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Thomas S. Johnson, Jr.

Corporations Outline
Spring 2010
Professor S. Todd Brown

I. INTRODUCTION TO THE FIRM:


1) How to delegate corporate authority?
2) How to finance various endeavors?
3) How to delegate both intrinsic and extrinsic risks?

II. CORPORATE BASICS:

A) Fiduciary Duties:

Meinhard v. Salmon

Facts: P and D were business partners. P and D undertook a joint venture, under which they leased a building and fixed it up.
At the conclusion of the lease, the landlord approached D with a new lease option, which would involve the construction of a
new building. D didn’t tell P and undertook the option individually.

Issue: Whether P and D’s relationship extended to new business opportunities that arose from the initial project?

Holding: Yes. Joint ventures owe a duty to one another while the enterprise continues. Courts rarely undermine this.
Accordingly, one partner may not appropriate to his own use a renewal of a lease, through its term is to begin at the
expiration of the partnership. The fact that D had no malice is irrelevant. Because the subject matter of the lease was an
extension of the original one, P and D’s business relationship extends to it. Not far enough removed.

Rule: Partners in a business have a fiduciary duty to inform one another of business opportunities that arise.

Importance:
1) Cardoso was concerned about eroding fiduciary obligations.
2) Also was concerned that this could lead to unfair results.
3) The dissent vehemently noted that the original K didn’t provide for continuing the business when the lease cased
– the venture is thus over!

B) Corporate Players:
1) Shareholders: People who bought ownership in the corporation; financers.
a) Principal powers: Vote, sue, and sell.
2) Directors: Responsible for the basic oversight of the company.’
a) Elected by shareholders.
3) Officers: Report to directors; handle day-to-day operations.
a) Make reports.
b) Publically traded corporations have to make various reports.
c) Often also directors in subsidiary companies.
4) Preferred Shareholders: Preferred rights of payments — paid dividends before common shares.
a) May not have voting power.
b) Could have their own director.
c) Have priority over common shares in bankruptcy.
d) Sometimes restrictions on selling.
5) Creditors: governed by K law, not corporate law.

C) Other Basics:
1) Term of Corporation: Corporations are established for an indefinite term.
2) Bylaws: Internal corporate constitution, which sets basic parameters, rights, and corporate powers.
a) Established in Articles/Certificate of Incorporation.
3) State Law: Outlines basic duties of directors and officers.
a) Some statutory, but many are common law.
4) Issuing Shares: Articles provide how many shares the corporation can issue.
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a) Treasury Shares: Shares the company buys back.
b) May need to do this is offering stock options to employees.
5) Sources of Law:
a) Most major corporations are in Delaware.
b) New York has its own corporate law.
c) Model Business Corporation Act.

D) Schnell v. Stahl:

Schnell v. Chris-Craft Industries

Facts: Directors wanted to avoid getting voted out of office. Thus, in accordance with Delaware law, the directors changed
the date and location of the meeting to an obscure location.

Issue: May directors change the meeting time in order to block a proxy contest so long as they are technically in accordance
with state law regarding the scheduling of shareholder meetings?

Holding: No. The Directors attempted to use Delaware law for the purpose of perpetuating themselves into officer and for
the purpose of obstructing the legitimate efforts of Ps in the exercise of their rights to undertake a proxy contest. Moving the
meeting for these reasons cannot stand. Management may not change the date in order to obtain an inequitable advantage.

Rule: Where corporate directors exercise their legal powers for inequitable purpose, their action may be rescinded or nullified
by a court at the request of an aggrieved shareholder.

Importance:
1) At the core, there is nothing wrong with wanting to stay in control — interest in staying in control (private
interest) is aligned with incentives of corporation as a whole to the extent that all parties when directors to do a great job.
2) Aligning private interest with interest of public corporation is an important concept.
3) But the instant directors conflict with this concept because they only want power, a good job notwithstanding.
4) If directors can avoid voting (a check), what is to say they can go in one direction wihle the company goes wildly
in another direction.
5) Simply complying with law is no longer enough; now show:
a) Show you complied with law; and
b) Show it wasn’t inequitable (the court added this step).

Stahl v. Apple Bancorp, Inc.

Facts: P is acquiring a lot of shares and announced its intention to make a tender offer. P wanted to “court pack” board,
despite the fact that it was staggered; P therefore offered an amendment to increase Board. Consequently, directors
postponed by withdrawing the April 17 record date; the directors hadn’t actually scheduled the meeting, though. P seeks a
preliminary injunction to stop this. Proxies had not yet been solicited.

