I. Who Is An Agent?: Gorton v. Doty (1937)

Business Associations – Fall 2003
AGENCY
I. Who is an Agent?
a. RS §1 “Agency” – the fiduciary relation which results from the manifestation of consent by 1 person to
another that the other shall act on his behalf and subject to his control, and consent by the other to so act.
1. Principal  the one for whom action is to be taken

2. Agent  the one who is to act
ii. 3 principal forms of Agency:

1. Principal & Agent (deals w/ Ks and communication);
2. Master & Servant (deals w/ torts); and,
3. Employer/Proprietor & Independent Contractor (communication or statement).
Three Elements Required to Show Agency Relationship:

(1) Manifestation by Principal that Agent will act for him
(2) Acceptance by Agent of the undertaking, and
(3) Understanding b/w them that Principal will be in control of the undertaking.
b. Vicarious Liability – wrongful act of Agent is imputed upon Principal to ensure that injured party
obtains remedy for wrongful act done by Agent. It’s important to know who Agent is in order to go after
the “deep pockets” of Principal.
i. Gorton v. Doty (1937) – Facts: Kid injured in car accident driven by football coach. Π’s argue
that coach was acting as Agent of Owner. Owner of car argued that she simply loaned her car and
nothing more. App: Owner volunteered use of her car upon express condition that coach drive it,
and his consent to do so stemmed from his act of driving the car. Owner manifested her consent
that coach could use her car for the narrow purpose under narrow conditions. Held: Owner is a
principal. Thus, coach’s negligence is imputed to owner; she has to pay for injuries.
1. For Agency, you need an agreement b/w Principal and Agent, but not necessarily a K,
promise, or compensation. It may result although parties do not call it an agency and do
not intend the legal consequences of the relation to follow (circumstantial evidence).
2. Ownership alone, regardless of presence/absence of owner in car at time of accident,

establishes a prima facie case against the owner b/c presumption arises that driver is the
agent of the owner.
3. Injured party gets favored by the law, more than owner who is also innocent b/c she
could protect herself through her insurance, which covers any accidents by others driving
the car, and she voluntarily made a conscience choice to give the coach her car.
ii. A. Gay Jenson Farms Co. v. Cargill, Inc. (1981) – Facts: Warren had some unsettled accounts
w/ farmers, when it entered into agreement w/ Cargill. Cargill financed Warren's grain elevator
operation and purchased the majority of Warren’s grain. Issue: Whether Cargill, by its course of
dealing w/ Warren, became liable as Principal on Ks made by Warren w/ Farmers. App: (i)
Manifestation – by directing Warren to implement its recommendations, Cargill manifested its
consent that Warren would be its agent. (ii) Acceptance – Warren acted on Cargill’s behalf in
procuring grain for Cargill as part of its normal operations which were totally financed by Cargill.
(iii) Control – Warren couldn’t do much w/o Cargill’s approval b/c they had given Warren an
open-line of credit. Warren hid the $4M debt from Cargill, who kept increasing Warren’s loans
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up to $3.6M. Held: Agency relationship was established by Cargill’s interference w/ internal
affairs of Warren, which constituted de facto control of the elevator. A creditor becomes a
Principal when he assumes de facto control over the conduct of his debtor, whatever the
terms of their formal K may be. Here, creditor was an active participant in debtor's operations
rather than simply a financier. Cargill and Warren had a paternalist relationship, w/ Cargill
making the key economic decisions and keeping debtor in existence. All portions of Warren’s
operation were financed by Cargill and Warren sold almost all of its market grain to Cargill.
Relationship was not that of buyer and supplier, it was an agency relationship. Since the farmers
did not indicate to Cargill that Warren had settled their accounts w/ them, Cargill, as Principal,
was not discharged from liability to the farmers by making a settlement payment to Warren.
1. Agent vs. Supplier – Factors indicating that one is a supplier, rather than an agent:
a. Supplier is to receive a fixed price for the property irrespective of price paid by
him – most important.
b. Supplier acts in his own name and receives the title to the property which he
thereafter is to transfer.
c. Supplier must have an independent business in buying and selling similar
property.
2. Thus, Cargill ends up on the hook for another $2M owed to the farmers by Warren. Had
Cargill kept his role as a simple lender then it would not have to pay the farmers.
a. Precautions 
i. Cargill – could’ve been careful in limiting degree of control, by being
specific and detailed, and by keeping the relationship at arms-length.
ii. Farmers – if they weren’t feeling secure w/ Warren paying them, they
could’ve:
1. Asked Cargill to guarantee Warren’s payment (w/ line of credit);
2. Schedule a more restrictive payment for quick turnaround; or
3. Get cash on delivery.
II. Liability of Principal to 3rd Parties in Contract
LAF for Vicarious Liability:

(1) Who is the Agent?
(2) Who is the Principal?
(3) Who is the 3rd Party?
(4) What did the Agent Say or Do?
(5) Was What the Agent Said or Did Authorized? analyze it and see which kind of authority fits:
Four Kinds of Authorities:

a. Actual Authority (spoken or written – it’s given – i.e. Doty case)
b. Implied Authority (incidental to actual authority – reasonably necessary to accomplish
authority – i.e. Mill Street Church case)
c. Apparent Authority (i.e. Lind case)
d. Inherent Authority (gives agents some flexibility in what they can do (i.e. Nogales, Watteau)
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a. What is the Scope of the Agent’s Authority?
i. RS §26 Actual Authority – granted by Principal’s written/spoken words other than conduct,
which, reasonably interpreted, causes Agent to believe that Principal desires him to act on
Principal’s account
ii. RS §35 Implied (Incidental) Authority – Actual authority circumstantially proven which
Principal actually intended Agent to possess. Includes such powers as are practically necessary to
carry out the duties delegated. Authority to do acts which are:
1. Incidental to it,
2. Usually accompany it, or
3. Are reasonably necessary to accomplish it.
iii. RS §8 Apparent Authority Part I – “Holding Out” – Power to affect legal relations of another
person by transactions w/ 3rd persons, professedly as Agent for the other, arising from and in
accordance w/ the other’s manifestations to such 3rd persons. E.g. Principal holds out (manifests)
salesperson as an agent to 3rd parties by giving the agent business cards, title, etc… Thereby,
giving Agent apparent authority to bind the Principal.
iv. RS §27 Apparent Authority Part II – “Reasonable Belief” – Conduct of the Principal which,
reasonably interpreted, causes 3rd person to believe that principal consents to have the act done on
his behalf by the person purporting to act for him.
1. Note: Apparent authority is not actual authority but it’s the authority that agent is held
out by principal as possessing. It’s a matter of appearances on which 3rd parties rely.
v. RS §8A Inherent (Agency Power) Authority – Power of agent derived solely from agency
relation and exists for protection of persons harmed by or dealing w/ a servant or other agent.
1. Note: §8A is a fiction of the law b/c Agent is doing something that may be directly
contrary to what Principal authorized him to do, Principal may not even know Agent is
doing this, or 3rd party doesn’t even know that Principal exists. Here the power is based
neither upon the consent of the Principal nor upon his manifestations. Under these
circumstances, Agent’s act may be imputed upon the Principal. Rationale – the totally
innocent party is favored and Principal is responsible for having hired the Agent.
2. 3 types of situations in which Inherent Authority exists:

a. Agent does something similar to what he is authorized to do, but in violation of
orders.
b. Agent acts purely for his own purposes in entering into a transaction which
would be authorized if he were actuated by a proper motive.
c. Agent is authorized to dispose of goods and departs from the authorized method
of disposal.
b. Implied Authority
i. Mill Street Church of Christ v. Hogan (1990) – Facts: Church hired Bill to paint building, and
during previous jobs, it allowed him to employ his brother Sam to help. Sam was injured on 1st
day and Church treasurer paid Bill for ½ hour Sam worked. Sam filed workers’ comp claim, old
board denied it, but new board reversed. Employer appealed. App: (i) Bill, in the past, had hired
his brother whenever he needed assistance. Maintaining a safe and attractive place of worship is
part of the church’s function, and one for which it would designate an agent to ensure that the
building is properly painted and maintained; (ii) Sam believed that Bill had the authority to hire
him as had been the practice before. Treasurer even paid Bill for Sam’s work. Thus, Sam was
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w/in the employment of the Church at the time he was injured. Held: Bill had implied authority
to hire Sam. Sam was an employee of the church under the workers’ comp statute.
1. Note: For implied authority determine whether Agent reasonably believes b/c of present
or past conduct of the Principal that principal wishes him to act in a certain way or to
have certain authority. Existence of prior similar practices is the most important factor.
The nature of the task or job may be another factor to consider. Person alleging agency
and resulting authority has the burden of proving that it exists.
2. Precaution  Church should’ve been careful to avoid the problem by being specific and
certain. Be very specific in your agreement – put it in writing w/ very strong language b/c
agent may have the authority to hire outside help.
c. Apparent Authority
i. Lind v. Schenley Industries, Inc. (1960) – Facts: Lind sued Park & Tilford Employer for
compensation due to him by virtue of K expressed by written memo supplemented by oral
conversations. Kaufman, sales-manager for NY informed Lind that he would receive 1%
commission on gross sales of the men under him. Lind was also told the same by another
manager. Reasoning: (i) Kaufman, NY sales manager is the Agent (his title determines type of
authority); (ii) Schenley, owner of P&T is the Principal; (iii) Lind is the 3rd party; (iv) Kaufman
allegedly promised commission to Lind; and (v) Whether the principal authorized Kaufman to do
this doesn’t matter b/c this was part of running an office, which is what Kaufman was doing – this
would be Implied Authority. Held: Kaufman has apparent authority b/c of his title as manager
(holding out), and it was reasonable for Lind to believe that he was going to get 4 times his salary
as commission b/c that’s how this business works.1
1. Note: Kaufman also had inherent authority to offer Lind a raise, the alleged K b/w them
was sufficiently definite and certain to be sustainable. Inherent agency is used (as an
alternative) to impose liability on Principal when there is neither actual authority nor
apparent authority; it arises “solely from the designation by the Principal of a kind of
Agent who ordinarily possesses certain powers.”
ii. 37 Leasing Corp. v. Ampex Corp. (1976) – Facts: Kays, Ampex salesman, initiated discussion
w/ Joyce, owner of 37 LC, to buy computer equipment from Ampex. Joyce made an offer, but the
issue was whether there was an acceptance by Ampex for there to be a K. Joyce sued Ampex for
breach of K to sell computer core memories. Evidence showed there was an enforceable K and its
terms precluded recovery of lost profits. Reasoning: It’s reasonable for 3rd parties to presume that
one employed as salesman has the authority to bind his employer to sell. (i) Kays submitted the
controversial document to Joyce for signature. Document contained a space for signature by an
Ampex rep, which wasn’t signed. Nothing in the document suggests that Kays did not have
authority to sign it on behalf of Ampex. (ii) Joyce indicated to Kays and Mueller that he wished
all communications to be channeled through Kays. Mueller agreed and acknowledged this in an
intra-Co memo. (iii) Kays sent Joyce a letter confirming delivery dates for the memory units –
this letter could reasonably be interpreted as a promise to ship the units on the dates specified and
on the terms previously set out in the document executed by Joyce and given to Ampex. Held:
Joyce could reasonably expect that Kays would speak for the Co. Kays had apparent authority to
act for Ampex, and accept Joyce’s offer on behalf of Ampex. Thus, Joyce wins.
1
Arguably, Kaufman had actual authority if shown (production of documents) that he was authorized to structure commissions for his employees.
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d. Inherent Authority
i. Nogales Service Center v. Atlantic Richfield Co. (1980) – Facts: NSC and ARCO enter
agreement for truck stop. ARCO gives NCS $300K to help finance construction. They also enter
into products agreement – NSC would purchase at least 50% of ARCO’s fuel. NSC’s operation
was in financial difficulty. Joe Tucker, ARCO’s manager of truck stop marketing, discussed w/
Terpenning the problem of competitive pricing and told him to build a motel and restaurant. Joe
said ARCO would lend NSC $100K and give them a 1 cent per gallon discount on fuel. Relying
on this, Terpenning bought out Cafone and went ahead w/ construction. ARCO approved the
loan, but not the discount. NSC defaulted on its loans. ARCO foreclosed on them. ARCO argued
that the oral agreement made by its agent was outside his authority b/c Tucker was in marketing
and not in sales and could not make a deal on pricing. Thus, there’s no actual or implied
authority. Reasoning: Inherent authority depends upon neither actual nor apparent authority
since it may make the principal liable b/c of conduct which he did not desire or direct, to persons
who may or may not have known of his existence or who did not rely upon anything which the
principal said or did. Held: For inherent authority, Terpenning must show that what Tucker did
was not foreign to his duties as marketing manager. Argue  competitive pricing for truck stops
is part of marketing. Arguably, Tucker would’ve had inherent authority since it requires a looser
connection than implied authority.2
1. RS §161 Unauthorized Acts of General Agent – a general agent for a disclosed or

partially disclosed principal subjects his principal to liability for acts done on his account
which usually accompany or are incidental to transactions which the agent is authorized
to conduct if, although they’re forbidden by principal, the other party reasonably believes
that the agent is authorized to do them and has no notice that he is not so authorized.
a. Thus, principal may be liable upon a K made by a general agent of a kind usually
made by such agents, although he had been forbidden to make it and although
there had been no manifestation of authority to the person dealing w/ the agent.
ii. Watteau v. Fenwick (1892) – Facts: Brewery was sold to ∆s who retained former owner,
Humble, as manager and kept his name on the door. ∆s had agreement that Humble had no actual
authority to purchase anything other than bottled ale & mineral water. Π sold cigars and bovril to
Humble and requested payment for them. Π sued to get paid. Reasoning: Π gave credit to
Humble and had never heard of ∆s. Although ∆s had forbidden Humble to buy cigars on credit,
the cigars were such as would usually be supplied to and dealt in at such an establishment. Once
it’s established that ∆ was the real principal, the ordinary doctrine as to principal and agent
applies. There was no holding out, as Π knew nothing of ∆. However, very mischievous
consequences would result if that principal were not upheld. Held: Humble had inherent
authority. Thus, Π wins.3
1. Note: In both Watteau and Nogales, 3rd party is totally innocent – they did nothing wrong
and relied to their detriment – this invokes “inherent authority.” 3rd party delivered what
they promised. Principal hired the agent as manager and for Principal bears the loss.
2. RS §194 Acts of General Agents – An undisclosed principal is liable for acts of agent
“done on his account, if usual or necessary in such transactions, although forbidden by
the principal.”
2
For apparent authority, although Tucker was held out by Arco as an agent, it would be hard to for Terpenning to show that he “reasonably believed”
that Tucker had authority to enter into a sales deal.
3
Arguably, Humble had apparent authority - his name was on the door - this is “holding out” and it’s reasonable to believe that as owner he would
pay.
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3. RS §195 Acts of Manager Appearing to be Owner – An undisclosed principal who
entrusts agent w/ management of his business is subject to liability to 3rd persons w/
whom agent enters into transactions usual in such business and on principal’s account,
although contrary to the directions of the principal.
e. Generally, an Agent needs to act w/in the scope of its authority to bind the principal. However, there are 2
concepts by which an agent may still bind the principal:
i. RS §82 Agency by Ratification – Ratification is the affirmance by Principal of a prior act which
did not bind him but which was done or professedly done on his account by Agent. Thereby,
making the act valid as of the moment it was done. Principal must have intent to ratify and must
know what it’s ratifying (need knowledge, voluntary and intention).
1. Botticello v. Stefanovicz (1979) – Facts: Owners, couple, each held undivided one-half
interest in a farm. H executed lease w/ an option to purchase w/ lessee. After taking
possession and making improvements to land, lessee exercised option to buy. Owners
refused. Held: Insufficient evidence to support lessee’s conclusion that H acted as W’s
authorized agent in the discussions concerning the sale and in the execution of the K.
Moreover, there was no evidence that W ratified underlying K. Thus, W was not bound
by the agreement and could not be forced to convey her interest. But, H could K on
behalf of himself. New trial ordered b/c lessee was entitled to H’s defective title or
damages, but not specific performance as to W’s interest.
a. Note: Before the receipt of benefits may constitute ratification, the other
requisites for ratification must 1st be present. Thus, if original transaction was not
purported to be done on account of the principal, the fact that the principal
receives its proceeds does not make him a party to it.
ii. RS §8B Agency by Estoppel - Principal creates certain circumstances where it appears that
imposter is an agent. Principal is estopped from denying that imposter is not an agent.
1. Hoddeson v. Koos Bros. (1957) – Facts: Π bought furniture from ∆ Co, but failed to get
receipt for cash payment she made. After delivery date elapsed, she contacted ∆ as to the
whereabouts of her furniture. ∆’s records failed to disclose such sale to Π or any payment
made by her, and Π was unable to identify the salesman who assisted her. Δ contended
that person who served Π was an imposter. ∆ argued that there was a deficit of evidence
to support that a relationship of master and servant existed b/w ∆ and man who served
and received $ from Π. Held: Π should be entitled to reconstruct her complaint as the
inadequacy of the evidence to prove agency required reversal.
a. Note: The liability of a principal to 3rd parties for the acts of an agent may be
shown by proof disclosing:
i. Express or real (actual) authority which has been definitely granted;
ii. Implied authority, that is, to do all that is proper, customarily incidental
and reasonably appropriate to the exercise of the authority granted; and
iii. Apparent authority, such as where the principal by words, conduct, or
other indicative manifestations has held out the person to be his agent.
The appearance of authority must be shown to have been created by the
manifestations of the alleged principal and not alone and solely by proof
of those of the supposed agent.
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III. Liability of Principal to 3rd Parties in Tort
a. Respondeat Superior – “Master/Servant” – Agency relationship in tort that serves to impute the
tortious conduct of the servant (employees) to the master (employer). Similar to vicarious liability in K.
Focus is on the concept of:
i. Control, and
ii. Right to Control
1. Actual Asserted Control vs. Power to Control –difference lies in the degree of control.
iii. Master-Servant relationship exists where Servant has agreed to:

1. Work on behalf of the Master, and
2. Be subject to the Master’s control or right to control the “physical conduct” of the
Servant. That is, manner in which job is performed, as opposed to result alone.
LAF for Respondeat Superior:

(1) Who is the Servant? RS §220 (compare w/ § 1 Agent)
a. Did the Master Control the Servant?
b. Did the Master have the Right to Control the Servant?
i. Methods and Details are controlled
ii. Day-to-Day Operations are controlled
(2) Was Servant’s Conduct within Scope of Employment? RS §§ 228, 230 & 231
a. Motivation Test
b. Foreseeability Test
iv. RS §2 Master; Servant; Independent Contractor –
1. Master – Principal who employs agent to perform service in his affairs and who controls
or has right to control physical conduct of agent in the performance of the service.
2. Servant – agent employed by Master to perform service in his affairs whose physical
conduct is controlled or is subject to control by the master.
3. Independent Contractor – Person who contracts w/ another to do something for him but
who is not controlled by the other or subject to other’s right to control w/ respect to his
physical conduct in the performance of the undertaking. He may or may not be an agent.
a. Agent-type Independent Contractor – agrees to act on behalf of the principal,

but not subject to the principal’s control over how the result is accomplished.
b. Non-Agent Independent Contractor – operates independently and simply
enters into arm’s length transactions w/ others.
4. Meyer v. Holley – Facts: Officer was found subject to vicarious liability under FHA for
allegedly discriminatory conduct of its salesperson, even though officer did not
personally engage in any unlawful conduct. Held: Vicarious liability under FHA is
limited to liability of the real estate Co, but not its officer, in accordance w/ traditional
agency principles. Neither the right of the officer to control the salesperson, nor the
overriding societal priority of the FHA’s objectives warranted extending tort-related
vicarious liability rules to include the officer. Further, application of traditional vicarious
liability to FHA was supported by administrative interpretation of FHA, and there was no
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support under FHA itself for imposing a non-delegable duty upon the officer to ensure
that its salesperson did not discriminate.
b. Who is the Servant?
i. Humble Oil & Refining Co. v. Martin (1949) – Facts: The Martins were injured when
unoccupied car at service station rolled out of the station and hit them. Car was owned by Mrs.
Love and station was owned by Humble. Humble contends it’s not liable for employee’s
negligence since the station was operated by an independent contractor, Schneider. Reasoning:
Schneider and Humble had “Commission Agency Agreement” that required Schneider to make
reports and perform other duties in connection w/ station’s operation. Humble had strict financial
control and supervision; Schneider had to pretty much do anything Humble asked him to do.
Relationship b/w them was that of employer and employee. Furthermore, the agreement was
terminable at the will of Humble. Held: Humble is liable to the family for the negligent act of
Schneider’s employee b/c Humble’s responsibility for the station’s operation is based on a
Master-Servant relationship w/ Schneider.
ii. Hoover v. Sun Oil Co. (1965) – Facts: Car owners sought damages as a result of fire that started
at rear of their car while careless employee filled it w/ gas at Sun Oil’s service station, operated
by Barone. Sun Oil argued that Barone was an independent contractor. Thus employee’s
negligence could not be attributed to Sun Oil. Car owners argued that Sun could be liable b/c
Barone acted as its agent. Reasoning: Test is whether the oil company retains the right to control
the details of the day-to-day operation of the service station; control or influence over results
alone is insufficient. The degree of control over the method of operation is determinative. Some
control ensures that the oil company will turn a profit and protect the brand name. But oil
companies also need to limit their liability and therefore also treat service stations operators as
independent contractors. Held: Barone was an independent contractor. Lease K and dealer's
agreement failed to establish any relationship other than landlord-tenant and independent
contractor. There was nothing in individuals’ conduct that was inconsistent w/ that relationship.
While Sun Oil and Barone had a mutual interest in the sale of Sun Oil’s products and the success
of Barone’s business, Sun Oil had no control over the day-to-day operation of the service station.
Hence it could not be liable for the allegedly negligent acts of Barone’s employee.
iii. Murphy v. Holiday Inns, Inc. (1975) – Facts: Π sued Holiday Inn based on its relationship w/
Betsey-Len, operator of franchise’s premises. Betsey-Len, negligently maintained the premises of
the hotel and Π slipped and fell due to water draining from the air conditioner that had been
allowed to accumulate. ∆ argued it had no relationship w/ regard to the operator of the premises
other than a franchise license agreement. Π argued that several provisions and rules of the
agreement satisfied the control test. Reasoning: Betsey-Len agreed to pay a fee to use ∆’s assets,
and retained the right to profit and bore the “risk of loss.” The purposes of those provisions was
to achieve system-wide standardization of business identity, uniformity of commercial service,
and optimum public good will, all for the benefit of both contracting parties. Held: The license
agreement gave Holiday Inn no control or right to control the methods or details of doing the
work. No M-S relationship was created. Betsey-Len retained all such powers and other mgt
controls and responsibilities customarily exercised by an owner and operator of an on-going
business.
1. Franchise Agreements – In determining whether a K establishes an agency relationship,

the critical test is the nature and extent of the control agreed upon, regardless of what the
parties call themselves. Although franchiser supplies franchisee w/ “know-how” and
brand identification, franchisee enjoys the right to profit and runs the risk of loss.
Franchiser controls the distribution of his goods and/or services through a K that
regulates the activities of the franchisee, in order to achieve standardization. However, if
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a franchise K so regulates the activities of the franchisee as to vest the franchisor w/
control, the agency relationship arises even though the parties expressly deny it.
2. General Rule: A principal is not liable for the torts of his non-servant agents
(independent contractors). Control is an essential element of the definition of an agency
relationship, whether one is dealing w/ a servant or independent contractor. Key
distinction b/w servant and independent contractor types of agents, however, is the
differing natures and degrees of control exercised by the principal.
3. RS § 219(1) When Master is Liable for Torts of His Servants – “A master is subject to
liability for the torts of his servants committed while acting in the scope of their
employment.”
c. Scope of Employment
i. RS §228 General Statement of Scope of Employment Doctrine – (1) conduct of a servant is

w/in the scope of employment if, but only if (a) it’s of the kind he is employed to perform; (b)
occurs substantially w/in the authorized time and space limits; (c) it is actuated, at least in part, by
a purpose to serve the master, and (d) if force is intentionally used by the servant against another,
the use of the force is not unexpected by the master. (2) Conduct of a servant is not w/in scope of
employment if it’s different in kind from that authorized, far beyond the authorized time and
space limits, or too little actuated by a purposes to serve the master.
ii. RS §229 Kind of Conduct Within Scope of Employment – list of factors to determine whether
or not the conduct, although not authorized, is nevertheless so similar to or incidental to the
conduct authorized as to be w/in the scope of employment.
iii. RS §230 Forbidden Acts – An act, although forbidden, or done in forbidden manner, may be
w/in scope of employment.
iv. RS §231 Criminal of Tortious Acts – An act may be w/in scope of employment although
consciously criminal or tortuous.
1. Ira S. Bushey v. US (1968) – Facts: Π was owner of drydock in which Δ Fed gov’t was
docking a coast guard ship. ∆’s employee, seaman who lived on the boat, was drunk and
opened tank valves which caused the ship to fall and destroy parts of the drydock. Fed
gov’t argued that it was not liable for seaman’s acts b/c these acts were not w/in the scope
of his employment. Reasoning: Seaman’s conduct was not so “unforeseeable” as to
make it unfair to charge ∆ w/ responsibility. An employer should be held to expect risks,
which arise out of and in the course of his employment of labor. Here it was foreseeable
that crew members crossing the drydock might do damage, negligently or intentionally.
Moreover, it is known that seamen find solace for solitude by resort to the bottle while
ashore. While Seaman’s act is not readily explicable, at least it was not shown to be due
entirely to facets of his personal life. Held: ∆ was properly held liable for damages
caused to the drydock where it was reasonably foreseeable that a crewmember might
cause some damage, whether negligently or intentionally. It’s immaterial that employee’s
specific acts were not foreseen.
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a. Ct relied on 2 theories to find that what Seaman did was w/in his scope of
employment:
i. Foreseeability – Ct choose this one b/c what seaman did happened on

the boat which was his place of employment. Respondeat superior
derives from “deeply rooted sentiment that a business enterprise cannot
Depends on justly disclaim responsibility for accidents which may fairly be said to be
Jurisdiction  characteristic of its activities.”
ii. Motivation – the conduct of a servant is w/in the scope of employment

if, but only if, it is actuated, at least in part by a purpose to serve the
master. Ct, here, rejected this theory.
2. Manning v. Grimsley (1981) – Facts: Π spectator brought an action for battery and
negligence against ∆s, pitcher and baseball club. Fenway Park, pitcher threw ball after 3rd
inning to bleachers, injuring Π. Pitcher was angry that bleacher creatures were heckling
him. Manning is the servant of the Baltimore Orioles Club. Judgment for negligence, but
not battery, was entered for Π. Π appealed. Reasoning: Jury could have found a battery
on facts that the pitcher was an expert, looked at the spectators several times immediately
following heckling, and that the ball traveled at a right angle from the direction in which
he had been pitching. Also, jury could reasonably have found that such conduct had
either affirmative purpose/effect to rattle the employee so that he could not perform his
duties successfully. Thus, jury could’ve found that pitcher’s assault was not a mere
retaliation for past annoyance, but a response to continuing conduct which was “presently
interfering” w/ his ability to pitch in the game if called upon to play. Held: Battery count
could have been submitted against pitcher and the Baseball club.
a. Motivation vs. Foreseeability – Court did not know whether conduct was w/in
the scope of employment, but held that it’s foreseeable that a pitcher might lose
his temper. When you’re a servant and you lose your cool, your master may be
held accountable for it b/c it’s foreseeable that eventually you’ll lose your cool.
Foreseeability is an infinite theory, as opposed to motivation, a narrower theory.
d. Rationale for Vicarious Liability and Respondeat Superior
i. Common Sense & Fairness – 2 rational/policies for the rule exist:
1. Risk Spreading Theory – a.k.a. Enterprise Liability – everybody in that industry should
pay their fair share of any damages that may result from that industry’s practice (you get
the benefit, you get the liability). It’s more fair for the totally innocent person (3rd party
injured) to be compensated; it’s the risk of doing business.
2. Deep Pockets Theory – usually the one that has the most money (master) and stands to
lose the least should be liable - the enterprise. The party best able to bear the loss bears it.
a. Precautions 
i. Indemnification Clause – so that if the enterprise gets sued for what the
servant did, the clause holds the master harmless, not having to be liable
or pay for litigation costs.
Vanessa Verduga 10
ii. Get Insurance or post a bond.
iii. Contract away imputed liability - hire a non-agent independent

contractor and put in the K that the independent contractor is “not” your
agent. See Arguello v. Conoco.
1. Form vs. Substance – Even w/ these clauses a Master can be

held liable depending on the relation. Form is the fact that
they’re independent contractors, but Substance is the master-
servant relationship.
b. Insulate against being vicariously liable in employment situations 

i. Make sure you limit control
ii. Hire carefully
iii. Train the person well
iv. Have in writing the procedures that you can point to.
e. Statutory Claims
i. Arguello v. Conoco, Inc. (2000) – Facts: Minority Πs alleged ∆ Conoco violated state and
federal statutes barring racial discrimination by refusing to serve minorities, and subjecting them
to derogatory remarks. In 3 separate incidents (2 of them at franchisee-owned stores), appellants
were subjected to discrimination. ∆ argued that it was not liable for incidents at franchise stores,
and the store clerk was not a supervisory employee. Reasoning: To impose liability on ∆ under
§1981 for discriminatory actions of a 3rd party, Π must prove agency relationship b/w ∆ and 3rd
party. Πs must show that Conoco has given consent for the branded stores to act on its behalf and
that the branded stores are subject to control of Conoco. The language of the Agreement b/w
Conoco and the branded stores, while offering guidelines, did not establish that Conoco had any
participation in the daily operations of the branded stores nor that Conoco participated in making
personnel decisions. Held: No agency relationship.
1. Step 1: Look at the store and its parent company and see what agreements and policies
they have in place.
2. Step 2: 2 different kinds of convenient stores:

a. Conoco-owned stores – Master/Servant relationship exists
b. Conoco-branded stores – No Master/Servant relationship – 2 of the 3 Πs failed
to establish that relationship existed b/c Conoco did not exert control over those
stores’ hiring and firing policies.
3. Note: It’s not strict liability, but it’s close to it when dealing w/ these types of situations.
This doctrine is extremely fact-sensitive.
4. Factors For Considering Whether Employee's Acts are w/in Scope of Employment:4
a. Time, Place and Purpose of Act – employee’s behavior occurred while she was
on duty inside Conoco station where she was employed. Smith asked Π for ID
for credit card purchases. Purpose of their interaction was to complete the sale of
store items and it was then that the racial epithets occurred;
4
See RS §229 – other factors include: (i) Whether act is one commonly done by such servants; (ii) previous relations b/w Master and Servant; (iii)
whether instrumentality w/ which harm is done was furnished by Master to Servant; and (iv) whether act is seriously criminal.
Vanessa Verduga 11
b. Similarity to Authorized Actions Which Servant Commonly Performs – the
sale of gas, store items and completion of credit card purchases are customary
functions of a gas store clerk;
c. Extent of Departure From Normal Methods – employee did not use normal
methods for conducting a sale. No evidence that Conoco expected or anticipated
employee to perform her functions in such manner. However, Conoco did
authorize employee to interact w/ customers as they made their purchases.
Therefore, although employee departed from normal methods of conducting a
purchase this does not mean that as a matter of law she was outside the scope of
her employment; and
d. Master Reasonably Expects Such Act Would Be Performed – No evidence.

However, even if Conoco can show that they could not have expected this
conduct by employee, jury is entitled to find that the other factors outweigh this
consideration.
f. Liability for Torts of Independent Contractors
i. Majestic Realty Associates v. Toti Contracting Co. (1959) – Facts: Πs, building owner and
tenant, filed suit against ∆s, parking authority and demolition contractor, after Πs’ building was
damaged during demolition of an adjacent building by ∆ demolition contractor. Reasoning: The
supervisory interest of ∆ parking authority was related to the result accomplished, not to the
means by which it was accomplished. However, ∆ parking authority, as landowner, retained
liability for the work of ∆ demolition contractor b/c the work done was inherently dangerous. Π’s
expert categorized this as “hazardous work.” NJ statute specifies that in demolition of buildings,
walls shall be removed part by part, and they weren’t. Held: Contractee may have no control
over the doing of the work and in that sense is also innocent of the wrongdoing; but he does have
the power of selection. Therefore, loss arising out of the tortious conduct of a financially
irresponsible contractor should fall on the contractee. It’s up to jury to decide whether activity is
inherently dangerous or not
1. Precaution  Assurance that contractor will meet all tort obligations in requiring an
indemnity bond signed by responsible sureties. Liability insurance to cover such
demolition operations is available to contractors and it may be assumed fairly that
procurement of that type coverage is an ordinary business expense.
2. General Rule – ordinarily where a person engages an independent contractor to do work

not in itself a nuisance, he is not liable for the negligent acts of the contractor in the
performance of the K.
a. 3 Exceptions:
i. Where landowner retains control of the manner and means of the doing
of the work which is the subject of the K
ii. Where he engages an incompetent contractor, or
iii. Where the activity contracted for constitutes a nuisance per se – work
categorized as “inherently dangerous.”
b. Inherently Dangerous vs. Ultra-Hazardous – Latter is one which (a)

necessarily involves a serious risk of harm to the person, land or chattels of
others which cannot be eliminated by the exercise of the utmost care, and (b) is
not a matter of common usage. This distinction is important b/c liability is
absolute for ultra-hazardous work – very close to strict liability.
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IV. Fiduciary Obligation of Agents
Fiduciary Duty:
A duty of undivided loyalty, utmost good faith and trust where 1 person acts in the benefit and interest
of another person to whom the duty is owed (and not in self-interest).
(1) Is the Person a Fiduciary?
(2) What is the Scope and Extent of the Fiduciary Duty?
a. In the Principal/Agent context fiduciary duty exhibits itself in 3 scenarios:
i. No Self-Dealing – if you work for someone as an employee you can’t simultaneously run a side
business that you are diverting business to or out doing a side job while you’re supposed to be
working. If there is full disclosure to principal then it is not a problem. See Automotive.
ii. Protection of Confidential Information – an employee or an agent has an obligation to keep

secret confidential proprietary info he has. Confidential proprietary info are: customer lists, trade
secrets, salaries, etc. See Town & Country.
iii. Post-Employment Restrictive Covenants – binds the employee to certain requirements even
after he has left the employ of the employer. Scope and time (duration and geography) how long
does it last for? Is it limited to five mile radius? Fifty mile radius? See Town & Country.
b. Duties during Agency
i. RS §379 Duty of Care & Skill – standard care and w/ skill which is standard for the kind of
work which he is employed to perform, and, in addition, to exercise any special skill that he has.
ii. RS §385 Duty to Obey – all reasonable directions in regard to manner of performing a service he
has been contracted to perform.
iii. RS §387 General Principle [Duty of Loyalty] – agent is subject to a duty to his principal to act
solely for the benefit of the principal in all matters connected w/ his agency.
iv. RS §388 Duty to Account for Profits Arising Out of Employment – agent who makes profits
in connection w/ transactions conducted by him on behalf of principal is under a duty to give such
profit to principal.
v. RS §389 Acting as Adverse Party w/o Principal’s Consent – agent has duty not to deal w/ his
principal as an adverse party in a transaction connected w/ his agency w/o principal’s knowledge.
vi. RS §393 Competition as to Subject Matter of Agency – agent has duty to not compete w/
principal concerning the subject matter of his agency.
vii. RS §394 Acting For One w/ Conflicting Interests – agent has duty not to act during agency for
persons whose interests conflict w/ those of principal in matters in which the agent is employed.
viii. RS §395 Using or Disclosing Confidential Info – agent has duty not to use or to communicate
info confidentially given him by principal or acquired by him during or on account of his agency
or in violation of his duties as agent, in competition w/ or to the injury of principal, on his account
Vanessa Verduga 13
or on behalf of another, although such info does not relate to the transaction in which he is then
employed, unless the info is a matter of general knowledge.
ix. Reading v. Regem (1948) – Facts: British Soldier stationed in Cairo served as escort for
smuggler’s packages since he could bypass customs. He was remunerated well. The Crown found
out and seized his $. Reasoning: It doesn’t matter that there was no loss of profit to the Crown.
There was not a fiduciary relationship; Π was not acting in the course of his employment.
However, the uniform of the Crown and the status of Π’s position as servant of the Crown were
the only reasons why he was able to get this $, and that is sufficient to make him liable to hand it
over to the Crown. Held: He is not entitled to this $. Even though the Crown didn’t lose any $
from the soldier’s ventures, he breached his duty by using his uniform and status, not for the best
interest of the Army, but for his own self-interest.
x. General Automotive Mftg Co. v. Singer (1963) – Facts: Π hired ∆ Singer, reputable machinist,
as general manager of its business and affairs pursuant to written K. Π sued ∆ for breach of K
when it discovered that Δ was pocketing $ from deals that were coming to him by virtue of his
status as an employee. Reasoning: Under a fiduciary duty to an employer, an employee is bound
to exercise utmost good faith and loyalty so that he does not act adversely to the interests of the
employer by serving or acquiring any private interest of his own. Employee is also bound to act
for the furtherance and advancement of the Employer’s interest. Upon disclosure, it was in
Automotive’s discretion to refuse to accept the orders or fill them, and the profit would go to
Automotive who would then decide whether to expand its operations, install suitable equipment,
or make further arrangements w/ Singer or Husco. Held: By failing to disclose all facts relating
to certain orders and by receiving secret (personal) profits from the orders, ∆ violated his
fiduciary duty to employer by acting solely for his own benefit. ∆’s liable for profits he earned in
his sideline business.
1. Precaution  Disclosure – If Singer would’ve “disclosed” this info and reached an

agreement w/ employer that those jobs it couldn’t handle he would take, he wouldn’t be
in trouble. Maybe employer would’ve allowed it, maybe not, but he should’ve disclosed.5
c. Duties During and After Termination of Agency: Herein of “Grabbing and Leaving”
i. Post-Employment Situations – in which you’re working w/ someone and you’re planning to

leave or you have left.
1. There’s a written employee agreement
2. Non-competition clause
3. Non-use clause
4. Non-solicitation of customers, and maybe even employees
a. Note: These clauses in essence prevent the employee from competing w/ former
employer. Problem is that these clauses are non-competitive and restrain the
employee’s options.
5. No written employment agreement
ii. RS §396 Using Confidential Info After Termination of Agency – agent has duty not to
compete w/ principal; not to use or to disclose to 3rd persons in competition w/ principal or to his
injury, trade secrets, written lists of names, or other similar confidential matters given to him only
for principal’s use or acquired by the agent in violation of duty. Agent is entitled to use of general
info concerning the method of business of principal and the names of customers retained in his
memory, if not acquired in violation of duty as agent; has duty to account for profits made by any
5
If your law firm’s client wants to give you, personally, a bonus for your work – don’t take it; it’s a breach of fiduciary if you do. Either do it through
your firm and get paid your fee, or do it at a discounted fee, or for pro-bono, but don’t take the $ and keep it.
Vanessa Verduga 14
sale or use of confidential info; has duty to principal not to take advantage of a still subsisting
confidential relation created during the prior agency relation.
iii. Ct breaks it down to 2 parts by looking at:

