory re5uirements of a merger. 9he various sections of the $&2) are independent of one another. It may be possible to accomplish under one section what would be forbidden under another. Comment( 2ourt respects formalism of law and says that any innovations to corporate code !such as de facto merger rule# would be best addressed by legislature Free#e*+uts A free8e>out is a transaction in which those in control of a corporation eliminate the e5uity ownership of non> controlling shareholders o $escribes techni5ues by which the controlling shareholders legally compel non>controlling holders to give up their common stock ownership o "5uee8e>out: Cethods that do not legally compel minority to surrender shares but in a practical sense coerce them into doing so " 2orporate law generally recogni8es that controlling shareholders owe a fiduciary duty of loyalty to corporation and minority shareholders. Eut all shareholders have a right to vote their best interests.

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9he controlling shareholders obligation of fairness arises from the de facto power to Fdo what other shareholders cannotG o 0*amples: Access non>public corporate information, influence the board to approve a transaction with another company with which the controller is interested, etc. 2onte*ts of free8e>out o Cerger of two affiliates "econd step of a two>step transaction o &oing private Lree8e>out 9echni5ues o Cash,o-t mer er( Cajority causes corporation to merge into a well>funded shell and minority holders are paid cash in e*change for their shares o Short,form mer er( If A owns more than =-K of 9, a free8e>out may be done via short>form merger o "everse stock split( After a reverse stock split, all minority shareholders can be reduced to fractional shares. 9he shareholders are then forced to e*change their shares for cash. o Lree8e>out +e5uirements !;5TE 4F L4EALTE ?SS5FS# 9he transaction must be basically fair, taken in its entirety !fairness review# Lair price Lair procedures by which the board decided to approve the transaction Ade5uate disclosure to minority shareholders about transaction A parent>subsidiary merger is much more likely to be found fair if the public minority stockholders of the subsidiary are represented by a special committee of independent directors not affiliated with the parent o 9he transaction must be undertaken for some valid business purpose "ome but not all courts impose this additional re5uirement $0 has abandoned the business purpose re5uirement o Weinberger: Dnce a plaintiff alleges and shows that a transaction was between the controller and the company, the fiduciary will be deemed to have the burden to establish that the transaction was fair in all respects to the corporation. 9he process of the deal AN$ the terms of the deal must be entirely fair to the corporation. o 1ahn v. ,"nch Communications "stems0 Inc. Facts( 2ontrolling shareholder Alcatel indicated that it would launch an unfriendly tender offer if )ynch did not accept the terms of its cash per share merger. Holdin ( A shareholder owes a fiduciary duty if it owns a majority interest in or e*ercises control over the business affairs of the corporation. 9he initial burden of proving entire fairness rests on the party on both sides of the transaction. Approval of the transaction +! an independent committee of directors or an informed maAorit! of the minorit! shifts to the challen in shareholder the +-rden of showin that the price paid was -nfair& However, -nless the controllin or dominatin shareholder can demonstrate that it has not onl! formed an independent committee +-t also has replicated a process as tho- h each of the contendin parties had in fact eIerted its +ar ainin power at armDs len th, the +-rden of provin entire fairness will not shift from the controllin shareholder& Comment( ?ere, no such arms length negotiation took place because the independent committees ability to say no was compromised by Alcatels ability to veto any other transaction !Alcatel held .(K and a super>majority provision in the charter re5uired B-K approval of a business recombination# and its threat to launch a hostile tender at a lower price.

In re iliconi3 ?ss-e( 3hat about the controlling shareholder who skips the board entirely and offers a transaction directly to the public shareholder via a tender offerM $oes he have an obligation to pay an objectively fair priceM Holdin ( No. "o long as the offer is not coercive, entering such a transaction is voluntary on the part of the minority shareholders. If these shareholders are unhappy with the price, they can remain shareholders and force the company to cash them out !giving them appraisal rights#.

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In re C*; Gas Cor'oration Facts( 2DN"D), the 2ontrolling "hareholder, revamped the corporate governance structure of the corporation. It sought to ac5uire an institutional investor7s shares of the corporation in connection with the free8e>out transaction, and those parties entered into a tender agreement. 2DN"D) commenced its tender offer with a commitment to effect a short>form merger after the success of the 9ender Dffer. 9he corporation formed a special committee to evaluate the 9ender Dffer but did not endow the committee with authority to negotiate terms or consider alternatives. 9he "pecial 2ommittee decided to remain neutral with respect to the offer. Holdin ( nder the Co% Communications framework, if a free8e>out merger is both 1# negotiated and approved by a special committee of independent directors and ,# conditioned on an affirmative vote%tender of a majority of the minority, then the EI+ presumptively applies. If the transaction does not incorporate both protective devices 1 or if a plaintiff can plead particulari8ed facts sufficient to raise a litigable 5uestion about the effectiveness of one of the devices 1 then the transaction is subject to entire fairness review. Comment( 9he absence of "pecial 2ommittee approval imposes an obligation on defendants to show that the 9ender Dffer price was fair. 'laintiffs also raised enough 5uestions about the independence of institutional investor 9 +owe 'rice to undercut the effectiveness of the majority of the minority tender condition.