Issue: Whether Ds have exercised corporate power inequitably, and therefore, whether they have taken action for the purpose
of impairing of impeding the effective exercise of the corporate franchise?

Holding: No. The primary purpose” was not to impede or impair the effective exercise of a corporate franchise. The purpose
was avoiding a bad price; wanted to delay and create time to work out a better strategy. However, if meeting date had been
set and proxies already solicited, the outcome may have been different.

Rule: If the corporate directors’ primary purpose is to impair and impede the effective exercise of corporate franchise, their
action may be rescinded or nullified by a court at the request of an aggrieved shareholder.

Importance: Must now examine the “primary” purpose of the directors’ action; before it was only a “purpose” that impairs or
impedes.

1) Reconciling Schnell and Stahl:


a) The primary distinction in these cases is the perceived primary purpose of the action.

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III. CORPORATE FEDERALISM:
1) Choice of Law: State of incorporation governs internal affairs, i.e., Internal Affairs Doctrine.
a) This includes voting rights, distribution of corporate property, etc.
2) Choice of Law: External affairs, however, are governed by the laws of the place where the activity occurred.
a) This includes employment conditions, tax laws, Ks, torts, right to property, mergers, etc.
3) The corporation is analogous to a person in this regard.
4) May incorporate in any state.
5) Although New Jersey once had the most favorable laws, it is now well settled that Delaware has the most
favorable corporate laws.
6) Race to the Bottom: A state is going to have the worst corporate social policy in order to generate fees and attract
corporations — corporate fees are very lucrative for a state.
7) Sarbanes-Oxley Act:
a) In response to Enron, Worldcom, etc.
b) Federal corporate regulation.
c) Officers must personally certify all public filings such that they are taking personal responsibility.
d) No more personal loans to directors or executives.
e) Lawyers must report fraud/corruption — must be whistleblowers.
8) Horizontal Federalism: Competition among states to attract corporations.
9) Vertical Federalism: Relationship between state and federal government — dual sovereignty.

McDermott v. Lewis

Facts: McDermott, Inc. (sister) became a 92-percent-owned subsidiary of McDermott International (parent), a Panamanian
corporation. Sister has 10% of Parent’s stock; Parent has 92% of Sister. As such, Parent controls the Sister’s 10% of its
stock and wants to vote it. Although no state allows this, Panama does.

Issue: Should Panama law apply?

Holding: Yes. Due process demands that a corporation has notice of the laws to which it will be subjected. This is internal
affairs of Panama — not Delaware — because dealing with voting rights regarding the parent’s internal affairs. Therefore,
Panama law applies, even though it violates US public policy.

Rule: State of incorporation governs internal affairs.

A) Anti-Takeover Legislation:
1) First Generation: Limit tender offers to state residents; however, Edgar found this to be unconstitutional.
2) Second Generation: Focus on Internal Affairs of corporation. See next case.

CTS Corp v. Dynamics Corp. of America

Facts: The Indiana Act — which was essentially an anti-takeover device — provided that when a shareholder sought to
acquire control shares (e.g., a tender offer), the acquiring party will only obtain voting rights if the takeover was approved by
a majority of preexisting shareholders. P sought to make a tender offer, but was subject to this statute. P claimed it was
unconstitutional under the commerce clause because it discriminates against non-resident shareholders.

Issue: Does the Indiana Act violate the Commerce Clause?

Holding: No. It does not violate the commerce clause because it applies equally to in-state and out-of-state residents. Edgar,
however, specifically discriminated against out-of-state residents.

Rule: Federal courts should abstain from regulating the internal affairs of United States corporations unless there is a federal
statute that applies and requires a different result, such as the Commerce Clause.

3) Third Generation: Have also survived scrutiny. For example, Wisconsin has a third-generation statute.

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IV. CORPORATE SOCIAL AND POLITICAL ACTIVITY:
1) What is the purpose of a corporation: maximize profits or be a good citizen?
2) The answer to this question drives corporate action, and is outcome determinative.
3) Legislatures in different states have different approaches.
4) But remember, if too many limitations, corporations will shop for another state (race for the bottom).

Dodge v. Ford Motor Co.

Facts: Ford regularly paid special dividends. However, Ford decided to stop this in order to put money back in Ford to,
among other things, build a new plant. Ford wanted to do this to lower prices, improve quality, and hire more workers. The
Dodge brothers — minority shareholders — objected.

