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BLaw 425
Spring 2009

Susan A. Morgan
Former Entrepreneur (MacInTax, TurboTax)
J.D. – Santa Clara University, School of Law
Fenwick & West, LLP – 7 years
Corporate Attorney
Start-ups and Private Companies
Equilytics, Inc. – private equity analysis
Katovich Law Group – Oakland (Virtual)
Contact Info:
Available after class, for questions
Class Assignments
Texts – case book plus supplement
Statutes – recommended
Syllabus – rough cut, will be updated
Material increases in complexity later on
Briefing cases – recommend paper/written briefs for every case
Why is this case in this book?
Participation – expect to be called on and participate in class
Notify me, if you are unprepared
Final Exam – Essay (closed book)
Format (most likely):
2 longer, multi-part questions (1 hour)
3-4 shorter essay questions
Grading – Final will count for most of your grade

Up to +5 points, for class participation
Final Exam Date: Wed., May 13th, 10am-1pm
Pleasant Hill Campus, Room N271
Best practice – come to class prepared, and participate! 
Class Mechanics
Roll Call
Sign-up Sheet
Must attend at least 80% of class (to earn credit)
3 unit class = no more than 3 classes missed!
Tardy – same result if more than 1 hr late for more than 9 classes.
Seating – pick your permanent seat next week
Breaks – 3hr class
55 min, then 10 min break (each hour); OR
80 min (1 hr, 20 min), then 20 min break, then 80 min.

Class Content
Rules of agency
Actual and apparent agency
Inherent power
Principal’s liabilities
Agents duties
Rules of partnership; creation
Partners’ rights and duties (property, each other)
Partnership dissolution
Liability (limited)
Shareholder derivative actions
Role/purpose of corporations
Duties of Insiders (D&O, etc.)
Duty of Care and Duty of Loyalty
Ratification (by corporation of D&O actions)

Insider Trading (Rule 10b-5) and short-swing profits (Rule 16(b))
Indemnification and D&O insurance

Proxy fights
Shareholder duties in closely-held corporations
Dissolution and transfer of control
Mergers and Acquisitions (M&A)
De facto mergers
Freeze-out mergers
Pre-emption (State vs. Federal law)
Skip Ch . 4 (LLCs) and Ch. 8 (Corporate Debt)
Restatement (3rd) of Agency
Actual Express Authority (AEA)
P tells A to act, A acts (A believes has authority)
Actual Implied Authority (AIA)
P tells A to act, A takes needed steps not expressed
Apparent Authority (AA)
P tells 3P that A is authorized, or P tells A to make statements to 3P that A is authorized
P tells A not to act, but fails to tell 3P that A has no authority
3P believes A authorized, based on P’s actions, or based on normal business customs
Ratification (R)
A has no authority to act, but does so anyway, P adopts act after the fact
Inherent Agency Power (IAP)
No explicit authority but A does act similar to those A does has authority for

BLaw 425 – Class 2
Spring 2009

Liability / Obligations of Agents

Apparent Agent (Franchise / License)
Is there an Agency relationship?
Rest.2d §2 - Nature and Extent of Control

Rest.2d §220 – Agent vs. non-agent
Scope of Employment (Employer/Employee)
Agency relationship exists (not at issue)
Was Employee acting with Scope of Employment
Rest.2d §219, 228; Rest.3d §7.07
Fiduciary Duties
Duty of Care, Loyalty
Kickbacks/secret profits, taking business opportunity, trade secrets
Rest.2d §387, 388, 389, 404

Rest.2d § 2
Master: principal who employs an agent to perform service in his affairs and
who controls or has the right to control the physical conduct of the other in the
performance of the service. [Employer]
Servant: agent employed by a master to perform service in his affairs whose
physical conduct in the performance of the service is controlled or is subject to
the right to control by the master. [Employee]
Independent Contractor: person who contracts with another to do something
for him but who is not controlled by the other nor subject to the other’s right to
control with respect to his physical conduct in the performance of the
undertaking. [non-agent contractor]

Rest.2d § 220(2)
Agent vs. non-Agent (Independent Contractor):
(a) the extent of control which, by the agreement, the master may exercise over the details of the work;
(b) whether or not the one employed is engaged in a distinct occupation or business;
(c) the kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of
the employer or by a specialist without supervision; {WHAT vs. HOW}
(d) the skill required in the particular occupation;
(e) whether the employer or the workman supplies the instrumentalities, tools, and the place of work for the
person doing the work;
(f) the length of time for which the person is employed;
(g) the method of payment, whether by the time or by the job;
(h) whether or not the work is a part of the regular business of the employer;
(i) whether or not the parties believe they are creating the relation of master and servant; and
(j) whether the principal is or is not in business

Apparent Agent Cases

Murphy v. Holiday Inns
Miller v. McDonald’s
Vandemark v. McDonald’s

Rest.2d § 219(1); 228(1)

219(1): A master is subject to liability for the torts of his servants
committed while acting in the scope of their employment.
228(1): Conduct of a servant is within the scope of employment, if,
but only if:
(a) it is of the kind he is employed to perform;
(b) it occurs substantially with the authorized time and space limits;
(c) it is actuated, at least in part, by a purpose to serve the master,

(d) if force is intentionally used by the servant against another, the use of
force is not unexpected to the master.

Rest.3d § 7.07
(1) an employer is subject to vicarious liability for a tort
committed by its employee acting within the scope of
(2) An employee acts within the scope of employment
when performing work assigned by the employer or
engaging in a course of conduct subject to the employer’s
Rest.2d § 229(2)
Scope of Employment – factors:
Time, place, purpose of act
Similarity to authorized acts
Act commonly performed
Extent of departure from normal methods
Would employer expect such an act?
Previous relations
Business apportioned
Act outside of employer’s business (or not performed by employees)
Employer provided instrument of harm
Act seriously criminal

Bushey v. U.S.
Forseeable (R.2d §228)
Arguello V Conoco
3 incidents, 2 issues:
Apparent Agency (branded stores)
Scope of Employment (owned stores – R.2d §229)

Fiduciary Duty: Rest.2d §387-389

§387: Unless otherwise agreed, an agent is subject to a duty to his principal to
act solely of the benefit of the principal in all matters connected with his agency.