$efensive Tactics

4nocal v. Mesa )etroleum Facts( Cesa, a shareholder in nocal, was attempting a takeover that nocals directors tried to fight by making an e*change offer from which Cesa was e*cluded. 9he take>over was a coercive two>tier tender offer that gave a less> than>ideal !but greater than market# price on the front end and junk bonds on the back end. Holdin ( 9he restriction placed upon a selective stock repurchase is that the directors may not have acted primarily out of a desire to perpetuate themselves in office. $irectors must show that they had reasonable grounds for believing that a danger to corporate policy%effectiveness as a conse5uence of the offer. If a defensive measure is to fall within the ambit of the EI+, it must be reasonable in relation to the threat posed. If the board of directors is disinterested, has acted in good faith and with due care, its decision 1 in the absence of abuse of discretion 1 will be upheld as a proper e*ercise of business judgment. Comments( -nocal announces a new standard for reviewing defensive tactics 1 the enhanced EI+. In order to earn the protection of the EI+, the board must show that its defensive tactic was Freasonable in relation to the threat posedG In adopting the selective e*change offer, the board stated that its objective was either to defeat the inade5uate Cesa offer, or, should the offer still succeed, to provide the .=K of its stockholders with H@, worth of senior debt, rather thank junk bonds. 9he court found both purposes valid. Cesa could not, by definition, fit within the class of shareholders being protected from its own coercive and inade5uate tender offer !to buy back their shares would subsidi8e their coercive tender#. 4nitrin v. !merican General Cor'& Holdin ( If the board of directors defensive response is not draconian !preclusive or coercive# and is within a range of reasonableness, the court must not substitute its judgment for that of the board. If the defendant directors establish that the board action was proportionate and within a range of reasonableness, burden shifts to the plaintiffs to prove that the defensive action was nevertheless a breach of fiduciary duty. Comment( If defendant cannot make this showing, it can still argue that the action is fair !3hamroc )olding9 Inc. v. ,olaroid Corp.# 'reclusive: preventing hostile takeover no matter what the bidder does 2oercive: management cannot cram its alternative down on shareholders

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4nocal and 4nitrin in review: 1. ,. (. 9he targets directors 1 not the plaintiffs 1 bear the burden of going forward with evidence to show that the defensive action was proportionate to the threat An action that is preclusive or coercive will fail to satisfy the enhanced EI+ of -nocal If an action passes the preclusive%coercive test, it will satisfy -nocal so long as it is also within a range of reasonable action. 9his last aspect of the test is Foperationally similarG to the EI+ 1 the action will be sustained if it is attributed to any reasonable judgment.

The ,oison ,ill 9he 'oison 'ill makes bad things happen to the bidder if it obtains control of the target !thereby making target less attractive# o Flip,in plans 9hese plans contain a flip*in provision that is triggered when an outsider buys a certain percentage of the targets stock. 3hen the flip>in is triggered, the holder of the right has an option to ac5uire some number of shares of the targets common stock at one half of the market price !holder of right can buy stock from company at half price# If every right holder bought stock at half price, the aggregate effect is to increase the holdings of all shareholders e%cept the Ftriggering personG whose right is cancelled by causing the triggering event. +esult: 9riggering person would own a much smaller interest in company than that for which he paid. o Flip,over plans 9hese plans contain a flip*over provision that is triggered when an outsider buys a certain percentage of the targets stock. 3hen the flip>over is triggered, the holder of the right has an option to ac<uire shares of the bidder at a cheap price 3e are not certain whether or not this can be done because the 5uestion of whether a triggering shareholder must respect an obligation created by a flip>over plan has yet to be litigated o Chewa+le *ill( 'oison 'ill plan where rights disappear if certain fair price criteria are met "hareholder approval is not normally re5uired to enact a 'oison 'ill plan. All that is typically re5uired is a board meeting !and such plans may sometimes be implemented even after a hostile bid has emerged# o Cay re5uire shareholder approval to amend charter to authori8e the number of shares needed Moran v. Househol# International0 Inc. Facts( ?ousehold adopted a poison pill to discourage takeovers generally, rather than to discourage a specific threat. Coran !a board member of ?ousehold# who had made several overtures about ac5uisition but stated nothing specific sued to enjoin enforcement of pill provisions. Holdin ( A corporation may adopt a poison pill as a general anti>takeover device. 3hen corporate directors show 1# that they had reasonable grounds for believing that a danger to corporate effectiveness e*isted and ,# that a defensive mechanism adopted was reasonable in relation to the threat posed, the EI+ applies. Comment( According to later cases by $0 "upreme 2ourt, boards have an ongoing fiduciary obligation to redeem the pill if it is no longer reasonable in relationship to the threat of an ac5uisition offer.

!ir )ro#ucts & Chemicals v. !irgas0 Inc. Comment( FDur law would be more credible if the "upreme 2ourt acknowledged that its later rulings have modified ;oran and have allowed a board acting in good faith !and with a reasonable basis for believing that a tender offer is inade5uate# to remit the bidder to the election process as its only recourse. 9he tender offer is in fact precluded and the only bypass of the pill is electing a new board. If that is the law, it would be better to be honest and abandon the pretense that preclusive action is per se unreasonable.

Revlon0 Inc. v. Mac!n#re%s an# Forbes Hol#ing0 Inc.

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Facts( 9he board of +evlon granted Lorstmann !a friendly investor# certain lock>up provisions in order to prevent a hostile takeover by 'antry 'ride. )ock>up option: A defensive strategy to a takeover attempt whereby a target corporation sets aside a specified portion of the companys shares for purchase by a friendly investor

Holdin ( A board of directors cannot grant lock>up options solely to prevent competitive bidding for a corporation. 3hen it appears that an active bidding contest is underway, the board !whose primary duty is to the shareholders# is under an obligation to do what it can to ma*imi8e the sale price for the benefit of the stockholders. Comment( A lock>up is not necessarily illegal. 3hen it is done to prevent a takeover that would be detrimental to shareholders, it may be used. 3here it has no effect other than to prevent competitive bidding, it is improper.