Issue:
1) Must Ford pay the special dividends?
2) Must Ford cease building the new plant?

Holding:
1) Yes. Ford may not sacrifice shareholder profits to benefit non-shareholders. “It is not within the lawful powers of the
Board to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary
purpose of benefiting others.” Can’t sacrifice shareholder interests for this.
2) No. A corporation’s plan does not have to be for immediately benefit/profit, but may be for long-term benefit. May
sacrifice short-term shareholder interests for this.

Rule:
1) “A corporation is organized and carried on primarily for the profit of shareholders.”
2) A corporation may complete long-term profits and ventures — which may cause short-term losses — without sacrificing
its shareholders’ interests.

Importance: The principal question is when may a corporation sacrifice shareholder interests?

Theodora Holding Corp. v. Henderson

Facts: CEO proposed that the board approve a gift of $528,000 gift of company stock to the Foundation to finance the camp.
The camp was on land that the corporation previously donated. P wanted the corporation to make a different contribution.

Issue: Was the charitable contribution reasonable in terms of amount and purpose thus rendering it valid?

Holding: Yes. In fact, if corporations do not make charitable donations, this will arouse the public. Taking into account tax
law, this gift only cost shareholders $80,000. But the gift also reduced the corporation’s unrealized capital gains tax by
$130,000. This is reasonable as to amount and purpose.

Rule: In order for a corporate charitable or educational gift to be valid, it must be within reasonable limits both as to amount
and purpose.

Importance:
1) Almost every state recognizes that corporations have a right to make certain charitable contributions.
2) Under the IRC, a corporation may make charitable deductions of up to 10% of its total income.
3) A gift may also reduce a company’s unrealized capital gains taxes.

5) Political Activity: These cases normally turn on whether a corporation has a right to free speech.
a) We only glossed over this.
b) If a shareholder is not happy with a political contribution, he or she may vote, sue, or sell.
c) A political contribution, however, must be aligned with the corporation’s expressed authority.

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V. CHOOSING A CORPORATE FORM:
1) There are many corporate forms.
2) Except for a general partnership, you have to file with the state.
a) NYPTR § 91: The statute under which one forms a limited partnership.
b) NYPTR § 10: The statute under which one forms a general partnership; remember, no filing necessary.
c) NYBSC § 443: The statute under which one forms a corporation.
d) NYLLC § 203(d): The statute under which one forms a LLC.
3) There is always a danger of inadvertently entering into a partnership.
4) If no agreement, courts will usually classify as general partnership!!!!!!!!!!!

A) General Partnership:
1) Liability: Yes.
a) There is joint and several liability for anything partners do in business.
2) Management/Control: The default rule is equal power.
a) This can be varied, however, with a membership agreement.
3) Continuity: No.
a) There are a number of things that will terminate a partnership, including the death of a partner, of one of
the partners goes into bankruptcy, etc.
b) Could set it up so it practically has continuity; namely, set each partner up as its own corporation, which
after death, keeps it going (kind of).
c) NYPTR § 62: The statute that lists how a partnership is terminated.
4) Tax: Each partner is taxed on income of partnership at the end of the taxable period.
a) Taxed proportionally on the income of the partnership at the end of the taxable period.
b) If partnership loses money, can’t personally write off losses.
c) When the partnership is sold, any losses after initial contribution and recovered can be written off — so
only claim losses when the partnership is disposed of.
5) Distribution Rights: Equally.
6) Transferability: Can transfer rights to proceeds, but not rights as a partner.
a) Can transfer rights as partner, however, if ALL partners consent.
b) NYPTR § 53: The statute under right transferability in the general partnership context is discussed.

B) Limited Liability Partnership:


1) Liability: Yes for general partners; no for limited partners.
a) General partners exercise “control” of a company.
b) Limited partners do not. See NYPTR § 96.
c) Limited partners can only lose their investments, but are not personally liable.
d) If a “limited partner” performs functions of a general partner, will be subject to liability as a general
partner.
2) Management/Control: General partner. See NYPTR § 98.
3) Continuity: No.
a) Some state laws may allow exceptions to this.
b) If the general partners all die, the LLP ends.
4) Tax: Same as General Partnership.
5) Distribution Rights: Each partner’s contributions are going to control who gets what in distributions.
a) Will vary by agreement.
b) This makes sense because who is going to want to take on additional liability as a general partner
without getting more.
c) See NYPTR §§ 121-504.
6) Transferability: Limited partners may assign interest; general partners may not assign control rights.
a) A general partner may assign someone their ability to collect proceeds.
b) A general partner may hire someone to control and assign them the right to collect.
c) See NYPTR § 108.