§388: Unless otherwise agreed, an agent who makes a profit in connection with
transactions conducted by him on behalf of the principal is under a duty to give
such profit to the principal. [disgorge]
§389: Unless otherwise agreed, an agent is subject to a duty not to deal with
his principal as an adverse party in a transaction connected with his agency
without the principal's knowledge.
Rest.2d §404
An agent who, in violation of the duty to his principal, uses for his own purposes
or those of a third person assets of the principal’s business is subject to liability to
the principal for the value of the use. If the use predominates in producing a
profit he is subject to liability, at the principal’s election, for such profit; he is not,
however, liable for profits made by him merely by the use of time which he has
contracted to devote to the principal unless he violates his duty not to act
adversely or in competition with the principal.
Fiduciary Duty Cases
Reading v. Regem
Secret profits
Gen. Auto v. Singer
Secret profits
Town & Country v Newbery
Trade secret – customer lists

Contract vs. Fiduciary Duty

Breach of Contract
Litigate exact terms of contract
Remedy is restitution
Equitable remedy – restore ¶ to original position prior to “loss”
Breach of Fiduciary Duty
Violates duty of care, loyalty, trust
Remedy is disgorgement
Regardless of NO loss to ¶ due to ∆’s actions
Using Confidential Information After Termination of Agency
(Rest.2d §396(a) & (b))
After the termination of the agency, the agent:
(a) has no duty not to compete with the principal;
(b) has a duty to the principal not to use or to disclose to third persons, on his
own account or on account of others, in competition with the principal or to his
injury, trade secrets, written lists of names, or other similar confidential
matters given to him only for the principal's use or acquired by the agent in

violation of duty. The agent is entitled to use general information concerning the
method of business of the principal and the names of the customers retained in
his memory, if not acquired in violation of his duty as an agent.

BLaw 425 – Class 3
Spring 2009

Partnership Law
Sources of Law
Common Law / cases
Uniform Partnership Act (UPA) (1914)
Currently used by ~1/3 states
Revised Uniform Partnership Act (RUPA) (1997)
Adopted by ~2/3 states
CA adopted RUPA: CA Corp. Code §16100-16962

Partnership Basics
Types of Partnerships:
General Partnership (GP)
Limited Partnership (LP)
Limited Liability Partnerships (LLP)
Some Other Entities
Corporations (S-corp, C-corp)
Limited Liability Companies (LLC)
Professional Corporation (PC)

Factors Differentiating Entities

Ownership (who owns the entity?)
Management (centralized / owner)
Liability (Who’s liable? For what? When?)
Distributions (of profits and losses)
Tax treatment (who gets taxed? When?)
Transferability of interests (buy / sell)
Continuity of life (Limited life or perpetual?)
Formalities/formation (filings?)

Flexibility of structure (standardized/flexible?)

Some Differences Among Entities

Partnership pays no taxes (as an entity)
Gains and losses “flow-thru” to the partners
Are recognized on partners individual income tax returns
“Phantom income” – gains flow-thru, but not distributions
Corporation pays taxes on gains and losses (as an entity)
Corporation cannot deduct dividends to shareholders
Shareholder must also recognize dividends as income, and pay taxes on them = DOUBLE TAXATION
How to get the $$ out?
Bonuses, perks, (problems with excess payments)
Buyback shares (capital gains tax - lower [15%])
Why get the $$ out?
Limited accumulations (personal holding company)
corporate tax – lower [35%]

What is a Partnership?
UPA (§6(1)):
A partnership is an association of two or more persons to carry on as co-
owners of a business for profit
No one-person partnership
No non-profit partnership
Person – can be entity (e.g., corp., partnership, LLC)
No written documents required

UPA §7 / RUPA §202 – Rules for Existence

Partners vs. Employees

Fenwick: Is Chesire an Employee or Partner?
Written Agreement:
No capital investment by Chesire
Fenwick - control and manage
Chesire – salary plus bonus (20% profits)
Fenwick – liable for debts
“Partnership” would continue until notice by either party

Partnership or Contract?

Commission – Employment Agreement
S. Ct. - Partnership:
Entered into written agreement - partnership
Called themselves Partners
App. Ct. – Reversed, Contract /employ

UPA §7(3)&(4): Rules

§3: The sharing of gross returns does not of itself establish a partnership …
§4: The receipt by a person of a share of the profits of a business is prima facie
evidence that he is a partner in the business, but no such inference shall be
drawn if such profits were received in payment:
(a) Asa debt by installment or otherwise,
(b) Aswages of an employee or rent to a landlord,
(d) Asinterest on a loan, though the amount of payment vary with the profits of the

Test of Partnership - Fenwick

Intention of Parties
Language = partnership / intent = financial
Right to share in profits
Yes (but not conclusive)
Obligation to share in losses
No – Fenwick took all the losses
Fenwick owned (contributed all the $$)
No $$ to Chesire on dissolution
Chesire – no ownership

Fenwick (cont’d)
Management (community of power)
Fenwick – exclusive control!
Language of agreement
Called themselves Partners / Partnership
Chesire had no rights of partnership
Conduct toward 3rd parties
Filed partnership returns, Fenwick report indiv. tax
Held themselves out as partners to Commission
NOT claim partners to others (vendors, etc.)
Not file trademark registration for partnership

Fenwick (cont’d)
Rights of parties on dissolution
Fenwick received all partnership property
Same results as if Chesire quits employment
Burden of proof – partnership exists => party claiming partnership exists

Ct => NO partnership
NO authority / control
Not subject to losses
Not held out as partners
Definition: Co-ownership lacking (essential element)
Distribution vs. wages
Sharing profits =>prima facie evidence of partnership

Partners vs. Lenders

Martin v. Peyton: is ∆ a lender or partner?
Written Agreement:
Loan of $2.5M (securities) – 2 yrs
∆’s get 40% profits ($100K - $500K)
∆’s have option join firm (buy up to 50% equity interest)
Inspection rights, right to veto speculative transactions
Hall to manage, signed resignations from partners

Partners vs. Lenders

KNK speculation – insolvent, creditors sue
Ct. – Not a partner
Provisions proper to secure lenders interests
Option unusual, but not sufficient to create partnership
Possible for individual elements (of partnership test) to
fail, but taken as a whole – the set is
so broad that a partnership exists.
BUT – not the case here – taken as a whole, no partnership exists
Compare: Cargill (Gay Jenson Farms) – Lender was Principal (agency
relationship existed)

Partnership by Estoppel
Young v Jones
PW entities: Franchise or Partnership?
No partnership in fact
If two partnerships are partners by estoppel, then PW-US is
liable for negligent acts of PW-Bahamas
UPA §7(1) & 16(1)

Estoppel (cont’d)
Ifestoppel: joint and several liability!!
¶: PW held itself out as partners (brochure)
No distinction in advertising, TM, names, …
“common knowledge” – they are partners

∆: NO reliance
¶ did not rely on brochure to make their decisions
Brochure did not state that PW entities are liable for each other