Elaborations on Revlon +ar&an v. !mste# In#ustries6 F9he directors may not use defensive tactics that destroy the auction process. Lairness forbids directors from using defensive mechanisms to thwart an auction or to favor one bidder over another.G F+evlon $utyG 1 duty of board to procure highest current value for shareholders o Dnce management decides to offer the company for sale 1 or once sale appears inevitable 1 board may no longer use defensive measures6 it must instead make every effort to achieve best price o &etting the best price for stockholders means treating all bidders e5ually, not preferring one over another o In choosing among offers, the boards sole duty is to the common stockholders to get the highest price. Eoard may not attempt to get e*tra protection for employees, management, etc. Are 'oison 'ills beneficialM o Academics and institutional investors generally believe that hostile tender offers are useful devises for disciplining poor corporate management o Canagement believes that vulnerability to hostile bids is a weakness !opens disaggregated shareholders to tender>offer abuse#

,ulling Together -nocal and (evlon )aramount Communications0 Inc. v. Time0 Inc. 8)aramount I9 Facts( 'aramount contended that anti>takeover measures enacted by 9imes directors in response to its tender offer were invalid because 'aramounts per>share offer was more valuable than shares in the new corporation would have been !hence, there was no danger to 9ime and no reasonable grounds upon which 9ime could view the 'aramount offer as a threat to shareholders#. ?ss-e( nder what circumstances must a board of directors abandon an in>place plan of corporate development in order to provide its shareholders with the option to reali8e an immediate premiumM Holdin #Revlon Claim%( nder (evlon, a board is under a duty to ma*imi8e shareholder prices only when it is clear that a sale is inevitable. In negotiating with 3arner, the 9ime board did not make the dissolution or breakup of 9ime inevitable. o 9ime was neither the object of a bidding war nor effectively up for sale. (evlon duties were not triggered. o FIf the boards reaction to a hostile tender offer is found to constitute only a defensive response and not an abandonment of the corporations continued e*istence, (evlon duties are not triggered.G Holdin #4nocal Claim%( 9he boards fiduciary duty to manage a corporation includes the selection of a time frame for achievement of corporate goals. $irectors are not obliged to abandon deliberately conceived corporate plans for a short> term shareholder profit unless there is clearly no basis to sustain the corporate strategy. 9his duty cannot be delegated to shareholders. Comments( ,aramount illustrates that the targets board may generally Fjust say noG 1 it may refuse to take affirmative steps so as to give the shareholders a chance to approve the transaction. Normally, approval for a tender offer is not necessary 1 shareholders individually decide whether to tender their shares. Eut where an ac5uirer makes a tender offer that is conditional upon acts by the board !e.g., redeeming a poison pill or cancelling some other pending transaction#, the board may simply refuse to take action so long as the board response is a reasonable response to a perceived threat !-nocal#. According to ,aramount, although the court may bar managements FdisproportionateG plans, shareholders are not capable of passing on these plans by voting to remove the pill%defensive tactic. 9his outcome is ironic in light of

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,aramount&s emphasis on how the EI+ militates against the court evaluating investment goals on behalf of shareholders. )aramount Communications0 Inc. v. <(C *et%or&s0 Inc. 8)aramount II9 Facts( 'aramounts board approved unusually restrictive contractual provisions to prevent unsolicited tender offers form interfering with their intention to transfer control of 'aramount to Qiacom. Holdin 1( 3hen a corporation undertakes a transaction which will cause: !a# a change in corporate control/ or !b# a break>up of the corporate entity, the directors obligation is to seek the best value reasonably available to the stockholders. Holdin 2( A board breaches its fiduciary duty if it contractually restricts its right to consider competing merger bids. !Liduciary out clause# Comment( 'ost ,aramount II, stock option lockups were seen as overly risky. 9ermination fees, however, are still considered acceptable as a price for cancelling a major negotiation. 9he reasonableness of different termination fee si8es has not yet been clearly tested6 but it seems that (K>.K of the transaction value is permissible. ,"on#ell Chemical Co. v. R"an Facts( )yondells board approved a merger and recommended it to the shareholders. 9he merger was eventually approved with over ==K of voted shares. Nonetheless, some shareholders alleged that the directors had only looked out for their own self>interest and that the process by which the merger was approved was flawed. )yondells charter contained a A1-,!b#!@# e*culpatory provision protecting the directors from personal liability for breaches of the duty of care !thus, this case turned on whether there was a violation of the duty of loyalty#. Holdin ( 9here are no legally prescribed steps that directors must follow to satisfy their (evlon duties such that failure to take those steps during the sale of the company demonstrates a conscious disregard of their duties. 9here is only one (evlon duty 1 to get the best price for the stockholders at the sale of the company. 2ourts cannot dictate how directors reach this goal because they will be facing a uni5ue combination of circumstances. Comment 1( In this case, the $0 "upreme 2ourt found that the 2hancery 2ourt had improperly applied (evlon because it imposed (evlon duties on )yondell directors before they had either decided to sell or before the sale had become inevitable !2ourt should have focused on the one week when the offer was considered, not the two months of inaction#. Comment 2( FIf the directors failed to do all that they should have under the circumstances, they breached their duty of care. Dnly if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty.G Comment $( $irectors are re5uired to reasonably, not perfectly Omnicare Inc. v. *C Healthcare0 Inc. Facts( Dmnicare sought to ac5uire N2". &enesis had made a competing bid for N2" that the N2" board had originally recommended, but the N2" board withdrew its recommendation and instead recommended that stockholders accept the Dmnicare offer, which was worth more than twice the &enesis offer. ?owever, the agreement between &enesis and N2" contained a provision that the agreement be placed before the N2" shareholders for a vote, even if the board no longer recommended it. 9here was also no fiduciary out clause in the agreement. 'ursuant to voting agreements, two N2" shareholders who held a majority of the voting power agreed unconditionally to vote all their shares in favor of the &enesis merger, thus assuring that the &enesis transaction would prevail. Holdin ( )ock>up deal protection devices that are coercive and preclusive are invalid and unenforceable absent a fiduciary out clause. 9o the e*tent that a merger contract or a provision thereof purports to re5uire a board to act or not act in such a fashion as to limit the e*ercise of fiduciary duties, it is invalid and unenforceable. ;issent( 9he majority rule means that Fa merger agreement entered into after a market search, before any prospect of a topping bid has emerged, which locks up stockholder approval and does not contain a fiduciary out provision is invalid per se when a later significant topping bid emerges.G In this case, &enesis was the only party willing to take N2" out of bankruptcy6 and they were only willing to act if there was a lock>up. 9he majoritys decision might well deter future actors !like &enesis# who were not interested absent the lock>ups.

