Agency
Policy
- Assigning liability to the least-cost Archbishops
avoider (e.g., P, employer)
- Reduce total agency cost =
monitoring + residual (fringe)
P’s liability to 3P in K can come from
A’s…
1. Express authority
2. Implied authority
3. Apparent authority – requires
awareness of P
a. DEFENSE: estoppel Roles with director discretion
by 3P
4. Inherent agency power from
undisclosed P?
P’s… Ratification
P’s liability to 3P in tort
- Relationships in law, not labeled LP vs. GP – see RULPA 303 liabilities
- Apparent agency control
o Over “instrumentality”? LLCs – best choice unless startup
- Type of A
o Employee? Respondeat
superior
o IC (non-servant agent)?
Not liable
o Franchisee (hybrid)?
Depends on purpose
A’s liability to 3P in K can come from
nondisclosure of unidentified P.
Fiduciary duties of A to P
- Unjust enrichment
- Duty to inform (disclose/abstain)
- Loyalty, noncompetition, care,
competence, diligence
Partnerships
Formation: Act like it
Existence: 2+ co-owners
- TOTC to assess existence
o Partners vs. employees
o Partners vs. lenders
o Profit sharing necessary,
rebuttable presumption
- Partnership by estoppel
Fiduciary duties of partners to ptship
- Loyalty: Act in best interest of
ptship; disclose
- Care: Negl/careless/violate law
- Breach limited to “secret profits”?
No specific possessory property rights.
Vs. joint ventures
- Fact-dependent scope and effect
- Same fiduciary duties as partners Duties of care & loyalty
Rights of partners in management
- 2-person ptrship
o Disagree on “ordinary”? Duty of good faith (condition to loyalty)
o Maj. in two-person ptship?
o Who’s suing: 3P or ptr?
o Recover expenses by one?
- Agreements very flexible, comes
with risks of disagreement
Corporations
Formation: formal filing (MBCA 2)
Piercing the veil (never works for public)
- Personal liability (Sea-Land)
o 1) Unity of interest +
o 2) Sx injustice or fraud
- Subsidiary as alter ego
o Fact-based TOTC
o No respondeat superior
among subagents
- Tort action (e.g., products liability)
- Corporate gift giving
- Dividends
- GF business judgment (BJR)
Limited Liability Companies
LLPs – only covers negligence, pro service Proxy fights
- Member/manager managed?
- No personal liability
o Agents disclose to avoid Takeovers (t-offers) – “enhanced scrutiny”
o Dissolve properly to avoid
- Generally, freedom of K
- PCV – same as corporations
- Fid duties to LLC (ULLCA 409)
o Loyalty, care, noncompete
o Members can agree waiver
o Ends upon dissociation
Board of Directors Duties
BJR presumption (Π burden to rebut), unless
uninformed (gross negligence std), fraud,
dishonest practice, bad faith, irrational BP
- Rebut Δ burden “entire fairness”
- Dissent: directors always informed
Duty of care (hasty decision-making
process)
- Informed? Gross negligence std
- Rely in GF on officer reports
- Merger duties: be informed, have
adequate basis, disclose to s/h
- DGCL 102(b)(7) limits $ dmg
Duty of loyalty (self-dealing, COI + GF)
- Trumps BJR – ↑ scrutiny if COI
o Safe harbor EXCEPTION
- Corporate opportunity doctrine – 4-
part Broz test
- Dominant/controlling s/h’s duty
o Self-dealing? “Fairness”
- Ratified by interested director s/h
- Revlon (sale of control)
- Unocal (takeover defenses)
- More than gross negligence
- In executive compensation
o Corporate waste?
- In executive oversight
- BF necessary cond for liability
Securities
Is it a security? Economic reality
Sale of securities (§ 5)
- SEC registration + approval
o Exempt transactions
§ 4(1)
Private offerings
o Exempt securities
- Material misstatement/omission
- Exchange Act disclosures
Insider trading – silent about material fact?
- Insiders
o Temporary fiduciaries
o 10b-5 policy vs. CL
- Misappropriation
o Cady, Roberts duty to disc
o vs. “while in possession”
CL vs. 10b-5
- Tippees
- S/h list – right of inspection by s/h
o Conflicting state laws
- Other corp records – prove purpose
- Revlon duties – sale of control
- Unocal duties – if no Revlon duties
o Self-interest? Entirely fair
o Concern for non-s/h?
o No discrim self-tender
o Poison pill OK
Corporate Litigation
Derivative suits
- Demand requirement
o Rejected? BJR
o Cannot bifurcate claims
o Futility EXCEPTION
- Demand excused? Litigation
o SLC determination
o 2-step test for MTD
Indemnification & insurance (DGCL 145)
- Rights must be consistent w/ statute
- Must indemnify: D/O successful
- May indemnify: Pt in good faith
- May pay suit expenses in advance
o Rsbl agreements enforced
- May maintain insurance
Close Corporations
Ways for minority s/h to get more power
- Shareholder agreement?
o By 100% shareholders?
o City magistrate
Fiduciary duty – utmost GF and loyalty
- Minority squeezed out?
o Mass. vs. Del.
o Remedy
- Terminating directors?
- Ad-hoc controlling minority?
- Both employee and s/h?
Agency
“Agency” indicates the relation that exists where one person acts for another. Specifically, an agency
relationship results from assent by one person (principal) to another (agent) that the agent shall act on
the principal’s behalf and subject to the principal’s control, and assent/consent by the agent so to act
(1.01-03)
Assent or intention manifests through words or conduct
o Dissent: Agency means more than mere passive permission. It involves request, instruction or
command (Klee)
Control ex – condition that coach drive it (or merely a natural precaution)
Control is NOT: characterization in agreement, context of industry, popular usage
o Not probative by itself: marital status, joint ownership
The principal is responsible for the acts of his agent. Where one undertakes to transact some business or
manage some affair for another by authority and on account of the latter, the principal-agent relationship arises.
(See R.3d 2.04, 7.07(2) respondeat superior)
Not necessary: K, compensation, business matter
A creditor (security holder) who assumes control of his debtor’s business may become liable as principal
for the acts of the debtor in connection with the business.1
Can show control in light of all the circumstances an active participant in the debtor’s business
o A creditor becomes a principal when he assumes de facto (actual) control over the conduct of his
debtor, whatever the formal K may say
o If he takes over management of debtor’s biz in person/through agent and directs what K
may/may not be made
NOT merely holding veto power over business acts of debtor
Buyer-supplier vs. principal-agent
Factors showing one is a supplier:
o Receives fixed price for property regardless of price paid by him!
o Acts in his own name and receive title to property
o Has an indep biz (operations not financed by someone else like a buyer) in buying and selling
similar property
Agent: One who contracts to acquire property from a 3rd pt and conveys it to another, only if it is agreed
that he is to act primarily for the benefit of the other and not for himself
Moral hazard: when someone knows he doesn’t have to bear the full costs of bad things that might happen if the
decision turns out bad, changes his behavior, making losses likelier
Liability of principal to 3rd parties in contract
Type Description Dutiful Agent Rogue Agent Imposter Agent
Actual Express Authority through express ✔
manifestations to A
Authority
Actual Implied Actual + incidental, ✔ But implied
Authority necessary, and customary authority may be
worth arguing
1
Cargill: Grain storage company (Warren) became insolvent and owed grain dealer (Cargill) $millions without having paid farmers
for their grain. Cargill was found to be the principal of Warren because Cargill was an active participant in Warren’s operations rather
than simply a financier, thus showing control in light of all the circumstances (the 9 factors together, some of which would be found in
an ordinary debtor-creditor relationship).
 Apparent rd
Manifestations to 3 party ✔ But not ✔ Holding out Inherent agency power
Authority traceable to P necessary b/c actual unlikely & maybe R.2d 8A: Power of an agent derived not from authority, apparent authority or estoppel but solely from
(holding out) agency required the agency relation and exists for the protection of persons dealing with an agent
Undisclosed Negates unusual ✔ But not ✔ Requires P R.3d threw out inherent agency
Principal limitations by undisclosed necessary b/c actual Liability of undisclosed principal3
principal o R.2d 194: An undisclosed principal is liable to 3rd parties for an agent’s acts “done on his
Ratification Acceptance of results w/ ✔ But not ✔ ✔ account, if usual or necessary in such transactions, although forbidden by the principal”
intent necessary b/c actual o R.3d 2.06(1) covers Watteau: An undisclosed P is subject to liability to 3P who is justifiably
Estoppel Carelessly allowing rogue Just the way rule ✔ Apparent easier ✔ induced to make a detrimental change in position by an A on P’s behalf and without actual
or imposter agent is written b/c it’s not equitable authority, if P, having notice of A’s conduct and that it might induce others to change their
positions, did not take reasonable steps to notify them of the facts
The liability of a principal to third parties for the acts of an agent may be shown by proof of: Rogue A doing things outside normal course of business that P doesn’t notify
Express, real, or actual authority that was definitely granted o R.3d 2.06(2)
a. What A believes
Implied authority (to do all that is proper, customarily incidental, reasonably appropriate to the exercise Contracts w/ 3rd parties (R.3d 6.01-03)
of the authority granted) Agent for undisclosed principal (PAT all bound)
a. What A reasonably believes P would authorize A to do on P’s behalf o Principal is party to K, unless excluded by K
Apparent authority (where the principal by words/conduct has “held out” the person to be his agent) Principal (if party to K) and 3P have same rights against each other as if principal made
a. What 3P reasonably believes (no direct communication b/w 3P and P required) K personally
b. Requires awareness of P: 3P’s belief is traceable to P’s manifestations o Agent and 3P are parties to K
Inherent agency power? Agent for disclosed or unidentified principal
a. Liability of undisclosed P possible o Only principal and 3P are the parties to the K, unless agent and 3P agree otherwise

Implied vs. apparent authority an agent can exercise (R.3d 2.01-03)
Implied authority is actual authority circumstantially proven which the principal actually intended the
agent to possess. P can’t think of and articulate everything for A to do. Includes powers necessary to
carry out the duties actually delegated
o Determine whether A reasonably believes because of present or past conduct of P that P
wishes him to act in a certain way or have certain authority
o Existence of prior similar practices is one of the most important factors. Specific conduct by the
principal in the past permitting the agent to exercise similar powers is crucial
Apparent authority is not actual authority but is the authority the agent is held out by the principal as
possessing
o Depends on principal’s manifestations: An agent has apparent authority sufficient to bind the
principal when the principal (not the agent) acts (or refrains from acting) so as to lead a
reasonably prudent 3rd person to suppose that the agent had the authority he purports to
exercise2
o An agent has the apparent authority as long as 3rd parties lack knowledge to the contrary
o P just has to bear the risk of A doing something P doesn’t want, if P wants A working for him
(“agency costs”). Or fire A if he goes beyond scope of duty
Ways to protect oneself
1. Put a disclaimer in the document that only certain officers could sign on P’s behalf
2. Make explicit on form K. Could make compensation contingent to non-deviation
3. Doctrine of assigning costs to least-cost avoider (who can avoid loss at the least cost?)
2 4
370, 18: P: Ampex; A: Kays; T: Joyce. Joyce could reasonably expect that Kays spoke on behalf of the company when Joyce
received Kays’ letter confirming delivery dates. Nothing in the document suggests that Kays didn’t have authority to sign on behalf of
Ampex. Joyce indicated to Kays that he wanted all communications to be channeled through Kays. It is reasonable for 3Ps to presume
that one employed as salesman has the authority to bind his employer to sell. There was no evidence of limitations being
communicated to Joyce in any manner. Kays had apparent authority to act for Ampex.
Ratification: The affirmance by a person of a prior act of another, whereby the act is given effect as if done by
an agent acting with actual authority. Retroactively creates the effects of actual authority to act on P’s behalf
(R.3d 4.01-02) and binds P.
To exist, ratification requires acceptance of the results of the act with an intent to ratify and with
full knowledge of all the material circumstances4
o Must be done before any manifestation of intention by 3P to withdraw from the transaction
o Receipt of benefits? Before this may constitute ratification, other requisites for ratification must
first be there
o Implied affirmance through
Silence about lack of real authority
Acceptance of benefits before P had opportunity to decline
Resulting in prejudice of innocent 3P (buyer who buys from an unauthorized agent a
house that later burns before P could affirm the K), unless 3P assents to being bound
Estoppel (vs. apparent authority): T reasonably believes “A” has authority; P carelessly permits belief; T
detrimentally changes position.
If a proprietor of a place of business by his careless neglect (e.g., not monitoring) enables one who
is not his agent conspicuously to act to lead a person of ordinary prudence to believe that the
impostor was actually the proprietor’s agent, then the proprietor may NOT defensively avail
himself of the impostor’s lack of authority and escape liability for the customer’s loss 5
3
Watteau, 20: P: Watteau; A: Humble; T: Fenwick. Not apparent authority because that requires 3P to reasonably believe A had
authority from P. Here, 3P didn’t even know about P.
Botticello, 24: Walter (with half interest of the property) was not acting as an agent on behalf of Mary. No apparent authority existed
because Plaintiff never knew that Mary was a principal. There was no ratification by Mary for Walter’s conduct because she was
unaware that the benefits she received from the agreement stemmed from a lease with an option to buy.
5
Hoddeson v. Koos Bros., 28: Impostor clerk at store took P’s money and never delivered. No apparent authority (there was
appearance of authority, but P did not put him out as an agent).
 o No manifestation by P required. P need not have put him out as an agent—just careless holding
out as agent such that a 3P could reasonably infer that the purported agent has authority to The agent also remains subject to liability
contract on your behalf even though the actor acted as an agent or
o See R.3d 2.05: intentionally/carelessly caused belief of agency to 3P, or did not take reasonable employee, with actual or apparent authority,
steps to notify 3P of the facts or within the scope of employment (R.3d
For P to win, show reasonable belief and GF that the impostor was real, that it’s reasonable that the non- 7.01).
agent’s behavior was reasonable Scope of An employer will be held liable under respondeat superior if the actions of the
Cf. apparent authority (tracing back to P involved) employment employee arise out of the course of his employment.