1. Purpose – what was the reason the employee did what he/she did?
2. Means – how did the employee go about doing it? Was it surreptitiously done, deceitful;
did he lie, etc.
iv. Avtec Industries v. Sony Corp. (1985) – Facts: Π former employer appealed judgment for ∆
new employer. Reasoning: ∆ had violated generally accepted standards of morality by hiring
employee and the means used were wrongful. However, ∆ acted in good faith, w/o malice, and
w/o exploiting confidential relationship. That finding precluded liability for tortious interference
w/ an at-will employment relationship. Held: Ct affirmed judgment for Δ.
v. Town & Country House & Home Service v. Newberry (1958) – Facts: Π former employer
sought injunctive and other relief after ∆s former employees formed a competing house cleaning
service using many of Π’s methods and persuaded several of Π’s customers to switch companies.
Reasoning: Π’s customer list was a trade secret. Π had expended great amounts of time and
energy to develop it, and the contents of the list were not easily discernable from any other
source. The info became known to ∆s only b/c of their employment by Π. Held: Π was entitled
to enjoin ∆s from further solicitation of its customers and to receive damages corresponding to
the profits ∆s made by reasons of the customers they enticed away from Π. Π was not, however,
entitled to enjoin ∆s from operating a competing business.
1. Advertised vs. Unadvertised – distinction is made in the cases b/w a former employee
soliciting customers of his former employer who are openly engaged in business in
advertised locations, and his soliciting unadvertised customers who became known to the
employee only b/c of info obtained during his employment.
Vanessa Verduga 15
PARTNERSHIPS
V. What is a Partnership and who are Partners?
Totality of Circumstances to Determine Whether the Business is a Partnership:

Intention of the Parties – UPA §202(a) the
NO intent, knowledge or
(1) Association of (assumes that it is voluntary) writing is needed to form
a Partnership.
(2) Two or more (requires 2 at least)
(3) Persons (can be an individual or a Corp)
(4) To carry on as Co-Owners (community of power / control / management – the focus is on “owner”
and its meaning, which implies risk, profit and loss sharing – it’s a strong word)
(5) A business for Profits forms a partnership, whether or not the persons intend to form a
partnership. (Profits and losses are helpful, but don’t decide the outcome of the partnership).
a. The Uniform Partnership Act (UPA) of 1997 governs:

i. Whether a partnership exists;
ii. Relationship b/w the partners;
iii. Partners inter se and 3rd parties; and
iv. Termination of a P-ship
b. UPA (1914) §9 Partner Agent of P-ship as to P-ship Business – every partner is an agent of the P-ship
for the purpose of its business, the act of every partner for apparently carrying on the usual way of
business binds the P-ship, unless the partner has in fact no authority to act for P-ship in particular matter,
and person w/ whom he’s dealing has knowledge of the fact that he has no such authority.
c. UPA (1914) §13 P-Ship Bound by Partner’s Wrongful Act – where by any wrongful act or omission of
any partner acting in the ordinary course of business of the P-ship or w/ the authority of his co-partners,
loss or injury is caused to any 3rd person, or any penalty incurred, the P-ship is liable therefore to the same
extent as the partner so acting or omitting to act.
d. UPA §301 Partner Agent of P-ship – (1) each partner is an agent of the P-ship for the purpose of its
business. An act of a partner, including the execution of an instrument in the P-ship name, for apparently
carrying on in ordinary course the business, unless the partner had no authority to act for the P-ship in
particular matter and person w/ whom partner was dealing knew or had received a notification that
partner lacked authority. (2) An act of a partner which is not apparently for carrying on in the ordinary
course the business binds the P-ship only if the act was authorized by the other partners.
e. UPA §306 Partner’s Liability – All partners are liable jointly and severally when acting w/in the scope
of that P-ship unless otherwise agreed by the claimant or provided by law.
f. UPA (1914) §21 Partner Accountable as a Fiduciary – every partner must account to P-ship for any
benefit, and hold as trustee for it any profits derived by him w/o consent of other partners from any
transaction connected w/ formation, conduct, or liquidation of the P-ship or from any use by him of its
property.
g. UPA §404 General Standards of Partner’s Conduct – Partners owe each other fiduciary duties of
loyalty and care.
h. 2 Prongs of Partnership Law:

Vanessa Verduga 16
i. 3rd Parties – joint and severally liable – duties and obligations owed to 3rd parties cannot be
altered by agreement. In these cases, UPA serves as a default rule.
ii. Inter Se – fiduciary duty owed (care and loyalty). The relationship b/w and among the partners
can be altered by the underlying P-ship agreement.
1. UPA §103 Effect of P-ship Agreement; Non-Waivable Provisions – This is a default

rule used to figure out what the duties and obligations are inter se.
i. Typical Situation – 3rd party sues Partner for tortious conduct. Note: A partner’s wrongdoing can wipe
out the P-ship; make sure to get good malpractice insurance.
i. Southex Exhibitions v. Rhode Island Builders Ass’n (2002) – Facts: RIBA contracted w/
exhibitor SEM to produce home shows. K was assigned to Southex. RIBA became dissatisfied w/
Southex and hired another exhibitor to do its home shows. Southex argued that K showed a P-
ship was formed as it provided for (1) a 55-45 % profit sharing; (2) mutual control over
designated business operations; and (3) respective contributions of valuable property to the P-ship
by the partners. Reasoning: There is an association b/w 2 or more persons. However, focusing
on “co-ownership” and “profits / loss sharing” no intent by the parties to form a P-ship was
found. (1) Southex had entered into K and conducted business w/ 3rd parties in its own name, (2)
the venture was never given a name, (3) there were no P-ship tax returns filed, (4) there was no
jointly owned property, (5) the term “partners” appeared only once in K, (6) K was not labeled as
P-ship agreement, was devoid of the provisions usually found in a P-ship agreement, and
contained other provisions inconsistent w/ intent to form a P-ship. Also, there was no P-ship by
estoppel as Southex had not exercised due diligence to clarify the terms of the agreement. Held:
No P-ship. Thus, no inter se duties existed. RIBA could fire Southex w/ no problem.
1. Note: Simple approach would’ve been reach had court decided that a P-ship existed.
However, ct did not go down that route b/c it’s hard to impose a P-ship on the parties
when it’s not in accordance w/ their intent.
j. Partners compared w/ Employees
Factors Distinguishing Partners from Employees:

(1) What Was the Actual Intent of the Parties? (Is there an association / consent / agreement to be partners?)
(2) Two or more Persons (community of power / co-ownership / control of management)
(3) Right to Profit Sharing (there’s a difference b/w profit, revenues, wages, interest. Theoretically all partners
share equally, but not every agreement that gives this right is a P-ship agreement).
(4) Obligation to Loss Sharing (in same percentage as profit sharing).
(5) Decision-Making Ability (can you make decisions as to the business?)
(6) Language in the Agreement, if any, and conduct of the parties toward 3rd persons.
(7) Did you put Capital into the Business? (Capital contribution).
(8) Rights on Dissolution (do you have any?)
Vanessa Verduga 17
i. 4 Reasons Why It’s Important to Figure out Whether a Person is a Partner or a Creditor /
Wage Earner:
1. Partners are personally liable for the debts of the P-ship
2. Partners share profits – lends itself to litigation
3. Acts of individual partners are binding on the P-ship (including Ks)
4. Breach of fiduciary duty
a. Note: LLC / LLP – shield you from personal liability; you can be a member of
one of these and get all the tax benefits but not have personal liability. See infra.
ii. Fenwick v. Unemployment Compensation Commission (1945) – Facts: Fenwick employer

entered into agreement w/ receptionist after she demanded more $. She was to receive 20% of the
profits at yr end. Fenwick retained all control of the business and its management. Fenwick wants
to claim that Receptionist was a partner in order to not pay $ to unemployment Comp.
Reasoning: Sharing of profits by Fenwick and his receptionist alone did not give rise to a P-ship.
Fenwick retained all control and management of the business, she had no obligation to share in
losses and he contributed all of the capital, and upon dissolution she would receive no
compensation. Held: Receptionist was an employee not a partner. Sharing of profits is prima
facie evidence of p-ship but no such inference shall be drawn if such profits are received in
payment as wages of an employee.
k. Partners compared w/ Lenders
i. Martin v. Peyton (1927) – Facts: Broker firm is losing $. A partner of the firm, Hall who is
friends w/ Martin and Peyton, asks to borrow $2.5M from Δs Peyton, Perkins, and Freeman who
in return want a high rate of return. Martin creditor claimed that ∆s became partners in the firm
by doing business as bankers and brokers. Reasoning: ∆s refused to become partners in the firm,
but reached a written agreement w/ Hall, who was given all control. General purpose was for ∆s
to loan the firm liquid securities for use in the business. To insure ∆s against losses, the firm was
to turn over its own more speculative securities, which could not be used as collateral for bank
loans. In compensation for the loan, ∆s were to receive a % of firm's profits, and an option to join
the firm. Held: The documents did not associate ∆s w/ the firm so that they and it together
carried on as co-owners of a business for profit. ∆s’ measures taken as precautions to safeguard
the loan were ordinary caution and did not imply an association in the business.
1. “Intent” Dominates: The indicator to zero in on in the agreement is the fact that these 3
guys had the power to “veto any business” – that’s control. Also, they were supposed to
get profits. However, the court pushed to find that they weren’t partners b/c that was not
the intention of the parties – they had the option of joining the firm but never did. Ct gave
these 3 guys a pass b/c that’s not what the parties intended.
2. General Rule: Only partners inter se may be charged for P-ship debts by others.
a. Exception: Recovery is allowed where in truth such relationship is absent. This

is b/c debtor may not deny the claim. In some written K b/w the parties the
question may arise whether it creates a P-ship. If it be complete; if it expresses in
good faith the full understanding and obligation of the parties, then it’s for ct to
say whether P-ship exists. It may, however, be a mere sham intended to hide the
real relationship. Then other results follow. Statements that no P-ship is intended
are not conclusive. If as a whole a K contemplates an association of 2 or more
persons to carry on as co-owners a business for profit a P-ship exists. But, if it be
less than this no P-ship exists. Profit sharing is considered, but not decisive.
l. UPA (1914) §16 Partnership by Estoppel – similar to Apparent Agency (see supra).
Vanessa Verduga 18
i. There has to be a representation by Partner or Non-Partner (holding out).
ii. There has to be underlying reliance by 3rd party (reasonable belief).
1. E.g. Person who claims to be a partner; can claim to be a partner or can allow someone to
misrepresent her status as a partner.
2. E.g. Person who holds another out as a partner; i.e. introduces another as a partner when
they are not, would be bound by what the person does.
iii. Young v. Jones (1992) – Facts: Young, Texas investor who lost $550K after relying on a
falsified audit statement attached to an audit letter by PW-Bahamas, sought to recover damages
from PW-U.S. Held: Person who represents himself, or permits another to represent him, to
anyone as a partner in an existing partnership or w/ others not actual partners, is liable to persons
to whom such a representation is made who has given credit to the actual or apparent P-ship.
However, Young did not present evidence of any extension of credit to either PW-Bahamas or
PW-US. Nor did he show that he relied on any act or statement by any PW-US partner which
indicated the existence of a P-ship w/ PW-Bahamas.
VI. The Fiduciary Obligations of Partners
Distinguishing Partners from Employees:

Fiduciary duties arise out of fiduciary relationships permeated by superior knowledge and skills, inequality of
bargaining position. Partners stand in a fiduciary relationship to each other.
(1) Does a Fiduciary Relationship Exist? If so,

(2) What is the Scope and Extent of the Fiduciary Duties Flowing Therefrom?
Generally, where you have a fiduciary relationship it is embodied in 2 basic concepts:

(1) Duty of Undivided Loyalty
(2) Duty of Care
a. UPA §404(b) General Standards of Partner’s Conduct – Partner’s duty of loyalty is limited to (1)
account to P-ship and hold as trustee for it any property, profit, or benefit derived by the partner in
conduct and winding up of the P-ship business or derived from a use by partner of P-ship property,
including appropriation of P-ship opportunity; (2) to refrain from dealing w/ P-ship in conduct or winding
up of P-ship business as or on behalf of a party having an interest adverse to the P-ship; and (3) to refrain
from competing w/ P-ship in the conduct of the P-ship business before dissolution of P-ship.
i. The Duty of Undivided Loyalty deals w/:

1. No-Competition clause
2. Disclosure
3. Good Faith and Fair Dealing
4. Misappropriation of a P-ship Opportunity to himself
b. UPA §404(c) General Standards of Partner’s Conduct – Partner’s duty of care to P-ship and other
partners in the conduct and winding up of the P-ship business is limited to refraining from engaging in
grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.
c. Fiduciary Duty of Partners – a partner must consider his partners’ welfare, and refrain from acting for
purely private gain. Must act w/ utmost good faith and loyalty. See Meinhard.
Vanessa Verduga 19
i. 2 types of disputes may arise (most disputes can be solved by open and honest disclosure):
1. Inter se (b/w and among partners) Disputes – such as fighting about $; or bringing in
or terminating partners
2. Partner in dispute w/ P-ship entity – such as misappropriation of business; or using the
P-ship property for personal gain.
d. Expelled/Departing Partners - partners can agree to expel another partner for no reason whatsoever –
cause need not be given. Reasons partners get expelled: nobody likes him, or 3rd party wants him out.
e. Wrongful Expulsion – some courts follow notion that there is no wrongful expulsion. Others find an
implied fiduciary duty not to kick out a partner for a wrongful reason such as:
i. Protected Class – gender, age, race, disabilities. Usually applies only to employees but
sometimes to non-equity partners.
ii. Bad faith/Retaliation – against whistleblowers.
f. Meinhard v. Salmon (1928) – Facts: Joint venture6 in which 2 partners pooled their $ to lease a building
for shops and offices. ∆ Partner was more business savvy and, in an effort to increase his wealth, entered
into agreement w/ another businessperson (lessor) to purchase surrounding property as a leasehold estate.
The specifics of this transaction were not disclosed to Π partner who then sued for breach of joint venture
agreement when he discovered the transaction. Reasoning: 1 partner may not appropriate to his own use
a renewal of a lease, though its term is to begin at the expiration of the P-ship. Δ was guilty of a conscious
purpose to defraud. Held: ∆ would not have been in the rewarding leasehold position if it were not for
the joint venture. Thus, judgment for Π. Court granted Π a choice of remedy: (1) 50% on the new lease;
or (2) split the shares and give Δ 49.999% of the shares, but Π would retain 1% more of the shares so he
can retain control. Note: If the property had been far from the P-ship property, then the lease would’ve
been found outside the scope of the fiduciary duty.
i. Fiduciary Duty of Loyalty – Joint adventurers, like co-partners, owe to one another, while the
enterprise continues the duty of the finest loyalty. A trustee is held to something stricter than the
morals of the market place. A co-adventurer has the duty to concede and reveal any chance to
compete and any chance to enjoy the opportunity for benefit that had come to him alone by virtue
of his agency.
ii. Dissent – This was only a joint venture, which had in view a limited object and was to end at a
limited time. There was no intent to make it last for many years. The design was to exploit the
particular lease. The interest terminated when the joint venture terminated.
1. Note: Dissent focuses on diff b/w joint venture and P-ship. Joint venture is more limited
in scope than a P-ship (marriage), but that doesn’t matter b/c fiduciary duty is the same.
g. Grabbing and Leaving
i. Meehan v. Shaughnessy (1989) – Facts: Πs former law partners left ∆ law firm to start own
firm. Πs sued ∆ for declaration of what they owed the firm and for $ firm owed them. ∆ counter-
claimed for violation of fiduciary duty, breach of P-ship agreement and tortious interference.
Reasoning: Provision gave Πs power to dissolve P-ship at any time and allowed them to design
their own methods of dividing assets. However, Πs did not act properly in acquiring consent to
remove clients and withdraw cases from ∆. Πs failed to timely provide Δ w/ list of taken clients
they intended to solicit, they denied about leaving the firm (equivalent to lying), and their one-
sided letter to clients excluded their partners from presenting their services as an alternative. The
letter’s content was unfairly prejudicial to Δ. Held: Πs owed ∆ a fiduciary duty of the utmost
6
Joint Venture – Venture undertaken based on an express or implied agreement b/w the members, common purpose and interest, and an equal
power of control.
Vanessa Verduga 20
good faith and loyalty and they must have refrained from acting for purely private gain. Πs failed
to make a full and complete disclosure.
1. ABA Committee on Ethics and Prof. Responsibility Standards for Attorneys – (a)
notice shall be sent only to clients w/ whom lawyer had a relationship; (b) notice shall
not urge client to sever relationship w/ firm or recommend lawyer’s new employment; (c)
notice shall make clear that client has right to decide who will continue the matter.
2. UPA §20 Duty of Partners to Render Information – Partners shall render on demand
true and full information of all things affecting the P-ship to any partner.
h. After Dissolution
i. Bane v. Ferguson (1989) – Facts: Partner's law firm adopted retirement pension plan that
provided that plan payments would end if firm dissolved. Partner retired and began drawing his
pension. Firm merged w/ another firm but dissolved w/ no successor, and partner's pension
terminated. He sued the firm members, alleging they had committed negligent mismanagement in
merging. Reasoning: This is not a duty of undivided loyalty case, but rather duty of care.
However, firm members had no fiduciary duty to the partner b/c he was no longer a partner and
the BJR shields them from their alleged negligence. If the dissolution is motivated by good
faith judgment for the benefit of the Corp rather than personal gain of the officers,
directors or SHs, no liability attaches to the dissolution. Held: No tort claim exists for mere
negligence of the firm members in their management decisions where there’s no allegation that
they acted in bad faith.
i. Expulsion
i. Lawlis v. Kightlinger & Gray (1990) – Facts: Π, former partner, was expelled from law firm
due to alcoholism. He sued for wrongful expulsion, alleging that ∆ breached P-ship agreement,
breached a fiduciary duty to him, committed constructive fraud against him, and breached an oral
K to restore him to P-ship status if he quit drinking. Reasoning: Π has been sober, but his
productivity is not as high; it doesn’t meet the formula (seniority, originations, and value of work,
star potential, hours, bar service, publications, and pro bono) of the firm. Π had no claim for
damages for wrongful expulsion b/c he remained a senior partner till he was expelled by vote of
the partners in accordance w/ p-ship agreement. Also, Π had no claim for breach of fiduciary duty
b/c the facts showed the firm had no “predatory purpose” in expelling him, there was no
constructive fraud b/c ∆ acted in good faith, and ∆ violated no oral agreement to restore Π to
partner status b/c he was never downgraded from that status. Held: Executive committee had the
right to expel Π w/o stating a cause pursuant to P-ship agreement. No breach of fiduciary duty.
1. Covenant of “Good Faith & Fair Dealing” – implied into K in NJ, and most
jurisdictions. Π could argue that this covenant was breached b/c the firm was harsh in
dumping him the minute he got back on his feet. However, this argument failed b/c the
firm showed good faith from the very beginning by letting him stay and getting him help;
they cut him a break twice.
2. “Guillotine” Involuntary Severance – immediate termination by P-ship vote w/o notice

or hearing. Provides a simple, practical and speedy method (in the best interest of the P-
ship) of separating a partner from a firm, if necessary for any reason. However, the fact
that the law firm recommended a step-down severance over 6 months rather than the
“guillotine” severance shows a compassionate, not greedy purpose.
VII. The Rights of Partners in Management
Vanessa Verduga 21
a. UPA § 18(e) Rules Determining Rights and Duties of Partners – All partners have equal rights in
management and conduct of P-ship business.
b. UPA § 18(h) – Any difference arising as to ordinary matters connected w/ P-ship business may be
decided by majority of the partners.
c. 2 concepts:
i. Where There’s an Agreement – UPA provisions can be changed by agreement. E.g. Under the
Note: 1st see if
there’s a P-ship UPA you need “unanimity.” However, in Lawlis, under the P-Ship agreement, the Executive
agreement in place Committee was responsible for the day to day operations. Thereby, not having to gather all
that changes the partners all the time just to get a unanimous vote for everyday decisions.
UPA. Don’t go
straight to the UPA ii. In the Absence of an Agreement to the Contrary – the following UPA applies:
statute. 2nd
remember, all 1. Rule #1: UPA §103(a) Effect of P-Ship Agreement; Non-Waivable Provisions –
agreements bear
relations among and b/w the partners and the p-ship are governed by the P-ship
the covenant of GF
and FD. 3rd always
agreement.
get modifications
to agreement in 2. Rule #2: UPA §401(f) Partner’s Rights & Duties – default. Each partner has equal
writing! rights in the management and conduct of the P-ship business. Applies no matter what!
3. Rule #3: UPA §401(j) – differences of opinion arising in a:

a. Matters w/in the ordinary course of business  may be decided by majority of
partners.
b. Matters outside the ordinary course of business  requires unanimity of all
partners.
4. Rule #4: 2 Person P-Ship

a. In the ordinary course of business  yes, bound
b. Outside ordinary course of business  probably not bound b/c not unanimous
5. Rule #5: 2 Person Deadlock

a. Go to arbitration
b. Dissolve it (divorce)
d. National Biscuit Co. v. Stroud (1959) – Facts: Stroud and Freeman entered P-ship to sell groceries.
Stroud advised Π Co that he was no longer responsible for any additional bread sold by Co to the P-ship.
Afterwards, Freeman requested additional deliveries of bread from Π and Π provided the bread.
Reasoning: Freeman as partner of Stroud had “equal rights in the management and conduct of the P-ship
business.” Stroud could not restrict Freeman’s authority to buy bread for the P-ship, for such was an
“ordinary matter connected w/ the P-ship business.” Held: Freeman's purchases of bread from Π as a
going concern bound the P-ship and Stroud. Activities w/in the scope of the business of the P-ship cannot
be limited except by the expressed will of a majority decision on the disputed question and half of the
members is not a majority.7
e. Summers v. Dooley (1971) – Facts: Despite ∆’s repeated objections to Π’s request to hire a 3rd man to
work for the P-ship; Π hired a new employee, paid him out of his own pocket, and sought reimbursement
from ∆. Reasoning: B/c the parties’ P-ship agreement did not specify otherwise, the business differences
b/w the parties should have been resolved by a majority of the partners. Held: Π was not entitled to full
reimbursement of the expenses he incurred when unilaterally hiring a new employee over ∆’s objections
b/c it would have been manifestly unjust to permit recovery of an expense that was incurred individually
for the benefit of Π and not for the benefit of the P-ship.
7
Stroud is not a “majority”; he’s just 50%. His directive cannot countermand Freeman’s.
Vanessa Verduga 22
i. Why is Summers different from Stroud? B/c in Summers a 3rd party was actually being
brought into the P-ship. Thus, Summers should’ve ended the P-ship before hiring this 3rd person.
f. Day v. Sidley & Austin (1977) – Facts: Day Π was senior partner & chairman of Wash, DC office (very
prominent guy). Firm merged w/ a Chicago firm (Day voted in favor of the merger) and Day’s office was
closed down, he became co-chairman and his office was relocated. Day was hurt; he’s got no power w/in
his own firm so, he resigns b/c he’s not the sole chairman. Π claimed breach of fiduciary duty, wrongful
dissolution, breach of K and misrepresentations. Reasoning: Under the UPA, Day would’ve had a say in
closing down the DC office, but the P-ship agreement shifted these rights to an Executive Committee. He
has no breach of fiduciary, he wasn’t treated unfairly, his pay wasn’t docked, and the agreement didn’t
give him rights. Held: This is just a case of “bruised ego.” Day had no legal right to remain sole
chairman under P-ship agreement. P-ship agreements can modify the rights of partners in management.
VIII. The Consequences of Dissolution
a. UPA (1914) §31 Causes of Dissolution – caused (1) w/o violation of P-ship agreement, (a) by
termination of definite term or if specified in agreement, (b) by express will of any partner, (c) by express
will of all partners who have not assigned their interests or suffered them to be charged for their separate
debts, (d) by expulsion of any partner from the business bona fide in accordance w/ such power conferred
by P-ship agreement; (2) in contravention of agreement, where circumstances don’t permit a dissolution
under any other provision, by express will of any partner at any time; (3) by any event which makes it
unlawful for P-ship to be carried on; (4) by death of a partner; (5) by bankruptcy of any partner or P-ship;
(6) By decree of court.
b. UPA (1914) §32 Dissolution by Decree of Court – On application by or for a partner the court shall
decree a dissolution whenever (a) a partner is judicially insane; (b) partner is incapable of performing his
part of P-ship K; (c) partner’s conduct affects prejudicially the carrying on of the business; (d) partner
willfully breached P-ship agreement, or so conducts himself in manner that is not reasonably practicable
to carry on business w/ him; (e) P-ship business can only be carried on at a loss; and (f) other
circumstances that render dissolution equitable.
Three Key Phases:

(1) Dissolution – point in time when partners cease to carry on business together. Automatic or by Court.
(2) Winding Up/Liquidation – worry about 2 principal categories of persons when settling P-ship’s affairs:
a. 3rd Parties – Creditors and debtors.
i. Collect Money and Receivables
ii. Paying Bills and Settle Debts
iii. Split what’s left accordingly among the Partners
b. Partners – should treat each other fairly. Fiduciary duties apply throughout entire process.
(3) Termination
c. UPA §801(1-4) Events Causing Dissolution and Winding Up of a P-ship Business – Automatic acts
of dissolution:
i. In a P-ship at will, the P-ship having notice from a partner of that partner’s express will to w/draw
as a partner (surviving spouse of deceased Partner could dissolve p-ship);
ii. In a P-ship for a definite term or a particular undertaking;
1. Expiration of 90 days after partner’s dissociation by death or wrongful dissociation,
unless a majority agrees beforehand to continue P-ship.
a. Express will of all partners to wind up; or
Vanessa Verduga 23
b. Expiration of term or completion of undertaking;
iii. Event agreed to in P-ship agreement that would result in winding up
iv. Event that makes it unlawful for P-ship to continue.
d. UPA §801(5) Dissolution by Way of Judicial Termination –

i. Economic purpose of P-ship will most likely be frustrated
ii. Partner is engaged in conduct not making it reasonably practical to carry on business
iii. It’s otherwise not reasonably practical (catch-all provision)
e. UPA §802 P-Ship Continues After Dissolution – Winding Up Business – consider fiduciary duties,
binding authority of Partners
i. P-ship is terminated when the winding up of its business is complete
ii. Business continues for purposes of winding up
iii. However, remaining partner(s) may waive right to have P-ship terminated, in which event the P-
ship resumes carrying on business as if dissolution never occurred. §802(b).
f. UPA §803 Right to Wind Up Business – partner who has not wrongfully dissociated may participate in
winding up P-ship’s business, but on application of any partner, partner’s legal rep, or transferee, for good
cause shown, may order judicial supervision of winding up.
g. UPA §804 Partner’s Power to Bind P-Ship After Dissolution – A P-ship is bound by a partner’s act
after dissolution that:
i. Is appropriate for winding up the p-ship business, or
ii. Would have bound the P-ship before dissolution, if the other party to the transaction did not have
notice of the dissolution.
h. UPA §807 Settlement of Accounts and Contributions Among Partners – Liquidation – who gets what.
See Prentiss – one partner taking advantage of another.
i. Termination
i. Monin v. Monin (1990) – Facts: 2 brothers in a P-ship; relationship deteriorated so they agreed
to dissolve. They decide to bid on the P-ship business to wind it up and split the assets. They had
an agreement not to compete w/ each other. However, before they bid, unbeknownst to Charles,
Sonny individually contracted to fulfill the milk hauling K. When Charles gets the high bid and
gets the business he learns that his brother already had the K in his pocket and that he’s going to
be hauling for the major customer of the business. Charles sues his brother for violating his
fiduciary duty to the P-ship and for tortiously interfering w/ P-ship’s contractual relations w/
clients and customers. Held: A partner’s fiduciary duties extend beyond the P-ship to persons
who have dissolved the P-ship and have not completely wound up and settled the P-ship affairs.
1. Note: Also, argue breach of covenant of good faith and fair dealing b/c the agreement
had a “non-compete” clause, which brother breached. Consent and disclosure are key.
ii. Pretiss v. Sheffel (1973) – Facts: After freezing Prentiss out of the P-ship’s management and
affairs, Scheffel and a 3rd partner filed for dissolution, purchasing P-ship assets at a judicially
supervised sale. Prentiss counterclaimed seeking a winding up of the p-ship and the appointment
of a receiver, contending that his rights as a partner were violated b/c he had been wrongfully
excluded from the P-ship. Reasoning: Πs sued to dissolve and didn’t want anything to do w/
Prentiss. Πs bought out the assets forcing Prentiss out. Prentiss failed to show how he was injured
by the participation of the Πs in the judicial sale. Court can’t amend his hurt feelings; it’s an
intangible principle. Held: Πs were allowed to purchase the P-ship and exclude Prentiss where
there was no indication that such exclusion was done for the wrongful purpose of obtaining the P-
ship assets in bad faith.
Vanessa Verduga 24
1. Precaution  For dissolution of P-ship, you’re better off working it out amongst
yourselves b/c you’re able to control the results. Court should be your absolute last resort.
Best way to deal w/ this is to put it into the P-ship agreement in the outset or amend the
agreement to deal w/ the division of assets. Maybe go to mediation (arbitration is risky
b/c arbitrator can adjudicate like a judge) and try to settle the issue, but don’t put it in the
hands of the court b/c you lose control over the result and end up w/ a mess.
iii. Pav-Saver Corp. V. Vasso Corp. (1986) – Facts: Pav-Saver Corp (Dale had the “know-how”)
was owner of a trademark and patents for the design and marketing of concrete paving machines.
Corp formed a P-ship w/ Meersman (had the $) for the manufacture and sale of the machines. P-
ship agreement states that person who ends it has to pay royalty fees. They had a fallout and Dale
was physically thrown out. Dale’s lawyer unilaterally sent a letter to Meersman saying “it’s
over.” Meersman’s lawyer doesn’t accept. Dale sued seeking to dissolve P-ship, get back his
patents and trademark, and get an accounting. Meersman argues that this was a breach of K b/c
there was not a mutual agreement to dissolve, as required. Held: P-ship agreement contemplated
a permanent P-ship, terminable only upon mutual approval; the Corp's unilateral termination
violated the agreement. When a wrongful dissolution occurs, partners who have not
wrongfully caused the dissolution shall have the right to continue the business in the same
name and to receive damages for breach of the agreement. Trial ct did not err in refusing to
return the patents and trademark to Corp or assigning a good-will value; the amt of liquidated
damages was not unreasonable and was a legitimate matter bargained for b/w the parties.
1. Precaution  Dale should have rescinded the letter right away. Dale’s idiot lawyer
breached the agreement and allowed Meersman to get Dale’s patents and trademarks
leaving Dale w/ his share of the business which was less than the liquidated damages and
now he has nothing (Dale has a malpractice claim against his lawyer).
j. The Sharing of Losses
i. Kovacik v. Reed (1957) – Facts: Kovacik asked Reed to be his superintendent on several
remodeling jobs. Thereby forming a “Service P-Ship” whereby Kovacik would invest the $ and
Reed the service. When the jobs were unprofitable, Kovacik asked Reed to share equally in the
losses and Reed refused. Kovacik sued Reed for one-half the losses. Held: In a joint venture in
which one party contributes funds and the other labor, neither party is liable to the other for
contribution for any loss suffered b/c both parties have shared equally in the loss. Reed got lucky.
1. General Rule: In absence of agreement to contrary, the law presumes that partners and
joint adventurers intended to participate equally in the profits & losses of the common
enterprise, irrespective of any inequality in amounts each contributed to the capital
employed, w/ losses being shared by them in same proportions as they share the profits.
a. Exception: Where one party contributes $ and the other contributes services,
then in the event of a loss each would lose his own capital – the one his $ and the
other his labor.
k. Buyout Agreements
i. Buyout / Buy-sell Agreement – an agreement that allows a partner to end his/her relationship w/
the other partners and receive a cash payment, or series of payments, or some assets of the firm,
in return for his/her interest in the firm.
1. Agree ahead of time what the partner who wants to leave is going to get or what the
surviving spouse will get upon partner’s death.
2. The $ comes from buy-out insurance.
Vanessa Verduga 25
3. Effective way to reduce risk of dissolution.
a. E.g. These agreements may provide that in the event of such and such the P-ship
will pay you $X for your share. The trigger event is the event of dissolution. This
protects the parties and avoids litigation. Also avoids having someone
inexperience become a partner of the P-ship by taking over the decedent’s share.
ii. Process for Buyout Agreement

1. Step 1: put in provision that says business will continue
2. Step 2: define trigger event, event that will allow for dissolution
3. Step 3: specify obligation to buy versus option
4. Step 4: come up w/ price formula
5. Step 5: determine method of payment
iii. G&S Investments v. Belman (1984) – Facts: The General P-ship, the deceased, and 2 other
partners were engaged in an LLP. The deceased started using cocaine and caused enormous
problems. The P-ship, deciding that he was incapable of making rational business decisions,
sought dissolution of the P-ship; however, shortly after filing the complaint, the deceased died
and the LLP dissolved upon his death. The general P-ship filed to invoke their right to continue
the P-ship and acquire the deceased’s interest under the articles of LLP. Held: P-ship buy-out
agreements are valid and binding although the purchase price agreed upon is less or more than the
actual value of the interest at the time of dissolution, since the partners may agree among
themselves by K as to their rights and liabilities. Buy-out agreements are enforceable even when
they provide that the decedent’s interest is to pass to the survivors w/o any payment.
1. Capital Account – is the amt you’ve invested less what you took out as your partner’s
compensation. When you leave your accountant will have a number that represents your
capital account, which you will get. Ct found that “capital account” clearly meant the
partner’s capital account as it appears on the books of the P-ship, and not the FMV
(which is likely to be higher).
a. Formula: Capital Account = Capital Contribution + Profits – Losses
i. E.g. Take whatever interest you had in that P-ship – how to determine
what that interest is:
ii. P-ship is $1 Million (3 partners)
iii. 1 takes 50%
iv. 2 takes 25%
v. 3 takes 25% - the proportionate share of the P-ship is what you get.
2. Borteck v. Riker, Danzig (2003) – Facts: A Tax partner at Riker Danzig decided to
leave to work for another firm so they had to decide what to give this partner. He got his
capital account. The issue arose w/ respect to his early retirement benefits payment.
Under Riker P-ship agreement, a partner gets those benefits under certain conditions.
Only time partner doesn’t get them is if he doesn’t retire from the private practice of law.
Borteck is leaving to continue working in private practice. Bortek sues to invalidate that
part of the Riker agreement that was designed to be a restraint of trade. Held: Riker
can’t do this b/c it’s anti-competitive (interferes w/ Bortek’s ability to serve clients).
a. Rules of Professional Conduct 5.6 – Lawyer shall not participate in making a P-

ship agreement that restricts post-employment. Restraint clauses are illegal and
unethical. Rationale – preserve the right of clients to choose.
Vanessa Verduga 26
i. Note: Borteck works at Riker for 11 yrs, gives them no notice, leaves the
firm, takes 2 associates and clients w/ him, goes to a competing firm and
is able to get his capital account and also his early retirement benefits
from Riker. This only applies to the practice of law (lawyers).
IX. Business Forms
Business Forms:
Sole Proprietor – 1 person show. Problem is you may not have the $ to grow your business, also unlimited direct
personal liability, as well as vicarious liability.
Partnership – association of 2 or more persons...
General P-ship
Limited P-ship
Corporation
Limited Liability Company (LLC)
Relevant Factors in Deciding What Business Form to Recommend:

Unlimited Personal Direct Liability – how much personal liability does client want to incur?
Capital – how much capital are they willing to invest?
Trust
Compensation
Profits / Losses
Exit Rules / Dissolution – ability to get out of the business; it’s complicated in a p-ship but in a sole proprietorship
it’s easy, in a Corp there are stocks that need to be sold to get out.
Size – how big do you want the business to be?
Management / Governance – in sole proprietorship control is unlimited; in a P-ship, under UPA everyone has equal
say, but can be changed in agreement; in a Corp, SHs don’t have much to say about day-to-day governance.
Agency / Vicarious Liability – to what extent do they want to be bound by the acts of others? All forms have it,
except Corps where SHs are not liable.
Costs – of forming the business. Sole and p-ship costs practically nothing, a Corp costs a lot to run.
Taxes – tax consequences can be more favorable for sole and p-ships than for Corp.
Fiduciary Inter Se duties / rights – sole – he/she may have duties, but employee has fiduciary duty but not as high
as the fiduciary duty of partners inter se.
a. Limited Partnership – The problem w/ general partners’ is vicarious liability, which holds not only the
P-ship liable but also holds the partners personally liable. Some partners want to be silent partners, not
engaged in the governance of the enterprise, and such setup would seem rather unfair to them. In an LLP,
if you’re a pure limited or passive investor then your personal liability is limited to the amt of your
Vanessa Verduga 27
investment. Thus, you have the benefit of a P-ship, but your personal and vicarious liability is limited to
the amount of your investment b/c you’re not really running the business so why should you be held
responsible for the actions of your partners.
i. Holzman v. De Escamilla (1948) – Facts: Hacienda Farms was formed as an LLP w/ Russell
and Andrews acting as limited partners. Holzman sought to hold Russell and Andrews personally
liable for P-ship debts when Hacienda Farms went bankrupt. Reasoning: Russell and Andrews
told Escamilla how to plant, what to plant; they hired/fired people, made out checks, etc. Held: If
a limited partner exercises control over the P-ship business, he becomes a general partner.
Evidence shows that Russell and Andrews took part in the control of the P-ship business and thus
became liable as general partners. They simply put Escamilla as the one that takes the fault if
anything goes wrong; they hid behind him (they wanted to have their cake and eat it too).
1. Precaution  They could’ve set up either a Corp or an LLC b/c they would not have
been liable beyond their investment. When you form a Corp a shield is created.
Vanessa Verduga 28
THE NATURE OF THE CORPORATION
Attributes of a Corporation:
Separate Legal Entities
They are fictitious persons (can make contract, own property, sue or be sued, invoke constitutional rights). Corp
shields the SH from having his personal assets seized.
Ownership
Manifested by shares of stock
Allow SH to w/draw from corporation w/o dissolving business by selling share of stock
2 types of Corps
Public Corps – publicly traded - could sell stock on NYSE, NASDAQ, markets for buying and selling shares of
stock; trade stocks in publicly trading companies
Closed Corps – private; not publicly traded
Management
representative democracy- managed by board of directors, officials elected by shareholders
shareholders elect board of directors
board of directors elect officers
Corporation shareholders have no personal liability for acts of corporation!
all that SHs can lose is the value of their stock
liability shield encourages investment
X. Corporate Players
a. Shareholders – depending on # of shares held that represents their interest in the Corp; it’s analogous to
being a partner, but not in the legal sense. Since you’re not vicariously liable, you’re more like a limited
partner.
i. However, a SH can lose the protection of the invisible shield if it was just a fraud setup to use it
as your personal piggy bank. Cts will not allow this.
b. Officers – run the day-to-day business of the Corp (CFO, CEO, President, etc… people that go to work
daily). It includes owners of a large amount of shares that allows them to control the Corp – a.k.a.
Control Shareholders (i.e. Martha Stewart).
c. Directors
d. Lenders – venture capitalists, banks, etc., and
e. Investment Bankers – make public offers. If Corp is in need of capital – go to Investment Banker (JP
Morgan, Merrill Lynch) to issue stocks publicly. This is why SHs are not held liable b/c SHs change
constantly - these shares change owners in the stock market from 1 minute to the next.
f. Typical kinds of disputes in Corp:
i. Suits involving 3rd parties – Pierce through the shield to get to the pockets of the Corp.
Vanessa Verduga 29
ii. Relationship b/w and among SHs, officers and directors – what are their fiduciary duties –
inter se family problems.
iii. Corporations and Government – major area - gov’t is deeply involved in policing public
companies. Lately many people have lost $ due to corporate greed (i.e. ENRON).
XI. Promoters and the Corporate Entity
a. Promoter - a person who identifies a business opportunity and puts together a deal, forming a Corp as an
investment vehicle for other people. Types of Ks that get formed during this pre-incorporation stage are:
i. Leases
ii. Employment contract
iii. Soliciting customers
b. Southern-Gulf Marine Co. Inc. v. Camcraft, Inc. (1982)8 – Facts: Southern Gulf contracted w/
Camcraft for purchase and sale of a supply ship which Camcraft was to construct. K indicated that
Southern Gulf was a Texas Corp, when in fact it had yet to be organized under the laws of any state, but
had been incorporated in the Cayman Islands. Camcraft sought to get out of a K w/ Southern-Gulf, b/c it
had not been incorporated when K was signed. Held: Where a party has contracted w/ what he
acknowledges to be a Corp, he is estopped from denying the existence or the legal validity of such a Corp.
Southern-Gulf’s legal status should not be grounds for avoidance of the K. Also, location of
incorporation was not germane to the deal. Camcraft then claims that deal was made w/ promoter not
Corp – essentially an estoppel argument. When a promoter is dealing w/ someone else on behalf of the
Corp they act as if Corp has been formed.
i. MBC §2.04 Liability for Pre-incorporation Transaction – All persons purporting to act as or
on behalf of a Corp, knowing there was no incorporation under this Act, are jointly and severally
liable for all liabilities created while so acting.
1. Precaution  To protect himself, promoter can:

a. Put in provision that K is void if Corp is not formed
b. Indemnify himself
c. Take out insurance
XII. The Corporate Entity and Limited Liability – Piercing the Corporate Veil
a. A properly formed Corp will normally shield SHs from being personally liable for Corp’s debts, so their
losses will be limited to their investment. This concept of limited liability supports a vital economic
policy upon which large undertakings rest, vast enterprises are launched, and huge sums of capital are
attracted. However, cts sometimes pierce the corporate veil, and hold some or all of the SHs personally
liable for the Corp’s debts.
b. Piercing The Corporate Veil (PCV) – involves a 3rd party (outside of the corporate family) who has a
c/a against someone inside the corporate family and he wants to get into the pockets of the owners of the
Corp who may have done nothing wrong, other than owning the entity. Note: If SH is the active
wrongdoer, PCV is not required b/c it becomes a matter of direct liability. Don’t make the mistake of
thinking that a SH who is the owner of a Corp and a wrongdoer is not liable.
8
Riccio doesn’t like this case!
Vanessa Verduga 30
“Totality of Circumstances” – 4 Factors for Piercing the Corporate Veil:

Assumption of risk: K or tort action? Court’s willingness to pierce the veil is generally greater for Ks than for
Torts; assumption of risk means you had some choices when you were contracting during which you should have
conducted some due diligence.
Unity of Ownership / Alter Ego – is the Corp really you? Is it used as a plaything (sham, dummy or
instrumentality)?
Corporate formalities – keeping of minutes of corporate meetings, slate of directors, keep books, by laws, issuance
of stock certificate.
Commingling – the combining of $ or property into a joint account or asset; same office, phone line, expense
account.
Control
Undercapitalization – a business that does not have sufficient funds to operate.
Fraud or wrongdoing (e.g. knowingly siphoning out all the profits of the corporation)
Injustice / Inequity
In sum, piercing the corporate veil is an equitable result. If you advise a client to avoid piercing, don’t do
things that suggest alter ego, fraud or assumption of risk!
c. Walkovszky v. Carlton (1966) – Facts: Walkovszky Π alleged that he was injured when a taxicab struck
him. Π sued Carlton Δ for the negligence of the penniless taxicab driver. ∆ was a SH of 10 Corps,
including Seon Cab Corp of which he was the sole SH, each of which had 2 cabs registered in its name
and carried the minimum automobile insurance of $10K required by law. Although independent of one
another, Π alleged that the Corps were operated as a single enterprise w/ regard to financing, supplies,
repairs, employees, and garaging. Π argued that ∆ was personally liable for his damages b/c the multiple
corporate structure constituted an unlawful attempt to defraud members of the public. Reasoning: Π is
PCV b/c the total amt of assets available for Π to recover from Seon was $10K, which is not enough.
Thus, he sues all 10 Corps to try to get at Carlton who has the $; he pays himself a salary and dividends.
Held: Carlton is not liable personally b/c he has the Seon shield. Π lacks evidence that Carlton was doing
business in his individual capacity. Thus, Π cannot PCV.
i. General Rule: Whenever anyone uses control of a Corp to further his own interest rather than
Corp’s business, he would be liable for Corp’s acts under the principle of Respondeat superior.
Respondeat superior extends liability to negligent acts as well as commercial dealings.
1. Exception: where Corp is a fragment of a larger corporate combination which actually

conducts the business, ct will not PCV to hold individual SHs personally liable.
d. Sea-Land Services, Inc. v. Pepper Source (1991) – Facts: When Sea-Land could not collect a shipping
bill b/c Pepper-Source had been dissolved, Sea-Land sought to PCV to hold PS’s sole SH personally
liable. Sea-Land alleged that individual debtor intentionally shifted assets and liability among his Corps,
but failed to produce sufficient evidence, at first, but prevailed the second time around. Reasoning: To
determine whether Corp was so controlled by another to justify disregarding their separate entities: (1)
Unity of Interest in Ownership – show that separate personalities of the corps and Marchese are one and
the same. Marchese’s Corps had no formalities, Marchese used $ from the Corps to pay his personal bills.
Thus, PS was a Sham for Marchese; he’s running everything through his corps; (2) Promoting Injustice –
on remand, Sea Land showed that Marchese was manipulating corporate funds “to insure there would not
Vanessa Verduga 31
be funds to pay Sea Land.” Held: Marchese was the sole owner of PS. Sea-Land was able to get through
the shield. Marchese used corporate facades to avoid responsibility to creditors.
i. General Rule: SH of Corp has no personal liability for acts of the Corp b/c it’s a separate entity.
1. Exception: PCV in the 7th Circuit – 2 Requirements:

Depends on a. Unity of Interest and Ownership – unity must be such that the separate
Jurisdiction 
personalities of the Corp and the individual (or other Corp) no longer exist.
Sham/dummy/alter ego.
i. Failure to maintain adequate corporate records or to comply w/ corporate

formalities;
ii. Commingling of funds or assets;
iii. Undercapitalization;
iv. One Corp treating the assets of another corporation as its own; and
b. Fraud or Promotion of Injustice – circumstances must be such that adherence

to the fiction of separate corporate existence would sanction a fraud or promote
injustice.
i. Rationale – reason for the personal liability rule is to get the benefit of
the shield that must be created for a real thing, not a Sham or Alter Ego.
e. 3 Different Factors Courts Look at when PCV:
i. Tort vs. Contract – If it’s a tort, party injured had no contemplation at all as to whether or not he
would be able to pierce the veil. In this situation, party is completely innocent. If it’s a K, then
parties entering in it voluntarily and assume the risk. When making a deal w/ a Corp you know it
has limited liability. Thus, you have an opportunity to asses who you’re dealing w/ and your
remedy is going to be against that Corp. You would be foolish to enter the K w/o investigating,
assessing yourself.
ii. Unity of Ownership – Adhere to the formalities of the Corp and not intermingle personal funds
w/ Corp funds. Most of the time, Π will not be able to PCV b/c the general rule will be applied.
iii. Fraud/Injustice – Weight on this varies depending on jurisdiction. RR: If SH did not treat Corp
as a separate entity, then why should anybody else treat it as a separate entity?! Common sense.
f. Kinney Shoe Corp. v. Polan (1991) – Facts: Kinney Corp sued Polan seeking to recover $ owed on
sublease w/ Polan’s realty Co. Polan was realty Co’s sole SH. Finding 2 prong test in Laya satisfied,
district ct concluded Corp was damaged by Polan's failure to carry out Corp formalities and realty Co's
gross undercapitalization. However, ct then applied Laya's 3rd prong and concluded PCV doctrine did not
apply b/c Corp assumed risk of Polan's Co defaulting. On appeal, ct reversed and remanded b/c, under
totality of the circumstances, Laya's 3rd prong was only permissive since even if it applied to creditors like
Corp, it did not prevent appellant from PCV in this case. Held: B/c Polan failed to follow corporate
formalities and invested nothing in his company, Corp could PCV.
i. PCV in a Breach of K case for the 4th Circuit:

Depends on
Jurisdiction  1. Unity of Interest and Ownership such that the separate personalities of the corporation
and the individual SH no longer exists, and
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2. Equitable Result would occur if the acts are treated as those of the Corp alone.
3. 3rd prong Assumption of Risk – could’ve made reasonable investigation prior

contracting – is only permissive not mandatory.
ii. Precaution  Due Diligence by Kinney would’ve led him to discover that Polan was the sole
SH of Industrial, which didn’t have $ or assets or any formalities in place. Kinney should’ve
asked for further guarantee from Industrial. Exercise due diligence and get a personal guarantee!
1. Note: Kinney was lucky; ct could’ve held that since this was a K transaction he assumed
the risk. PCV is based on totality of circumstances; it’s an equitable remedy.
g. Parent/Child Cases
i. Parent  Corp that owns all shares of common stock of another Corp  Subsidiary
ii. Generally, Parent, like any SH, is not liable for debts of Subsidiary. Thus, Parent can undertake
an activity w/o putting at risk its own assets, beyond those it decides to commit to Subsidiary.
Like an individual SH, however, Parent Corp SH must be aware of the danger that if it’s not
careful, creditors of Subsidiary may be able to PCV of the Subsidiary and hold the Parent directly
liable by virtue of its participation in the activities of the Subsidiary.
iii. In re Silicone Gel Breast Implants Products Liability Litigation (1995) – Facts: Bristol
(Parent) is sole SH of MEC (Subsidiary), a major supplier of breast implants. Bristol asserted
there was insufficient evidence to proceed against it through PCV theory or direct liability. Held:
Under PCV, there was ample evidence that MEC was Bristol’s alter ego. Evidence included –
their shared directors; MEC was part of Bristol's health care group and used its legal, auditing,
and communications departments; they filed consolidated federal tax returns; and Bristol
prepared consolidated financial reports. As for the direct liability claims, by allowing its name to
be placed on breast implant packages and product inserts, Bristol held itself out as supporting the
product, and thus could not deny its potential liability on a theory of negligent undertaking.
1. Note: In Alabama, ct just looks at alter ego! Many jurisdictions that require showing of
fraud, injustice or inequity in a K case do not require the same in a tort situation.
2. Rationale For K vs. Tort Distinction – In a K case the creditor has willingly transacted
business w/ the Subsidiary although it could have insisted on assurances that would make
the Parent also responsible. In a Tort case, however, the injured party had no such
choice; the limitations on corporate liability were fortuitous and non-consensual.
3. Precaution  Bristol was way too involved in MEC; they made a mistake in not
distancing themselves of MEC. Note: Analysis is close to Principal/Agent.
iv. Frigidaire Sales Corp v. Union Properties, Inc. (1977) – Facts: Frigidaire Corp attempted to
hold the limited partners of Commercial Investors generally liable after Commercial breached its
K w/ Frigidaire. Reasoning: The limited partners conscientiously kept the affairs of the Corp
separate from their personal affairs, and no fraud or manifest injustice is perpetrated upon 3rd
persons who deal w/ the Corp. Record showed that the limited partners did not form the general
partner for the sole purpose of operating the P-ship, but to create several business opportunities.
Thus, their control of the general partner was not merely for the benefit of the P-ship. Also,
although the limited partners signed the K, contractor knew they were agents and it was dealing
w/ a limited P-ship w/ a corporate general partner. Corp’s separate entity should be respected.
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Held: Limited partners do not incur general liability for the limited P-ship’s obligations simply
b/c they are officers, directors, or SHs of the corporate general partner.
1. Note: Chart your Corporate Structure. Advantage of this corporate setup is the “Double
Side Shield” – on one side as a Corp both Mannon and Baxter are shielded and on the
other side as limited partners they’re also shielded. M & B haven’t exercised too much
control so as to convert them to general partners. Thus, Frigidaire can’t PCV.
XIII. Shareholder Derivate Actions
a. Shareholder Suits – arise when SHs are part of corporate family; frequently SHs will get into squabbles
w/ others inside the corporate family (other SHs, officers, directors). Officers and directors have fiduciary
duties to SHs. Note: THESE SUITS ARE NOT PCV!
Types of Shareholder Suits:
Direct Claims – SH must allege more than an injury resulting from a wrong to the Corp. SH must state a
claims for injury that is separate and distinct from that suffered by other SHs.
Derivative Claims – SH must allege that BD rejected his pre-suit demand that BD assert the Corp’s claim
(demand wrongfully refused), or allege w/ particularity why SH was justified in not making effort to obtain
BD’s action (demand excused). Generally, 3 categories of people involved:
Shareholders
Officers and Directors (O/Ds), and
Corporate entity (which is a person)
Distinguishing b/w Direct and Derivative Claims:
It’s often difficult to distinguish these b/c they’re fact-sensitive (good lawyering prevails). Distinction depends on:
Nature of the Wrong Alleged, and

Relief, which could result if Π were to prevail.
b. The Requirement of Demand on Directors – Suppose the O/Ds are looting the Corp (excessive
compensation / personal expenditures / etc.). Who is getting hurt? The Corp and the SHs b/c their
ownership interest is being diminished due to the losses of the Corp. Who is going to sue to stop this
from happening? Corp cannot sue b/c it is not a human being. Therefore, O/Ds sue, except that they’re
the ones committing the harms. So, there is no chance they’ll bring an action against themselves. This
may lead to abuse of the corporate form by the O/Ds. However, Equity creates the concept of the
Derivative Suit (which is a form of 3rd party standing) allowing SHs to stand in the shoes of the Corp and
go after O/Ds who are damaging the Corp. The SH derivative suit is a good thing, but it often gets abused
by means of a Strike Suit (lawyers basically hold up the Corp by suing the O/Ds of the Corp in a case
that may have very little merit, but will cost so much to defend, that the insurance provided to O/Ds will
be used to pay off the lawyers in settlement and make it appear as though something meaningful
happened, when in reality it did not). Thus, the original abuse is corrected, but a new abuse takes its place
 what to do? Cts and legislatures have enacted Screening Mechanisms to strike a balance b/w the 2
abuses. Π looking to bring a derivative action has to jump over hoops before the claim can be taken to ct.
Ct says to SHs “Put your $ where your mouth is” – this basically eliminates the strike suit.
i. FRCP 23.1, NJ 4:32-5 State SH derivative; Federal Private Litigation Format (PSLRA)
1. Π might have to file a verified complaint, which puts you at risk of committing perjury
if you file a false complaint.
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2. SH might have to have a certain amount of stock in Corp
3. You may have to post a bond
4. There could be a cap on attorney fees
5. If you lose, you could be liable to the other side – fee shifting
6. This targets the filing lawyer by making it more difficult for them to file a suit.
Screening Mechanism for Derivative Suits – The (Pre-Suit) Demand Requirement:
Derivative action impinges on managerial freedom of directors. Demand requirement is recognition of fundamental
precept that directors manage the business and affairs of the corp (BJR). If SHs think O/Ds are doing something
wrong they should allow them an opportunity to make corrections.
Universal Demand – whenever, regardless of the circumstances, a SH wants to bring a derivative action, it is
required to make a written demand to do the thing that will make SH happy (ABA demand).
Demand Excused – “making a demand would be futile” and therefore I don’t have to make the demand. This is
what Π’s argument would be. SH in great detail must show why demand should be excused. The basis for claiming
excusal would normally be that:
Majority of BD has a material financial or familial interest

Majority of BD is incapable of acting independently for some other reason such as domination or control
The underlying transaction is not the product of a valid business judgment.
Demand Wrongfully Refused – when SH makes demand, he’s entitled to know promptly what action BD has
taken in response. If BD refuses SH’s demand then SH must show that demand was wrongfully excused. SH can
then use the “tools at hand” to obtain relevant corporate records – reports or minutes, reflecting Corp action and
related info to determine if there’s basis to assert that demand was wrongfully refused. However, court will not
upset what BD has done unless they have deviated from the BJR; so if the BD is clever enough to dress up the
refusal (‘on the basis of our research, no action should be taken’) the ct will say ‘ok’ and SH Π is out of luck.
Rationale for Demand Requirement:
(1) Relieve courts from deciding matters of internal Corp governance by giving BD opportunities to correct
alleged abuses.
(2) Provide BD w/ reasonable protection from harassment by litigation on matters w/in BD’s discretion; and
(3) Discourage “strike suits” commenced by SHs for personal gain rather than benefit of Corp.
Creates Balanced Environment B/w:
(1) Preserving the discretion of O/Ds to manage a Corp w/o undue interference, through the demand
requirement; and
(2) Permits SH to bring claims on behalf of Corp when it’s evident that directors will wrongfully
refuse to bring such claims, through the demand futility exception.
c. Grimes v. Donald (1996) – Facts: Grimes SH seeks to invalidate employment and income continuation
agreements b/w Donald CEO and Corp, also seeks damages against Donald and other directors alleging
that BD breached its fiduciary duties by abdicating its authority, failing to exercise due care and
committing waste. Grimes made demand and claimed that Donald’s compensation package was
excessive. BD replied - “thorough analysis leads to conclusion that Donald’s duties are not impermissible
delegation of duties of the BD of Directors.” Reasoning: Due care, waste and excessive compensation
claims asserted are derivative. Abdication claim that BD handed over their power to Donald b/c of the
Vanessa Verduga 35
unreasonable interference clause is, however, a direct claim. Held: Abdication claim failed b/c it was not
adequately pled. BD considered and rejected Grimes demand; demand was not wrongfully refused b/c the
BJR allows board to make decisions that are reasonable in the normal course of business. Donald’s
Agreements do not formally preclude BD from exercising its statutory powers and fulfilling its fiduciary
duty. An informed decision to delegate a task is a matter of business judgment. If an independent and
informed BD, acting in good faith, determines that services of particular individual warrant large amts of
$, as salary or severance pay, BD has made a business judgment unless facts show that such amts,
compared w/ services received, constitute waste or could not be a valid business judgment. BD retains
“ultimate freedom” to direct strategy and affairs of Co.
i. Donald’s Employment Agreement – He can declare “constructive termination w/o cause” as a

result of unreasonable interference, in his and the BD’s good-faith judgment. In the event of
termination w/o cause, he is entitled to big severance package and lifetime income continuation
plan. In the event of Change of Control, he’ll have right to cash payments for his units (awarded
to him under Long Term Incentive Plan), which Π alleges could be $60M at stock price in effect
at time complaint was filed.
ii. Grimes Delaware Demand Approach – Once director’s conflict of interest is established, BJR
is n/a and demand is excused w/o further inquiry. Whether BD has validly exercised business
judgment must be evaluated by determining whether directors exercised procedural (informed
decision) and substantive (terms of transaction) due care.
d. Eisenberg v. Flying Tiger Line, Inc. (1971) – Facts: Flying Tiger incorporated FTC, which is a wholly
owned subsidiary of FT and then FTC forms FTL, which is a wholly owned sub of FTC; FT and FTL
merge and FTC became the holding company for FTL, whose name was changed back to FT. Effect of
the merger is that business operations are now confined to a wholly owned subsidiary of a holding Co
whose stockholders are the former stockholders of Flying Tiger. Eisenberg owned stock in the initial FT.
Eisenberg argued that his interest in the operating company might have been diluted by virtue of the
merger. Eisenberg brought a class action suit. Corporate BD argued that this is a derivative claim.
Eisenberg allows the case to get dismissed and he appeals on the issue of “whether his claim is direct of
derivative.” Held: This is a direct personal claim b/c the injury is one to SHs individually, not the Corp.
Voting rights never belonged to the Corp, but to SHs per se. In routine mergers SHs retain voice in Corp’s
operation. Here, however, the reorganization deprived SHs of any voice in affairs of their previously
existing operating Corp.
e. Note: Sometimes ct awards an individual recovery in a derivate action.
i. Lynch v. Patterson – Facts: Patterson and Lynch formed a Corp. Patterson quit working and
thereafter Lynch increased his and the BD’s salaries – paid themselves $266K in excess
compensation. Patterson filed derivative action to recover the excess salaries from Lynch. Held:
Corporate recovery would simply return the funds to the control of the wrongdoers. Thus,
Patterson gets 30% (represents the common stock he owned) of $266K ($79,800).
Shareholders’ Derivative Claim:

(1) Is the Action Direct or Derivate?
a. Direct – If the nature of action is to remedy a wrong done to the Corp, as opposed to wrong done to SH,
and would only benefit the SH
b. Derivative – If nature of action is to remedy a wrong done to the Corp, and would only benefit the
Corp.
(2) Important Screening Mechanisms – Demand Requirement: (Varies according to Jurisdiction)
Vanessa Verduga 36
a. ABA Universal Demand (11 states) – requiring demand no matter what. Suit is brought w/in 90 days
of demand unless demand is rejected earlier. However, suit may be brought before the 90 days, even if
demand has not been rejected, if Corp would suffer irreparable injury as a result.
b. Demand Excused – If making a demand is futile then demand is excused.
c. Demand Wrongfully Refused - Made demand, but was wrongfully refused.
f. Marx v. Akers (1996) – Facts: Π commenced SH derivative action against IBM and its BD w/o 1st
demanding that BD initiate lawsuit. Complaint alleges that BD wasted Corp assets and violated fiduciary
duties to IBM by awarding unreasonably high compensation to IBM exec and outside directors during a
period of declining profits. The complaint only names 1 of 3 inside directors as IBM exec (Akers, former
CEO). Reasoning: (1) Suit is derivative b/c Π is trying to prevent the waste of Corp funds by the BD’s
action to give themselves a raise during a period of declining profits. (2) Jurisdiction is NY. However,
demand would’ve been futile b/c the directors authorized, approved, and participated in this, and they
cannot be expected to vote to prosecute an action against themselves. Thus, demand here is unnecessary
and excused. Held: Demand as to the 15 outside directors was excused, but as to the 3 inside directors,
demand was not excused (RR: this is wrong; it should be an “all or nothing” rule). However, for
complaint to survive a dismissal motion Π must allege compensation rates are excessive on their face or
other facts that call into question BD’s business judgment. Here, Π alleged conclusory allegations.
i. NY’s Approach to Demand Futility – Demand would be futile if complaint alleges w/

particularity that:
1. BD majority are interested in transaction (director interest may be self-interest in
transaction at issue or loss of independence b/c a director w/ no direct interest in
transaction is “controlled”), or
2. Directors failed to inform themselves to a degree reasonably necessary about the
transaction, or
3. Directors failed to exercise their business judgment in approving the transaction
(complaint must allege w/ particularity that transaction was so egregious on its face that it
could not have been the product of sound business judgment).
XIV. Primer on The Business Judgment Rule
a. BJR – It’s not Court’s function to resolve for Corps questions on matters of business policy and mgt.
Directors are chosen to pass upon such questions and their judgment unless shown to be tainted w/ fraud
is accepted as final. Judgment of directors enjoys the benefit of presumption that it was formed in good
faith and was designed to promote the best interests of Corp they serve. In a purely business Corp, the
authority of directors must be regarded as absolute when they act w/in the law, and ct is w/o authority to
substitute its judgment for that of directors. See Shlensky infra.
i. Rationale of BJR – O/Ds get a high degree of protection if they make a mistake b/c court
1. Wants to protect risk-taking, and
2. Wants to stay out of internal Corp matters.
b. Wealth vs. Due Care – Primary function of O/Ds is to maximize wealth for SHs. In maximizing the
wealth, O/Ds have to act honestly and w/ due care. If not, then SHs can hold them accountable. There’s
tension b/w due care and wealth maximizing. In order to maximize wealth you may need to take risks, but
you must exercise due care. Risk  if you make a mistake you can be held accountable and may have to
forgo opportunities that would’ve maximized wealth. This is where the BJR comes into play.
Vanessa Verduga 37
c. MBC §8.30 Standards of Conduct for Directors – O/Ds shall act (1) in good faith, and (2) in manner
the director reasonably believes to be in the best interest of the Corp.
i. O/Ds Must Act as Reasonably Prudent Persons Under Similar Circumstances. BJR serves as
a shield for O/DS who make mistakes. Otherwise, they’ll constantly be looking over their
shoulders, before making a decision, to see if any SH is waiting to jump on their backs.
d. MBC §8.31 Standards of Liability for Directors – directors shall not be liable to Corp or its SHs for
any decision to take or not to take action, or any failure to take any action, as a director, unless the party
asserting liability in a proceeding establishes that director’s conduct was the result of (i) action not in
good faith; or (ii) an unreasonable decision or invalid business judgment.
XV. The Role of Special Committees
a. Auerbach v. Bennett (1979) – Facts: BD’s audit committee conducted investigation w/ assistance of
Arthur Anderson, outside auditors, and found that Corp and its subsidiaries had engaged in bribes, large
kickbacks, and that some directors had been personally involved. Following release of report, Π SH filed
suit alleging that directors and Arthur A are liable to Corp for breach of their duties to Corp and should be
made to account for payments made in those transactions. BD setup a special litigation committee to deal
w/ derivate suits. Committee determined that it would not be in Corp’s best interest to pursue Π’s
derivative action. Reasoning: BD has 15 members and derivative suit was brought against 4. Nothing
suggests they participated in the challenged transactions, and the 3 directors of the special litigation
committee joined thereafter. BD followed prudent practice that when individual members of BD prove to
have personal interests that may conflict w/ Corp’s interests such interested directors must be excluded
while remaining disinterested and independent BD members proceed to consideration and action. Held:
BJR applies. Procedures and methodologies chosen and pursued by special litigation committee did not
raise an issue as to good-faith pursuit of its examination. Committee properly engaged special counsel,
reviewed prior work of audit committee thoroughly, interviewed directors that participated in transaction,
and reps of Arthur A, sent questionnaires to each Corp’s non-mgt directors, and at end of investigation
obtained legal advice by special counsel.
i. Action of Special Litigation Committee:
1. Selection of Procedures appropriate to pursuit of its charge – Proof that investigation

has been so restricted in scope, shallow in execution, or pro forma or halfhearted as to
constitute a pretext of sham would raise questions of good faith or conceivably fraud
which would never be shielded by BJR.
2. Substantive decision – predicated on procedures chosen and data produced thereby, not
to pursue claims advanced in SHs’ derivate actions. This falls w/in BJR and is outside
scope of ct’s review.
XVI. The Role and Purpose of Corporations
a. Dodge v. Ford Motor Co. (1919) – Facts: Henry Ford majority SH (58% common shares) and Dodge
brothers owned 10%, were not BD members and were not employed by Ford. Ford announced that no
future special dividends would be paid; profits would be reinvested in the business for expansion and
construction; and price of cars would be reduced. Dodge brothers sued to enjoin both the dividend policy
and Ford’s proposed plans. Reasoning: It had been the practice to declare larger special dividends. Thus,
refusal to declare dividends appears to be arbitrary. Plan does not call for a more profitable business, but a
less profitable one b/c apparent immediate effect will be to diminish the value of shares and the returns to
SHs. A Corp is organized and carried on primarily for profit of SHs. Although, ct can’t interfere w/
director’s decision to expand business; judges are not business experts. Plans must be made for a long
prosperous future. The output was continuous and could easily be turned into cash. Moreover, the
Vanessa Verduga 38
contemplated expenditures were not to be immediate. Held: Director’s had a duty to continue
distribution of very large sums of $ to SHs.
i. General Rule: Directors have power to declare a dividend of Corp earnings and determine its
amt. Ct will not interfere unless directors are guilty of fraud or misappropriation of Corp funds, or
refuse to declare dividend when Corp has surplus of net profits which it can, w/o detriment,
divide among SHs, and when refusal would be an abuse of discretion as to constitute fraud, or
breach of good faith towards SHs. 9
ii. Note: In response to Ford’s philanthropic argument that its actions were to expand business in
order to provide jobs for everyone, ct held that Corp may make donations that tend reasonably
to promote the Corp’s objectives.
b. Shlensky v. Wrigley (1968) – Facts: SH’s derivative suit against directors for negligence and
mismanagement. Π wants Δs to install lights in Wrigley Field and schedule night Chicago Cubs games to
maximize attendance at games and maximize revenue and income. Π attributes operating losses sustained
due to inadequate attendance at games and he concludes that if directors refuse to install the lights and
schedule night games Corp’s financial condition will deteriorate. Π alleges that Wrigley, director, Pres of
Corp and owner of 80% stock therein, has refused to install lights b/c of his personal opinion that baseball
is a day sport and that installation and scheduling will have deteriorating effect on neighborhood. Π
alleges that such arbitrary and capricious acts constitute mismanagement and waste of corporate assets,
and directors have been negligent in failing to exercise reasonable care and prudence in mgt of Corp.
Reasoning: Directors considering patrons of who would or not attend night games if park were in a poor
neighborhood may well consider the effect on neighborhood. Also, the long interest of Corp in its
property value at Wrigley Field might demand all efforts to keep neighborhood from deteriorating.
Besides, factors other than attendance affect the net earnings or losses. Held: BJR applies. Cts can’t
decide questions in directors’ discretion in the absence of a clear showing of dereliction of duty on part of
specific directors and mere failure to “follow the crowd” (do as other Corps do) is not such a dereliction.
i. RR  Make a bridge b/w Dodge (where you intentionally refuse to make a profit BJR is n/a) and
Shlensky, and argue the same against Wrigley. Ct here, however, didn’t buy that argument. Board
is protected even if they’re wrong b/c they probably could’ve made more $. However, if the
decision is not tainted w/ fraud or self-interest then BJR applies and court will not intercede.
c. Doctrine of Ultra Vires – the act is beyond one’s power. It has limited application to actions that are
illegal or not expressly or impliedly authorized by Corp’s charter. Basis for its application include
donations to a pet charity; political or social issues; or excessive contributions.
d. MBC §3.01 Purpose of Corporation – Every Corp incorporated under this act has the purpose of
engaging in any lawful business unless a more limited purpose is set forth in the articles of incorporation.
Primary Purpose and Role of Directors is to make $ for SHs!
e. MBC §3.01(13) – to make donations for the public welfare or for charitable, scientific, or educational
purposes.
f. A.P. Smith Mfg. Co. v. Barlow (1953) – Facts: BD decided to donate $1,500 to Princeton University.
SHs questioned this action and in response Corp instituted declaratory judgment in Chancery Division.
Objecting SHs took the position that (1) Π’s certificate of incorporation does not expressly authorize the
contribution, and under CL the Corp does not have power to make it, and (2) NJ stats which expressly
authorize the contribution may not constitutionally be applied by Π, a Corp created long before their
enactment. Reasoning: CL (1702) held that Corp funds could not be disbursed for philanthropic causes
unless the expenditure benefits the Corp. Then in 20th cty, when control of wealth passed from individual
9
Riccio thinks judge made the wrong decision on the merits. Judge used the BJR for expansion of smelting plant, but not for the dividends.
Vanessa Verduga 39
entrepreneurs to dominating Corps, public support called upon Corps for reasonable philanthropic
donations. In 1930, NJ stats provided that any Corp could cooperate w/ others in creation and
maintenance of charities/contributions conducive to public welfare, and could expend Corp funds as
directors “deem expedient and as in their judgment will contribute to protection of Corp interests.” 50 yrs
before incorporation of A.P., legislature provided that every corporate character thereafter granted “shall
be subject to alteration, suspension and repeal, in discretion of legislature.” Similar reserved power was
placed in NJ Const. SC has held this constitutional. Held: Public policy prevails. There’s no suggestion
that contribution was made indiscriminately or to a pet charity of the directors. On contrary, it was made
to preeminent institution of higher learning, was a modest amt and w/in limits of stats, and voluntarily
made in reasonable belief that it would aid public welfare and advance interests of Π as private Corp and
as part of community in which it operates.
i. Pet Charities/Large (excessive) Contributions  are ways directors may breach fiduciary duty
to Corp. Cts have been extremely tolerant in accepting business judgment of O/Ds of Corps about
whether donation will be good for Corp in long run. One rare exception is Dodge supra. It’s
possible for Corps to adopt charter provisions expressly limiting or prohibiting charitable
contributions. However, such provisions are unheard of.
Vanessa Verduga 40
THE LIMITED LIABILITY COMPANY
XVII. Formation of an LLC
a. Review of Business Forms:

i. Sole Proprietor – treated as taxable, personal income to owner of business
ii. Partnership – files an informational tax return – lists distribution made by P-ship. Partners
would then file their tax returns on revenue distributed to them (as income).
iii. Corporation – pays “double tax” b/c treated as separate entity. Corp income gets taxed when
income comes in. When Corp distributes $ out to SH as dividends, which SHs have pay tax on.
1. S Corp – is a way of getting around “double tax” b/c S Corp gets taxed as a P-ship.
Income passes through Corp tax-free and passes to SHs directly so they pay tax on it.
This is limited to small businesses of 75 or less SHs.
b. LLC – alternative business form – combines best features of Corp and general P-ship. Investors are
“members.” Like Corp, LLC provides liability shield for members. Allows somewhat more flexibility
than Corp in mgt and control. LLC may be managed by all members (as in P-ship) or by managers, who
may or not be members (as in Corp). Investors in LLC are taxed, like partners, only once on profits as
earned. Investors can take account, on individual tax returns, of any LLC losses as incurred; losses are
said to “pass through.” Also, LLC allows greater freedom than Corp in allocating profit & loss for tax
purposes. Its formation requires paperwork & filings w/ state agency.
c. LLP – another recent development. Limited Liability is achieved by filing document w/ state official.
Most LLP stats provide LL only for P-ship debts arising from negligence and similar misconduct, not
contractual obligations, although a few provide for both K and tort liabilities.
Features of an LLC:
The Preferred Form of Business b/c it’s a blend of Corp/P-Ship into one.
Taxes – LLC is like a Corp, but like a P-ship for tax purposes. In 1988, LLC’s came into being. IRS issued Rev.
Ruling stating that for tax purposes, LLC = P-ship
LLC Act §303(a) Limited Personal Liability – debts, obligations and liabilities of LLC, whether arising in K, tort
or otherwise, are solely debts, obligations and liabilities of the Co. A member or manager is not personally liable for
the debt, obligation or liability of the Co. solely by reason of being or acting as a member or manager.
LLC §409 Fiduciary Duties – same as P-ship inter se – General Standards of member’s and Manager’s Conduct
(see pp 71 § book).
Idea of Agency – to a certain extent, there’s an attribution of vicarious liability b/w and among members of LLC but
if imputed it’s still limited to Corp assets b/c of no personal limited liability rule.
LLC §404 Governance – can’t have mgt by consensus so, you have mgt by a Board (same as Corp). Also like a P-
ship – each member has a say (see pp 67 § book).
d. Water, Waste & Land, Inc. (Westec) v. Lanham (1998)10 – Facts: Clark negotiated w/ Westec to
perform engineering work in connection w/ development project to build fast-food restaurant. Clark gave
Westec his business card – while Co’s name was not on the card “PII” appeared above the address on it.
10
Not sure if Riccio covered this case?
Vanessa Verduga 41
Clark and Westec reached oral agreement. Clark told Westec to send K proposal to Lanham who was to
execute and return it to Westec, but never did. Clark verbally authorized Westec to commence work.
Westec finished and sent bill to Lanham who never paid. Westec sued Lanham. Issue: Whether members
of LLC are excused from personal liability on K where other party had no notice that those members or
managers were negotiating on behalf of LLC at time K was made. Reasoning: Under LLC Act, the filing
of articles of organization serves as constructive notice of Co’s status as LLC. However, Westec did not
know Clark was acting as an agent for Co or that letters “PII” stood for “Preferred Income Investors,
LLC.” To broadly interpret the LLC Act’s notice provision would be an invitation to fraud. Held:
Lanhman and Clark did not identify Preferred Income Investors, LLC, as the principal in transaction. The
“missing link” b/w the limited disclosure made by Clark and the protection of the notice statute was the
failure to state what PII stood for.
i. General Rule – LLC Act notice provision applies only where 3rd party seeks to impose liability
on members simply due to their status as members/managers of LLC.
1. Exception: When 3rd party sues a member under agency theory, the principles of agency
law apply notwithstanding the LLC Act’s stat notice rules. If both existence and identity
of agent’s principal are fully disclosed to other party, agent does not become a party to
any K that he negotiates. But where principal is partially disclosed, it’s usually inferred
that agent is a party to the K. It’s a question of fact.
e. Fiduciary Obligation
i. McConnell v. Hunt Sports Enterprises (1999) – Facts: After breaking away from Columbus
Hockey LLC, McConnell obtained NHL franchise. McConnell sought declaratory judgment that
LLC operating agreement permitted members to compete for NHL franchise as well as judicial
dissolution of LLC. Hunt’s counterclaim alleged interference w/ prospective business
relationships and breach of K and fiduciary duty. Reasoning: Agreement stated that “members
can compete w/ one another.” Normally, the presence of a fiduciary relationship would preclude
direct competition b/w members. However, agreement here allowed it so there’s no breach of
fiduciary. Also, agreement stated that no members were to take any action on behalf of Co unless
approved by majority of members, which Hunt failed to do. Thus, Hunt engaged in wrongful
misconduct. Held: Operating agreement unambiguously allowed competition. In competing,
McConnell did not violate any fiduciary duties or commit any tortious acts. Hunt breached
operating agreement by unilaterally rejecting arena lease proposal and usurping control of LLC.
1. Note: You can adapt the LLC to whatever you want w/o losing the biggies of “Taxes”
and “Limited Personal Liability.” That is, you can change governance, duties and agency.
f. The Operating Agreement
i. Elf Atochem North America, Inc. v. Jaffari (1999) – Facts: Elf Π entered agreement w/ Jaffari
Δ, President of Malek Inc, to setup joint venture to create an EPA friendly maskant. Thereby,
forming Malek LLC as a separate entity. Elf, Malek Inc, and Jaffari entered into agreement
detailing governance of Malek LLC, not itself a signatory to the Agreement. Under Agreement,
Elf contributed $1M in exchange for 30% interest in LLC, and Malek Inc contributed its rights to
water-based maskant in exchange for 70% interest in LLC. Agreement also had an arbitration
clause. Π brought purported derivative suit on behalf of LLC calling into question whether: (1)
LLC, which did not itself execute the LLC agreement defining its governance and operation, was
bound by the Agreement; and (2) contractual provisions directing that all disputes be resolved
exclusively by arbitration or Ct proceedings in CA were valid under the Delaware LLC Act.
Held: (1) Agreement was binding on Δ LLC as well as the members; and (2) since the Act did
not prohibit members of an LLC from vesting exclusive subject matter jurisdiction in arbitration
proceedings in CA to resolve disputes, the contractual forum selection provisions must govern.
Vanessa Verduga 42
1. Policy of the Delaware LLC Act – to give maximum effect to the principle of freedom
of K and to the enforceability of LLC agreements. Allows broad discretion in drafting
and for default rules to come in only where members have not expressly covered the
situation. Also, Delaware recognizes a strong public policy in favor of arbitration.
g. Piercing the “LLC” Veil
i. Kaycee Land & Livestock v. Flahive (2002) –Facts: Ct was reluctant to reach a conclusion that
the equitable doctrine of PCV could never be employed in the LLC context. Ct first reviewed the
development of the PCV doctrine in the corporate context and then reviewed the legislative
history of the Act. Ct concluded that nothing in Act's history indicated a legislative intent to
prevent application of the doctrine in LLC context. Certainly, various factors that would satisfy
piercing the veil would not be identical to the Corp situation b/c LLCs are intended to be more
flexible than a Corp. Held: B/c the issue was presented as a certified question in the abstract w/
little factual context, remand was appropriate.
ii. LLC Act § 303(b) Liability of Members and Managers – Failure of LLC to observe usual Co
formalities or requirements relating to exercise of its Co powers or mgt of its business is not a
ground for imposing personal liability on members or managers for liabilities of the Co.
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THE DUTIES OF OFFICERS, DIRECTORS & OTHER INSIDERS
XVIII. Fiduciary Duties
a. Directors and Officers Of A Corporation Owe A Fiduciary Duty to:

i. Corporation
ii. Shareholders
b. Fiduciary Duties:
i. Duty of Care – directors may be procedurally inattentive
ii. Duty of Loyalty – directors put their own interest before the SHs; 2 scenarios include:
1. Related party transactions – conflict of interest
2. Misappropriation of business opportunity
c. Policy of Fiduciary Duties  balance b/w the freedom to manage & accountability
d. 2 Overarching Components:
i. Procedural Prudence
1. deliberate/time
2. information
3. consult/experts
ii. Substantive Merits
e. Application of BJR – Applies when BD did their job but made a stupid decision. BJR protects:
i. Board Members
ii. Roles of Court / Expertise
iii. SH protection
iv. Encourage Less Growth / Risk Taking
v. Encourage getting qualified BD Members.
f. BJR Does Not Apply to:

i. Negligence
ii. Malfeasance
iii. Nonfeasance (?)
g. Parameters of BJR – BJR creates a “rebuttable presumption” that O/Ds acted in good faith and in an
informed manner in making a business judgment. Once BJR is triggered, there is a new framework. Π
must rebut presumption by showing that board acted w/ dishonesty, gross dereliction of judgment, self-
dealing, egregious behavior, conflict of interest.
i. If you’re representing O/Ds  argue that the decision is protected under the BJR.
ii. If you’re representing SH  argue that this is negligence!
h. When Can the BJR Presumption Be Overcome? Varies. In some jurisdictions, Π can overcome the
presumption if Π can prove something short of showing that O/Ds were engaged of intentional
wrongdoing (high presumption to rebut). In NJ, the standard is lower to overturn what the O/Ds do. Thus,
NJ is less protective of O/Ds than other states (see Francis).
i. Strict Scrutiny of the BJR – After ENRON, Cts are going to apply the standards strictly to hold more
O/Ds accountable of their judgments (mistakes). That is, they’ll still get the protection of BJR, but cts are
going to scrutinize carefully how the decision was made, if it’s questionable. E.g. in Executive
Compensation issue, cts will not just let O/Ds say that they’ve made a business judgment and are
protected. Also, in connection w/ the CL (Sarbanes-Oxley Act of 2002) – lawyers are going to be held
Vanessa Verduga 44
accountable for what they do as well. If you’re a lawyer and you saw something being done by another
and you did nothing then you’re going to be held accountable b/c you did nothing to prevent it. Thus, the
shield of the rule is not as insurmountable as before. Note: If Smith v. Van Gorkom were decided today,
it would be on the front page of every newspaper as an example of a bad (horrible) board of directors
making decisions w/ little or no knowledge and being careless. See infra.
XIX. The Obligation of Control: Duty of Care
Duty of Care:
Directors should acquire at least a rudimentary understanding of the business of the Corp; directors should become
familiar w/ the fundamentals of the business in which the Corp is engaged
Directors are under a continuing obligation to keep informed about the activities of the Corp
Directors may not shut their eyes to corporate misconduct
Directors must generally monitor the corporate affairs and policies
This is a fact-sensitive analysis
a. Kamin v. American Express Co (1976) – Facts: Kamin, minority SH in Amex, brought a derivative suit
claiming Amex had engaged in waste of corporate assets by declaring a certain dividend in kind. Kamin
argued that the FMV of the DLJ shares was only $4M and that Amex should have sold them on the
market in order to offset the $25M capital loss against taxable capital gains on other investments and thus
obtain an $8M tax savings that would otherwise be unavailable. Reasoning: Real reason, Amex did not
want to do this was b/c it would affect their net income by making them look less profitable. This was not
a situation in which Amex directors totally overlooked the facts called to their attention; they gave them
consideration and attempted to view the total picture in arriving at their decision. Held: Whether or not a
dividend is to be declared or a distribution made is exclusively a matter of business judgment for the BD,
and cts will not interfere as long as it was made in good faith.
i. Pre-Business Judgment Process by the Board – examine the process that the board took to
make that judgment:
1. Consultation
2. Meeting Culture of Compliance &
Due Diligence Procedural Prudence
3. Deliberation
4. Expert Advice
b. Smith v. Van Gorkom (1985) – Facts: Πs argued that Δ directors’ decision to approve a $55 per share
cash-out merger of their Corp into another violated Del Code, and did not warrant BJR protection. Board
of Trans Union Corp voted to approve a merger agreement based solely on the representations of Van
Gorkom, one of its directors (soon to retire). Reasoning: On the surface the cash-out merger looks good
since it would’ve paid SHs $17 more than FMV per share. However, Pritzker knew he’d end up making
$100M b/c he would borrow $590M and sell of Trans Union’s assets for $690M and once it merged w/
his Co the stock price would go up from $55 to $65 on the market. Pritzer locked in the right to buy the
million shares unless somebody comes along and buys more at a higher price. He can’t lose. The cleverest
thing Pritzker did was give Van Gorkom 3 days to decide beginning Saturday night when they signed the
deal. 2 meetings were held. 1st w/ senior mgt, Van Gorkom told them about the offer and didn’t provide
them w/ hard copies of the oral presentation. Senior Mgt didn’t want the deal. 2nd, Van Gorkom holds
meeting w/ the BD, which doesn’t know anything about this deal. BD discusses offer w/ an investment
banker to determine whether or not the offer is fair. Brennan lawyer advised BD members that they might
be sued if they failed to accept the offer (serious flaw – malpractice). Note: Some SHs could’ve brought
suit against the BD for direct personal losses if they didn’t sell for $55. Held: Δ directors based their
decision on 1 person's representations, which did not constitute a report on which they could reasonably
Vanessa Verduga 45
rely under Del Code, and they did not seek documentation of either the merger terms or the adequacy of
the proposed price per share. Also, Δ directors were grossly negligent in permitting the agreement to be
amended in a way they had not authorized. Finally, SHs’ vote did not ratify the action and was invalid b/c
SHs weren’t aware of the lack of valuation info, and Δ directors’ statements were misleading.
i. General Rule: BJR shields O/Ds of a Corp from liability only if, in reaching a business decision,
the O/Ds acted on informed basis, availing themselves of all material info reasonably available.
1. BD was too trusting and careless. These judgments can no longer be made b/c the
damage Corp America has done to the public is so extreme that courts are going to be
stringent.
ii. Leverage Buyout – it’s the purchase of a Company financed by a relatively small amt of equity
(common stock) and a large amt of debt (which provides the leverage). Often assets of a
Company are sold to pay off part of the debt.
iii. Note: States have enacted statutes that eliminate O/Ds personal liability (unless there’s willful
misconduct). As a result, Corps are forced to take out huge O/Ds insurance, which ultimately
affects SHs in the end. If you’re asked to be a BD director, ask if there’s liability insurance for
directors. Also, know where the business is incorporated b/c different states have different laws,
and courts in different jurisdictions may be more strict or lenient.
c. Review: Duty of Care – Cts will focus on the process BD took in arriving at its substantive decision. BD
must have been careful, informed, and must have deliberated before reaching the substantive decision.
i. Was it a bad decision?
1. Irrational
2. Out of Proportion
3. Unreasonable by accepted BD standard
4. Inequitable / Unfair / Bad
5. Special Rules – Stringent BJR
a. E.g. Executive Compensation
d. Brehn v. Eisner (2000) – Facts: Eisner recommended his buddy Ovitz for Pres. Eisner negotiated an
employment K for Ovitz. Ovitz was given A and B stock options (ability to buy stocks at the locked in
price specified, usually lower than FMV); the B options never kicked in. He gets his base salary,
severance package and he gets the right to exercise the options, which are accelerated, so he doesn’t have
to wait. This creates a problem for the SHs b/c it was an incentive for him to get fired. Besides, he had no
experience as Pres of a Corp and he’s Eisner’s buddy. SHs challenge 2 things: (1) BD didn’t inform itself
properly prior to entering this agreement, and (2) BD is committing waste by giving Ovitz such a deal and
thereby reducing the assets of the Corp. Held: BJR clothes the BD w/ an armor of presumption, which Π
must rebut. Even though the deal was shocking ($140M for a no-cause termination), and the BD had a
sloppy bad expert upon who it relied, ct will protect the BD. Only thing left is to sue the compensation
expert for malpractice b/c he never actually did a spreadsheet analysis of what the consequences of the
agreement would be, but that’s a separate issue. As for the waste complaint, that’s a separate substantive
matter. Complaint was dismissed w/o prejudice. Currently in trial again.11
i. Relying on an Expert – Del law – if you rely on an expert then that’s helpful in getting you the
benefit of the BJR, but SH can rebut by showing that their reliance was not in good faith; they did
not reasonably believe the advice of the expert; expert was not selected w/ reasonable care;
subject matter was so obvious that BD’s failure to consider it was grossly negligent regardless of
expert’s advice, or that BD’s decision was so unconscionable as to constitute waste or fraud.
11
Riccio thinks this case is going to be settled and Ovitz is going to win.
Vanessa Verduga 46
ii. Waste Test – “an exchange that is so one-sided that no business person of ordinary, sound
judgment could conclude that Corp has received adequate consideration.”
iii. Precaution  The BD should’ve negotiated a pay-out w/ Ovitz. Not give him a no-cause
termination but rather a cause termination. Ovitz would’ve then gotten $0.
e. Francis v. United Jersey Bank (1981) – Facts: Lillian Pritchard ignored her duties as a director,
allowing her sons to w/draw over $12M from client trusts accounts. Δs argued that corporate directors
were not liable for fellow directors’ conversion of trust funds b/c they were not aware of it. Πs argued that
directors were negligent in not noticing or trying to prevent the misappropriation, and that their
negligence proximately caused the resulting harm. Reasoning: Directors have a duty to exercise ordinary
care in managing the Corp. Ordinary care includes becoming familiar w/ corporate business, staying
informed about activities, becoming familiar w/ corporate financial status, and objecting to or taking
means to prevent illegal activity when discovered. Held: Breach of fiduciary duty of care b/c of straight
negligence. Pritchard is liable for client’s losses b/c she made no effort to exercise her duties as a director.
i. Liability of a Corp’s Directors to its Clients Requires a Demonstration that:
1. Duty existed – standard of care was established by NJ statute;

2. Directors breached that duty – inherent in director’s role is a duty to acquire a basic
understanding of Corp’s business and a continuing duty to keep informed of its activities.
Overall monitoring of Corp’s affair and regular review of its financial statements.
3. Breach was a proximate cause of the clients’ losses – Π must substantiate negligence
(show inaction, did not attend board meetings, etc.)
f. If on the BD, know your responsibility in terms of the things the Corp or O/Ds do – 2 Respects:
i. Criminal Liability – it used to be that BD members didn’t have to worry about suits such as
RICO and other criminal offenses, but now if the BD knows that the CEO or the Corp is engaging
in wrongful behavior and doesn’t do anything then they may be indicted and found criminally
liable b/c they are found to have the mens rea to hold themselves criminally liable.
ii. Civil Liability – Duty of care:

1. BJR
a. Substantive (substance)
b. Procedural (process)
2. Situation where no BJR exercised but nevertheless the BD could be held civilly liable
b/c they failed to monitor the officers or workers or nonfeasance.
a. Eisner (Disney) case is non-monitoring
b. Prichard case is nonfeasance
g. To show that directors breached their duty of care by failing adequately to control employees, Πs
would have to show:
1. that directors knew or

2. should have known that violations of law were occurring and, in either event,
3. that directors took no steps in good faith effort to prevent or remedy that situation, and
4. that such failure proximately resulted in the losses complained of
a. Heart of the matter is that if you’re on the BD you either knew or should’ve
known that something wrongful was going on and you did nothing about it.
Vanessa Verduga 47
h. Things a BD could implement to satisfy duty of care to monitor and duty of care of the law (See
Caremark):
i. Ethics committee
ii. Retain council or experts
iii. Guidelines
iv. Periodic meetings w/ the board
v. Compliance department
vi. Training sessions – workshops (specifically about compliance w/ sexual harassment or
discrimination). BD must inform employees that such acts constitute a violation of the law, and
attempt to control those jerks violating the law so that when someone does bring a suit the board
could point to these things. You can’t stop employees from breaking the law, but you can try to
monitor, limit and contain them. Thereby, impeding the injured party from getting any $ from the
Corp/board for it.
1. Note: Do a cost-benefit analysis for implementing these things.

a. Benefits  less likely that Corp is going to get into legal trouble.
b. Cost  could be enormous.
i. In re Caremark Int’l Inc. Derivative Litigation (1996) – Facts: Caremark provided medical services
and patient care. It got most of it’s $ from Ins. Co. that funded bills and HMO. It was good for Caremark
to keep good relations w/ physicians in order to get referrals. In response to this, the anti-referral payment
OIG law was passed in 8/91. Caremark didn’t think they were paying the referral but had relations w/
doctors who were referring patients using the QSA that could be looked at as running afoul of the anti-
referral law. Caremark did many things to monitor employees to make sure the anti referral act was not
violated, especially after OIG came in “they kicked it up a notch.” Then the indictment came down on
Aug 4 1994 alleging that Brown got a kick back for writing prescription medication that Caremark was
writing (a quid pro quo) the very thing the anti referral act designed to protected. Aug 5, 1994, SHs file a
derivative action against Caremark. Note: Strike suit lawyers probably initiated the derivative action
immediately after they heard about the indictment. Held: Case settled for $800K and $53K in expenses.
i. Note: Although Caremark did not fail to exercise their oversight function, they settled instead of
going to trial in order to expend less legal fees, avoid possibilities of something not going their
way at trial, and then having the lawyer get legal fees for piggy backing this suit.
ii. Riteaid Case – Riteaid was the 1st pharmacy to begin the chain stores before others figured out
that lots of $ can be made by chaining drug stores and lowering prices due to economy of size.
While CEO of Riteaid is on trial on charges including conspiracy to defraud Riteaid and SHs by
inflating profits, the lawyer is also fucked b/c he gave some kind of tacit approval and then when
asked for documents said they’re probably in Atlantic Ocean. Derivative action was already
settled b/c it was easy since they had the FCC indictment to piggyback on. Thus, you basically
can’t lose. Also, have criminal culpability b/c BD members did not just fail to monitor but also
had criminal culpability as active wrongdoers. This was not just a breach of duty of care but also
of loyalty. The lawyer for Riteaid is on trial for criminal charges b/c of the advice he gave the BD
and for saying that the records were in the Atlantic Ocean.
iii. As lawyers, do not condone breaking of any laws! Don’t worry about the cost benefit analysis;
this will lead you down the wrong road. Also, don’t become an enabler for a client by saying “do
what you want; you’re on your own” cause guess what as your client they’re not on their own.
XX. Duty of Loyalty
Fiduciary Duties:
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Flow from a Fiduciary Relationship:
(1) Directors
(2) Officers
(3) Dominating Shareholders
LAF:
(1) What is the Transaction?
(2) What type of Matter is this – Duty of Care or Loyalty?
a. Duty of Care  BJR
b. Duty of Loyalty  Strict Scrutiny – here the burden shifts to directors to show that what the
transaction accomplished was “fair and reasonable” w/ proper “disclosure.”
Note: If you’re Δ, you want to make a duty of care case, but if Π, you want to make it a duty of loyalty (S/S) case.
a. Duty of Loyalty – Sometimes there are transactions where Directors have a self-interest that is apart from
the interest of the Corp. When SH attacks a transaction in which the directors have an interest other than
as directors of the Corp, the directors may not escape review of the merits of the transaction. Ct will view
it under a duty of loyalty analysis, rather than due care.12
b. Del Gen Corp Law §144 Interested directors – embodies the way the duty of loyalty works. “No K
or transaction b/w Corp and 1 or more of its O/Ds, or b/w a Corp and any other Corp, P-ship, Ass’n, or
other Org in which 1 or more of its O/Ds, are O/Ds or have a financial interest, shall be void or voidable
solely for this reason, or solely b/c O/Ds are present at or participate in meeting of BD which authorizes
the K or transaction, or solely b/c any such O/D votes are counted for such purposes, if:
i. What to do when Directors’ personal interest is conflicting w/ Corp’s – if:
1. §144(a)(1)13 – The material facts as to O/D’s relationship or interest are disclosed or

known to Board and when that happens the interested Director doesn’t vote.
2. §144(a)(2) – it’s better than (a)(1) – Material facts as to O/D’s relationship or interest
and as to K or transaction are disclosed or known to SHs entitled to vote thereon, and K
or transaction is specifically approved in good faith by vote of SHs; or
3. §144(a)(3) – if you screwed up under (a)(1) or (a)(2) – K or transaction is fair as to

Corp as of the time it is authorized, approved or ratified, by BD, committee or SHs - if
you can show that transaction was fair and reasonable ct will uphold transaction
(See Bayer).
a. Note: Even if transaction smells bad due to self-interest of Director, if it’s

otherwise fair it’s not void or voidable and it’s upheld.
c. Directors and Managers
12
Most common scenarios of “Conflict of Interest” – a director engages in a transaction w/ his own Corp; 2 Corps w/ a common director engage in a
transaction (“interlock”); a parent Corp engages in a transaction w/ a subsidiary; O/D usurps a corporate opportunity or O/D competes w/ the Corp.
13
Riccio has a problem w/ this rule b/c if dominating SH discloses to BD, they’re still going to vote in his favor.
Vanessa Verduga 49
i. Bayer v. Beran (1944) – Facts: Directors of Celanese Corp were charged w/ negligence and self-
interest in commencing a radio program b/c President’s wife was chosen to perform in it.
Reasoning: (1) Transaction – Dreyfus was 10% SH of Corp, part of the Board and CEO. 1st the
Board took action – it decided to spend $1M in advertising on radio Ad called the “Celanese
Hour” (high class opera music). 2nd thing BD did was hire Mrs. Dreyfus as singer. SH challenges
both actions. (2) Duty of Care/Loyalty – 1st Radio Ad implicates the duty of “care” b/c it flows
from the transaction and not the relation that directors had in the transaction. 2nd hiring Dreyfus’
wife implicates “loyalty” b/c it flows from the relation directors had in the transaction (personal
interest in it). B/c Dreyfus voted for the radio show before hiring wife there was no disclosure,
but it can be saved. Directors here have to show the inherent fairness of the transactions; burden’s
on Board. BD showed that (i) Wife could sing; (ii) she was actually paid less than other
comparable singers; and (iii) it was not done to boost her career. Thus, transaction was fair.
Held: Policies of business mgt are left solely to discretion of BD and may not be questioned
absent a showing of fraud, improper motive, or self-interest. No evidence that radio ad program
was inefficient, disproportionate in price, or conduced for the personal gain of Mrs. Dreyfus.
1. Duty of Loyalty in a Related Party Transaction:
a. Court will apply heightened scrutiny (BJR presumption is n/a)

b. Burdens shifts from Π to Δ; Δ must show it was a good faith transaction that is
fair and reasonable to the Corp (despite there possibly being some self-interest)
c. Concept of substantive and procedural prudence
i. Ct will see if transaction was done w/ procedural prudence
ii. Ct will see if it was inherently fair
1. Note: Ct will invoke the BJR following a preliminary

determination that the duties of care and loyalty have not been
violated.
2. Precaution  The easiest thing would’ve been to convince Dreyfus not to hire his wife,
and maybe keep the transaction at arm’s length. Even if there’s disclosure, at the end of
the day, ct will look at whether the decision was fair and reasonable.
ii. Lewis v. S.L. & E. (1980) – Facts: Lewis, SH of SLE, refused to sell his shares under K to
closely held Corp b/c its directors had committed waste for failure to charge a reasonable rent to
another closely held Corp w/ same O/Ds. Reasoning: Under strict scrutiny analysis, the burden
shifted onto Δs to meet both procedural and substantive prudence elements – show that the rent
paid by tenant reflected the FMV of the property. Held: Δs, as O/Ds and/or SHs of lessee Corp
while serving as directors of Δ closely held Corp, failed to prove that there was no waste.
Remedy for Π may be the difference b/w the book value and the FMV of the shares.
d. Dominant Shareholders – The majority has the right to control, but when it does, it occupies a fiduciary
relation toward the minority, as much as the Corp itself or its O/Ds.
i. Sinclair Oil Corp. v. Levien (1971) – Facts: Π SH of subsidiary Corp, brought derivative action
against Parent Corp for accounting of excessive dividends and breach of K b/w 2 subsidiaries.
Sinclair contended that, although it controlled its subsidiary Sinven and owed it a fiduciary duty,
its business transactions w/ Sinven should be governed by the BJR, and not by the intrinsic
fairness test. Held: Intrinsic fairness test should not be applied to business transactions where a
fiduciary duty exists but is unaccompanied by self-dealing.
1. Intrinsic fairness standard – is a defense to a claim that a director engaged in an

interested director transaction by showing the transaction’s fairness to the Corp.
Vanessa Verduga 50
2. Sinclair is a good case to show how everything comes together: There were 3
allegations against Sinclair:
a. Π claimed Sinclair paid excessive dividends  this decision is guarded by BJR
b. Π claimed Sinclair usurped business opportunities  2 potential issues:
i. Whether Sinven should get business outside of Venezuela is BJR
ii. Π argues that is an usurpation of business opportunity (Sinclair would
defend by saying Sinven’s line of business is Venezuela only)
c. Breach of Contract  Sinclair being the Parent company, this is self-dealing 
(Sinclair failed to show that its actions were intrinsically fair to Sinven) a duty of
loyalty issue regarding related-party transactions:
i. Related party
ii. Strict scrutiny
iii. Burden shifting
e. Misappropriation of Corporate Opportunity – where O/Ds seizes an opportunity that gets presented to
the Corp in which they’re the dominant SH or directors. They divert a business opportunity meant for the
Corp for themselves. Cts have criteria to determine whether what the O/D did was illegal or okay.
Corporate/Business Opportunity - 5 Factors:

Individual or official “Capacity” – What was the capacity of the director/officer/dominant SH when this
opportunity came about? Did it come about as a result of his relationship to the Corp or did it come to him
personally?
Corp’s “Capability” to take opportunity – Does the entity have the capability financial/legal/otherwise to
capitalize on the opportunity?
Line of Business – Is the opportunity w/in the general nature or scope of the type of business the entity is engaged
in?
Conflict of Interest – Whether if he follows through w/ the opportunity will that put him in a conflict of interest w/
the entity?
Process – When the opportunity was presented to him, how did he react? Was he sneaky/surreptitious or did they
disclose this opportunity to others?
There still will be S/S here, it needs to be fair and reasonable, and the shifting of the burden varies depending on
jurisdiction (some put it on Δ others don’t).
f. Broz v. Cellular Info Sys, Inc. (1996) – Facts: Broz utilized a business opportunity for his wholly
owned Corp instead of Cellular Information Systems Inc, for which he served as a member of the BD.
CIS sued Broz alleging that the purchase constituted a usurpation of a corporate opportunity that allegedly
belonged to it. Held: Broz did not usurp an opportunity that belonged to CIS. Corporate opportunity
doctrine is implicated only in cases where the fiduciary’s seizure of an opportunity results in conflict b/w
the fiduciary’s duties to the Corp and the self-interest of the director as actualized by the exploitation of
the opportunity. Broz was not required to consider the contingent and uncertain plans of a 3rd party that
sought to acquire CIS in reaching his determination of how to proceed.
g. Corporate Finance – 2 ways to fund a Corporation:
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i. Equity Financing- Sale of shares of stock. Unlimited upside potential and unlimited downside
risk – young people go for these risky investments. A Corp issues stock in return for
consideration such as $, property or services (something of value). Corp traditionally engages in
this type of financing to raise capital for its business. There are classes of shares of stock – sort of
like P-ship. In absence of contrary, each share is of equal value, rights, etc. But Corp creates
classes of stock to motivate investors to buy depending on what type of class they find suitable:
1. Common
2. Preferred
3. Voting
4. Non-voting
5. Convertible
a. Stocks are sold in 2 different markets – 2 different ways to raise $

i. Initial Public Offering (IPO) – Primary Market
ii. Secondary Offering – Secondary Market – investors invest at risk.
ii. Debt Financing – Opposite of Equity Financing b/c people don’t invest $ they’re loaning it as
creditors. Under the terms of the debenture, the Corp promises to pay them back (it’s similar to
borrowing $ from a bank, but instead it’s the public lending the $ in the form of bonds). This is
preferable for people that are risk averse. Types are debenture, a bond, an annuity, etc.
1. Note: Corporate financing companies put these together and package them for investors,
either based on equity or debt financing.
iii. Zahn v. Transamerica Corp. (1947) – Facts: Π held Class A stock in a Axton-Fisher Tobacco
Co. Δ, Transamerica, owned virtually all of the same A-F’s Class B stock and dominated the mgt,
business, and affairs of the Co. Π filed a class action suit alleging that Δ caused A-F to redeem its
Class A stock and then liquidated the Co so that Δ could acquire most of the value of A-F for
itself. Reasoning: There was no reason for the redemption of the Class A stock to be followed
by the liquidation of A-F except to enable Class B stock to profit at the expense of the Class A
stock. Held: Transamerica breached duty of loyalty b/c they failed to disclose material info that
would have allowed them to get more value for their stocks. Δ as majority SH, has a fiduciary
duty to minority Class A SHs that is similar to the duty owed by a director, and when a
dominant/controlling stockholder is voting, he violates his duty if he votes for his own personal
benefit at the expense of the stockholders. Act of redeeming the Class A stock was consummated
at the direction of Δ, for its own profit, not for the protection of the minority SHs' interests.
1. Disgorgement – it’s a remedy – when you’ve gotten $ illegally, you must give it back.
XXI. Disclosure & Fairness
a. The SEC has 2 major responsibilities:

i. Make sure there’s adequate disclosure to public, and
ii. Make sure stock trading is done properly w/ integrity
b. Every state has Securities laws, which you should abide by. Some states will even engage in merit
(approval) review by looking at the offering prior to it being sold.
i. Sarbanes-Oxley Act of 2002 – Gov’t reaction to corporate abuses in the aftermath of corporate
scandals i.e. Enron. It makes changes to the Securities Exchange Act of 1934 since it’s aimed at
addressing problems relating to publicly held companies.
c. What is a Security?
Vanessa Verduga 52
i. Exchange Act (1934) §2(a)(1) – lists financial instruments that qualify as securities. “Unless the
context otherwise requires….
1. “security” means any note, stock, treasury stock, bond, and/or debenture;
2. Evidence of an indebtedness, certificate of interest or participation in any profit-sharing
agreement, investment K, voting trust certificate, any put, call, straddle, option, or
privilege on any security, certificate of deposit, or group or index of securities … or, in
general,
3. Any interest or instrument commonly known as a “security,” or any certificate of interest
or participation in, temporary or interim certificate for, receipt for, guarantee of, or
warrant or right to subscribe to or purchase, any of the foregoing
ii. Break it down into 3 issues:

1. Context otherwise requires
2. Typical Securities
3. Atypical Securities – i.e. Investment K
a. If transaction qualifies as a security then all rules and regulations that pertain to
securities will apply.
iii. Howey test – 3 requirements to determine if it’s a security:

1. An Investment of $
2. In a Common Enterprise
3. W/ profits to come solely from the efforts of others
d. Great Lakes Chemical Corp. v. Monsanto Co. (2000) – Facts: Monsanto and SDI are members of an
LLC. Great Lakes buys NSC, problem is that the sweetener (product) depreciated in value and this wasn’t
disclosed to them. Thus, they think they’ve been deceived into buying NSC so Great Lakes sues alleging
that Δs failed to disclose material info in conjunction w/ sale of an LLC in violation of Fed statute and
state law. Δ argues that the interest acquired by Π in NSC was not a security under the Fed statute. Held:
Fed securities statutes did not apply to the transaction b/c the interests transferred were not traditional
stock, where the LLC was not a Corp, and the instruments purchased by Π did not constitute an
investment K b/c there was no investment in a common enterprise. Further, no investment K subject to
securities laws was shown where Π's authority to remove LLC managers w/o cause indicated that Π was
not a passive investor whose profits derived solely from the efforts of others. Great Lakes’ federal claim
is dismissed; state claims get dismissed w/o prejudice to be reinstituted in State ct.
i. Note: Great Lake could’ve had a claim for breach of covenant of good faith and fair dealing and
breach of K. However, Great Lake’s lawyer brought a claim under the Fed Securities Law b/c you
can bring it into fed ct under Fed Q Jurisdiction.
ii. Analysis: Great Lakes made 3 arguments to convince the ct that it was a security:
1. That the security was a stock

2. That it was an investment K
3. That it falls w/in any interest known as “security”
a. Note: There’s the Forman test for argument (1) stock and the Howey test for (2)
investment K.
iii. 1st argument – Under Forman factors – common features of stock:

1. Right to receive dividends contingent upon an apportionment of profits
2. Negotiability
3. Ability to be pledged or hypothecated
4. Voting rights in proportion to the # of shares owned; and
5. Ability to appreciate in value.
Vanessa Verduga 53
a. Ct found that although it may seem “stock-like” in nature, it was not a traditional
stock. Ct looked to the primary goal of the securities law, which is to regulate
investments, and not commercial ventures. Ct based it on “context” which is the
escape clause “unless the context otherwise requires.”
iv. 2nd argument – Under Howey factors – for an Investment K there must be:
1. An investment of $ - this was not in dispute
2. In a common enterprise - there wasn’t a pooling of interests; Great Lakes bought the
whole thing.
3. W/ profits to come solely from the efforts of others – profits here came from Great
Lakes, not solely from somebody else.
a. Thus, it’s not an investment K.
v. 3rd argument – Ct found that it doesn’t fall under “any interest.” If it’s not an investment K then
it’s not any interest commonly known as “security” b/c there’s no distinction b/w the 2.
e. Registration Process
i. The Securities Act of 1933 – is primarily concerned w/ Primary Market. Goals: (1) mandating
disclosure of material info to investors, and (2) prevention of fraud. Note: Not a merit review.
ii. Securities Act (1933) §5 General Rule – Unless a registration statement is in effect as to a
security, it shall be unlawful for any person, directly or indirectly, to sell a security. 15 U.S.C.
§77(e).
1. Imposes 3 basic rules:

a. A security may not be offered for sale through the mails or use of other means of
interstate commerce unless a registration statement has been filed w/ the SEC,
b. Securities may not be sold until registration statement has become effective, and
c. The prospectus must be delivered to the purchaser before a sale
iii. 2 parts to the Registration Process:

1. Prospectus – a disclosure document, and
2. Registration Statement – a prospectus, which tells you about the Co, it’s business,
financial condition, why it needs $, why it’s selling stock to raise $, risk of investment,
competition, it tells you more than you want to know. Rationale – Congress has decided
that before someone invests in a public Co he must have enough info to make an
informed decision to buy or not the stock.
a. Both go to the SEC. Before sale, SEC requires purchaser to receive preliminary
prospectus. Prospectus goes to purchaser when sold.
iv. Securities Act §4 Exemption to the General Rule – under certain situations you can sell a
security w/o going through the cost and aggravation of filing a registration statement. Sometimes
people that are going to buy the stock don’t need this info maybe b/c they’re highly sophisticated
investors. Such as:
1. Transactions by any person other than an issuer, underwriter or dealer – meaning
that the 3rd party is exempt from filing a registration statement (your average Joe who
bought some stock doesn’t need to file this – there’s nothing to be gained by having him
do this b/c he may not know nothing about the Co.)
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2. Transactions by an issuer not involving any public offering - private offering which is
exempted only for the initial sale, and not to the resale of such security.
v. Parties involved in the registration process:

1. Underwriters (lawyers) – generally get 2-3% of the deal
2. Accountants- gives evaluation to the financial aspect of the investment enterprise
3. Issuers – lawyers
f. Doran v. Petroleum Mgt Corp. (1977) – Facts: Δs organized a limited P-ship for purpose of drilling
wells. When Doran became a participant in P-ship, he assumed responsibility for payment of a
promissory note to be paid from production payments. The wells were shut down b/c of violations of
production allowances and the note went into default. The lender obtained a state judgment against Doran
and Δs. Doran filed suit for rescission of the K based on violations of the securities registration
requirements of the Securities Act of 1933 and 1934. Δs claimed the offering was private and, therefore,
exempt from the requirements. Held: Even where an offering of securities is relatively small and is made
informally to just a few sophisticated investors, it will not be deemed a “private offering” exempt from
the registration requirements of the 1933 Act absent proof that each Offeree had been furnished, or had
access to, such info about the issuer that a registration statement would have disclosed. Note: Purchasing
a limited P-ship interest is a security.
4 Factors Relevant to Whether an Offering Qualifies for the §4(2) Exemption:
(1) Number of Offerees and their relationship to each other and the issuer:
a. The role of investment sophistication – there must be sufficient basis of accurate info upon which
sophisticated investor may exercise his skills.
b. Requirement of available info – Δ must demonstrate that all Offerees, whatever their expertise,
had available the info a registration statement would have afforded a prospective investor in a
public offering.
(2) Number of Units Offered
(3) Size of the Offering
(4) Manner of the Offering
g. Safe-Harbor provisions – As §4(2) is notably imprecise, most issuers who hope to rely on it turn to
SEC’s Regulation D. In addition, many lawyers will rely on Rule 144.
i. Regulation D – Provides a series of safe-harbors that issuers can use to come w/in the private-
placement exemption and avoid (or reduce) their required disclosure by using “reasonable care”
to make sure buyers are planning to hold the stock themselves. To show such care, they should
exercise “reasonable inquiry” into buyer’s plans, disclose to buyers that stock is unregistered and
subject to various resale restrictions, and print those restrictions directly on the stock. In most
cases, issuer must give buyers some info about Co. Extent of info required varies w/ amt of $ at
stake. (See pp 422 for how Reg D works).
1. Reg D and §4(2) generally exempts only the initial sale (works only once). Most buyers
can resell the securities only if they find another exemption.
ii. Rule 144 – subject to various qualifications, the rule allows buyers to resell stock they acquire in
a Reg. D offering if they 1st hold it for 2 yrs and then resell it in limited volumes.
Vanessa Verduga 55
h. Remedies – what happens when securities are sold either w/o a Regis statement, which it should’ve had,
or w/ Regis statement, which was faulty? Rescind K and get $ back; returned to status quo before
transaction was consummated. Injured party is entitled to both private and public remedies.
i. 3 statutory rights relevant for purposes of Private Remedies:
1. Exchange Act §11  15 U.S.C. § 77(k) – Anybody who has anything to do w/ a

“materially” false registration can be held liable. Allows injured party to get damages.
This rule requires a Registration statement to be applicable.
2. Exchange Act §12  15 U.S.C. § 77(l) – deals w/ imposing strict liability on

issuers/sellers of securities w/o a registration statement when they should’ve had one
(Doran – not entitled to the exemption and failed to file Registration statement, thus
they’re strictly liable under §12 – automatic rule of rescission).
3. Exchange Act §17  15 U.S.C. § 77(q) – deals w/ fraud in connection w/ sale of

securities – allows injured party to get damages. It’s a blanket rule – w/ or w/o Regis
statement.
ii. Public Remedies:

