Unit 1 - The Nature of the Firm

Tuesday, August 30, 2016

3:09 PM

3-24
Unit 1 Class Notes

Meinhart case
o Not initially a typical corporations case
o Important because looking at active vs passive management
o Had an active manager and a passive one who was just for money
o In regards to the article he sent us before school, the price mechanism does not work anymore
The price to the business is determined by the market place, but the article says that has gotten
really expensive
Think of the make or buy decision
A company like GM will buy brakes for their cars elsewhere unless it is cheaper for them to
make the brakes
Risk is quantifiable uncertainty
o Shirk - to avoid or neglect a duty or responsibility
Money closer in time is worth more to us than money further out in time
o The annual discount rate bears a relation to interest rates
o Time value of money
FV (future value) = PV (present value) x r (rate, aka interest)
PV = FV/r
Multiple time periods forward, divide by I for as many time periods as there are
EX)
PV = FV in (n) years / (1+r)^n
Coase Theorem
o LOOK UP
o Parties have the right to contract around rules
o Welfare economics
Externalities

9/6
Tuesday, September 6, 2016
2:02 PM
Contd unit 1 outline, starting from inherent business risk

Can look at US T bills for the risk free rate

Meinhard v. Salmon
o Calculating Meinhard's return
Assume an investment of $100,00

Worst

Meinhard's Share

Probability Expected Annual

Return

($6,000)

20%

($1,200)
1

Case
Likely
Case

$10,000

50%

$5,000

Best Case $15,00Higher the interest rate, the higher 30%

the risks in investing with the business
Risk and return, r is the key*** in the
formula
0

$4,500

Weighted average expected annual return = $8,300

Internal Rate of Return (IRR) - 1
The metric used to determine whether to make an investment
What would discount rate would be required to make the present value of net cash flow
(including the initial investment) equal zero?
Hypo with the numbers
Assumptions
The partnership lost $50,000 per year for the first 3 years
The partnership made $50,000 per year in operations over the past 17 years
Initial investment $200,000
$100,000 per partner
Operating expenses
Rent - $55,000 per year
Other - $45,000 per year
Total = $100,000 per year
Lease revenue
1st three years - $50,000/yr = $150,000
Last 17 years - $150,000/yr = $2,550,000
Status of 3rd year
$200,000 investment + $150,000 loss = ($350,000)
($175,000 per partner)
Twenty year status
Total revenue = $2,700,00
Total expenses = ($2,000,000)
Total investment = ($200,000)
Rate or return on initial investment = ~9.12%/yr
Potential costs
o Transactional costs
Think closing fees in real estate
Agency costs
Think a broker
Default and mandatory rules
Default rules come with the package
They are in the statute
They are the rules that govern unless you change them
Think partnership, default rule would be share profits equally, unless changed
Mandatory rules are ones that cannot be changed
In DE you HAVE to have a board of directors, no exceptions, its a mandatory rule
Debt vs. equity

LOOK UP
Review of quiz 1
The most significant aspect of equity in a firm is
A residual interest in the business after all the revenue has been collected and expenses
paid
The time value of money
Means that money to be received in the future is worth less than the same amount
received at present
A transaction cost is
The cost of accomplishing a transaction, such as a broker's commission
An agency cost is
A transaction cost incurred in which the agent's interest does not align fully with that of
the principal
The "Coase Theorem" holds that:
In theory, if there are no transaction costs, the default rules of law are clear, and the
parties have freedom to contract around the default rules, the initial allocation of rights
A default rule in the law of business enterprises is one
Embodied in statutes or case law
Meinhard is significant because
It involves the relationship between an active manager and a passive investor

Unit 2 - Intro
Monday, September 5, 2016
5:17 PM

25-54, 151-155

Fundamental Shareholder Rights

o
Voice views on various issues
o
Litigate claims against the corporation and its directors, officers, and controlling shareholders
o
To exit the corporation, by selling shares
Tax status
o
Most public corps are "C corporations"
o
Most private corps are "S corporations"
Articles of incorporation
o
Constitution for the corp
Bylaws
Organic documents
o
Bylaws and articles of incorp
Corporate actors
o
Shareholders
o
Directors
o
Stakeholders

Creditors, employees, customers, and the community

People and institutions who are involved with and depend on the corporation but do not
fit the legal categories of shareholders, directors, or officers
Corporate securities
3

Debt securities
Equity securities
Authorized, issued and outstanding shares
Corporate fiduciary duties
o
Duties of care and loyalty
o
Business Judgment Rule (BJR)
o
Liability to corporation and stakeholders
o
Duties of shareholders
o
o
o

Class Notes Unit 2

The nature of the corporation
o Conceptual metaphors
Corporation as a Web of contracts
Corporation as a church
Corporations are institution in which the rights of the citizens have been modified and coded
The rights come from bylaws, from other writings
Codification of the rights are really the skeletons of the corp
Vocabulary
o Corporate fundamentals
As distinct from partnership
Profit vs non-profit
Public vs closely held
o Technology
Incorporation
Articles/cert of incorporation
Board of directors
Bylaws
Officers
Shareholders
Other stakeholders
o Corporate finance
Debt
Private
Public
Cost of debt
Equity
Common stock
Preferred stock
Authorized, issued, and outstanding
Authorized is # in articles of incorp that they can issue
Issued is the number that has been issued for sale
Outstanding is issued minus treasury shares
Treasury shares is any repurchased stock held by the corp
Cost of equity
o Basic rules
Business judgment rules
Presumption the board is making decisions in the best interest of the shareholders
4

Courts believe the board is in the best possible position to make business decisions
for the corp
Must be disinterested, independent, informed, and making the decision based on a
rational business purpose
Duties of care and loyalty
The duty of care stands for the principle that directors and officers of a corporation in
making all decisions in their capacities as corporate fiduciaries, must act in the same
manner as a reasonably prudent person in their position would
Duty of Loyalty in corporation law to describe a fiduciaries' "conflicts of interest and
requires fiduciaries to put the corporation's interests ahead of their own." "Corporate
fiduciaries breach their duty of loyalty when they divert corporate assets, opportunities, or
information for personal gain."
Derivative and direct actions
Derivative is a lawsuit brought by a shareholder on behalf of a corporation against a third
party. Often, the third party is an insider of the corporation, such as an executive officer or
director.
Corp would be P, any settlement or judgment belongs to corp
Direct action is Shareholder suing the corp for a direct harm the shareholder suffers
Rules in action: changing the annual meeting
No constitutional right to form a corporation
o Whatever not in const is left to the states
o Therefore state laws and codes are the primary sources of law
Articles of incorporation
o In DE its the certificate of incorporation
Deleware Chancery Court is one of the biggest court we will deal with
o Court of chancery, not court of law, so no juries
Vocabulary
o Corporation vs partnership
You can have an inadvertent partnership, but you cant accidentally form a corporation
You have to go out and fill out the paperwork and take the actual steps to create a
corporation
Legitimacy of the double tax
o Comes from allowing a corporation to be its own entity, its own person
Tax the income of the corp, then also tax the dividend paid to shareholders
o Doesnt apply to partnerships or LLCs since they arent their own entity
Pass through something
o Corporations are subject to C in the internal revenue code
Taxed on its profits at the corporate tax rate
The shareholders of a C corporation are not taxed on the corps profits
They are only taxed when given dividends
Corporations can file to become an S corporatin
o Taxed like a partnership, no double taxation
35 employees or less
Domestic
All shareholders are people or trusts for people
Kentner factors (how to distinguish if you have a corp or a pass through partnership)
o In order to be a pass through partnership, you need to not have 2 of the 4. if you have 3 or more you
are a corp
o Is your org one of limited liability?
5

Corps are
Shareholders arent liable for more than their investment
o Are you an organization with centralized management?
Typically corps yes, partnerships typically not
o Do you have or does your org have perpetual existence?
o Is ownership transferrable?
Typically shares are transferrable
*** typically, for above you would be a partnership if you lacked two of the four above, as deemed by the
IRS
Non profit
o Enforcing agency is not shareholders, typically the attorney general
o There are no shareholders to hold them accountable
o Even if non profit makes a profit, just doesnt distribute to shareholders
Public vs private
o Public is traded on DOW and NASDAQ, for example
Regulated by the SEC
Board of directors
o Subsection A, section 141 DE corporate law
Rule that says every corp has to have a board of directors
Board of directors manages the corp, not the shareholders
o Model business corporation act is a little different
Mandates a board of directors unless the shareholders agree not to have one
7.32
o Directors are not agents
Directors has no power over managing, they only have a vote or the ability to influence others in
a directors meeting
Cannot bind the corp
They are a unique body, the represent you like a congressman but owe you a fiduciary duty,
unlike a congressman

Terminology
o
If you do not fill out bylaws, your state will fill them in
o
You cannot legally divest the shareholders of their ability to amend the bylaws

Think of it as someone agreed to the terms of the contract then tries to unilaterally change
the terms, that should not be allowed
o
MBCA says since board of directors can amend the bylaws, the shareholders can say their
amendment is final and cannot be amended by the board

Bylaws are ministerial until they give someone an advantage

Under DE law, you have to have at least one officer that can sign instruments and stock
certificates, and has the duty to keep the minute books

8.42 in MBCA

But in DE this arises from case law

o
Implied authority

Example president has authority to manage a business day to day affairs

So he can hire a vp with implied authority

Its not expressly stated they have the authority to hire a vp, but if it falls under day
to day activities it is implied
o
Shareholders

Owners of equity

Do not have to be human beings

6

Rights are determined by the statute, corporation code, cert of incorp, bylaws
Ability of shareholders to vote for board of directors is a default rule that can be changed
No provision in mbca says you have to have shareholders

DE has something to deal with this tho

o
Stakeholders

Are corps stakeholders of the community?

You want the community to thrive so that good employees will want to come
work for your company where it is located
Nobody wants to go move to detroit for work for example
o
Preferred stock vs. debt

Unlike debt, if there isnt sufficient surplus in the corp, if there is some bar to paying
dividends, they cannot be paid (thats why stock rather than debt)

Non cumulating (regular stock), so if the board decides dividends cannot be paid
itll never be paid

If you negotiated for preferred cumulating stock, when dividends can be paid
again then you will be owed everything that was not paid before
o
The articles for cert of incorp will state how many shares of stock the corp is allowed to issue

You pay the state per share for the right to issue shares

The more shares, the higher your franchise tags

o
Just because a corp is authorized to issue shares, they dont have to issue them
o
Outstanding shares

The number of issued shares minus the number of treasury shares

o
Treasury stock

Shares the corp bought and keeps

These are not outstanding

o
Equity
o
Corp is not being run for the benefit of the directors or the officers

Being run for the benefit of the shareholders

Business judgment rule
o
In ordinary circumstances, the officers and directors are in better positions to make business
decisions than the courts are, and the courts accept that
o
Need for these things tobe true:

***look up the things

o
On the other hand, the directors and officers have fiduciary duties of care and loyalty

Duty of care means you take the expected care in doing your job

You do your job well

Duty of loyalty means you must act in a way that always puts the interest of the
corporation ahead of your own
o
If you dont follow these, the court will examine whether you have breached a fiduciary
responsibility and not follow the business judgment rule
Distinction between a derivative action and a direct action
o
Derivative action is the avenue by which a shareholder would vindicate its fiduciary rights
against corporate officers and directors

Ex: suppose board learns president has been using the purchasing department something
at above market price from wife's company

Pres has certainly violated his fiduciary duty

He could be sued for restitution of the gain

Who would the parties of the lawsuit be?

Corporation itself would be a party as the plaintiff

7

Board decides whether to sue or not

If board is corrupt and decides not to sue because they are in on it, the
shareholders can then decide to sue

This is a derivative action

23.1 and 7.6 rules of the mbca

Here, shareholder is only suffering harm because the corp is suffering

harm
Contrast to the derivative is a shareholder direct action

Claim has to be one the shareholder suffered directly in the shareholder status as a
shareholder

Ex: youre a shareholder of preferred stock. One term is that the corp shall redeem
the stock after 10 years, but the corp hasnt redeemed it. You sue the corp to get a
redemption of the shares

Unit 3 - Corps as Social Orgs

Friday, November 25, 2016
3:43 PM

57-72; 80-87; 89-105

A corporation can be incorporated, or "chartered", in any state even if it does not do business there
Sarbanes-Oxley Act
o
2002
o
Imposed federal standards in a number of areas previously subject to corporate state law
o
Specified the functions and membership of the audit committees of public corp boards, required
senior corporate execs to personally certify the corp's financial statements, banned public corps from
making loans to their directors and execs, and told the SEC to require lawyers who represent public
corps to become "whistle blowers" when there is evidence of corp corruption or fraud
o
Most importantly

Section 404 requires public corps to undertake the costly process of assessing their
internal controls over financial reporting and possible corporate wrongdoing
Dodd-Frank Act
o
2010, Dodd-Frank Wall Street Reform and Consumer Protection Act
o
Required new rules regarding "say-on-pay", a required vote by shareholders on the compensation
practices of public companies
o
Section 1502 required the SEC adopt a rule requiring disclosures by corps whos products contain
"conflict minerals, such as tin, tantalum, tungsten, and gold"
Internal Affairs Doctrine
o
Widely accepted choice of law rule
o
Says wherever business is incorporated, the laws of that state will govern any dispute regarding
the corp's "internal affairs"
State corporate law will be a mix of statutory law and common law
Who does a corporation serve?
o
Theories

Corp as a Private Property

Corp is crested to maximize profits for shareholders, and the only social
responsibility is to maximize profits. Social responsibility is govt or people's
responsibility
8

Corp as a social institution

Dodge v. Ford Motor Co.
o
Often cited as support of shareholder primacy view

"a business corporation is organized and carried on primarily for the profit of the
shareholders."
Theodora Holding Corp. v. Henderson
o
Court adopts a "reasonableness" standard for reviewing corporate giving

Class Notes Unit 3

o How we got here
A brief history
State chartering
Corporate personhood
Federal intervention
Internal affairs doctrine
o Why is Delaware so important
o Property or Institution
o The broad view of corporate purpose
Dodge v. Ford Motor Co.
Charitable Giving
US corporate law timeline
o Pre 1800
State legislative special chartering
o 1800-1850
General incorporation statutes
Didnt need legislative permission
Avoid corruption
Limits on capital you could invest
Certain # of years it could exist
o 1850-1900
Sherman antitrust act (1890)
Deleware CGL (1899)
o 1900-1950
Federal securities laws (1933, 1934)
o 1950-2000
Takeover wave (1980s)
The "rights" tension in corporate personhood
o Individual human beings have certain unalienable rights, but robots have no rights
o Artificial mechanisms populated by human beings (i.e. corporations)
What rights do they have?
Some say they are humans so should have rights, otherss say more like robots so they should have less
rights
o Dartmouth College did a study looking at this
Human characteristics
Individuality
Ownership of prop
Freedom to manage and convey prop
9

Creating collective bodies of humans

Freedom from govt intrusion
Have rights even outside of what is written down
More robot characteristics
Artificial being
Invisible and intangible
Exists only because of law
No rights other than as conferred by character
Internal Affairs Doctrine
o Can have a corporation be subject to up to 4 state's laws
o States have all agreed through case law that the law of governance if a corp is sued depends where the corp
is incorporated
o Example of dunkin donuts, incorporated in DE but HQ is in Canton, MA
To be clear, a fired employee in Canton, MA can get personal juris in MA to apply MA discrimination
laws
But if a shareholder filed a derivative suit in MA, DE law would apply because DE is where dunkin is
incorporated
McDermott, Inc. v. Lewis
o Even tho McDermott was a public company, majority of shares owned by Mr. McDermott
He didnt wanna pay international taxes, so set up a corporation in Panama
Most shareholders exchanged their stock for stock in the company in panama
o 10% of the international corp stock is owned by the american subsidiary company
The other 90% was public shareholders
So effectively, management of the american company owns 10% of the vote of the international
company
Reason for this was to impede a 3rd party from being able to do a hostile takeover
o DGCL s160(c): "shares of its own capital stock belonging to the corp or another corp, if a majority of shares
entitled to vote in the election of directors of such other corp is held, directly or indirectly, by the corp, shall
neither be entitled to vote nor be counted for quorum purposes."
But this doesnt apply to the panama corp
Panama law then dictates the panama corp
Why DE?
o legislature
Legislature defers in DE called the Council of the Corporate Section
DE practicioners, most represent corps but some are plaintiff lawyers, and reps from SOS office
Any change to the statue in DE has to be approved by 2/3 of each chamber, per the DE
const
And only the people can amend the const
No single interest group really get to influence things
o Judiciary
Chancery court
So the judge knows the law thru and thru
DE Fed Ct is the most widely sought juris for patent litigation because the DE fed bench has a
reputation for understanding patent law
Generally, you can get juris in DE because corps are resident of DE
Staggered v unstaggered board of directors
o Unstaggered would be all are elected in the same year
o Staggered would be some elected this year, some next