Agent’s liability (on K) under a partially disclosed / unidentified principal 2 tests for employee’s actions:
Actual (or reasonably equivalent) knowledge is the test for liability: It is the duty of the agent to Intent (Restatement): plausible story for why e’ee was acting in e’er interest
disclose (not the other pt to discover) not only that he is acting as a representative but also the
identity of the principal, if he wants to avoid personal liability.6 (If A wants to avoid liability, must Foreseeability: It is only required that an employer could perceive that harm could flow
disclose P’s identity) from actions of their employees related to work (activities “characteristic” of the business).
The level of foreseeability in a respondeat superior issue is lower than in a negligence case.7
Liability of principal to 3rd parties in tort
The relationship of the parties does not depend on what the parties themselves call it but rather in law Course of employment
what it actually is. E’ee acts within scope of employment when performing work assigned by e’er or engaging
in a course of conduct subject to e’er’s control.
Type Description Actual control over Limited agent (for Looser affiliations
details of the work contracts) E.g., franchisor NOT within scope of employment when it occurs within an independent course of conduct
E.g., McDonald’s E.g., Sun Oil not intended by e’ee to serve any purpose of e’er. R.3d 7.07(2)
Actual Agency Employer/master liable ✔
(vicarious for employee/servant
liability/respondeat torts in scope of Control is an essential element of the relationship to distinguish employee and IC (and franchisee): Does the
superior) employment principal have the right to control the details of the day-to-day operation of the alleged employee/IC?
Control or influence over results alone is insufficient.8
Apparent Agency Holding out causing ✔ ✔ ✔
plaintiff to rely on skill Hoover (Sun) not liable (didn’t control hours of operation, less control over pricing…)
and care of purported No bright line: More quality of analysis than conclusion on exam
agent; reliance tricky
to prove Assigning liability to the least-cost avoider: Party with incentive to minimize losses is the one with biggest
opportunity to profit, one who controls how the store is run, how employees are trained, variable fees, etc.
Can use to justify assigning liability to P/employer, who can better spread risk of losses (cost of doing
business, distribute to customers)
Employee/servant – principal liable Independent contractor – principal not liable
Degree of A person employed to perform services in Agent-type IC Franchisor-franchisee relationship (E-IC hybrid)
control the affairs of another who with respect to the Agrees to act on behalf of principal Is the purpose of the franchise K to achieve system-wide standardization of business identity, uniformity
physical conduct in the performance of the NOT subject to principal’s control of commercial service, optimum public good will, or benefit both parties?
See also R.2d services is subject to the other’s control or over method of accomplishing Or is it to regulate day-to-day activities (control)—daily maintenance, power to hire/fire employees, set
220(2). right to control (R.2d 220(1)). result—the physical conduct of the standards for employee skills, or supervise work routine?
task
Non-agent IC
7
Operates independently in arm’s- Bushey, 52: Lane, a U.S. Coast Guard seaman, returned to Plaintiff’s drydock after a night of drinking. For some unexplained
length transactions reason, Lane opened three water intake valves, flooding the drydock. The drydock and vessel were damaged by Lane’s actions.
POLICY of economic incentives was not a basis; the fact that D is better able to afford damages is not alone sufficient to justify legal
Liability Under the doctrine of respondeat A principal is not liable for the torts of his responsibility; there is a deeply rooted sentiment that a business can’t disclaim responsibility for accidents that may fairly be said to be
superior: A principal is subject to liability ICs (non-servant agents). characteristic of its activities. Here, Lane’s conduct was not so unforeseeable as to make it unfair for charge D with responsibility.
to 3Ps for the torts of his employees Human expressions of fun making and emotional flare-ups are inherent risks in the working environment. It was foreseeable that crew
committed while acting in the scope of members crossing the drydock might do damage, negligently or intentionally (pushing Pl’s employees or property into the water). The
their employment. incident was not related to his domestic life but his seafaring activity.
Cf. Clover, 55: SCOTUS said a jury could reasonably find that the employee had resumed his employment and that his deviation
wasn’t enough to be a total abandonment of his duties, and that SJ shouldn’t have been granted in favor of the ski resort. SCOTUS
6
Curran, 33: P: “Marketing Designs, Inc.” (not actually incorporated); A: Curran; T: Atlantic Salmon. Curran said the real principal remanded for trial, but the Utah court simply said that the foreseeability standard was not the applicable test in Utah.
8
was Marketing Designs, Inc. “Marketing director” for the ambiguously formed company was found personally liable. Sun Oil, 40 (found to be IC); cf. Humble Oil, 36 (found to be employee b/c of degree of control exercised by corporate)
 Tort liability9 During that time, an agent may take action, not otherwise wrongful, to prepare for competition following
o Apparent agency? If the franchise agreement goes beyond setting standards and allocates to termination of the agency relationship.
the franchisor the right to exercise control over the daily operations of the franchise, an
agency relationship exists (and franchisor becomes subject to vicariously liability as effective 8.08 Duties to Principal to Act with Care, Competence, and Diligence:
“employers”)10 Normally exercised by agents in similar circumstances
3P must have relied on a manifestation of apparent principal, and it must have been Normally exercised by agents with special skills or knowledge
that reliance that exposed 3P to harm
Vandemark focuses on control over “instrumentality” that caused the harm 8.09 Duty to Act Only Within Scope of Actual Authority and to Comply with Principal’s Lawful
o Apparent authority would not work in tort cases! P would not authorize its agent to act Instructions
negligently
Tradeoff between taking on more legal risk from control and reputational risk from substandard service. 8.14 Duty to Indemnify (Compensate) Agent
Is there a way to eliminate both risks? Contract
o Try to control compensation structure Agent makes a payment
o Try to end the relationship (drastic) o w/in scope of actual authority
o beneficial to the principal, unless the agent acts unofficially
Fiduciary obligation (duty of loyalty, care) of agents
Agent suffers a loss that should fairly be borne by principal
Unjust enrichment: If an employee takes advantage of his service and violates his duty of honesty and good
faith to make a profit for himself, and the principal’s assets and the employee’s position play the predominant
(sole) part in enriching himself, then he is accountable for it to the principal.11
P doesn’t need to be harmed as a result
Accountable to P for profit solely due to opportunity created by employee’s position, rank, facilities, etc.
o Law professors, war heroes, etc. generally not going to be a problem

“Disclose (& secure P’s assent) or abstain” duty to disclose/inform self-dealing in conflict with P: An agent
has a duty to disclose to the principal what the principal should rightly know—matters affecting the principal’s
business. An agent cannot use the relationship to benefit his personal interest, except with the full knowledge
and consent of the principal.12
Duty to deal fairly and openly with the principal applies in all transactions between them. An
employee’s independent enterprise cannot compete or contract with the employer without the
employer’s full knowledge

8.01 Loyalty: An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected
with the agency relationship.

8.04 Non-Competition: Throughout the duration of an agency relationship, an agent has a duty to refrain from
competing with the principal and from taking action on behalf of or otherwise assisting the principal’s
competitors.

9
Holiday Inns, 42: Holiday Inns was not given any power to control its licensee’s business expenditures, fix customer rates, or
demand a share of the profits. It was given no power to hire/fire employees, determine wages or working conditions, set standards for
employee skills or productivity, supervise employee work routine, or discipline employees. All such powers and responsibilities
typically exercised by an owner were retained by the licensee. Thus, the regulatory provisions of the franchise K did not constitute
agency control, in favor of defendant Holiday Inns.
10
Miller v. McDonald’s, 49: D had precise control methods, and P relied on common signs to believe that all McD’s restaurants were
the same because she believed that one entity owned and operated all of them (or at least exercised enough control that the standards
that she experienced at one would be the same as others).
11
Reading, 70: Sergeant took bribe to transport a lorry with cases of unknown contents without being inspected. The uniform and
position of Pl were the only reasons he was able to get the money. He got the money by virtue of his employment, and must not be
allowed to enrich himself this way.
12
Rash, 74: Breach of fiduciary duty by employee for subcontracting with his company. Even if his boss said he had no problem with
forming a business that might contract with the employer, failing to inform specifically his ownership in his own company was a
violation of fiduciary duty.
Partnerships The labels the parties assign to their intended legal relationship, while probative of (relevant to) partnership
Corporations LLC Partnership formation, are not necessarily dispositive as a matter of law. Its existence must be assessed under a TOTC
Liability Limited Limited Ptrs pers liable test (factors that indicate the extent of the relationship).15
Tax Double tax (C-corp) Single tax Single tax Profit sharing creates rebuttable presumption of partnership, but rebuttal is not limited to list of
VC & IPO? Yes (C-corp) No (no IPO; VC rare but No exceptions in statute. Receipt by a person of a share of the profits of a business is prima facie evidence
possible) that he is a partner in the business, but no such inference is drawn if profits were received:
Formalities Important Less important? Not important o As a debt
o Employee wages
Separate ownership/ Yes Somewhat No
o Annuity
control?
o Loan interest
o Consideration
Big differences between corporations?
Liability: Partners are personally liable for liabilities of partnership. Shareholders are not personally
Partnership by estoppel (cf. partners in fact)16
liable—all they can lose is the money invested in the corporation
If a person represents himself (or permits another to represent him) to anyone as a partner in an existing
o Limited liability important for large corporations
partnership or with others not actual partners + the 3P to whom such a representation is made relies on
Legal formality: Start a corporation by filing the appropriate documents with secretary of state. Start a
the actual or apparent partnership on the faith of such representation, then the first person is liable to the
partnership by acting like one (see the Uniform Partnership Act (1997), CA adopted)—share profits and
3P
control
Generally, partners are jointly and severally liable for everything chargeable to the partnership (UPA
Term: Corporations are theoretically immortal (until dissolution). Partnerships by default (unless
306)
contracted) dissolve when one of the partners drops out
o If two partners are partners by estoppel, one partner can be held jointly and severally liable for
Taxation: Partners pay taxes on partnership profits as part of normal income. Corporation pays taxes, the negligent acts of the other partner
and then shareholders pay taxes on dividends
Partners are all agents and principals to each other (UPA 301). Often in a corp, the managers are Fiduciary obligations of partners
agents, and shareholders are principals Each partner (or joint adventurer) in a partnership owes the other partners a fiduciary duty to act in the
Don’t need a board of director in a partnership best interests of the partnership over the interests of the individual in matters concerning the
Partners share profits and losses in proportion (UPA 401(b)) partnership.17
Disclose the deals, opportunity, information
A partnership is an association of 2+ persons to carry on a business for profit as co-owners. See also UPA
§ 101(6). Partnership requires money. Each partner contributes capital. Default rule is that partners share equally in
“business”: a series of acts directed toward an end, which includes every trade, occupation and profits and is chargeable with a share of the losses in proportion to the share of the profits (UPA 401).
profession (UPA § 202 comment 1, 101(1)) Account balance can be negative.
If partners want to modify the default statutory requirements, they need a written partnership agreement.
The primary source of “partnership law” is the partnership agreement. Thus, much of the law of Fiduciary duties a partner owes to the partnership (UPA § 404)
partnerships is K law: Was there an agreement? If so, what does it say about the issue in question? Duties of loyalty to
o Account to the partnership and hold as trustee for it any property, profit or benefit derived by the
Partners vs. employees: The sharing of profits (e.g., with an employee) is a necessary factor but does not partner through the partnership
alone create a partnership, despite the parties’ intentions or contract terms. 13 o Refrain from dealing on behalf of a party with an interest adverse to the partnership
o Refrain from competing before dissolution
Partners vs. lenders: Creditors who are granted a share of profits and some management control are not
necessarily deemed partners if other factors indicate contrary intent.14
15
Southex, 89: Whether a partnership was formed turns primarily on factual findings, reviewed for clear error. Given the highly
deferential standard of appellate review, Southex (plaintiff who acquired SEM) did not provide sufficient evidence to prove a
13
Fenwick, 79: Mrs. Chesire, a receptionist, is an employee despite respondent and Chesire’s agreement that termed her as a partner. partnership relationship with RIBA (DC affirmed). Southex insists that the agreement contained ample indicia of partnership
The sharing of profits is but one factor in determining whether a partnership exists. The court looked at several other factors that did formation: sharing of profits, mutual control, contributions of property. BUT the agreement was not titled “Partnership Agreement,”
not indicate a partnership in this case, such as obligation to share losses, ownership and control, conduct towards third parties (didn’t and SEM never considered itself as a partner (simply the producer, disclaimed ownership interest). As far as their conduct post-
hold out as partners), and rights of dissolution. When the court weighed this against parties’ intent and the sharing of profits, the scales agreement, the parties may have split the profits, but they never shared in tangible property; SEM was responsible for most
weighed in favor of an employer-employee relationship. She got nothing from the agreement but a new method of compensation as an management decisions; Southex did not hold themselves out as partners to third parties; nor gave the collaboration a separate name.
employee. It did not establish a partnership; she was an employee. See 91-93. No parternship.
14 16
Martin v. Peyton, 84: Hall was a friend of respondents, and Hall’s brokerage business was suffering. Respondents discussed helping Young, 93: Found no partnership by estoppel. No reliance by brochure in making the decision to invest the money that disappeared.
Hall and his business, but they needed to ensure that Hall’s business would discontinue their speculative, unwise investments. No credit given in reliance on representations as to the existence of a partnership.
17
Respondents agreed to loan Hall $2.5M in securities for Hall to secure $2M in loans. In return, respondents received Hall’s more Meinhard v. Salmon, 97: π, Morton Meinhard, was a partner with Δ, Walter Salmon, in the leasing and operation of a hotel. Δ was
speculative collateral and would receive a percentage of Hall’s profits. Hall retained management over the firm. Respondents, as the manager of the building. Four months prior to the expiration of the lease, Δ signed a new lease with the lessor that would
trustees, acquired the ability to review Hall’s books and veto speculative investments. The agreements did not establish a partnership encompass the hotel plus the surrounding area. The deal was between the lessor and a business solely run by Δ. It was a deal with a
b/c the controls they bargained for were to ensure that their investment was secure in the lender’s interest lender status. third party over the future of the hotel that was not disclosed to π. Shares owned by Δ awarded to π (half?).
 Duties of care to refrain from engaging in grossly negligent or reckless conduct, intentional conduct or
knowing violation of the law
Day implies breach of fiduciary duty is limited to cases of “secret profits” advantaging oneself at
ptship’s expense: One partner is essentially stealing opportunity from partnership, kickbacks,
contracting with another business, etc.
Joint ventures18
A JV is similar to a partnership but is more limited in scope and duration, and principles of partnership
law apply
o Joint adventurers owe the same duty of loyalty as partners
o JV vs. partnership is also arguable
For a business enterprise to constitute a JV, these must be present:
o (1) contribution by the parties of money, property, time, or skill in some common undertaking,
but the contributions need not be equal or of the same nature;
o (2) a proprietary interest and right of mutual control over the engaged property;
o (3) an express or implied agreement for the sharing of profits, and usually, but not necessarily, of
losses; and
o (4) an express or implied contract showing a joint venture was formed
o There is, however, no fixed formula for identifying a joint venture relationship in all cases, and
each case will depend upon its own unique facts
Partnership property: A conveyance of partnership property by one partner held in the name of the partnership
is made in the name of the partnership and not as a conveyance of the individual interests of the partners. A
partner does not personally own any specific property of the partnership (only possessory rights on the
claims to profits/losses) and therefore cannot retain any rights to the partnership after conveyance.19
Interest in a partnership is interest in “share of the profits” (and losses)
o A partner is not a co-owner of partnership property and has no interest in partnership property
that can be transferred (UPA 501)
Like a hypothetical oil discovery on the partnership real property after transfer of a partnership interest
with neither pt believing oil to be there: The interest in the real property remains in the partnership. The
transferor wouldn’t have transferred his partnership interest had he known of the oil, but mutual
ignorance wouldn’t warrant a reformation of the contract for sale of the interest nor a share of the value
of the oil
o It might matter if there was a failure to disclose, though. Partners who convey interest in the
partnership are not entitled to profits to a surprise discovery
The only transferable interest of a partner is his share of the profits and losses and the right to receive
distributions. The interest is personal property (UPA 502)
A transfer of a partner’s transferable interest in the partnership does not by itself cause the partner’s
dissolution or dissociation (UPA 503(a)(2))
o When there has been a dissociation (UPA 601), the partnership continues as to the remaining
partners (UPA 701)
18
Sandvick, 106: A JV did exist in regard to the pts’ purchase, but LaCrosse and Haughton breached their fiduciary duties of loyalty
by taking advantage of a JV opportunity when they purchased the top leases without informing Bragg and Sandvick.
19
Putnam, 123: Putnam and her husband owned one half of a business, Frog Jump Gin, with another couple. After Putnam’s husband
died, the business became unprofitable, and Appellees offered to take Putnam’s share of the business. Putnam and the other partners
would put $21,000 into the partnership and then Putnam would convey her share of the business. After Putnam conveyed her interest
in the partnership and rights to partnership property, Appellee’s discovered that the former bookkeeper was stealing money from the
business. The business collected $68,000, but Putnam asserts that Appellee’s share is rightfully the estate of Putnam’s because the
misconduct happened while she was a partner. BUT she is not entitled to the money collected by the business. Although the dishonest
bookkeeping occurred while Putnam was still a partner, Putnam signed over her undivided interest in the partnership to Appellees. If
she had an interest in the money, then she had an interest in the partnership.
Court may charge the transferable interest of a judgment debtor to satisfy the judgment for a judgment
creditor of a partner (UPA 504)
Rights of partners in management
If there is a disagreement as to an “ordinary course of business,” the decision of the majority controls. An
act outside the ordinary course of business and an amendment to the partnership agreement may be
undertaken only with the consent of all of the partners (UPA 401(j)).
Nabisco: two-person partnership + claim from 3P (biased for first acting partner)20
Partners are jointly and severally liable for the actions of the partnership
Buying bread from Nabisco was the status quo, need a majority to change this
What could Stroud have done to protect himself? He could have amended the partnership agreement.
They could bring in a mediator they trusted. They could delineate areas of responsibility and provide
one party with greater voice in certain areas (one gets to control bread buying). Tiebreaker is what is
considered what is “ordinary course of business”
On the other hand, couldn’t the court view Stroud’s refusal of the deliveries as a decision within the
scope of the business that cannot be overruled by Freeman’s consent? Is it less “ordinary” to refuse
deliveries?
Two partners in conflict (biased for second acting partner)
A partner will not be permitted to recover expenses that benefit the partner individually (even
fulfilling a K obligation) rather than benefiting the partnership21
A way to resolve: Who’s suing, 3P or partner?
3P creditor who relied on 1 partner acting as agent? Then this partner bound the partnership (Nabisco)
If partners arguing about sharing costs incurred by 1 partner? Less likely to bind if clear other partner
didn’t consent (Summers)
One person may have implied powers in one department as an implied term of the partnership agreement, but
another may have power to override decisions as someone higher up.
Agreements can be very flexible: Partners are free to make any agreement it suits them, without concern about
minutiae of partnership theory.22 There are business risks of disagreements, which are not for courts to
adjudicate.
In a ptrship, the default rule is that participation in the biz is the right of a partner.
20
Nabisco, 127: Partners are jointly and severally liable for the actions of the partnership. Since Stroud is only one half of the
partnership, and not a majority, he is unable to prevent Freeman from exercising his rights. Freeman had actual authority (and maybe
apparent authority) to authorize bread deliveries while Stroud specifically attempted to disclaim responsibility.
21
Summers v. Dooley, 129: π and Δ were partners who agreed that if either was unable to perform then that partner was responsible
for paying a third party to work on his behalf. π should not be compensated by the partnership for the cost of the additional employee.
The additional employee was brought on for the personal benefit of π and not the partnership. Δ repeatedly rejected the hiring. A
decision to change the status quo (of paying for own employee) would also require a majority approval, and π’s one vote did not
constitute a majority. Hiring an extra employee was seen as in the ordinary course of business.
22
Day v. Sidley & Austin, 131: Sidley & Austin (Δ) did not violate a fiduciary duty to Day (π) by their merger and subsequent title
change for Plaintiff. The partnership agreement that Plaintiff signed authorized the executive committee to appoint members and
chairpersons, so Plaintiff was aware of the possibility of a co-chair. Also, Defendants decisions were not made to personally profit at
the expense of the firm, and their fiduciary duty does not extend to what Plaintiff proposes. Finally, even if Plaintiff was aware of the
title change, his vote against the merger would not have affected anything because a proposed merger only requires a majority vote
unless specifically stated otherwise in the partnership agreement.
In an absence of an agreement to the contrary, none of the partners is entitled to a salary. Can draw a return Corporations
from the ptrship (like a salary) by agreeing that all partners do. Ptrs cannot pay themselves without paying Differences between Partnerships Corporations
others. partnerships and
corporations
Any ptr can dissolve the ptship, forcing the others to buy him out. How to form Act like it File articles of incorporation with secretary of
state

Must include name of corporation, which must

Liability Can bargain with creditors to
limit liability, and buy
insurance
Continuity Partnerships at will, can end
at any time
Management Partner is an agent but can
agree to the contrary
include words like “corporation,” “company,”
“incorporated” or abbrs.
C shareholders have limited liability, but not
absolute (veil piercing)
Default is indefinite, but possible (rare) to limit
term of corporation
Centralized management

What rights do shareholders have?