Revlon E Fuic and 'irty

3hen a corporation initiates an active bidding contest it starts (evlon duties (evlon establishes that where the board decides to Fsell the company,G the court will give enhanced scrutiny to both the process that the directors followed and to the substantive fairness of the result. A similar enhanced scrutiny will be given to transactions in which the board Fsells controlG of the company. 3hen is (evlon scrutiny usedM

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 2orporation initiates an active bidding process 2orporation abandons long>term strategy "ale of control 3hen is (evlon scrutiny not usedM Eoard says no: 3hen the target receives an unsolicited offer and the board essentially Fsays no to the offer6 this scenario also applies where the board refuses to undo some previous defensive measure !however, if the target takes defensive measures, the measures must satisfy -nocal# Cerger into uncontrolled public company: when the target, without putting itself up for sale or break>up, proposes to merge into another public company that is not controlled by any one person or small group

*art 6
"tate anti>takeover statutes Eefore poison pill, there was state legislation tried to limit the disruption of hostile takeovers o Lirst wave after 1=;B 3illiams Act: disclosure and fairness concerns, and was generally limited to attempted takeovers of companies with a connection to the enacting state o )ike the Illinois Eusiness 9akeover Act of 1=@=, which "2D9 " struck down in 1=B, 'reempted by the 3illiams Act, and in violation of the "upremacy 2lause A second generation of statutes attempted to avoid preemption by maintaining an appropriate balance between the interests of the offerors and the targets within the overarching policy of investor protection 9hey do this by re5uiring a very high supermajority vote unless the merger provides shareholders with a statutory fair price that e5uals or e*ceeds the original tender offer price !back>end mergers# Another statute is the Jcontrol share stat-teK which resists hostile takeovers by re5uiring a disinterested shareholder vote to approve the purchase of shares by any person crossing certain levels of share ownership that are deemed to constitute Fac5uisition of controlG Indiana: you could cross the threshold numbers for ownership, but you lose voting rights Cts Cor'. v $"namics Cor' of !merica !"2D9 " 1=B@# Facts( 9he Indiana 2ontrol "hare Ac5uisition Act applies only to Fissuing public corporations.G It focuses on the ac5uisition of Fcontrol sharesG in an issuing public corporation. 9riggers when control shares bring voting above ,-K, (( 1%(K, or :-K thresholds. A control share doesn7t entail voting rights automatically6 the buyer gains rights only to the e*tent granted by resolution approved by the shareholders of the issuing corporation. 9he act re5uires a majority vote of all Upre>e*istingV disinterested shareholders holding each class of stock for passage of such a resolution. Jfair price stat-teK G deters coercive two>tier takeovers by re5uiring that minority shareholders who are fro8en out in the second step receive no less for their shares than the shareholder who tendered in the first step Holdin ( Indiana act okay, because under 3illiams Act: It allows shareholders to evaluate the fairness of the offer collectively 9here is also the ability in this act for offerers to make a conditional offer, which will let them receive voting rights within a certain period of time. It7s okay that there might be some delay $oesn7t treat in>state offerors different than out of state o 9here were ( things wrong with the Illinois act that were preempted: !1# ,- day pre>comment period !,# 'rovision for a hearing on a tender offer because it set no deadline !(# 9he re5uirement that the fairness of tender offers be reviewed by the Illinois secretary of state put investor protection at odds with autonomy. Ead. 9hird>&eneration Antitakeover "tatutes 1=B@>,-- After "2D9 " approval of Indiana statute, a lot of states took on similar statutes. o J=-siness com+ination stat-teK or moratori-m stat-te o 'rohibits a corporation from engaging in a business combination within a set time period after a shareholder ac5uires more than a threshold level of ownership.