10

Ways to prevent take over

o Poison pill
Created 1980s
Technically a "Shareholder Rights Plan"
Corp adopts this plan and existing shareholders are given rights to acquire more shares, but they only
vest and become useable if a 3rd party acquires more than 15% of the corp's stock
So existing shareholders would get this right to get all this new stock, but the new 3rd party
doesnt get these rights
Called a poison pill because it poisons the takeover
Question: does the corp violate a civic duty by taking a poison pill?
o Staggered board
If you have both a staggered board and a poison pill, there is NO WAY for you to be taken over
The "Purpose" Debate
o What is the purpose of the corp?
Shareholder asset or social institution?
Too much focus on money, not enough focus on social responsibilities and vise versa
Will sometimes be a pendulum and swing back and forth
o "artifact"
"something created by humans usually for a practical purpose; especially: an object remaining from a
particular period"
Ex: artifacts of cavemen found in caves
Dodge v. Ford Motor Co.
o Ford wanted to not pay dividends and invest the $17 mil into building a new plant
Injunction from the court
Employees have no standing to contest payment of dividends
o However, shareholders could have standing

Unit 4 - Corps and the Political Process

Tuesday, September 27, 2016
3:34 PM

111-132, Corporation as a political actor

Corporations are constitutionally protected people

Sup ct has held that constitutional protections for corps do not extend to non-commercial activities
o
Have no privilege against self-incrimination
o
Generally corps not protected from unreasonable (warrantless) searches and seizures
Tillman Act of 1907 prohibited corps from spending "treasury funds" (general corp assets) on campaign
contributions or independent expenditures "advocating the election or defeat of a clearly identified
candidate"
Federal Elections Campaign Act of 1971
o
Allowed corps and unions to establish "separate segregated funds," popularly called political
action committees (PACs)
o
PAC money comes from receiving voluntary contributions from people with ties to the corp, not
from the corp's treasury funds
11

So comes from shareholders, execs, and employees with their consent, intead of coming
from the corp's general funds as determined by managers who control the corp

Lobbying
o
Corporate lobbyists must register and disclose any payments they receive if they engage in
"direct communications with members of Congress on pending or proposed fed legislation"
o
However, things like tv ads and appearances, congressional testimony, letter-writing campaigns,
and comments on govt regulations are not subject to lobbyist disclosure rules

Pre-Citizens United case law

o
In 1978, Sup ct held that 1st Am limited the ability of states to regulate corporate speech in
connection with a referendum

First National Bank of Boston v. Bellotti

o
In 1986, Sup ct made clear that not all corps are the same and held that states could not ban
political advocacy by non-profit corps

Federal Election Commission v. Massachusetts Citizens for Life, Inc.

o
In 1990, Sup ct reversed direction and upheld the power of states to ban for-profit corps from
spending their treasury funds for or against political candidates

Austin v. Michigan Chamber of Commerce

Class Notes Unit 4
Tillman act 1907
o Made it illegal for a corp to make any contributions or expenditures in connection with any election in
which presidential or senators are elected, or for prmaries for either office
o Contribution directly to a campaign is still regulated
For example personal contributions are $2700
o Expenditures are everything else
o Doesnt address partnerships, LLCs, etc.
Only addresses corps
o LLCs are essentially partnerships unless you check the box to be a corp or are publicly traded
Federal Election Campaign Act 1971/74
o Set up the present PAC system
US Corporate Law Timeline
o Dartmouth College Case 1829
o Fourteenth Amendment 1873
o Santa Clara County v. Southern PAC RR (US 1888)
o Sherman Antitrust Act 1890
o Tillman Act 1907, amended 1947
o Federal Securities Laws 1933,34
o Fed Election Campaign Act 1971/74
o Takeover Wave 1980s
o SOX 2002
o D-F 2010
Citizens United Timeline
o First Natl Bank v. Bellotti (US 1978)
o FEC v. MCFL (US1986)
o Austin v. Michigan CC (US 1990)
o Bipartisan Campaign Reform Act (2002)

Bellotti Case
o State statute made it a crime for a business to make an expenditure for the purpose of influencing or
affecting a vote unless it affected the business or assets of the corp
12

Important
Dealing with expenditure, not a contribution
State statute
o Held that the statute was unconstitutional as invalidating the 1st am
No compelling reason to limit corporate speech
o Part of the reasoning was if youre worried about corps affecting elections then why is lobbying ok?
Nobody had attacked lobbying or said that was an 9
Austin v. Michigan
o State law said no $$ (contributions or expenditures)
o Fed Law held unconstitutional as it applied to a nonprofit corp set up for the express right to have
political expression
Bipartisan Case
o Said if the campaign itself doesnt run the ad on tv, then there has to be a tagline saying who ran it
Citizens United
o Politically active
o Nonprofit corp existing for the sole purpose for participating in the political realm
Therefore they argued Belotti case applied
Sup ct disagreed because Belotti case did not receive money from corps or unions
o Citizens united collected money from for profit corps
o Holdings
The issue here relates to expenditures, not to contributions
Nothing that permits unlimited contributions directly to campaigns
$2,700 contrbution limit still exists for individuals, and corps are still barred from
contributing irectly to campaigns
Govt may not limit political speech just because they are a corp
OVERRULES AUSTIN CASE
Election nearing ban in the Bipartisan Reform Act of 2002 is unconstitutional reform of political
speech
Also overrules McConnell
Disclaimer and disclosure provisions are all okay
Upheld as constitutional
o Kennedy (swing vote)
No restrictions on corporate speech was a 5-4 vote
Dissent: stevens, ginsburg, breyer, sotomayer
BCRA Disclaimer and Disclosures was an 8-1 vote
Only dissent was thomas
o Rationales
Cant limit free speech just because corp
Corruption argument doesnt hold (Austin Case, going against that case)
First amendment doesnt protect us from the fact that rich people can buy more ads than poor
people
Cant distinguish media corps from other corps
Argument that worries about shareholders that dont agree with the political views of the corp is
not an argument that holds merit
o Improtant question: does a corp get the same rights as a natural born person?
o CEO who makes a personal contribution to a campaign, can make a matching contribution out of corp
assets to a super PAC
If pac makes contribution to presidential campaign, the corporate contribution will be disclosed
o

13

Unit 5 - Forming and Managing the Corp

Friday, November 25, 2016
3:43 PM

157-171; 173-197

Formal requirements to form corp

o
Vary slightly state to state, but the MBCA is typical
o
Formally done by an "incorporator" who has no other role after filing

Incorporator signs and files the articles of incorp with Sec. of State

Incorporators under MBCA s 2.01

o
Pieces that must be included in the articles

Name of the corp

Number of shares authorized to issue

The name and address of each incorporator

The name and address of the corp's registered office and registered agent

Agent is the person and place to receive service of process or other official notices
o
After legally incorporated, an organizational meeting must be held

Done by incorporator or initial board

At this meeting, these must happen

Election of directors

Adoption of bylaws

Appointment of officers

Designation of a bank depository for corporate funds

Approval of the sale of stock to initial shareholders

MBCA s 2.05
MBCA s 2.02 tells us how to insulate directors from liability
o
Also is the thing that tells us what articles must set forth (see above)
ABA Model Rules of Professional Conduct Rule 1.13: The Organization as a client
o
Counsel represents the organization, no individual
"entity" vs. "aggregate"
o
Under the entity theory, the lawyer does not represent the individuals who constitute the
business, but only the corporation
o
Under the aggregate theory, assumes the lawyer represents both the corporation and the
participants within the corp
o
A lawyer who plans to only represent the entity should make that clear from the beginning

However, if the engagement letter suggests aggregate theory, the lawyer assumes ethical
obligations to each participant of the corp
MBCA s 2.03
o
Corp beings when articles are filed
When promoter (person making deal for corp that does not yet exist) contracts for the benefit of a corp
that is contemplated but not yet organized, he is personally liable on the contract in the absence of
agreement otherwise
o
The parties may agree to discharge the promoter's liability-but to do so they must agree there will
be a novation once the corp is formed and formally accepts the K
o
Question become some of intent
14

Factors courts consider:

The form of signature-did the promoter sign as an agent of the corp?

Actions of the 3rd party-did the 3rd party plan to look only to the corp for performance?

Partial performance-did the promoter's partial performance of the contract indicate an

intent to be held personally liable?

Novation-did the actions taken by the parties discharge the promoter's liability?
When the parties mistakenly believe a corp exists there are judicial approaches and statutory approaches
o
Judicial approaches

under the doctrine of de facto corporation, courts infer limited liability if

The promoters in the would-be corp had made a good faith effort to incorporate;

The promoters were unaware that the incorporation had not happened; and

The promoters used the corporate form in a transaction with a 3rd party

Under the doctrine of corporation by estoppel, courts prevent the 3rd party from asserting
the promoter's personal liability when the 3rd party had dealt with the business on the
assumption the only recourse would be against the business assets
o
Statutory approaches

MBCA s 2.04 creates a bright-line rule

Seems to preserve a version of the de facto doctrine, focusing on the lack of

knowledge (and thus "good faith") of the person purporting to act for the corp
MBCA s 8.01
o
(b) all corporate powers shall be exercised by or under authority of the board of directors of the
corp, and the business and affairs of the corp shall be managed by or under the direction, and subject
to the oversight, of its board of directors
Agency is a consensual relationship between two parties, the principal and the agent
o
The principal selects the agent, who then must agree to act on the principal's behalf
o
The principal has power to terminate the agency relationship unilaterally and can dictate to the
agent how the agent will perform his duties
o
The agent is a fiduciary of the principal, which means the agent owes to the principal duties of
loyalty, care, and obedience
o
An agent has the legal authority to bind the principal in legal relationships with 3rd parties with
either actual authority, implied authority, or inherent agency power

Two types of actual authority

Actual authority-principal manifests consent to the agent to bind the principal

Express authority-growing out of explicit words or conduct granting the agent

power to bind the principal, or may be implied from words or conduct taken in the
context of the relations between the principal and the agent

Apparent authority comes from written or spoken words or any other conduct that,
reasonably interpreted, causes a 3rd person to believe that the principal has consented to the
agent as acting for their behalf

Inherent agency power arises from the agency relationship to protect 3rd parties, despite
the absence of actual or implied authority

A general agent can bind a disclosed principal if the agent is generally authorized
to conduct transactions, the 3rd party reasonably believes the agent has authority, and the
3rd party has no notice otherwise

***seems that difference between inherent and implied is that implied is

between the agent and principal, whereas inherent is between 3rd party and agent to
protect the 3rd party on what they believe the power the agent has
o
A principal can also become obligated to a 3rd party by ratifying the act of another who, at the
time of the act, lacked the power to bind the principal
15
o

Can be inferred from acts, words, or conduct of the principal showing an intention to
ratify, and need to not be made to the agent
or even the other party

Authority of corporate officers are usually specified in

the corps bylaws
o
Ways to determine if officers have the power
to do something is always express authority since
it comes from the bylaws

Courts have developed a rule of thumb

to facilitate dealings between the corp and
third parties

One rule is the distinction

between "ordinary" and "extraordinary"
transactions

Essentially, officers do
not have the power to enter into
extraordinary transactions

Lee v. Jenkins Brothers

Case tells us the

court held that a life pension
offered by the company's president to attract a new executive could be found
within the president's apparent authority
Courts differ on how much they expect 3rd parties to investigate the powers of an officer
o
Courts are more likely to require 3rd parties to investigate corp authority when they are aware
that the transaction involves a conflict of interest
o
Another factor is whether the corp acquiesced to the transaction

Even inaction after a transaction with a 3rd party can be binding

Scientific Holding Co., Ltd. v. Plessey Inc. tells us that a corp's inaction following
a transaction with a 3rd party can have a binding effect

Called "corporate acquiescence"

Evidence to prove someone has power from their corp:
o
Provision of statutory law
o
Articles of incorp
o
By-law of the company
o
Resolution of the board of directors
o
Evidence that the corp had allowed the officer to act in similar matters and has recognized,
approved or ratified those actions
Times jurisdictions bind corps on agreements never approved at formal board meetings
o
Unanimous director approval
o
Emergency
o
Unanimous shareholder approval
o
Majority shareholder-director approval

If the directors who participate in the informal action constitute a majority of the board
and own a majority of the corp's issued shared, the corp is bound
o
If no common law exceptions in the state, the state may have adopted MBCA s 8.21

Says board action can be taken without a meeting on the unanimous written consent of
the directors
16

By signing a unanimous written consent, the directors can ratify a previous action where
there is concern the action was not properly authorized

Board meetings do not need to be in person

o
MBCA s 8.20(b) permits the board to conduct a meeting by "any means of communication by
which all directors participating may simultaneously hear each other during the meeting"

Statutory norm for quorum is a majority of the number of directors

Committees of the board

o
Executive committee

Can have the full authority of the board in all but a few essential transactions such as the
declaration of a dividend or approval of a merger

MBCA s 8.25(e)
o
Audit committee

Functions usually include selection of the corp's auditors, specification of the scope of
audit, review audit results, and oversight of internal accounting procedures
o
Finance committee

Responsible for giving advice on financial structure or new securities

o
Nomination committee

Nominating new directors and officers

o
Compensation committee

Fixing salaries and other compensation of execs

o
Board Risk Committee

Dodd-Frank requires all financial companies establish one

Class Notes Unit 5
Incorporation doctrine
Unit 5
o Organizing the corp
Mechanics
State of incorporation
Representation
o Corporate powers
Ultra vires
Defective incorporation
o Managing the corporation
A quick review of agency and authority
Corporate officers
The board
o Legal opinions in corporate transactions
Standart certificate o incorporation
o (he used DE one instead of MC?? One as an example)
o (also found in DGCL s102
o Name of the corporation
o Address of the registered office
o The nature of the business or purposes to be conducted or promoted
o The total number of authorized shares
Simply the number of shares that you have authorized
Can get really expensive
# of shares is the basis on which the franchise fee is assessed
Also where you would include the terms of preferred stock, unless is plus(?) preferred
17

The name and mailing addresses of the incorporator or incorporators

If the powers of the incorporator or incorporators are to terminate upon the filing of the cert of incorp,
the names and mailing addresses of the persons who are to serve as directors until the first annual
meeting of stockholders or until their successors are elected to qualify
Where do you incorporate?
o General question is do you incorporate in the state you are or do you incorp in DE?
More expensive in DE
Can then be sued in DE
o If you plan on taking 3rd party investors, there is a common understanding you will incorp in DE
Because everyone understands DE
Ex: if you incorporate in utah you need a utah lawyer because nobody else knows the utah law
o If you plan on going public, generally incorporate in DE
Representing a corp
o You are representing the abstract body of the corp
o If you have investors, CEO, corporate employees, etc., who is the corporate client?
The answer is yes
They all can be, and also they all arent
o Maybe put a waiver in your letter to say you arent everyone's personal lawyer as well
Role of the lawyer - organizing the corp
Several rules of personal conduct
o Written by litigators primarily about litigation
Rule 1.4 communication
A lawyer shall promptly inform the client of any decision or
Rule 1.6 confidentiality of information
A lawyer shall not reveal information relating to the representation of a client unless the
client gives informed consent
Rule 1.7 conflict of interests: current clients
a lawyer shall not represent a client if the representation involves a concurrent conflict
of interest [But] a lawyer may represent [such] a client if
[lawyer provides competent representation]
[not prohibited]
[not in the same litigation]
[each affected client gives informed consent, in writing]
Rule 1.13 organization as client
(a) a lawyer employed or retained by an organization represents the organization acting
through its duly authorized constitutnts
(b) if a lawyer for an org knows of [someone intending to violate legal obligation or law],
the lawyer shall refer the matter to higher authority in the org [including the board of
directors]
(c) if despite the lawyer's efforts in (b) the highest authority fails to act and the lawyer
believes substantial injury is reasonably certain the lawyer may reveal information relating
to the representation
Ultra vires
o The purpose of the corp is to engage in any lawful act or activity for which corps may be organized
under the General Corp Law of DE
Defective
o Two types of architypes he discussed
Both parties are aware corp does not exist yet
Neither party is aware the corp does not exist yet
18
o
o

types of architypes
2 opposite ideas
An agent of a disclosed principle is not liable on a K
An agent of a disclosed principle is not a party to the K
Think about if K was signed prior to corp being formed but its soon to be formed
Technically the person signing would be an principle and liable to the K
Can add in a waiver to relieve them of liability
Other type
Think of two friends using a do it yourself website and they both think they really
formed a corp
Are they liable.
Equitable doctrine of incorporation
As long as you had good faith in the deal, neither party is liable to the K
MBCA 2.04
Logic is that its so easy to incorporate, you are essentially an insurer if you do
not incorporate
Last type is post incorporation
Think example if corp forgets to file annual report
Day after they forget, the SOS administratively deletes your corp
You keep going and sign a K with a supplier
You sign individually as the pres of the corp
Except the corp doesnt exist
Corp later figures out they were dissolved, pays the tax and is reinstated
Later a dispute with the merchant who was never paid
Sues corp and pres individually
In most states, the usual rule (MBCA 14.22) is that pres gets the retroactive
benefit of limited liability
Problems with agency will always involve a principle, an agent, and a third party
o Fundamental agency triangle
Any agency K, the agent binds the principle to the third party
o Either agent is not personally liable, or the agent doesnt have the resources to pay, but the 3rd party
purportedly entered into K with principle
o Essentially, any litigation is ether agent was acting as individual or that the agent didnt have authority
to enter into K
ABCs of agency formation
o P+A manifest assent (assent to act)
o A to act on P's behalf (behalf)
o A to be subject to P's control (control)
o Assent to act + behalf + control = agency
Q is who are the agents that have the ability to bind P to a 3rd party and how do they get authorized?
Agency law
When there is litigation after the fact over whether the agent had the power to do what they did,
3rd party has several theories to argue, but you only need to win on one
o Actual authority
Knowledge of a 3rdparty is irrelevant
Only axis that is relevant is the axis between the principle in the agent
(think of te agency triangle P to A to 3rd party, thats the axis hes talking
about)
Has 2 sub categories
19
o