Fiduciary Duties (RUPA §404)

Duty of Loyalty
Trustee of partnership property
No adverse interests
No competing
Duty of Care
No negligent or reckless conduct
No intentional misconduct
No intentional violation of the law

BLaw 425 – Class 4
Spring 2009

Dissolution v. Going out of Business

Dissolution is not the same as going out of business:
A dissolution is simply the “change in relationship of the partners
caused by any partner ceasing to be associated in the carrying on”
of the firm’s business. UPA § 29.
“Winding up”: The process of shutting down post-
Dissolution and Winding Up:

Effect on Partnership

dissolution, the partnership must be wound up, absent
agreement among the partners to carry on the business.
Assuming that the business will not be continued, the winding up process
generally contemplates that the firm’s assets will be distributed to the
Authority of partners to act on behalf of partnership terminated
except in connection with winding up of partnership business. UPA §
33; RUPA § 804.
Continuation per Agreement:
Effect on Partnership
Technically creates a new partnership
Recall confusing treatment of this issue in Putnam v. Shoaf
Creditors of former partnership automatically become
creditors of new partnership. UPA § 41.
Continuation per Agreement:
Effect on Departing Partner
Departing partner entitled to accounting
Fair value of partnership
Interest from date of dissolution in event of unreasonable failure
to pay
Departing partner remains liable on all firm obligations
unless released by creditors. UPA § 36; RUPA § 703.
Continuation per Agreement:
Effect on New Partners
Ifa new partner joins the firm when it continues after a
dissolution, the new partner is also liable for the firm’s old debts,
but such liability can only be satisfied out of partnership property.
UPA § 41(1); RUPA § 306(B).
The new partner can not be held personally liable for the old debts,
unless he or she expressly agrees to be so held.
The Right to Dissolve
“there always exists the power, as opposed to the right, of
dissolution”—Collins v. Lewis
Dissolution by act of one or more partners. E.g., UPA § 31(1)(b)
Dissolution by operation of law. E.g., UPA § 31(4)
Dissolution by court order. E.g., UPA § 32(1)(a)

Owen v. Cohen
UPA § 31(1)(b):
“Dissolution is caused … By the express will of any partner when no definite
term or particular undertaking is specified”
Potential for wrongful dissolution
UPA § 31(1)(b) v. § 31(2)
Dissolution of a “term partnership” (a.k.a. “partnership for a term”) prior to
expiration of the term is “wrongful”
Adverse consequences; see UPA § 38(c)
Hence, “there always exists the power, as opposed to the right, of dissolution

UPA § 18
“The rights and duties of the partners in relation to the partnership shall be
determined, subject to any agreement between them, by the following rules:
“(a) Each partner shall be repaid his contributions, whether by way of capital or
advances to the partnership property and share equally in the profits and surplus
remaining after all liabilities, including those to partners, are satisfied; and must
contribute towards the losses, whether of capital or otherwise sustained by the
partnership according to his share in the profits.”
UPA § 40
§ 40(b): subject to contrary agreement, upon dissolution partnership assets
should be distributed as follows: “(I) Those owing to creditors other than partners,
(II) Those owing to partners other than for capital and profits, (III) Those owing to
partners in respect of capital, and (IV) Those owing to partners in respect of
§ 40(d): "partners shall contribute, as provided by [§18(a)] the amount
necessary to satisfy the liabilities [set forth in § 40(b)]. . . ."

Possible rules
All capital losses were to be borne by the capital partner
alone (Kovacik)
Sharing of capital losses in accordance with sharing of
profits (statute)
Allocate capital losses as per ratio of capital contributions

Courts do not apply the Kovacik rule where:
The service partner (Reed) was compensated for his work
The service partner (Reed) made a capital contribution, even if
that contribution was nominal

Limited partnerships
Defined: A partnership formed by two or more persons and having one or more
general partners and one or more limited partners.
Formation: The limited partnership is formed by filing documents required by
Typicallyfiled with Secretary of State
Pre-Tax Reform Act of 1986, significant tax shelter advantages
Post-TRA, those advantages eroded but still widely used to generate passive losses

Limited Partner Liability in Limited Partnerships

ULPA (1976): “A limited partner shall not become liable
as a general partner, unless, in addition to the exercise of
his rights and powers as a limited partner, he takes part
in the control of the business.”
What constitutes control?
Limited Partnership (added)
Limited Partnership similar to General Partnership, except – two types of
At least one GP, who manages and is liable for debts;
At least one LP, who invests $$, does not participate in management, and is usually not
liable for debts
Limited Partnership is taxed like a General Partnership
Profits and losses flow through
Partnership files a tax return
Partners receive and file IRS form K-1’s
Formation of Limited Partnership
Partners must file the Certificate of Partnership with the State and pay a fee

Dissolution Summary (added)

Partnership at will, unless:
Parties agree to a term, or
Court implies term (e.g., to repay partnership debt)
Partners entitled to share in control
They must have access to information and allowed to vote
May be altered by agreement
Agreement violated if majority deprives minority of opportunity to participate
Upon dissolution
Partners may wind up, or if disagree, count may appoint receiver, order sale (as a going concern, or
piecemeal – as a liquidation)
Fiduciary Duty
Partners owe each other a fiduciary duty – can not dissolve in bad faith
Must bid fair price


BLaw 425 – Class 5
Spring 2009

Intro to Corporations
Public (publicly-held)
Public secondary market in which shares of the company are listed for
Public companies: e.g., IBM or Microsoft
Trading exchanges: e.g., NYSE or NASDAQ
Private (close or closely-held)
Absence of a secondary market for its stock
Usually, small number of shareholders, some who actively participate in the
firm’s management
May display many characteristics of partnerships (like “incorporated

Intro to Corporations – Other Types

Professional Corporations (PC):
Physicians, dentists, lawyer, accountants
Increasingly use LLPs
Non-profit corporations
None of the surplus revenue (profit) may be distributed to shareholders (members)
Often have members rather than shareholders
 Charities, Churches, Fraternal Organizations
Quasi-governmental corporations
E.g., Fannie Mae and Freddie Mac
Government corporations
Universities, hospitals, etc.

Corporate Attributes
Legal “person” – corporation is a separate entity
separate legal existence from its owners (“legal fiction”)
Possesses (some) constitutional rights
Separate taxpayer
Requirement for formal creation
Limited liability - MBCA § 6.22(b):
“Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is
not personally liable for the acts or debts of the corporation except that he may become
personally liable by reason of his own acts or conduct.”

Corporate Attributes (cont’d)

Separation of ownership and control - MBCA § 8.01(b):
“All corporate powers shall be exercised by or under the authority of, and
the business and affairs of the corporation managed by or under the direction
of, its board of directors….”