C) Corporation:
1) Liability: Shareholders are not liable.
a) NYBCL § 606 provides, however, that shareholders are individually liable for unpaid employee wages.
b) Therefore, can’t start a corporation and loot it while leaving employees with nothing.
2) Management/Control: See previous discussion on officers, directors, and shareholders.
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3) Continuity: Yes.
a) See NYBSC § 202(a)(1).
4) Tax: Both the corporation and shareholders pay taxes.
a) Shareholders only taxed on (1) dividends and (2) gains from selling shares.
b) If there is an individual loss, can write off losses against other gains.
c) But the corporation itself is taxed as its own entity and pays taxes on its profits.
d) Shareholder only taxed if he or she receives some direct benefit from corporation.
e) In short, a corporation is double taxed because corporation is taxed on its income and then the
shareholders are taxed on their dividends/returns.
f) S Corporation: Taxed like partnership.
i) Have to be domestic.
ii) No more than 100 shareholders.
iii) Membership limited to certain group of people; cannot have non-resident aliens in your
membership.
iv) Have to one class of stock — same return rights, but can have different voting rights.
v) Consent of all shareholder to get S corporation status.
g) C Corporation: Taxed like a corporation.

5) Distribution: Shareholders have no right to share in profits via dividends.


a) See NYBSC § 510.
b) This can be varied in the Bylaws — can provide that shareholders have a right to certain dividends.
c) But the default rule is no rights.
6) Transferability: Shareholders may sell shares, but some shares can be issued subject to conditions that restrict
transferability.

D) LLC:
1) Liability: No.
2) Management/Control: Member managed.
a) See NYLLC art. 4.
b) Looks like a general partnership in its management.
c) Different members of the LLC, absent an agreement to the contrary in operating agreement, all enjoy
EQUAL POWER.
3) Continuity: In theory, no; depends on articles of incorporation.
a) See NYLLC §§ 203(d) & (e)(3).
b) Operates by negative implication.
c) That is, LLC law does not say it has perpetual existence.
d) Instead, it says it will terminate based on a time listed in articles of incorporation.
e) Also provides that an LLC doesn’t have to put termination time in articles.
4) Tax: Partnership.
5) Distribution: Manner provided in operation agreement.
a) See NYLLC § 503.
b) Default rule is share equally in gains and losses as members of the LLC.
c) But this can be varied via agreement.
6) Transferability: Members may assign LLC interest.
a) See NYLLC § 603.