Voting rights on who is on board of directors, big decisions (mergers)
Receive dividends
Be residual claimants, get paid whatever is leftover when a corp goes bust
Amendments to articles of incorporation (constitution), bylaws (statutes)

Limited liability
Advantages
o Encourages capital formation, risk taking
o Reduces monitoring costs
Downside of limited liability
o Negative externalities (co can’t absorb all costs)
o Risks to creditors

Can incorporate in any state but most who hope to go public incorporate in Delaware.
Race-to-the-top theory: Delaware is the best place for shareholder benefits. Delaware won the race to the
top
o Why would management choose this state?
Signal shareholders and not get removed from management
Network effect: Everyone else is using it, like MS Office. More efficient to have
everyone operating by the same rules
Predictability to companies from precedents, want to know what the rule is
Business cases are tried in Delaware chancery, a highly experienced and specialized court
that deals almost exclusively with business matters

Formation and limited liability

Model Business Corporation Act
1+ person may act as the incorporator(s) of a corporation by delivering articles of incorporation to the
secretary of state for filing (2.01)
Corporate existence begins when the articles of incorporation are filed, unless a delayed effective date is
specified (2.03)
Pre-incorporation transactions: Jointly and severally liable for all liabilities created while appearing to
act as / on behalf of a corporation while knowing there was no incorporation (2.04)
 Bylaws may have any provision not inconsistent with law or AOI (2.06) Not having an elected board
Shareholders are not liable to the corporation or its creditors except to pay the consideration for the Treated as “mere instrumentality”
shares (6.22) o 2) to allow the limited liability would promote an injustice (injured the party seeking to pierce
o Shareholders are not personally liable for the acts/debts of the corporation except by reason of the veil) or sanction a fraud.25
his own acts To afford creditor protection where some bad faith conduct makes it inequitable for the
A director who assents to a distribution to shareholders in excess of what may be authorized is equitable owner of a corporation to hide behind its corporate veil
personally liable to the corporation for the amount of the distribution that exceeds the art of inc/6.40(c) Not required to fully prove intent to defraud
limit Courts that have properly pierced the corporate veils to avoid promoting injustice found
that some “wrong” beyond a creditor’s inability to collect would result, e.g.,
An archbishop can be a corporation sole under CA Corp. Code with the same civil rights and duties as other A corp would be unjustly enriched unless liability is shared by all
corps (Sheffield). Usage of corporate facades to avoid responsibilities to creditors
NOT satisfied when an unsatisfied creditor is trying to collecting payment26
Piercing the veil / “alter ego” (CA) theory
NEVER works for public companies (can own AAPL and sleep soundly)! Only for private companies (usually General doctrinal approach: If shareholder observes formalities and “respects separate existence of
smaller group of shareholders) OR wholly owned subsidiary of larger, public company. corporation,” no PCV. Otherwise, may be liable—depending on jx, usually need to show some injustice for
PCV, not just unhappy creditor.
An individual can be held liable for the acts of a corporation through the doctrine of respondeat superior
only if it can be shown that the individual used his control of the corporation for personal gain rather Subsidiary as alter ego of parent
than furthering the corporation’s business.23 Fact based: TOTC must be evaluated in determining whether a subsidiary may be found to be the alter
Makes a “parent” liable for the actions of a “subsidiary” which it controls, but it doesn’t mean that ego or “mere instrumentality” of the parent corporation.27 All jx require a showing of substantial
where a parent controls several subsidiaries each subsidiary then becomes liable for the actions of all domination. Factors to be considered in applying the doctrine:
other subsidiaries. There is no respondeat superior between the subagents!24 Need something like o Sheffield
enterprise liability Commingling of funds
The veil of limited corporate liability will be pierced when the plaintiff proves that Holding out by one entity that it is liable for the debts of the other
o 1) not only does the corp appear to be influenced and governed by the individual, there is a unity Identical equitable ownership in the two entities
of interest between the individual and the corporation such that the separate personalities of the Use of the same offices and employees
corp and the individual no longer exist, and Use of one as a mere shell or conduit for the affairs of the other
Fail to respect the corporate’s separate existence o In re Silicone
To determine whether a corp is so controlled by another to justify disregarding their the parent and the subsidiary have common directors or officers
separate identities, focus on 4 factors: the parent and the subsidiary have common business departments
(1) the failure to maintain adequate corporate records or to comply with corporate the parent and the subsidiary file consolidated financial statements and tax returns
formalities, the parent finances the subsidiary
(2) the commingling of funds or assets, the parent caused the incorporation of the subsidiary
(3) undercapitalization, and the subsidiary operates with grossly inadequate capital
(4) one corporation treating the assets of another corporation as its own the parent pays the salaries and other expenses of the subsidiary
Not holding meetings, not keeping minutes the subsidiary receives no business except that given to it by the parent
the parent uses the subsidiary's property as its own
the daily operations of the two corporations are not kept separate
23
Walkovszky, 176: Plaintiff, John Walkovszky, was injured by a taxi owned by a corporation owned by Defendant, William Carlton. the subsidiary does not observe the basic corporate formalities, such as keeping separate
Plaintiff sought to hold Defendant personally liable for his injuries. Defendant would be held liable under the respondeat superior
doctrine if he controlled the corporation for his personal benefit at the expense of the corporation’s benefit. Plaintiff did not offer proof
books and records and holding shareholder and board meetings.
to make that claim, and instead offered proof that the ten corporations operated as one large corporation. The fact that the corporations
25
may have been one large corporation, however, does not prove that Defendant was controlling the corporations for his own behalf. Sea-Land Services, 181: First prong met. Corporate records and formalities have not been maintained; funds and assets have been
The dissent argued that the corporations were undercapitalized (each cab had only $10,000 worth of insurance coverage, which is the commingled with abandon; PS, the offending corporation and perhaps others have been undercapitalized; and corporate assets have
statutory minimum) and the corporate entity was clearly used to simply escape liability. The dissent wanted to pierce the corporate been moved and tapped and “borrowed” without regard to their source. Second prong not met. Π did not adequately offer evidence on
veil to achieve a more equitable result, but the majority believed that it was the legislature’s responsibility to raise the mandatory the second point to be awarded a motion for summary judgment. Need more than simply an unsatisfied claim.
26
insurance coverage. The majority and the dissent both regard the series of corporate entities set up by Defendant as a method of Sheffield, 190
27
limiting Defendant’s liability, but the majority reasons that the legislature should be the one to correct the abuse. In re Silicone, 195: 1) The fact-finder at a trial could find that the evidence supports the conclusion that many of these factors have
24
Sheffield, 187: π filed suit in CA against the Roman Catholic Archbishop of San Francisco after a Roman Catholic order’s been proven: two of MEC's three directors were Bristol directors . . . (p.195). These facts, even apart from evidence that might
monastery in Switzerland failed to ship a St. Bernard dog after installment payments. Δ argued in support of MSJ (denied) that he was establish some of the other factors listed above, would provide significant support for a finding at trial that MEC is Bristol's alter ego.
not a party to the contract, had no knowledge of the alleged tx, and was a distinct legal entity. Π countered that the Roman Catholic 2) Delaware courts don’t necessarily require a showing a fraud if a subsidiary is found to be the mere instrumentality or alter ego of its
Church is one worldwide entity, not a composite of entirely separate entities as Δ claimed. Π didn’t contend that Δ was involved in the sole stockholder. Even in jx that require a finding of fraud, inequity or injustice, MEC may have insufficient funds to satisfy the
tx between him and the monastery argued under the “alter ego” theory. But π doesn’t meet either of the two requirements for alter ego potential risks of π’s claim. Bristol also permitted its name to appear on breast implant ads and packages to improve sales by giving
because the issue is whether the Archbishop may be held liable. Π doesn’t show that the Swiss organization is an alter ego of the the product additional credibility. It would be inequitable and unjust to allow Bristol now to avoid liability to those induced to believe
Archbishop or vice versa. Also it is not sufficient that π won’t be able to collect if the corporate veil is not pierced. Bristol was vouching for this product. See also R.2d Torts 324A(c) (p.197).