Owners = shareholders (stockholders)
Managers = board of directors

Shareholders - limited control

Shareholders entitled to vote on:
Election of directors (MBCA §§ 8.03-.04)
Any amendments to the articles of incorporation (certificate of
incorporation, charter) - MBCA §§ 10.03
Usually, amendments to by-laws (MBCA §§ 10.20)
Fundamental transactions (e.g., mergers; MBCA § 11.04)
Odds and ends, such as approval of independent auditors

Consensus v. Authority
Consensus (Partnership):
Collective decision-making チ¨ used when constituents have:
Similar interests
Comparable information
Low collective action problems
Authority (Corporation):
Central decision-making body チ¨ used when constituents have:
Differing interests
Asymmetric information
Serious collective action problems

Rights of Shareholders
Vote on limited range of issues
Receive payment of dividends when and as declared by board
Inspect corporate books and records
Receive distribution upon termination
File derivative suit to redress wrong suffered by the corporation.
(Damages recovered belong to corporation)
Corporate Attributes (cont’d)
Liquidity– sell/transfer shares
Flexible capital structure
Many different types of securities:
Stocks (common, preferred), options, warrants, convertible debt, bonds
claims (contingent) on the corporate assets and future earnings
Issued through formal contractual instruments

Security Classes: Debt vs. Equity

Debt (senior) – bonds, loans, notes
Interest – paid over period of years
Return of principal – after period of years
Holder is a “creditor”, not an owner

Holder does not share in corporate appreciation (or upside)
Equity – stock or shares
No interest, no repayments of principal
Rights to receive dividends
if declared by board – “pro rata” share
Rights to receive distribution in a liquidation (after creditors)
Holder is an owner = shareholder
Shareholders receive the benefits of corporate appreciation

Debt vs. Equity: “crossovers”

Convertible Promissory Note (“bridge loans”)
Looks like debt (is a note, gets interest), but:
Can convert into equity – i.e., the principal amount is used to pay for future stock in the
Preferred Stock
Looks like equity (is a stock), but:
Gets “repaid” after debt, and before other (common) stockholders receive distribution
Warrants (“next financing” type)
Looks like equity (right to purchase stock in the future), but:
May require an “interest-like” payment, until exercised

Capital structure terminology

Authorized shares
Total number of shares authorized is specified in the Articles
Authorized but unissued shares: shares authorized but not yet sold
Outstanding shares
shares actually sold (and not repurchased by the corporation)
Charter authorizes total of 20,000 common shares.
Corporation sells 4,000 shares to investors.
Corporation now has 4,000 outstanding shares and 16,000 authorized but unissued shares
How many total authorized shares does the corporation have?

Issuance of stock
Board of directors approves issuances
Shareholders involved only if:
Board wants to sell more shares than are presently authorized in its charter
Board of directors wants to issue a new class of shares not authorized in the charter
If charter
(i)authorizes the class of shares in question and
there are sufficient authorized but unissued shares to sell;
then, the board can sell shares for “any valid purpose”,
as long as the corporation receives adequate consideration for the shares.

Old Dominion – Case 1

Third-Party Sale
A buys land for $125K, sells it to P for $200K
No fiduciary duty between A and P
Fraud – cannot misrepresent to buyer

Avoiding Fraud (and answering)
“price I paid is not relevant - property is worth $200K”
“no, that’s not entirely true” (2 mo vs. 1 mo)
No recovery if no damages
Even if A lies about purchase price, if property is worth $200K at sale, P has
no damages to recover

Old Dominion – Case 2

Principal-agent Sale
A represents P in acquiring land
A owns land, does not reveal to P
A sells land to P - $75K profit
A must disgorge profit to P
A has fiduciary duty to P
A should have revealed to P his ownership
Old Dominion – Case 3
Promoter Sale
P forms corporation C
P is sole shareholder of C
P is president of C
A agrees to act for C (as agent) in sale of land to C
A has fiduciary duty to C (but not directly to P)
C can recover from A
P has NO INDIVIDUAL cause of action against A

Old Dominion – Case 4 /#1

A forms corp. C
P buy stock in C for $200K
P is sole SH of C
P’s are directors/officers of C
A sells land to C for $200K
BOD approves sale
A is a promoter (incorporator) of C
A owes fiduciary duty to C
If all steps were part of single transaction (intended by A), A may have to disgorge profit
Unless A disclosed profit, and BOD approved it

Old Dominion – Case 4 /#2

A sells land to P - $200K
P forms corp. C – contributes land for stock (P is sole SH of C)
Can P recover from A?
If A acted as agent for P – yes.

Otherwise, no (assuming no fraud)
Can C recover from A?
No – C has no relationship with A

Old Dominion – Case 4 /#3

A forms corp. C
A contributes $200K cash to C for shares
A’s are directors and officers of C
A sells land to C for $200K
BOD approves purchase
5 days later (as planned), A sells shares to P for $200K
P’s replace A’s as officers and directors
Old Dominion – Case 4 /#3 (cont’d)
Should C be able to recover from A?
Difficult issue
Disclosure: A’s “knew” the price of the land, so C “knew” the price of the land => full disclosure was
“given” – no “harm” to C
SH approval: “Insider” transaction -> SH approval
 BOD has fiduciary duty to C, but SH can act in their own interest
 Who are the SH? A only, or should P be included?
Ct. rulings differ:
st st
Mass Rule: IF later sale was contemplated at time of 1 sale, C can attack 1 sale
US rule: C cannot attack 1st sale, because disclosure – all SH at the time (A) consented to 1 st sale
CA rule: follows Mass rule – promoter liable to C because 1 sale not approved by later SH (P –
contemplated at time of 1st sale)

Old Dominion – Case 4 /#4

A forms corp. C
A contributes $125K cash to C for stock
C uses $125K to buy land
A sells his shares in C to P for $200K
Can C recover from A?
A sold at “cost” to C – no profit. Nothing to recover
Can P recover profit from A?
Did P inspect corporate records before buying stock (books should show purchase price at
If P did “due diligence”, then P had “notice” of sale price – bought shares with “knowledge” –
no recovery

Represent corp. before it is formed – incorporate the entity
Often enter into contract with potential SH (who will purchase stock)
Called “Subscription Agreements”
Enforceable by SHs and promoter
Owe a fiduciary duty to corp. (and SH)
Cannot make “secret profit” from corp.
Liable for pre-incorporations contracts (entered into in corp.’s behalf)
Promoter remains liable after corp. is formed, unless:
 Agreement expressly states that promoter is not liable

OR, other party agrees to let corp. be liable instead (novation)
Corp not liable prior to incorporation
Corp. becomes liable by adopting/ratifying pre-incorporation contracts
Corp. relieves promoter of liability post-incorporation
Corp. may indemnify promoter, post-incorporation

De Facto vs. Estoppel

De Facto: Corporation was not properly organized
Promoter tried in good faith to organize
Promoter acted as if was corp.
You ask lawyer to form corp.
You buy computer for corp. from IBM on credit
IBM thinks it is selling to corp.
Your business fails – you discover lawyer never filed corp. papers
IBM sues for $$ of computer – tries to sue you individually
Ct. could find “de factor” corp., and shield you from personal liability (as if you were a SH)

But – what if you did not make good faith effort to incorporate?
No de facto corp. (no good faith effort)
BUT, IBM dealt with you on premise (belief) that you were a corp.
IBM may be estopped from denying that you are a corp.