VI. FORMATION ISSUES:


1) New York Corporation Formation:
a) File a certificate of incorporation with the Secretary of State.
b) $125 fee.
c) Share tax of at least $10.
i) If the corporation states it will have up to X shares, the tax will be based upon the amount of
issued shares.
ii) If 200 or less shares, only $10; if issue more, higher tax.
2) Choosing a Name/proper Form:
a) Must choose one of the following three words in a corporate name: (1) Incorporated/Inc; (2)
Corporation/Corp.; or (3) Limited/Ltd.
i) See NYBSC § 301.
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ii) Some states allow Company/Co.; however, § 301 does not allow this in New York.
b) Must distinguish from other already-existing businesses:
i) Can do a request to see if a name is available.
c) Pursuant to NYGBL § 130, a corporation must have a real name, albeit it can operated under an assumed
name.
i) Wal Mart, Inc. operates under Wal Mart.
ii) On any advertisement, real name must be listed (in fine print).
iii) There must also be notice of the real name on the premises.
d) NYBSC § 301(a)(5): List of names a corporation can’t use.
e) NYBSC § 309(a)(9): Nothing indecent or obscene, that implies an unlawful activity, or ridicules or
degrades an person, group, belief, etc..
f) NYBSC § 309(10): Can’t use the word exchange without attorney general approval.
i) Doing so is a bureaucratic nightmare; as such, not worth trying.
g) NYBSC § 301(a)(8): Can’t mislead to think that agency of New York or the United States.
i) Test: will a reasonable person confuse this entity as some entity acting on behalf of the United
States government.
ii) Indeed, can still have companies with America, etc. in them: e.g., Bank of America.
h) NYBSC § 301(a)(5): Can’t use word “bond,” as well as any derivative of “investment.”
i) NYBSC § 301(a)(7): Can’t use word blind or handicap unless first get approval from department of
Social Services.
j) NYBSC § 301(a)(2): Likelihood of confusion.
k) NYBSC § 301(a)(3): Can’t have a word/phrase prohibited by any other statute in the state.
i) E.g., there is a New York statute that expressly prohibits using the United Nations in any
business name.
3) Certificate of Incorporation:
a) See NYBSC § 402 for requirements.
b) Must list valid name and purpose.
c) Specify county in which business will be located.
d) Specify number of shares that are authorized to be issued.
e) The website provides a form.
f) Optional Terms: See NYBSC §§ 402(a) & (b).
i) E.g., preferred shares, if company not perpetual.
g) General rule: put as little as possible in this because difficult to amend; rather, put substance in bylaws.
4) Bylaws:
a) Number of directors.
i) If bylaws don’t state, default is one.
b) Specifics about directors’ meetings.
c) Quorum.
d) Voting.
e) Authorized officers.
5) Choice of State:
a) For most companies, doesn’t make sense to incorporate outside state in which they reside.
b) Only makes sense for very-large corporations.
6) Incorporator: Any person who is 18 years-old or older. See NYBSC § 401.
7) Existence Date: As soon as accepted by secretary of state; however, can specify that it won’t begin until date in
future, up to 90 days after filing. See NYBSC § 403.
8) Organization Meeting: See NYBSC § 404.
a) Meeting for adopting bylaws; electing directors; initial transactions; etc.
b) Basically the first meeting.
c) If more than one incorporator, five-day notice requirement, which can be waived.
9) Defective Incorporation:
a) The incorporator can be on the hook for transactions entered into before the corporation exists.
i) This is the default rule.
ii) If enter into Ks before formation, will be binding on incorporator unless Ks state otherwise.
b) If the corporation is defective, it could undermine limited liability.
10) De Facto Corporation Doctrine: Where made a good faith effort to incorporate and then entered into a
transaction, a corporation will be considered to have existed.
11) Corporation by Estoppel: Court’s prevent the third party from asserting the promoter’s personal liability when
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the third party had dealt with the corporation on the assumption that the only recovery/resource would be against the
corporation, not the promoter.

VII. BINDING THE CORPORATION: Agent-Principal Jurisprudence


1) How can an agent bind the principal:
a) Actual Authority: The principal expressly gives the agent authority to do something.
b) Apparent Authority: Principal creates an expectation such that a reasonable person would view that the
agent has the authority to act.
i) Not expectation of agent/principal; rather, expectations/understandings of third party.
ii) From third party’s perspective, does it reasonably appear that agent has authority.
c) Inherent Authority: Elements:
i) Incidental to transactions that the agent is authorized to conduct, despite the fact that he or she is
forbidden by the principal;
ii) The third party reasonably believes that the agent is authorized; and
iii) The third party has no notice that he or she is not duly authorized.
d) Ratification: Principal can become obligated to a third party by ratifying the act of an agent who, at the
time of the act, lacked the power to bind the principal.
i) E.g., if principal waits three years before disclaiming to a third party.
2) Establishing Corporate Officers’ Authorities:
a) General and specific powers in bylaws.
b) Some positions, such as a CEO, are assumed to have inherent authority.
i) Sometimes the issue is whether it is an extraordinary transactions such that the agent, such as a
CEO, can’t bind the corporation.
c) Employees can also bind the company:
i) E.g., a “purchasing manager” can bind the company to certain purchases — very specific role.

Menard, Inc. v. Dage-MTI, Inc.

Facts: Despite the fact that only the Board could find the corporation, CEO negotiated and completed a sale with Menard. In
so doing, CEO bound the corporation to the terms of the deal. But CEO only had the explicit authority to solicit offers The
Board notified Menard that it does not think the K is enforceable. In response, Menard brings the instant action to enforce
the K. Incidentally, Menard was aware that its first offer had to be approved by the Board — the Board rejected the first
offer.

Issue: Did CEO possess the authority to bind the corporation?

Holding: Yes. With respect to element 1, CEO purchased real estate in the past without approval. With respect to element 2,
should not scrutinize a purchaser too closely. Here, Menard reasonably believed that a CEO could bind the corporation. In
addition to the fact that CEO did it before, the company’s attorney was present for the deal. With respect to element 3,
Menard had no knowledge. No evidence that Menard became aware of the Board’s rule. Plus, CEO signed a document
saying he had authority. The early notice (rejecting first offer) is insufficient for a CEO; only sufficient for a lower-tiered
employee. Also policy argument: because Board may him CEO, it has burden—not innocent third party.