Tort actions
To PCV in tort actions against corporations, a plaintiff needs to show that the corporation is a “mere
instrumentality” of the stockholder, and there is no burden to prove fraud.28
Where arguing to pierce the corporate veil, a decision based upon a totality of the circumstances,
summary judgments will rarely be granted because the decision is so fact-based
Respect the corporate formalities to avoid liabilities! Have shareholder meetings, have a real board, let them
keep money in their own bank account, and be careful with using corp name. Can retain control by selecting
directors who know what’s expected of them, know who they need to please, and act formally as independent
directors.
Roles and purposes
Corporate gift-giving is an allowable method of increasing goodwill. Any corporation could cooperate with
other corporations and persons in the creation and maintenance of community funds and charitable,
philanthropic or benevolent instrumentalities conducive to public welfare, and could for such purposes expend
such corporate sums as the directors deem expedient and as in their judgment will contribute to corporate
interests.29
Courts are deferential. “We think this will help us. We think this will create goodwill”
Limits? Barlow: The gift should be less than 1% of the capital stock and require approval if written
objections were made by holders of more than 25% of the stock
Shareholder should know where the money is going. If anonymous, they won’t know and there is no
good will built through PR
Dividends: The directors of a corporation, and they alone, have the power to declare a dividend of the earnings
of the corporation, and to determine its amount. Courts of equity will not interfere in the management of the
directors unless it is clearly made to appear that they are guilty of fraud or misappropriation of the corporate
funds, or refuse to declare a dividend when the corporation has a surplus of net profits which it can, without
detriment to its business, divide among its stockholders, and when a refusal to do so would amount to such an
abuse of discretion as would constitute a fraud, or breach of that good faith which they are bound to exercise
towards the stockholders. The purpose of the corporation is to make money for the shareholders, and it
cannot arbitrarily (lack of good faith) withhold money that could go to the shareholders.30
28
In re Silicone Gel Breast Implants Products Liability Litigation, 191: Since the cause of action is a tort action, product liability, there
is no burden on the plaintiffs to establish fraud because there was no element of a mutual bargaining position and therefore no consent
by the plaintiffs to the corporate structure of Defendant and its subsidiary.
29
Barlow, 251: Plaintiff corporation, founded in 1896, had a history of donating minor sums of money to various charities and
institutions. In 1956 Plaintiff voted to give $1,500 to Princeton University. Plaintiff instituted a declaratory judgment action after
Defendant stockholders questioned the proposed gift. Although a state statute allows corporations to contribute to charities,
Defendants assert that the corporation’s certificate of incorporation does not allow the gift, and the corporation was incorporated prior
to the statute that authorizes the gift-giving. Where justified by advancement of public interest, reserved power of State to alter
corporate charter may be invoked to sustain later charter alterations even though they affect contractual rights between corporations
and its stockholders and between stockholders inter se. There is no suggestion that it was made indiscriminately or to a pet charity of
the corporate directors in furtherance of personal rather than corporate ends. It was voluntarily made in the reasonable belief that it
would aid the public welfare and advance the interests of the plaintiff as a private corporation and as part of the community in which it
operates. It was a lawful exercise of the corporation’s implied and expressly authorized powers. The potentially infinite lifespan of
corporations would lead to corporations a varying ages to live under various sets of laws.
30
Dodge v. Ford, 257: Plaintiff shareholders, Dodge bros., brought an action against Defendant corporation, Ford Motor Co., to force
Defendant to pay a more substantial dividend and to change questionable business decisions by Defendant. Henry Ford, admitted that
the price negatively impacted short-term profits, but Ford defends his decision altruistically, saying that his ambition is to spread the
benefits of the industrialized society with as many people as possible. Further, he contends that he has paid out substantial dividends
to the shareholders ensuring that they have made a considerable profit and should be happy with whatever return they get from this
point forward. Instead of using the money to pay dividends, Ford decided to put the money into expanding the corporation. The court
reversed the portion of the lower court’s injunction of the building the plant but upheld the portion ordering payment of a dividend.
Defendant is arbitrarily withholding money that could go to the shareholders. However, the court will not question whether the
company is better off with a higher price per vehicle, or if the expansion is wise, because judges are not business experts.
Business judgment rule: A court will not interfere with an honest business judgment as to the best
interests of the corporation and the stockholders, absent a showing of fraud, illegality or conflict
of interest, clearly not aligned with shareholder interest31
o Unless there’s evidence of fraud, illegality, or COI, courts will be deferential to company board-
of-director decisions. Mention what is the best interest of s/h
o As π, try to show action (e.g., night baseball) is profitable to director
o As Δ, try to show action is not in conflict or is profitable to company
Limited-liability companies
Partnerships
General partnership
o Limited-liability partnership
Limited partnership (not as common anymore)
Corporations
C corporation
S corporation
Limited-liability company (corporation x general partnership)
“Limited liability” only refers to the liability of the owners of the entity. Creditors may not reach the personal
assets of the shareholders who own the corporation to satisfy corporate debts.
Limited partnership (not LLP): Partnership where there are one or more general partners who manage the
business, and one or more limited partners who have virtually no management authority
Needs at least 1 GP who has unlimited liability and has management responsibility for the firm
Needs to file to create a LP
A limited partner shall not become liable as a general partner (i.e., have unlimited liability), UNLESS in
addition to the exercise of his rights and powers as a limited partner, he takes part in the control of the
business.32
Revised Uniform Limited Partnership Act
o 303(a): A limited partner is not liable for the obligations of a limited partnership, UNLESS the
limited partner is also a general partner or in addition to the exercise of his rights and powers as a
limited partner, he takes part in the control of the business
31
Shlensky, 262: Defendant is president of the Chicago National League Ball Club, which is the company that owns the Chicago
Cubs. Although every other major league team had installed lights, Defendant did not install them for the Cubs because he was
concerned that night baseball would be detrimental to the surrounding neighborhood. Plaintiff, a minority stockholder, argued that the
team was losing money, and that the other Chicago team, the White Sox, had higher attendance during the weekdays because they
played at night. Therefore, reasoned Plaintiff, the Cubs would draw more people with weekday night games. In this stockholders’
derivative suit against the directors for negligence and mismanagement, Plaintiff asserts that Defendant’s first concern should be with
the shareholders rather than the neighborhood. Π relied on Dodge, but Dodge did involve lack of bad faith. The court affirmed TC’s
dismissal. The court cited some reasons why the light installation could be detrimental, such as lowering the property value of the park
itself, a lack of proof on behalf of Plaintiff that financing would be available for lights and would be certain to be offset by increasing
revenues. The court cites precedent that asserts that business decisions should not be disturbed just because a defendant can make a
reasonable case that the policy chosen by the company may not be the wisest policy available. There was no evidence of any of
illegality, fraud or conflict of interest. Why didn’t π try to sell shares like Dodge bros.? The point was they were unvalued because of
this problem.
32
Holzman, 167: The evidence sufficiently shows that Russell and Andrews both took "part in the control of the business." The
manner of withdrawing money from the bank accounts is particularly illuminating. The two men had absolute power to withdraw all
the partnership funds in the banks without the knowledge or consent of the general partner. Either Russell or Andrews could take
control of the business from de Escamilla by refusing to sign checks for bills contracted by him and thus limit his activities in the
management of the business. They required him to resign as manager and selected his successor. They were active in dictating the
crops to be planted, some of them against the wish of de Escamilla. This clearly shows they took part in the control of the business of
the partnership and thus became liable as general partners.
 If the LP takes part in the control of the business and is not also a GP, the LP is liable
only to persons who transact business with the limited partnership and who reasonably
believe, based on the LP’s conduct, that the LP is a GP
Mt. Vernon, 168
A LP acting substantially the same as a GP has unlimited liability regardless of
π’s knowledge of his role
Unlimited liability for exercising less than a GP’s power if the fact that he acted
as more than a LP was actually known to π
o 303(b): A LP does not participate in control solely by consulting with and advising a GP with
respect to the business of the limited partnership
LLPs are general partnerships that permit general partners to limit their personal liability (by filing with the
Secretary of State, statutory requirements, and revising the partnership agreement to provide for limited
liability).
Most LLP statutes provide limited liability only for partnership debts arising from negligence and
similar misconduct (other than misconduct the partner is directly responsible for), not for contractual
obligations. A few statutes provide protection for both
Professional services firms only, e.g., law, accounting
LLLP? Limited-liability limited partnership. CA doesn’t have this.
Takes GP and extends LL to all partners
LLCs (corporation x general partnership)
Features
o Tax treatment of partnership: Investors are taxed only once on its profits as they are earned.
Losses can “pass through” and be taken account on investors’ individual tax returns
o Limited liability of a corporation—LLC provides a liability shield for its members
o Flexibility in developing rules for management and control
Professional services firms cannot be LLCs
Best choice unless a VC advising a startup firm—incorporate as a normal Delaware C corp. Why? The
ultimate goal of a startup is an “exit event,” which will be an IPO or a sale to another company. If a
company buys you, prefer to buy as a C corp. If IPO, have to create transferrable, liquid shares, which
only C corp can do. VCs also don’t take dividends; they want to profit by selling their shares and taking
capital gains
Uniform LLC Act
103: All members of a LLC may enter into modified rules
Members vs. managers
Member-managed LLC: Members are allowed to directly manage the business
o ownership + control
Manager-managed LLC: Members can elect one or more managers to manage the business
o ownership with less control
301. Agency of members and managers
o (a) Each member is an agent of the LLC
Act of a member binds the company, UNLESS the member had no authority to act for the
company + the person with whom the member was dealing knew or had notice that the
member lacked authority
Act of a member which is not apparently for carrying on in the ordinary course of the
company’s business binds the company, ONLY IF the act was authorized by the other
members
o (b) In a manager-managed company
A member is not an agent of the company
Each manager is an agent of the company
o (c) Any member or manager may sign and deliver any instrument transferring or affecting the
company’s interest in real property
303. Liability of members and managers
o A member or manager is not personally liable for a debt, obligation and liability
Debts, obligations and liabilities of a LLC are liabilities of the company
A LLC not observing usual company formalities or requirements is not a ground for
imposing personal liabilities
UNLESS provided in articles of organization + written consent by a liable member to the
adoption or to be bound by the provision
Agents of a LLC
When a 3P sues a manager or member of an LLC under an agency theory, the principles of agency law apply
notwithstanding statutory notice rules (i.e., filing of the articles of organization serve as constructive notice of a
company’s status as a LLC). An agent who negotiates a contract with a third party can be personally liable
for breach, unless the agent disclosed both the fact that he or she is acting on behalf of a principal + the
identity of the principal.33
LLCs: the operating agreement
It is the policy of LLC statutes to give maximum effect to the principle of freedom of contract and to the
enforcement of LLC agreements!
LLC statutes give broad deference to the LLC members’ freedom of contract, unless the terms overstep
any of the mandatory statutory provisions.34
The mere exercise of one’s K rights, by itself, cannot be a breach of the implied covenant: The implied
covenant protects the spirit of what was actually bargained and negotiated for in the K. It is clear that a
court should not use the implied covenant of good faith and fair dealing to fill a gap in a K with an
implied term, UNLESS it is clear from the K that the parties would have agreed to that term had they
thought to negotiate the matter.35
Piercing the “LLC veil”
For the purposes of piercing the corporate veil, there is no law or policy that would require treating
limited liability companies (LLC’s) different from corporations. 36
Fiduciary obligation
ULLCA 409 – affirmative duties of loyalty and care and noncompetition
In a member-managed company, a non-manager member owes no duties
33
Water, Waste & Land v. Lanham, 269: During the negotiations, Defendants never notified Plaintiff that they were acting as agents
on behalf of their LLC, Preferred Income Investors (P.I.I.). The only reference to P.I.I. available to Plaintiff was the initials “P.I.I.” on
Defendants’ business cards. When Plaintiff tried to collect for the work performed, Defendants could not pay. Clark and Lanham
asserted that they were not liable because Colorado’s statutes regarding LLC’s provided constructive notice to third parties by the act
of incorporation. The county court found for Plaintiff (dismissing Clark as not personally liable and entering judgment against
Lanham and the company). DC reversed, relying on the notice provision of the LLC Act. However, the missing link between the
limited disclosure made by Clark and the protection of the notice statute was the failure to state that “P.I.I.,” the Company, stood for
“Preferred Income Investors, LLC.” The court reversed the district court and reinstated the findings for Plaintiff.
34
Elf Atochem v. Jaffari, 274: See brief.
35
Fisk Ventures v. Segal, 280: See brief.
36
Kaycee Land, 287: See brief.
Members of an LLC can agree to limit the scope of the fiduciary (of trust and confidence in another) duty
they owe to the LLC.37
ULLCA 603(b): Upon dissociation of a member…
Member’s duty of loyalty under 409(b)(3) (noncompete) terminates
Member’s other duties of loyalty under 409(b)(1)-(2), 409(c) (no grossly negligent conduct) continue
only with regard to matters arising before member’s dissociation
Members of an LLC can be held (proportionately) personally liable for the debts of their LLC if they fail
to properly dissolve the LLC under the relevant statutes.38
Board of directors
Manager/director = agent shareholder = principal
Business judgment rule: The business judgment rule posits a powerful presumption in favor of actions taken
by directors in that a decision made by loyal and informed board will not be overturned by courts unless it
cannot be attributed to rational business purpose. A shareholder plaintiff challenging a board decision has
the burden at outset to rebut the rule's presumption. To rebut the rule, shareholder plaintiff assumes burden
of providing evidence that directors, in reaching their challenged decision, breached any one of triads of
their fiduciary duty--good faith, loyalty or due care. If shareholder plaintiff fails to meet evidentiary burden,
the business judgment rule attaches to protect corporate officers and directors and decisions they make, and the
courts will not second-guess these business judgments. If rule is rebutted, burden shifts to defendant
directors, proponents of the challenged transaction, to prove to trier of fact the “entire fairness” of
transaction to shareholder plaintiff.39 BJR precludes attempts to measure the reasonableness of a board’s
decision. Irrationality is the outer limit of BJR.
Duty of care
Concerns directors’ decision-making process, not the substance of their decisions: There is a presumption
that in making a business decision, the directors of a corporation acted on an informed basis, in good
faith and in the honest belief that the action taken was in the best interest of the company, unless it was in
gross negligence (VG).
A court will not interfere with the decision of a company’s directors unless there is evidence of fraud or
dishonest practice.40
Van Gorkom: Under the business judgment rule, a business judgment is presumed to be an informed
judgment, but the judgment will not be shielded under the rule if the decision was unadvised
(uninformed, without substantial research) (in gross negligence).41
37
McConnell, 294
38
Haack, 303: Defendant LLC was not properly dissolved. Creditors have priority over former partners of the LLC for the assets of
the dissolving LLC. Because Haack took assets of the dissolving LLC, and evidence showed that the assets could have covered the
debt owed to Plaintiff, Haack personally owes Plaintiff the outstanding gas card balance.
39
Cede & Co. v. Technicolor, 634 A.2d 345, 361 (Del. 1993)
40
Kamin, 308: Plaintiffs, Howard Kamin et al., filed a shareholder derivative suit against Defendant corporation, American Express,
classifying the directors’ decision as negligent decision-making. Plaintiff demanded that Defendants sell the stock on the open market
and use the $25.9 million capital gains loss to offset other capital gains. The offset would save Defendant corporation $8 million in
taxes. Defendant didn’t pursue this demand, reasoning that the significant loss would adversely affect the value of Defendant’s stock.
Δ’s decision may have been an unwise judgment, but it is a judgment that is outside the scrutiny of the court.
41
Van Gorkom, 312: Δ directors failed to inform themselves before recommending a merger to the stockholders, which constitutes a
breach of the fiduciary duties of care and disclosure and rebutted the presumptive protection of the business judgment rule. They
based their decision on Van Gorkom’s representations, which did not constitute a report on which they could reasonably rely, and they
did not seek documentation of either the merger terms or the adequacy of the proposed PPS. Was $55 a fair price? Van Gorkom’s 20-
minute oral presentation of his understanding of the terms of the proposed merger agreement, which he hadn’t seen, does not qualify
as a “report” under DE statute. The directors were grossly negligent in permitting the agreement to be amended in a way they had not
Leveraged buyout (LBO): Put down little equity and large debt load to buy a company (usually public)
Under the business judgment rule, there is no protection for directors who have made an unintelligent or
unadvised judgment
The rule itself is a presumption that in making a business decision, the directors of a corporation acted
on an informed basis, in good faith and in the honest belief that the action taken was in the best interests
of the company. The party attacking a board decision as uninformed must rebut the presumption