BLaw 425 – Class 6
Spring 2009

Shareholder Derivative Suits

Corp. is a “legal person” (separate entity)
Distinct from SH, directors, officers (D/O)
Can sue and be sued
If corp. is harmed, cause of action belongs to corp. (not SH)
Derivative Actions arise from:
rd rd
Harm to corp. by 3 party (3 party could be a D/O, or related to a D/O)
Corp. refuses to sue 3 party – to recover (e.g., “lost” or “stolen” value)
SH (who is “harmed”) wants to “compel” corp. to sue 3 party
If SH successful – recovery will be to corp. not SH (Corp. is “nominal” ∆)
Direct vs. Derivative suit (suit brought by SH of Corp):
Direct: suit to benefit SH directly – SH is suing corp. for SH recovery
Derivative: suit to compel corp. to sue 3rd party – to recover “loss”

Shareholder Derivative Suits

Example 1
ABC Corp. has contract with Jane.
Jane breaches, but ABC doesn’t sue.
May SH sue Jane directly (or derivatively)?
Example 2
ABC Corp.’s treasurer embezzles all its money and disappears.
SH stock is now worthless.
May SH sue treasurer directly (or derivatively)?

Derivative Suits (cont’d)

Example 3
Tina was run over by cab operated by Sean Corp. Sean Corp.
has little assets/insurance.
Sam SH owns Sean Corp.
Tina wants to pierce the corp. veil and sue Sam. Is this direct or
Neither – it’s a trick question (why?)
Derivative Suits (cont’d)
Example 4
Dan is a director, officer and SH of Acme, Inc.
Dan is indicted by DOJ for antitrust violation (related to Acme
product prices set by Dan)

Acme refuses to pay Dan’s legal expenses
Dan sues Acme seeking payment (under DEL indemnification
statute). Direct or derivative?
Neither – it’s a trick question (why?)
Shareholders vs Directors
IfSH are unhappy about actions taken by Directors, what
can they do?
Sell their shares
Elect new directors

What is “The Demand”?

Typically a letter from shareholder to the board of directors.
Must request that the board bring suit on the alleged cause of action
Must be sufficiently specific as to apprise the board of the nature of the
alleged cause of action and to evaluate its merits
Must identify the alleged wrongdoers, describe the factual basis of the
wrongful acts and the harm caused to the corporation, and request remedial
Shareholders must make “demand” before filing suit …
unless it’s futile
Demand required – unless excused
Excused when futile
Legal effect of making Demand
Concession that demand was required
May no longer litigate demand excusal issue
Almost certain to lose – corp. dismiss demand

Business Judgment Rule

The management of the business and affairs of a corporation is entrusted to its
Court will presume that in making its decisions, the directors acted:
on an informed basis (due care)
in good faith
in (their belief that their actions were in) the best interests of the company and its
Plaintiff will have to overcome this presumption
Court will not examine reasonableness of board’s decisions
Plaintiff can overcome this presumption by a showing of:
Illegality, Fraud, or Self-dealing (conflict of interest) of BOD

Dodge v. Ford Motor Co.
“A business corporation is organized and carried on primarily for the
profit of the stockholders. The powers of the directors are to be
employed for that end. The discretion of directors is to be exercised
in the choice of means to attain that end, and does not extend to a
change in the end itself, to the reduction of profits, or to the
nondistribution of profits among stockholders in order to devote them
to other purposes.”
Page 292
Limited Liability Companies
Cross between partnership and corporation
Tax advantages of partnerships
Limited liability of corporations
None of the restrictions (e.g., number and type of shareholders)
applicable to S corporations
Limited Liability Companies
Members typically contribute capital
Contribution may be cash, property, services rendered, a promissory note, or other
obligation to contribute cash, property, or to perform services.
Members stand to lose capital contributions, but their personal assets are not subject to
Tax Consequence
Income passes through to members
LLC does not pay taxes

Advantages of Pass Through (Partnership) Taxation

Profits are not subject to double taxation (as in corporation tax)
Losses flow through to owners
Capital gains flow through to owners and retain their tax attributes (i.e., are
subject to lower rates)
There is no penalty tax for accumulating profits within the entity
There are fewer negative consequences to transfers of assets between the
entity and owner(s)
Check-the-Box Regulations
Check-the-Box Regulations give LLC’s the ability to choose
their tax status without regard to the entity’s nontax legal
Can choose to be taxed as a partnership (flow-thru) or as a
corporation (separate entity tax)

LLC Formation
File articles of organization in the designated State office
Other formation tasks:
Choose and register name: LLC statutes generally require the name of the LLC to include
the words limited liability company, the abbreviation LLC, or similar phrases.
Designate office and agent for service of process
Draft operating agreement – the basic contract governing the affairs of a limited liability
company and stating the various rights and duties of the members
Add need for annual report to tickler list

Conversion of existing entities: Partnerships

ULLCA § 902 authorizes conversion of partnerships or limited
partnerships to LLCs
ULLCA § 903 (b)(2) converts debts of partnership to debts of LLC
Per 902(g), however, members remain liable as partners vis-à-vis pre-
conversion partnership debts
IRS treats conversion as a nonrecognition event
Conversion of existing entities: Corporations
No ULLCA provision for corp. conversion
Need to structure it as a merger into a corp.
IRS treats as a potential tax recognition event
Tax free reorganization provisions do not apply

LLC Members’ Interest

A member's rights include:
Financial interest
Right to distributions
 Liquidation participation
Management rights
Financial Interests
Profit and Loss Sharing
Absent contrary agreement, most statutes allocate profits and losses on the
basis of the value of members' contributions
Member may withdraw and demand payment of his/her interest upon giving
the notice specified in the statute or the LLC's operating agreement
Management Rights
Absentcontrary agreement, each member has equal rights in the
management of the LLC
Most matters decided by majority vote