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In some statutes there is a fair price e*ception for this 9hese statutes act as a ban on immediate li5uidation of an ac5uired entity but not as a bar to takeovers where the ac5uirer will continue to operate the business of the target. NO in 1=B:, and $elaware in 1=BB ;7CL 820$ !1=BB# ;7CL8 20$ is meant to deter junk bond financed bust>up takeovers o 9here are two outs that may affect the planning of an ac5uisition !1# "tatute7s restriction does not apply if the bidder can ac5uire B:K of the outstanding voting stock in a single transaction. 9his has never happened !,# If you get between 1:K and B:K, a bidder can go forward if you secure ,%( vote from the remaining shareholders as well as the board o 9his has the effect that the minority holdouts gain more power. 9he more the bidder ac5uires short of the B:K, the more power is concentrated in a small pool of minority shareholder holdouts Eidder can protect against this by specifying an B:K percent minimum tender condition to its obligation to close its tender offer o ;7CL 820$ bars business combinations between ac5uirer and target for a period of three years after the ac5uirer passes the 1:K threshold unless: !a#!1# takeover is approved by target board before the bid occurs !Tim+erAack#/ or !a#!,# ac5uirer gains more than B:K of shares in a single offer !a#!(# ac5uirer gets board approval and ,%( vote of approval from disinterested shareholders !i.e. minority who remain after the takeover# o 9hree federal district courts held in 1=BB that $elawares antitakeover statute must give bidders a Jmeanin f-l opport-nit! for s-ccessK in order to be valid under the "upremacy 2lause of the .". 2onstitution. Eut do e*emptions , and ( really give a meaningful opportunity for successM @E +-siness com+ination stat-te bars any substantial sale of assets or merger for five years after the threshold is crossed without prior approval o ;7CL 820$#c%#$% defines business combination narrowly so as to cover only transactions between the target and the bidder or its affiliates o A takeover entrepreneur could still seek to ac5uire control of a company via asset sale by having a li5uidation value substantially in e*cess of its stock market value in order to sell those assets 1 either piecemeal or in a single sale 1 to others, and it could then pay out the proceeds of this sale as a pro rata dividend to all remaining shareholders A second statute type is the dis or ement stat-te( mandate the disgorgement of profits made by bidders upon the sale of either stock in the target or assets of the target !covers assets as well as stock#. o Any bidder who ac5uires a fi*ed percentage of voting rights, including voting rights ac5uired by pro*y solicitation, is subject to this statute o Any profit reali8ed by a controlling person from the sale of any e5uity security of the target within 1B months of taking control belongs to the target o In 'A, Fcontrolling personG is somebody who has ac5uired or offered to ac5uire over ,-K of voting rights "olicitation of pro*ies triggers the disgorgement provision Lor Dhio, there are provisions for safe harbors to management pro*y solicitations A third type is constit-enc! stat-te( o 9hey allow, or in some states re5uire, the board of a target corporation to consider the interest of constituencies other than the shareholders when determining what response to take to a hostile takeover. o +eleases directors from some of the fiduciary constraints imposed by case law in the takeover conte*t to allow for more defense Two eItreme antitakeover stat-tes( o ;is or ement stat-tes #*A 1 4H%: re5uire bidders to disgorge short>term profits from failed bid attempts o Classified +oard stat-te !CA 1 C;#: provides classified boards for all companies incorporated in the state !with opt>out possible# 'ro*y 2ontests for 2orporate 2ontrol:

"ince the board can unilaterally adopt the poison pill, it7s tough to change management:

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!1# Negotiate with the incumbent board and hope that they7ll be friendly !,# ?ostile option of running both a pro*y contest and a tender offer simultaneously 2losing the tender offer is conditioned on electing the ac5uirer7s nominees to the board and the board7s redemption o the target7s poison pill )esson: Q0+O ?A+$ 9D $I"')A20 CANA&0C0N9 9D$AO o o +lasius In#usitries v. !tlas Cor' !$el 2h. 1=BB# Facts( Elasius wanted to restructure Atlas by enlarging the board from @ to 1: !with the B new directors being chosen by Elasius#/. Atlas fought back 1 the board responded by voting to enlarge the board to = members. 9he board then chose the persons to fill the new seats. Holdin ( A board may not enlarge its si8e for the purpose of preventing a majority of shareholders from voting to e*pand the board to give control to an insurgent group. "easonin ( If the board e*panded in the normal course of business, then there would be no cause of action. It would also be okay if the board acted in a good faith effort to protect its incumbency, not selfishly, but in order to thwart the implementation of a plan !like recapitali8ation# that it feared would cause injury to the company. Comment 1( If it was not done in the course of ordinary business, we look to see whether chnell was violated. 4nocal said that a board could defeat a threatened change in corporate control when they were taken in good faith pursuit of a corporate interest and were reasonable in relation to a threat6. 4nocal reasoning does not apply when the point was to thwart stockholder vote. Comment 2( An attempt to defeat a pro*y contest can7t by justified by the argument that the voters are uninformed. Interference with voting process is presumptively ine5uitable. 9he EI+ is FflippedG 1 board must show that its justification was compelling in light of the alternative. Cercier v& ?nter,Tel Facts( Eoard delayed a merger vote to give more info to shareholders because they knew they weren7t going to approve the merger on the original date Holdin ( $irectors have burden of proving that their action !1# served and was motivated by a legitimate corporate objective and !,# was reasonable in relation to the legitimate objective and not preclusive or coercive. 9his test shouldn7t signal a tolerance of the concept of substantive coercion in the director election process. Hilton v ?TT Corp @evada( Facts( I99 tried to resist takeover attempt by ?ilton by transferring all its assets to a subsidiary. 9his didn7t re5uire a shareholder vote. 9hen, it rejected the bid. 2ourt said that it was reasonable for I99 to reject bid6. but was its course of action coerciveM Holdin ( Installation of a classified board for the spinoff !which had most of the assets# was clearly coercive under -nitrin. 9he board provision for the spinoff would preclude current I99 shareholders from e*ercising a right they currently possess 1 to determine the board membership. Tra#ing in Cor'orate ecurities Xuestion of obligations of directors, officers, and issuing corporations when dealing in the corporation7s own securities. 'ublic corps are covered by federal law "ecurities Act of 1=(( is the principal statute for public distributions of securities "econdary Carkets, the "ecurities 0*change Act of 1=(. is primary source of regulatory law Liduciary duties !states# aren7t as important here. 2ommon )aw of $irector7s $uties 3hen 9rading in the 2orporation7s "tock Fra-d is common law claim of fraud has five elements: !1# false statement of a !,# material fact !(# made with the intention to deceive !.# upon which one reasonably relied and which !:# caused injury o Eefore: these re5uirements didn7t include failure to disclose without overt deception. No cause of action for traders on open market. o Dnly common law duty of full and fair disclosure on a seller: in contracts between trustees and their beneficiaries. "2D9 " in trong v. Re'i#e 1=-=: A director has an obligation to disclose material facts or refrain from buying corporate stock in a face.to.face transaction. Goo#%in v. !gassi/ !Cass. 1=((# Facts( $ and another, president and directors of the corporation, purchased stock of ' in the corporation !through a stock e*change# without disclosing inside info which turned out to be important. $ had also failed to bring up the info