that its business judgment was an informed one
o Informed? The determination of whether a business judgment is an informed one turns on
whether the directors have informed themselves “prior to making a business decision, of all
material information reasonably available to them”
o The concept of gross negligence is the proper standard for determining whether a business
judgment reached by a board of directors was an informed one
In a merger context
o A director has a duty to act in an informed and deliberate manner in determining whether to
approve an agreement of merger before submitting the proposal to the stockholders. A director
may not abdicate that duty by leaving to the shareholders alone the decision to approve or
disapprove the agreement
o A substantial premium may provide one reason to recommend a merger, but in the absence of
other sound valuation information, the fact of a premium alone does not provide an adequate
basis upon which to assess the fairness of an offering price
o A director has a fiduciary duty of care and loyalty to disclose to shareholders all material facts
bearing upon a merger vote42
Directors are fully protected in relying in good faith (but not blindly) on reports made by officers
o Information must be pertinent
o The term “report” has been liberally construed to include reports of informal personal
investigations by corporate officers
At a minimum (under DE law), a report must be pertinent to the subject matter upon
which a board is called to act, and otherwise be entitled to good faith, not blind, reliance
Not oral statements
Dissent: The directors had many years of collective experience as directors and employees of the
company. They were not taken into this multimillion-dollar corporate transaction without being fully
informed and aware of the state of the company. They knew the company like the back of their hands
and were more than well qualified to make on-the-spot informed business judgments concerning the
affairs of the company including a 100% sale of the corporation
A legislative response to Van Gorkom – DGCL 102(b)(7) limits $ damages for breach of duty of care (not
loyalty): Directors will not be liable for monetary damages for any breach of fiduciary duty as a director,
except the things BJR permits courts to go after. Can still seek an injunction.
Duty of loyalty (COI + GF)
Directors and managers: A director has a fiduciary duty to support the corporation’s interest over his or her own
conflicting interests, and any competing interests renders the business judgment rule inapplicable. The business
authorized. The directors breached their fiduciary duty to their stockholders by their failure to inform themselves of all information
reasonably available to them (VG’s role, “intrinsic” value) and relevant to their decision to recommend the merger and by their failure
to disclose all material information such as a reasonable stockholder would consider important in deciding whether to approve the
offer. The directors were liable for damages.
42
Technicolor, 323: Cf. Van Gorkom. The Technicolor board (Δ) quickly approved a deal after the CEO presented it to the board,
without adequate information and deliberation. However, this case favored Δ because the CEO did a thorough job of investigation
(was the most informed about the strengths and weaknesses of Technicolor as a business), bargained hard (sought the highest price for
sale), and hired experts who did a thorough job in support of the fairness of the deal for Technicolor. The price was fair, so there was
no harm and no cause of action. Δ met its burden of proving entire fairness, and the lower court dismissed the action.
judgment rule is trumped by the rule of undivided loyalty, to avoid the possibility of fraud and the
temptation of self-interest.43
Where a close relative of an executive officer of a corporation takes a position closely associated with a
new and expensive field of activity, the motives of the directors are likely to be questioned (unless one
director owns all or most the stock for example)
Business decisions that would not typically merit an analysis under the normal business judgment
rule will undergo strict scrutiny when there is a conflict of interest: If there is any evidence or
indication of unfairness or undue advantage, the transactions are subjected to rigorous scrutiny, and
where any of their contracts or engagements with the corporation are challenged, the burden is on the
director not only to prove the good faith of the transaction but also to show its inherent fairness from
the viewpoint of the corporation and those interested therein
Safe harbor EXCEPTION44 (DGCL 144(a)(1))
o There is a safe harbor (under DE law) if the material facts as to the director’s relationship or
interest and as to the contract or transaction are disclosed or are known to the board of directors,
and the board in good faith authorizes the contract or transaction by the affirmative votes of a
majority of the disinterested directors fall back to BJR
o After approval by disinterested directors, courts review an interested transaction under the
business judgment rule
Corporate opportunity doctrine45
The corporate opportunity doctrine provides that directors, officers, and controlling shareholders of a
corporation must not take for themselves any business opportunity that could benefit the corporation.
The corporate opportunity doctrine is one application of the fiduciary duty of loyalty.
It applies even if the corporation benefits from the transaction!
Rule. A corporate officer or director MAY NOT take a business opportunity for his own if:
(1) the corporation is financially able to exploit the opportunity;
(2) the opportunity is within the corporation's line of business if is of practical advantage to it;46
An opportunity is within a corporation's line of business if it is an activity as to which the corporation
has fundamental knowledge, practical experience and ability to pursue
(3) the corporation has an interest or expectancy in the opportunity; and
A corporation has an interest or expectancy in a business opportunity if the opportunity would further an
established business policy of the corporation
43
Bayer v. Beran, 334: πs filed a derivative shareholder action against Δ directors, contesting their decision to pay for radio
advertising that employed a director’s wife. No breach of fiduciary duty by the directors. Her contract was on a standard form
negotiated through her professional agent. Her compensation was in conformity with that paid of comparable work. She received less
than any of the other artists on the program. She received no undue prominence.
44
Benihana, 339
45
Broz, 345; see Guth
46
In re eBay, Inc. Shareholders Litigation, 351: Goldman Sachs was hired to underwrite the initial public offering of eBay stock. In
doing so, Goldman Sachs allocated shares of the initial eBay stock to eBay “insiders,” including members of eBay’s board of
directors. Shareholders of eBay (plaintiffs) brought suit against the directors (defendants), alleging that the directors’ acceptance of the
private allocations violated their fiduciary duty to eBay by usurping eBay’s corporate opportunity in that eBay could and would have
purchased the stock that was allocated. It is undisputed that eBay could afford the stock financially and that it was in the business of
investing in securities. Investing in various securities was held to be in a line of business of eBay despite the fact that eBay's primary
purpose is to provide an online auction platform. Investing was in a line of business of eBay because eBay "consistently invested a
portion of its cash on hand in marketable securities." The complaint suggested that investing was integral to eBay's cash management
strategies and a significant part of its business. There is a reasonable inference that that the insider directors accepted a commission or
gratuity that rightfully belonged to eBay but that was improperly diverted to them. This conduct placed the insider defendants in a
position of conflict with their duties to the corporation. Even if this conduct does not run afoul of the corporate opportunity doctrine, it
may still constitute a breach of the fiduciary duty of loyalty. Δ’s MTD denied.
(4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position adverse to
his duties to the corporation (the self-interest of the officer or director will be brought into conflict with that of
the corporation).
In this case, the officer/director needs the board to approve it!
TOTC: No single factor is dispositive. The court must balance all factors as they apply to a particular case. 47
Corollary. A director or officer MAY take a corporate opportunity if (in the absence of any countervailing
duty):
(1) the opportunity is presented to the director or officer in his individual and not his corporate capacity;
(2) the opportunity is not essential to the corporation;
(3) the corporation holds no interest or expectancy in the opportunity; and
(4) the director or officer has not wrongfully employed the resources of the corporation in pursuing or
exploiting the opportunity.
See also MBCA 8.70.
Dominant shareholders
Majority controlling? Yes
Controlling majority? Not necessarily. Shareholders too spread out to coordinate. Different classes of shares.
20-30% holding generally considered controlling.
Generally, regular shareholders don’t have fiduciary duties to other shareholders.
But a parent owes a fiduciary duty to its subsidiary when there are parent-subsidiary dealings.
Self-dealing? A standard of “intrinsic fairness” will be applied in a situation that involves a parent-
subsidiary dealing, with the parent controlling the transaction and fixing the terms, AND only when the
fiduciary duty is accompanied by self-dealing.48
The transaction will be self-dealing if the parent receives something from the subsidiary to the detriment
to and exclusion of minority shareholders of the subsidiary
High degree of fairness (vs. just not grossly negligent under BJR) – (could have gotten the same deal in
an arm’s-length tx)
The majority shareholder has the right to control. But when it does so, it occupies a fiduciary relation toward the
minority, as much as the corporation itself or its directors.
Difference in voting roles as a shareholder and director: When voting as a stockholder, he has the legal
right to vote with a view of his own benefits and is representing himself only; but, a director represents
47
Beam v. Stewart, 353
48
Sinclair, 355: Defendant, as the majority shareholder of Sinven, caused Sinven to pay dividends that were so large that the amount
exceeded the earnings of Sinven. The dividends provided cash to Defendant as well as minority shareholders, but it left no resources
for Sinven to expand its operations. Defendant also neglected to meet the terms of the contract between them and Sinven. Plaintiff, a
minority shareholder of Sinven, brought this action, claiming the dividends were excessive and that Defendant breached the contract
with Sinven. The court held that Defendant did not engage in self-dealing by issuing large dividends, but it did engage in self-dealing
when they breached the agreement. The minority shareholders of Sinven received a proportionate share of the dividends. Defendant
complied with a Delaware statute authorizing payment of dividends, and Defendant’s motives are not a factor unless π can show
improper motive. BJR should have been applied here. However, the contract breach was to the detriment of Sinven and its minority
shareholders with the positive effect being exclusive to Defendant (Sinclair received the products from Sinven, and Sinven’s minority
shareholders were not able to share in the receipt of those products), so the breach is self-dealing.
 all the stockholders in the capacity of trustee for them and cannot use his office as director for his
personal benefit at the expense of the stockholders.49
o Directors may not declare or withhold the declaration of dividends for the purpose of personal
profit or, by analogy, take any corporate action for such a purpose
See also MBCA 8.61-63.
Ratification by interested director shareholders (like safe harbor exception for s/h?)
Shareholder ratification of a self-interested transaction between the corporation and an interested party (D/O)
will NOT be legitimate if the majority of the shareholders are the interested parties.50
Under Gottlieb, shareholder ratification of an “interested transaction,” although less than unanimous,
shifts the burden of proof to an objecting shareholder to demonstrate that the terms are so
unequal as to amount to a gift or waste of corporate assets. “[The] entire atmosphere is freshened
and a new set of rules invoked where formal approval has been given by a majority of independent,
fully informed [disinterested shareholders]”
o Shareholder ratification can be used to switch the burden of proof back to a plaintiff to prove that
a transaction was not legitimate. It therefore can reset the standard back to the business judgment
rule (safe harbor exception?)
o Without ratification by majority of disinterested s/h or directors, transaction is subject to intrinsic
fairness test (same as Sinclair)
See DGCL 144 (interested directors)
If director/officer fails to disclose his position, K is voidable regardless of proof of fairness.
Revlon (sale of control) and Unocal (takeover defenses) also implicate duties of care and loyalty.
Duty of good faith
A subsidiary element of the duty of loyalty.
In executive compensation
The law presumes that in making a business decision, the directors of a corporation acted on an informed
basis, in good faith, and in the honest belief that the action taken was in the best interests of the
company.51
49
Zahn, 362: The company’s charter allowed for the redemption of Class A stocks, but the timing of it was suspicious because right
after causing the redemption Δ liquidated the company (through the company’s board of directors). Π alleged that if Class A
stockholders had been had been allowed to participate in the assets on liquidation and had received their respective shares of the asset,
he and the other Class A stockholders would have received $240/share instead of $80.80. Π alleged that the redemption was made to
appear as incidental to the business and then liquidated. Dismissal is reversed because if Π’s allegations were true, Δ as controlling
stockholder had a fiduciary duty to minority Class A stockholders that was violated. Π entitled to equitable relief if, as Π maintains,
the directors were acting on Δ’s behalf when they decided to redeem Class A shares. Δ is entitled as a shareholder to vote in favor of
its own interest, but its capacity as director (if the directors are acting as an instrument of the majority shareholders, rather than
independently calling the Class A stock) is limited because of the fiduciary duty owed to the other shareholders.
50
Fliegler, 366: Agau’s directors voted to exercise the option. A majority of shareholders voted the same way, but the directors also
comprised a majority of shareholders. Plaintiff argued that Defendant directors usurped a corporate opportunity for their own
individual benefit, and that the transaction was inherently unfair. Defendants responded that their voted was ratified by shareholders,
thereby shifting the burden of proof to Plaintiff to prove that the transaction was fair (under Gottlieb). The burden of proof that the
transaction was fair was still on the Defendant directors because the shareholder ratification was not legitimate: Defendants controlled
a majority of the shares, and there was not enough proof that disinterested shareholders voted with the directors. However, Defendants
did offer enough proof to demonstrate that the transaction was “intrinsically fair.”
51
In re Walt Disney, 374: Eisner and Ovitz entered into a letter agreement that outlined the terms of Ovitz's employment, including a
five-year term and a generous severance package, all of which was subject to approval by the board. The board granted its approval
shortly thereafter, and Ovitz began his employment on the date the agreement was officially executed. It soon became clear, however,
that Ovitz was a poor fit with other Disney executives. The Disney board approved Ovitz's termination without cause. Brehm (P),
Categories of “bad faith” fiduciary behavior (examples of conduct that would establish a failure to act in
good faith)
o Intentional dereliction of duty (between subjective intent to do harm to the corp & lack of due
care) – a legally appropriate, although not the exclusive, definition of fiduciary bad faith
A conscious disregard for one's responsibilities is an appropriate (although not the only)
standard for determining whether fiduciaries have acted in good faith
Deliberate indifference and inaction in the face of a duty to act is conduct that is clearly
disloyal to the corporation. It is the epitome of faithless conduct
Requires more than gross negligence (due care standard)
o Subjective bad faith (also discussed in case but not followed)
Fiduciary conduct motivated by an actual intent to do harm
Intent to violate the law
o Lack of due care (also discussed in case but not followed)
Fiduciary action taken solely by reason of gross negligence and without any malevolent
intent
But gross negligence by itself cannot constitute bad faith
o MBCA 8.31(a)(2)(iv): A sustained failure of the director to devote attention to ongoing oversight
of the business and affairs of the corporation, or a failure to devote timely attention by making or
causing to be made appropriate inquiry, when circumstances of significant concern materialize
that would alert a reasonably attentive director
Corporate waste (Even if BJR protected a director’s action, did it constitute waste?)
o Π who fails to rebut the BJR presumptions is not entitled to any remedy unless the transaction
constitutes waste
o Standard is similar to con law’s rational basis (outer boundary is rationality, rational purpose):
To recover on a claim of corporate waste, Π must shoulder the burden of proving that the
exchange was "so one sided that no business person of ordinary, sound judgment could conclude
that the corporation has received adequate consideration." A claim of waste will arise only in the
rare, "unconscionable case where directors irrationally squander or give away corporate assets."
This onerous standard for waste is a corollary of the proposition that where business
judgment presumptions are applicable, the board's decision will be upheld unless it
cannot be "attributed to any rational business purpose"
Directors cannot act in bad faith without also violating their duty of care/loyalty.
Example where BF violated but may not violate care or loyalty: Delivery service where drivers allowed
to double park and any fines are covered. It violates the law (BF) but is more cost effective for
shareholders
o Duty of loyalty not violated? But acting in GF is condition to loyalty. Maybe duty of care not
violated
Black’s dictionary on bad faith: A complete catalog of bad faith is impossible.
Disney shareholder, brought a derivative suit against Eisner (D) and other directors, claiming that the termination of Ovitz was
corporate waste, and that the employment contract and termination were breaches of fiduciary duty and not entitled to BJR protection.
No reasonably prudent fiduciary in the president's position would have unilaterally called a board meeting to force the corporation's
chief executive officer to reconsider his termination and the terms thereof, with that reconsideration for the benefit of shareholders and
potentially to the president's detriment. The decisions to approve the president's employment agreement, to hire him as president, and
then to terminate him on a no-fault basis were protected business judgments, made without any violations of fiduciary duty. So it was
unnecessary to reach the shareholders' contention that the directors were required to prove that the payment of severance was entirely
fair. Because the shareholders failed to show that the approval of the no-fault termination terms of the employment agreement was not
a rational business decision, their corporate waste claim failed. There was enough evidence showing that, at the time they approved
the agreement, the compensation committee members were adequately informed of the potential magnitude of an early severance
payout. The approval of the severance payout had a rational business purpose of inducing Ovitz to join Disney at what would
otherwise be a considerable cost to him (in leaving CAA). Eisner only had the option to terminate Ovitz and thus pay for the non-fault
termination as agreed. Eisner had breached no duty and had exercised his business judgment.