1. SEC
2. Exchanges
3. Indictment
SEC Act §11(b):
No person, other than issuer, shall be liable as provided therein who shall sustain the burden of proof. That is, if
you’re the issuer then you’re toast b/c this is strict liability for issuer. If you’re anybody, other than issuer, then
you have available to you the defense of “due diligence.”
Registration statement contains untrue statement of material fact or omitted to state a material fact.
Materiality – “an average prudent investor ought reasonably to be informed before purchasing the security
registered.”
Issuer: strict liability (no due diligence defense)
All others: can assert due diligence affirmative defense
Experts: due diligence (only as to their expertise portion)
Do not have to show Scienter or reliance.
i. Escott v. BarChris Construction Corp (1968) – Facts: Escott and other purchasers of 5½ % convertible
debentures14 sued BarChris for material false statements and omissions on the registration statement of the
debentures. BarChris (constructor of bowling alleys) were the underwriters and auditors. Δs, except for
BarChris, to whom, as the issuer, the defenses are not available, asserted a due diligence defense. Held:
A prerequisite to liability is that the info falsely stated or withheld is material. Gross overstatements of
sales, profits, and customer orders; understatements of liabilities; and the failure to disclose officer loans,
customer delinquencies, and application of proceeds constituted material matters. Moreover, Δs who had
known that the statements contained false info, as well as Δs who had failed to investigate or verify info,
14
Debentures – long-term unsecured debt securities issued by a Corp. Like a bond, but not a bond nor a stock, but can be converted to a stock.
Vanessa Verduga 56
but merely relied upon the statements of others, cannot assert a due diligence defense. Such defense
requires a showing that Δ had made a reasonable investigative effort or had a reasonable basis for
believing that the info was true.
i. Was the Registration statement false and misleading? Yes
ii. Were the false and misleading facts stated or omitted “material”? Sales were overstated, but
found not to be material b/c debenture was rated “B” (characterized as speculative) so investor
knew what he was getting himself into. Balance sheet was also overstated in terms of assets, and
contingent liabilities were understated. Other portions were wrong as well. Ct found these to
make the investment less attractive and thus, the 1961 figures were material.
iii. If so, have Δs established their affirmative defenses of due diligence? Due diligence is a
defense under SEC Act (1933) §11 when Δ believes after a reasonable investigation, and there are
reasonable grounds to believe, that alleged misstatements are correct and that there are no
material omissions. “He can escape liability only by using that reasonable care to investigate
the facts which a prudent person would employ in the mgt of his own property.”
1. Vitolo (Pres) & Pugliese (VP) – not smart men, but not as naïve as they claim to be 
No due diligence.
a. Should’ve asked questions to show they didn’t have blind/ignorant reliance.
2. Kircher (treasurer of BarChris & CFO) – worked on preparation of Regis statement 
No due diligence.
3. Birnbaum (lawyer) “signed” the Regis statement, hasn’t read it, doesn’t know what’s in
it, but is personally liable – this is not malpractice case, but failure to exercise due
diligence.
4. Auslander (“outside” director) may have investigated at first and he signed 2 signature
pages w/o knowing what it was for, but he later on found out about it and didn’t take the
time to read the Regis statement so, he’s liable.
5. Grant (director of BarChris), his law firm was handling this (BE CAREFUL – when
you’re a director don’t send your work to your law firm b/c it’s a potential “conflict of
interest”). He was most directly concerned w/ Regis statement  No due diligence.
6. Peat, Marwick – expert (only responsible for expert portion) – did nothing to verify the
info  No due diligence.
a. They all probably were not fraudulent in their actions, but were stupid and
careless in not conducting a reasonable investigation of the material facts
pertaining to the Regis statement.
j. Integrated Disclosure and Exchange Act Disclosures – Originally, Securities Act of 1933 and
Exchange Act of 1934 had separate disclosure systems, but due to overlapping chaos SEC adopted
modern integrated disclosure system, which starts w/ the reports that must be filed under the Exchange
Act. All publicly traded companies, as well as some large close Corps, are required to file Exchange Act
reports. Covered Corps must register w/ SEC by filing an initial Form 10 only once. Thereafter, Corp has
to annually file 10-K of audited financial statements and mgt’s report of previous yr’s activities and
usually also SHs’ annual report. Must also file 10-Q (1st 3 quarters of yr), and, finally, form 8-K w/in 15
days after certain events affecting Corp’s operations or financial condition. In addition to periodic
disclosures, registering a class of securities under Exchange Act triggers variety of other requirements –
i.e. issuer becomes subject to proxy rules and tender offer rules under §§ 13, 14 and certain anti-fraud
provisions of the Act.
k. Rule 10B-5: Employment of Manipulative and Deceptive Devices (implementing regulation of §10(b)
of 1934 Act) – It shall be unlawful for any person, directly or indirectly, by the use of any means or
Vanessa Verduga 57
instrumentality of interstate commerce, or of the mails or of any facility of any national securities
exchange,
i. to employ any devise, scheme, or artifice to defraud,

ii. to make any untrue statement of a material fact or to omit to state a material fact necessary in
order to make the statements made, in light of the circumstances under which they were made,
not misleading, or
iii. to engage, in any act, practice, or course of business which operates or would operate as a fraud
or deceit upon any person,
iv. in connection w/ the purchase or sale of any security.
1. It’s an implied private right of action under Exchange Act §10(b) and Rule 10b-5.
Federal ct has exclusive jurisdiction over 10b-5; Π can bring all their state claims under
supplemental jurisdiction §1367. SC said SOL is 1 yr after discovery of fraud, but in no
event more than 3 yrs from the time the fraud took place. This is like a “catch-all for all-
inclusive fraud”, only need the purchase or sale of security.
Rule 10B-5 “Purchase/Sales of Securities in Connection w/ Fraud Therewith”

(1) Jurisdiction – transaction has to involve an instrumentality of interstate commerce (i.e. phone, mail, email, press
release, all of these are instrumentalities of I/S C).
(2) In connection w/ purchase or sale of security
a. Defining the security is an important factor – you have to satisfy this requirement.
b. Also, you must show that wrongful act of which you’re complaining is in connection w/ the security
transaction.
c. 10b-5 is not a substitute for a breach of fiduciary duty.
d. 10b-5 is broader than §11 b/c it applies to registration statement or exempt transaction, whereas §11 only
applies to registration statement or prospectus.
e. 10b-5 applies to Reg. or non-Reg. buyer or seller, whereas §17 of 1933 Act only applies to sellers.
(2) Standing – person who brings action has to be an actual buyer or seller of securities (Blue Chip Doctrine).
(3) Deceptive/Manipulative – there has to be some manipulation, fraud, deceptive, dishonest something deceitful
has to have occurred.
(4) Scienter – Must have intent to deceive, manipulate or defraud. Intent is purposeful or reckless, not negligent
(Hochfelder Doctrine).
(5) Materiality – depends on what the reasonable investor would want to know – what would influence his decision
to purchase or not.
(6) Reliance / Causation – there must be a link b/w the unlawful act and the injury complained of. Loss was
proximately caused by the wrongful act complained of. Reliance and causation go hand in hand  if you didn’t
rely upon the wrongful act to make your decision then you have no causation. Lots of times a person doesn’t rely
on the wrongful act, but the market does and that’s what gave rise to:
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a. Fraud on the Market theory (a.k.a. Efficient-capital-market hypothesis) – substitute for actual reliance
(Basic Doctrine).
b. Efficient Market Capital Hypothesis – Market price gets influenced by fraud, substitute for actual
reliance; false information entering the market driving the price down. You can have a claim even if you
didn’t know of the wrongful act if you show that there was a public disclosure that influenced the market.
c. Rebuttable presumption of reliance:
i. Show that “market makers” were privy to the truth
ii. News entered the market, those who traded after corrective statements would have no direct or
indirect connection with fraud
d. Materiality - a misrepresentation (both affirmative and omission) has to be material- a statement is
material when there “is a substantial likelihood that the disclosure of the omitted fact would have been
viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made
available (Northway)
e. Causation – 2 kinds:
i. Transaction Causation - but for the misrepresentation, I would not have done this, and
ii. Loss Causation - harm done was proximately caused by misrepresentation
 Need both
(7) Remedies – damages and rescission
(8) Aiding and Abetting Liability - there is no implied right of action against aiders and abettors (Central Bank
Doctrine)
l. Basic Inc. v. Levinson (1988) – Facts: Basic was involved in merger discussions w/ another company.
Yet it publicly denied that any merger discussions were under way, and denied knowing any other reason
why the company’s stock was trading heavily and setting new highs. A buyout of Basis was finally
announced, and SHs who had sold prior to the buyout announcement at less than the final buyout price
brought a class action. Πs claimed that they were injured by having sold shares in Basic at artificially
depressed prices in a market that had been affected by Basic’s misleading statements. Held: An omitted
fact is material if a reasonable SH would consider it important in making their vote and this standard
should be applied to all §10(b) and Rule 10b-5 actions. Also, materiality requires a case by case review of
the facts, and a rebuttable presumption exists that stockholders relied on available info when buying or
selling securities. SC essentially accepted the “fraud on the market” theory and consequently gave Π
the benefit of a presumption of reliance on Δ’s misleading statements.
i. Is there jurisdiction? Yes – announcements made  instrumentalities of I/S Commerce.

ii. It is in connection w/ the actual purchase or sale.
iii. Standing15 – SHs alleged that they were injured by selling Basic shares at artificially depressed
prices in a market affected by Basic’s misleading statements and in reliance thereon.
iv. Deceptive/Manipulative – you can argue that the 1st press release was not deceptive or
manipulative, but the 2nd one was deceitful.
15
Someone who was thinking of buying but didn’t and later found out about the wrongful act and thought “I should’ve bought it then” - he can have
a witness to testify that he wanted to buy but didn’t due to the wrongful info  he has no standing. Some people think this is not a good rule b/c such
person should have standing.
Vanessa Verduga 59
v. Scienter – it’s not present here; it’s premature – in fact this is a summary judgment.
vi. Materiality – To fulfill the materiality requirement there must be a substantial likelihood that the
disclosure of the omitted fact would’ve been viewed by a reasonable investor as having
significantly altered the “total mix” of info made available.
1. 2 categories of materiality:
a. Straightforward - Where the impact of corporate development on the target’s
fortune is certain and clear, materiality definition is straightforward.
b. Contingent/Speculative – If event is contingent/speculative in nature, it’s
difficult to ascertain whether “reasonable investor” would have considered the
omitted info significant at the time. I.e. Merger negotiations, b/c of ever-present
possibility that contemplated transaction will not be effectuated.
vii. Reliance/Causation  Fraud on the Market Theory – is based on hypothesis that, in an open
and developed securities market, the price of a company’s stock is determined by the available
material info regarding the company and its business. Misleading statements will therefore
defraud purchasers of stock even if the purchases do not directly rely on the misstatements. It
becomes the casual connection b/w Δs’ fraud and Πs’ purchase of stock in such a case.
1. The most important way in which Π can show that he was harmed by Δ’s misconduct
even though he did not rely on anything Δ said or did.
2. Instead of requiring §’s to prove that he personally knew of Δ’s misstatements and relied
on them in making his decision to sell the stock, Ct would presume that:
a. The price of Δ’s stock at any time reflected everything that was publicly known
about Δ’s prospects, and
b. Therefore, the price Π received was affected by any material misrepresentations
made to the public by Δ.
3. Where materiality misleading statements have been disseminated into an impersonal,

well-developed market for securities, the reliance of individual Πs on integrity of market
price may be presumed. An investor who buys or sells stock at price set by market does
so in reliance on integrity of that price. B/c most publicly available info is reflected in
market price, an investor’s reliance on any public material misrepresentation, therefore,
may be presumed for purposes of rule 10b-5 action.
a. Any showing that severs the link b/w alleged misrepresentation and either the
price received by Π, or his decision to trade at fair market price, will be sufficient
to rebut the presumption of reliance.
m. West v. Prudential Securities, Inc. (2002) – Facts: Investors alleged that their stockbroker who worked
for Co told investors that a certain bank was going to be acquired at a big premium. This statement was a
lie. Investors traded on this info which they thought was confidential. In their lawsuit, investors sought
class certification for everyone who bought the bank's stock during the months when the stockbroker was
making his false statements. Held: Fraud-on-the-market doctrine does not apply b/c info was not made
available to the public. The investors failed to identify any causal link b/w the non-public statements/info
and securities prices.
i. Note: Theory not allowed b/c in Judge’s economic mind he has concluded that a contingent
merger press release and the broker statement to 11 clients is not going to have a casual effect on
the market. Riccio doesn’t agree – Judge does not know that those 11 clients might talk to more
clients. Info disseminates quickly – this was the dissent’s issue.
Vanessa Verduga 60
XXII. Inside Information
a. 3 Types of Material Non-Public Information – comes up in the context of:
i. Insider – Secrist and Wahsal (Martha Stewart)
1. Permanent Corporate Insiders (Directors, officers, counsels, etc.)

2. Temporary Insider (Consultant, Attorney, Accountant) – someone who’s professional
duties gives them access to inside info of a Co, no matter if only temporary, they still
have access to what the general public doesn’t.
ii. Tippee – persons to whom the Insider tips info of a material non-public matter. I.e. Wahsal’s
daughter and father.
iii. Outsider – O’Hagan (he got info by virtue of his status working for law firm) and Chiarella
b. Insider/Tippee context  Traditional Classical Theory – Purpose is to Protect SHs (fiduciary duties)
i. Insider “classical theory” context – §10(b) and Rule 10b-5 are violated when a corporate
insider trades in the securities of his Corp on basis of material, nonpublic info. Trading on such
info qualifies as a “deceptive device” under §10(b) b/c a relationship of trust and confidence
exists b/w SHs of Corp and those insiders who have obtained confidential info by reason of their
position w/ that Corp. That relationship “gives rise to a duty to disclose or to abstain from trading
b/c of necessity of preventing a Corp insider from taking unfair advantage of uninformed
stockholders.” This theory applies not only to O/Ds, and other permanent insiders of Corp, but
also attorneys, accountants, consultants, and others who temporarily become fiduciaries of a
Corp. Way around this problem is to abstain or disclose. If you abstain, nothing happens; there’s
no case. If you disclose, you’re making the info public. It’s a straightforward fiduciary duty issue.
ii. Tippee “classical theory” context – is more complicated. E.g. Martha Stewart is a tippee w/ no
fiduciary duties to anyone. Prosecutors dropped this claim against her b/c it would be hard to
prove that Washal (insider) tipped her w/ the info. So, she’s indicted for a cover up as to the
investigation of whether or not she’s a tippee.
c. Outsider context  Misappropriation Theory – Purpose is to Protect the Integrity of the Market
i. Misappropriation Theory – A person commits fraud “in connection w/” a securities transaction,
and thereby violates §10(b) and rule 10b-5, when he misappropriates confidential (material
nonpublic) info for securities trading purposes, in breach of a duty owed to the source of the info.
Under this theory, a fiduciary’s (agent - O’Hagan) undisclosed, self-serving use of a principal’s
(law firm) info to purchase or sell securities, in breach of a duty of loyalty and confidentiality,
defrauds the principal of the exclusive use of that info. In lieu of premising liability on a
fiduciary relationship b/w Co insider and purchaser or seller of Co’s stock (classical), the
misappropriation theory premises liability on fiduciary-turned-trader’s deception of those who
entrusted him w/ access to confidential info.
d. Information Disparity – where different people know different things - likelihood is that seller and
buyer have different info. This is not so much of a problem, but access disparity is.
e. Access Disparity – by virtue of their status, people are able to gain info that is non-public material
(Insider/Tippee/Outsider).
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i. Note: If you’re an outsider, and you get non-public material info as long as you’re not breaching
a duty to anyone then you may divulge it.
f. Dirks v. SEC (1983) – Facts: Dirks was an analyst of a broker-dealer firm that specialized in investment
analysis of insurance company securities to investors. Dirks received info from Secrist (Insider) that a
Corp had vastly overstated assets. Dirks discussed this info w/ clients, and some of those clients sold their
holdings in the Corp. Dirks also spoke to a WSJ reporter to get him to write on it to expose the Corp
fraud, but he didn’t believe him. Basically, Dirks, relying on some nonpublic info he received and a
subsequent investigation, aided the SEC in convicting EFA for corporate fraud and was then sued by the
SEC for violating §10(b) b/c he openly disclosed the nonpublic info to investors. SEC argued that he
aided and abetted the violations by repeating the allegations to members of the investment community.
Held: There was no actionable insider-trading violation by Dirks where he was a stranger to the Corp,
had no fiduciary duty to Corp’s SHs, did try to gain corporate SH’s confidence, and did not illegally
obtain the info about the Corp. Dirks as a tippee had no duty to abstain from use of the inside info.
i. General Rule: A tippee assumes a fiduciary duty to the SHs of a Corp not to trade on material
nonpublic info only when the insider has breached his fiduciary duty to the SHs by disclosing
the info to the tippee and the tippee knows or should’ve known that there has been a breach.
1. There was material non-public info – Secrist gave this info to Dirks.
2. Ct found no breach of fiduciary duty b/c the insiders are whistleblowers actually helping
the Company. They deserve a medal for uncovering the fraud.
3. Therefore, Dirks couldn’t have known of any breach of a fiduciary duty.
Tippee Liability:
(1) There must be material non-public info
(2) Insider breaches fiduciary duty
(3) Tippee knew or should’ve known of breach of fiduciary duty by Insider
Tippee’s liability is a derivative liability that stems from the liability of the Insider.
Loophole: Since liability is derivative, tippee must 1st show that insider breached fiduciary duty (factual issue) b/c
tippee has no duty to anyone.
g. SEC v. Switzer (1984) – Facts: Barry was football coach (almost of god-like status in his town). He was
at H.S. track watching son compete. Couple (Plat CEO and wife) was also there watching their son
compete. During a break, Barry ends up sunning himself at the bleachers and the couple decides to have a
conversation near Barry. Plat tells W about a merger that is going to happen b/w his company and another
company. Barry gets his buddies and they buy the heck out of the Co b/c the price of the stock is going to
rise. SEC says that Barry traded on insider info and is a tippee. Held: for Barry – he’s a lucky guy. On
theory that insider didn’t breach a fiduciary duty just by talking of the info w/ his wife (she wasn’t going
to do anything w/ that info) – thus, no tippee derivative liability.
h. Chiarella v. U.S. (1980) – Facts: Chiarella worked for a printing company as “markup” man. As he’s
doing his typesetting, he reads what he’s putting together and realizes that he can profit from the tender-
offer info in the document by buying stock to make a huge profit. When tender-offer was announced, the
target shares rose in value and Chiarella sold his shares at a profit. Held: Chiarella did not violate Rule
10b-5 b/c he was not an “insider” of Corp. Chiarella is not a tippee b/c he did not receive info from an
Insider. He did get the info from a law firm who was an Insider. However, by the nature of his job he got
to see the document, but not by volition did he get the info.
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i. Note: Under the misappropriation theory Chiarella would’ve been liable b/c under that theory,
there is a duty to the source of the info and Chiarella had a duty to his employer and his
customers. However, ct didn’t go down that road and Chiarella got away w/ it. There was no way
legally to impose a Rule 10b-5 liability b/c he had no duty to anyone.
i. Misappropriation Theory
i. U.S. v. O’Hagan (1997) – Facts: O’Hagan partner in law firm which represented a company
regarding a potential tender offer for the common stock of Pillsbury. During representation,
O’Hagan purchased call options for the other company's stock and sold them for a significant
profit. After SEC initiated an investigation into O’Hagan’s transactions, a jury convicted him of
securities fraud. Reasoning: O’Hagan obtained confidential info by virtue of his association w/
Corp’s law firm. Held: Criminal liability under §10(b) may be predicated on the
misappropriation theory for breaching a fiduciary relationship w/ source of the info.
1. A person who improperly uses confidential info from one other than the issuer can
be liable under Rule 10b-5.
2. Rule 10b-5 Analysis:
a. Jurisdiction – Yes it involved an instrumentality of interstate commerce.

b. In connection w/ purchase or sale of security - He bought stock and call-option
– he knows that price of stock is going to go up (similar to Chiarella – both had
info of an impending tender-offer). O’Hagan could’ve abstained or disclosed to
Pillsbury or the Law Firm. He made $4.3M – he needed this to replace the
embezzling of client trust funds.
c. Standing
d. Deception
e. Scienter – the source of the info was being deceived.
f. Materiality – yes
g. Reliance/Causation – who suffered the loss? Nobody really got hurt, but the
Integrity of the Market got hurt – Fraud on the market theory.
3. Note: O’Hagan case is criticized (similar to Santa Fe) b/c SC could’ve said that was a
state issue, but didn’t b/c this was such an egregious case. It consisted of all larceny and
SC didn’t want to take this out of the 10b-5 realm.
ii. Santa Fe Industries, Inc. v. Green (1977) – Facts: Santa Fe merged w/ Kirby for sole purpose
of eliminating minority SHs. Green minority SH filed suit alleging that merger had not been
made for a business purpose. Green argued that Δ’s actions employed a scheme to defraud and
engaged in an act that operated as a fraud or deceit in connection w/ purchase of any security in
violation of rule 10b-5. Held: SC said enough – before a claim of fraud or breach of fiduciary
duty may be maintained under §10(b) or Rule 10b-5, there must 1st be a showing of manipulation
or deception. Primary wrong here was not fraud in connection w/ sale of securities, but rather
fiduciary duty state law claims. Rule 10b-5 is not meant to replace traditional state fiduciary duty.
Merger was carried out in full compliance w/ Del law and did not involve manipulation or
deception.
XXIII. Indemnification & Insurance
a. Many good people are shying away from serving on Corp BDs b/c they don’t want to be subject to
lawsuits, especially where their personal assets are at risk. Thus, a person may want indemnification,
Vanessa Verduga 63
advances for legal fees, reimbursements, and insurance from the Corp that his/her personal assets are
not at risk as a result of litigation. When it comes to indemnification there are exceptions built in – i.e.
for willful and wanton conduct, for fraud, for punitive – it depends on the given state statute. Before
going on a BD you need to know the ins and outs of the indemnification agreement. Note: “Advances”
are the heart of the problem (see pp 535 ¶ 7 for sample Indemnification Agreement).
i. Waltuch v. Conticommodity Services, Inc. (1996) – Facts: After silver market crashed,
customers sued Waltuch, former silver trader (VP and chief metal trader), and his former
employer, Conticommodity, alleging fraud, misrepresentation market manipulation and antitrust
violations. Δs settled the private lawsuits w/ a “neither admit nor deny” settlement. Waltuch, who
had also been sued by CFTC,16 a regulatory agency, resolved the regulatory case by paying a fine
and accepting a 6-month trading bar. Waltuch then sued Conti for expense indemnification.
Held: Under Art 9, Waltuch was covered even if he acted in bad faith. Problem is that Del.
Statute §145(a) requires “good faith.” Art 9 was invalid and unenforceable b/c it exceeded scope
of indemnity granted to Corps by §145(a). So, Waltuch doesn’t get indemnified for the CFTC
suit. However, Waltuch was entitled to indemnity under §145(c) for private lawsuit expenses b/c
those suits were settled and good faith is not required. Waltuch did not make any payment or
assume any liability in connection w/ settlement, meaning that he had been "successful on the
merits or otherwise," and was entitled to indemnity w/o regard to good faith. Success is
sufficient to constitute vindication for purposes of § 145(c). Success/vindication was that Waltuch
had been dismissed from the case and had nothing to pay. It’s all about statutory interpretation.
16
CFTC, like NYSE, is an exchange that deals w/ commodities and futures traders.
Vanessa Verduga 64
PROBLEMS OF CONTROL
Topics under the general topic of Control:

(1) Proxies
(2) Tender Offer
(3) Inspection Rights
(4) Cumulative Voting
(5) SH Agreements
(6) Statutory Rights of Oppressed Minorities
XXIV. Strategic Use of Proxies
a. MBC §7.22 Proxies – Corps hold annual meetings of SHs, some (most) SHs don’t attend. So Corps asks
SHs for a “proxy.”17 SHs fill out a proxy card (absentee ballot), which authorizes someone who is
physically there as an agent to vote on their behalf. In connection w/ a proxy solicitation, Corp must
provide SHs with info needed to aid their vote. This relates to control b/c if SH doesn’t show up or
doesn’t vote by proxy then it’s the equivalent of having no control of what may affect SHs’ interests.
Proxy Fights & Reimbursement of Costs:

Insurgents (non-happy group) vs. Incumbents (power group) – Insurgents usually want to oust the Incumbents b/c
they’re doing a bad job or they want to kill a merger that Incumbents support. When there’s a proxy fight, proxy cards
and info are mailed to SHs. Both sides contact SHs to try to win over their votes.
(1) Good Faith – can’t institute proxy fight to harass Incumbents

(2) Proxy solicitation is for corporate business policy and not personal issues – nobody will get reimbursed if
fight doesn’t have to do w/ a Corp policy matter or decision (Charade)
(3) Expenses have to be Reasonable – ct will require them to show that the costs of contacting SHs were
reasonable and were related to Corp matters
(4) Reimbursement of Incumbents and Insurgents:
a. Incumbents – Corp always pays if they win or lose (if 1-3 are present)
b. Insurgents – Corp reimburses them only if SHs ratify the expenses incurred. Note: Proxy fights are not
common b/c SHs don’t want to spend their $ w/o the guarantee that they will be reimbursed.
b. Proxy Fraud – Has to be viewed in the same context as rule 10b-5. The proxy fraud sections are:
i. Exchange Act §14(a) Proxies – It shall be unlawful for any person, by use of instrumentality of
I/S C, to solicit or permit the use of his name to solicit any proxy or consent or authorization in
respect of any security (other than an exempted security) registered pursuant to §12 of this title.
17
Proxy- agent appointed by SH to attend annual meeting of SHs for election of directors and, where necessary, for voting on other matters, to vote
on their behalf.
Vanessa Verduga 65
ii. Rule 14a-9 False or Misleading Statements – No solicitation subject to this regulation shall be
mage by means of any proxy statement… containing any statement which, at the time and in the
light of the circumstances under which it is made, is false or misleading with respect to any
material fact, or which omits to state any material fact necessary in order to make the statements
therein not false or misleading …”
Rule 14a-9 Private C/A for False or Misleading Statements (similar to rule 10b-5):
(1) Jurisdiction – I/S C – since you have a proxy statement in these cases you have I/S C.
(2) Proxy Statement – informational document that goes to SHs to help them cast a fair and informed vote on
whatever it is that they’re being asked to vote on.
(3) False and Misleading – All you need to show is that there is something wrong w/ the proxy statement either
due to affirmance or omission.
(4) Standing – if SH’s vote is being solicited then they have standing
(5) State of Mind – compare w/ 10b-5, which requires intent or knowledge, under 14a-9 state of mind could be
simple negligence. Thus, burden of proof of Π is not to show that proxy statement was false or misleading, but
simply that it is false and misleading b/c Π has been asked to cast his vote on incomplete info. Note that under
10b-5 we’re dealing w/ buying or selling security; under 14a-9 we’re dealing w/ having SH exercise his vote.
a. Keep in mind 3 different scenarios:
i. Registration Statement deals w/ offer for sale of securities – §11
ii. Buying and selling security – §10b-5
iii. Proxy statement – we want your vote – §14(a)
(6) Materiality – under Northway an omitted fact is “material” if there is a substantial likelihood that a
reasonable SH would consider it important in deciding how to vote. Ct will put itself in the shoes of the SH
and ask whether the Norway test is met. [See Seinfeld]
(7) Reliance/Causation – it almost doesn’t apply b/c all we’re dealing w/ whether or not there is a proxy statement
that was false or misleading. [See Mills]
a. Even if the matter that you’re voting upon may have happened anyway w/ or w/o an informed vote, it
doesn’t matter b/c the pool of info that goes out to SHs has been polluted, maybe innocently, but it still
creates a false and misleading info. And it doesn’t matter if only 1 SH brings the claim.
NB: Know the difference b/w 10b-5 and 14a-9
c. Private Actions for Proxy Rule Violations
i. Seinfeld v. Bartz (2002) – Facts: CISCO Sys (routers) had SHs meeting and issues a proxy
statement, which describes the compensation that was going to be paid to its Directors. It said
they will get roughly $32K a yr as a retainer to sit on the BD, and also stock option, for which
they failed to insert the value. If it had been valued, SHs would’ve discovered that they were
Vanessa Verduga 66
worth over $1M as of the date of the proxy statement. If SHs are going to want to vote, then
shouldn’t they know what the value of the options is? Held: No b/c this is not material. Ct stood
in the shoes of SH and decided whether or not under the Northway test it was material or not. The
fact that they were worth $1M is not material b/c there has to be “substantial likelihood”.
Thereby, raising the level of proof. Π has to show that what is missing is not just wrong, but there
must be a substantial likelihood that it would’ve been viewed by a reasonable SH as something
important that would alter their vote.
ii. Mills v. Electric Auto-Lite Co (1970) – Facts: SHs filed suit against Co to enjoin a merger w/
3rd Co. SHs asserted that Co distributed a misleading proxy solicitation informing them that BD
of directors recommended approval of the merger, w/o also informing them about a conflict of
interest of directors w/ the merging 3rd Co, in violation of §14(a) and Rule 14a-9. SHs filed
motion for summary judgment. Held: Conflict of interest was a materially misleading aspect of
the proxy solicitation.
1. Objective Test: Where there has been a finding of materiality, a SH has made a
sufficient showing of causal relationship b/w violation and injury for which he seeks
redress, if, he proves that proxy solicitation itself, rather than particular defect in
solicitation materials, was an essential link in the accomplishment of the transaction.
a. Note: This test avoids impracticalities of determining how many votes were
affected, and, by resolving doubts in favor of those who the statute is designed to
protect, will effectuate congressional policy of ensuring that SHs are able to
make informed choice when they’re consulted on corporate transactions.
XXV. Shareholder Proposals
a. Rule 14a-8 SH Proposals – A SH recommendation or requirement that Co and/or its BD take action,
which SH intends to present at the annual SHs’ meeting. SH has a right to demand Corp to include in
proxy statement/card any proposal SH wishes to put before fellow SHs for vote at an annual SHs’
meeting; this gives SH a voice. Generally, all SH proposals get included into proxy statement
provided it meets the following requirements:
i. SH must have continuously held at least $2,000 in market value, or 1%, of the company’s
securities entitled to be voted on the proposal at the meeting for at least 1 yr by the date SH
submits proposal. SH must continue to hold those securities through date of the meeting.
ii. SH can only submit 1 proposal of no more than 500 words per SHs’ meeting.
iii. Corp may exclude proposal only after it has notified SH w/in 14 days of receiving SH’s proposal.
b. Procedurally:
i. SH submits proposal to Corp’s general counsel
ii. Corp reviews and decides whether to include or exclude by looking at rule 14(a)-8(i) exceptions
iii. If Corp decides to exclude it, Corp contacts SEC
iv. SEC reviews it; if SEC agrees, then a no-action letter is issued
1. Sample wording of letter - “Accordingly, we will not recommend enforcement action to
the Commission if the proposal is omitted from Corp’s proxy materials.”
v. SH has to go to court
c. Rule 14(a)-8(i) Exceptions – 3 main exceptions under which issuer of securities may omit a proposal:
i. Insignificant Relationship (Relevance) - if it relates to operations which account for less than
5% of the registrant’s total assets at the end of its most recent fiscal year, and for less than 5% of
its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly
related to the registrant’s business.
Vanessa Verduga 67
ii. Beyond Power to Effectuate (Absence of power/authority) - if the company would lack the
power or authority to implement the proposal.
iii. Ordinary Business Operations (Mgt functions) - if the proposal deals with a matter relating to
the company’s ordinary business operations.
d. Lovenheim v. Iroquois Brands, Ltd (1985) – Facts: Lovenheim sought an injunction barring Iroquois
Brands from excluding from its proxy statements a proposed resolution he intended to offer at the
upcoming SHs meeting. Lovenheim wanted Corp to form a committee to study methods of production for
force-feed geese in France (pate de foie gras). Held: Injunction was granted. A SH proposal can be
significantly related to the business of a securities issuer for non-economic reasons, including “ethical
or social significance,” and therefore may not be omitted from the issuers proxy statement even if it
relates to operations which account for less than 5% of the issuer’s total assets.
i. Rule 14a-8(i): excludes proposals that are not significantly related to the company’s
business  “…if proposal relates to operations which account for less than 5% of the registrant’s
total assets at the end of its most recent fiscal year, and for less than 5% of its net earnings and
gross sales for its most recent fiscal year, AND is not otherwise significantly related to the
company’s business.”
ii. Statutory Interpretation – Even though it’s a conjunctive rule “, AND” look at the comma –ct
treated it as an independent requirement. 1983 revision adopted this 5% threshold, but Comm’n
stated that proposal will be includable notwithstanding “failure to reach the specified economic
threshold if a significant relationship to issuer’s business is demonstrated on the face of the
resolution or supporting statement.”
iii. If the proposal is significant b/c of the social or ethical issues that it raises, and these issues
are related to Corp’s business, the proposal will not be excludable automatically merely b/c
it doesn’t satisfy the 5% threshold test. E.g. human rights and environment.
iv. Civil Pro Review: Elements for a preliminary injunction

1. Likelihood of success on the merits - The meaning of “significantly related” is not
limited to economic significance. In light of ethical and social significance of Π’s
proposal and the fact that it implicates significant levels of sale, Π has shown a likelihood
of prevailing on the merits w/ regard to the issue of whether his proposal is “otherwise
significantly related” to Δ’s business.
2. Irreparable injury (not compensable monetarily) – Π will suffer irreparable harm by
losing the opportunity to communicate his concern w/ proxy SHs.
3. Injury to Corp – this proposal was included in 1983 and they suffered no resulting
harm.
4. Public interest - §14(a) overriding public interest in assuring SHs the right to control the
important decisions which affect the Corp.
e. NYC Employees’ Retirement System v. Dole Food Co, Inc (1992) – Facts: Π pension fund, SH in
Dole, sought to enjoin Dole from soliciting proxies for an annual meeting w/o informing SH of Πs
proposal requesting a study of the impact of various health care reform proposals being considered by
national policy-makers. Based on an SEC finding that the proposal concerned employee relations and
benefits, a matter traditionally w/in the “ordinary business” category, Dole argued that it could exclude
the proposal b/c a necessary consequence of the proposal is political lobbying. Held: Corps may omit SH
proposals from proxy materials only if the proposal falls w/in an exception listed in Rule 14(a)-8(c). Dole
failed to meet burden that proposal fell w/in an exception. Injunctive relief was granted.
XXVI. Shareholder Inspection Rights
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4 Devices for Minority Shareholders in Public Companies to Have a Voice:

(1) Proxy Fights
a. Rule 14(a)-9 really isn’t a device per se, but should be viewed more as a remedy for SHs when they’ve
been mistreated or misled.
(2) Shareholder Proposals
a. Rule 14(a)-8 a SH recommendation/requirement that Co or its BD take action, which SH intends to
present at the annual SH’s meeting. SH has a right to demand Corp to include in proxy statement/card any
proposal SH wishes to put before fellow SHs for vote at an annual SHs’ meeting.
(3) Shareholder Inspection / Copying of Corporate Records
a. Way of communicating with other SHs
(4) Classified / Dual Shares
a. Recall Transamerica – different classes of stock – most stock rights are broken down in 2 factors:
i. Economic Right – usually pertain to dividends, ability to convert your stock from one class into
another class, could have stock options attached to it, etc.
ii. Voting Right – 3 different kinds of voting
1. Straight – big issue – majority always wins b/c it is one vote per share.
2. Class shares – allows SH have the power to vote on selected issues – on some but not
others. Not a big issue.
3. Cumulative – Big issue / valuable for minority SHs – has 2 concepts:
a. Cumulate – minority SH can take his one share and multiply it to give him more
votes by cumulating the votes.
b. Concentrate – put all your eggs in one basket.
a. MBC §16.01 Corporate Records – A Corp shall keep as permanent records of all SH, director and
committee meeting minutes, accounting records, articles, bylaws, resolutions, written communications,
names, businesses and addresses of current directors, and annual reports; maintain accounting records,
SHs’ records, written conversations.
b. MBC §16.01(e) – certain records you will get just by asking in a timely manner providing notice: articles
of Incorp; bylaws; resolutions adopted; minutes of SHs’ meeting; all written communications to SHs w/in
past 3 years including financial statements sent; list of O/Ds; and most recent annual report.
c. SH Inspection Rights are covered in state law (statutes) or common law, not federal law. 3 different
approaches taken by states:
i. SH inspection must be for a proper purpose – SH may have to file an affidavit stating its
Depends on proper purpose
Jurisdiction  ii. Rights may be limited based on # of shares or how long SH held stock
Vanessa Verduga 69
iii. Distinction may be drawn depending what you are looking for – SH can readily get non-
controversial records; may need to show particular purpose for other types of records (e.g.
names/addresses of SHs)
d. MBC §16.02 Inspection of Records by SHs – this is the best way to do it – broad parameter of how the
process works. SH is entitled to inspect and copy, during regular business hours, all records (§16.01(e))
given written notice of his demand at least 5 business days before date of inspection.
e. MBC §16.02(b) – qualifies the right to get certain more sensitive corporate records (excerpts form
minutes of any meeting, accounting records, and record of SHs) – demand requires:
i. Good Faith (most important for ct)
ii. Proper Purpose (most important for ct)
iii. Describe w/ Reasonable Particularity as to both
1. Purpose, and
2. Records Requested
a. When drafting a notice to produce documents, the tricky part - knowing how to
ask for them and what to ask for – if not done carefully, you give the other side
a loophole. In Sadler, the lawyers knew what they were looking for and asked for
documents (NOBO and CEDE lists).
f. Crane Co. v. Anaconda Co. (1976) – Facts: Crane Co publicly announced a proposed offer to purchase
common stock of Anaconda Co, which was opposed by Anaconda’s management. Crane sought to
inspect Anaconda’s SHs list to send them info regarding the pending trade offer. After Anaconda refused,
Crane sued Anaconda to compel compliance w/ Business Corp Law. Held: Matter was proper being one
of general interest to Anaconda’s SHs by virtue of their common interest in the Corp as stockholders.
Anaconda failed to sustain its burden of proving an improper purpose. Ct compelled inspection of
records. A SH wishing to inform others regarding a pending tender offer should be permitted access
to Co’s SH list unless it is sought for an objective adverse to the Co or its SHs.
i. Notes: There’s a liberal construction in favor of SHs to satisfy the good faith and proper purpose
requirements.
g. State Ex. Rel. Pillsbury v. Honeywell, Inc. (1971) – Facts: Pillsbury was opposed to Honeywell's
participation in Vietnam War effort and eventually bought 100 shares of Honeywell's stock for purpose of
voicing his concerns to Honeywell's SHs. Pillsbury sought SH ledgers and all corporate records in order
to find the identity of SHs so he could speak to them about Honeywell's participation in the war. Held:
Law required Pillsbury to have proper purpose in seeking inspection of corporate records. Mere desire to
communicate w/ other SHs was not proper b/c it gave an almost absolute right to compel inspection.
Furthermore, Pillsbury's status as a stockholder was shaky. He had few shares, purchased for the purpose
of the present suit – lacks good faith. A stockholder has the right to inspect shareholder lists and
other corporate records only if he has a “proper purpose germane to his economic interest as a
SH.” “Proper purpose” means “concern w/ economic return.”
i. Note: This is also a good faith case (intertwined w/ proper purpose). B/c the power to inspect
may be the power to destroy, it’s important that only those w/ a bona fide interest in Corp enjoy
that power. Pillsbury was not interested in the long-term well-being of Honeywell or the
enhancement of the value of his shares. His sole purpose was to persuade the Co to adopt his
social and political concerns, irrespective of any economic benefit to himself or Honeywell.
h. Sadler v. NCR Corporation (1991) – Facts: The Sadlers and AT&T attempted to obtain SH lists from
NCR in an effort to execute a tender offer. Πs, NY residents, sued under NY law to compel Δ NCR
foreign Corp which did business in NY to provide a list of record SHs and to compile and produce a list
Vanessa Verduga 70
of non-objecting beneficial owners (NOBO). NCR's state of incorporation, Maryland, did not allow Πs to
obtain the lists. Held: NY Bus. Law §1315 authorized production of the SH and NOBO lists. Πs were
qualified persons under the statute to obtain the lists, even though they named another as their agent for
purposes of inspecting the records. §1315 also compelled NCR to compile and produce a NOBO list
when one was requested by Πs. §1315 did not violate the Commerce Clause of Const. There was no
direct conflict or inconsistency b/w NY and MD law.
i. Poison pill – device that target Co will use either through issuance of more stock or other devices
to make the tenderor’s offer economically bad (poisons it). NCR had a poison pill for AT&T, and
the only way AT&T could go around this was to convene a meeting and get SHs to vote to oust
the Board. AT&T needed 80% of SHs vote (NCR’s 80% rule - high threshold) so it had to get the
SHs list to contact 100% of them to reach the 80% vote rule.
ii. Shares held in “street name” – brokers and dealers hold the shares for you to sell/buy/trade on
your behalf.
iii. NOBO list – list of beneficial owners of shares who do not object to disclosure of their name.
iv. CEDE list – identifies brokerage firms and other record owners who bought shares in a street
name for their customers and who have placed those shares in the custody of depository firms.
1. Note: It’s crucial to know what to ask for b/c if you just ask for NCR’s SHs list you’ll get
names of brokers and dealers that are holding NCR stocks in street name. Must know to
ask for NOBO and CEDE lists. Sadler’s lawyers made a good demand for documents.
XXVII. Shareholder Voting Control
a. Stroh v. Blackhawk Holding Corp (1971) – Facts: SHs of Class B stock in Blackhawk Holding Corp
claimed that a limitation on their rights at dissolution rendered their share invalid. SHs claimed that the
term proprietary in the definition of shares meant a property right and that the shares must represent some
economic interest in the property or assets of the Corp. Corp claimed that the word proprietary did not
necessarily denote economic or asset rights. Held: Word proprietary meant that the rights conferred by
the ownership of stock could consist of 1 or more of the rights to participate in the control of the Corp,
but did not require that the shares possess an economic interest in the Corp. Ill Const. requires only that
the right to vote be proportionate to the # of shares owned and does not require shares to be an investment
in a Corp. A SH could be deprived of an economic interest in the Corp but could not be deprived of his
voice in management. Thus, the Class B shares were valid shares of stock in the Corp entitled to vote.
Even if Class B (cheaper) stocks are minimum they still have equal rights as Class A stocks.18
XXVIII. Control in Closely Held Corporations
Voting Devices Minority SHs Can Use to Gain Control – How to Have a Voice:
(1) Public Corporations - often 1,000s of outside investors who are just concerned w/ stock values and central mgt;
easier exit for SHs  sell stock
a. Proxies
18
A Corp would put out 2 different stocks and give one no economic right in order to keep close control w/ the class A stocks (more expensive).
Class B (cheaper) will be bought maybe by average people and the Corp doesn’t want them having a say. Such classification of stocks may carry w/
it the possibility for wrongdoing. However, it also serves a valid purpose and there’s nothing inherently wrong in such a scheme. The cheaper Class
B stock carried the same voting power per share, but was not permitted to share at all in the dividends or assets of the Corp. This additional step did
not invalidate the stock
Vanessa Verduga 71
b. SH Proposals
c. Inspect Corp Records
d. Causes of Action – either CL claims of State statutory claims
i. Class actions
ii. Direct action
iii. Derivative action
(2) Closed Corporations - are not as freely transferable as in public Corp; SH agreements as a practical
consideration are quite necessary for the protection of those financially interested in the closed Corp
a. Before the Fact – how to be heard before there’s a problem – similar to a pre-nup – transactional stuff
used by lawyers to protect minority SHs from getting hurt.
i. Class of Share (Classification of Stocks) (Stroh)
1. Dividends can differ depending on class of stock
2. Rights on liquidation may be different
3. One class of stock may have more voting rights; economic interest may be smaller, but
control is greater
ii. Cumulative Voting (Ringling)
1. Concentrating votes (instead of straight voting, one share for one vote → concentrate all
shares for one vote)
iii. Supermajority – provided for in the articles of incorporation – have a supermajority vote
(similar to amend of Const).
1. A meaningful tool that effectively gives minority SHs veto power; requires more than the
simple majority (50%) vote
iv. Employment Agreement – frequently the case is that minority SHs are the employees of the
Corp. Get this to protect yourself
1. Critical issues include years, termination (constructive discharge is treated as termination
without cause), compensation
v. Shareholder Agreement – 2 devices:
1. Buy/Sell Agreement - employer will fund insurance, handle payout, will pay out those
discharged.
a. It will be in the form of an annuity, for which premiums are paid and if minority
SH gets ill or dies the insurance policy will kick in and give their beneficiary $ as
opposed to having them come into the Corp and exert control of things w/o really
knowing anything b/c that’s when problems arise.
2. Vote Pooling Agreement (Ringling) – “a group of SHs may, w/o impropriety, vote their
respective shares so as to obtain advantages of concerted action.” Not objectionable b/c
they don’t interfere w/ obligations of directors to exercise their sound judgment in
Vanessa Verduga 72
managing affairs of Corp. Ct has had more difficulty w/ SH agreements requiring
appointment of particular individuals as officers or employees of Corp, since such
agreements do deprive directors of one of their most important functions. Modern view
 such agreements are enforceable, at least for closely held Corps, as long as they’re
signed by all SHs.
a. RR LAF  clearly enforceable w/ voting directors, might be enforceable
when relating to internal matters
vi. Other devices:
1. Voting trusts – Agreement establishing a trust, whereby SHs transfer title of shares to a
trustee authorized to exercise their voting powers as instructed in document establishing
the trust. Used to maintain control of Corp by family or group, when there’s fear that
some members of family or group might form coalition w/ minority SHs to shift control.
b. After the Fact – how to be heard after there’s a problem – similar to a divorce settlement
i. CL claims
ii. Oppressed minority SH statute
a. Ringling Bros. Barnum & Bailey Combined Shows v. Ringling (1947) – Facts: Edith Ringling and
Aubrey Haley entered into written agreement to act jointly in regard to all matters pertaining to ownership
of their stock. In 1946 meeting Mrs. Ringling agreed to vote for herself and her son, and Mrs. Haley was
to vote for herself and her 2nd husband James. After a dispute at a corporate meeting over an election of
the 5th director, Mrs. Ringling sued, arguing that the agreement had required Mrs. Haley to either vote for
an adjournment of the meeting or for a particular slate of directors. Haley contended that the agreement
was invalid. Held: An arbitration provision w/in the agreement gave the appointed arbitrator (Mr. Loos)
no substantive powers to enforce his decision to adjourn meeting. However, the agreement b/w SHs was
binding. A SH could enter into a binding agreement w/ respect to the voting rights of corporate shares. Ct
refused to declare the election invalid in order to respect the voting rights of Mr. North SH who was not a
party to the agreement, instead vacating Mrs. Haley’s position that had not received a majority vote.
Thus, the BD will be Edith, her son, John and anybody else other than Mrs. Haley and her husband. If
you want before the fact to enter into a SH agreement it is enforceable in regards to voting.
i. Note: SHs were Mrs. Ringling (widow 315 sh), Mrs. Haley (divorced 315 sh), and Mr. John
Ringling North (son Ringling by blood 370 sh). They could’ve had a class share of A, B, and C
w/ different rules for each – this could’ve solved their problem, but instead they had an agreement
for the women to be able to jointly have a supermajority of votes against John’s votes. There
were 7 directors on the BD – by pooling their votes, they have [2 (315 x 7)] = 4,410; and John has
(370 x 7) = 2,590. 882 x 5 = 4,410 votes for 5 people. So no matter what John does he can only
get 2 directors and one of them had to be himself.
ii. Note: Ct here is punishing Mrs. Haley and her husband for being stubborn jerks (seems to be a
subjective remedy). Today, most courts would give Mrs. Ringley the specific performance
(compliance) she desired.
iii. MBC §7.31 Voting Agreements – SHs may provide for manner in which they’ll vote their
shares by signing an agreement for that purpose. SH voting agreements are specifically
Vanessa Verduga 73
enforceable!! However, may not be enforceable if there is fraud, injury to majority SH,
and/or violation of the law. RR: important to know this if representing minority SH!
b. McQuade v. Stoneham (1934) – Facts: McQuade and McGraw purchased 70 shares of stock. As a part
of the transaction the parties agreed to use their best endeavors for the purpose of continuing as directors
of the company. McGraw and Stoneham did not keep their agreement w/ McQuade to use their best
efforts to keep him as treasurer. McQuade sued for breach of K. McGraw and Stoneham argued that the K
was void b/c the directors held their office charged w/ the duty to act for the Corp according to their best
judgment and that any K which compelled a director to keep a person in office and at a stated salary is
illegal. Held: SH agreement was invalid b/c it interferes w/ exercise of fiduciary duties. SHs may not, by
agreeing among themselves, place “limitations on the power of directors to manage the Corp by the
selection of agents at defined salaries.” McQuade could not continue to serve as treasurer of a Corp b/c,
as a city magistrate, he was prohibited from attempting to make the management of a business an outside
activity. As a city magistrate, he was obligated to the duties of his office.
i. Note: This SH agreement was different than that found in Ringling b/c it decided on internal
matters of the business. This decision will not be the same if decided today 
ii. MBC §7.32(a)(1) SH Agreements – An agreement is effective among SHs and Corp even
though it is inconsistent w/ one or more other provisions of this Act in that it eliminates the BD of
directors or restricts the discretion or powers of the BD of directors.
iii. But see MBC § 7.32(e) – an agreement authorized by this section that limits the discretion or
powers of the BD of directors shall relieve the directors of, and impose upon the person(s) in
whom such discretion or powers are vested, liability for acts or omissions imposed by law on
directors to the extent that the discretion or powers of the directors are limited by the agreement.
1. Note: These 2 provisions in relation to McQuade case mean that this agreement would be
unenforceable under §7.32(a)(1), but b/c you’re allowing for SHs to restrict powers of
BD, if something goes wrong and hurts SHs, then these SHs stand in the shoes of the
Directors and it’s as if they did the screw up under §7.32(e).
2. McQuade would’ve won b/c there was no restriction of power of the directors here.
However, McQuade was a Judge and he had no business owning shares – can’t be both.
Assuming he wasn’t a Judge, an employment agreement would’ve been good for him. He
had a SH agreement instead, which didn’t help him then, but it would help him today.
c. Shareholder Voting Agreements – are necessary for the protection of those financially interested in the
close Corp. While the SH of a public-issue Corp may readily sell his shares on the open market should
management fail to use, in his opinion, sound judgment, his counterpart of the close Corp often has a
large total of his entire capital invested (it’s their livelihood) in the business and has no ready market for
his shares should he desire to sell. As a lawyer you need to think of ways to make an agreement work in a
matter that will prevent deterioration of a close Corp, especially when dealing w/ family squabbles.
Pre-Disaster Tools:
(1) Class shares
(2) Cumulative voting
(3) Supermajority
(4) Employment Agreement
Vanessa Verduga 74
d. Clark v. Dodge (1936) – Facts: Clark and Dodge, sole SHs in 2 pharmaceutical Cos, entered into SHs’
agreement regarding Clark’s continuation as manager and director. Whereby, both parties agreed to
exercise voting rights in an effort to maintain benefits from the Corp’s success. Litigation ensued in
which Clarke sued Dodge for not exercising his voting power in keeping Clarke in an officer role. As a
result, Clarke sought reinstatement. Held: Where directors are also sole stockholders of a Corp, a K
b/w them to vote for specified persons to serve as directors is legal, and not in contravention of
public policy.
i. Review Example: Clark has the “know-how,” he knows of a secret formula for making
medicinal formulas, and Dodge has the $ - together they can have themselves a successful
profitable business. Suppose Clark asks you for advice. You need to find out:
1. What are their options?
2. What business form do they want? LLC; P-ship; LLP; SH in Corp; or Clark could just
want to be an employee and work in Dodge’s company.
3. Assuming Clarke says he wants a piece of the action and wants to maximize profits, you
should:
a. Discuss liability considerations, such as protection of personal assets in the
context of piercing the LLC veil.
b. Taxes – tell him about forming an S Corp for tax purposes.
c. Control Issues – probably zero in an LLC or Corp.
4. If Clark says that he wants to own a majority of the stock then tell him that this is going
to be a point of negotiation. Discuss w/ him what Dodge may be willing to give up when
he is putting up the $. It’s all a matter of how much Clark’s “know-how” is worth to
Dodge. E.g. If his “know-how” is a secret formula to making Bagels, then maybe Clark
doesn’t have much leverage, but if it’s a secret formula that cures cancer Clark has
substantial leverage.
a. Trust – Here, SHs’ split was 25% for Clarke and 75% for Dodge. There was an
agreement b/w them whereby Clark would remain officer and director, and the
secret formula would go to Dodge’s son. You would have to discuss w/ Clark
trust issues such as how well he knows Dodge’s family and how comfortable he
feels about this. The formula upon Clark’s death would go to Dodge’s family
since Clark had no children. Ask Clark of what this is worth to him.
ii. Precaution  2 ways Clark could’ve been protected:

1. SH Agreement
2. Employment Agreement - this is a very strong tool!
a. Want to know how long Clark is going to be employed
b. What his control is
c. Issues of termination
i. Can he only be terminated for cause?
ii. If so, what does “cause” mean.
d. Compensation
i. What does it entail
ii. Retirement pay
iii. Other benefits of compensation
1. Is Company going to pick up Social club expenses?
2. Professional dues such as bar review course in law firm, and if
you get a percentage of fess coming in.
e. Is there provision dealing w/ confidential info? E.g. In the bagel case when the
one guy wanted to leave and make his own bagels he was told he couldn’t use the
“know-how” any more b/c it was theirs.
iii. Note: This is All a Matter of Negotiation. Discuss w/ client all potential issues that could arise.
Vanessa Verduga 75
e. Galler v. Galler (1964) – Facts: Ben and Isadore Galler brothers entered into SH agreement for purpose
of maintaining themselves and their spouses as officers of drug Co, and for the continued support and
maintenance of their families. At the time Isadore, Rose and Aaron (Ben’s wife and son) were in control
of the Co. Ben was bed ridden and gave wife Emma the right to stand in his shoes vis-a-vis Isadore and
Rose. When Ben died, Isadore, Aaron, and Rose attempted to destroy copies of the agreement and refused
to abide by the SH agreement. Aaron was freezing-out19 his Aunt Emma b/c he wants to make more $.
Reasoning: This is not fair to Emma b/c she had rights under the SH agreement such as (1) salary
continuation agreement - she had a right to salary equal to twice the salary of such officer payable
monthly over a 5 year period; (2) voting rights; and (3) right to be a director in the Corp. Held: This case
involved a close Corp, public policy and statute preventing agreements granting non-board member
management powers was inapplicable where enforcement harmed no one. The terms of the agreement
were reasonable, and supplied a term that limited the duration of the agreement to Π’s life to effectuate
the purpose of the agreement. Agreement was upheld even though discretion of BD was limited.
i. An agreement must satisfy 3 tests before it can be enforced:

1. There must be no minority interest who is injured by it;
2. There must be no injury to the public or to creditors; and
3. Agreement must not violate a clear statutory prohibition.
ii. Note: Public policy argument that agreement is invalid when it interferes w/ internal judgment of
BD is n/a here b/c (i) there was no minority SH hurt, and (ii) it doesn’t interfere w/ the operations
of the Corp b/c Emma was suppose to be involved in the operation of the business anyway.
f. Ramos v. Estrada (1992) – Facts: 2 entities, Broadcast and Ventura made a bid to buy a station they
wanted. The SHs of Broadcast were Ramos (50%) and other 5 SHs (10% ea). The 2 entities formed 1
entity “Television Inc.” Broadcast had a SH agreement that if a majority makes a decision the others had
to go along w/ it, so Ramos only needed 1 other SH. If SH doesn’t abide then he is forced to sell shares at
cost plus 8% (crappy agreement). Reasoning: (1) Oct 8th Directors’ meeting – the Estradas (10% ea)
voted to remove Ramos and elect someone else. Thereby, shifting power in Television Inc from 50/50 in
favor of Ventura. This is not a violation of SH agreement b/c she was voting as director, and SH
agreement only governs your vote as a SH and not as a director. [They could’ve had something in
Broadcast’s by-laws that said they could not do this, but they didn’t. So, they found a loophole that
allowed them to vote Ramos out, Ventura and Estrada both wanted him gone]. (2) Oct 15th SHs’ meeting
– Estrada doesn’t go to the meeting b/c if she did she would have to vote for Ramos and against herself,
as required by the agreement. If Estrada doesn’t vote for then she’s forced to sell her shares. [Ventura’s
lawyer was right that Estrada could vote Ramos out in directors meeting, but he was wrong that the SH
agreement was not enforceable. Estrada could have gotten an opinion statement from Ventura’s lawyer
that the SHs agreement was invalid and get some guarantee for this, but she didn’t]. Held: Δs’ shares
must be sold in accordance w/ specific enforcement provisions of voting agreement. SHs’ voting
agreement was valid even though the Corp was not technically a close Corp. The agreement, including its
buy/sell provisions, was unanimously executed after Δs had a full and fair opportunity to consider it in its
entirety; they were aware of the consequences. Thus, Δ violated agreement by voting her shares in
opposition to the majority. SH voting agreements that bind individual SHs to vote in concurrence w/
Majority are valid. IN all these cases the SH voting agreements are enforceable.
XXIX. Abuse of Control
a. This area is like Implied Fundamental Rights in Constitutional Law.

i. RR: If representing Corp, be sure agreement is ironclad b/c cts could imply fundamental rights!
ii. RR: When someone comes to you and it looks like they don’t have any rights- they probably do!
19
Freezing-out — means “you’re going to get your $ but keep your mouth shut, can’t look at the book or have any say.”
Vanessa Verduga 76
b. Who is a minority SH? One who owns less than 50% of shares. However, a person can be a minority SH
even when they own 50% of the stock or can be a minority SH by means of oppression.
c. Ways in which Oppression/Unfairness occur:
i. “Freeze-out” – technique to deprive minority SH of voice. Kick them out of their office, demote
them, take privileges away, dilute his status (can lead to “constructive termination”) - whatever
you can think of to hurt somebody  oppression.
1. NJ stat 14A:12-7 – deals w/ oppressed minority SHs
During or After Oppression/Disaster – Devices for Minority Shareholders:
(1) Expanded Concept of Fiduciary Duty Claim – majority SH attempts to squeeze out or freeze out minority SH
by cutting off salary, not electing to board, not continuing as officers, reducing responsibilities
a. Wilkes Balancing Test (S/S):
i. Whether controlling group can demonstrate a legitimate business purpose for its action; when
this is advanced by the majority
ii. Minority SH can demonstrate the same legitimate purpose could have been achieved through an
alternative course of action less harmful to the minority’s interest (narrowly-tailored)
b. “Reasonable Expectation” Test (Bonavita)
(2) Oppressed Minority SH statute:
a. MBC §14.30(2)(ii)  Judicial Dissolutions - allows minority SH to bring action to dissolve
corporation for illegal, oppressive, or fraudulent conduct; huge drastic remedy for minority SHs…
add to your toolbox! (RR: BIG ONE!)
b. MBC §14.32 Receivership or custodianship  court has power to do something short of judicial
dissolution, appoint receiver to wind up and liquidate or custodian to manage the business or affairs of
the corporation
c. MBC §14.34 Election to purchase in lieu of dissolution  court can order majority to buy shares
at fair value (RR: BIG ONE); fair value can be:
i. Minority discount – shares sold for less than actual fair value because buyer will say minority
shareholder’s at the risk of being exploited
ii. Marketability discount – discounted because not readily marketable
d. NJSA 14A:12-7(c) - court may dissolve Corp for mismanaged or abused authority or acting
oppressively (much broader statute). Minority SH has very liberal basis for requesting dissolution.
(3) Implied Covenant of Good Faith and Fair Dealing – NJ implies this into every K, even terminable-at-will
employment Ks. (Wilson)
(4) Remedies:
a. Array of statutory remedies available (court appointed custodian, dissolving Corp, court-ordered buy-
Vanessa Verduga 77
out)
b. Buy-out (two issues- who buys who and at what price) – Either situation occurs: minority SH wants to
sell and Corp doesn’t want to buy then it can be forced by Ct to buy, OR Corp buys out minority SH.
This is the main remedy – issue is how to value them. Generally, minority SH gets bought out (may
depend on conduct of the parties or who’s the better manager).
c. Involuntary Dissolution - a drastic remedy; must balance appropriateness of dissolution to loss to
society; double-edged sword- majority SH could be oppressed if judicial dissolution is given too freely.
Two situations can arise:

(1) Majority SH could have rights under the oppressed minority SH statute
(2) Minority SH may have a fiduciary duty
d. Wilkes v. Springside Nursing Home, Inc (1976) – Facts: Wilkes and individual Δs (Riche, Quinn, and
Pipkin  Connor) entered into P-ship agreement. The 4 men participated jointly in the purchase and
decided to operate it as a nursing home (better profit potential). Agreement was that each invested $1,000
– 10 sh each; each would participate actively in mgt and decision making involved in operating Corp;
each would receive equal amts of $ from Corp as long as they assumed an active and ongoing
responsibility of operating business; each were directors of the Corp. As a result of Wilkes selling to
Quinn at a high price a portion of Corp property, p-ship relationship began to deteriorate and the other 2
SHs side w/ Quinn. There’s a directors’ meeting where they excluded Wilkes and discontinued his salary.
Wilkes gave notice of intention to sell his shares for amt based on their appraisal value. Next, annual
meeting – they did not reelect him as director or officer, told him they didn’t need him anymore, and told
him that he wasn’t allowed on the premises. Wilkes brings suit and requests as damages his salary and his
1/4th of the P-ship. Held: The duty of utmost good faith and loyalty would demand that majority
consider that their action was in disregard of long-standing policy of the SHs that each would be director
of Corp and that employment w/ Corp would go hand in hand w/ stock ownership; that Wilkes was 1 of 4
originators of nursing home venture; and the he, like the others, had invested his capital and time for more
than 15 yrs w/ expectation that he would continue to participate in corporate decisions. Cutting off
Wilkes’ salary, plus the fact that Corp never declared a dividend assured that Wilkes would receive no
return at all from Corp. In closely held Corp, there’s a strict obligation on Majority SHs to deal w/
Minority SHs w/ utmost good faith and loyalty.
i. Minority SH typically depends on his salary as the principal return on his investment, since
(i) the earnings of a close Corp are distributed in major part in salaries, bonuses, and retirement
benefits, and (ii) other economic interests of minority stockholder are likewise affected by barring
him from corporate office b/c his participation is restricted in the management of his enterprise,
and he is relegated to enjoying those benefits incident to his status as a stockholder.
Wilkes “Balancing”Act (S/S):
Majority’s conduct will be upheld if there is:

1. Legitimate business purpose for it, and
2. Purpose could not have been achieved by a different course of action less harmful to the
minority SH (narrowly tailored).
Vanessa Verduga 78
ii. In close Corps, ct will not give majority SHs the benefit of the BJR, but rather the expanded
fiduciary duty. Majority did not have a legitimate business purpose (failed 1st prong). Wilkes
probably did not have a duty of care (protected by BJR) or duty of loyalty (must show personal
gain by the directors or self-dealing) claim against directors.
e. Bonavita v. Corbo (NJ 1996) – Facts: Π SH filed suit against Δ SH and Δ Corp alleging deadlock and
oppression and sought a mandatory buy-out of his shares. This c/a arose as the result of Π receiving no
benefit from his shares of stock in Δ Corp. Δ SH and several of his family members were on Δ Corp’s
payroll while Π did not have the opportunity to earn any salary. Further, Δ Corp did not pay out dividends
to Π SH. Ct failed to find deadlock but did find oppression and accordingly ordered a mandatory buy-out.
The test for oppression was conducted by examining the “reasonable expectations” of Π and the effect of
Δs’ action on those expectations. Under this approach, the oppression to which Π could be subjected was
not limited to illegal or fraudulent actions. Rather the test of oppression had to focus on Π’s “reasonable
expectations” and whether the actions of Δs frustrated those expectations. Here, Δs’ course of conduct
was consistent w/ no one’s reasonable expectations; therefore, a remedy was appropriate. Held:
Numerical status as SH is not necessarily determinative as to whether person will be treated as a minority
or majority SH. Ct will look to de facto relationships in determining whether SH will be treated as a
minority SH. It depends on power.
NJ’s “Reasonable Expectation” Test (Majority View):

Oppression is based on the reasonable expectations of the minority SH.
(1) Are the reasonable expectations of the minority SH being frustrated?
(2) This does not mean wrongful conduct (remember that majority SH can be treated as a minority SH by virtue
of Corporate by-laws).
(3) Reasonable expectations over the course of time
Note: Under the “reasonable expectation” test Mrs. Bonavita wins, but not under the Wilkes test. NJ Cts are
unbelievably protective of minority SHs.
f. Ingle v. Glamore Motor Sales, Inc. (1989) – Facts: Ingle, a SH, officer, and business manager of
Glamore Motor Sales, was terminated by Glamore’s BD of directors, and his shares therein repurchased,
consistent w/ the SHs’ agreement he entered into w/ James Glamore. If he “ceases to be an employee for
any reason” his shares are repurchased – he gets fired. Ingle sued Glamore Co and its owners, alleging
that he had been improperly terminated in violation of duties of good faith and fair dealing and claiming
breach of fiduciary duties and wrongful interference w/ his employment. Reasoning: (1) the term of
employment had not been definite and therefore the employment had been at-will, (2) a contractual
agreement to the repurchase upon termination for any reason of the shares in the Co owned by the former
employee barred him from receiving any rights against at-will discharge, (3) the payment given to the
former employee for his shares in the Co had been fair value, (4) therefore there had been no breach of
fiduciary duties or wrongful interference w/ employment in the termination. Held: A minority SH in a
closely held Corp, who is also employed by the Corp, is not afforded a fiduciary duty on the part of the
majority against termination of his employment. Ingle served as an employee-at-will; no employment K
existed. CL does not recognize an implied duty of good faith and fair dealing in such situations.
Vanessa Verduga 79
i. Employment K Terminable-At-Will – Generally, under employment K terminable at will, one
can be fired for any reason or no reason at all. Such K will be enforced, unless:
1. Public Policy Exception – when employers act contrary to clear mandate of public
policy, e.g. discrimination, whistleblower (in NJ).
2. K Exception – implied covenant of good faith and fair dealing (“honest in fact”,
“consistent w/ reasonable community standards”, “faithful to agreed common purpose”)
– the way in which employee was fired was wrong or unfair, this is the most subjective –
e.g. firing someone deceitfully (this is followed in NJ and in most jurisdictions).
a. Note: NJ treats this situation much differently – even if you have an employee
terminable at will, a covenant of good faith and fair dealing is implied in
every K in NJ.20 RR: Ks have implied provisions that can be used!!!
g. Wilson v. Amerada Hess Corp. (NJ 2001) – Facts: Dealers entered into dealership agreement w/
distributor, whereby dealers purchased gasoline from distributor. Dealers claimed that distributor set
prices w/ intent to impair dealers’ ability to compete, or to discourage them from continuing in the
business in order to replace them w/ distributor’s own co-op stations. The agreement gave distributor
unilateral authority to set and change prices. Dealers sought the production of documents showing the
performance of distributor’s co-op stations in the marketing areas of dealer’ stations. Held: A party
setting prices under a K breached the implied duty of good faith and fair dealing if that party exercised its
discretionary authority under the K arbitrarily, unreasonably, or capriciously, w/ objective of preventing
the other party from receiving its expected fruits under the K. If the discovery showed that distributor
knew that its pricing rendered it impossible for dealers to meet their operating expenses and perform
profitably, w/o reasonable explanation, there would be a breach of implied covenant claim. Note: Apply
this covenant to Wilkes.
h. Sugarman v. Sugarman (1986) – Facts: Leonard Sugarman, majority SH in a close Corp, was alleged to
have breached his fiduciary duty by acting in bad faith in an attempt to “freeze out” family members,
minority SHs. Reasoning: Leonard took actions to ensure that minority SHs would not receive any
financial benefits from the Corp and evidence showed that he overcompensated himself, refused to pay
dividends, paid his father too much, refused Jon and Marjorie jobs, which they asked for, and offered to
buy the SHs’ stock at an inadequate price. Held: SHs in a close Corp owe one another a fiduciary duty of
utmost good faith and loyalty.
i. Note: Under Wilkes, Leonard would have to show that he had a legitimate business purpose for
all the things he did. Arguably, he could have a legitimate business purposes that may be
sustainable. However, under the “Reasonable Expectation” test it gets complicated for Leonard.
Minority SHs have a reasonable expectation so all of Leonard’s legitimate business purposes may
carry the weight under the Wilkes test, but are irrelevant under the “Reasonable Expectation” test.
Rationale is that if this is like a P-ship, then there are fiduciary duties owed. There is a fiduciary
relationship that defines the scope of the fiduciary duty.
Review:
(1) Is it a closed Corp?

a. If it’s not a closed Corp, then what? If it’s a Public Corp, then BJR applies and will be more respected.
20
Under this, Ingle could argue that he was fired for the sole purpose of ousting him out by repurchasing his stocks. Ingle got a raw deal – the K was
drafted by James Glamore. That covenant is one of the few terms that the Ct has been called upon to define as effective a term in a K as those that
are expressed. Good Faith & Fair Dealing cannot override express terms, but a party’s performance under a K may breach the covenant even though
it does not violate an express term.
Vanessa Verduga 80
Also, investment in a public co is liquid; minority SH can sell shares, as opposed to an illiquid investment
in a close Corp.
(2) Is person a minority SH?
a. Percentage of ownership may not be relevant
(3) Relevant underlying agreements?
a. Are there any devices in place that can be used by minority SH to prevent the oppression (short of
litigation)? E.g. SH agreements, employment agreements, etc.
(4) What happened?
a. Ways of beating up on a minority SH
(5) Causes of Action?
a. Expanded Fiduciary Duty
b. Minority SH oppression statutes
c. Covenant of Good faith and Fair Dealing
d. If dealing w/ securities, then look to Fed Securities Act
(6) Remedies?
a. Typical remedy – one where there is a buyer
b. Extreme remedies
(7) What happens now?
a. If minority SH loses, what do you advise your client?
i. Jordan v. Duff and Phelps, Inc. (1987) – Facts: Jordan purchased 188 shares of stock from Duff and
Phelps, Inc and later resigned. He delivered his certificates on Dec 30, 1983, and Corp mailed him a
check for the book value of the stock. Before Jordan cashed the check, he became aware of a merger b/w
Corp and a subsidiary that was to take place on Jan 10, 1984. Had Jordan quickly paid for the other 62
shares he was making payments on, he would have received $452K in cash. When Jordan heard of merger
announcement that would’ve increased the value of stock he had sold to D&P, he filed suit seeking
damages measured by the value his stock would have had under the terms of the acquisition. Held: Close
Corps buying their own stock have a fiduciary duty to disclose material facts. Jordan sold his stock in
ignorance of facts that would have established a higher value. The relevance of the fact does not depend
on how things turn out. Ct called this opportunistic firing  breach of implied covenant of good faith
and fair dealing.
i. Is it a Close Corp? D&P had 40 SHs plus Jordan  close Corp (# varies according to state
statute).
ii. Is person a minority SH? Jordan is a minority SH (188 shares), and employee of D&P in
Chicago. Jordan’s wife and his mother were not getting along. His choices – either get out of
Chicago or divorce. He decides to leave – gets a job in Houston.
iii. Relevant Underlying Agreement? There was an underlying agreement – Stock, Restriction &
Purchase Agreement – upon termination for any reason then Corp buys back his stocks at book
value corresponding to Dec 31 of yr of termination. Book value – usually lower than FMV.
iv. What happened? Jordan tells his boss he’s leaving. At the time, Corp was contemplating a
merger by which it would get $50M, but Jordan didn’t know about it and wasn’t told of it either.
1. Jordan sells his stock for $23,225
Vanessa Verduga 81
2. Merger announcement – subject to Federal approval, which doesn’t happen and merger
never happens.
3. Corp decided to dance w/ itself and formed an “Employee Stock Ownership Trust.”
4. Jordan – if I had known of the merger talks I would’ve hanged in there.
v. Causes of Action (all emanate from a Common Nucleus of Operative Facts) – Expanded
Fiduciary duty or Covenant of GF/FD to the “Stock, Restriction & Purchase Agreement.” Can
argue that the non-disclosure of merger by Hansen to Jordan was “material” under Northway.
vi. Does Hansen have a duty and where does it stem from?
1. Fiduciary Duty – Duty to disclose comes from the fact that Majority SH is conversing
w/ Jordan minority SH of buying his stock.
2. Reasonable Expectation standard might also work here.
3. Rule 10b-5 insider trader analogy to argue against disclosure – would Hansen have a
duty to disclose or not disclose? Hansen is an insider of the Corp w/ inside information
and I he discloses then he’s breaching his duty to his Co and to the merging Co.
4. Oppressed minority SH statute – Bonavita – could argue that oppression equals the
violation of Jordan’s reasonable expectations as a minority SH.
5. Can argue breach of K, etc.
vii. Remedies? Rescission – rescinds the original agreement – he gets back his stock and goes back
to work at Duffy & Phelps. Thus, he really wants money damages – how can you argue for this?
1. Damages – There’s a difference b/w the value that he got and what he would’ve gotten –
the value would’ve been higher even though the merger didn’t occur.
2. Note that BD paid mistress hush $ to keep stocks for 5 yrs after being fired – argue that if
BD is willing to do this for Hansen’s mistress then why can’t it do the same for Jordan?
XXX. Control, Duration, and Statutory Dissolution
a. Alaska Plastics, Inc. v. Coppock (1980) – Facts: 3 original SHs, each held 300 shares. 1 SH got
divorced and in divorce settlement gave wife Patricia Muir (Coppock) 150 shares. After Alaska Plastics
failed to notify Coppock of annual SHs meetings, paid her no dividends, and did not allow her to
participate in the business, she filed suit, seeking to compel Alaska Plastics to purchase its stock she had
received in a divorce settlement. Held: Alaska Plastics was obligated to buy Coppock’s shares at fair
value. Majority SHs in a closely held Corp owe a fiduciary duty of utmost good faith and loyalty to
minority SHs.
i. This is a closed Corp.
ii. Patricia is a minority SH.
iii. There are no underlying agreements.
iv. She argues that they’re freezing her out. She has zero chance of having any say – this a “won’t go
away fact” – of course, they’re not being fair to her – she’s their buddy’s ex-wife, they don’t want
her there – this is a good fact for Patricia. She’s getting the run around and being excluded by
majority SHs.
v. Causes of Action:
1. Minority SH can join a Derivative SH claim to her direct claim if she can show that their
actions are hurting the Corp. She can argue that they’re taking their wives to Seattle and
discounting it as a corporate expense. This was dismissed b/c the hurt was to her and not
the Corp. On the merits, the BJR applies to the derivative claim.
2. Breach of Fiduciary Duty
3. Implied Covenant of GF/FD in divorce settlement since there’s no other agreement.
vi. Remedies:
1. Dissolution / Liquidation (be a bitch) – that’s too extreme; ct “may” not order it. The
Corp is in paralysis (SH don’t get along at all) – if Corp is paralyzed then Ct will issue
involuntary dissolution.
2. Forced Buy-Out – more likely that ct will order this.
Vanessa Verduga 82
vii. Precaution  Advice to Patricia – don’t take the 150 share and try to get something else in the
divorce settlement. Could have made an agreement that Majority buy her out.
b. Balsamides (NJ 1999) – how to calculate Fair value for stock in Close Corp - don’t need to know.
Facts: 2 business associates, each 50% SHs a closely-held Corp. Π petitioned ct for dissolution under the
“Oppressed SH Statute,” NJSA §14A:12-7. Held: Π was entitled to buy-out Δ’s interest and ordered Δ to
sell his shares to Π. Trial ct has substantial discretion to adjust a company's purchase price in determining
its “fair value” when dissolution of a closely-held company is ordered under NJSA §14A:12-7. Case was
remanded for reconsideration of the use of a 30% capitalization rate in valuing Δ’s interest.
c. Stuparich v. Harbor Furniture Mfg., Inc. (2000) – Facts: 2 classes of stock – non-voting and voting
stock. Voting stock – Malcolm Jr. given to him by his father. Brother and 2 sisters – brother Malcolm Jr.
ran the business w/ his wife and his son, and the sisters didn’t run it; they were school teachers.
i.It’s a close Corp