Actual express authority (AEA)

Principle tells the agent exactly what to do and the agent consents
to do it
Only matters what happened between P and A, doesnt matter if
3rd party even knew that P had authorzed A
Actual implied authority (AIA)
If A tells B to do X, but in order to do X B also has to do Y, B has
the implied authority to do Y to be able to do X
o Apparent authority (AA)
The power held by the agent or other actor to affect a principle's legal relations
with 3rd parties when the 3rd party reasonably believes the actor has authority to
act on behalf of the principle and that belief is traceable to the principle's
manifestations
o Inherent agency power (IAP)
o Ratification
Authority that didnt exist before the fact, but after the fact the principle sees what
was done and said it was ok
Deleware 104(A)
The corp is run by the directors and do so through resolutions that are voted on
Bylaws and board resolutions combine to give actual express authority to officers and employees
DE s142(a)
Consent resolutions of the board have to be unanimous
The meeting is important because if one person objects they need the opportunity to say their
piece
o Therefore proxy votes are not allowed
o So that decisions can be made on an informed basis
Boards can consist of people who are not bound by monetary or family ties but who have relationships
with executives
3rd Party Legal opinions
A legal opinion is a formal legal letter or memo to the effect the transaction is legally binding on
the parties
o It is a lawyer offering an opinion on that certification that establishes the authority to
undertake the transaction and undertake a binding obligation is in fact a binding
obligation
Unit 5-16 Opinion Exercise 1 PPT
Opinions are allowed to have normal and reasonable assumptions
But the more exceptions you have the more problematic the opinion becomes
o Usually indicates the lawyer is less confident in the opinion
Opinion will be qualified to the extent the lawyer has assumed the documents to be accurate
It doesnt say what it is that Kraft is authorized to sign
o Needs to be more specific about this particular agreement

Unit 6 - A Primer on Financial Accounting and Valuation

Friday, November 25, 2016
3:43 PM

201-244
20

GAAP - Generally Accepted Accounting Principles

o
Most firms and all public corps use GAAP
o
But, they recognize that the rules do not embody immutable scientific or mathematical truths

Instead, GAAP represent the often controversial judgments and policy preferences of a
group of highly-qualified accounting professionals from the financial accounting standards
board (FASB)
Accounting is subjective
Stages of accounting
o
Recording and controls stage

A company records in its books info concerning every transaction in which it is involved
o
Audit stage

Company, or sometimes with assistance of outside and independent accountants, verifies

the accuracy of the info it has recorded
o
Accounting stage

Company classifies and analyzes the audited info and presents it in a set of financial
statements
o
Public companies always go through these stages, but private corps often do not
Fundamental equation
o
Assets = Liabilities + Equity
o
Assets - property, both tangible and intangible
o
Liabilities- all debt owed to others
o
Equity - the accounting value of the interest of the firm's owners
Cookie jar accounting
Balance sheet
o
Balance sheet assets

Current assets - cash and other assets that in the normal course of business will be
converted into cash in the reasonably near future, generally within a year of the date of the
balance sheet

Cash, accounts receivable, inventory, prepaid expenses, etc.

Many large, public corps will separate items as "cash and cash
equivalents" and "short term investments"

Fixed assets

Long-term assets not expected to be converted to cash within the next year

Under GAAP, when a corp acquires a fixed asset it records on its balance sheet at
cost

PP&E and Depreciation

"Property, plant, & equipment"

PP&E represents assets the firm uses to conduct its operations, as opposed to
assets it holds for sale

Under GAAP, when a corp acquires a fixed asset it records on its balance sheet at
cost

Depreciation

GAAP requires that the firm charge a porton of the fixed asset cost against
the revenues received during the period the fixed assets are in use

Go on the asset side of the balance sheet under GAAP

Useful life in accounting means a valuable asset could be worth zero on a

balance sheet because it has depreciated so much its useful life is gone

LIFO/FIFO/average cost
21

Last in first out

First in first out
Average cost - inventory is sold at random from a bin
o
Balance Sheet Liabilities

Current liabilities - debts a firm owes that must be paid within one year of the balance
sheet date

Long-term liabilities - debts due more than one year from the balance sheet date

Off balance sheet liabilities - transactions that involve long-term financial obligations, but
which, because if their form, are not recorded as liabilities on the balance sheet

GAAP requires firms usually discuss the off balance sheet liabilities in footnotes

Can be extraordinarily complex

GAAP also complex as to ow "contingent liabilities"- such as loan guarantees,

warranty obligations, and claims by Ps in civil suits-are to be calculated and when they
must be disclosed
o
Balance sheet equity

Also referred to as net worth

Balance sheet value of equity often does not represent the actual market value of the
firm's equity

Two components in economic terms

Paid-in capital - total amount the corp has received from those who have
purchased stock

Retained earnings - also called earned surplus, reflects the cumulative results of
the corp's operations over the period since it was formed
Balance sheet analysis
o
Current ratio - divide current assets by current liabilities

Rule of thumb, analysts prefer a 2:1 ration

o
Debt-equity ratio - divide a firm's long-term debt by the book value of its equity

A ratio of more than 1:1 may indicate the firm is relying principally on borrowed capital
o
Interest-coverage ratio - divide the firm's annual earnings by the annual interest payments due on
its long-term debt

Most analysts consider debt a safe investment if a firm's ratio is at least 3:1
Income statement
o
Also called statement of income or profit and loss statement
o
Provides a view of how the firm has performed during a period of time
o
GAAP requires most firms use accrual accounting to prepare financial statements
o
Two ways of when to recognize revenue

Under the realization principle, a firm must recognize revenue in the period that services
are rendered or goods are shipped, even if payment is not received in that period

Under the matching principle, a firm must allocate the expenses it incurred to generate
certain revenues to the period in which those revenues are recognized
o
Items on income statement

Net sales - also called revenue or top line revenue

Operating expenses

COGS, depreciation, selling, administrative expenses (overhead, general

expenses), R&D

Operating income - subtract all operating expenses from net sales

Sometimes called EBIT (earnings before interest and taxes)

EBITDA - earnings before interest, taxes, depreciation, and amortization

Interest expense and taxes

22

Interest expense represents the amount of interest the firm paid on its debt during
the year

Interest before taxes is obtained by subtracting interest expense from

operating income

Net income

Also called bottom line

Return on equity
o
Divide equity at the end of the previous year (not the current year) into the net income reported
for the current year
o
If a firm's return on equity greatly exceeds the returns available from risk-free investments, an
analyst might conclude that the firm is worth considerably more than its book value

Statement of Cash Flows

o
Split into three parts
Operating activities, investing activities, or financing activities
Each is based on whether the cash flow falls into that category

Valuation, think old man with the tree selling apples story
o
Asset value

Essentially the cost of what you could sell all of the pieces for, does not take into account
anything else

Essentially cost of w

hat you could chop down the apple tree and sell the wood as firewood for

Or offering an asset at cost for what it was purchased as

This method doesnt take into account what the asset could produce as future earnings,
only its sale price now
o
Earnings method

Essentially take the expected life of the asset and multiply that by how much the asset can
earn per year

If the tree makes $100 in apples per year and will live another 30 years, this method
would provide a cost of $3,000
o
Market Comparables

Offering the price the market has offered for the same asset elsewhere
o
Capitalization of Earnings

Subtracts expenses, say fertilizer, from the yearly income, includes that income may not
be as high in future years, and divides that number by the interest rate of an investment to get
the future value and that will be the current price

Also accounts for risk

o
Discounted cash flow
DCF analysis uses future free cash flow projections and discounts them to arrive at a present
value estimate, which is used to evaluate the potential for investment
Class Notes Unit 6

Corporate Numeracy in Context

o Corporate acquisition agreement almost always contains the financial statements of the company being
sold
o Financial statement representation
Schedule 6.5(a) sets forth the unaudited consolidated balance sheet of the business as at sept 30,
1995 (the initial balance sheet), and unrelated unaudited consolidated statement of income of the
business for the nine months then ended (the income statements)
The initial balance sheet presents fairly in all material respects the financial position of the biz as
a whole as of the date thereof in conformity with the Specified Accounting Principles

23

The Initial Balance Sheet reflects only assets and liabilities of Sellers and the Transferred Entities
related to or previously used in the Biz and the Excluded Assets and the Excluded Liabilities are
excluded therefrom (except as may be expressly set forth in the Specified Accounting Principles)
***a few other bullets, can be found on the powerpoint on BB
o Adjust sale price because you cannot close the deal on the date you set the price for it
Especially with big deals, think you dont close when you agree to buy a house, takes time
So therefore the company may be worth something different when closing the deal than when
they negotiated, so the price may need to be adjusted
Deal Timeline
Financial statement components
o It focuses primarily on the inflow and outflow of cash because cash is eventually the basis on which
creditors get paid and investors get returns
Cant focus on all on cash, because it is trying to capture at any given moment:
What does the business own
How much does the business owe
How much income and cash are being generated
Who owns the business
How much is what the owner owns worth?
o 4 main parts of financial statement
Balance sheet
Static
Tells you at a single moment in time what the corp owns in terms of its assets, what it owes
to creditors, and the difference between what it owes to creditors and what it owns is its
equity
Will have a specific date
Income statement
Also profit/loss statement
Dynamic
It is a statement of what is happening over a period of time
Shows results over a period of time
Will be dated over a period of time
Ex) for all of 2015
Statement of cash flows
Different than the income statement
Has to do with the difference between accounting in a cash method, which is simply cash in
and out, and accrual accounting, which is something very different
Statement of owner's equity
The Fundamental Equation
o Assets = Liabilities + Owner's Equity
OR
Assets - Liabilities = Owner's Equity
o Above equations are the same, just said in different ways
o With respect to the agglomeration that make up the entity of the corp, any real or notional entity
conducting financial transactions, somebody has to have a claim on those assets
The resources to gain those assets or gather those assets had to come from somewhere
Either came from who owns the business or someone who doesnt own the biz
If come from someone who doesnt own biz, we owe them something
They are our creditors
Somebody is going to have a claim of the value of 100% of the assets
24

Either ownership or creditor obligation

This is the source of the fundamental equation
Claim of ownership is called equity
Sometimes called net assets or net worth
Claims of the creditors, those to whom we owe, are liabilities
o Can take the fundamental equation and apply it to any entity
From biggest corp to one individual
o Dont assign any value or little value to assets that are contingent
Ex) what is the value of a diploma? Really depends what you do with it so you cannot really assign
a value to it
Accounting says once we know the value of something we can book it
For the diploma, and other things that are contingent, accounting says to put it aside

10/5 Unit 6
Wednesday, October 5, 2016
2:01 PM

The entity being accounted for is distinct from those who own it, whether or not it is a separate legal
entity
o We assume the entity is a growing concern, will not be liquidated
o We assume the entity can be broken up into time periods
o The transactions reported in the financial reporting:
Must be capable of measurement in money
Problem with value of diploma
And based on a real transaction
Matching principle
o Items of expense should be matced to the period in which they generate the revenue, regardless of
when you actually spend the cash, and regardless of when you actually receive the revenue
Trying to measure inflow of resources against what those resources produce and we want to
match it
Want to match it because the cash doesnt always give us the best matching
Leads us to the issue of accural and depreciation of long term assets
o Conservative principle is to Prefer to understate earnings and cash flows rather than overstate
o Record assets at cost, not at market value
Balance sheet
o Assets listed on the left side
Top is very liquid assets, and towards the bottom is the very fixed ones
Example list
Cash
Securities
Accounts receivable
Inventory
Equipment
Plant
Land
o FIFO/LIFO
FIFO - first in first out
25

Say you buy and sell chairs, and you bought chairs for $20 in march and $30 in April.
For FIFO, when you sell chairs in October, you would use the $20 chairs first in FIFO
because they were first into your assets
LIFO - last in first out
The right side of the balance sheet is the liability accounts and owner's equity accounts
Liability accounts
Accounts payable
Short term notes payable
Long term debt
Owner's equity
Paid in capital
What did the shareholders actually pay in
Retained earnings
Profit made that is not distributed to shareholders
Increases amount of equity
Example) youre selling chairs. You buy a chair for $50 but have 90 days to pay it, then sell it for
$100 within those 90 days, but the people who bought it have 90 days to pay
You literally have no difference in cash, but you have made money
This is accrual accounting
Working capital
Current Assets - Current Liabilities = Working Capital
Positive number means positive working capital, and vise versa
Current assets
Cash
Securities
Accounts receivable
Inventory
Current liabilities
Accounts payable
Short term notes payable

Current ratio
Current assets : current liabilities
Balance Sheet Exercise for Widget, Inc - 1
Income statement accounts
o Revenue accounts
Account for reporting money that comes in
Could be sales, fee revenue, interest from bank accounts (interest accounts)
o Expense accounts
Outflow accounts, money going out
Account for Cost of Goods Sold (COGS)
Cost of making something that you sell
Depreciation
Rent for the office
Copying expense
Personal checkbooks are run on cash accounting, not accrual based
o The reason business do accrual accounting as to better show what you are doing to put resources
into output
26

On a cash basis, there are no accounts payable or accounts receivable

o Only an asset when you receive it
o Wouldnt recognize revenue when cash comes in, and only recognize expense when cash goes out
o No public company does cash accounting
Market value of stock does not necessarily affect your accounting
o It doesnt match
GAAP - Generally Accepted Accounting Principles
GAAS - Generally Accepted Auditing Standards
10/12 Unit 6
Wednesday, October 12, 2016
2:00 PM

What attorneys need to know about accounting

o The subjectivity of accounting
o Non-GAAP financial measures
o Asymmetrical information
o Synergies/Professional skepticism
o When to say no
Accounting theory and practice - the subjectivity of accounting
o Cookie jar accounting is related to quality of earnings. Quality of earnings is an indication of
where company's earnings are coming from. If the earnings are coming from normal business
activities and accepting accounting practices, then the earnings are said to be of higher quality
o Contrary, if earnings are caused by aggressive accounting practices and are not related to
management's actions to improve the bottom line, the earnings are said to be of lower quality
o Cookie jar accounting is a company's attempt to manage their earnings by using accounting
reserves, and it may not result in the good quality of earnings
o Example of reserves
Samsung phones are exploding
Litigation reserves
Warranty reserves
Inventory reserves
(so overall profit is lowered, and they put reserves aside for future litigation per
say)
Asymmetrical information
o What does asymmetrical info mean?
A situation in which one party in a transaction has more or superior information when
compared to another
This often happens in transactions where the seller knows more than the buyer, although the
reverse can happen as well
Potentially, this could be a harmful situation because one party can take advantage of the
other party's lack of knowledge
Synergies
"faithful representation"
o Is the Overarching Accounting Principle
o Subjectivity of accounting
o Watch out for non-GAAP fantasy numbers
o Asymmetrical information
27

Buy. Sell. Divide. Repeat. Buy. Sell. Divide. Repeat.