In executive oversight
Directors are not expected to know, in minute detail, everything that happens on a day-to-day basis. Just
understand the business and be informed about general operational activities.
Liability of directors where they are unaware of employee misconduct that results in the corporation being held
liable52
A director’s obligation includes a duty to attempt in good faith to assure that a reasonable corporate
information and reporting system (which the board concludes is adequate) exists, and that failure to do
so under some circumstances may render a director liable for losses caused by non-compliance with
applicable legal standards
Only a sustained or systematic failure of the board to exercise oversight—such as an utter failure
to attempt to assure a reasonable information and reporting system exists—will establish the lack
of good faith that is a necessary condition to liability.
Board must:
o 1) Set up a system: Adopt rules and procedures to ensure lawfulness (follow the law)
File suspicious activity reports w/r/t financial tx, e.g., on money laundering
o 2) Monitor
Only the duties of care and loyalty, where violated, may directly result in liability. A failure to act in good faith
may do so indirectly, as a subsidiary/conditional element of the duty of loyalty. Bad faith conduct violates the
fiduciary duty of loyalty.
52
Stone v. Ritter, 391
Public company issues
Securities law
’33 Act Securities Act of 1933 (initial stage)
Regulates primary market – when company itself issues shares, money goes to company
Disclose all relevant information about company and letting individuals decide
o Material misstatements/omissions in the prospectus that would impact investor judgment
generally strictly liable under 33 Act
o If SEC is satisfied, can sell even risky vehicles
’34 Act Securities Exchange Act of 1934 (after issuance)
Regulates trading in 2° market – after securities are out there
Most relevant to insider trading
What is a security? The way it’s defined in the 33 Act, which lists a bunch of things it considers a security. It
also generally captures future instruments created (“investment contracts”).
SCOTUS definition of “investment contract”: a contract, transaction or scheme whereby a person
invests his money in a common enterprise with a reasonable expectation of profits primarily (not
necessarily solely) from the entrepreneurial or managerial efforts of others (includes anything
generally considered to be security – kind of circular)
o Economic reality/features of the instrument: What matters more than the form of the investment
scheme is the “economic reality” that it represents—whether an investor, as a result of the
investment agreement itself or the factual circumstances that surround it, is left unable to
exercise meaningful control over his investment (passive security)53
Registration process (’33 Act)
33 Act § 5 prohibits the sale of securities unless the company issuing the securities has registered them
with the SEC:
Securities may not be sold until the registration statement has become effective
The prospectus (disclosure doc) must be delivered to the purchaser before a sale
Strict liability for violation of § 5
SEC considers whether the registration statement contains the required disclosures, not whether the security
would be a good investment. The core of the registration statement thus is the prospectus. Until the SEC has
approved the disclosures, companies cannot sell the new securities.
Two ways to sell securities without registering them:
Exempt security
o Need never be registered, either when initially sold by the issuer or afterward
o Highly specialized, less likely to be encountered
Exempt transactions (more likely to encounter transactional exemptions)
o One-time exemptions: A buyer is not automatically free to resell a non-exempt security in an
exempt tx, unless it is registered or another exempt tx is utilized
53
Robinson, 401: Glynn had a company trying to develop new phone tech. Robinson (bizman with no experience in the tech) and
Glynn entered into an agreement to purchase interest in the company if field test was successful. Glynn lied about the field test. Does
Robinson’s membership interest in the company, an LLC, count as a security? No. Robinson was an active and knowledgeable
executive rather than a mere passive investor in the company (not primarily derived from others’ effort, contributed too much). Also,
LLCs lack standardized membership rights or organizational structures, so they can assume an almost unlimited variety of forms. It
becomes difficult to declare that LLCs possess or lack the economic characteristics associated with investment contracts. The parties’
invitation for a broader holding is declined.
 o § 4(1): Tx by anyone if you are NOT an issuer, underwriter (buys security with a view to
reselling, takes risk, middleman between issuer and investing public) or dealer – careful: broad
definitions
o Non-public, private offerings (statutory affirmative defense): Absent a registration statement,
factors that Δ has the burden to show to determine whether an offering is private include the…
1) Number of offerees and their relationship to each other and the issuer – most critical!54
Purpose of the Act was to protect investors by promoting full disclosure of
information thought necessary to informed investment decisions. The exemption
question runs on the knowledge of the offerees
The more offerees the more likely that the offering is public
o Few (1-8) aids Δ’s search for exemption
High degree of business or legal sophistication of offeree does not suffice to bring
the offering within private exemption
o Δ must demonstrate that all offerees, whatever their expertise, had
available the information a registration statement would have
afforded any prospective investor in a public offering, not just those
who ultimately accepted (necessary but not sufficient)
o Sophistication (education, net worth) is not a substitute for access to the
information that registration would disclose. If the offeree did not have the
requisite information, he could not bring their sophisticated knowledge of
business affairs to decide whether or not to invest
2) Number of units offered
Small aids Δ’s search for exemption
3) Size of the offering
Modest financial stakes aid Δ’s search for exemption
4) Manner of the offering
Personal contact and free of public advertising or intermediaries (i-bankers,
securities exchanges) aid Δ’s search for exemption
Civil liabilities from material misstatement/omission (§ 11)
In a registration statement, if there is a material misstatement/omission, those who buy in that primary offering
can sue for any losses they suffer as a result of the material misstatement/omission. The issuer (Δ) is strictly
liable to make whole; it doesn’t matter if it were an inadvertent mistake. Issuer isn’t the only possible Δ; other Δ
are individual directors, designated experts (e.g., accountants, underwriters).
Due diligence defense for directors and underwriters: Unlike issuer itself, they can defend themselves
by proving they were not negligent.
If Π can make prima facie case, BOP shifts to Δ to show any losses Π suffered were not caused by material
misstatement/omission.
Exchange Act disclosures & integrated disclosure
54
Doran, 410: Plaintiff was an educated investor with a degree in petroleum engineering. A broker contacted Plaintiff to propose a
sale of a participant interest in an LLC Wyoming oil drilling operation from Defendants to Plaintiff. Eight other entities were offered
an interest, and three declined. Plaintiff paid for his interests through a down payment and a promissory note to take over payments on
a debt held by the LLC. Shortly after Plaintiff purchased an interest, the wells were closing down for almost a year, and the operation
was never as profitable as it was prior to his investment. Plaintiff sought to rescind his obligations to the LLC, citing violations by
Defendants under the Securities Exchange Act. Defendants countered that the investment was a personal (private, not public) offering
that was exempt from the Act (rescission of K). Δ raised this affirmative defense under statute. Δ may have shown factors 2-4. As for
factor 1, the 5th Cir. remanded to find whether the offerees knew or had a realistic opportunity to learn facts essential to an investment
judgment.
Publicly traded companies (and some large close corps) are required to file Exchange Act reports: Form 10
(initial), Form 10-K (annual), Form 10-Q (each of first 3 quarters of the year), Form 8-K (within 4 days after
certain important events affecting the company’s operations or financial condition).
Insider trading (’34 Act)
It’s an issue only if you are silent about a material fact. Affirmative misleading statements will lead to liability
anyway.
Cady, Roberts affirmative duty to disclose when dealing in securities—10b-5 violation occurs when there
are:
1) The existence of a fiduciary relationship affording access to inside information intended to be
available only for a corporate purpose
2) The unfairness of allowing a corporate insider to take advantage of that information by trading
without disclosure (to make “secret profits”)
Duty is owed to shareholders by (i.e., the disclose or abstain rule applies to)
Officers, directors employees (“insiders”)
Tippees when insider breached duty in tipping
Temporary fiduciaries – revealed legitimately to underwriter, accountant, lawyer or consultant working
for the corp – special confidential relationship given access to info solely for corporate purposes – the
corp must expect the outsider to keep the disclosed nonpublic info confidential, and the relationship at
least must imply such a duty
Would-be misappropriators
Material nonpublic information? Insiders cannot act on material information (information that a reasonable
person would deem important to the value of the stock) until the information is reasonably (to the point that the
public would have had a reasonable opportunity to act on it), publicly disseminated.55
Who are insiders? Employees, directors – who have fiduciary duties to shareholders – need to show
possession of material nonpublic information
o Others (e.g., lawyers) can be liable for insider trading if they breached a duty as temporary
fiduciaries
Insider would also be liable if these people breached a duty
Material? Would a reasonable person believe that the information would be relevant to the price of the
stock? (sort of reasonable standard)
o Information classically considered material
Takeover is coming
Pharma drug is approved or disapproved by FDA
Publicly disseminated: If misleading PR, recklessness standard generally. Negligent in releasing press
release can be liable
55
SEC v. Texas Gulf Sulphur Co. (TGS), 466: Defendants were officers, employees or were closely tied to employees of Texas Gulf.
After a promising mining exploration, the trading activity and sample drilling prompted rumors in the industry of a significant find by
Texas Gulf, and on April 12, 1964 Defendants sent out a misleading press release to calm the speculation. The press release
misrepresented the actual results of the samples. Defendants decided to announce the results on April 15, although the news did not
reach the public until April 16. Defendants still traded between April 12 and the announcement. Defendants claimed that the
information was not material to the value of the company and therefore did not feel obligated to publicly disclose the information.
They also argued that any trading after they released the news at midnight of April 16 was legitimate because technically the news was
disseminated to the public. The 2d Cir. found that Defendants withheld information that was material to shareholders and therefore
were acting on insider information when they purchased their shares and calls on Texas Gulf stock. The court looked at the conduct of
Defendants as evidence that the information was material: They purchased a great deal of shares in Texas Gulf, they deliberately kept
the information from others, and the timing of their purchases occurred during the period that they exclusively held the information.
Further, Defendants should not act upon the information until the information is disseminated to the point that the public would have
had a reasonable opportunity to act on it.
 Does Δ have an advantage over anyone without the information?
Obligations of insiders possessing MNI: Disclose it or abstain from trading the security!
Rule 10b-5 policy: All investors should have equal access to the rewards of participation in securities
transactions and be subject to identical market risks
o Under common law, silence between two market participants OK? Under 10b-5, can go after
people who are silent! Not just misstatements but omissions
Other circumstances barring trading while in possession of MNI
Misappropriation by “outsider”
o A person commits fraud in connection with a securities transaction (thereby violating § 10(b) and
Rule 10b-5) when he misappropriates confidential info for securities trading purposes, in breach
of a duty owed to the source of the information56
Deception through nondisclosure is central to liability, which is premised on deception of
the source of the info by a fiduciary who was entrusted with access to confidential
information
Rule 10b5-2. Duty of trust or confidence exists for misappropriation theory where
someone is in a position of trust or confidence with
the source of the information…
Someone agrees to maintain info in confidence
Two people have a pattern or practice of sharing confidence such that the
recipient of the info knows or reasonably should know that the speaker expects
the recipient to maintain the info’s confidentiality, or
Someone receives MNI from a spouse, parent, child or sibling
Misappropriator’s deceptive use of info must be “in connection with the purchase or sale
of [a] security”
o Eavesdropping (instead of given) not liable under 10b-5
Some tippees must assume an insider’s duty of loyalty to shareholders because it has been made
available to them improperly: Insiders are forbidden by their fiduciary relationship from personally
using undisclosed corporate information to their advantage, and they also may not give such info to an
outsider for the same improper purpose of exploiting the information for their personal gain
o Insider breach of duty by tipping required: A tippee assumes a fiduciary duty of loyalty to
shareholders not to trade on MNI only when the insider has breached his duty by
disclosing the info to the tippee, and the tippee knows or should know that there has been a
breach57
Whether disclosure is a breach turns in large part on the purpose of the disclosure. The
test is personal gain, whether the insider personally will (tangibly) benefit, directly
or indirectly, from his disclosure
Absent some personal gain, there has been no breach of duty to stockholders. Absent a
breach by the insider, there is no derivative breach
But if the breach of fiduciary of duty is of care, then tippee is not liable!
Liability on those who trade “on the basis of” vs. “while in possession” of MNI
56
O’Hagan, 487: O’Hagan, in breach of a duty of trust and confidence he owed to his law firm and to his client, traded on the basis of
nonpublic info regarding the planned tender offer for common stock.
57
Dirks, 482: Dirks received MNI from “insiders” of a corporation with which he had no connection. He disclosed this information to
investors who relied on it in trading in the shares of the corporation. Dirks did not violate antifraud provisions of the federal securities
laws by this disclosure: He took no action that induced the shareholders to put trust in him; there was no expectation by Dirks’ sources
that he would keep their information in confidence, nor did Dirks misappropriate or illegally get the info. Unless the insiders breached
their duty to shareholders in disclosing the nonpublic information to Dirks, he breached no duty when he passed it on to the investors
and the WSJ. The insiders did not breach their duty to shareholders by providing info to Dirks: They received no monetary or personal
benefit for revealing the secrets, nor was their purpose to make a gift of valuable information to Dirks. They were motivated by a
desire to expose the fraud. Without breach of duty by insiders, there is no derivative breach by Dirks. Thus, Dirks could not have been
a participant after the fact in an insider’s breach of a fiduciary duty.
o Common law (Adler and Smith)
Mere knowing possession of MNI by an inside trader is not a per se violation of 10b-5.
Trading while in possession of such info merely raises a strong inference that the insider
traded on the basis of that info. The insider can rebut that presumption by showing that he
did not use such info in making trading decisions
In criminal case, gov’t must prove the insider used inside info as the basis for his
trading activity
o Cf. Rule 10b-5
Prohibition of insider trading is violated whenever someone trades “on the basis of” MNI,
but one is deemed to have traded “on the basis of” MNI if one was aware of such info at
the time of the trade (subject to narrow exceptions)
Effectively rejects Adler and Smith
Proxy fights
Because few shareholders of public corps attend the annual meeting (“rational apathy”), the outcome generally
depends on which group has collected the most “proxies”—agents who attend the meeting and vote on their
behalf. “Proxy fights” result when an insurgent group tries to oust incumbent managers by soliciting proxy
cards and electing its own representatives to the board.
Courts will intervene only if illegal or unfair means of communication employed by the present
management58
If insurgents start a proxy fight, they won’t get reimbursed for costs unless they win59. Incumbents’ costs
are reimbursable
Shareholder inspection rights
Insurgents want the shareholder list to try to convince major shareholders to support them, but incumbents will
mail the materials for proxy solicitation rather than release the shareholder list (choices under Rule 14a-7).
Federal proxy rules (14a-7) do not require the corp to give the shareholder list, but federal rules do not impair
any rights under state law. Thus, battles for the shareholder list are fought under state laws.
MBCA 7.20: Shareholders’ List for Meeting
(a) Alphabetical list of all shareholders who are entitled to notice of a shareholders’ meeting
(b) Shareholders’ list for notice must be available for inspection by any shareholder
(c) List of shareholders entitled to vote shall be made available at the meeting
(d) If the corp refuses to allow a shareholder, his agent or attorney to inspect a shareholders’ list before/at
the meeting, the court of the principal office’s county court may order the inspection or copying
(e) Refusal or failure to make available a shareholders’ list does not affect the validity of action taken at the
meeting
MBCA 16: Records
16.01: Corporate Records
Corp shall keep permanent records of
o Minutes of all meetings of its s/h and board
o Its shareholders in a format that permits preparation of a list
16.02: Inspection of Records by Shareholders
(a) A shareholder is entitled to inspect and copy any of the records in 16.01(e)
58
Levin v. MGM, 517: Plaintiffs and Defendants were fighting for control of MGM, and each was campaigning for their directors to
be elected at the annual shareholder’s meeting. Defendants used resources of the company and hired outside assistance to promote
their candidates. Plaintiffs did not allege any fraud or corruption. MGM limited the proxy solicitation budget to $125,000. The court
did not find the amounts to be paid excessive or the method of operation disclosed by MGM management to be unfair or illegal. It
doesn’t violate any federal statute or SEC rule.
59
Rosenfeld, 520
 (c) A shareholder is entitled to inspect and copy any of the records in 16.02(c) (includes shareholder
records) if the demand is made in GF and for a proper purpose (and other 16.02(d) requirements)
16.03: Scope of Inspection Right
16.04: Court-ordered Inspection
If a corp does not allow a s/h who complies with 16.02(a)
If a corp does not allow a s/h to inspect and copy other records within a reasonable time
A court may impose reasonable restrictions on use or distribution of the records by the demanding s/h
No absolute right of inspection
A shareholder desiring to discuss relevant aspects of a tender offer is granted access to the shareholder
list, UNLESS it is sought for a purpose other than the business (improper purpose adverse to the corp) or its
stockholders. The manner of communication selected should be within the judgment of the shareholder.60
1961 law: Access must be permitted to qualified shareholders on written demand, subject to denial if the
petitioner refused to furnish an affidavit that the inspection is not for a purpose other than the business of
the corp
There must be no improper purposes: Courts will look at not just whether there is a proper purpose but
whether it’s the only purpose. Would be problematic if there were another improper purpose
If tender offer is announced, it could pass muster since purposes related to tender offers are proper. If no
tender offer, really need to show proper purpose
o Spam mail not a proper purpose. Publicizing tender offer is a proper purpose
Conflicting out-of-court state laws: Even if the state of incorporation does not allow requesting shareholders to
obtain stockholder lists, a party can inspect records under section 1315(a) of the New York Business
Corporation Law through an agent as long as the elements of the statute are met.61 NY amended law to DE: A
corp is not required to obtain info then hand over info about beneficial owners not in its possession.
The shareholder must prove a proper (investment-related) purpose to inspect corporate records other
than shareholder lists. Where it is shown that stockholding is only colorable (only looks bona fide) or solely
for the purpose of asserting opinions to oppose management policy or maintain suits to compel production, the
requesting stockholder cannot be said to be a person interested as a stockholder in return of investment.62
Supplier list – harder for s/h to argue it is within investment return purposes
Takeovers
The bidder contacts shareholders directly with tender offer. The goal is to get enough shares to be in control of
the corp. Highlights from federal rules:
1. Anyone (singly or as part of a group) that acquires a 5 percent stake in a company must alert the
company and the SEC within 10 days of their identity and intent (e.g., whether it intends to try to gain
control of the company, any major changes it will implement in the company's strategy if it does gain
control, etc.). (§ 13(d)(1))
60
Crane, 565: Crane wanted Anaconda’s list of shareholders as part of a tender offer deal. Crane owned no Anaconda stock at this
time; Anaconda refused saying there was no basis for Crane’s request. 2M+ Anaconda shares were then tendered to Crane, making
Crane Anaconda’s largest stockholder. Since it appears that Anaconda failed to sustain its burden of proving an improper purpose (and
court below did not abuse its discretion), inspection should be compelled.
61
Sadler, 569
62
State ex rel. Pillsbury v. Honeywell, 566: Petitioner decided to purchase 100 shares of Honeywell for the purpose of requesting
corporate documents, as a shareholder, in order to give himself a voice in Honeywell’s affairs so he could persuade Honeywell to
cease producing bombs for the gov’t. Π said a stockholder who disagrees with management has an absolute right ot inspect corp
records for purposes of soliciting proxies, that such solicitation is per se a “proper purpose.” Δ and court said “proper purpose”
concerns investment return. It is important that only those with a bona fide interest in the corp enjoy the power to inspect (b/c it may
be the power to destroy). Π was not interested in the long-term wellbeing of Honeywell or the enhancement of his share value. His
sole purpose was to persuade the company to adopt his social and political concerns, irrespective of any economic benefit to himself
and Honeywell. Affirmed denial of Π’s writ of mandamus.
2. Any acquirer must hold the tender offer open for 20 business days. (Rule 14(e)(1)))
3. Any acquirer who raises his/her price during the term of a tender offer must raise it for any stock already
tendered. (§ 14(d)(7))
Sale of control + adoption of defensive measures? Having informed themselves of all material
information reasonably available, the directors must decide which alternative is most likely to offer the
best value reasonably available to the stockholders (Unocal, Revlon, QVC).63