ii.No underlying Agreements
iii.Sisters were frustrated b/c they weren’t being listened to.
iv. The reasonable expectation test is a low level of oppression – sisters could argue that the way in
which Malcolm was running the Corp did not meet their reasonable expectations.
1. They received huge dividends – this influenced the Ct’s decision
2. One of sisters was physically injured as a result of disagreement w/ brother.
3. Ct balances the facts and gives deference to the brother’s business judgment.
4. Can’t prove anything
v. No remedies
vi. What happens now? Make a deal to have Malcolm buy the sisters out (get them out of the
picture) – need to arrange the cost of the stock (negotiate).
XXXI. Sale (Transfer) of Control
a. When you buy a Company you try to buy control. Suppose a party wants to acquire a Corp (public or
private) and in order to do that the party wants to know how to get control of the Corp - what to do? You
need to get either:
i. Majority (actual) control, or
ii. Effective control (Feldmann) - you need to contact the person who has this control.
b. Corporate Takeovers – An act or instance of assuming ownership or control of another Corp. It’s
typically accomplished by a purchase of shares, a sale of assets, a tender-offer, or a merger. It can be
friendly or hostile.
i. Friendly - parties deal at arm’s length and negotiate a deal to sell control at a fair price - there’s a
willing buying and a willing seller. It’s favored or approved by the Corp being acquired.
ii. Hostile - acquisition by the Corporate Raider who makes a tender offer to all SHs to sell their
stocks at above the market price (may announce it in newspaper). This causes a flood of shares to
be transferred from the SHs to the Corporate Raider thereby allowing the Raider to take over. It’s
a takeover that is resisted by the Corp being acquired. It’s hostile to target Corp’s BD b/c if
executed directors will likely lose their jobs.
c. Looters - are undertakers (liquidators) who go out and look to acquire companies which they can then
liquidate and sell of in parts/divisions and thereby make more money.
Whether the Seller or his control shares is in a Fiduciary Relationship w/ a Minority SH:
3 different rules flow from this situation:
Vanessa Verduga 83
(1) General Rule: Stockholders can sell their shares at whatever price they want and there’s no obligation to the
minority SH;
a. Recognizing that those who invest the capital necessary to acquire a dominant position in the ownership
of a Corp have a right of controlling that Corp. Rule: Absent looting of corporate assets, conversion of
corporate opportunity, fraud or other acts of bad faith, a controlling stockholder is free to sell, and a
purchaser is free to buy, that controlling interest at a premium price. (Zetlin)
(2) 4 Limitations: When you buy the control shares, you’re getting a control premium (a bump in the price of what
your shares are really worth). There’s nothing wrong w/ doing this, unless you’re selling to a knowing looter,
taking a corporate opportunity for yourself, or if it’s fraudulent or a bad act  Ct will not allow you this.
a. If controlling SH sells to a corporate looter (Feldmann)
i. A majority or dominant SH is ordinarily privileged to sell his stock at the best price obtainable
from the purchaser. In doing so he acts on his own behalf, not as an agent of the Corp.
However, if he knows or has reason to believe that the purchaser intends to exercise to the
detriment of the Corp the power of management acquired by the purchase, such knowledge or
reasonable suspicion will terminate the dominant SH’s privilege to sell and will create a duty
not to transfer the power of management to such purchaser.
1. Ways to know or have reason to believe:
a. Is there a record of looting?
b. Red flags - how is the deal structured?
c. Is there an exorbitant premium?
d. Liquid assets, as opposed to buildings?
b. A Conversion of Corporate Opportunity (Feldmann)
c. Fraudulent
d. Bad Act
(3) Take Me Along Concept: Equal treatment / Equal opportunity - we’re all in this together and therefore if
someone comes along and wants to buy your control shares and gives you a premium then you can’t sell unless
the same offer is made to me. (Jones, Frandsen).
a. On One Hand - this is fair.
i. Certainly minority SHs are entitled to protection against such abuse by controlling SHs. They
are not entitled, however, to inhibit the legitimate interest of the other stockholders. It’s for this
reason that control shares usually command a premium price, which is an added amt an investor
is willing to pay for the privilege of directly influencing the Corp’s affairs. (Zetlin)
b. On the Other Hand - why should minority SH ask to be taken along - Most of the Courts will say no to
this.
i. Granting minority SHs an opportunity to share equally in any premium paid for a controlling
interest in the Corp would profoundly affect the manner in which controlling stock interests are
Vanessa Verduga 84
transferred. It would require, essentially, that a controlling interest be transferred only by means
of an offer to all SHs (i.e. a tender offer). This is contrary to existing law and change should be
made by Legislature not the Court.
c. Frandsen v. Jensen-Sundquist Agency, Inc. (1986) – Facts: Frandsen minority SH entered into a
stockholder agreement w/ majority SHs of J-S small company that gave him (1) a right of first refusal in
the case of the sale of the majority's stock and (2) a right to have his stock purchased at the same price as
the stock was sold (“take-me-along”). 1st Wisconsin Corp larger company proposed to merge w/ J-S’s
Bank and later agreed instead to buy J-S's stock and assets and then to liquidate its assets. Frandsen
refused to consent and filed suit after his attempt to exercise his right of first refusal to buy the majority
bloc’s shares at the offer price in a proposed acquisition failed. He alleged that J-S breached its agreement
and 1st WN tortiously interfered w/ his rights under the agreement. Held: The agreement applied where
the majority stockholders sold their stock, which did not occur when 1st WN purchased J-S. The sale of
the majority block's shares was not the same as the sale of J-S’s assets. Frandsen had no right to block the
sale of assets and was not protected from the proposed merger or the actual liquidation of J-S.
i. Note: The sale of assets does not result in substituting a new majority bloc b/c 1st WN wasn’t
looking to acquire majority control, which is what the right of 1st refusal protective provision was
for. Rights of first refusal to buy shares at the offer price are to be interpreted narrowly.
Furthermore, if no contractual right of Frandsen’s was violated then there’s no tortuous
interference w/ his rights by1st WN. RR: Stockholder Agreement here is good drafting.
ii. Advice: Frandsen should have had broader language in the agreement (language including
mergers and acquisitions). If representing Frandsen, don’t stop at breach of fiduciary duty 
perhaps argue oppressed minority statute.
d. Perlman v. Feldmann (1955) – Facts: After Feldmann sold his controlling interest in Newport Steel
Corp to Wilport Co (consortium of Steel Co.s), Perlman and other minority stockholders brought a
derivative action to compel accounting for, or restitution of, allegedly illegal gains accruing to Feldmann
as a result of the sale. Held: Feldman as director and dominant stockholder stood in a fiduciary
relationship to Corp and minority stockholders as beneficiaries. By selling his control block for a
premium, Feldmann violated his fiduciary duty to the other SHs. When there is an opportunity for
corporate-level gain, and instead the controlling SH appropriated that gain for him, there was a breach of
such obligations. When the sale of a controlling block of stock necessarily resulted in a sacrifice of the
element of corporate good will and resulted in unusual profit to the fiduciary that caused the sacrifice, he
was required to account for his gains.
i. Note: The asset being looted was the interest free loans - the Feldmann Plan, which consisted of
securing for firm interest-free advances from prospective purchasers of steel in return for firm
commitments to them from future production. Minority SHs lost on their opportunity to capitalize
on the shortage of steel such as raise prices and get more $ through these interest-free loans b/c
Wilport was not buying control to continue the Plan and sell steel, but rather to supply themselves
w/ steel. This is unfair to minority SHs b/c they’re not getting their fair return on their investment.
Ct held this not to be a derivative suit, but rather a direct claim. Rationale – in a derivative suit
the damages go to Corp, in this case they would’ve gone to Newport/Wilport and there would be
no remedy for the minority SHs. Remedy is to pay to minority SHs of Newport the bonus
premium Feldmann got for selling the asset (shortage of steel, interest-free loans) that wasn’t his
to sell.
Vanessa Verduga 85
ii. Diverted Collective Opportunity – Corp has a business opportunity that it would normally
pursue on its own, but for some extraneous reason the value of this opportunity is instead “sold”
to the buyer of a control bloc in return for a control premium.
e. Zetlin v. Hanson Holdings, Inc. (1979) – Facts: When Hanson Holdings and the Sylvestri family sold
their controlling interest in Gable Industries for a premium price, Zetlin, a minority SH, brought suit,
contending that minority SH were entitled to an opportunity to share equally in any premium paid for a
controlling interest. Held: Absent looting of corporate assets, conversion of a corporate opportunity,
fraud or other bad faith, a controlling SH is free to sell, and a purchaser is free to buy, that controlling
interest at a premium price.
f. Essex Universal Corporation v. Yates (1962) – Facts: A K b/w Essex and Yates called for a sale of
stock in Republic Pictures to Essex. K included a provision that called for 8 of Republic’s 14 directors to
resign and be replaced by Essex nominees. Essex is ready and willing to go through w/ the K, but Yates
on his lawyer’s advice, backs out. Essex sues Yates. Held: Although an agreement to sell control of
management of the Corp by itself is invalid, Essex was actually buying substantial % of company's stock.
It was not improper for Yates to derive premium from sale of controlling block of stock. There was no
suggestion that transfer of control carried any threat to interests of company or its SHs. B/c K was for
ownership of majority of stock and b/c it was permissible for seller to choose to facilitate immediate
transfer of majority control  K was permissible. A sale of a controlling interest in a Corp may include
immediate transfer of control.
i. What are the loopholes that a good lawyer might be able to assert on behalf of Yates? Yates
is not only selling his stock, but he’s also selling seats on the Board of Republic, and he’s not
authorized to do that. Yates was advised by his lawyer that he can’t sell something that he does
not own. So Yates backs out of the deal.
ii. However, ct assumed that Essex was contracting to acquire a majority of Republic stock,
deferring consideration of the situation where only 28.3% is to be acquired. Court was essentially
saying the 28.3% is a mere formality, and it really amounts to control. Thus, Essex is able to do
the very thing that Yates promised to do the only difference is that it would take Essex 18 months
after the sale of the stock to do it in accordance w/ Republic’s by-laws. Yates was getting a
premium for his shares not for delivering the Board b/c Essex would’ve gotten that on its own
anyway. Therefore, no minority SHs were hurt by this K.
iii. Effective Control - a block that is less than a majority but still large enough that, as a practical
matter, the possessor will ultimately be able to get his nominees elected to a majority of BD seats.
Vanessa Verduga 86
MERGERS, ACQUISITIONS & TAKEOVERS
XXXII. Mergers & Acquisitions
a. The De Facto Merger Doctrine - 3 ways in which a merger is legally accomplished

(combination/amalgamation toolbox):
i. Statutory Merger – of one Corp w/ another (stock)
ii. Sale of All/Substantially all Assets
iii. Direct Purchase of Stock from SHs (solicitation/tender offer)
b. 3 considerations govern which form you choose:

i. Internal Revenue Code – sometimes these exchanges are tax-free and sometimes they’re not -
it’s all about saving $.
ii. SH Director Approval
iii. Appraisal Rights of the Dissenters – most important
c. MBC §11.01- §13.31 (p. 208 read this section!)
d. Device #1: Statutory Merger – What happens procedurally under a statutory merger is:
i. Need to come up w/ a Plan of Merger – the Acquiring Corp’s and the Target Corp’s boards will
come together and they’re lawyers will prepare a Plan of Merger – document which spells out the
terms of the merger, drafted by the parties, describes the treatment of the SHs - specifies how
many shares would go to the SH of each Corp.
ii. MBC §11.04(a) Board must adopt the Plan of Merger – requires Board Approval by votes.
iii. MBC §11.04(b) SH Approval of the Plan of Merger – from SHs of each of the Corps
iv. MBC §13.02(a)(1) Dissenter’s Appraisal Rights – dissenters would be entitled to demand that
they be paid in cash the “fair value” of their shares. This right to be paid off is an “appraisal
right.”
1. Minority SH deserves this appraisal right b/c they now own stock which is materially
different from the former Corp. Note: Know what State you’re in and what laws you
need to follow!
2. E.g. ABC and XYZ are going to merge, if survivor is ABC then it’s called the “survivor”
and XYZ is called the “merged” or “disappeared” Corp. If they merge and the new
company is called “DEF” then it becomes the “survivor” and DEF is called a
“consolidation.”
v. MBC §12.01 Disposition of Assets not requiring SH Approval – No approval of SHs is

required, unless the articles of Incorp otherwise provide:
1. to sell, lease, exchange or otherwise dispose of any or all of the Corp’s assets in the usual
and regular course of business;
2. to mortgage, pledge, dedicate to the repayment of indebtedness, or otherwise encumber
any or all of the Corp’s assets, whether or not in the usual and regular course of business;
3. to transfer any or all of the Corp’s assets to one or more Corp or other entities all of the
shares or interests of which are owed by the Corp; or
4. to distribute assets pro rate to the holders of one or more classes or series of Corp’s
shares.
e. Device #2: Acquisition of Assets – Acquiring Corp buys all assets of target Corp. One advantage is that
the Acquiring Corp does not succeed to unforeseen liabilities of the target Corp. Rights of minority SH
are different. Generally, there is no appraisal right.
Vanessa Verduga 87
f. Device #3: Purchase of Stock (Tender Offer) – Acquiring Corp offers premium for target Corp’s
shares. AC would seek to acquire enough shares to gain control of target. Since the transaction would be
b/w the AC and the target SHs, no votes of the target are required. Neither would there be any appraisal
rights. Once the AC acquires sufficient control, AC could use special procedure called a “short-form
merger” to merge target into AC or target could dissolve altogether.
g. Farris v. Glen Alden Corporation (1958) – Facts: Glen Alden and List Corp entered into a
reorganization agreement under which Glen Alden was to acquire List’s assets. Farris, a stockholder in
Glen Alden, sued to enjoin performance of this agreement. Farris argued that the reorganization
agreement was actually a merger b/w Glen Alden and List Corp and that proper notice was not given to
the SHs of their right to dissent and claim fair value for their shares. Glen Alden Corp contended that the
agreement was a purchase of corporate assets of which SHs had no right of dissent or appraisal. Held:
The nature of the agreement proposed a de facto merger b/c it fundamentally changed the character of
Glen Alden and the interest of Farris as a SH therein. Glen Alden would be completely transformed into a
diversified holding company, and Farris would find himself a member of a company w/ assets of $169M
and a long-term debt of $38M. Since Farris would be forced to give up his stock in Glen Alden and
accept that of List, he should have been notified. A transaction which is in the form of a sale of
corporate assets but which is in effect a de facto merger of 2 Corps must meet the statutory merger
requirements in order to protect the rights of minority SHs.
i. Note: Even though List is calling the shots, it is Glen Alden who is acquiring List - reason is that
Glen Alden has a huge Tax Loss Carryover that might evaporate if it’s not done this way. List has
Glen Alden in its clutches; it controls the Board and structures the deal as a sale of assets. Clever
lawyering  agreement specifically says “acquire all assets” (masquerade).
h. Hariton v. Arco Electronics, Inc. (1963) - (this case says the opposite of Farris) – Facts: Π SH sued
Arco Corp to enjoin consummation of a plan to sell Arco's assets under Del Law § 271, dissolve pursuant
to Del Law § 275, and distribute the purchasing Corp's stock to SHs. Π contended that the sale of assets
and dissolution statutes could not be legally combined, and that the plan constituted a de facto merger w/o
affording SHs rights provided in the merger statute. Summary judgment was granted in favor of Arco.
Held: The combination of the sale of assets and dissolution statutes was legal. Although Arco's actions
did accomplish a de facto merger, the sale of assets and merger statutes were independent and the validity
of actions taken pursuant to one statute did not depend on the other. Thus, this was permissible even
though the result may be a de facto merger. Note: Delaware is a merger friendly state.
XXXIII. Freeze-Out Mergers
a. Situation – If you’re in the majority and have control by virtue of majority ownership you have a lot of
power and prerogatives - you almost can always get your own way if you do it fairly. When Majority SHs
want to get rid of minority SHs there are a # of ways in which minority SH could be forced out (sold-out).
b. Rationale – Why would a majority SH want to do this?

i. Corporate Greed - you want 100% of the pie.
ii. Free Riding - these minority SHs are “dead wood” - we don’t need them. It’s Corporate Greed
based on the fact that minority SHs bring nothing to the profitability of the Corp.
iii. Avoid Minority SH Problems - could be reporting problems, minority SH oppressed problems,
fiduciary duty problems  just don’t want to have to deal w/ these problems.
1. Note: The Law does not bar Majority SHs from eliminating Minority SHs.
c. Mechanisms for Eliminating the Minority SH:
Vanessa Verduga 88
i. Dissolve and Liquidate – when Corp closes down, majority SHs go off and start a new business
w/o the minority SHs. However, there may be business reasons for not doing this - it’s probably
the least effective way.
ii. Reversed Stock Split - shares are cut in half or in accordance w/ the ratio cut - what you end up
holding is a fractional part of the Company, which may be less than 1 fractional share and under
Corp’s by-laws you may eliminate these types of minority SHs by buying them out. They have no
choice but to sell b/c under the by-laws they cannot be a SH (depends on Corp’s by-laws).
iii. Freeze-out Mergers / Cash-out Mergers – It’s a merger whereby majority SH forces minority
SH into the sale of their securities - a.k.a. “squeeze-out,” “force-out,” or “cash-out” merger. It’s a
way that majority SH gains control over the Corp for whatever reason, and get richer thereby.
Majority is using something totally legitimate by following the merger statute:
1. Get an evaluation/appraisal, by an outsider, of the value of the minority SHs’ stocks and
in accordance w/ merger statute pay them out by giving them the “Fair Value” of their
shares in stock. You’re robbing that person of their property w/o any choice - if this were
public law then the minority SH would go to Ct and argue Due Process violation, but this
is corporate law (private) and the minority SH has other ways to protect him.
Type of Cash-Out Merger:

(1) 1st Step – get control by gaining a majority of the Corp (go out and acquire control)
(2) 2nd Step – the actual implementation of the terms and provisions of the merger cash-out.
(3) 3rd Step – filing a complaint
(4) LAF
a. Legitimate Business Purpose supporting the majority’s decision to eliminate the minority.
i. Weinberger - we’re only interested in “Fairness”
1. Fair Dealing
2. Fair Price
b. Majority / Minority Vote
i. Usually the minority that dissents is a minority of the minority – these can then file a complaint
and allege that there was no
1. Business Purpose, and
2. It was not Fair
a. Fair Dealing
b. Fair Price
c. Remedy – what minority SH can do in the face of a cash-out:
i. Appraisal - if you wait too long you get an appraisal of the present value of the shares. Make
sure minority SH is getting a reasonable amt.
ii. Rescission - you get this if you don’t wait too long, otherwise you get an Appraisal. Court can
unwound the transaction an return the parties to status quo.
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iii. Injunction - if you’re really early then you can get an Injunction. However, it’s hard b/c you
usually don’t know early enough and it’s expensive and hard to stop.
d. Weinberger v. UOP, Inc. (1983) – Facts: Class Action brought by Π SH of UOP who challenged the
elimination of UOP’s minority SHs by a cash-out merger b/w UOP and its majority owner Signal.
Reasoning: The feasibility study showed that minority SHs of UOP could’ve received $24 per share
instead of the $21 per share they gave them. This was a difference of only 2/10ths of 1%, but it meant
over $17M to minority SHs. This was material information not provided to UOP. “Complete Candor” is
required b/c the feasibility study was done by 2 of UOP’s directors (appointed by Signal) for the sole
benefit of the structurer of the deal, which was Signal. Held: When Directors of a Delaware Corp are
on both sides of the transaction, they are required to demonstrate their utmost good faith and the
most scrupulous inherent fairness of the bargain. The transaction did not satisfy any reasonable
concept of fair dealing, as the matter of disclosure to UOP’s directors was wholly flawed by conflicts of
interest raised in feasibility study, and the minority SHs were denied critical info. The Signal, Companies
effected a freeze-out merger w/ subsidiary UOP, Inc. w/o disclosing to minority SHs the value of UOP
shares. Thus, the freeze-out merger approved w/o full disclosure of share value to minority SHs
invalidated their vote b/c it was not an informed vote. The standard “Delaware block” or weighted
average method of valuation should not control. Rather, ct endorsed a more liberal approach requiring
consideration of all relevant factors pursuant to Del Law §262(h).21
i. Note: Although there was majority and minority vote approval, Signal failed when it came to the
Fairness Doctrine:
1. Fair Dealing - Complete Candor is required - duty of loyalty is being breached.
Disclosure was necessary. If they would’ve disclosed this then Signal and UOP would’ve
negotiated the price of the share.
2. Fair Price - remand for evaluation.
a. Note: Court here treated the Fairness Doctrine as a whole (entire) - thus, if on
remand the price was in fact fair then Signal can oust the minority SHs under
Delaware law.
ii. Remedies available: expanded appraisal remedy (evaluation method was expanded to allow any
appraisal method generally accepted in the financial community), and broad discretion of the
court to fashion such relief as the facts of a given case dictates.
iii. Court in Weinberger does not adopt the “business purpose requirement.” If the ct would’ve
adopted the “business purpose requirement” it would’ve been harder for Signal to show that what
it was doing was not just good for Signal, but it must show that it was good for UOP as well.
iv. Precaution  One way Signal could’ve insulated the transaction from subsequent attack is by
making sure that a special committee of disinterested directors is appointed to negotiate the
transaction. Signal made a really stupid move by having Arledge and Chitiea conduct feasibility
study when they both were directors of UOP and members of the Signal board – there’s an
inherent conflict of interest!
The “Fairness” Doctrine:

(1) Fair Dealing - Phase I of doctrine; majority SH must not only act for his benefit, but for the benefit of the Corp
as a whole; focuses on the totality of circumstances:
21
RR: other potential claims against UOP  Rule 10b-5, §14, breach of fiduciary duties (to UOP SH), proxy statement, reg. statement, claim against
majority SH, claim against the board, no fair dealing, etc.
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a. Timing of Transaction
b. How it was initiated
c. Structured
d. Negotiated
e. Disclosed to Directors; was there candor?
f. How the approval of the Directors and Stockholders were obtained
(2) Fair Price - Phase II of doctrine. Relates to the economic and financial considerations of the proposed merger -
assets, market value, earnings, future prospects, and other elements that affect the intrinsic or inherent value of a
company’s stock. This is not a bifurcated test as b/w fair dealing and price. All aspects must be examined as a
whole since the question is one of entire fairness.
(3) Business Purpose - followed in Coggins, not followed in Weinberger
(4) Remedies - may not just be appraisal remedy; may be able to block the merger.
e. Coggins v. New England Patriots Football Club, Inc. (1986) – Facts: Sullivan purchased a Football
Franchise and contributed it to a Corp he organized along w/ 9 other persons who contributed $25K
getting 10,000 voting shares. Later the Corp sold 120,000 nonvoting shares at $5 a share. Sullivan had
effective control and was later ousted by a hostile board. He made a come-back and regained complete
control of the Corp - he was able to do this by taking out loans and backing them with his 100% voting
shares. However, the Bank had him on a string – “we’re not giving you the $ unless you’re going to re-
tool the structure of the Corp to guarantee that all income of Corp could be devoted to repayment of the
loan.” Thus, Sullivan has to eliminate the nonvoting shares. He later organized a new Corp (New Patriots)
and agreed to merge it w/ the Old Patriots Corp thereby extinguishing the voting stock of Old Patriots and
exchanging at $15 a share the nonvoting stock, and the name of the New Patriots would be turned into the
Old Patriots. Coggins did not want to be forced to give up his nonvoting shares and brought a class action.
Held: The freeze-out was designed for Sullivan’s own personal benefit to eliminate the interests of the
minority SHs and did not further the interests of the Corp. The merger was a violation of fiduciary duty to
minority SHs, and therefore impermissible. It goes against the essence of liberty of the minority SHs to
invest their money in the Corp w/o being compelled to sell-out. Although rescission is the normal
remedy, the ct determined it would be inequitable and remanded for a determination of the present value
of the nonvoting stock, as though the merger had been rescinded.22
i. Note: Mass, along w/ NY, maintain the business purpose requirement (even though Del abolished
it). Thus, Coggins has a right to have his stock. It could’ve been taken away from Coggins had
Sullivan showed a legitimate business reason (BJR), but his reasons were solely personal. In
Delaware, Sullivan would’ve gotten away with it as long as it satisfied Fairness Doctrine. Thus,
Delaware allows the minority SH to be cashed out w/o a business reason as long as it’s fair and
appraisal is reasonable.
ii. Mechanics of a merger:

1. Majority SH vote to dissolve Corp
2. Majority SH can vote to distribute cash to minority SH and corporate assets to majority
SH
3. Majority SH can start new Corp
22
RR: Potential causes of action against Coggins  breach of fiduciary duty against the Board, against the majority SH, self-dealing (waste of
corporate assets), rule 10b-5 if there’s sale/purchase of securities, proxy 14a-9, entire fairness (no business purpose).
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XXXIV. LLC Mergers
a. VSG, Inc. v. Castiel – Facts: Castiel, sole member, formed VGS LLC. Shortly after 2 other entities,
Holdings and Ellipso, became members of LLC. LLC Agreement creates 3-member Board of Managers.
Pursuant to LLC Agreement Holdings received 660 units, Sahagen 260 units, and Ellipso 120 units. As
majority holder Castiel had the power to appoint, remove and replace 2 BD members. Castiel named
himself and Quinn to the BD, and Sahagen named himself as the 3rd member. Castiel and Sahagen were at
odds. Sahagen ultimately convinced Quinn that Castiel must be ousted from leadership in order for LLC
to prosper. W/o notice to Castiel, Quinn and Sahagen acted by written consent to merge into VSG, and
cease LCC. Castiel was not made member of VSG BD. Holdings and Ellipso went from having 75%
controlling combined ownership interest in the LLC to 37.5% interest in VSG. On the other hand,
Sahagen went from owning 25% of LLC to 62.5% of VGS. Notice to Castiel would’ve resulted in
immediate removal of Quinn from BD w/ someone loyal. Held: Both Sahagen and Quinn breached their
duty of loyalty to the LLC, its investors and Castiel. A majority vote of the LLC’s BD could properly
effect a merger. But, Sahagen and Quinn failed to discharge their duty of loyalty to Castiel in good faith
by failing to give him advance notice of their merger plans under the circumstances and LLC agreement.
Thus, the acts taken to merge the LLC into VGS are invalid and the merger is ordered rescinded.
i. Notes: Sahagen issued a promissory note for $10M (didn’t even put up cash) and the note was
probably not secure. Furthermore, if he was smart, he did it as an agent of the company so there
was no personal liability. For this, he got 2M shares of the new Corp. Sahagen ends up putting
no cash out of his pocket, takes Castiel and Quinn down from 75% to 37.5% and takes himself up
from 25% to over 60% and he gets to do this b/c Quinn cooperates. Castiel argues that it needs to
be unanimous but the court rejected this argument b/c in the bylaws only a majority vote was
needed.
1. LLC Act §18-404(d) – “any matter that’s to be voted on w/o a meeting, w/o prior notice,
and w/o a vote shall be signed by managers having not less than a minimum the # of
votes that would be necessary to authorize such action at a meeting.”
ii. Sahagen figured that he can acquire the extra shares in the LLC and gain control and reduce
Castillo and do this all w/o telling him, the statue does allow him to take action w/o giving notice
to other directors. So what Sahagen does is Co-opt Quinn, have a secret meeting and vote for
merger, can issue promissory note as agent of the Corp so he’s not personally liable. This is
creative by him and his lawyer. Their best argument was that Castillo was running the Co into the
ground. Burden is on Castillo to show why rescission should be granted by Ct. Sahagen loses.
XXXV. Takeovers
a. Fundamental Difference b/w takeovers and statutory merger/sale of assets:

i. Acquiring Corp deals directly w/ the SHs;
ii. Board of the target Corp is not involved;
iii. Don’t need to go through Board as a gatekeeper;
iv. Majority SH approval is not necessary.
b. Corporate Raider – the person or entity attempting to take control of the target Corp.
c. Target Corp – Corp the CR is trying to get control of.
d. Tender-Offer – acquirers solicit SHs to purchase their shares at a premium (more than what shares sell
for).
Risk Losing Job/Protect Own Incumbency or Entrenchment vs. Agreeing to Takeover if Good for the SH:
Takeovers create potential fiduciary duty problems for the BD of Directors.
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Takeover Defenses a.k.a. “Shark Repellent” – aimed at preventing corporate raider from taking over.
Fiduciary duty question kicks in when one decides to use one or more of these devices:
(1) Greenmail – the practice of buying out a takeover bidder’s stock at a premium that is not available to other
shareholders in order to prevent the takeover (p. 762 n. 13) (now gets taxed)
(2) Self Tender –
(3) Poison Pills – definition below, some include: Crown Jewel, White Knight, Pac Man, and Golden Parachute
(which is a termination agreement providing substantial bonuses and other benefits for managers and certain
directors upon a change in control in the company)
(4) Staggered Board – a minority of the board will only stand for election in any given year (an acquiring
corporation will not be able to gain control immediately, but will have to wait)
Options of judicial review when directors of target Corps use defensive measures:
(1) Traditional BJR – doesn’t work b/c it’s a hybrid; there’s an inherent conflict of interest
(2) Traditional Burden Shifting Fairness – don’t want this other extreme; strict scrutiny
(3) Intermediate Review/Proportionality Review – Unocal Test; measure used must be proportional to the
harm/threat averted
(4) Intermediate Review w/ a Bite- Revlon Test
e. E.g. If a corporate raider gets 15%+ of stock in Corp, bells and whistles go off and the Target Corp’s SHs
can exercise rights provisions and buy the same common shares the Corp Raider is attempting to get. All
SHs can buy 1000s of these shares. Thereby creating more shares – this dilutes the power of the corporate
raider. These shares are waiting in a lock box and the key to the lock box is the corporate raider getting
more than 15% and then the shares come flowing out and screw the Corp raider’s attempt to gain control.
The corporate raider will know this before hand and not attempt the takeover.
f. Cheff v. Mathes (1964) – Facts: Directors of Holland Furnance Co (Δ) alleged that repurchase of
corporate stock at a premium was effected solely to perpetuate their control of the Corp. Maremount, an
investor had acquired a large share of Holland and Holland’s president Cheff (Δ) believed Maremount
was going to loot company so the BD decided to buy back its own shares from Maremount at a price
significantly higher than the market price. Mathes (Π) SH filed a derivative action alleging that this was
done solely to preserve the BD’s positions. Held: Corporate fiduciaries may not use corporate funds to
perpetuate their control of the Corp. However, evidence indicated that directors’ decisions were based
upon direct investigation, receipt of professional advice, and personal observations of the company
attempting a takeover. Based upon their info, board of directors believed, w/ justification, that there was a
reasonable threat to the Corp's continued existence. The question was thus one of business judgment and
furnished no justification for holding the directors personally liable for losses even though, in hindsight,
their decisions might not have been the best for the business. Acts undertaken for the good of the Corp
in good faith that have the incidental purpose of maintaining the BD’s control are permissible, but
if no other reason than invalid. Note: The situation here also creates a panic in the company that
everyone was going to lose their jobs so they were doing this to protect their jobs. Based on this, ct
believed they were doing it for the good of the Corp.
i. E.g. You are a SH of target Corp and find out that Corp fraud had been going on, now b/c of the
greenmail paid your stock price is going to be lower, less corporate assets. You would then bring
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a derivative suit for waste of corporate asset. When looking to see if the buy back of the stock is
a beach of fiduciary duty – the burden is on the Δ. Here, Holland board had to show that they
made the purchase in good faith, and that the motive was not self interest but for the business.
ii. Note: If the board shows that it is worried that a particular hostile takeover will damage the
Corp’s existence or business policies, and buying back the raider’s shares at a premium in return
for a standstill agreement will prevent the hostile takeover, the Delaware courts will generally
approve the transaction even though it enriches the bidder at the expense of the corporation’s
treasury. Maremount (acquirer) had a history of looting companies he acquired.
iii. RR- thinks this judgment is similar to the BJR to determine whether the board’s use of their
corporate money was proper
1. Corp’s money was being used
2. Therefore injury was to Corp
3. Therefore this was a SH derivative action
4. Therefore there is a demand issue
5. Should SH be entitled to a demand? The answer is: it depends (go to Demand LAF)
Dominant/Primary Purpose Test:
(1) If the action of the board were motivated by a sincere belief that the buying out of the dissident stockholder was
necessary to maintain what the board believed to be proper business practices, the board will not be held
liable for such decision, BUT
(2) If the board has acted solely or primarily because of the desire to perpetuate themselves in office, the use of
corporate funds for such purposes is improper.
This is a very subjective test – a mix of duty of loyalty and duty of care.
XXXVI. Development
a. Superimposed on all of this is the fact that Ct doesn’t just look at substance but also at how the BD of the
target Corp went about reviewing the takeover bid (procedure) – was it rational (not whether it’s good).
b. Two-tiered Front-End Loaded Offer – a 2 step technique by which a bidder tries to acquire a target
Corp, the first step involving a cash tender offer and the second a merger in which the target company’s
remaining SHs receive securities from the bidder that are less favorable than the cash given in the first
step. Thus, it coerces each SH into tendering so that they don’t get the lesser price on the back-end and
also forecloses a more advantageous auction for the stock.
c. Selective Exchange offer: Offering a certain price for a select group of SHs shares. Defensive tactic to
ward off takeover.
d. Greenmail: An unfriendly suitor’s act of buying enough stock in a company to threaten a hostile
takeover, and of then agreeing to sell the stock back to the corporation at an inflated price.
e. Poison Pill – a tactic employed by a target Co to make the purchase of its shares less attractive to a
potential buyer by requiring the issuance of a new series of shares to be redeemed at a substantial
premium over their stated value, if a party purchases a specified percentage of voting shares of the Corp;
target creates convertible preferred stock – when AC reaches certain percentage, converts to common
stock that has value double that of market value! This essentially kills the takeover.
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f. Lock-up Option – common form is the “Crown Jewel Option” given to a 3rd party bidder favored by
management, who in return for entering the bidding war as a white knight gets the option to buy one or
more of the target’s best business at a very low price if the 3rd party’s bid is eventually topped by the
hostile bidder; courts closely scrutinize this anti-takeover device and it is often invalidated
g. Unocal Corp v. Mesa Petroleum Co. (1985) – Facts: To ward off a hostile take over by Mesa
Petroleum (Π) the directors of Unocal (∆ ) instituted a selective exchange offer. Mesa’s hostile tender
offer was a 2-tiered front loaded offer. Following consultations w/ financial professionals, the BOD of
Unocal approved a defensive tactic (selective exchange offer) wherein Unocal issued an exchange offer
for its own stock, at an amount higher than that offered by Mesa and specifically excluded Mesa from that
offer. Mesa sought an injunction. Held: A selective tender offer is not in itself invalid. There was
directorial power to oppose Mesa’s tender offer, and to undertake a selective stock exchange made in
good faith and upon a reasonable investigation pursuant to a clear duty to protect the corporate enterprise.
Unocal’s repurchase plan was reasonable in relation to the perceived threat and was entitled to be
measured by BJR.
i. Notes: Target Corp is Unocal. Raider is Mesa owned by Pickens, a big corporate raider (big
greenmailer). Pickens takeover bid was a 2-tier tender offer. Mesa owned 13% at the time. The
1st tier “front-end” involved 37% (64M shares) which Mesa was to acquire by paying $54 per
share cash. 2nd tier “back-end” consisted of “junk bonds” (valued at less than $54 a share) which
would go to acquire the remaining 50% of Unocal stock. As a SH you would rather have the $54
per share than the “junk bonds.” Idea behind the 2 tier is to cause a stampede so you have only 1
viable choice - the front-end and avoid being stuck w/ the back-end. Unocal BD needs to meet on
this – what should they do?
1. 1st make an honest and fair appraisal about the tender offer. Make sure the two-tier
tender offer is in the best interest of the Corp and its SHs.
a. April 13 meeting 9½ hrs – you’re Unocal’s lawyer – Take your team of
accountants and analyze this deal. Superimposed on all of this is that Mesa is a
noted corporate raider. BD concluded that Mesa’s offer was inadequate.
2. What can we do to drive Mesa away?
a. Selective Exchange Offer – to ward off a hostile takeover by Mesa Petroleum.
Ct held that a selective tender offer effected to thwart a takeover is not in itself
invalid. Terms: If Mesa acquired 64M shares of Unocal stock through its own
offer, Unocal would buy the remaining 49% outstanding shares for an exchange
of debt securities having an aggregate par value of $72 per share. This means
$72 kicks in when Mesa gets 51% (64M shares), Mesa gets paid $54 a share; this
is a disincentive for Mesa to get the 64M shares. This causes a reverse stampede
– however, the problem w/ the reverse stampede is that if the $72 per share
doesn’t happen they’ll get nothing b/c they’re not going to stampede the $54
value per share, and the $72 per share stampede only kicks in if Mesa acquires
50% of outstanding shares. Unocal is putting their $ in their mouth and that will
affect the way the Corp is run – huge move on Unocal’s part.
b. What Unocal did to quell this was to self tender 50M shares at $72 a share. They
don’t pay cash for the shares they do it on debt. This assumes that all Unocal SHs
are going to cash in here and get their $72 per share. Unocal self tenders the 50M
shares, borrows $ from bank to begin paying back debt. Unocal is playing
hardball b/c it doesn’t have the profits to pay this.
c. Also, the offer would be subject to other conditions, including the exclusion of
Mesa from the proposal. This is a great move for Unocal. Mesa sues Unocal.
Mesa can’t get the $72 per share.
i. What is Mesa’s argument as a 13% SH? Mesa is going to lose $; can’t
cash out at $72 a share, then their stock price is going to go down. So this
leaves Mesa really nothing.
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3. Once you convince the judge that what you did was proportionate under #2, then pretty
much you’re going to be allowed to use the method of shark repellant that you want if it’s
reasonable. Ct then doesn’t have the right to say that they should have used a different
method like greenmail. Thus, it’s none of their business so long as you meet the BJR.
Unocal needs to show that they had a reasonable ground to believe that there was a
danger to the Corp due to the 2-tier tender offer.
4. Conclusion: There was directorial power to oppose Mesa’s tender offer, and to undertake
a selective stock exchange made in good faith and upon a reasonable investigation
pursuant to a clear duty to protect the Corp enterprise. Further, the selective stock
repurchase plan chosen by Unocal is reasonable in relation to the threat the BD rationally
and reasonably believed was posed by Mesa’s inadequate and coercive 2-tier tender offer.
Under those circumstances, BD’s action is entitled to BJR. Thus, unless it is shown that
directors’ decision were primarily based on perpetuating themselves in office, or some
other breach of fiduciary like fraud, overreaching, lack of good faith, or being
uninformed, Ct will not substitute its judgment for that of the BD.
h. Junk Bonds – generally riskier than general grade bonds b/c the company whose bonds are being issued
may not be Microsoft, but rather Riccio’s Taco Store in Mexico. They may be unsecured, may be more
difficult to transfer, and/or may be subordinated – these are some of the reasons why junk bonds are
riskier. May give you more interest/return on investment (ROI), but are not guaranteed  it’s a gamble.
Testing the Decision of Target Corp Directors when using Defensive Mechanisms to Prevent Hostile Takeovers:
1. Potential for conflict places upon the directors the burden of proving that they had reasonable grounds for
believing there was a danger to corporate policy and effectiveness, a burden satisfied by a showing of good
faith and reasonable investigation, AND
2. the directors must analyze the nature of the takeover and its effect in the Corp in order to ensure balance- that the
responsive action taken is reasonable in relation to the treat posted (Unocal)
a. Proportionality review
b. Subject to enhanced review- b/c of the inherent conflict of interest  there is a likelihood that if an
unfriendly takeover is effected they will be ousted.
Directors of a Corp whose sale and breakup is inevitable are under a duty to maximize share value and cannot cut
off the bidding process.
i. Note: Under the BJR, ct will not substitute its judgment for that of the board if its decision can be
attributed to any rational business purpose. When a board address a pending takeover bid it has an
obligation to determine whether the offer is in the best interests of the Corp and its SHs. There’s
inherent danger in the purchase of shares w/ corporate funds to remove a threat to corporate policy when
a threat to control is involved. The directors are of necessity confronted w/ a conflict of interest and an
objective decision is difficult. In the face of inherent conflict directors must show that they had
reasonable grounds for believing that a danger to corporate policy and effectiveness existed b/c of
another person’s stock ownership. However, they satisfy that burden by showing:
i. Good Faith, and
ii. Reasonable Investigation
j. Such proof is further materially enhanced by the approval of a BD majority of outside independent
directors who have acted in accordance w/ the forgoing standards. Corporate directors have a fiduciary
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duty to act in the best interest of Corp’s SHs. However, a Corp does not have unbridled discretion
to defeat any perceived threat by any Draconian means available. Restrictions placed upon a selective
stock repurchase is that directors may not have acted solely or primarily out of desire to perpetuate
themselves in the office. A defensive measure to thwart or impede a takeover is indeed motivated by
a good faith concern for the welfare of Corp and its SHs, which must be free of any fraud or other
misconduct.
k. Unocal “Balance” Test – if a defensive measure is to come w/in the ambit of the BJR, it must be
reasonable in relation to the threat posed.
i. Factors taken into consideration:

1. Inadequacy of the price offered,
2. Nature and timing of the offer,
3. Questions of illegality,
4. Impact on constituencies other than SHs,
5. The risk of non-consummation, and
6. The quality of securities being offered in the exchange.
7. While not a controlling factor, BD may consider the basic SH interests at stake.
a. Note: Delaware law is pretty protective of Board.
Unocal – Compare the 2-tier tender offer & see if it was reasonable in face of the tender offer that was used.
Whether the BD Has Breached Their Fiduciary Duty in the Context of a Hostile Takeover:
(1) Authority – does the board have the authority to adopt such a defensive tactic against a takeover?
a. Large reservoir of authority vested w/in the BD to make such a decision.
b. Notwithstanding this fact, check the corporate statute. For example in Unocal, the general grant of power
to a BD is conferred by Del.C. §141(a).
(2) BJR w/ a Bite – Enhanced Review
a. Directors must show by good faith and reasonable investigation that they had reasonable grounds for
believing that a danger to corporate policy and effectiveness existed b/c of another person/s stock
ownership
i. This is necessary b/c directors are of necessity confronted w/ a conflict of interest and an
objective decision is difficult b/c of the omnipresent specter that the BD may be acting in its own
interests, rather than those of the Corp and its SHs.
ii. Balancing Approach: The severity of the tactic must be reasonable in relation to the level of
perceived threat.
XXXVII. Extension of the Unocal Framework to Negotiated Acquisitions
a. Ace Ltd v. Capital Re Corp (1999) – Facts: Ace entered into a merger agreement w/ Capital Corp
(engaged but not married). Bargaining over the circumstances in which Capital’s board would consider a
3rd party’s acquisition or merger proposal and/or terminate the merger agreement resulted in both a “no
talk” provision restraining Capital’s officer, directors, and agents from considering a 3rd party proposal,
and a termination provision that required Capital to pay Ace a $ 25M termination fee. Ace is concerned
that in the interim some other suitor will come along and take Capital away. So they arrange to not have
this happen. Ace is more in love w/ Capital than the converse. They both agree to not get seduced by any
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3rd parties except under very specific circumstances. Ace is trying to keep the Capital board loyal. Along
comes XL Capital – suitor. Capital board dilemma – if a better deal comes along are we under a fiduciary
duty to take it? Held: On the merits, Capital would not likely prevail in that its interpretation of the “no-
talk” provision was disfavored by Delaware law, which disallowed Capital's directors to contract away
their fiduciary duty to decide whether they should enter into acquisition/merger discussions w/ a 3rd party.
Also, Ace did not show irreparable harm, that threat did not outweigh the threat to Capital's SHs if delay
caused the “auction” price to spiral down rather than up. It’s Ultra Vires under strict K interpretation –
Ace’s lawyers put that language. Ace cannot tell Capital that it cannot even consider another suitor while
they’re engaged. Ace can’t paralyze the board from considering other suitors during the
engagement period.
i. Notes: So called SH “lock-ups” effected by Ks b/w a bidder and 1 or more Target SHs, run the
gamut from stock options, to stock purchase agreements, to agreements that SH will tender to
bidder or not to others, to voting agreements. In Ace, SH lock-ups required Capital SHs to vote
for the merger w/ Ace unless the merger agreement was validly terminated by Capital’s BD.
XXXVIII. Extension of the Unocal Framework to SH Disenfranchisement
a. Hilton Hotel Corp. v. ITT Corp (1997) – Facts: Hilton made a hostile takeover attempt ($55 per share
tender offer) of ITT. Hilton wanted to vote out the incumbent board and bring in their own directors (done
by mailing out to SHs a proposal). Hilton only wants ITT for its casinos. ITT rejected Hilton’s offer, and
sold several non-core assets (not Crown Jewels – idea was that maybe that will get Hilton to go away b/c
the stock would be less valuable). Also, ITT refused to conduct its annual meeting, and adopted a
“Comprehensive Plan” whereby it would split itself into 3 new entities, 1 for the gaming. ITT sought to
implement its Comprehensive Plan, which contained a “poison pill”, prior to the annual meeting and w/o
SH approval. ITT took its same exact BD members and put them on the ITT gaming BD. ITT also did
something w/ the local casino control commission so that when Hilton made an application for a casino
license ITT would oppose it and make life miserable for Hilton who may want to open Casinos wherever.
Hilton sought an injunction and declaratory relief regarding the powers of ITT’s board of directors; ITT
also sought declaratory relief. Hilton argued breach of fiduciary duty - since no SH meeting was held,
Hilton was not going to be voted on at all, and SHs voice was being taken away. Held: When taking
away SHs’ voting stock privileges, even if it is a defensive measure, BD needs a compelling
justification. Ct granted Hilton’s motion for a permanent injunction preventing ITT from implementing
its Comprehensive Plan and ordered ITT to hold its annual meeting. The Comprehensive Plan was
preclusive, and ct found little doubt but that its primary purpose was to disenfranchise ITT’s SHs.23
i. Note: Ct basically said that it’s going to use the Unocal balancing test to balance the threat vs. the
repellant if the repellant involved a disenfranchisement of the voters or other disproportionate
defensive measures.
ii. Injunctions:
1. Need to show strong likelihood you would win on the merits
2. Affidavit
3. Complaint
4. Notice to produce documents
5. Need to show irreparable injury—injury that cannot be fixed by money damages
b. The Parties’ Contentions and Applicable Legal Standards:

i. Standing: Hilton was a SH so it had standing, but if it weren’t it would find a SH who did.
ii. Standard for permanent injunctive relief w/ regard to Hilton’s motion. Hilton must show:
1. Irreparable injury, and
2. Must actually succeed on the merits of their claims.
23
Riccio likes the way case is written w/ heading and subheadings and want exam to look this way.
Vanessa Verduga 98
c. Discussion – case involves consideration of the powers and duties of the BD of directors in responding to
hostile takeover attempt, and the importance of protecting the franchise of SHs of the Corp in the process.
i. Coupling an unsolicited tender offer w/ a proxy contest to replace the incumbent BD is a favored
strategy of would-be acquirors. A variety of sophisticated defensive measures, including “poison
pill” plans have also evolved to frustrate a host of takeover attempts. As a result, replacing the
incumbent directors of target Corp is viewed as an efficient way to eliminate the target Corp’s
ability to utilize these anti-takeover defenses.
d. BD Action in Response to a Proxy Contest and Tender Offer Launched Together:
i. Proper legal standard is a Unocal/Blasius analysis:

1. In assessing a challenge to defensive actions by target Corp’s BD in a takeover context,
Ct should evaluate BD’s overall response. Where all of target BD’s defensive actions are
“inextricably related”, the principles of Unocal requires that such actions be scrutinized
collectively as a unitary response to the perceived threat.
2. Both Unocal and Blasius are applicable b/c both test recognize the inherent conflicts of
interest that arise when SHs are not permitted free exercise of their franchise. BD must
show a compelling justification.
ii. Distinction b/w the exercise of 2 types of corporate power:

1. Power over the assets of the Corp
a. Invokes BJR, or Unocal if action is in response to a reasonably perceived threat
to Corp.
2. Power Relationship b/w BD (mgt) and SHs.
a. Invokes Blasius analysis.
b. This case requires ct to focus on power relationship b/w ITT’s BD and ITT SHs,
not on ITT BD’s actions relating to corporate assets.
c. Comprehensive Plan here would violate power relationship b/w ITT’s BD and its
SHs by impermissibly infringing on SHs’ right to vote on members of the BD, it
must be enjoined.
iii. Unocal requires ct to think of:

1. Reasonable Grounds for Believing Threat to Corp Policy and Effectiveness Exists
2. 9 of ITT’s 11 directors are outside directors. Under Unocal, such a majority materially
enhances evidence that a hostile offer presents a threat warranting a defensive response.
3. ITT has failed to show that Hilton will pursue a different Corp policy than ITT seeks to
implement through its Comprehensive Plan.
4. ITT has also failed to show good faith and reasonable investigation.
5. The Primary Purpose of the Comprehensive Plan is to interfere w/ SH Franchise.
iv. Blasius illustrates that even if an action is normally permissible, and BD adopts it in good
faith and w/ proper care, a BD cannot undertake such action if the primary purpose is to
disenfranchise the SHs in light of a proxy contest.
1. Thus, while ITT would normally adopt a classified BD or issue a dividend of shares
creating ITT Destinations, it cannot undertake these actions is the primary purpose is to
disenfranchise ITT SHs in light of Hilton’s tender offer and proxy contest.
2. As a BD would likely never concede that this is its primary purpose, Ct must look to
circumstantial evidence to determine primary purpose.
3. Collective Factors:
a. Timing – ITT makes no mention of when BD determined to move from an
annually elected BD to a classified BD. Moreover, all aspects of ITT’s
Comprehensive Plan were formulated against the backdrop of Hilton’s tender
offer and proxy contest, and Plan was not announced till well after Hilton’s intial
tender offer. Finally, this major restructuring was announced to be implemented
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in about 2 months, and designed to take effect less than 2 months before the
annual meeting was to be held.
b. Entrenchment of the Incumbent BD – ITT directors who approve the Plan are
the same ones who will fill the classified BD positions. They’re appointing
themselves to new, more insulated positions, and at least 7 of the 11 directors are
avoiding the SH vote that would otherwise occur at the annual meeting.
c. Stated Purpose – ITT has offered no credible justification – simply stated that
its “advisors” suggested a rapid implementation of the Plan w/o pointing to a
specific risk or problem. ITT failed to meet burden.
d. Benefits of Comprehensive Plan – ITT alleges economic benefits to Corp and
general benefits to directors. True, but benefits that infringe on SHs voting rights
do not remedy the fundamental flaw of BD entrenchment.
e. Effect of Classified BD – While SH may not be absolutely required to split ITT,
the fact that BD decided to subject the prior split of the Corp to a SH vote is
strong evidence that primary purpose of its attempt to implement Plan this time is
to entrench the incumbent ITT BD.
f. Thus, entire Comprehensive Plan must be enjoined.
v. Rationale: SHs do not exercise day-to-day business judgments regarding operations of the Corp -
O/Ds do that and are protected by the BJR. As a result, SHs generally only have 2 protections
against perceived inadequate business performance:
1. Sell their stock, or
2. Vote to replace incumbent BD
a. For this reason, interference w/ SH franchise is especially serious. It’s not to be
left to BD’s business judgment b/c it undercuts a primary justification for
allowing directors to rely on their business judgment in almost every context.
b. ITT argues to the Ct that its Plan is superior to Hilton’s alternative tender offer.
ITT should argue that to its SHs instead.
XXXIX. State and Federal Legislation
a. Competing Interests in the Context of Hostile Takeovers:

i. Bidders
ii. Management (Target/Bidder)
iii. Investors (Target SH/Bidder SH)
b. Benefits of Hostile Takeover:

i. Increase Premium to Target SH
ii. Possibility of Better Mgt
iii. Monitors / Chills Target BD
c. Disadvantages of Hostile Takeover:

i. Lost employment, tax base, liquidation
ii. Could induce Mgt mistakes
iii. Minority freeze-out Risks
iv. Reflexive tender w/o enough consideration (sold too cheap – converse of increase premium)
d. Statutory rules that apply to hostile takeovers (analogous to oppressed minority SH statues):
i. The Williams Act (Federal Statute) – designed by Senator Williams to protect the integrity and
fairness of hostile takeovers, part of the 1934 Exchange Act. It regulates the tender offer process:
1. Timing – the offer must remain open for 20 business days. Effect: Entrenched
management can lobby the SHs to convince then not to tender or to w/ draw their tender.
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2. Cooling Off – if you tender your shares in response to tender offer, you have a period of
time (couple of days) in which to change your mind.
3. Pro-Rata - If tender offer is oversubscribed (tendered more shares then have) it is not
“first come-first serve”, but it is prorated and everyone gets a piece of tender offer.
Every SH gets the proportional share of the bidder’s bid.
4. Fair/Best Price – If the price of the tender offer continues to get bumped up along the
way, every SH gets the same higher price, even if subscribed at lower price.
5. Disclosure by 5% Owner – key disclosure provisions:
a. §13(d)(1) – if bidder acquires more than 5% of Public Corp’s outstanding stock,

bidder must file a 13D schedule and disclose his identity, the source and amount
of the funds to be used in making the purchase, the purpose of the purchase
including any plans to liquidates or make major changes, and the extent of the
offeror’s holding in the target company. This is material info SHs should have.
b. §14(d)(1) – requires acquiring SH to file a 14D Schedule form w/ SEC. Deals w/

people seeking to gain control through a tender offer. Must file disclosure
document on the day you commence your tender offer. Imposes disclosure
requirements on any tender offeror who, if tender offer were successful, would
own more than 5% of any class of stock (doesn’t deal w/ open market).
ii. Anti-Fraud Provision – Statutory remedy whereby injured party obtains relief from fraud in
tender offer. Don’t have to be an actual purchaser or seller of securities to have standing.
iii. State Anti-Takeover Statutes – states began to enact their own laws to regulate the process and
make it harder for corporate raiders:
1. E.g. Delaware state law does not allow a corporate raider to takeover a business unless
it’s agreed by the majority of the SHs of the Corp. Purpose is to keep undertaker out of
the state economy. Thus, if you’re an undertaker this law provides a disincentive. It keeps
Corps in the state instead of having it go elsewhere by being sold or liquidated. Also,
keeps the tax ratables in the State. Also, Del law – When a corporate raider gets 15% of
shares, there’s a 3 year moratorium on mergers – so $ just sits there.
2. 1 of 3 things can happen when a state enacts a law similar to the Williams Act:
a. Co-exist w/ Federal Law
b. Federal Statute pre-empts state statute
c. State statutes violate the Dormant CC
i. Economic Protectionism
ii. Pike Balancing Test – state’s interest in regulation vs. impact on I/S C.
3. Wisdom of State Anti-Takeover Statutes – 2 schools of thought:

a. Helpful – existing BD is doing a bad job and a take over bid will result in a
better-run Corp and a premium for SHs stock. This is beneficial to the economy.
b. Harmful – there is a risk of unemployment and present BD may need more time
to put their plans into work. Also, if Corp is liquidated there will be a loss of tax
base to the state.
i. Reality is – Corps have enacted these statutes to protect entrenched BD
from takeovers.
e. CTS Corp v. Dynamics Corp of America (1987) – Facts: Indiana enacted a statutory scheme requiring
shareholder approval prior to significant shifts in corporate control. Dynamics Corp announced that it
would purchase 1M shares of common stock, which would increase its ownership in CTS Corp. CTS’ BD
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of directors elected to be governed by the Control Share Acquisitions Chapter of the Indiana Business
Corp Law. Dynamics filed an action against CTS, alleging that the Act was pre-empted by the Williams
Act. Reasoning: The Act does not violate the DCC b/c it does not discriminate against I/S C as it
applies to both Indiana and non-Indiana would-be acquiring entities. In addition it does not conflict w/ the
Williams act b/c the difference b/w a 20 hold-open period (Williams Act) and a 50-day period (Indiana) is
not significant enough. An entity that acquires control shares does not necessarily acquire voting rights.
The acquired shares were “sterilized” until the remaining investors restored their voting rights. Held: SC
found that the Act evenhandedly determined the voting rights of shares of Corps and that the Act did not
conflict w/ provisions or purposes of the Williams Act. A law permitting in-state Corps to require SH
approval prior to significant shifts in corporate control is constitutional. Great Potential to hinder
tender offers is an insufficient reason to invalidate state anti-takeover statutes. Thus, the Act was not pre-
empted by the Williams Act.24
i. State Anti-Takeover Measure – Indiana enacted a statutory scheme whereby large Corps could,
if they so opted, require any entity acquiring either a 20%, 33.33%, or 50% interest to be
subjected to a SH referendum wherein voting power of those shares could be w/ held. This is pure
protectionism of Indiana in-staters (Indiana Corp) – out right to vote unless disinterested SHs
vote to allow them. Note: After this case, states passed many similar laws under the guise of
protecting SHs when it really protected entrenched Mgt.
ii. Review:
1. BD’s main responsibility is to the SHs.
2. When a BOD ceases to defend the Corp and decides to consent to a buy-out their duty
changes from the preservation of the Corp as a corporate entity to the maximization of
the company’s value at a sale for the SH’s benefit. In affect, they become auctioneers and
their duty to the SHs becomes an obligation to maximize the sale price.
3. Lock-ups and related defensive measures are permitted where their adoption is untainted
by director interest or other breaches of fiduciary duty.
iii. White Knight – a person or corporation that rescues the target of an unfriendly corporate
takeover buy acquiring a controlling interest or by making a competing tender offer.
iv. Leveraged buy-out – purchase of outstanding stock by an outside investor financed w/ funds
borrowed from investment bankers secured by the target company’s assets.
v. Lock-up Provision – A defensive measure that allows a friendly suitor to purchase securities—or
an entire division - when a hostile takeover is threatened.
vi. No-Shop Provision – A stipulation prohibiting 1 or more parties to a commercial K from

pursuing or entering into a more favorable agreement w/ a 3rd party.
Devices to Fend Off Hostile Takeovers:

1. Staggered BD – a BD in which a fraction of the BD is elected every year to serve for 2 or 3 years. Hostile
takeover bidder may have to wait 1, 2 or 3 annual meeting election cycles.
2. Cumulative Voting
3. Selective Exchange Offer
4. Lock-Up Provision
5. White Knight
24
RR: when counseling your client, advise them to look for a state w/ the best anti-hostile statute and incorporate there!
Vanessa Verduga 102
6. Poison Pill – SHs are granted the right to purchase stock at a low price in order to increase the aggressor’s
acquisition costs (SH’s “rights” plan).
7. Shark Repellant – a measure such as issuing new shares of stock or making a significant acquisition, taken by
a Corp to discourage unwanted takeover attempts.
8. Statutory:
a. William Act
b. State Anti-Takeover statutes
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CORPORATE DEBT
Corporate Finance:
(1) Does Corp need to borrow $?
(2) Who is selling $?
(3) Evidence of the borrowing?
a. Equity (shares)
b. Debt
(4) Why Equity? Why Debt?
XL. Corporate Finance
a. Who is selling money?
i. Small Businesses
1. Term Loan
2. Open Credit Line
3. Revolver Credit Line – Banks do this to ensure that you have enough $ to pay up the
loan. E.g. if you have a seasonal business (X-mas décor store), bank puts in a revolver b/c
it wants to make sure that when your cash comes in you pay off the line of credit.
ii. Large Businesses – Most Corps raise $ through debt (more than through stocks) – the debt
market is huge!
1. 2 ways Corp gets financing:
a. Equity Financing – Issue stock – 3 events occur:
i. Consideration - Corp receives capital in form of cash, property, securities
ii. Ownership – becomes owner of Corp w/ rights (e.g. fiduciary duty)
iii. Classes – allows for classes of stock.
b. Debt Financing – borrow money – sources of borrowing:

i.Banks, investors, other institutions, pension funds
ii.Investors – public funding or private placement
iii.Banks – loan agreement containing terms and conditions
iv. Act of default provision – accelerate repayment, missed payment, used
for other than stated purpose, bankruptcy, dissolution, liquidation
v. Bonds – notes, debentures (long term unsecured debt securities issued by
a corporation) or bonds (secured loans)
1. Bond holder is a lender (IOU)
2. SH is an owner (no IOU)
b. Debt Market instruments:
i. Notes – a promise to pay by a certain date. A note is typically a relatively short term instrument
(1-5 yrs). Companies issue billions of $ in notes everyday. A common interest issued by a Corps
(most of the time these are publicly sold, but some are privately sold). The reason that Corps go
public is b/c the rate of interest on these notes are less – so Corps go through the trouble of going
public to save money. Private Corps have to pay higher rates of returns.
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ii. Bonds – usually 30 yr bonds (there are some 100 yrs – controversy). Bonds are secured (backed)
by Corp assets. Bonds are classified by the “use of proceeds.” E.g. construction bonds – used to
construct buildings or something – usually named dependent on the collateral. Asset-backed
bonds; mortgage-backed, etc. However, sometimes they aren’t classified.
iii. Debentures – like bonds except they don’t have any specific security attached to them by the
Corp. Look like a stock (pretty). It’s an unsecured obligation of the Co so that if the Co ever goes
bankrupt, a debenture holder is going to be left at the level as the general creditors of the Co.
iv. Non-recourse loan – assume small company w/ 1 SH – sandwich shop, but SH doesn’t have
enough $ - goes to bank to get business loan on non-recourse basis – means the Corp makes the $,
but the SH who is the beneficiary of the loan has no personal liability.
v. Commercial Paper – real short-term paper (30 – 70 days) – typically bought by the very wealthy
people – very popular.
1. The more secure the investment, the lower the interest rate Corps has to pay.
2. The less secure the investment, the higher the interest rate Corps has to pay.
c. Reasons Corporation would want to borrow over issuing stock:

i. Tax principle – interest on loans is tax deductible
ii. Guaranteed rate of return – in bankruptcy proceeding economic leverage
iii. Control – lose control through equity but retain true ownership w/ debt financing.
XLI. Evidence of the Borrowing
a. Bonds and Debentures – piece of paper writing and attached are other papers – like coupons. You take
the coupon to the bank and the bank will pay you the interest you make on that bond. Coupon is the term
used for bonds and debentures – not what is the rate? But rather what is the coupon? (Lingo).
i. Bonds – long-term debt obligations secured by the property of the debtor

ii. Debentures – long-term unsecured debt obligations
b. Forms of debt owed by Corps, to individuals and institutions such as pension funds, insurance companies,
and mutual funds. Corps are said to “issue” bonds and debentures, but they “borrow” from banks. Most
debt obligations to bank are secured, but most others are not. Main function of a security interest is to
give some creditors priority over others and there is an alternative method of doing that. The alternative is
the subordination agreement, which allows debt to be issued in layers of priority. The right of
bondholders is largely governed by private K. Most of the contractual terms are contained in document
called “indenture” which includes, among other things, various covenants (promises). Lenders are most
concerned about financial soundness of the borrower and the interest rate to be paid. Covenants and other
terms are relatively less important. Generally, corporate trustee is appointed to enforce the terms of the
indenture. They’re subject to certain conflicts of interest b/c trustee is likely to be part of a bank, which
may have loaned Corp the $, and there may be conflict b/w the interests of the bank, as lender, and the
debenture holders.
c. Bonds are issued through a document called an “indenture.” 2 entities – issuer and trustee.
d. Trustees (Bond Holder Trustee) act on behalf of bond holders to make sure that issuer’s promises are
kept. Trustees have:
i. Power to act on behalf of bond holder to enforce any provision or condition
ii. Gives one person authority to negotiate re: modifications on bonds
Vanessa Verduga 105

iii. Voting requirements: even though you are lender, you can get out-voted by majority of the
bondholders of the corporation; need majority of bondholders to agree
e. Promises are covenants made by the issuer, which can be

(i) Positive or – e.g. company has to maintain a working capital ratio 2:1
(ii) Negative – probably says “not” or “never” – e.g. an issuer is forbidden from paying dividends on
common stock until the debt is repaid.
XLII. Duty Owed to Creditors
a. Corp directors owe fiduciary duties to SH who are equity investors in the Corp. SHs are part owners who
have entrusted their ownership to the Corp’s directors. SH Investors can also be creditors, $ lenders
(banks, institutions, pension funds, mutual funds). They want to be a creditor and get paid a rate on return
at an attractive schedule.
b. Equity Investor vs. Debt Investor

i. Equity investor assumes a greater risk than a debt investor; duties owed to debt holder are
different than the duties owed to equity investor (owner unlike debt investor).
ii. Difference in governance
iii. W/ Debt investors it’s a contractual relationship.
c. Types of Creditors – debt investors can be:

i. Banks
ii. Trade creditors (sell a product or service) i.e. when MS hires painter for office, then painter is a
trade creditor – they owe him $ for his services, and
iii. Involuntary creditors – a person who has a judgment against the Corp for negligence of one of
its agents.
1. Note: No fiduciary duties in these relationship b/c not a lender. However, where it’s
tricky is where the creditor is like a SH is getting back a bond/debenture in the
“indenture.” K b/w debtor and holder - this is securities that sometimes get traded. Thus,
that person is a creditor no different than other creditors, but at the same time the person
is dealing w/ a security and sometimes these securities get traded – i.e. bond market. The
question then becomes – is there an obligation on the part of the directors of the Corp to
make sure that the interests of the bond holders, or debt holders are protected in terms of
fiduciary duties? So if you have an investor who is getting a security in the Corp, but
is not an owner getting an interest in the Corp is there a fiduciary duty protecting
the bondholder or the issuer holder?
2. Asset securitization investment vehicle – a.k.a. a collateralized loan obligation. An int’l

bank has billions of dollars of loans outstanding covered by notes w/ US or int’l Corps.
Int’l bank might decide for various reasons to sell them to someone else so they then
form a “special purpose investment vehicle” (SPV) – it’s formed outside the US. SPV
is controlled by the sponsoring bank, which then goes out and sells notes issued by the
SPV to non-US people b/c it’s not subject to US Securities Laws that are very protective
of investors in connection w/ disclosure and fraud.
a. Riccio’s case – Facts: deals w/ a Cayman Island LLC (SPV) – this SPV sold to
his client, Dutch Bank in Netherlands, $300M worth of loans. SPV issued
tranches of notes – 1st pure debt, and 2nd an income note. It’s important to
determine what type of tranche is given to know if a fiduciary duty is owed or
not. Issue: Whether Dutch bank under NY law is owed a fiduciary duty as an
income note holder b/c they’re more like an equity investor than a pure debt
holder. Argue: Breach of the covenant of GF and FD, and breach of fiduciary b/c
client is like an equity investor although a creditor. Held: If Riccio’s client is a
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SH (equity investor) then client is owed a fiduciary duty, but if a debt lender then
not owed fiduciary duty.
i. Note: If client losses under this then argue that maybe under very narrow
circumstances a fiduciary duty is owed to debt lenders – this is the Katz
case – Π owed debentures and convertible rights. Ct there said interesting
argument, but this is not a fiduciary duty case b/c of the relationship b/w
a Corp and its debt holders even though these debt securities were
convertible they could not, however, be converted into common stock.
Thus, they’re just money lenders and not equity investors.
d. General Rule: Relationship b/w a Corp and the holders of debt securities (even convertible debt
securities) is contractual in nature. Thus, no fiduciary duty is owed.
i. Exceptions:
1. “Quasi-Trust” – Francis case, Mrs. Pritchard was asleep and her 2 sons were ruining the
co. The Πs there were depositors/creditors of Mrs. Prichard’s Corp and the Ct found a
fiduciary duty b/c the Corp were holding the $ in “trust.”
2. Insolvency Situation – when there’s a conflict – it’s good for SHs but bad for creditors
 tension b/w duty owed to SH and duty owed to Creditor when Corp is on the brink of
insolvency. Here, Corp has fiduciary duty to the creditor – when insolvent or on the brink
of insolvency and you favor SHs over creditors then there’s a breach of fiduciary to
creditor – can’t prefer SHs over creditor. In the absence of those circumstances you’re
stuck w/ Katz general rule.
XLIII. Exchange Offers
a. Katz v. Oak Industries, Inc. – Facts: Oak Co entered into acquisition and stock purchase agreements w/
interested buyer. Stock purchase agreement was conditioned on the tender and exchange of at least 85%
of the principal amt of company's debt securities. Accordingly, company extended exchange offers to the
holders of its long-term debt securities. The offers provided for an exchange of the securities for either
common stock or cash. Katz sought to enjoin the consummation of the exchange offers and consent
solicitation made in connection with Oak’s attempted reorganization and recapitalization efforts. Katz
alleged that this benefited the common stockholders at the expense of the debt securities holders, forced
the exchange of the debt instruments at an unfair price, and forced the debt holders to consent to the
elimination of certain protective covenants. Held: An exchange offer and consent solicitation made by a
Corp seeking to maximize the benefit of its stockholders, at the potential expense of its debt holders, does
not constitute a breach of the directors’ duty of loyalty to the Corp. Oak did not breach the implied
covenant of good faith b/c its conduct did not violate the reasonable expectations of those who negotiated
the indentures on behalf of the securities holders, and injunctive relief was inappropriate b/c Katz failed to
show a likelihood of success on the merits and Oak was in perilous financial condition.
i. Note: Katz is the owner of long-term debt securities (bonds pursuant to “indenture” K) issued by
Oaks. Indenture has the rate of return (10% on 10yr bonds), maturity date (7yrs), and positive and
negative covenants such as priority as a creditor, can’t be called until a certain time, Corp shall
maintain enough working capital to run the business successfully (important provision you may
want to put in to protect yourself), operation of the Co have inside and outside directors so there’s
no domination of control, don’t change BD or Prez unless certain conditions are met. Katz had
these bonds and things start going poorly for Oak. Bonds are trading below face value – who is
going to want to buy these bonds? Nobody. There are some people who are willing to buy these
bonds they might figure that the Corp will make a turn around. Oak BD can only do one of 2
things – either increase Revenue or decrease Expenses. BD first opts for decreasing expenses by
discontinuing one of its business segments. 2nd, they make deal w/ Allied – 2 Agreements:
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1. Acquisition - $160M to buy something – that gets them cash immediately.
2. Stock Purchase Agreement - $15M worth of stock issued.
ii. They’re putting together a plan to survive. Allied imposes a condition of this deal that at least
85% of Oak’s debt securities shall have tendered and accepted the exchange offers. In order to do
that they had to agree to amend the covenants in the indentures that protected the financial
requirements that were applicable to Oaks. This is what gave rise to Π’s breach of K. In effect,
the bond holders that don’t sell are getting hurt b/c they’re losing their rights to protection b/c the
covenants are getting changed. Katz tries to get an injunction (it’s still early to do this) to prevent
the entire deal. Katz sought to enjoin an exchange offer and consent solicitation made in
connection with Oak Industries’ attempted reorganization and recapitalization efforts. The court
held that an exchange offer and consent solicitation made by a corporation seeking to maximize
the benefit of its stockholders, at the potential expense of its debt holders, does not constitute a
breach of the directors’ duty of loyalty to the Corp. Katz was a debenture holders and this was not
an insolvency situation nor was there a trust fund. Oak was financially in trouble and directors
had to do something quick to prevent the Co from going under so they enter into agreement w/
Allied. Katz said you’re breaching a fiduciary duty to us. Ct says no b/c you’re a mere creditor –
no different that the painter who is owed money for services. You had a contractual relationship –
no fiduciary duty owed. K did not give Katz a right to a breach of K. But ct created the covenant
of GF and FD and implied it into the “indenture” K b/w Corp and Debt holder.
iii. Scope of GF and FD – Is it clear from what expressly agreed upon that parties who negotiated
the express terms of the K would have agreed to proscribe the act later complained of as a breach
of the implied covenant of good faith – had they thought to negotiate w/ respect to that matter.
iv. If the answer is YES then a Ct is justified in concluding that such act constitutes a breach of the
implied covenant of good faith. Ct uses the “reasonable expectation” language – but they’re based
on the language in the “indenture.” The reasonable expectation that got Katz upset was the loss
of the covenant that protected his financial investment. However, ct said NO – looking at the
indenture Oak can do this. Note: Del Law – so long as they’re not equity investors there’s no
fiduciary duty owed to creditor.
v. Implied covenant of good faith and fair dealing – implied warranty that the parties will deal
honestly in the satisfaction of their obligations and w/o intent to defraud. Debt holder could
argue:
1. Modifying an indenture to the perceived detriment of a bondholder.
2. Bondholder outvoted by majority of other bondholders; lost the terms of the original
bond.
3. Owes fiduciary duty to bondholders.
4. Boilerplate provisions contained in Trust Indentures so don’t have to redraft entire
document.
Corporate Debt:
1. Fiduciary Duty – there is no fiduciary duty owed by BD to bondholders; the relationship is contractual
in nature; not based on fairness, but contractual obligations; may find implied covenant of good faith and
fair dealing.
2. Boilerplate provisions – meaning is determined by judges, it’s a matter of law; uniformity and their
meaning is imperative in contract law; not issue for jury, not negotiated
3. Modifying covenants – Π owns debt securities (not stock, not an owner, no fiduciary duty owed);
Vanessa Verduga 108

modification was agreed upon to the debentures; subject to majority vote.
Vanessa Verduga 109

I. Who Is An Agent?: Gorton v. Doty (1937)

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Business Associations – Fall 2003

1. Principal  the one for whom action is to be taken

ii. 3 principal forms of Agency:

Three Elements Required to Show Agency Relationship:

2. Ownership alone, regardless of presence/absence of owner in car at time of accident,

II. Liability of Principal to 3rd Parties in Contract

LAF for Vicarious Liability:

Four Kinds of Authorities:

2. 3 types of situations in which Inherent Authority exists:

1. RS §161 Unauthorized Acts of General Agent – a general agent for a disclosed or

iii. Master-Servant relationship exists where Servant has agreed to:

LAF for Respondeat Superior:

iv. RS §2 Master; Servant; Independent Contractor –

a. Agent-type Independent Contractor – agrees to act on behalf of the principal,

b. Who is the Servant?

1. Franchise Agreements – In determining whether a K establishes an agency relationship,

i. RS §228 General Statement of Scope of Employment Doctrine – (1) conduct of a servant is

i. Foreseeability – Ct choose this one b/c what seaman did happened on

ii. Motivation – the conduct of a servant is w/in the scope of employment

d. Rationale for Vicarious Liability and Respondeat Superior

i. Common Sense & Fairness – 2 rational/policies for the rule exist:

iii. Contract away imputed liability - hire a non-agent independent

1. Form vs. Substance – Even w/ these clauses a Master can be

b. Insulate against being vicariously liable in employment situations 

2. Step 2: 2 different kinds of convenient stores:

d. Master Reasonably Expects Such Act Would Be Performed – No evidence.

f. Liability for Torts of Independent Contractors

2. General Rule – ordinarily where a person engages an independent contractor to do work

b. Inherently Dangerous vs. Ultra-Hazardous – Latter is one which (a)

a. In the Principal/Agent context fiduciary duty exhibits itself in 3 scenarios:

ii. Protection of Confidential Information – an employee or an agent has an obligation to keep

b. Duties during Agency

1. Precaution  Disclosure – If Singer would’ve “disclosed” this info and reached an

i. Post-Employment Situations – in which you’re working w/ someone and you’re planning to

iii. Ct breaks it down to 2 parts by looking at:

V. What is a Partnership and who are Partners?

Totality of Circumstances to Determine Whether the Business is a Partnership:

a. The Uniform Partnership Act (UPA) of 1997 governs:

h. 2 Prongs of Partnership Law:

1. UPA §103 Effect of P-ship Agreement; Non-Waivable Provisions – This is a default

j. Partners compared w/ Employees

Factors Distinguishing Partners from Employees:

ii. Fenwick v. Unemployment Compensation Commission (1945) – Facts: Fenwick employer

k. Partners compared w/ Lenders

a. Exception: Recovery is allowed where in truth such relationship is absent. This

VI. The Fiduciary Obligations of Partners

Distinguishing Partners from Employees:

(1) Does a Fiduciary Relationship Exist? If so,

Generally, where you have a fiduciary relationship it is embodied in 2 basic concepts:

i. The Duty of Undivided Loyalty deals w/:

g. Grabbing and Leaving

2. “Guillotine” Involuntary Severance – immediate termination by P-ship vote w/o notice

VII. The Rights of Partners in Management

3. Rule #3: UPA §401(j) – differences of opinion arising in a:

4. Rule #4: 2 Person P-Ship

5. Rule #5: 2 Person Deadlock

VIII. The Consequences of Dissolution

Three Key Phases:

d. UPA §801(5) Dissolution by Way of Judicial Termination –

j. The Sharing of Losses

ii. Process for Buyout Agreement

a. Formula: Capital Account = Capital Contribution + Profits – Losses