Accounting is all about Ethical Decisions
Example
o GE
Net income - $1B
Sold a small business for $100M
So total year income would be $1.1B
But Non-GAAP rules may say one time sales wont be included in revenue, so
would say net income was still $1B
To offset, would say that something else somewhere cost $100M to take out that
$100M sale
The discount rate in the general formula for the time value of money has to do with risk
o Often time r is referred to in the equation as the firms 'cost of capital'
PV = FV / (1+r)^n
o Example for calculating GE's r, or cost of capital
R = WACC
Weighted Average Cost of Capital (WACC)
Is the total weighted cost that the firm pays as interest to lenders on its debt and
as return to shareholders on its equity
R = [(D/V) x r_d x (1-t)] + [(E/V) x r_e]
r_d = discount rate for debt
t=corporate tax rate
r_e = discount rate for equity
D = market value of debt
E = market value of equity
o Cost of equity
r_e = r_f + [beta x (r_m - r_f)]
r_e = cost of equity
r_t = risk free rate of return
Beta = (market beta = 1.0; beta measures degree of correlation (fill in from online
powrpoint rest)
If you want to ensure someone always has a certain stake in the company, you can give them a certain % of
shares and then require a certain % in a vote to be able to take away the shares
o Example, give someone 25% of shares and require 85% of the vote to change the number of shares,
would need that person to vote yes otherwise a vote could never possibly pass
In DE, can have written consent from the board if unanimous (question 10 quiz unit 5)
o
o

28

Trying to estimate what the business will reutrn to us in the future, then use the time value of money with an
appropriate discount rate to bring it back to the present value
o Will tell us how much the company is worth
o r, the discount rate, is equal to the ? Of capital because it is what investors expect to get that back
IRR - internal rate of return
o the interest rate at which the net present value of all the cash flows (both positive and negative) from a
project or investment equal zero. Internal rate of return is used to evaluate the attractiveness of a
project or investment.
How much is a company worth?
o Net asset method - valuing a company at what the balance sheet says it is worth based on
Looks at equity and goes by that
Assets - liabilities = equity
Would really only be a good sale if the company is about to go bankrupt
Because then they are really only worth their assets and wont have future value
o Next couple answers using info from pg.s 202-203 of the book
o Earnings Capitalization Method
Annual Return = Asset Value x Rate of Return
Ex) $100,000 bond x 5% interest
Interest is $5,000 per year
So use this to divide Annual Return by Rate of Return (simple look at formula just
above)
Example 1: $10,000 annual return / 8% rate of return = $125,000 bond
o Comparables

29

Comparable Element x Multiplier = Enterprise value

Simple example, think house
In a certain area, each Sq. foot of a house costs a certain amount
So # Sq. Ft. x cost per sq. ft = value of house
EBITDA - Earnings Before Interest, Taxes, Depreciation, and Amortization
Form of popular comparable
Sales is also a popular comparable, subscribers, revenue, reserves (oil and gas for
example)
Valuations come out differently based on which comparable element that you use
Discounted Cash Flow

30

Take ALL models for valuating a company with a grain of salt because you can easily
change the valuation with the different assumptions that can be made
This method is theoretically very sound, but has problems
Hockey stick means that your projections start small but then all of a sudden look
exponential, and on a graph it looks like a hockey stick
Good example of Discounted Cash Flow method on p. 243 of the book***
Balance sheets do not reflect value
No fiduciary duty to preferred shareholders
o More contractual

Unit 7 - Capital Structure

Friday, November 25, 2016
3:43 PM

245-284

Capital structure refers to structure on the right hand of the balance sheet
Corporate securities have two categories
o
Equity
o
Debt
31

Equity securities
o
stock
o
Generally represent permanent commitments of capital to a corp
o
Returns on these generally depend on corp making a profit
o
While they may share in the corp's assets in the event of liquidation, the rights of equity
securities are lower in rank than the claims of creditors, including those who hold the corp's debt
securities
Debt securities
o
Represent capital invested for a limited period of time
o
Typically represent temporary contributions of capital (example, until the maturity of a loan date)
o
More likely to have priority in terms of payment if the firm becomes insolvent or liquidates
voluntarily
o
Holders of debt securities can secure their rights by placing liens on some or all of a corp's assets
or by negotiating covenants restricting the corp's operations
Two basic types of equity securities
o
Common stock
o
Preferred stock
Basic terms of equity securities
o
Authorized shares

When a corp is first formed, its shares are authorized but not yet issued

When sold, they are authorized and issued or authorized and outstanding

If repurchased, they are authorized and issued, but not outstanding

o
Treasury shares

Authorized and issued, but not outstanding

Common stock
o
Usually have the exclusive power to elect the board of directors
o
Have a residual claim on both current income and the assets of a corp
o
All income that remains after a corp has satisfied the claims of creditors and holders of its more
senior securities-preferred shares and debt-"belongs" in a conceptual sense to the holders of common
stock

Distributed as a dividend

If nothing left, no dividend is paid

o
Primary beneficiaries of the fiduciary duties that corporate law imposes on the board of directors

BJR under the assumption the directors have exercised reasonable diligence and acted
with the shareholders' best interests
If corp is liquidated, corps assets first must be used to pay the claims of creditors and holder of preferred
shares
o
After those are satisfied, common stock holder have a residual claim to what is left
Preferred shares
o
Economic rights senior to those customarily assigned to common shares
o
If no attributes are assigned to a class of shares with respect to its voting rights, rights of
dividends, or rights to redemption or in liquidation, courts will say that stock is stock-essentially just
common stock then

The attributes have to come from the articles of incorp

Where attributes are provided in the articles, they are seen as a contract between
shareholders and the corp
o
Dividend preference usually will be stated as a fixed amount that must be paid annually or
quarterly
32

Unpaid dividends may expire or may be cumulative, so as to stack up and all must be paid when
the corp can again pay dividends, and if cumulative all those must be paid first before common stock
dividends
o
Also may be participating

Will receive dividends paid whenever common stock ones are paid
o
Often have a preference on liquidation, generally stated as a right to receive a specified amount
before any amounts are distributed to common shares

Amount is usually what was paid for the share plus any accumulated (cumulative)
dividends that went unpaid
o
Sometimes a permanent commitment of capital to the corp, sometimes not

If not, shares are "redeemable" for a specified amount

o
Can have voting rights, and if they do will be deemed as having equal voting power to common
shares unless specified otherwise in the articles of incorp

However, often limited to specified instances of voting

o
Usually have a statutory right to vote on changes in the corp structure that affect adversely their
rights and preferences
o
Standard features of preferred stock can be changed

Examples are the right to convert to common shares at some specified ratio, right to vote
on certain transactions, or the right to require the corp to redeem preferred shares if and when
specified events should occur
Debt Securities
o
Can be labelled notes, debentures, or bonds

Typically, notes and debentures have shorter maturities than bonds

o
Bonds

Terms of a bond typically fixed by a complex contract known as an indenture that

specifies the rights and obligations of the bondholders and the corp

Fixed amount of principle to be paid back on a certain day with interest

Can be paid all at once or amortized payments over time

May be callable or redeemable at a fixed price at the option of the borrower

o
Convertible debentures

Hybrid securities that closely resemble convertible preferred shares

Give the bondholder the right to convert bonds into common shares
o
Unless provided in the articles, the board has the authority to issue debt securities w/o
shareholder approval

Must only involve shareholders if could become convertible to common stock

Options
o
The right to buy securities, typically common shares, at a specified time and price

"the right to buy or sell something in the future"

o
Generally known as contingent claims, because they are assets whose value and future payoff
depend on the outcome of some uncertain contingent event

Party has a contractual right, not a contractual obligation, when they have an option
o
Terminology

Call option - the right to buy shares

Put option - the right to sell shares

Strike price - also called exercise price, is the specified price in an option contract

Maturity date - also called expiration date, is the date specified in an option contract

Warrants - name sometimes of stock options issued to the public

Taxes
o
Allows corps to deduct from their taxable income all interest paid on bonds they have issued
33
o

Repayment of principle on a bond is also typically treated as a tax-free return of capital

The tax code does not allow corps to deduct dividends paid on preferred or common
shares

Bankruptcy and leverage

o
Leverage is the concept that a corporation will find it profitable to finance business activities
with borrowed money whenever it can earn more income from those activities than it will pay in
interest on the borrowed money

In effect the corp is using borrowed money as a lever to increase its shareholders income
o
Deep Rock Doctrine

Taylor v. Standard Gas & Electric Co.

Courts may treat debt taken by insiders to the corp as equity, pushing the payment back
of this debt further down the chain

This "equitable subordination" doctrine means inside creditors usually receive no

repayment with respect to the debt they hold

Equity is an option
o
Equity is investing and that cash is traded for debt, equity is the debt
o
And if the company goes bankrupt you lose your investment

Capital structure law and policy

o
Legal capital
o
Payment of distributions to shareholders
o
legal and policy implications of one common type of distributions-dividends

Legal capital
o
Sometimes called stated capital
o
Legal capital = (# of shares outstanding) x (par value)

Outstanding shares is the number of shares held by shareholders

o
Some states still have statutes that require par value, but MBCA did away with it

DE still has par values mandated by state law

o
Most corp statutes explicitly provide that directors can be held liable if they approve the issuance
of shares or other distributions to shareholders in violation of applicable statutory provisions
o
DGCL s 151, 152, and 153

Payment of distributions to shareholders

o
Generally, today states prohibit corps from making distributions that will render them unable to
pay debts or make themselves essentially insolvent

Violating such state laws can hold the directors personally liable if they authorized the
distribution

In DE, directors remain liable for unlawful distribution even if they acted in good
faith
o
Courts have permitted directors to justify distributions by "revaluing" their assets
Class Notes Unit 7

The interest on debt is tax deductible, whereas dividends are not

OPM - other people's money
LBO - leveraged buy out
When you are a leveraged buyout specialist, you want to use as little of your own money as you can
Good explanation of dilution on page 250 of the book***
o Dilution of voting power
o If you issue more shares, you have fewer shares as a percentage in the overall vote
Types of securities
Type of Security

Whos It

Why Does it Fit?

34

For?
Common Stock

Justin
Kathy
Lorenzo
Lorenzo?

Preferred Stock

Participating or not
Convertible or not
Debt

Short term notes

Long term loans

Derivatives/Options

Flexibility in term of fixed return

and growth, voting rights, and ultimate conversion to
common stock

Lorenzo?

First
National

Widget Bros.

Lorenzo?

High growth potential

Voting rights
Capable of being leveraged

Fixed contractual return

Flexibility in terms of being tied
to current or future income
Can be secured
Allows growth potential without
present ownership

To understand names, see slide on BB from unit 7 titled "Types of Securities"

There has to be in the corporation something that has to be the equivalent of common stock
o Someone gets the leftover money after everyone has been paid
o And someone has to have unlimited voting rights
Can have different classes of stock with different voting rights
Can accept payment for common stock in things other than cash
Property, promissory notes, etc.
o Most control, but also most risk vs reward falls within common stock

Unit 8 - Piercing the Corporate Veil

Friday, November 25, 2016
3:43 PM

287-297; 301-318
Class Notes Unit 8

If you are not adequately capitalized, you the shareholder wont get the benefit of the liability shield under
the default rule
The default rule is you have limited liability unless you fail to sufficiently capitalize or get sufficient
insurance
Freeman Case
Glazier was really the only shareholder
Theories
o These people used Horton st associates, had full control and didnt abide by formatlities.
Promises made to shareholders that theyd get paid
Trial court held no fraudulance
No guarantee of mortgage
Knew there was no guarantee
But Ds didnt observe the corporate formalities and when a crisis occurred, they
simply took control
35

Sup Ct of Maine says the burden is more difficult in a contract case to pierce the corporate
veil because in a contract case P chooses who they chose to work with
Burges should have been smart enough to get it in writing, to have a formal guarantee
Other lenders had been smart enough to get the guarantee in writing

Unit 9 - Shareholder Voting Rights and Activism

Sunday, November 13, 2016
3:34 PM

Casebook: pp. 349-353(top); 363-395; 423-428; 441-447; 456-462(top); 465-475

Shareholder meetings
o
Regularly scheduled annual meetings

Only matter for shareholders is to elect directors

If the articles do not specify how directors are elected to the board, all board seats are up
for straight up elections at each annual meeting
o
However, directors often seen shareholder approval on a number of things

Appointment of auditors, adoption of management compensation plans, or ratification of

some decisions the board made during the past year as a few examples
o
If a shareholder meeting has not occurred in 15 months (13 in DE) any holder of stock can
require the corp to convene an annual meeting
o
Special meetings may be called by

The board

Special person authorized in the articles or bylaws

Under some statutes (not DE) by any 10% shareholder

o
Shareholders can act by means of written consent instead of a meeting

Some statutes may require action by written consent to be unanimous, effectively limiting
to closely held corps

Under DE statute, action by written consent can be taken by a majority of a corp's

voting shares

Shareholder voting procedures

o
Shareholders entitled to vote must receive written notice of the shareholder meeting

The notice, which typically must be sent at least 10 days, but not more than 60 days,
before the meeting

Describes the location of the meeting and the time

The notice for "special meetings" must also describe the purpose of the meeting
o
Most statutes require a quorum equal to a majority of shares entitled to vote

May be increased or decreased in the bylaws

But some states (including DE) require a quorum of at least 1/3

o
Shareholders can vote by attending the meeting or if they do not attend they can vote by proxy

This is unlike directors, who cannot vote by proxy

How to revoke proxy

o
Give your proxy notice
o
You show up at meeting
o
Or a later dated proxy sheet

Shareholder voting rights

o
Unless articles specify otherwise, one vote is equal to one share
36

Supermajority voting or voting caps on any shareholder who owns more than a specified
percentage of shares are permissible, but mostly used in closely-held corporations
o
Non-voting shares also permissible
o
All directors are up for election annually unless the articles of incorporation provides for
staggered terms, in which directors serve for terms of two or three years
o
For a vacant director position, the seat can be filled by the shareholders or by the remaining
directors, unless the articles provide otherwise
o
Normally directors are elected by plurality vote

Some public corps now provide for a majority vote to be required for directors
o
Bylaws
Shareholder Power to Initiate
o
Shareholder rights to veto fundamental rights are passive

Think reactive

The board initiates the decision to merge, then the shareholders have to react to that
decision
o
Shareholders have three active shareholder powers

To make recommendations

Shareholders can NOT make demands, only recommendations and requests

To remove and/or replace directors

To remove, need cause and director needs opportunity to address shareholders

To amend by-laws

If shareholders amend a bylaw, they can include in it a provision to not allow the
board to change it after

Since the board can also amend bylaws, they could easily change back the
amendment right after the special meeting. An added provision saying the board
cannot change it if amended comes under MBCA 10.20(a)(2)
o
Shareholder Recommendations and Removal/Replacement of Directors

Leading case is Auer v. Dressel

Power over articles and bylaws
o
Shareholders can amend bylaws, but to change the articles the directors must initiate then
shareholders approve
How to remove corporate directors
o
V difficult
o
A meeting must be called, notices sent, and proxies must be solicited

If removing a director for cause, appropriate charges must be brought and a defense
allowed

Key case is Campbell v. Loews

o
WHILE SHAREHOLDERS CAN REMOVE DIRECTORS, THEY CANNOT***** REMOVE
OFFICERS
Campbell v. Loew's
o
DE statute about removal of directors is s141(k)
CA, Inc. v. AFSCME Employees Pension Plan
o
Key case about the power of changing bylaws and the wrestling of power between boards and
shareholders

The power is shared

o
Held that the SEC can turn to the DE Sup Ct for resolution of federal regulatory issues that turn
on STATE corporate law
o
Clarifies that s109 is secondary to s141, which the court says is a "cardinal precept" of corp law
o
Concluded the board has greater power over the bylaws than the shareholders
37
o

Interference with shareholder voting

o
Blasius Industries, Inc. v. Atlas Corp.
Any limitation of board authority must be set out in the articles of incorp***
Any limits on a board's control of a poison pill must come, if at all, from the articles of incorp***
DE courts have held that bylaw amendments initiated by a controlling shareholder are invalid if they
have an inequitable purpose or effect
Shareholder proposal rule
o
SEC shareholder proposal rule adopted in 1942

Under 14a-8, any shareholder who meets the ownership requirements of the rule and
submits a proposal in a timely fashion and in proper form can have the proposal included in the
company's proxy materials for a vote at the shareholders' annual meeting

That is, the rule compels the company to subsidize proper shareholder proposals
o
Operation of rule 14a-8

To be eligible, the proponent must have continuously held at least 1% or $2000 worth of
the company voting shares for at least one year

Proponent must then continue to hold the shares and present the proposal at the
meeting

A proponent may submit no more than one proposal per company for a particular
shareholders meeting

The proposal and any accompanying supporting statement may not exceed 500 words

The proposal must be submitted to the company not less than 120 calendar days before
the date of the company's last-year proxy statement

If included, the company may recommend to vote against the proposal and give reason
for its opposition

SEC no-action review

If the corp omits a proposal from its proxy materials, it must notify the SEC by
filing the proposal and the company's reasons for exclusion

The SEC staff then advises the company whether or not I t will recommend that
the Commission take any enforcement action if the company omits the proposal

If the answer is no, the staff response is known as a "no-action" letter

o
Proper proposals

There are 13 substantive grounds for the exclusion of shareholder proposals

Come from rule 14-a(i)

(1) Improper under state law: If the proposal is not a proper subject for action by
shareholders under the laws of the jurisdiction of the company's organization;
Note to paragraph (i)(1):
Depending on the subject matter, some proposals are not considered proper
under state law if they would be binding on the company if approved by
shareholders. In our experience, most proposals that are cast as
recommendations or requests that the board of directors take specified action
are proper under state law. Accordingly, we will assume that a proposal
drafted as a recommendation or suggestion is proper unless the company
demonstrates otherwise.
(2) Violation of law: If the proposal would, if implemented, cause the company to
violate any state, federal, or foreign law to which it is subject;
Note to paragraph (i)(2):
We will not apply this basis for exclusion to permit exclusion of a proposal on
grounds that it would violate foreign law if compliance with the foreign law
would result in a violation of any state or federal law.
38

(3) Violation of proxy rules: If the proposal or supporting statement is contrary to

any of the Commission's proxy rules, including 240.14a-9, which prohibits
materially false or misleading statements in proxy soliciting materials;
(4) Personal grievance; special interest: If the proposal relates to the redress of a
personal claim or grievance against the company or any other person, or if it is
designed to result in a benefit to you, or to further a personal interest, which is not
shared by the other shareholders at large;
(5) Relevance: If the proposal relates to operations which account for less than 5
percent of the company's total assets at the end of its most recent fiscal year, and for
less than 5 percent of its net earnings and gross sales for its most recent fiscal year,
and is not otherwise significantly related to the company's business;
(6) Absence of power/authority: If the company would lack the power or authority
to implement the proposal;
(7) Management functions: If the proposal deals with a matter relating to the
company's ordinary business operations;
(8) Director elections: If the proposal:
(i) Would disqualify a nominee who is standing for election;
(ii) Would remove a director from office before his or her term expired;
(iii) Questions the competence, business judgment, or character of one or
more nominees or directors;
(iv) Seeks to include a specific individual in the company's proxy materials
for election to the board of directors; or
(v) Otherwise could affect the outcome of the upcoming election of directors.
(9) Conflicts with company's proposal: If the proposal directly conflicts with one of
the company's own proposals to be submitted to shareholders at the same meeting;
Note to paragraph (i)(9):
A company's submission to the Commission under this section should
specify the points of conflict with the company's proposal.
(10) Substantially implemented: If the company has already substantially
implemented the proposal;
Note to paragraph (i)(10):
A company may exclude a shareholder proposal that would provide an
advisory vote or seek future advisory votes to approve the compensation
of executives as disclosed pursuant to Item 402 of Regulation S-K (
229.402 of this chapter) or any successor to Item 402 (a say-on-pay
vote) or that relates to the frequency of say-on-pay votes, provided that
in the most recent shareholder vote required by 240.14a-21(b) of this
chapter a single year (i.e., one, two, or three years) received approval of
a majority of votes cast on the matter and the company has adopted a
policy on the frequency of say-on-pay votes that is consistent with the
choice of the majority of votes cast in the most recent shareholder vote
required by 240.14a-21(b) of this chapter.
(11) Duplication: If the proposal substantially duplicates another proposal
previously submitted to the company by another proponent that will be included in
the company's proxy materials for the same meeting;
(12) Resubmissions: If the proposal deals with substantially the same subject matter
as another proposal or proposals that has or have been previously included in the
company's proxy materials within the preceding 5 calendar years, a company may
exclude it from its proxy materials for any meeting held within 3 calendar years of
the last time it was included if the proposal received:
39