Requires some degree of effort by corp to make sure they’re getting a good deal. Perfection isn’t the
goal; reasonable decision is
Revlon rule: Once it’s clear that the company is going to be sold off, the duties of the board change. No longer
are they defenders, but auctioneers, to get the best price they can for shareholders. Revlon duties are to
maximize short-term shareholder value, treat all other interested acquirers on an equal basis, and auction the
company fairly, in a situation where 1) dissolution of the corporate entity is inevitable (e.g., bidder keeps
increasing bid),64 OR 2) the transaction causes a change in corporate control (QVC). In either case, directors are
obligated (and are subject to enhanced judicial scrutiny) to seek the best value reasonably available to the
stockholders.65
Is there a pending sale of control? Implicated in at least two situations:
1. (clearer) When a corporation initiates an active bidding process seeking to sell itself or to effect a
business reorganization involving a clear breakup of the company
63
Paramount v. QVC, 789: QVC started bidding against Viacom’s offer, which forced Viacom to renegotiate with Paramount to raise
their offer, although the defensive measures were never renegotiated. QVC raised their offer even further, but the Paramount believed
that the offer was too conditional (similar to Viacom’s offer, it was two-tiered) and the board still felt that the merger was not in the
company’s best interests. Therefore, the Paramount board turned down a QVC offer that could have been about $1 billion more than
Viacom’s offer. In the lower court, QVC (Π) successfully enjoined Paramount (Δ) from carrying out the merger agreement.
Directors’ obligation to seek the best value reasonably available to s/h arises because the effect of the Viacom-Paramount tx,
if consummated, would shift control of Paramount from the public stockholders to a controlling stockholder, Viacom. Since
Paramount directors decided to sell control, they had an obligation to continue their search for the best value reasonably available to
the s/h. This continuing obligation included the responsibility to determine if, inter alia, the PVC TO could be improved. The
Paramount directors decided that a strategic merger with Viacom was in the best interests of Paramount and its s/h.
The directors’ process was not reasonable, and the result for the s/h was not reasonable under the circumstances: The
Paramount board clearly gave insufficient attention to the potential consequences of the defensive measures demanded by Viacom.
The stock option agreement had draconian provisions. The termination fee clearly made Paramount less attractive to other bidders.
The no-shop provision inhibited the board’s ability to negotiate with other potential bidders, especially QVC, which had already
expressed an interest in Paramount. QVC’s interest gave the opportunity for the board to seek significantly higher value for s/h than
that being offered by Viacom. QVC kept showing its intention to meet and exceed Viacom offers and negotiate possible further
increases. Under the circumstances at the time, it should have been clear to the board that original merger agreement impeded the
realization of best value reasonably available to the Paramount s/h. However, the board made no effort to modify these
counterproductive devices and instead clung to its vision of a strategic alliance with Viacom. It was paralyzed by its uninformed belief
that QVC’s offer was “illusory.” The defensive measures, as a whole, were problematic. The injunction of the original merger
between Paramount and Viacom was affirmed and invalidated.
64
Revlon, 761: TC concluded that Revlon directors breached their duty of loyalty by making concessions to Forstmann (who had
access to certain financial data among other exclusive privileges), out of concern for their liability to noteholders, rather than
maximizing the sale price of the company for s/h benefit. Forstmann made a $57.25 offer, which the board unanimously approved
because it was higher than Pantry Pride’s $56, it protected the noteholders, and Forstmann’s financing was firmly in place. Revlon
directors had concluded that Pantry Pride’s initial $47.50 tender offer was grossly inadequate. In this regard, the board acted in GF and
on an informed basis with reasonable grounds to believe that there was a harmful threat to the corporate enterprise (complying with
Unocal duties). However, when P.P. increased its offer to $50, then $53, it became apparent that the breakup of the company was
inevitable. Here, the duty, role and objective of the board changed from preservation of Revlon as a corporate entity to maximization
of the company’s value at a sale for s/h benefit, an auctioneer getting the best price for s/h at a sale. The whole question of defensive
measures became moot. Thus, Revlon couldn’t make the requisite showing of GF by preferring the noteholders and ignoring tis duty
of loyalty to s/h—duty of loyalty breached. The principal benefit went to the directors, who avoided personal liability to a class of
creditors to whom the board owed no further duty under the circumstances. The board’s action is not entitled to the deference provided
by BJR.
65
Paramount v. QVC, 791: Viacom-Paramount tx, if consummated, would shift control of Paramount from the public stockholders to
a controlling stockholder, Viacom. Not a breakup scenario.
 2. In response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative Court would consider any intent was to tear the company down, sell assets, fire
transaction involving the breakup of the company employees, etc.
o NOT triggered if board’s reaction to a hostile tender offer is found to constitute only a defensive Unless rationally related benefit accrues to s/h (Revlon)
response and not an abandonment of the corporation’s long-term plan for continued existence.66 o The element of balance: If a defensive measure is to come within the ambit of the BJR, it
But Unocal duties (for defensive response) attach! must be reasonable in relation to the threat posed (in light of the circumstances then
existing)
Unocal duties – if Revlon duties don’t apply Inadequacy of the price offered
Burden to prove the following before BJR attaches to defensive actions of a board of directors: Nature and timing of the offer
Was there a legally cognizable threat (to shareholders – adequate value, long-term plans)? Questions of illegality
Was the board adequately informed of the potential benefits of the other offer? Impact on non-s/h constituencies (creditors, customers, employees, general community)
Is the defensive response reasonable in relation to a perceived threat? Risk of non-consummation
o Not permissible if it is “draconian,” i.e., “coercive or preclusive” Quality of securities being offered in the exchange
o Discretion of board to choose a defensive measure from among alternatives within the “range of Basic s/h (including short-term speculator) interests at stake
reasonableness” (QVC) Offer’s fairness and feasibility
Proposed/actual financing for the offer, consequences of this financing
Unocal burden/duty: When a board implements anti-takeover measures, there arises the suspicion that the Bidder’s identity
board may be acting primarily in its own interests, rather than those of the corp and its shareholders. This Bidder’s business plans for the corp, their effects on s/h interests
potential for conflict places on the directors the burden of proving that they had reasonable grounds for Where actual self-interest is present and affects a majority of the directors approving a tx, a court will
believing there was a danger to corporate policy and effectiveness. apply even more exacting scrutiny to determine whether the tx is entirely fair to the stockholders68
“Enhanced scrutiny test” (QVC)—There are two elements to look at in a board’s exercise of corporate Concern for various corporate constituencies other than shareholders is proper when addressing a
power (before the board is entitled to be measured by the BJR standard) to prevent a hostile takeover takeover threat, but this principle is limited by some rationally related benefit accruing to the
bid:67 shareholders69
o Showing of good faith and reasonable investigation (as required by BJR) Look for a reasonable decision, not a perfect one
There is a fiduciary duty to act in the best interests of the corp’s stockholders
Impeding a takeover should be motivated by disinterested, informed, GF concern for the Rule 13e-4(f)(8): Discriminatory self-tenders are disapproved. Issuer tender offers other than those made
welfare of the corp and its s/h—free of breach of fiduciary duty, such as fraud, lack of to all shareholders are prohibited. However, it does not prohibit “poison pills,” which can have much the
GF, being uninformed, primary purpose to entrench (perpetuating themselves in same effect.
office), or other misconduct Favoritism to the exclusion of a hostile bidder might be justifiable when the latter’s offer adversely
affects s/h interests, but not when bidders make relatively similar offers or dissolution of the company
66
Paramount v. Time (Time-Warner), 772: No substantial evidence that Time’s board, in negotiating with Warner, made the becomes inevitable
dissolution of the corporate entity inevitable like in Revlon. Π relied on subjective intent of Time’s directors that the Warner tx might What is a poison pill? Right that attaches to shares, defensive measure against hostile takeovers.
be viewed as effectively putting Time up for sale. Π argued that certain agreements prevented s/h from getting a control premium in “Rights” give all s/h except acquirer something cheap or free (e.g., stock split) – dilutive effect
the immediate future and thus violated Revlon. Such evidence is insufficient to invoke Revlon duties. Π’s Unocal claim also failed:
Time board reasonably determined that inadequate value was not the only legally cognizable threat that Π’s all-cash offer could
Trigger for right to exercise?
present. Other threats were posed—Time s/h might elect to tender into Π’s cash offer in ignorance of the strategic benefit of o For example, if corporate raiders end up owning 20% (typically), causing threat of takeover
combining with Warner, the conditions to Π’s offer introduced uncertainty that skewed a comparative analysis, and the timing of Π’s o Has flip-in, flip-out and redemption provisions (management can buy out rights)
offer was viewed as arguably designed to upset, if not confuse, Time s/h votes. Time board’s decision that Π’s offer posed a threat to But if there is a PP in the first place, mgmt. probably doesn’t want to redeem it. How to
corporate policy and effectiveness was not lacking in GF nor dominated by motives of either entrenchment or self-interest. Time board make them?
was also adequately informed of available entertainment companies, including Π, before determining that Warner provided the best
strategic fit. Π didn’t serve Time’s objectives or needs. Time’s response was reasonably related to the threat because its goal was to Proxy battle to kick out mgmt.
carry forward a pre-existing tx in an altered form rather than “cramming down” on its s/h a management-sponsored alternative. Sue the board for violating duties, force them to redeem the pill
67
Unocal, 751: Π was a corporation led by a well-known corporate raider. Π offered a two-tier tender offer wherein the first tier would Brute force to buy
allow for shareholders to sell at $54 per share and the second tier would be subsidized by securities that the court equated with “junk o Irrational to trigger halts takeovers
bonds.” The threat therefore was that shareholders would rush to sell their shares for the first tier because they did not want to be
subject to the reduced value of the back-end value of the junk securities. Δ directors met to discuss their options and came up with an What can it allow? For example, the 20% owner cannot exercise the right. Everyone else can get split
alternative that would have Δ corporation repurchase their own shares at $72 each. The Δ directors decided to exclude Π from the shares. Everyone else has same value of stock, but 20% owner’s new value is shrunk. 20 out of 100 + 80
tender offer because it was counterintuitive to include the shareholder who initiated the conflict. out of 100 20 out of 180 + 160 out of 180
The court held that Δ could exclude Π from its repurchase of its own shares. The directors for Δ corporation have a duty to protect
the shareholders and the corporations, and one of the harmful tactics that can befall a company is a takeover by a shareholder who is
offering an inadequate offer. There was evidence to support that the company was in reasonable danger: The outside directors
approved of their self-tender, the offer by Π included the junk bonds, the value of each share was more than the proposed $54 per
share, and Π was well known as a corporate raider. The selective stock repurchase plan chosen by Δ is reasonable in relation to the
threat the board rationally and reasonably believed as posed by Π’s inadequate and coercive two-tier tender offer. Under these
circumstances, the board’s action is entitled to be measured by the BJR standards. Unless it’s shown by preponderance that the
68
directors’ decisions were primarily based on perpetuating themselves in office, or some other breach of fiduciary duty such as fraud, Paramount v. QVC, 787 n.9
69
lack of GF or being uninformed, a court will not substitute its judgment for that of the board. Revlon, 762: No such benefit found.
Corporate litigation
A shareholder derivative suit is an action brought by a corporate shareholder on behalf of the corporation (claim
by corp) to enforce a corporate right that the officers and directors of the corporation have failed to enforce. In
bringing a derivative suit, a shareholder is asserting that the corporation was harmed, that the corporate officers
and directors failed to take action to redress that harm, and that the corporate cause of action has therefore
accrued to the corporation’s shareholders in place of its directors.
Shareholders can bring direct (usually part of class action on behalf of all s/h) vs. derivative actions against
directors. The distinction depends on the wrong alleged and any relief
Direct claims
o Declaration of invalidity of the challenged tx
o Abdication claim (no monetary recovery accrued to the corp as a result)
o 10b-5 claim
Derivative claims (primary harm & recovery to corp)
o Breach of loyalty or due care, waste, excessive compensation claims
o Director takes corp opportunity – self-dealing
o Compel it to sue a 3P by the corp?
Derivative claims: Requirement of Π’s pre-suit demand on the directors
Demand requirement: Prior to instituting a derivative action, a s/h must make a demand on the
board of directors to redress his grievances. Once demand has been made and rejected, the burden is
on Π s/h to show why the directors’ decision not to take action should not be respected by the court
o Or as a derivative Π, demand that the board litigate the alleged corporate claim
o Generally go directly to court and say demand would have been futile
A s/h who makes a demand is entitled to know promptly what action the board has taken in response to
the demand. But a demand, when required and refused (if not wrongful), terminates a
shareholder’s legal ability to initiate a derivative action (and contest board’s independence w/r/t
challenged tx)—if a pre-suit demand is made and rejected, the board rejecting the demand is
entitled to the presumption of BJR, UNLESS s/h can allege facts with particularity creating a
“reasonable doubt” (standard in Del but not NY, pretty easy) that the board is entitled to the
benefit of the presumption
o Can look at self-interest and lack of biz decision to the specific decision about
accepting/rejecting demand
Π may NOT bifurcate (separate) his theories relating to the same claim and set of facts alleged in
the demand. Π may not make a demand then later assert that demand was excused70
o A s/h who makes a demand can no longer argue that demand is excused as to one set of claims.
If a demand is made, s/h has spent one arrow in the quiver. The spent arrow is the right to claim
that demand is excused
o A pre-suit demand is a tool to avoid further litigation, but it would not serve that function
effectively if Π was allowed to bifurcate his claims and claim the demand was excused for one
set of claims
Futility EXCEPTION to demand requirement
70
Grimes (DE), 210: Π sought a declaration of the invalidity of the Agreements between CEO Donald and the board of directors of
the company. Π has not set forth well-pleaded allegations that would establish a situation that would amount to a de facto abdication
of directorial authority. Π made a pre-suit demand and later asserted that his demand was excused. Π, by making a demand, waived
his right to contest the independence of the board. Here, the board considered and rejected the demand. After investing the time and
resources to decide, the board is entitled to have its decision analyzed under BJR unless the presumption can be rebutted. Π can’t
avoid this result by holding back or bifurcating legal theories based on the same set of facts alleged in the demand. Π was required to
plead with particularity why the board’s refusal to act on the derivative claims was wrongful—to allege particularly to raise a
reasonable doubt that the board’s decision to reject the demand was the product of a valid business judgment. Π’s complaint generally
asserts why Π disagrees with the board’s conclusion b/c the refusal couldn’t have been from adequate GF investigation. Thus, Π
waived his right to contest the independence of the board of directors once he demanded that it invalidate the employment contract.
o If demand req is excused, s/h can initiate the action on the corporation’s behalf
o Demand is excused because of futility when a complaint alleges with particularity that…71
1) a majority of the board of directors is interested in the challenged tx,
Could be from a decision to increase compensation excessively (“you know it
when you see it”), self-interest, loss of independence or control—an example is
like Bayer where radio ads where most board members were also directors,
chairman of the board was also CEO where someone feels like he has to go along
(a director with no direct interest in a tx is “controlled” by a self-interested
director)
For demand excuse purposes, a director will always be an interested party when
voting on director compensation
In Marx, the court does not provide much guidance as to a precise threshold to
establish the excessiveness. Plaintiff established that the compensation was
greater than the cost of living increase and that the company was not prospering
under the current board, but this was not enough
2) the board did not fully inform themselves about the challenged tx to the extent
reasonably appropriate under the circumstances (majority “dominated”), or
like VG gross negligence
3) the challenged tx was so egregious on its face that it could not have been the product
of sound business judgment of the directors [NY]
[DE] Tx wasn’t product of a valid business judgment
like Disney waste, outer boundary of rational purposes
Role of special litigation committees
Special litigation committees – chief vehicle by which get suits dismissed in demand excused cases
Judicial review of independent special litigation committee (SLC) determination: BJR applies where some
directors are charged with wrongdoing, as long as the remaining committee members making the decision are
disinterested and independent. They must also show facts sufficient to require a trial of any material issue of
fact as to the adequacy or appropriateness of the modus operandi (examine the procedures, process – reasonable
investigation?) or that committee or has shown acceptable excuse for failure to make such tender.72
Demand excused cases: The court should apply a two-step test to the motion an independent committee files to
dismiss a derivative suit that was properly initiated by a stockholder in his own right.73
71
Marx (NY), 219: Plaintiff challenged Defendants’ decision to increase three of the outside director’s compensation to $55,000 plus
100 shares of IBM stock. The increase was above the rate of the cost of living, and the company under Defendants has been
struggling. Therefore, Plaintiff asserted that the compensation was excessive. Defendants argued that only three directors were
affected by the compensation increase, and therefore a majority of the board had no interest—and therefore demand was not excused
(i.e., can’t bifurcate claims?). Defendants also argued that Plaintiff only asserted conclusory statements and did not assert with
particularity any facts to establish that the compensation was excessive. Under NY law, demand should have been (and was) excused
because the Defendant directors have an interest when voting to increase their own compensation, so demand would have been futile.
However, the Plaintiff did not adequately support his claim and therefore the suit should be dismissed. Other than asserting that the
compensation was excessive, Plaintiff did not demonstrate with particularity what accounting decisions or any other facts that would
establish the excessiveness of the raises.
72
Auerbach, 225: After a corporate audit found that current and former members of the board of directors were involved in the
payment of bribes and kickbacks to foreign officials, a special committee of members appointed by the board concluded that a claim
against it would not be in the best interests of the corporation for this derivation action to proceed. Here, the committee engaged
special counsel to guide its deliberations and give pertinent legal advice. The committee reviewed the prior audit committee’s work
and tested it. Individual interviews were done with the directors found to have participated in any way in the questioned payments. No
material issue of fact concerning the sufficiency or appropriateness of the procedures chosen by the special litigation committee.
Nothing raises a triable issue of fact as to the GF pursuit of its examination by that committee. Nothing raises a triable issue of fact as
to the independence and disinterested status of the 3 directors of the special committee.
73
Zapata, 237: Maldonado, s/h of Zapata, brought a derivative action on behalf of Zapata against 10 officers and/or directors of
Zapata, alleging breaches of fiduciary duty. Π did not first demand that the board bring this action, stating instead such demand’s
 1. First, the court should inquire into the independence and good faith of the committee and the bases No good-faith requirement
supporting its conclusions. Δ corporation has the burden of proving (rather than presumption of)
independence, good faith and a reasonable investigation. Under DGCL § 145(e), a corporation may advance the costs of defending a suit to a director. An agreement to
a. If the court determines either that the committee is not independent or in good faith, or has not mandate advancements are (reasonably) enforceable, to the extent of the parties’ intent without producing an
shown reasonable bases for its conclusions, or, if the court is not satisfied for other reasons absurd result. This is independent of whether the company is required to indemnify the officer.76
relating to the process, the court shall deny the corporation's motion.
b. If, however, the court is satisfied that the committee was independent and showed reasonable Under DGCL § 145(f), a corporation may provide indemnification rights that go “beyond” the rights provided
bases for good faith findings and recommendations, the court may proceed, in its discretion, to by the other subsections. (§ 145 rights not exclusive of other rights granted by contract, etc.)
the next step. BUT any such rights must be “consistent with” the substantive provisions of § 145
i. Δ’s counsel should thoroughly investigate this
2. Next, the court should determine, applying its own independent business judgment, whether the motion Under DGCL § 145(g), a corporation may purchase and maintain insurance on behalf of any person who is/was
should be granted. a director, officer, employee or agent of the corp.
a. The second step provides the essential key in striking the balance between legitimate corporate
claims as expressed in a derivative stockholder suit and a corporation's best interests as
expressed by an independent investigating committee. This step is intended to thwart instances
where corporate actions meet the criteria of step 1, but the results doesn’t appear to satisfy its
spirit