Significant matters require unanimous consent
E.g., merger, admission of new member, dissolution, etc...
Manager-managed LLC option available
Can be structured as a “board of directors,” a CEO, or both
Must be specified in articles of organization

Assignment of LLC Interest

Unless otherwise provided in the LLC's operating agreement, a member
may assign his financial interest in the LLC
An assignee of a financial interest in an LLC may acquire other rights
only by being admitted as a member of the company if all the remaining
members consent or the operating agreement so provides.
Analogous to partnership rules

Fiduciary Duties
Manager-managed LLCs
The managers of a manager-managed LLC have a duty of care and loyalty
Usually, members of a manager-managed LLC have no duties to the LLC or its members by
reason of being members
Member-managed LLCs
All members of a member-managed LLC have a duty of care and loyalty
Derivative Actions
Member may bring an action on behalf of the LLC to recover a judgment in its favor if the
members with authority to bring the action refuse to do so

No member or manager of a limited liability company is
obligated personally for any debt, obligation, or liability of the
limited liability company solely by reason of being a member
or acting as a manager of the limited liability company
But veil piercing in the LLC is possible

Dissociation v. Dissolution
Withdrawal or expulsion of a member
Winding up of LLC triggered
Unlike Partnerships, dissociation does not necessarily lead
to dissolution
Dissociation Without Dissolution
Dissociated member’s interest must be purchased by the

Buy-Sell Agreements may specify
Judicial appraisal proceeding available
Member’s right to participate in firm business terminates
Exception for participation in a post-dissolution winding up
BLaw 425 – Class 7
Spring 2009

Balance Sheet (B/S)

Estimate of company worth on a given date
Assets (A) – Liabilities (L) = Owner’s Equity (E): A – L = E
Assets = economic resources
equipment, cash, land, A/R (accounts receivable)
Liabilities = creditors’ claims on company’s assets
debts, notes, A/P (accounts payable)
Owners’ equity = owners’ claims on company’s assets
net worth, retained earnings, surplus

Income Statement (I/S)

Profit or loss from a firm’s operations over a given period of time
Sales (Revenue) – Expenses = Profits (Net Income)
Revenue - from sale of product or service
Costs of producing product or service (Cost of Goods)
Operating expenses (marketing, selling, general and administrative expenses, and depreciation)
One time charges
Financing costs (interest paid)
Tax payments

Kamin or Dodge?
Kamin: “the question of whether or not a dividend is to be declared
or a distribution of some kind should be made is exclusively a matter
of business judgment for the Board of Directors”
Dodge: Courts will intervene when “refusal to [pay a dividend] would amount
to such an abuse of discretion as would constitute a fraud, or breach of that
good faith which they are bound to exercise towards the stockholders”

Kamin: BJR
Court says:
“A complaint which alleges merely that some course of action other than that pursued by the
Board of Directors would have been more advantageous gives rise to no cognizable cause of
Courts have more than enough to do in adjudicating legal rights and devising remedies for
wrongs. The directors’ room rather than the courtroom is the appropriate forum for thrashing
out purely business questions which will have an impact on profits, market prices, competitive
situations, or tax advantages.”
“We do not want to go there!”
Business Judgment Rule
Liability Standard for Board
No liability for negligence (“stupidity”)
Liability based on:
Illegal conduct
Court Deference to Board
Court will not review Board decisions
Court will review Board processes
Business Judgment Rule
Court will not interfere
unless a clear case is made out of
Fraud or illegal action
Oppression, Self-dealing or collusive
Bad faith or unconscientiously
Errors of judgment – NOT sufficient for court to interfere
Directors may be held liable for gross negligence in failing to make an informed decision
Directors must inform themselves of “all material information reasonably available to
Court will review the decision-making process

Van Gorkom
Deal Terms
$55 per share cash – all outstanding shares
Merge TU in sub of Marmon Group Inc (wholly-owned by Jay Pritzker)
90-day “test” period – TU could receive bids (but not solicit)
TU could only provide public info to bidders, not proprietary info
JP could purchase 1M new shares of TU at $38/sh
Deal contingent on JP obtaining financing (for LBO)
TU had one day to accept the deal

Merger – “normal” process

Discussions with BOD about desirability of selling company
BOD may agree to begin discussions; solicit offers
Identify potential acquirers

Begin discussions with potential acquirers
Obtain LOI (Letter of Intent) from an acquirer
Non-binding description of proposed deal terms (5-10 pages)
Board considers LOI – may reject, accept, or recommend counter-offer
Consult with experts, or accept contingent upon reports from experts
If all goes well – proceed to full-fledged Merger Agreement (50-100+ pages)
Board again considers agreements, consults with experts, approves
Agreement is submitted to shareholders for approval
If all goes well, Merger Agreement approved and signed
Parties complete the closing tasks required by the Agreement
Close Merger

VanGorkom - Issues
Derivativevs. Direct?
Price: Control Premium
$55 vs. $38 – why is this not a “no brainer”?
90-day “test period” (limited “no shop”)
Why not good enough? What happened to KKR and GE Credit?
MBO vs. LBO – what’s the difference?
1 day for BOD to decide – “take it or leave it”?
20 minute presentation; never read the documents
VanGorkom – Players
JP – big time wheeler-dealer/professional
Why not liable? Why not a defendant?
VG – retiring CEO/ “amateur”
What were his motives? What did he do wrong?
BOD – smart, sophisticated, knew TU’s value
What did they do wrong? What happened to BJR?
Senior Management – threatened to quit
Why? What effect?
SH – voted strongly in favor on the proposal
Why didn’t that validate the price/deal?
Officer/expert reports – attorney, CFO, COO
Why weren’t their reports good enough? DGCL §141(e)

DGCL §141(e)
“A member of the board of directors, or a member of any committee designated
by the board of directors, shall, in the performance of such member’s duties, be
fully protected in relying in good faith upon the records of the corporation and
upon such information, opinions, reports or statements presented to the
corporation by any of the corporation’s officers or employees, or committees of
the board of directors, or by any other person as to matters the member
reasonably believes are within such other person’s professional or expert
competence and who has been selected with reasonable care by or on behalf of
the corporation.”
Effect of Van Gorkom
Outcome surprised everyone!