(i) Less than 3% of the vote if proposed once within the preceding 5 calendar years;
(ii) Less than 6% of the vote on its last submission to shareholders if proposed twice
previously within the preceding 5 calendar years; or
(iii) Less than 10% of the vote on its last submission to shareholders if proposed
three times or more previously within the preceding 5 calendar years; and
(13) Specific amount of dividends: If the proposal relates to specific amounts of
cash or stock dividends.
Some exclusions seek to protect centralized corporate management
1, 5, 7, 13
Some seek to prevent interference with management's solicitation of proxies
8, 9, 11, 12
Others seek to prevent misguided proposals that are illegal, deceptive, or abusive
2, 3, 4, 6 ,10
The three exclusions that get the most use are
1, 5, and 7

Ordinary business vs. public policy

Dodd-Frank Act authorizes "proxy access" rule

Class Notes Unit 9
Directors can be personally liable for impairing legal capital if creditors are harmed
R. Hoe & Co. INC. case
o One of the most important of the unit
Especially of shareholders bringing action
o Auer v. Dressel
Name of slide
Campbell v. Loews, Inc.
o Public fight over control of a movie studio
o Do shareholders have the power to remove directors for cause?
They say the power is implied
o Does a removed director have to be given adequate notice and the opportunity to be heard?
Yes, and here they were given adequate notice
o Did the charges against the two directors institute cause?
Blasius Industries v. Atlas Corp.
Board doesnt have to absolutely go with shareholder resolutions, only if they vote for something as
shareholders
o Section 109 vs 141 debate, can you adopt a bylaw that impedes on the board's fiduciary obligations?
That if the classified board doesnt follow shareholder resolution they can be held accountable
Proxy Access example slide
o Proxy access rule 14a-11 two parts
Company does something to anger shareholders
Something like a withholding votes campaign
Failure to act on a majority shareholder proposal, or one other thing
If this happens, shareholders can nominate up to 3 directors and have them included in the
proxy
SEC Backed down to not pass this
o 2005: allows exclusion of proxy access bylaw - "relates to election"
o 2007: revises 14a-8 to exclude proposals that "relate to nominations"
o New DGCL s112 and 113 (2009)
Deleware seems to be saying we dont mind the idea of proxy access in the bylaws
Encouraging to shareholder access
40

After financial crisis, congress passes dodd-frank

2010
Proposes new 14a-11
Permits shareholder nominations, up to 1/4 of the board
o Business roundtable then sued the SEC in 2011
DC circuit strikes down the new rule
SEC did not do the appropriate cost/benefit analysis
Struck down on that basis
2010: revises 14a-8 to permit proposals for proxy-access bylaws
o

Unit 10 - Board Decision Making

Monday, November 14, 2016
2:05 PM

p. 521-564

Chapter about business judgment rule

A director cannot be assessed monetary damages, except where

o
You breach duty of loyalty
o
Did not act in good faith or intentionally violated the law
o
Violated s 174 (distribution when a corp is insolvent)
o
Or derived some personal benefit

Board, if held liable, can be held responsible for monetary damages that were the proximate cause of
their decision

A plaintiff challenging the director's conduct in connection with a corporate decision has the burden of
overcoming that presumption of regularity

A court will not interfere with an honest business judgment absent showing of fraud, illegality, or
conflict of interest
o
Shlensky v. Wrigley
o
Illegality would fall under not acting in good faith

Delaware courts have developed two doctrines for assessing directors business decisions: the duty of
care and the business judgment rule
o
Courts will only consider directors decision-making process, not the substance of the decision

This is because courts, with the benefit of hindsight, are not in a position to determine
whether a choice was a good business decision

Court's essentially say if there is any rational justification for a decision, it will insulate the board's
action

Three factors seem to matter for board negligence, which violate the duty of care
o
Voluntariness
o
Judicial expertise
o
Risk

Waste claims face a higher bar because the waste standards shields directors from liability and board
decisions from review, even when they seem unquestionably unwise or imprudent
o
DE Sup Ct: "there is only waste if what the corp has received is so inadequate in value that no
person of ordinary, sound business judgment would deem it worth that which the corp has paid"

Seems to be the adequately informed requirement of the BJR

Waste is under duty of care

The phrase "being informed" in the context of the decision making function, refers to the process of
gaining sufficient familiarity with the background facts and circumstances in order to make an informed
judgment
41

MBCA s 8.30(b)
When the board becomes aware of a potential conflict of interest, they have a duty under the duty of care
to inquire whether that conflict of interest is an issue that may taint the decision making process
o
If the board is aware of a potential conflict and does not inquire further, they lose they protection
of the BJR and may be able to be held personally liable for breaching the duty of care
Avoiding director liability
o
Exculpation

DGCL s 102(b)(7)

Permits DE corps to adopt charter provisions limiting directors' personal liability for
certain breaches of duty

The statute is not self executing

The board must propose and the shareholders must adopt any exculpatory
provision in the articles of incorp

"(7) A provision eliminating or limiting the personal liability of a director to the

corporation or its stockholders for monetary damages for breach of fiduciary duty as a director,
provided that such provision shall not eliminate or limit the liability of a director: (i) For any
breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts
or omissions not in good faith or which involve intentional misconduct or a knowing
violation of law; (iii) under 174 of this title; or (iv) for any transaction from which the
director derived an improper personal benefit. No such provision shall eliminate or limit the
liability of a director for any act or omission occurring prior to the date when such provision
becomes effective. All references in this paragraph to a director shall also be deemed to refer to
such other person or persons, if any, who, pursuant to a provision of the certificate of
incorporation in accordance with 141(a) of this title, exercise or perform any of the powers or
duties otherwise conferred or imposed upon the board of directors by this title."

Does not permit corps to limit directors personal liability for all breaches of duty

Instead, gives 4 exceptions

MBCA equivalent does not contain any exceptions for breaches of "duty of loyalty" or
for "acts or omissions not in good faith"
o
Indemnification

When looking here, think of three categories

Payments corps may indemnify (permissive)

Payments corps must indemnify (mandatory)

Payments corps must not indemnfiy (prohibited)

Statutes try to draw lines between the three categories

DGCL s 145 Indemnification of Officers, Directors, Employees and Agents

(a)A corporation shall have power to indemnify any person who was or is a party or is
threatened to be made a party to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other than an action
by or in the right of the corporation) by reason of the fact that the person is or was a
director, officer, employee or agent of the corporation, or is or was serving at the request
of the corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably incurred
by the person in connection with such action, suit or proceeding if the person acted in
good faith and in a manner the person reasonably believed to be in or not opposed to the
best interests of the corporation, and, with respect to any criminal action or proceeding,
had no reasonable cause to believe the person's conduct was unlawful. The termination
of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a
o

42

plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the
person did not act in good faith and in a manner which the person reasonably believed to
be in or not opposed to the best interests of the corporation, and, with respect to any
criminal action or proceeding, had reasonable cause to believe that the person's conduct
was unlawful.
(b)A corporation shall have power to indemnify any person who was or is a party or is
threatened to be made a party to any threatened, pending or completed action or suit by or
in the right of the corporation to procure a judgment in its favor by reason of the fact that
the person is or was a director, officer, employee or agent of the corporation, or is or was
serving at the request of the corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprise against expenses
(including attorneys' fees) actually and reasonably incurred by the person in connection
with the defense or settlement of such action or suit if the person acted in good faith and
in a manner the person reasonably believed to be in or not opposed to the best interests of
the corporation and except that no indemnification shall be made in respect of any claim,
issue or matter as to which such person shall have been adjudged to be liable to the
corporation unless and only to the extent that the Court of Chancery or the court in which
such action or suit was brought shall determine upon application that, despite the
adjudication of liability but in view of all the circumstances of the case, such person is
fairly and reasonably entitled to indemnity for such expenses which the Court of
Chancery or such other court shall deem proper.
(c)To the extent that a present or former director or officer of a corporation has been
successful on the merits or otherwise in defense of any action, suit or proceeding referred
to in subsections (a) and (b) of this section, or in defense of any claim, issue or matter
therein, such person shall be indemnified against expenses (including attorneys' fees)
actually and reasonably incurred by such person in connection therewith.
(d)Any indemnification under subsections (a) and (b) of this section (unless ordered by
a court) shall be made by the corporation only as authorized in the specific case upon a
determination that indemnification of the present or former director, officer, employee or
agent is proper in the circumstances because the person has met the applicable standard
of conduct set forth in subsections (a) and (b) of this section. Such determination shall
be made, with respect to a person who is a director or officer of the corporation at the
time of such determination:
(1)By a majority vote of the directors who are not parties to such action, suit or
proceeding, even though less than a quorum; or
(2)By a committee of such directors designated by majority vote of such directors, even
though less than a quorum; or
(3)If there are no such directors, or if such directors so direct, by independent legal
counsel in a written opinion; or
(4)By the stockholders.
(e)Expenses (including attorneys' fees) incurred by an officer or director of the
corporation in defending any civil, criminal, administrative or investigative action, suit or
43

proceeding may be paid by the corporation in advance of the final disposition of such
action, suit or proceeding upon receipt of an undertaking by or on behalf of such director
or officer to repay such amount if it shall ultimately be determined that such person is not
entitled to be indemnified by the corporation as authorized in this section. Such
expenses (including attorneys' fees) incurred by former directors and officers or other
employees and agents of the corporation or by persons serving at the request of the
corporation as directors, officers, employees or agents of another corporation,
partnership, joint venture, trust or other enterprise may be so paid upon such terms and
conditions, if any, as the corporation deems appropriate.
(f)The indemnification and advancement of expenses provided by, or granted pursuant
to, the other subsections of this section shall not be deemed exclusive of any other rights
to which those seeking indemnification or advancement of expenses may be entitled
under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise,
both as to action in such person's official capacity and as to action in another capacity
while holding such office. A right to indemnification or to advancement of expenses
arising under a provision of the certificate of incorporation or a bylaw shall not be
eliminated or impaired by an amendment to the certificate of incorporation or the bylaws
after the occurrence of the act or omission that is the subject of the civil, criminal,
administrative or investigative action, suit or proceeding for which indemnification or
advancement of expenses is sought, unless the provision in effect at the time of such act
or omission explicitly authorizes such elimination or impairment after such action or
omission has occurred.
(g)A corporation shall have power to purchase and maintain insurance on behalf of any
person who is or was a director, officer, employee or agent of the corporation, or is or
was serving at the request of the corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprise against any
liability asserted against such person and incurred by such person in any such capacity, or
arising out of such person's status as such, whether or not the corporation would have the
power to indemnify such person against such liability under this section.
(h)For purposes of this section, references to the corporation shall include, in addition
to the resulting corporation, any constituent corporation (including any constituent of a
constituent) absorbed in a consolidation or merger which, if its separate existence had
continued, would have had power and authority to indemnify its directors, officers, and
employees or agents, so that any person who is or was a director, officer, employee or
agent of such constituent corporation, or is or was serving at the request of such
constituent corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, shall stand in the same position under
this section with respect to the resulting or surviving corporation as such person would
have with respect to such constituent corporation if its separate existence had continued.
(i)For purposes of this section, references to other enterprises shall include employee
benefit plans; references to fines shall include any excise taxes assessed on a person
with respect to any employee benefit plan; and references to serving at the request of
the corporation shall include any service as a director, officer, employee or agent of the
corporation which imposes duties on, or involves services by, such director, officer,
employee or agent with respect to an employee benefit plan, its participants or
beneficiaries; and a person who acted in good faith and in a manner such person
44

reasonably believed to be in the interest of the participants and beneficiaries of an

employee benefit plan shall be deemed to have acted in a manner not opposed to the best
interests of the corporation as referred to in this section.
(j)The indemnification and advancement of expenses provided by, or granted pursuant
to, this section shall, unless otherwise provided when authorized or ratified, continue as
to a person who has ceased to be a director, officer, employee or agent and shall inure to
the benefit of the heirs, executors and administrators of such a person.

(k)The Court of Chancery is hereby vested with exclusive jurisdiction to hear and
determine all actions for advancement of expenses or indemnification brought under this
section or under any bylaw, agreement, vote of stockholders or disinterested directors, or
otherwise. The Court of Chancery may summarily determine a corporation's obligation
to advance expenses (including attorneys' fees).
145(a) covers lawsuits brought by a 3rd party, including class actions
(b) provides for dreivative actions brought on behalf of the corp
145 (ab) and (b) provide for permissive indemnification
(c) provides for mandatory indemnification when the director or officer has prevailed
o D&O Insurance
DGCL 145 (g)
(g)A corporation shall have power to purchase and maintain insurance on behalf of any
person who is or was a director, officer, employee or agent of the corporation, or is or
was serving at the request of the corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprise against any
liability asserted against such person and incurred by such person in any such capacity, or
arising out of such person's status as such, whether or not the corporation would have the
power to indemnify such person against such liability under this section.
Policies consist of two separate but equal parts
First part reimburses the corp for its lawful expenses in connection with indemnifying its
directors and officers, thus encouraging indemnification by the corp
The second part covers claims against individual directors or officers acting in their
corporate capacity, thus reducing their exposure wen the corp is unable or unwilling to
indemnify

Often extends to claims (including judgments, settlements and attorney fees)

arising in court litigation, as well as administrative, regulatory and investigative
proceedings
Policies can be rescinded I there were "material misrepresentations" in the policy application
Example, false financial statements
Side A insurance is the director is insured
First part above
Side B the corp is insured
Second part above
When there is a board meeting where a decision is made that the board can later be found liable, if you
voted yes on the action you will be liable
o
If you are present at the meeting and fail to object or abstain from the action, you are assumed to
have ascended

If you recuse yourself, you need to make sure abstaining is in the board meeting minutes
or immediately after the meeting notify the corporation of your abstaining
45

However, a provision can be adopted as an exculpation clause to make directors

not liable when they abstain from a vote
o
If a board member is not present at a meeting, under MBCA you are not liable

However, you may be liable under common law if you later acquiesce in wrongful board
decisions
Class Notes Unit 10
If the 4 elements are satisfied, we defer to the board
Duty of care
o Must be informed
o Have a purpose
Duty of loyalty
o Act not for self but for corp
Duty of good faith
o Duty to be honest in fact
Smith v. Van Gorkom
o Still holds, has never been overturned
o Deleware law changed in response to it
o Case dealing with Railroad Car Leveraged Leasing
SEE POWERPOINT to explain how this works
Essentially it can pay off the purchase of their railroad car with the income from leasing the car
o Because of this, low cash flow since all on paper
Next slide about case highlights the example of the income statement in the case to understand it
o As they buy equipment they get tax credits and carry them over over years
So they pay 0 income tax
Has unused tax credits of $5mil
o Income statement v cash flow in the slide
102(b)(7) exculpation clause
o Changed one thing
Said if you are a director and you violate your fiduciary duties, you cannot be personally liable
for damages
Except, where you have breached your duty of loyalty, acted in a way other than good faith, or
have intentionally violated the law, have violated section 174 (authorizing dividend to
shareholders when corp is insolvent), or you have derived a personal benefit
o This is an exculpation clause
Indemnification
o Non derivative claims would be someone suing someone personally within the corp for doing
something to them
Not the shareholders suing the board for being bad actors
o If you are a director, and you win, you must be indemnified for your defense costs
Can even advance defense costs, in fact some make it mandatory
o No restrictions on what insurance can cover in regards to other provisions limitations
Corp can go out and based on 145(g) can buy a directors insurance policy
The key language in 145 (g) is "corp has power to purchase insurance against liabilities.
The power of whether to indemnify this person is(?)"
o DGCL 145(g)
o If a director does not disclose a prior bad act, that can rescind the insurance
o (Talking about insurance with director indy slide)

46

The terms of that insurance "drop down" becomes primary in the event the prmary insurance
doesnt pay or refuses to pay
May not be rescinded because of error in the application or attached documents
THIS INSURANCE tends to be a gold standard and available on a limited basis

Unit 11 - Board Oversight

Friday, November 25, 2016
3:41 PM

573-606

DE s 102(b)(7) specifically permits companies to limit the personal liability of directors for monetary
damages for breaches of fiduciary duties, with an important exception for actions "not in good faith"