Indemnification and insurance

The court does not allow corporations to override—unless consistent with—state statutes regarding
indemnification because it would thwart public policy; a corporation’s grant of indemnification rights
cannot be inconsistent with DGCL § 145 (or other state indemnification statutes).74

Under DGCL § 145(a), a corporation may indemnify (protect/compensate) anyone who was a party if he acted
in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the
corporation. Conversely, corp article provisions that require indemnification of officers who have acted in bad
faith are thus invalid (see Waltuch).
All suits except derivative – expenses, judgments, fines, amounts paid in settlement
145(b) is similar but covers derivative suits
o Actual and reasonable expenses only (not judgments and settlements)
b/c judgments would be paid to corporation by corporation (circular)

Under DGCL § 145(c), a corporation shall indemnify its present/former officers and directors for actual
and reasonable expenses incurred for the “successful on the merits or otherwise” in defense of certain
claims. The only question a court may ask is what the result was, not why it was. Success is vindication
(does not necessarily mean moral exoneration)—escape from an adverse judgment or other detriment,
for whatever reason, is determinative.75 Two differences from 145(a)/(b):
Extra condition that D & O must be “successful on the merits or otherwise”
o Dismissal w/o settlement success

futility because all directors were named as Δ and allegedly participated in the acts specified. The board created an independent
investigation committee composed of two new directors to investigate Π’s actions and to determine whether the corp should continue
any of the litigation. After an investigation, the committee concluded that each action should be dismissed. Consequently, Zapata
moved for dismissal or summary judgment.
74
Waltuch, 506-07: The corp’s article that requires indemnification of Waltuch (corp’s VP) even if he acted in BF is inconsistent with
the permissive DGCL § 145(a) and thus exceeds the scope of a DE corp’s power to indemnify. Since Waltuch forwent his opportunity
to prove that he acted in GF, he is not entitled to indemnification under the article for the amount he spent in connection with the
private lawsuits.
75
Waltuch, 511: The corp argued that because of its $35M settlement payments to angry silver futures speculators, the settlement of
Waltuch (corp’s VP) without payment shouldn’t really count as settlement without payment. Waltuch was sued, and the suit was
dismissed without his having paid a settlement. The corp contended that the charges were dropped for practical reasons, not because of
innocence. But it is not the court’s business to ask why this result was reached, just what the result was. Once Waltuch achieved his
settlement, he achieved success “on the merits or otherwise.” Success is sufficient to constitute vindication (at least for § 145(c)
purposes). Waltuch’s settlement thus vindicated him.
76
Citadel Holding, 512: Citadel sued Roven for violating 34 § 16(b) by purchasing certain options to buy Citadel stock while he was a
director.* The agreement between a corporation and its officer mandated the corporation to advance an officer money to cover any
legal defense expenses. Court held that the agreement requires the corp to advance to the director all reasonable costs incurred in
defending the suit against him by the corp. Under statute and the agreement, the corp’s obligation to pay expenses is subject to a
reasonableness requirement—reasonable expenses and suits related to the business. This concerns the right to advances under the
agreement, not his right to indemnification.
34 § 16(b) provides strict liability for certain insiders to make money trading in the corp’s securities under certain
circumstances. Insiders are defined as officers, directors or s/h with at least 10% of the stock. More limited than § 10(b).
Applies to equity securities (stock, convertible debt), options insiders receive. Any sale/purchase occurring in any rolling 6-
month period by an insider is subject to strict liability (regardless of insider info) and disgorgement to the corp (the difference
in profit). This is a prophylactic rule to cover a broad class.
Close corporations
- Relatively few s/h. Shares not easy to sell, no active - Public s/h own very small percentage of shares
secondary market. - Mismanagement reflected in share price
- Minority s/h in close corps have hard time - S/h can cut their losses, not locked in
vindicating their rights
Ways for minority members to get more power
Voting trust (MBCA 7.30): Agreement among s/h whereby they transfer their actual shares to a trust and
completely yield power over voting those shares to a trustee according to a trust document. Have a voice in how
the corp is run; force a decision.
Shareholder voting agreement (MBCA 7.31-32): Don’t involve transfer of actual shares, just an agreement
between 2+ s/h to vote their shares in a particular way.
Cumulative voting: Let’s say the parties A, B, C have 650, 300, 250 shares, respectively. There are 4 director
spots. Each has their own 4 preferred candidates (12 overall). Each person gets to vote for each seat, so A1, A2,
A3, A4 would be voted in. Under straight voting, majority s/h determines every seat on the board!
Cumulative voting ensures B and C actually get some board representation. Instead of getting 1 vote for each
open seat, they can allot all their votes for 4 seats to 1 candidate. A gets 2600 votes; B gets 1200; C gets 1000.
B can give all 1200 votes to B1. C can give 1000 votes to C1. Now A can’t get more than 2 seats on the board
(1201 votes per candidate to beat B). With cumulative voting, minority s/h can secure some representation on
the board!
Employment agreement: Can specify, e.g., termination damages if terminated w/o cause.
Buy-sell agreement: Guarantees minority s/h can cash out at a given price on a triggering event.
Shareholder agreements: Problems of control by contracting
A group of shareholders of a close corporation may, without impropriety, vote their respective shares so
as to obtain advantages of concerted action. They may lawfully contract with each other to vote in the future
in such way as they, or a majority of their group, from time to time determine. If stockholders want to make
their power felt, they must unite.
But the DE statute does NOT purport to deal with agreements whereby shareholders attempt to bind
each other as to how they shall vote their shares. Court of Chancery may reject votes of a registered s/h
where his voting is found is found to be in violation of rights of another person.77
A shareholder may exercise wide liberality of judgment in the matter of voting, and it is not objectionable that
his motives may be for personal profit, or determined by whims or caprice, so long as he violates no duty owed
his fellow shareholders.
The ownership of voting stock imposes no legal duty to vote at all.
McQuade will be controlling when the agreements are between shareholders who do not have 100% ownership
of a company, protecting minority s/h who weren’t party to the agreement: Shareholders should* not form an
agreement to control the decisions traditionally vested in the judgment of the directors of a company
77
Ringling, 582: We think the particular agreement before us does not violate Section 18 or constitute an attempted evasion of its
requirements, and is not illegal for any other reason. Because you breached your contract, all your votes you cast are null and void.
(electing officers and fixing salaries).78 Courts frown on agreements limiting director discretion if they
are not unanimous.
Can enter agreements to elect directors
[McQuade-Clark] HOWEVER, an agreement between shareholders, wherein the shareholders
entering the agreement are the sole shareholders of the company (i.e., the agreement was
unanimous, entered into by all), is enforceable even if the agreement contemplates controlling
management decisions to vote certain people as officers79
o McQuade rule unnecessary when there is no minority s/h not party to the agreement
McQuade-Clark is consistent with modern law. See NYBCL § 620 (p.597): A provision otherwise prohibited
by law because it improperly restricts the board in its management of the business of the corporation shall
nevertheless be valid
1) If all s/h (whether or not having voting power) have authorized (ex post facto) such provision in the
certificate of incorporation, and
2) If, after adoption of such provision, shares are transferred or issued only to persons who had
knowledge or notice or written consent to such provision
Could go around to all the shareholders (shouldn’t be that many in a close corp) to receive approval for a
provision restricting the board in its management
Agreeing to let someone be on board as long as “competent” is an unsatisfactory floor for the best interest of the
corporation. Adequate and awesome can bring a difference of millions of dollars.
No city magistrate shall engage in any other business, profession or hold any other public office.80
Fiduciary duties
Stockholder fiduciary duty to one another: Stockholders in a close corporation owe one another substantially
the same fiduciary duty in the operation of the enterprise that partners owe to one another. The standard of duty
owed by partners to one another is one of “utmost good faith and loyalty” (putting others’ interests above their
own, may not act out of greed, expediency or self-interest).
There is a strict obligation on the part of majority stockholders in a close corporation to deal with the
minority with the utmost good faith and loyalty.
Squeeze-out: Majority s/h in a closer corporation violate this duty when they act to freeze/squeeze out
the minority (pressure to sell their stakes). Generally, the majority may not frustrate the minority’s
reasonable expectations of benefit from their ownership of shares.81
78
McQuade (NY), 589: At the time of purchase of NEC stock, the parties agreed to do everything in their power to keep Stoneham as
president, McGraw as vice-president and Plaintiff as treasurer. Plaintiff was not removed for any misconduct or ineptitude, but rather
for his conflicts with Stoneham. Plaintiff brought this action to be reinstated as treasurer, and he cited the agreement that he entered
with McGraw and Stoneham that provided for each of them to use their “best endeavors” to keep each other in their respective
positions. Defendant argued that the agreement was invalid because it granted authority to shareholders for a decision that is normally
left to the judgment of directors.
Crawford: The court’s opinion on unenforceability is treated not as stringently in other opinions—as dicta.
79
Clark v. Dodge (NY), 594: Plaintiff entered into an agreement with Defendant wherein Plaintiff agreed to disclose the formulae to
the son of Defendant in return for a promise that Defendant would keep Plaintiff as a director and would be entitled to 25% of all net
income providing that Plaintiff was competent in his position. Afterwards, Defendant did not vote Plaintiff in as director, stopped
delivering 25% of the income to Plaintiff. Plaintiff sought reinstatement and money owed from the stopping of payments and money
wasted by Defendant. Defendant countered, citing McQuade, that the agreement was invalid because it required Defendant as a
shareholder to usurp the directors’ judgment. The only shareholders were Defendant and Plaintiff, and therefore the agreement
between the two did not have any, or at least negligible, consequences on the public.
80
McQuade, 589: Plaintiff was also ineligible for employment with NEC because he was a City Magistrate.
81
Brodie (Mass.), 627: Walter Brodie, president and one of the founding members of the company Malden, died in 1997. Π was
appointed Walter’s executrix and inherited his 1/3 interest in the company. She attended a s/h meeting where she nominated herself as
a director, but the other two s/h voted against her. Π also asked them to perform a valuation of the company so that she could ascertain
the value of her shares, but such a valuation was never done. In 1998, Π filed suit against them.
 o Examples of frustration:
Refuse to declare dividends
Drain corp earnings through high salaries and bonuses to the majority shareholder-
officers and perhaps to their relatives
High rent for property leased from majority s/h
Deprive minority of corp offices and of employment by company
Cause corp to sell its assets at inadequate price to majority s/h
o Wilkes (Mass.) test (bailout of minority): When minority stockholders in a close corporation
bring suit against the majority alleging a breach of the strict good faith duty owed to them by the
majority (e.g., freeze out), the controlling group must demonstrate a legitimate business purpose
for its action82
In asking this question, the controlling group must have some room to maneuver in
establishing the business policy of the corporation. It must have a large measure of
discretion (declaring dividends, setting salaries, ability to dismiss directors, hiring
employees)
It is open to minority stockholders to demonstrate that the same legitimate objective
could have been achieved through an alternative course of action less harmful to the
minority's interest
The court must weigh the legitimate business purpose asserted by majority
stockholders, if any, against the practicability of a less harmful alternative
DE non-bailout rule (should have protected yourself before you got into this) (Nixon,
p.633): A s/h who bargains for stock in a closely held corp can make a business judgment
whether to buy into such a minority position
o Remedy for freeze-out of minority s/h is to restore the minority as nearly as possible to the
position he would have been in had there been no wrongdoing but not exceeding it (e.g., for
wrongful termination, the remedy may be reinstatement, back pay, or both)83
Discharging/terminating directors: Stockholders in close corporations must discharge their management
and stockholder responsibilities in conformity with a strict good faith standard. They may not act out of
avarice, expediency or self-interest in derogation of their duty of loyalty to the other stockholders and to
the corporation.
An ad-hoc controlling interest (by a minority) must stay within a reasonable range of the fiduciary duty
of utmost good faith and loyalty84
TC: Δs interfered with Π’s reasonable expectations by excluding her from corporate decision making, denying her access to
company information, and hindering her ability to sell her shares in the open market. On appeal, Δs didn’t seek review on liability.
Was Π entitled to remedy of having her shares bought out by the majority?
82
Wilkes (Mass.), 613: Plaintiff caused bad feelings between the partners. Defendants voted to terminate Plaintiff from his position
and took away his stipend (despite the fact that another owner at that point received a stipend while having no day-to-day
responsibilities). Defendants argued that they had the power, under the corporate by-laws, to set salaries and positions. Plaintiff
brought this action to recover lost wages due to his termination by Defendants, who violated either the partnership agreement between
the parties or the fiduciary duty that Defendants owed to Plaintiff. Although this is traditionally an issue of management, the test for
close corporations should be whether the management decision that severely frustrates a minority owner has a legitimate business
purpose. In the case at issue, Defendants’ decision would assure that Plaintiff would never receive a return on the investment while
offering no justification. Plaintiff is entitled to lost wages.
83
Brodie (Mass.), 627: The problem with the buyout remedy ordered by TC is that it placed Π in a significantly better position than
should have enjoyed without the wrongdoing and well exceeded her reasonable expectations of benefit from her shares. There was no
obligation for the company or Δs to purchase Π’s shares. In ordering Δs to buy Π’s stock, the judge created an artificial market for Π’s
minority share of a close corporation—an asset that has little or no market value by definition. Thus, this remedy had the perverse
effect of placing Π in a position superior to that she would have enjoyed had there been no wrongdoing. Remanded.
84
Smith (Mass.), 631: Corporate by-laws provided that any proposals had to be approved by at least 80% of the directors, meaning
that in real terms for the group of four officers, there would need to be a unanimous vote. Dr. Wolfson wanted to reinvest the
company’s earnings, while the others wanted to declare dividends. The IRS assessed penalty taxes in seven different years for the
accumulation of cash. Despite settling with the IRS and being warned by his s/h colleagues, Wolfson continued his opposition to
declaring dividends, and the IRS assessed further penalty taxes. Wolfson didn’t propose any “reasonable [or anticipated] needs of the
business” to satisfy the IRS. The company has clearly incurred substantial penalties and legal expense largely because of Wolfson’s
o There are cases where in a close corp, majority s/h may ask protection from a minority s/h (e.g.,
1 person in a 4-officer board exercising a veto concerning corporate action under a provision
requiring 80% votes, unreasonably preventing dividends in the face of tax penalties, Smith)
o Minority shareholders owe majority shareholders a fiduciary duty in the same manner that
majority owners owe minority shareholders, and therefore the majority can seek judicial
intervention for decisions that are unjustifiable for the corporation’s interests
o Δ counsel should try to show GF efforts, that Δ acted professionally to reduce inference of acting
out of spite
Majority is entitled to adopt a business strategy. If the minority s/h disagrees with the action itself, too
bad
Both employee and s/h? A minority shareholder in a close corporation, by that status alone, who
contractually agrees to the repurchase of his shares upon termination of his employment for any reason,
acquires no protection from the corporation or majority shareholders against at-will discharge.85 (another
DE-style “made your bed, now lie in it” case)
Under common law, a corporation has the right to discharge employees at will if without a
contract fixing employment of a definite duration, for any reason or even for no reason (even if
competent)
Keep distinct the duty a corporation owes to a minority s/h as a shareholder from any duty it might owe
as an employee
o [Ingle dissent] But does a minority s/h require special protection? A minority s/h can’t be
equated with an ordinary hiring?
refusal to vote for sufficient dividends. Π sought a court determination of the dividends to be paid by the company, the removal of
Wolfson as a director, and an order that the company be reimbursed by him for the penalty taxes and related expenses.
TC: Wolfson’s refusal to vote in favor of dividends was caused more by his dislike for other stockholders and his desire to avoid
more add’l tax payments than any genuine desire to improve the company’s property. Ordered the directors to declare a reasonable
dividend.
TC was justified in finding that Wolfson’s conduct went beyond what was reasonable. The inaction on dividends seems the
principal cause of the tax penalties. Wolfson was warned for the dangers of an assessment by the IRS. He refused to vote dividends in
any amount to minimize that danger and failed to bring a convincing program of appropriate improvements that could withstand
scrutiny by the IRS. Whatever the reason, Wolfson’s refusal to declare dividends was reckless and ran unjustified risks of the penalty
taxes eventually assessed, which were inconsistent with any reasonable interpretation of a duty of “utmost good faith and loyalty.” TC
was justified in charging Wolfson with the out-of-pocket expenditure incurred by the company for the penalty taxes and related fees.
85
Ingle (NY), 621: Π is an employee turned shareholder. Plaintiff was hired as a sales manager by Defendant owner, James Glamore,
in 1964 after Glamore refused his offer to buy an equity share into the company. In 1966 and 1982, Plaintiff entered into shareholder
agreements with Glamore that provided shares to Plaintiff with a provision that allowed Glamore to buy back the shares if Plaintiff
was terminated for any reason. In 1983, a shareholders meeting voted out Plaintiff from his position at Defendant company, and
Defendants bought Plaintiff’s shares for $96,000. Plaintiff brought this suit, claiming that as a minority shareholder in a close
corporation he was owed a fiduciary duty by Defendants to keep him in his employment as long as he was competent in his duties.
Defendants argued, absent an employment agreement, Plaintiff was an at-will employee who would be adequately compensated with
the buyback provision.
Traditionally, an employee is an at-will employee if he does not have an employment agreement that gives a duration for the
employment. This situation does not change when an employee attains shareholder status, especially when there is a provision in the
shareholder agreement that allows the majority shareholder to buy back Plaintiff’s share if he is terminated for any reason. Plaintiff
never asserted that the buyback amount of $2400/share was unfair or undervalued. Π accepted the payment without reservation, as
fixed by the parties’ buyout agreement. Thus, Π suffered no harm.