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in a shareholder meeting. Holdin ( $irectors have a duty of good faith because of trustee relationship to the corporation, but they don7t have this position toward individual stockholders. 3here a director personally see s a stockholder for the purpose of buying his shares without making disclosure of material facts... the transaction will be closely scrutini8ed and relief may be granted in appropriate instances Comment( 9he fact that $ only had a theory about certain facts !that land had good mining potential# was not enough. Dmitting a theory about material info at a shareholder meeting didn7t hurt anything. 9he 2orporate )aw of Liduciary $isclosure 9oday Almost all litigation of officer and director liability for trading in a company7s securities occurs in federal courts. 9wo situations for state fiduciary duty law: o !1# 2orporation can bring a claim against an officer, director, or employee for trading profits made by using information learned in connection with his corporate duties. !$iamon## 2orporate opporunity o !,# "hareholders can invoke state fiduciary duty to challenge the 5uality of the disclosure that their corporation makes to them. 2orporate +ecovery of 'rofit from FInsiderG 9rading Agency law says that profits from inside information belong to the corporation, so the corporation is the entity harmed by inside trading. 1+ro'h"2 o Liduciary theory isn7t widely accepted, but the <raak says its doctrinally sound. o 9wo aspects: !1# 2orporation FownsG nonpublic information and could allow its agents to trade on it if there were no other legal considerations !,# 9his theory doesn7t attempt to compensate the uninformed stockholder with whom the insider trades Freeman v. $ecio !@th cir. 1=@B# Facts( Lreeman alleged in a derivate action that $ecio and other insiders sold stock of the corporation on the basis of material inside info and demanded disgorgement to the corporation of the insiders profits. Holdin ( 9rading on the basis of material inside info does not constitute a breach of fiduciary duty to the corporation. Insider trading does not entail the disclosure of inside information, but rather its use in a manner in which the corporation itself is prohibited form e*ploiting it !information was not used at the e*pense of the corporation#6 Comment( An earlier case, 'iamond reached the opposite result. ?owever, the remedies for insider trading under the federal securities laws at the time of Freeman constituted a more effective deterrent than they did when 'iamond was decided because the 1-b>: class action had made substantial advances as a remedy. $elaware used to assume the purpose of a 6rophy claim was to remedy harm to the corporation, so disgorgement was for harm to corporation. Eut in ,-11, $elaware "upreme 2ourt said in =ahn v. =ohlberg =ravis (oberts B Co. that a corporation does not need to suffer actual harm. $erivative \ must show that a fiduciary !1# possessed material, nonpublic company information and !,# e*ecuted trades motivated by the substance of that information. 1 9his conclusion goes against Freeman !similar to 'iamond# (irginia +an&shares0 Inc. v. an#berg Facts( After a free8e>out merger, in which the minority shareholders of Lirst American Eank of Qirginia lost their interest, "andberg !'# and other minority shareholders sued for damages, alleging violation of A1.!a# and +ule 1.a>= !which prohibits the solicitation of pro*ies by means of materially false or misleading statements# for breach of the fiduciary duties. Holdin 1( An individual is permitted to prove a specific statement of reason knowingly false or materially misleading, even when the statement is couched in conclusive terms. Holdin 2( 2ausation of damages compensable through a federal implied private right of action cannot be demonstrated by minority shareholders whose votes are not re5uired to authori8e the transaction giving rise to the claim. Comment( knowingly false statements of reasons may be actionable even though conclusory in form, but that respondents have failed to demonstrate the e5uitable basis re5uired to e*tend the A1.!a# private action to such

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shareholders when any indication of confessional intent to do so is lacking

Eoard $isclosure Dbligations nder "tate )aw $elaware "upreme 2ourt now says that a board has a duty to provide candid and complete disclosure to shareholders o "tate duty of full disclosure: this parallels federal law under 1-b>: o Not just limited to board7s recommendations on how to vote on tender offers. "tate law director7s duty of candor re5uires them to e*ercise honest judgment to assure disclosure of all material facts to shareholders. )iability usually only when there is intent to mislead. $&2) A1-,!b#!@# waives liability for good>faith failure to disclose. Eut you still can get an injunction to remedy. 0*change Act of A1;!b# and +ule 1; -1;!b# is a strict liability rule meant to deter statutory insiders from profiting on inside information. +e5uires statutory insiders to disgorge to the corporation any profits made on short>term turnovers in the issuer7s shares -underinclusive because insider trading can occur over a period longer than si* months. overinclusive because short>swing transactions need not involve insider information -5uestion of how to calculate short>swing transactions: -grat/ v claughton8 matching sales: a court must take into account all purchases and sales of the same class of securities occurring within si* months of the reportable event !both si* months in the past and future#. -In calculating the profit, you first look back si* months and match the number of shares sold !or purchased with the same number of shares purchased !or sold#. 9he same process is repeated looking forward si* months. Oou then deduct the lower total purchase price from the amount reali8ed on the reportable sale to determine the profit that is payable to the corporation#. -"tatutory insidersM 3ho is an officerM Iob title doesn7t matter. 3hether you have recurring access to non> public information in thecourse of your duties. -3hat are the criteria for a purchase or saleM transactions might have the effects of a purchase or sale without having their forms. -All derivative combinations that track the financial characteristics of an issuer7s securities under A1;!b# -what about mergersM 3here target shareholders receive stock in the surviving companyM -=ern County $and Co. v. +ccidental ,etroleum Corp. 1=@( -facts( ] ac5uired a big stake in a target corp. these stocks were converted to those of the surviving corp. ] also sold option to these converted shares. -L-estion( does a merger trigger the ;>month FsaleG of a corporation is the stocks are convertedM "2D9 " said that selling an option was not the same thing as a 1;!b# transaction, and they e*tended beyond ; months anyway, in this case. -Eut now the "02 treats all contracts or instruments that derive current value from the value of a covered security !such as an option# as a security for A1; purposes -holdin ( merger wasn7t a sale/ there was no inside information ac5uired by the ac5uirer in this case, so does not trigger A1;. not an insider. 0lements of a 1-b>: claim