Suddenly and unexpectedly imposed liability on directors (possibly millions)
New legal standard: obtain all material information “reasonably available”
Boards now spend $$$$ to insure process
Reports from attorneys, accountants, experts
Valuation Reports, Fairness Opinions, …
Credible, contemporary evidence of deliberation
Document in extensive minutes of board meetings

Outcome of Van Gorkom

Information is costly
Where is point of diminishing returns?
Form over Substance: how much is 2 + 2?
Shortly after sale to JP:
Glut of rail cars – rates plummet
Competitors of TU file for bankruptcy
Is this relevant?
BJR and Duty of Loyalty
BJR: presumes that, in making a business decision, the directors of a
corporation act on an informed basis, in good faith, and in the honest belief that
the actions taken are in the best interests of the company.
Those presumptions can be rebutted if the plaintiff shows that the
directors breached their fiduciary duty of care or of loyalty or acted in bad
If that is shown, the burden then shifts to the director defendants to
demonstrate that the challenged act or transaction was entirely fair to the
corporation and its shareholders.
Duty of Loyalty
“The ‘business judgment rule,’ however, yields to the
rule of undivided loyalty. This great rule of law is designed
‘to avoid the possibility of fraud and to avoid the temptation
of self interest.’”
Burden of Proof – shifts to defendant
Defendant must show what?
Transaction was fair to the corporation

DGCL § 144
(a) No contract or transaction between a corporation and 1 or more of its
directors or officers, or between a corporation and any other corporation,

partnership, association, or other organization in which 1 or more of its directors
or officers, are directors or officers, or have a financial interest, shall be void or
voidable solely for this reason, or solely because the director or officer is present
at or participates in the meeting of the board or committee which authorizes the
contract or transaction, or solely because any such director’s or officer’s votes
are counted for such purpose, if:
DGCL § 144
(1) The material facts as to the director’s or officer’s relationship or interest and as to the
contract or transaction are disclosed or are known to the board of directors or the committee,
and the board or committee in good faith authorizes the contract or transaction by the
affirmative votes of a majority of the disinterested directors, even though the disinterested
directors be less than a quorum; or
(2) The material facts as to the director’s or officer’s relationship or interest and as to the
contract or transaction are disclosed or are known to the shareholders entitled to vote thereon,
and the contract or transaction is specifically approved in good faith by vote of the
shareholders; or
(3) The contract or transaction is fair as to the corporation as of the time it is authorized,
approved or ratified, by the board of directors, a committee or the shareholders.

“.. . A majority of the total number of directors shall constitute
a quorum for the transaction of business unless the certificate of
incorporation or the bylaws require a greater number. . . .” (§ 141(b))
Common or interested directors may be counted in determining the
presence of a quorum at a meeting of the board of directors or of a
committee which authorizes the contract or transaction. (§ 144(b))

Disinterested Vote
§ 141(b): “The vote of the majority of the directors present at a meeting at
which a quorum is present shall be the act of the board of directors unless the
certificate of incorporation or the bylaws shall require a vote of a greater
§ 144(a)(1): “the board or committee in good faith authorizes the contract or
transaction by the affirmative votes of a majority of the disinterested
directors, even though the disinterested directors be less than a quorum”
EXAMPLE: BOD has 5 authorized directors. 3 show up at a meeting. 1 is “conflicted” and
required to abstain. The other 2 vote to approve. Did the action pass – under 141(b)?


BLaw 425 – Class 8
Spring 2009

Benihana: Del. §144(a) (1)

“Safe Harbor” for interested transactions, if:
The material facts as to the director’s or officer’s relationship or
interest and as to the contract or transaction are disclosed or are
known to the board of directors or the committee, and the board or
committee in good faith authorizes the contract or transaction by the
affirmative votes of a majority of the disinterested directors, even
though the disinterested directors be less than a quorum

Gantler v. Stephens (1st Niles)

1 Niles – holding company
Owns Home Fed. S&L (“Bank”)

1st Niles: People

Gantler – former BOD, current SH
Stephens – COB, CEO/President (1st Niles and Bank)
Kramer – BOD (1st Niles and Bank)
Heating/air co – provides services to Bank
Eddy – BOD (1st Niles and Bank)
Csontos – BOD (1st Niles and Bank)
Compliance officer/Corp. secretary (1st Niles and Bank)
Shaker – BOD (1st Niles and Bank) – succeeds Zuzolo
Principal of law firm in Niles, OH
Safarek – Treasurer and VP (1st Niles and Bank)

1st Niles: Sales Process

Depressed economy – low growth (2003)
CEO/founder – beyond retirement (no heir)
Good acquisition market for banks
BOD sought advice on opportunities available
August 2004 – BOD authorize Sale of 1st Niles
BOD retain special Financial Advisor (investment bank)
BOD retain special Legal Counsel (law firm)
September 2004 – BOD meeting – a management propose Privatize
Delist shares 1st Niles (from NASDAQ)
Convert Bank to state charter (instead of federal charter)
Reincorporate in Maryland
No BOD action – Sales process continues

1st Niles: Sales Process (cont’d)
December 2004 – 3 potential acquisition bids:
NOT retain 1st Niles BOD

BOD not consider bid further

$18/share (stock & cash) – 3.4% premium

Terminate BOD, but consider them for Cortland board

First Place
No statements regarding BOD retention
$18-$18.50/share (stock swap) – 3.4%-6.3% premium

December 2004 – BOD considers bids (at regular meeting)

Financial Advisor – all bids within acceptable range (better than keeping 1st Niles shares)
BOD – took no action on bids. Further discussed Privatization proposal.

1st Niles: Due Diligence

January 18, 2005 – BOD directs due diligence for possible sale with
Cortland or First Place
Cortland due diligence
Management/Advisor agree to Cortland’s due diligence request – schedule
Feb. 6 meeting
Fail to send materials to Cortland – Cortland cancel meeting; demand
Materials never sent – Cortland withdraws bid Feb. 10
Management tells BOD after bid withdrawn – of due diligence “efforts”

1st Niles: Due Diligence (cont’d)

First Place due diligence
First Place diligence request – Feb. 7, 2005
Stephens not provide materials, resist setting due diligence date
Agreed to diligence review (after Cortland withdrew bid)
First Place revised offer – March 4th
Improved exchange ratio – 11% premium
Financial Advisor approved

1st Niles: Sales Process End

March 7, 2005 – regular BOD meeting
Stephens presents First Place revised offer
Financial Advisor suggest may increase offer

BOD does NOT discuss offer - Stephens propose defer discussion until next BOD meeting
Financial Advisor – First Place is unlikely to wait 2 weeks for response

Stephens propose special meeting March 9 – to discuss

March 8 – First Place increase offer
March 9 – special BOD meeting
Stephens presents revised offer to BOD
Financial Advisor approves