Rule: An agent’s inherent authority subjects his or her principal to liability for acts done on his or her account which:
1) Usually accompany or are incidental to transactions which the agent is authorized to conduct if, although they are
forbidden by the principal;
2) The other party reasonably believes that the agent is authorized to do them; and
3) Has no notice that he or she is not so authorized.

Importance: This case does a good job at distinguishing apparent authority from inherent authority:
1) Apparent authority requires from that an agent making an impression; it requires some clear power source
creating this appearance.
2) Apparent authority asks who told the third party and who was the source that gave you that appearance that the
agent had the authority; IT CAN’T BE THE AGENT!
3) E.g., if the Board signed a resolution that Agent had authority — even though he didn’t — then there could be
apparent authority.
4) In short, apparent authority requires some clear power source creating appearance of power; the agent must have
“authority” to create an appearance that he or she can do something.
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3) Obligations of a third party to investigative an agent’s authority:
a) If agent can benefit personally, probably an obligation to investigate further.
i) This, however, is not universal; it varies by jurisdiction.
b) Could demand a copy of minutes indicating board resolution.
i) Showing that everything is on the up-and-up is a good protection tool.
c) Could demand to see blaws.
d) Ultimately, it comes down to who bears the burden; in Dage, it was the board.

IX. PIERCING THE CORPORATE VEIL:


1) Definition: “Piercing” limited liability and holding the SHAREHOLDER personally liable.
2) Although it is threatened a lot, a P is rarely successful.
3) One of the great benefits of the corporate enterprise is limited liability for owners — this promotes investment.
4) Scorecard Factors for PCV:
a) Closely-held corporation.
i) Typically privately held and controlled by one individual/family or small group.
b) Insider deception.
c) Not following corporate formalities.
i) E.g., not holding meetings, not taking minutes, etc.
d) Commingling of assets.
e) Inadequate capitalization.
f) Defendant is active in the business.

A) PCV in Tort:
1) Tort creditors, unlike K creditors, are involuntary.
2) The idea that a corporate enterprise could be manipulated to prevent involuntary creditors from obtaining
compensation is particularly abhorrent.
3) The most important factor is inadequate capitalization.
4) Unlike K, insider deception is not important, unless, of course, a state classifies inadequate capitalization as
deception.
5) Defendant being active in business is also important.

Walkovszky v. Carlton

Facts: P injured by Seon’s taxi. D owns is shareholder of 10 corporations, including Seon. Each of these corporations has
only 2 taxis. Each cab is minimum insurance allowed by law. P seeking to PCV to sue D individually.

Issue: Should P be allowed to PCV to sue P individually for tort?

Holding: No. Here, there is no evidence that D controlled Seon—that is, complete control/domination. It is not fraudulent
for the owner-operator of a single cab corporation to take out only the minimum required liability insurance, the enterprise
does not become either illicit or fraudulent merely because it consists of many such corporations.

Rule: Where a corporation is a “dummy” for its individual stockholders who are in reality carrying on the business in their
personal capacities for purely personal rather than corporate ends, a plaintiff may PCV with respect to the shareholders.

Importance:
1) It’s a draw: there is closely-held and maybe inadequate capitalization; however, no insider description, corporate
formalities, or commingling. D’s involvement is disputed.
2) The big issue in this case was inadequate capitalization, which the court rejected.

Radaszewski v. Telecom Corp.

Facts: P hit by a truck owned by Contrux, a subsidiary of Telecom. P sues Telecom directly. Contrux had insurance of $11
million, $10 million of which was excess insurance, which was a subsidiary of Telecom and in receivership.

Issue: Can P PCV and hold Teleco for the conduct of its subsidiary, Contrux?

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Holding: No. P argues inadequate capitalization to satisfy element 2. Undercapitalizing a subsidiary, which means creating
it and putting it in business without a reasonably sufficient supply of money, has become a sort of proxy under Missouri law
for the second element. However, Contrux did have insurance. There is nothing sinister in the fact that the insurance was
purchased through an agency wholly owned by D-principal. A bad business decision is insufficient to PCV. Therefore,
having insurance was sufficient and Contrux wasn’t undercapitalized.