The business judgment rule presumes that directors acted on an informed basis, in good faith and in the
honest belief that the action taken was in the best interests of the company. Aronson v. Lewis, 473 A.2d
805 (Del. 1984).
Class Notes Unit 11
Statutory Standards of Conduct
o DGCL s141
o MBCA s8.24 Quorum and voting
o MBCA s 8.30 Standards of Conduct for Directors
Francis v. United Jersey Bank
o Individual director being personally liable for something that individual did or did not do
Not the whole board involved
o Loans to her son were a misappropriation of funds
Even tho she may not have been liable if she objected and resigned, she should be held liable
because you never know
o Sarbanes oxley 302 and 306 make the CEO and treasurer to certify the accuracy of financials
Graham vs Chalmer(?) standard
Caremark Case
o In shifting to an affirmative duty of oversight for the board, odd procedural posture, odd against
caremarks directors
No evidence the board knew about the medicaid fraud throughout the company
o Shareholders brought action saying directors violated duty of care by failing to uncover the fraud
Attempt in good faith to have a system that gathers and reports information, has internal controls
to fulfill the duty of good faith
Lack of good faith in putting the system like this in place exposes the directors to liability
Still a tough standard
To prevail, Ps would have to show "a sustained or systematic failure of the board for
oversight, so as to establish a lack of good faith"
This would be like not having a reporting system
Makes the cases so hard to win for Ps
Theory here is possibly the most difficult theory in corp law in which the P may hope
to win a judgment
o This case is now DE law
Rules for being a director, only Prof's rules
o Do your job
47

Pay attention
Dont be an idiot
Stone v. Ritter
o Recall what happened Smith v Van Gorkum
Duty of care case, now corp adopt exculpation clause, put in cert of incorp providing directors
cannot be liable for damages merely by violating duty of care
In other words, a class action against the board based on the duty of care, if what you are is
a regular basic P's securities firm, it isnt worth anything because you cannot collect
anything
Would need a client who wants to enjoin the merger
o S102(b)(7) does not exculpate sections of the duty of loyalty
Nobody is alleging here that someone violated the duty of loyalty
But it also has an exception to exculpation for acts or omissions not in good faith
o Has to be a claim against the board itself in order to exculpate, not the underlings
And the board has to have violated a duty for which the directors still have to pay damages
o If you can adequately plead as a P in a derivative claim the board in deed did something wrong, it is
understood the board is not going to look at the claim and go "oh lets sue ourselves"
The demand is futile
Being like hey directors we are asking you to have the corp sue yourselves
If the demand requirement is excused, the case moves forward to the certification of the class
If the class is certified, there is now settlement value
o So now, need a theory to show the directors did something wrong and that the demand is excused
o Need a theory of damages against the board
DE Sup Ct determined there is not
To succeed solely on a claim of lack of good faith, you have to show a sustained or systematic
failure of the board to exercise oversight, and an utter failure towards the recording standard
Almost willful blindness
Standard from the Caremark case
Not an independent theory of bad faith
Still in the theory of loyalty
o Not an independent good faith claim, its that you did your job so badly that you really were disloyal to
the corp
On the other hand, the report prepared by the outside auditors commissioned by the regulators,
shows on its face these directors were not willfully blind
o Result still favors stuff happens rather than gods and demons (see slide on Stone v. Ritter)
Securitized Mortgage Financing - Citigroup
o Places like citigroup set up special purpose vehicles (SPV)
Send them groups of mortgages that citigroup has received from the originators (see slide)
SPV then sorts the mortgages
Tranche AAA is great mortgages
But also lower Tranches, AA, A, BBB, etc.
SPV then sells bonds to investors that are based on the Tranches of mortgages
More risk with lower Tranches
SPVs pay credit rating agencies to rate the bonds
SPVs never worried because housing values never go down, always rising
Then insurance places like AIG offer a credit default sway to the SPV to insure against the fault
of bonds, and AIG gets a premium
AIG thinks it will never have to pay
o
o

48

Think even if mortgage not paid, can forclose and sell the house and housing always going
up

Unit 12 - Executive Compensation

Friday, November 25, 2016
3:42 PM

657-693

Corporate executive compensation packages typically consist of salary, bonuses, stock options, stockbased plans, deferred compensation (pension) plans, and fringe benefits (or "perks")

Arguments that stock options are a poor form of payment

o
Expensive

The cost to the company is generally greater than the value to the executives
o
Poor alignment

Stock options align incentives in only one direction since managers, unlike shareholders,
suffer no downside losses if stock prices fall

Makes managers with stock options more willing to gamble with decisions
o
Poor design

Stock options can become valuable if any executive merely stays in office during a rising
market
o
Distorted incentives

Because dividends are not paid on options, CEOs who receive option grants have an
incentive to have the company retain cash and reduce dividends
o
Encourages Fraud

Execs with options have an incentive to increase their company's stock price - sometimes
no matter the cost

Executive pay is determined by the board of directors

o
In public corps, setting exec pay is usually delegated to a compensation committee of the board

In 1993, Congress responded by revising the tax laws to disallow corp deductions for executive
compensation paid to the CEO and the four highest paid execs in excess of $1mil per year
o
An exception was made for compensation based performance goals

(1) determined by a compensation committee composed solely of outside directors

(2) approved by shareholders after disclosure of material terms

And (3) certified by the compensation committee to have been met

o
See Internal Revenue Code s 162(m)

SEC disclosure rules

o
Today require the company's annual proxy statement to disclose compensation of the CEO, CFO,
and 3 highest paid execs for the current and 2 preceding fiscal years

Sarbanes-Oxley (2002)
o
Prohibition of loans to insiders

Basically company cannot make personal loans to directors or execs

Security Exchange Act s 13(k), Sarbanes Oxley s 402

Has an exception for loans made in the ordinary course of business

o
Also calls for execs to pay back incentive pay when it is discovered misstated financial
information

If a public company is forced to restate its financial statements as a result of misconduct,

the corp's CEO and CFO must reimburse the company for incentive pay

Dodd-Frank: More pressure on exec pay

49

Gives shareholders an advisory vote on exec pay packages that arise in mergers or other corp
acquisitions

When a company seeks shareholder approval for an acquisition, the corp must now
disclose any special pay arrangements for company execs, such as "golden parachutes"
o
Mandates that the stock exchanges require their listed companies to adopt procedures to recover
up to 3 years of incentive pay from current and former company execs whenever the company must
restate its financials

Expands sarbanes-oxley by

Covering more execs than just CEO and CFO

Expanding the clawback period from 1 to 3 years

Applying to all restatements, not just those due to misconduct

o
Requires public companies to include new disclosures in their annual proxy statements

Must show relationship etween exec pay actually paid and the company's financial
performance

Must disclose ratio between the median compensation of all the company's employees
(with exception of CEO) and the CEO's total compensation
o
Requires all public corps of an advisory (nonbinding) shareholder vote on exec pay
Class Notes Unit 12
Stock options have to be shown as an expense in the period in which they are granted
Maybe on balance sheet?
Fas 123r, company will show as an expense in the financial statements
Accounting advantage, entice employees without actually paying them anything that the
shareholders could see in the financial statements
o That advantage ended
o Fair value of options has to be reported as an expense
Put option
I have paid for the right for the offer to stay open
o Paid to keep it open
o Have an option to make you take my shares at a particular price
Call option is the opposite of a put option
Is worth how much youre willing to risk to pay to buy the option and hope that you want to call it
o Problems
Volatility
The company could change dividend policy
Economy interest rates could change
"The value of an option is 1/3 what the stock is trading"
He said rule of thumb
Unsure if a fact
Option back dating
Current compensation of stock options = # of stock options x (market price - strike price)
o

Unit 13 - Duties within Corp Groups

Friday, November 25, 2016
3:42 PM

695-712; 964-973
50

A parent corporation must pass the intrinsic fairness test only when its transactions with its subsidiary
constitute self-dealing in that the parent is on both sides of the transaction with its subsidiary and the
parent receives a benefit to the exclusion and at the expense of the subsidiary
o
Otherwise, business judgment rule applies

"majority rule" allows controlling shareholders to structure transactions that force minority shareholders
to accept cash for shares. Three ways:
o
Cash-out merger (most common) - the parent corp uses its control of the subsidiary's board and
its voting majority to arrange a merger between the partially owned subsidiary and a wholly owned
corp of the parent (or the parent itself). In the process, the minority shareholders receive cash in the
merger or, if they are dissatisfied with the merger terms, in a judicial appraisal
o
Tender offer followed by short-form merger - a bidder corp (sometimes already with a
controlling interest) makes a tender offer conditioned on acquiring at least 90% of a corp's stock. If
successful, the bidder then merges with the corp under a streamlined procedure that requires only
approval of the parent corp's board of directors
o
Sale to outside buyer - the parent corp, rather than acquiring 100% ownership of the subsidiary,
arranges for the subsidiary to be merged with an outside buyer. In the merger, the parent corp and
minority shareholders receive consideration as specified in the merger plan
Weinberger v. UOP
o
Held that in a "one-step" cash-out merger, where the board of a company with a controlling
shareholder voted to approve a merger, the merger was subject to an "entire fairness" test

Court held that fairness has two basic aspects

Fair dealing

Timing of transaction, how it was initiated, structured, negotiated,

disclosed to the directors, and how the approvals of the directors and the
stockholders were obtained

Fair practice

Relates to the economic and financial considerations of the proposed

merger, including all relevant factors: assets, market value, earnings, future
prospects, and any other elements that affect the intrinsic or inherent value of a
company's stock
Alternatives to Cash-Out Mergers
o
Short-Form Merger

DGCL s 253 authorizes a short form merger between a parent corp and its subsidiary, if
the parent owns at least 90% of the subsidiary's stock

Parent simply files a certificate setting forth its stock ownership and the terms of the
merger, as set by the parent corp's board

No action is required of either the board or shareholders of the subsidiary

Parent corp must inform subsidiary's minority shareholders of the terms of the merger
and advise them of their appraisal rights if they are dissatisfied with the consideration offered
by the parent. DGCL s 262(d)(2)
o
Tender Offer followed by Short-Form Merger

Essentially someone with less than 90% of the stock tenders an offer to minority
shareholders to get to 90%, then uses a short-form merger

Not the same judicial review as simply a short form merger in DE

Judges focus on the structure of the tender offer and the disclosure to
shareholders, but no on the offer's entire fairness

Class Notes Unit 13

51

Intrinsic fairness test

o Not entire fairness
That would be procedural fairness and if the deal itself is okay
o Intrinsic fairness is more was it a fair deal
Deal has to favor the majority shareholder at the expense of the sub
Rule: self-dealing occurs when the parent causes the sub to act in a way that the parent
receives something to the detriment of the minority shareholders of the sub
Three different types of transactions
In some cases BJR applies because self-dealing was not present
Inter corporate transfer pricing
Transfer pricing
Closed corporations probably no dividends
o Even more so if shareholders work for the corp
o Pay salaries, show no profit, no taxes to be paid
Way of avoiding taxes for an S corp
Squeeze out
o Cash-out merger (weinberger) slide
Appraisal right under DE law
Not that great
Called the collective action problem
Essentially "why should I bother to vote? Does it even make a difference"
Very expensive to undertake
Before weinberger, DE law said a freeze out was not ok
Burden of parent needed to show entire fairness
Price intrinsicly fair
But, standard of sole purpose was unclear
Standard of entire fairness was unclear
If you were to represent the minority shareholders, it was very expenive to litigate
because you were litigating fact issues
In Weinberger
Minority challenged the cash out merger
Became how future deals were structured
Standard of entire fairness
Court did not think the board did a very good job at valuation of discounted value, that we
saw in unit 6
Asked for recission damages
Footnote 7***
UOP should have appointed an indepensent committee to negotiate with the parent
Key thing from this case***
Needed an independent board to negotiate to ensure the fair negotiation with the
parent and a fair value of the merger
Each board member has duties to each and every shareholder, including the minority
shareholders
Therefore, no benefit of BJR
Still subject to entire fairness review
Procedural hint in footnote 7***
V important
Now what lawyers do
52

Its your job as the controlling lawyer to find ways for a case to be decided under BJR because
the standard is relaxed
DE section 262 is to seek an appraisal
o Only manner of short term merger of a way for a >10% minority shareholder to fight the merger
o Fair value of the weinberger test, but no procedural safeguards, is the standard
If you are a minority shareholder and you dont like the price, you have to seek an appraisal
Another collective action problem
Which also means its expensive
Tender offer plus short term merger
o Same substance, different standard of review
o Tender offer standard of review is simply whether it is coercive and is somehow structured so that you
are going to tender at a coercively low price because you do not want to be left behind
Not the fairness of the price
Instead, is a process based standard
Have you structured the tender offer so that if you do not tender your shares, theres is
something on the back end that says you wont get as much money
We offer a low ball price in the tender offer, and we put conditions on such that if you
do not tender you are punished even more
Causes more people to tender at a price that is still too low
If coercive in this way, will be struck down
Fairness of the deal is not a standard of review here
o Judge ruled the deal was so fair that he applied the BJR instead of entire fairness
What case(?)
MFW case, last page of chapter for unit 11

Unit 14 - Antitakeover Devices

Friday, November 25, 2016
3:42 PM

839-879

Two basic methods for potential acquirers to use to takeover a corp

o
Make a tender offer
o
Seek control through a proxy contest
Takeover defenses
o
Classified boards

If the entire board can be replaced in each election then an insurgent could elect an
entirely new board who would vote in their favor

Having staggered terms of elections means not an entire board can be replaced all
at the same time

Many states permit this

DGCL s 141(d)

Some states may require the staggering be created through the articles
o
Poison pills

Also called "shareholder rights plan"

Corp issues additional rights to attach to outstanding shares

53

The new rights cannot be traded separately and initially have terms that make then
have little value\

The rights plan will specify a 'triggering' event

Usually when a potential acquirer buys a specified percentage of the corp's shares

Example, may trigger whenever anyone acquires 15% or more of the

shares

Or a merger with another corp for example

The plan will next provide that a term of rights change when the triggering event occurs

The rights after the triggering event will give the shareholder the option to buy
additional rights at a lower price

Importantly, the rights plan provides that the acquirer who triggered the
change in the terms of the rights is not entitled to this benefit

A board can unilaterally, without shareholder approval, authorize issuance of the rights in
a rights plan

Board can also redeem the rights w/o shareholder approval

To strip the board of these powers the shareholders must amend the articles of
incorp

Courts have read DGCL s 157 as giving directors authority to adopt a rights plan
unilaterally

Moran v. Household International, Inc. held for this

o
Share Repurchases

Directors can authorize the repurchase of shares, either by the corp directly or through an
employee stock ownership plan or pension plan

Can signal support of shareholders and can increase the price of shares

This makes a takeover more expensive

One form of this is known as "greenmail"

Involves the purchase of a potential acquirer's shares at a premium

Essentially the acquirer gives up the takeover in exchange for payment of a

premium
o
Lock-Ups

The board makes agreements to transaction with 3rd parties that "lock up" some or all of
the value sought by the bidder
CTS Corp. v. Dynamics Corp. of America
o
Sup Ct suggested that states have considerable, but not unlimited, scope to regulate takeover bids
Role of takeovers to management
o
Theory is that managers want to work hard to make sure the corp is doing well so the stock price
is high so nobody could take over the company, and this would ensure job security for managers
o
Problem with takeovers if the stock price is incorrectly valued

If the hostile bid was based on an incorrect stock price, then shareholder choice means
both good and bad managers could lose their jobs

So managers lose motivation to be faithful to the corp or risk losing their jobs b/c
they might lose their job anyway if the takeover happens

Managers are often more knowledgeable than the market about the true value of their
company
How takeover attempts can help but also hurt shareholders
o
Stock prices go up when there is a takeover attempt because shares are wanted (simple
economics supply and demand)

If an initial tender offer is denied and no second one comes, then the shareholder stock
price eventually goes down to the pre-bid level
54

Target shareholders lose the opportunity to sell at a premium

Or, even worse, the merger could go through and shareholders only break even

Three judicial approaches to antitakeover devices

o
Courts can apply the BJR

A transaction approved by a majority of independent, disinterested directors receives the

protection of the BJR
o
The courts apply an intermediate level of scrutiny

Like the duty of loyalty context, the courts recognize that when directors make decision
that might be motivated more by self-interest than the interests of shareholders, this conflict
generates a need to examine the facts more closely

Instead of BJR, courts inquire into the board's response to a perceived takeover threat and
question whether directors acted with self-interest or based on what the directors believed was
in the best interests of the shareholders

Self interest can even be just preserving their spot on the board

Often referred to as the Unocal Proportionality Test

Two prong "proportionality" test*****

Whether the board had reasonable grounds for believing a threat to the
corp existed; and

Whether the defensive measures taken were reasonable in relation to the

perceived threat

Comes from UNOCAL case

This court said a target board may consider "the impact on 'constituencies'
other than shareholders"

i.e. creditors, customers, employees, and perhaps even the

community in general
o
Courts can apply a strict level of scrutiny

When it is apparent a takeover attempt have proceeded so far that the corp can be deemed
"for sale" the role of the board shifts

Once the company is deemed for sale the board must act to maximize the value of
the corp in a sale for the benefit of the shareholders

Companies for sale are often deemed to be in "Revlon mode"

Class Notes Unit 14
Bear hug offer
o Offer with price clearly higher than what corp is worth but not as high as corp wants
Purpose to scare off other bidders, and hopefully scare the corp into accepting the low bid
o Two steps
Make an initial overwhelming but underwhelming offer to the board