()) similar to common law elements of fraud !1# false or misleading statement !,# of material fact that is !(# made with intent to deceive another !.# upon which that person !:# reasonably relies !;# and that reliance causes harm ()) rule 1-b>: adds: the reliance must be by a buyer or seller of stock, the harm must be to a trader in stock, and the misleading statement must be made in connection with a purchase or sale of stock
=>b.? an# tate Fi#uciar" $uties

anta Fe In#ustries Inc. v. Green Facts( ] wanted to use 826$ ;C7L short>form merger statute.

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Holdin ( A1-!b# gives no indication that congress meant to prohibit conduct not involving manipulation !practices that are intended to mislead investors by artificially affecting market activity# or deception. "o no violation here. Comment( $elaware responded to anta Fe by adding more fiduciary protections in inger v. Magnavo3. Weinberger reaffirmed obligation to pay fair price. Gol#berg v. Meri#or Comment 1( A derivative action could be brought under rule 1-b>: on the basis that a transaction between a corporation and a fiduciary or a controlling shareholder was unfair if the transaction involved stock and material facts concerning the transaction had not been disclosed to all shareholders. Comment 2( 9here is deception when controlling shareholder influences corp. to engage in a transaction adverse to its interests and there is nondisclosure or misleading disclosures as to the material facts of the transaction. anta Fe says that misrepresentation or nondisclosure is a necessary element of a 1-b>: action. Ereach of fiduciary duty isn7t enough. If there is a breach of fiduciary duty claim that could be brought at the state level, the claim could also be brought under 1-b>: IL !1# the transaction involved stock and material facts concerning the transaction were not disclosed to all shareholders !Gol#berg# AN$ !,# the misrepresentation by the insider rose to the level of manipulation or deception. ! anta Fe#. Theories of =>b.? ,iabilit" 9hee main legal theories trying to deal with the 5uestion of when an omission to disclose may be a predicate for 1-b>: liability: #1% e:-al access #2% fid-ciar! d-t! #$% misappropriation -!1# "02 and ,nd 2ir. Lirst took position that any possession of relevant, material, nonpublic information gives rise to a duty to disclose or abstain form trading. 2C v. Te3as Gulf -!,# "2D9 " said in Chiarella that an insider had to breach a fiduciary duty in trading on inside information -!(# "2D9 " has more recently adopted intermediate stance of augmenting the fiduciary duty theory with misappropriation theory 9he 05ual Access 9heory F:-al access theor!: All traders owe a duty to the market to disclose or refrain from trading on nonpublic corporate information. 2C v. Gulf Oil Ca#"0 Roberts gives two principle elements for application of 1-b>: -!1# 9he relationship giving access to information was intended for a corporate purpose, and not for personal benefit -!,# Inherent unfairness results when a party takes advantage of information no!ing it is unavailable to those with whom he is dealing Stren ths: It identifies the victims. And prohibits all FinsiderG trading. 9eaknesses: unclear why FunfairnessG of une5ual information constitutes fraud 9he Liduciary $uty 9heory "2D9 " adopted fid-ciar! d-t! theor! in 1=B-s when Chiarella rejected e5ual access theory A purchaser of stock who has no duty to a prospective seller because he is neither an insider nor a fiduciary has no obligation to disclose material information he has ac5uired and his failure to disclose such information does not constitute a violation of 1-b>: Chiarella. +9A2 !+elationship of 9rust and 2onfidence# A tippee will be held liable for openly disclosing non>public information received from an insider, if the tippee knows or should know that the insider will benefit in some fashion from disclosing the information to the tippee. $ir&s. o 9rading by a tippee is a derivative violation of rule 1-b>:. A tipper who owes a duty to other traders in his company7s stock, must first violate that duty by tipping improperly. 9ippee then assumes the tipper7s duty by trading. o 3hether tipping is improper in the first instance turns on whether the insider was securing a personal benefit from the tippee !tipper then in effect trades indirectly on his own tip#. A family relationship does not give rise to a per se fiduciary duty to refrain from tipping confidential information. Chestman& o Holdin ( "tockbroker was not found guilty of violating 1-b>:. 9he mere family relationship between "usan and <eith was not enough to make <eith a fiduciary regarding the merger information. 9his was true even though <eith knew the information came from the issuer and knew that the information derived from "usans familys control of the issuer. If <eith had promised confidentiality to "usan as