Rule: Under Missouri, a plaintiff needs to demonstrate the following elements to PCV:
1) Control, not merely majority or complete stock control, but complete domination, not only of finances, but of
policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction had at the
time no separate mind, will or existence of its own;
2) Such control must have been used by the defendant to commit fraud or wrong, to perpetrate the violation of a
statutory or other positive legal duty, or dishonesty and unjust act in contravention of plaintiff’s legal rights; and
3) The aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of.

Importance:
1) This could come out differently depending on the judges.
2) It is widely known in the insurance field when a company is not in good shape; should Telecom have known?

B) PCV in K:
1) In K, the most important factor is insider deception.
2) Harder for Ps to recover in K suits because they are more sophisticated and know they are dealing with a
corporation.
3) Although insider deception is most important, when combined with inadequate capitalization, will really hurt a
company.

The Barge v. Darbro, Inc.

Facts: P sold rental properties to Waldron. Waldron sold them to Darbro, which was owned by Smalls. Smalls then
informed that parties that Horton would be the new purchaser. Smalls and Darbro personally guaranteed this mortgage,
although this was not in writing. The economy then tanked and Smalls and Darbro were done giving money to Horton. P
wanted to PCV of Horton to hold Darbro and Smalls personally liable for the purchase.

Issue: Should the court PCV and hold Darbro and Smalls personally liable?

Holding: No. The court notes that it is more stringent in K cases because parties know that a corporation as limited liability
when entering into a K. Here, there was no fraud; Darbro and Smalls were just sophisticated.

Rule: In K, control and a closed corporation, without fraud, in not sufficient to PCV.

Importance:
1) It is not uncommon to create a new corporation for the purpose of a merger or purchase.
2) In this case, as in many PCV K cases, the lack of fraud was dispositive.

C) PCV of Subsidiary:

Gardemal v. Westin Hotel Co.

Facts: P stays at Hotel, a subsidiary of Westin. Concierge tells P to go swimming, and he dies. P sues Westin and tries to
PCV under alter-ego and business enterprise doctrines.

Issue:
1) To PCV, can P satisfy the alter ego doctrine?
2) To PCV, can P satisfy the single business enterprise doctrine?

Holding:
1) No. This is a typical parent-subsidiary relationship. There is insufficient evidence that Hotel surrendered its corporate
identity. In fact, evidence suggests the opposite: it has its own bank accounts; unlike the parent, adheres to Mexico’s rules;
and has its own staff, assets, and insurance policies. There is no evidence of inadequate capitalization, which is often
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evidence of a parent shielding its assets through limited liability.
2) No. The use of the same trademark, operations manuals, and reservation system is insufficient. Some integration, but not
enough to PCV via this doctrine. Pooling resources for efficiency does not mean all are in the same business operation;
Westin doesn’t even care if Hotel fails, which means not single business enterprise — their fortunes aren’t tied.

Rule:
1) Alter Ego Doctrine: Imposition of liability on a corporation for acts of another corporation when the subject corporation is
a mere too or business conduct. This is demonstrated by evidence showing a blending of identifies, or a blurring of lines of
distinction, both formal (set up in a way that domination is explicit) and substantive (commingling funds), between two
corporations. An important consideration is whether the subsidiary is underfunded or undercapitalized.
2) Business Enterprise Doctrine: When corporations are not operated as separate entities, but integrate their resources to
achieve a common business purpose, each constituent corporation may be held liable for the debts incurred in pursuit of that
business purpose.

OTR Associates v. IBC Services, Inc. — Alter Ego

Facts: P owned mall and leased space. Lease space to IBC, a subsidiary of Blimpie. P thought, however, it was leasing
directly to Blimpie. IBC was merely a subsidiary to deal with Blimpie leases. IBC didn’t pay. P sued to PCV of IBC and
hold Blimpie liable.

Issue: Should the court PCV and hold Blimpie liable for IBC?

Holding: Yes. It looks like the court used alter ago, although it didn’t say so. The court gives two hallmarks of abuse. Here,
Blimpie dominated/controlled IBC: IBC has had no assets other than the leases; no business premises of its own; shared an
address with Blimpie; had no employees or office staff; and didn’t manage its leases. In short, IBC could not survive without
Blimpie. The real issue was fraud. Here, there was fraud: P thought it was dealing with Blimpie because all the IBC people
had Blimpie uniforms and all correspondences were on Blimpie letterhead.

Rule: A P may PCV when the parent so dominated the subsidiary that it had no separate existence. But beyond domination,
the court must also find that the parent has abused the privilege of incorporating by using the subsidiary to perpetrate a fraud
or injustice, or otherwise to circumvent the law. The hallmarks of this abuse are typically the engagement of the subsidiary is
no independent business of its own but exclusively for performance of a service for the parent and, even more importantly,
the undercapitalization of the subsidiary rending it judgment-proof.