If board doesnt take it, make the same offer to the shareholders

Even if board believes in good faith the offer is undervaluing the company, the risk
aversion basis clicks in

Do you take the low offer, or take the lower chance of getting a higher offer in
the future
If you veer towards the policy that DE s 141a that business and affairs are managed by the board and that
the response to takeovers is fundamentally a responsibility of the board to asses on behalf of the
shareholders under the BJR, if you take this view you substantially weaken the takeover option as
management has too much power
o But if you give the power to the shareholders theres no need for the board under 141a
o All ofthis falls under equity when reviewed after the fact
o Tend to not be crisp rules on whats ok and whats not
55

Classified board
o Cert of incorp will have a provision that sets min and max directors, and if there will be a classified
board there will be a part of the provision that divides the board into its groups
When corp is started, one group starts with a 1 year term, one group with a 2 year term, then a
group with a 3 year term. After that, everyone elected gets 3 years, so its a rolling board
If you have both a classified board and a poison pill you are almost impenetrable from a takeover from
someone going directly to the shareholders to offer them a price without first coming to the board
In DE, the board has the right to create these rights or options of a poison pill unless the cert of incorp says
otherwise
o Moran v. intl household case
Says boards can adopt poison pills
Cheff v. Mathes
o
Book value is on the balance sheet using historical numbers from the past that the assets exceed
the liabilities by about $20mil, but if you look at the entire market utilization of the corp (shares
outon the market) times the share price is only $18 mil
o
No problem with corp buying back shares as long as no impairment of capital

If you spent so much corp money, if afterwards the value of the assets was less than the
value of the liabilities you could not do this

Cannot make the corp insolvent

DGCL s 160
o
Standard of review for 3 directors that dont have a personal pecuinary interest in the company
(the 3 other than Trencamp and Mr. Cheff) is the BJR

But the directors have the burden of showing why they bought back the shares

So they show good faith and reasonable decision satisifies BJR

Do not need to show it was the right decision, just satisfy BJR
o
Takeaway is the BJR standard that existed in DE until 1983
From 1983 on there has been a reshaping of DE law
o
UNOCAL and EVRON (idk if right names)
UNOCAL Corp. v. Mesa Petroleum Co.
o
Mesa had 2 stage transaction to acquire UNOCAL

Tender offer for 51% of shares in cash at $54/share

For 64 million shares

Stage two comes after acquiring majority control

Was going to be an exchange offer where remaining 49% of sharheolders would

receive junk bonds

Would give those shareholders bonds of the company's debt

Would be unstable

Much worse than taking $54 per share in case

Offer is designed to scare the crap out of shareholders

Designed to make them rush to want to take the $54 per share in
cash

In response, UNOCAL offered debt exchange offer bonds at $72/share

o
Does the board have the power or duty to prevent a takeover attempt it believes is detrimental to
the corp?

Yes
o
The corp can deal in its own stock, and if appropriate, can buy back shares in order to protect the
shareholders
o
Is the action here, as in CHEFF, entitled to the BJR?
56

2 standards to see if BJR applies

Corp must show directors had reasonable grounds that a danger to corporate
policy and effectiveness existed through the threat

Board knew from doing a thorough investigation

Helps when can be a board of outside directors

Purpose cannot be merely

Response selected by directors has to be reasonable to the threat posed

Response must be proportional

Board can consider the adequacy or inadequacy of the tender price, timing
of the offer, risk the deal cannot be consummated, quality of the consideration, long
term and short term interest, etc.

No fiduciary obligation to holders of debt, only to shareholders

Almost nothing is per say illegal to arm yourself against harsh threats
o
Can even make wrong judgments, as long as you are disinterested, independent, informed, and
rational***
Quiz 12 review

Binomial method looks at the changes up vs down for each year, more granular guessing
o
Black-scholes assumes value of option at the end, doesnt account for getting there

Number 8 is straight from the Disney case

To answer 9 you have to know the duties of care but also bring in 102(b)(7) from an earlier unit to
understand the Q

Review Session
Sunday, December 11, 2016
3:02 PM

o
o

Unit 14 Quiz Review

"Bear Hug" - A bear hug is an offer made by one company to buy the shares of another
for a much higher per-share price than what that company is worth. A bear hug offer is usually
made when there is doubt that the target company's management is willing to sell.

The name "bear hug" reflects the persuasiveness of the offering company's overly
generous offer to the target company.
Tender offer

The whole point is to go around the board

Poison pill is to avoid this

If some tenders and it triggers a poison pill, the rights will detach and will
force a potential tender offeror to go talk to the board first

Steps to takeover are usually

Negotiate with board

Bear hug

Then straight to shareholders to go around the board

"Front-end Loaded" Transaction

One in which the acquirer proposes to acquire all of the shares of the target
company in two stages, and makes the second stage far less attractive than the first
Intrinsic standard
Would procedural fairness make a difference?
If corp has a majority already, and process makes no difference, then doesnt matter much
57


o
o

o
o

o
o

o
o

Some instances are instead entire fairness

Board should have been obliged to do the right thing on behalf of the shareholders
If BJR standards are not met, then burden shifts to an ENTIRE FAIRNESS STANDARD

Board members now have to justify entire fairness

We did what we should have done;

And we have to show that it was a fair deal intrinsically

Committees
Typically make recommendations to the board as a whole
Proxy access
If you are a shareholder and you want to have a contested vote at a shareholder meeting,
it costs a lot of money

You have to pay lawyers, printers, mailing

Usually done by someone who wants to promote some other policy within the corp

But, usually most people dont wanna spend the money

So thats why theyll do shareholder resolutions

Much cheaper and included in the corp's proxy statement

Attempt to allow certain shareholders (ex. Lots of shares, heavy influence) nominate a
director and have the company pay for the materials going out

To force the corp to have a contested director election

SEC tried to make it happen, got shut down

Corps dont wanna do it

So, no SEC rule currently requiring proxy access

Duty of bad faith
Not its own duty
Stone v. Ritter tells us it falls under the duty of loyalty
Indemnification
Can be in bylaws or in the articles
145a is indemnification for non-derivative claims

INDEMNIFICATION HERE MEANS corp will take on the costs if director is

individually sued
145b director does something wrong

Assuming director found liable,

145c says if you are sued and you win, you dont have to worry about liability but you
MUST be indemnified your defense costs

Never have to worry about this for director losing, if youre having a shareholder
suit against you you will get advanced defense costs
DE vs MBCA VERY IMPORTANT
MBCA allows shareholders to add a provision to a bylaw change that says directors are
not allowed to change back

But in DE you can have a back and forth ping pong match changing then
changing it back
Debt securities can never be participating
Could be convertible into shares however
Corporate PAC can make contributions right to a campaign

CASE BRIEFS

Meinhard v. Salmon
Tuesday, August 30, 2016

58

3:09 PM

1.
2.
3.

2.
3.
4.
5.
6.

1928
Judgment entered for P, D appealed. AC affirmed, D appealed again
D executed a 20 year lease for a hotel which he intended to convert into retail space
a.
At the same time, D formed a joint venture with P to secure the funds for the lease
i.
P would pay 40% of the funds to operate/manage the prop, and D would give P
40% of profits for 5 years and 50% thereafter
ii.
Both agreed to bear losses equally
a.
During the course of the lease, someone else became the owner of the property (lessor)
i.
New lessor wanted to lease this land and others around it to someone who would
bulldoze everything and construct all new buildings
b.
With 4 months left on original lease, new lessor approached D about the plan
c.
D executed a new 20 year lease with new lessor for all of the new lessor's property
i.
D didnt tell P
d.
P found out and demanded the new lease be held in trust as an asset of the joint venture
Is a co-adventurer required to inform another co-adventurer of a business opportunity that occurs
as a result of participation in a joint venture?
Yes
New lease was an extension of the subject matter of the old lease
a.
Co-adventurers in a joint venture owe each other a high level of fiduciary duty
i.
D not alerting P about the new lease was a breach of that fiduciary duty
Court held a trust attaching to the shares of stock should be granted to P, with parties dividing
shares equally, but D receiving one additional share to retain control and manage the property
P wins

Schnell v. Chris-Craft Industries, Inc.

Monday, September 5, 2016
5:27 PM

1.
2.
3.

1.
2.
3.
4.
5.

1971
Idk
Angry shareholders (Ps) of the company (D) wanted to replace the existing directors at the
annual board meeting
a.
Board tried to move meeting up a month to make it virtually impossible for Ps to be able
to unseat the existing directors
May corporate directors take action solely for the purpose of obstructing shareholder objectives?
No
Directors of a corporation are bound to act in the best interest of the shareholders.
Shareholder elections are particularly important events and may not be manipulated by directors
for their personal gain
Ps win

Auer v. Dressel
Monday, November 14, 2016
9:33 AM

59

1.
2.
3.

1.
2.
3.
4.
5.

1954
TC granted summary judgment for P
D, a corp, had bylaws that required president to call a special meeting whenever requested in
writing to do so by a majority of its voting stockholders
a.
A majority of voting stockholders called for a meeting
b.
President did not hold a meeting
c.
P brought suit against president of corp seeking an order to compel for the president to
hold a meeting and comply with by-laws
d.
Answer from corp was simply to deny the corp or president had any knowledge or info
sufficient to form a belief as to the adequacy of the number of signatures on the request
Where a corporations bylaws require its president to call a special meeting whenever requested
in writing to do so by a majority of its voting stockholders, and the president receives such a request,
may the president refuse to call a meeting?
No
A corporations president must follow the provisions in its bylaws relating to calling special
shareholder meetings.
Where a corporations bylaws require its president to call a special meeting whenever requested
in writing to do so by a majority of its voting stockholders, and the president receives such a request,
the president may not refuse to call a meeting
Affirmed (P wins)

Campbell v. Loew's, Inc.

Thursday, November 24, 2016
12:26 PM

1.
2.
3.

2.
3.
4.
5.
6.

1957
n/a
D president of corp
a.
Director on board attempted to take control of company from D
b.
D sent notice to stockholders setting a stockholders' meeting to fill director vacancies,
increase the number of directors, and remove two directors
i.
D sent a letter saying the directors were being removed for cause for being
uncooperative and attempting to take control of corp
a.
D refused to provide a list of shareholders to the directors
b.
P filed suit
Under Delaware law, do corporate shareholders have the power to remove a director for cause?
Yes
It is implied authority since no statute specifically allows them to remove for cause
However, refusing to give the directors a list of shareholders does not give the directors the
opportunity to have their defenses heard by shareholders
Ps win, get to have the list of shareholders, but they're still being brought up for removal at the
meeting

CA, Inc. v. AFSCME Employees Pension Plan

Thursday, November 24, 2016

60

12:50 PM

1.
2.
3.

2008
n/a
P is a corp, and D is a shareholder
a.
D proposed a bylaw that would require P to reimburse shareholders for costs associated
with holding a contested election of its board of directors
b.
P requested a no-action letter from the SEC, and D responded in opposition
c.
The SEC certified the matter for a decision by the DE Sup ct to determine whether
i.
(1) the by-law is appropriate for stockholder action without agreement by the
board, and (2) whether the by-law would be violative of Delaware law.
1.
(1) Is a bylaw permissible if it defines the process and procedure by which a board of directors
makes business decisions?
(2) May a corporations board enter a contract that requires it to act in a manner that would violate its
fiduciary duties?
5.
Yes, no
6.
(1) A bylaw is permissible if it defines the process and procedure by which a board of directors
makes business decisions.
(2) A corporations board may not enter a contract that requires it to act in a manner that would
violate its fiduciary duties.
7.
To the first point
a. The bylaw in question falls within the scope of permissible bylaws because it regulates
the process through which directors are selected
i.
Explicitly stated in DE statutes
The election of directors affects the process and procedure through which business
decisions are made for a corporation, as it is the directors who make such decisions. Thus,
the bylaw in question is permissible. However, the bylaw as it is currently written could
violate other areas of Delaware law, and is thus impermissible on those grounds.
1. To the second point
a. Delaware General Corporation Law 109(a) vests the power to adopt, amend, or repeal a
corporations by-laws concurrently in a corporations directors and its stockholders.
b. Section 141(a) provides that a corporation is to be managed and directed by the
corporations board.
i.
Reading these two provisions together, it is apparent that a stockholders statutory
power to amend, adopt, or repeal a by-law is subject to a boards duty to manage the
corporation
c. Under Delaware law, a by-law is not intended to dictate how a board should decide
substantive matters, but rather the procedures by which substantive decisions are made
i.
The by-law at issue here governs the procedure for electing directors. The effect
of the by-law would be to encourage non-board sponsored nominees to seek
election, thereby furthering the right of shareholders to participate in the election of
directors. Consequently, this court finds the by-law to be a proper subject for a
stockholder vote. Nevertheless, directors may not enter contracts that require the
board to act in a manner that would breach their fiduciary duties. Here, it is possible
that a proxy contest could be motivated by pettiness, in which case the boards
fiduciary duties might require it to deny reimbursement. Because the by-law does
not allow for a board to deny reimbursement in such situations, this court finds the
by-law is violative of Delaware law.
61

Blasius Industries, Inc. v. Atlas Corp.

Thursday, November 24, 2016
1:11 PM

1.
2.
3.

2.
3.
4.
5.

6.

1988
n/a
P holds 9% of stock in a corp, who is D
a.
P proposed that D sell off some assets, issue bonds, and distribute a large one-time
dividend to shareholders
b.
Directors of D believed this was not a good idea and rejected the idea
c.
P formalized their proposal and requested the election of 8 new board members
i.
Would increase the board to 15, the max allowed under the corp charter
a.
Fearing a takeover, D held an emergency meeting the next day and amended the bylaws
to add 2 additional board members
i.
Move designed to prevent P from seizing an 8-7 voting advantage in the next
election
b.
P sued D
May a board, acting on its good-faith view of the corporations best interest, take steps with the
primary purpose of interfering with shareholder voting?
No
A board generally cannot undertake action with the primary purpose of interfering with
shareholder voting, even if it acts in the good faith pursuit of the corporations best interest.
while the board is given broad discretion in making most business decisions, they are far less
free to restrict shareholder voting
a.
Under the circumstances, the emergency meeting by the board here was inequitable and
improper, even if technically permissible under DE Corp law
P wins

Quickturn Design Systems. v. Shapiro

Thursday, November 24, 2016
1:28 PM

1.
2.
3.

1998
D appealed
Proposed bylaw would not allow directors to discharge fundamental management duties to the
corp and shareholder for at least 6 months
a.
Provision was to be added to the shareholder Rights Plan
i.
Rights plan is like a poison pill
a.
Provision and other things would essentially delay a takeover by 9 months
2.
Is this allowed?
3.
No
4.
The court affirmed, holding that the delayed redemption provision was invalid under 8 Del. Laws
141(a), because it prevented a newly elected board of directors from completely discharging its
fundamental management duties to the corporation and its stockholders for six months.

62

5.

The provision improperly and illegally restricted the board's exercise of fiduciary duties on
matters of management policy, including the ability to negotiate a possible sale of the corporation,
which was a matter of fundamental importance to shareholders.
6.
Bylaw not allowed

In re Walt Disney Company Derivative Litigation (Disney II)

Friday, November 25, 2016
5:06 PM

1.
2.
3.

2.
3.
4.
5.

6.

2003
D moved to dismiss based on the exculpatory provision
Shareholders are Ps, board of directors of Disney are Ds
a.
Ps filed derivative action against the old and new board (Ds) challenging the board's
approval of the compensation package for the company's number-two exec, another D
b.
When D's compensation committee first met they received a summary of the employment
K
i.
Summary indicated 5,000,000 stock option shares
1.
Worth $80-100mil
2.
Nobody on the committee calculated the worth of the options
a.
Committee recommended k to the board, and the board approved based on the
recommendation
i.
No director asked about the details of the options
b.
Options would vest immediately
c.
K essentially incentivised CEO to leave immediately, and he wanted to leave as soon as
he could
d.
D's charter had an exculpatory provision based on Del. C. tit. 8 102(b)(7), which would
protect individual directors from personal liability for breaches of the duty of care
Do exculpatory provisions protect corporate directors from personal liability if the directors
consciously and intentionally disregard their responsibilities?
No
Exculpatory provisions do not protect corporate directors from personal liability if the directors
consciously and intentionally disregard their responsibilities.
Exculpatory provisions do not apply to directors consciously and intentionally disregarding their
responsibilities
a.
Here, failing to inform themselves adequately about a material corporate matter is merely
negligence or gross negligence
i.
However, directors' adoption of a do-not-care attitude about the risks of a material
corporate decision is conscious and intentional disregard of their responsibilities
ii.
Such conduct is not in good faith of the company
b.
Here, viewed in the light most favorable to the plaintiffs, the complaint sufficiently stated
a breach of the directors' duty to act in good faith in the best interests of the corporation
Ps win, motion to dismiss is denied

In re Walt Disney Company Derivative Litigation (Disney III)

Friday, November 25, 2016

63

5:38 PM

1.
2.
3.

2.
3.
4.
5.

6.