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a condition of hearing the news, then he would have been a fiduciary. Eecause <eith was not a fiduciary, he had no obligation to abstain from improper tipping. ?is tippee had no 1-b>: liability. Stren ths( Ey isolating a pree*isting relationship between insiders and other traders, it supports an analysis to common law fraud that eases the assimilation of insider trading into the statutory prohibition against securities fraud. 9eaknesses: Liduciary duty theory is too clearly a liability filter that fails to answer the 5uestion of how does trading on information disparities defraud uninformed tradersM Cisappropriation 9heory Res'onses to Chiarella an# $ir&s Theor!( A deceitful misappropriation of market>sensitive information is itself a fraud that may violate 1-b>: when it occurs in connection with a securities transaction. 1-b>: liability arises when a person trades on confidential information in breach of a dut owed to the source of the information !even if the source is a compete stranger# O-Hagan Holdin 1( A person who trades in securities for personal profit, using confidential information misappropriated in breach of a fiduciary duty to the source of the information, is guilty of violating +ule 1-b>:. Holdin 2( +ule 1.e>(!a# does not e*ceed the rulemaking authority of "02 Comment 1( Lull disclosure forecloses liability under the misappropriation theory. Eecause the deception essential to the misappropriation theory involves feigning fidelity to the source of the information, if the would be trader discloses in advance to the source that he plans to trade on the nonpublic information, then he does not commit a violation. A fiduciary>turned>trader may remain liable under state law for breach of a duty of loyalty. Comment 2( 9he misappropriation theory premises liability on deception of those who entrusted the trader with access confidential information. Apparently if and only if the supplied of the information could bring some sort of theft of information tort claim against the defendant would the defendant be liable under misappropriation theory. 9eakness( Cisappropriation is wrong because it involves the appropriation of information rights that belong to someone else. Eut no doctrinal basis for civil recovery by someone other than the entity who owns the information rights !such as uninformed traders# e*ists. "-le 1'e,$ 2ame into play after "2D9 " narrowed 1-b>: in Chiarella and $ir&s "-le 1'e,$ prohibits trading on non>public information about a tender offer even if the information comes from the ac5uirer rather than the target and even if the information is not obtained in violation of a fiduciary duty. In effect, this rule reintroduces the e5ual access norm by regulatory fiat in the limited but important domain of corporate takeovers via tender offer. 9here may be !though this is not yet certain# an implied right of action under 1'e,$. O-Hagan validates as constitutional In ,---, "02 passed +egulation JFair ;isclos-re #F;% o 9he rule mandates that all publicly traded companies must disclose material information to all investors at the same time. 9he regulation sought to stamp out selective disclosure, in which some investors received market moving info before other !usually smaller# investors. o 'reviously, the people who received the info could use it !despite the unfairness# o No selective disclosure !companies often gave first disclosure to those analysts who gave them the most favorable forecasts# o nintentional disclosures must be rectified within ,. hours Insider Trading and 3ecurities Fraud Enforcement Act I9"L0A 1=BB A ,-A: creates a private right of action for any trader opposite an insider trader, with damages limited to profit gained or losses avoided. =>b.? Right of !ction

An outsider injured by insider trading has a right of action for damages under +ule 1-b>: if he can meet the following re5uirements: *-rchaser or Seller: ' must have been a purchaser or seller of the companys stock during the time of non> disclosure !+lue Chi'#

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 Traded on Caterial, non,*-+lic ?nfo( $ must have misstated or omitted a material fact !+asic# o A fact is material for purposes of 1-b>: if there is a substantial likelihood that a reasonable investor would !as opposed to might# consider it as altering the Ftotal mi*G of information in deciding whether to buy or sell. +asic& Special "elationship( Chiarella0 $ir&s0 O-Hagan Scienter( $ must have acted with scienter 1 ' must prove and plead that $ had an intent to deceive, manipulate, or defraud !2rnst#. o 'robably met by showing of reckless mistatement o 'leadings =th 2ir is most permissive and says that the ' need only state in the pleading that the $ had acted with scienter ,d circuit strictest: re5uires ' to plead facts that give rise to a strong inference of fraudulent intent. o "-le 10+,6#1%( 9rading Fwhile in possessionG info v. 9rading Fon the basis ofG info It is enough for liability that $ was merely in possession of the inside info at the time of trade even if the government cannot prove that $ in some sense used the information in making his decision to trade. ' need only show that $ was aware of the inside info at the time he traded 1 not that the info in any sense caused or even affected $s decision to trade "afe ?arbor for pre>planned trades: If before becoming aware of the inside info, the insider adopts a written plan for trading securities that locks the insider into making particular purchases at a particular time, the arrangement wont be disallowed. "eliance and Ca-sation( ' must show that he relied on $s misstatement or omission and that the misstatement or omission was the pro*imate cause of his loss. In cases of silent insider trading !as opposed to cases of misrepresentation#, these re5uirements usually dont have much effect !+asic# o +eliance !presumed reliance on price of stock# In an open and developed stock market, the efficient capital market hypothesis posits that market prices reflect all publically available info about a companys stock. Dn the assumption that material misinformation artificially distorts the market price, courts infer that investors have relied on the misinformation. 9his fraud on the market theory assumes that if the truth had been disclosed, investors would not have traded at the prevailing non> disclosure price. A defendant may rebut the presumption of reliance and avoid fraud on the market theory by showing either !1# the trading market was not efficient !showing that the challenged misrepresentation did not in fact affect the stocks price# or !,# the particular plaintiff would have traded regardless of the misrepresentation. o 2ausation 9here must be causation related both to the transaction and loss causation If it can be shown that the transaction resulted from reasons other than the misstatement or omission, liability will not result !even if the damage was caused by the misstatement or omission# $ura )harmaceuticals: An inflated purchase price will not by itself constitute or pro*imately cause the relevant economic loss needed to allege and prove Tloss causation. In the usual case, loss causation is demonstrated by showing a drop in price at the time of corrective disclosure !creating a logical link between the misrepresentation and the loss#. ;ama es( o +escission o $isgorgement if rescission is not possible 9he preferred measure of damages available when inside information indiciating stock price decline is involved is the decline in the purchasers stock up to the amount o fhte tipeees reali8ed benefit !2l&in# v. ,iggett#. Alternatively, the defrauded seller recovers the purchasers profits 1 the difference between the purchase and resale price 2l&in# is the standard measure of damages for omissions !as opposed to misstatements# 0nd of 6asic>type class>actionsM

!mgen, which was argued a month ago: ) Argument that under class action rules, in order to meet the re5uirements that there be a sufficiently large degree of commonality among the classs claims, \ must prove for class

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cert that the alleged misrepresentation is material prior to cert ) "2D9 " has yet to rule6 but doesnt like class actions !mgen may complicate basic

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