NO BOD discussion or deliberation

BOD vote 4-1 reject offer (Gantler votes to accept offer)
Stephens discuss Privatization – direct Legal Counsel to investigate

1st Niles: Privatization Proposal

April 18, 2005 – Privatization Proposal
Circulated to BOD
Reclassify shares of holders with <300 shares
From Common to new Series A (1-1 exchange)
Series A pays higher dividends
Other rights similar to common except limited voting rights (sale only)

Claim Reclass. would achieve flexibility and lower cost

April 20 – special committee for Reclassify
Reincorporate in new state
Change from federal to state charter bank
Deregister from NASDAQ
Delist shares

1st Niles: Reclassification Approval

Dec. 5, 2005 – present Reclass. Proposal to BOD
Special Outside Counsel present orally (no written materials)
BOD vote 3-1 to proceed (Gantler dissent)
Change in BOD
Jan. 2006 - Shaker replace Zuzolo (passed away)
April 2006 - Csontos replace Gantler
June 2006
BOD determine Reclass. is “fair” to SH (both common and Ser. A) – based on advice of
Management and counsel
BOD vote unanimously to amend Certificate – reclassify shares

1st Niles: Proxy

June 29, 2006 – Prelim. Proxy to SEC
August 10 – amended Prelim. Proxy filed
Gantler initiate lawsuit
Proxy – false and misleading
BOD corrected and file definitive Proxy – send to SH
Nov 20 – Plaintiff amend complaint
Proxy contains material misstatements and omissions
Dec 14, 2006 – SH approve Reclass
57.3% approval overall
50.28% approval – disinterested SH only
1st Niles: Complaint
Breach of Fiduciary Duties
1) Sales Process: rejecting First Place merger offer (and
Cortland due diligence process)
2) Proxy: False and misleading statements
3) Reclassification – structure
Trial Ct. dismissed complaint – ð appealed
1 Niles: Count I – Duty of Loyalty
“a presumption that in making a business decision the directors of a corporation acted on an informed
basis, in good faith and in the honest belief that the action taken was in the best interests of the
ð have burden of proof – to rebut presumption
Directors breached duty of care or loyalty

ð claim reason BOD reject merger:
Want to retain BOD positions, pay, prestige
No deliberations; disregarded Financial Advisor advice
S. Ct.: 2-prong analysis
Was BOD decision reached in good faith pursuit of legitimate corporate interest (Duty of Loyalty)?
Did BOD reach decision advisedly (Duty of Care)?
Need “yes” to both – for BJR presumption

1st Niles: Merger - BOD actions

Merger will cause BOD to be terminated
Not enough to show disloyalty to corporation
Mergers always mean change in BOD – not all rejections are in bad faith
Need to show more – to imply disloyalty
Facts Establish Director Conflict
Proxy admits D/O conflict – interests benefited differently than non-affiliated SH
Majority BOD conflicted
Stephens – sabotage Cortland and First Place bid
Kramer – Heating co. services to Bank would be lost
Zuzolo – Law firm, real estate firm provided services to Bank

Not need to show failure of due care (to act advisedly)

Burden of Proof switches to ∆ - to show loyalty to company (Entire Fairness standard)

1st Niles: Merger - Officer actions

Officers owe Fiduciary Duties – similar to BOD
Stephens and Safarek
Responsible for due diligence materials
Stephens – violate duty as BOD, also as officer
Safarek – aided and abetted Stephens
Stephens was his boss – needed to keep job
Could not act independently チ¨ assisted Stephens to “sabotage” due diligence

1st Niles: Count II - Proxy

Duty to disclose all material info – in seeking SH approval
Insufficient deliberations by BOD – in rejecting First Place bid
Not disclosed in Proxy チ¨ false and misleading
BOD claimed they “carefully deliberated” First Place bid
Materiality Standard
ð has burden of proof to show
“asubstantial likelihood that the disclosure of the omitted fact would have been viewed by the
reasonable investor as having significantly altered the ‘total mix’ of information made available”
FN 44 – SH would consider omitted fact important in deciding vote
Does not require proof that SH would have changed vote
But omitted fact would have been significant in SH deliberations
Altered “total mix” of information available

1st Niles: Count II – Proxy (cont’d)

∆ claim deliberations occurred outside of BOD meeting
rejecting bid
Discussions at other BOD meetings
Facts outside of the record

Cannot be used for motion to dismiss
S. Ct. reversed on Count II
1st Niles: Count III – SH ratify
ð: BOD Recommend Reclass.
Breach duty of loyalty
Recommendation based on self-interest
Stock buy-backs
Trigger “put” and appraisal rights under ESOP

Tr. Ct. – dismissed claim due to SH ratify

S. Ct. – no SH ratification
SH vote required to amend COI
Cannot use vote to ratify BOD conflict of interests
Proxy contained material misrepresentation
SH vote not fully informed

1st Niles: SH ratification doctrine

Common law doctrine – fractured
Classic: SH approve BOD action – that does not otherwise require SH vote
Expanded: Informed SH vote – on action that does require SH vote anyway
Implies SH ratifies BOD decision anytime they approve any action
S.Ct. – SH ratification is limited to “Classic” form
Applies only to (i) fully informed vote, (ii) not otherwise required (by statute)
Ratification only applies to specific action voted by SH

In re Disney
Ovitz as new President – 5yr contract
BOD compensation committee approved
Expert (Crystal) advised Employment Agreement (OEA) was reasonable
BOD approved OEA
14 months later – Ovitz fired
Not get along with executives and BOD
Severance: $38M cash; with options = $130M!!

Disney Claims
Due Care – in approving OEA
Not “best practices”, but not breach
Committee & BOD knew value of options
Dutyto act in “Good Faith”
Bad Faith examples:
Act with purpose other than advancing corporate interest
Violate known laws
Fail to action in face of known duty to act (conscious disregard for duties)

Corporate Opportunities
Objective of Doctrine:
To deter appropriations of new business prospects “belonging to”
the corporation
Officers & Directors of corporation
Dominant Shareholders who take active role in managing firm

Corporate Opportunity Test

A corporate opportunity exists where:
Corporation is financially able to take the opportunity
Opportunity is in the corporation’s line of business
Corporation has an interest or expectancy in the opportunity
Embracing the opportunity would create a conflict between director’s
self-interest and that of the corporation
“Initial Public Offering”
The first sale of stock by a company to the public
Underpricing of IPOs
Refers to the phenomenon that IPO price is typically 5-15% below the closing price on the
first day of trading, sometimes as much as 100-200%
Spinning: Allocating hot IPOs to the personal brokerage accounts of top
executives in return for company business
Guaranteed profit due to consistent underpricing

Corporate Opportunity