2005
n/a
Shareholders are P and disney board of directors are D
a.
P filed a derivative action against D challenging the board's hiring of the company's
number-two exec
b.
Exec left company and took a large amount of severance pay
i.
Ps allege the employment k incentivized exec to leave as soon as possible and
receive a non-fault termination, rather than complete the terms of the k
a.
Ps argued this amounted to waste
Do directors necessarily breach their fiduciary duties by failing to comply with the best practices
of ideal corporate governance?
No
Directors do not necessarily breach their fiduciary duties by failing to comply with the best
practices of ideal corporate governance.
In Delaware, although directors are strongly encouraged to employ the best practices of ideal
corporate governance, they do not necessarily breach their fiduciary duties by a failure to comply
with the best practices
a.
It is easy to blame a decision that eventually turns out to be a failure based on hindsight,
but the essence of business is risk
b.
Here, the evidence does not support the allegation that the k incentivized the exec to
leave
c.
Ordinary negligence is insufficient to constitute a violation of the fiduciary duty of care
Ds win, no breach

Shlensky v. Wrigley
Friday, November 25, 2016
6:04 PM

1.
2.
3.

1968
TC dismissed the action, P appealed
Cubs baseball did not play night games even when rest of MLB began playing night games in
1935
i.
As a result, Cubs sold fewer tickets and were less profitable than other teams
i.
D was owner of the cubs and the cubs
ii.
D was opposed to playing night games saying it was damaging to the neighborhood the
cubs played in
iii.
P filed suit claiming it would be financially practicable for the Cubs stadium to install
lights an dplay night games
i.
Alleged the only reason the cubs didnt play baseball was because the cubs owner
believed it somehow to be against the spirit of baseball
1.
Can a single aggrieved shareholder sue a board of directors alleging that the board is not
maximizing profits?
2.
No
3.
As long as a corporations directors can show a valid business purpose for their decision, that
decision will be given great deference by the courts.
64

4.

A corporations president and board have authority to determine what course of action is best for
the business
i.
D did not prove that night sales of tickets would be beneficial to shareholders, only that
night games had made other teams more profitable
5.
Affirmed, dismissed (P loses)

Smith v. Van Gorkom

Friday, November 25, 2016
6:13 PM

1.
2.
3.

2.
3.
4.
5.

1985
P appealed
Ceo of Trans Union Corp (Corp) engaged in his own negotiations with a 3rd party for a
buyout/merger of Corp (CEO tryna sell the corp)
a.
Prior to negotiations, CEO determined the value of Corp to be $55 per share and during
negotiations agreed in principle on the merger
b.
No evidence showing how CEO came up with this value other than Corp's market price at
the time of $38 per share
c.
Subsequently, CEO called a meeting of corp's senior management, followed by a meeting
of the board, who is D in this case
d.
Senior management reacted negatively to the thought of a buyout
e.
However, board, Ds, approved the buyout at the next meeting based only on the oral
presentation of CEO
i.
Board did not have an opportunity to review the merger agreement before or
during the meeting
ii.
Ds had no documents summariing the merger, nor did they jabe justification for
the sale price
a.
Ps brought a class action suit against the board, alleging the directors decision to approve
the merger was uninformed
b.
DE chancery court ruled in favor of Ds, Ps appealed
May directors of a corporation be liable to shareholders under the business judgment rule for
approving a merger without reviewing the agreement and only considering the transaction at a twohour meeting?
Yes
There is a rebuttable presumption that a business determination made by a corporations board of
directors is fully informed and made in good faith and in the best interests of the corporation.
Under the business judgment rule, a business determination made by a corporations board of
directors is presumed to be fully informed and made in good faith and in the best interests of the
corporation
a. However, this presumption is rebuttable if the plaintiffs can show that the directors were
grossly negligent in that they did not inform themselves of all material information
reasonably available to them.
a.
Here, Ds did not make an informed business judgment in voting to approve the merger
i.
They did not adequately inquire into CEO's role and motives behind bringing up
the transaction
b.
As a result, the plaintiffs are entitled to the fair value of their shares that were sold in the
merger, which is to be based on the intrinsic value of Trans Union
65

6.

Reversed, Ps win

In re Caremark International Inc. Derivative Litigation

Friday, November 25, 2016
6:45 PM

1.
2.
3.

1.
2.
3.
4.

5.

1996
n/a
Caremark was the subject of a major fed investigation for medicare and medicaid fraud
a.
A group of shareholders, Ps, brought derivative suits alleging the directors of Caremark,
Ds, breached their duty of care by failing to adequately oversee the conduct of Caremark's
employees and thereby exposing the corp to enormous civil and criminal penalties
Does a directors duty of care include a duty to ensure that an adequate internal corporate
information and reporting system exists?
Yes
The directors of a corporation have a duty to make good-faith efforts to ensure that an adequate
internal corporate information and reporting system exists.
The duty of care owed by corporate directors may be breached either by active decisions which
are negligent, or by negligent failure to act
a.
Directors are not expected to oversee all employees
b.
Here, directors made at least minimal efforts
i.
They made good-faith attempts to keep abreast of the law and to adjust
Caremark's practices when they strayed from legal requirements
a.
No systematic failure or oversight
Affirmed (settlement approved)

Graham v. Allis-Chalmers Manufacturing Co.

Sunday, November 27, 2016
12:20 PM

1.
2.
3.

1963
Ps appealed to Sup Ct of DE
D was an equipment manufacturer
a.
Board of directors did not set prices for individual products, only reviewed and approved
budgets
b.
One division, the manager and four of his employees (also Ds) began a price fixing
scheme with other manufacturers
c.
The employees pled guilty to antitrust law violations
d.
Ps filed a derivative lawsuit against the directors and the employees
i.
None of the directors had any knowledge of the violations
a.
When the directors did learn of the wrongdoing, the Legal Division investigated and
instructed subpoenaed employees
i.
Directors also issued a new antitrust policy
b.
Ps argued that the directors had notice of potential antitrust activity based on 2 FTC
decrees from 1937 warnings related to earlier antitrust activity by the company
66

i.
ii.

2.
3.
4.
5.

6.

The four employees began price fixing in 1956

Case is in 1963
c.
Some directors had known of the decrees but had felt they were complied with
Must corporate directors and officers be held liable for losses resulting from their failure to
actively supervise and manage the corporate affairs?
No
Under Delaware law, corporate directors and officers will not be held liable for losses resulting
from their failure to supervise and manage the business, so long as those directors and officers
reasonably relied on the honesty and integrity of their subordinates.
Generally a corporations directors and officers have a right to reasonably rely on the honesty
and integrity of company employees
a. Reliance is no longer reasonable if the directors and officers are put on notice that
wrongdoing may be happening
a.
Director and officer liability may be imposed if, after such notice, nothing is done to find
and prevent misconduct
b.
Here, the board felt they were complying with previous decrees and immediately
responded and put in place stronger policies upon finding out of the violations
i.
The directors had no duty to assume the companys employees were potentially
criminals
Affirmed (Ds win)

Stone v. Ritter
Sunday, November 27, 2016
12:32 PM

1.
2.
3.

1.
2.
3.
4.

2006
DE chancery court dismissed the claim, Ps appealed
Corp was forced to pay $50mil in fines for breaking banking and anti-money-laundering
regulations
a.
An external company audited a review of the Corp and found that the board of directors
had established programs and procedures for compliance and security oversight
b.
Ps nonetheless brought suit against the board (Ds) for failure to engage in proper
oversight of the Corp's policies and procedures
Can hindsight be used to determine whether directors exercised their corporate oversight
responsibilities in good faith?
No
Directors will be liable for failure to engage in proper corporate oversight where they fail to
implement any reporting or information system, or having implemented such a system, consciously
fail to monitor or oversee its operations.
The standard for such a determination is whether the directors knew that they were not fulfilling
their oversight duties and thus breached their duty of loyalty to the corporation by failing to act in
good faith***
a. This is a forward-looking standard and hindsight may not be used to determine whether
directors exercised their corporate oversight responsibilities in good faith
a.
Here, the directors had substantial policies in place as well as an oversight committee

67

i.

5.

The implementation of this system discharges the directors oversight

responsibilities because it is an adequate reporting system and it delegated monitoring
responsibilities to AmSouth employees and departments
Affirmed (D wins, claim dismissed)

In re Citigroup Inc. Shareholder Derivative Litigation

Sunday, November 27, 2016
12:55 PM

1.
2.
3.

1.
2.
3.
4.

5.

2009
n/a
Ps are shareholder of Citigroup, Ds are the board
a.
Ps sued after the housing crash in 2005 seeking to hold directors and officers personally
liable for the company's losses
b.
The plaintiffs claim that the defendants failed to oversee, manage, and disclose
Citigroups exposure due related to the subprime lending market, despite red flags that the
housing market was about to collapse
May corporate directors be held personally liable for failure to manage the companys business
risk?
No
Under the business judgment rule, corporate directors will not be held personally liable for
failure to manage business risk unless their conduct rose to the level of gross negligence.
The business judgment rule prohibits judicial second-guessing of corporate business decision
a.
In In re Caremark International Inc. Derivative Litigation, 698 A.2D 959 (1996), directors
were held liable for breach of duty for failing to monitor and prevent misconduct and illegal
activity by employees. The issue is whether the Caremark rule extends to failure to monitor
business risk
b.
Delaware courts have developed two doctrines for assessing directors business decisions:
the duty of care and the business judgment rule
i.
Courts will only consider directors decision-making process, not the substance
of the decision
1.
This is because courts, with the benefit of hindsight, are not in a position
to determine whether a choice was a good business decision
a.
The business judgment rule presumes that directors acted on an informed basis, in good
faith and in the honest belief that the action taken was in the best interests of the company.
Aronson v. Lewis, 473 A.2d 805 (Del. 1984).
b.
Here, Citigroups exculpation clause saves directors from personal liability absent bad
faith, intentional misconduct or illegality, or disloyalty
i.
Thus, the plaintiffs must show bad faith and gross negligence
c.
The directors may have made bad business decisions, but there is no evidence of bad faith
or conscious disregard of duty
Ds not liable (Ds win)

Sinclair Oil Corp. v. Levien

Sunday, November 27, 2016

68

4:35 PM

1.
2.
3.

2.
3.
4.
5.

6.

1971
DE court of Chancery found for P, D appealed
Corp, D, owner about 97% of the stock in its subsidiary corp, P
a.
For 6 years D caused P to pay out dividends higher than what P actually earned during the
time period
b.
While compliant with the law, P argued that D caused the dividends to be paid out simply
because D needed cash
c.
D also caused P to contract with another D subsidiary for all of its foreign affairs
i.
The subsidiary consistently made late payments and did not comply with
minimum purchase requirements of the k
a.
P brought suit against D for the damages it sustained as a result of dividends and breach
of the k from the other subsidiary
b.
The Delaware Court of Chancery applied the intrinsic fairness standard and found in
favor of P on both claims
Must a parent corporation always pass the intrinsic fairness test when it transacts business that
affects its subsidiary?
No
A parent corporation must pass the intrinsic fairness test only when its transactions with its
subsidiary constitute self-dealing.
A parent corporation must pass the intrinsic fairness test only when its transactions with its
subsidiary constitute self-dealing in that the parent is on both sides of the transaction with its
subsidiary and the parent receives a benefit to the exclusion and at the expense of the subsidiary
a. Otherwise, business judgment rule applies
a.
Here, the business judgment rule should be used in regards to the dividends instead of the
intrinsic fairness standard
i.
And there is no evidence to show the payments were fraudulent or made in bad
faith
1.
Therefore did not violate its fiduciary duty
b.
The contract with the other subsidiary was self-dealing
i.
So applying intrinsic fairness test was correct here
Affirmed in part, reversed in part (contract part P wins, dividends part D wins)

Wilkes v. Springside Nursing Home, Inc.

Sunday, November 27, 2016
5:25 PM

1.
2.
3.

1976
Lower court dismissed complaint, P appealed
P was a director on the board of D, a nursing home
a.
P one of four directors, each owning equal shares and having equal power within the corp
b.
P's relationship with other 3 directors soured
c.
Directors voted to be paid salaries but left out P
d.
P faithfully excuted his duties until he was not reelected as director and informed he was
no longer wanted in the management group
e.
P brought suit for breach of fiduciary duties owed to him
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1.
2.
3.
4.

5.

Are majority shareholders in a close corporation liable for breach of a fiduciary duty to a
minority shareholder if they remove him from office and cut off his salary without any showing of
misconduct?
Yes
Majority shareholders in a close corporation owe minority shareholders a strict duty of the
utmost good faith and loyalty, unless a legitimate business purpose can be demonstrated to justify a
breach of that duty.
Where no legitimate business purpose can be shown, the majority shareholders are liable for
their breach of that duty
a.
Here, there has been no showing of misconduct or poor performance on P's role
i.
Merely a personal desire of Ds to deny his salary
a.
No legit busines purpose was shown, so they should have paid him
Reversed (P wins)

Cheff v. Mathes
Tuesday, December 6, 2016
4:04 PM

1.
2.
3.

2.
3.
4.
5.

6.

1964
DE chancery court found for P, Ds appealed
D was a manufacturer who had a unique business plan with their salesmen
a.
Director and CEO of the manufacturer was approached by another CEO about a merger
i.
But did not work since other CEO did not like the business plan with the salesmen
a.
So the other CEO (another D) began buying shares of D on the open market
b.
Other CEO purchased so many shares that he had a majority control over the corp
i.
Demanded to be put on the board, was denied
c.
Board of manufacturer voted to buy back all the shares from other CEO
i.
Above market price, but a reasonable price given the majority, controlling nature
of the shares
d.
Ps brought suit against manufacturer, its board, and other CEO alleging the primary
purpose of the repurchase of stock was to effectuate a perpetuation of control by the directors
If a boards buying out of a dissident stockholder was motivated by a sincere belief that the
buyout was necessary to maintain what the board believed to be proper business practices, will the
board be held liable for the decision?
No
If a boards buying out of a dissident stockholder was motivated by a sincere belief that the
buyout was necessary to maintain what the board believed to be proper business practices, the board
will not be held liable for the decision.
Although in cases where shares are purchased by a corporation with corporate funds to remove a
threat to control, the burden is on the directors, the business judgment rule kicks in when the
directors prove a good faith and reasonable investigation behind their decision
a.
Here, the board had plenty of reason to believe the other CEO holding a majority of
shares was a threat to the corp's existence
Reversed (Ds win)

70

Unocal Corporation v. Mesa Petroleum Co.

Tuesday, December 6, 2016
4:14 PM

1.
2.
3.

2.
3.
4.

5.

6.

1985
DE chancery ct granted preliminary injunction, D appealed
P, a corp, owned 13% of D's, another corp, stock
a.
P submitted a "two-tier" cash tender offer for an additional 37% of shares at $54 per share
i.
Second tier offered junk bonds to those who did not initially sell their shares at
$54 per share
a.
To oppose, D adopted a selective exchange offer, where D would self-tender its own
share to stockholders for $72 per share
i.
This also excluded P from this offer
b.
P brought suit against the exchange offer of D and exclusion of P from buying additional
shares
May a board of directors repurchase stock from its stockholders selectively?
Yes
A board of directors may repurchase stock from a selected segment of its stockholders in order to
defeat a perceived threat to the corporations business so long as the boards selection of which
stockholders to repurchase from is reasonable in relation to the threat and not motivated primarily out
of a desire to effectuate a perpetuation of control.
Although in cases where a corporation purchases shares with corporate funds to remove a threat
to control the burden is on the directors to prove that their actions were reasonable, the business
judgment rule kicks in when the directors prove a good faith and reasonable investigation resulted in
the purchase
a.
Here, the board repurchased stock selectively in order to defeat a perceived threat to the
corp's business
i.
Was not motivated primarily out of a desire to effectuate a perpetuation of control
Reversed (Ds win)

Dodge v. Ford Motor Co.

Wednesday, December 7, 2016
10:22 AM

1.
2.
3.

1919
D appealed
After 3 years of high special dividends, Henry Ford announced there would be no more
dividends given out by Ford (D) and that all future profits would be invested in lowering the price of
product and growing the company
a.
The board ratified the decision
b.
P, dodge brothers and minority shareholders of ford, sued to reinstate the special
dividends and stop D from building the plant the profits would be used for
1.
Can a company choose to stop paying dividends and instead invest its profits in the communities
in which it is active?
2.
No
3.
A company cannot take actions that harm its shareholders and are motivated solely by
humanitarian concerns, not by business concerns.
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4.

While a company can choose to keep more cash on hand or invest in future ventures, D had been
able to do that and still produce huge special dividends in the prior 3 years
a.
Since no business concerns motivated the decision to stop the dividends, they acted
against the interests of the shareholders
5.
Reversed (Ps win)

McDermott Inc. v. Lewis

Wednesday, December 7, 2016
10:26 AM

1.
2.
3.

1.
2.
3.
4.

5.

1987
D appealed
D was a DE corp and a subsidiary of a Panamaian corp
i.
Underwent a reorg that changed the voting power of shares in a way that would be
prohibited by DE law but allowable under Panama law
i.
P, a shareholder, sued in DE to block the reorg
ii.
Question over which law to apply
Which law should be applied?
Internal affairs doctrine should be applied
The law of the place of incorporation should be applied
The Court found that Delaware's conflict of laws principles require that the laws of the
jurisdiction of incorporation should govern corporate disputes
i.
The Court found that corporations had a constitutional due process right to be sure of
what law would be applied to their actions
ii.
The Court found that the Commerce Clause of the Constitution would be violated by
applying Delaware law, because it would allow Delaware to interfere in the internal affairs of a
foreign corporation having no relationship to Delaware
Reversed (Ds win)

72