Importance:
1) Blimpie argues corporate formalities; the court, however, notes that this argument alone will never save a
company from PCV. It will only hurt, never help!
2) It’s arguable that Blimpie’s lawyers dropped the ball on the fraud argument; P was a sophisticated real estate
owner and could have found out in five minutes that IBC was not Blimpie.

D) PCV Exam Strategy:


1) Acknowledge PCV is rare.
2) Nonetheless, will PCV if, after looking at totality of the circumstances, it will otherwise lead to inequitable result.
3) What circumstances this analysis: scorecard factors.
4) Go through each one.
5) Focus undercapitalization in tort and insider deception for K.
6) Note that commingling and inadequate capitalization go hand-in-hand.
7) Don’t forget to talk about corporate formalities: won’t save you, but could hurt you.

X. SHAREHOLDER VOTING RIGHTS:


1) Meetings:
a) Corporations have annual meetings, which are set by bylaws.
b) Directors have considerable control concerning a meeting’s agenda.
c) Directors’ failure to call a meeting means a shareholder can force a meeting. See NYBSC § 606(a).
d) Among other things, elect directors at meetings.
2) Voting Procedures:
a) Must be notice of time, place, and issues. See NYBSC § 605.
b) Notice is considered to be given when sent, not received.
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c) After sent, a company files an affidavit of notice; this is a prima facie evidence of notice, but can e
rebutted.
d) Shareholders can waive notice even if they didn’t receive. See NYBSC § 606.
e) Waiving notice must be unanimous.
3) Record Date: The date on which a company sets as whoever owns shares on this time/day will be entitled to vote.

a) If sell after the record date, can expressly rant to buyer the right to vote for you.
4) List of Shareholders: Must be available at meeting to determine who can vote. See NYBSC § 607.
5) Quorum:
a) Must be a certain minimum shareholders present before a vote counts.
b) In New York, the default is a majority of shares.
c) But this can be altered by the certificate of incorporation/bylaws.
d) In New York, can be as low as 1/3 or more than 1/2.
e) If meeting starts with quorum, but people leave and there are less people than the quorum requirement,
there is STILL QUORUM.
6) Proxies:
a) See NYBSC § 609.
b) One can vote in person or via proxy.
c) A proxy may become irrevocable if:
i) To a pledge;
ii) To a purchaser of shares;
iii) Creditors giving credit in exchange for proxy (unless debt is paid);
iv) Proxy is part of employment K; and
v) NYBSC § 620(a) voting agreement (didn’t get into).
d) A subsequent purchaser of shares can revoke “irrevocable” proxy if unaware of proxy (unless note d
conspicuously on face or back of certificate).
e) Expires after 11 months.
7) Voting Requirements:
a) Default: A simple majority is required to approve something. See NYBSC § 614(b).
b) Election of multiple directors: plurality vote. See NYBSC § 614(a).
i) Can, however, give each share a vote for each open position. But must cast each vote for
somebody different.
ii) Can give each share a vote for each open position, but can case each for the same person or any
other way—this is used in small closed corporations where there are competing large holders.
iii) Can also give each share one vote overall.
8) Rights on Fundamental Transactions:
a) With respect to most transactions, shareholders don’t have the power to stop them; shareholders must
wait for a meeting.
i) Of course, shareholders can sue, but this is hard.
b) But there are some transactions that are so fundamental that there must be shareholder approval.
c) Without shareholders, a board ca modify business strategy/focus; acquire new businesses/product lines
(not absolute); etc.
d) Use to be unanimous consent, but now simple majority.
e) Essentially, the shareholder “veto” board approval in these instances.
f) SHAREHOLDERS MUST HAVE A COPY OF THE DEAL DOCUMENT BEFORE THE VOTE:
i) Must be signed/approved.
ii) Shareholders are entitled to this.
iii) If they vote, then there are changes, must vote again.

A) Fundamental Transactions:
1) Statutory Merger: Purchaser and Seller.
a) Seller is merged into purchaser so that only purchaser is left.
b) To achieve this end, must have a Planned Merger Agreement: this will spell out who is the purchaser, the
terms and conditions, treatment of seller’ shares, and treatment of seller’s executives.
c) Do you have to submit to shareholders:
i) Purchaser: Yes, in most cases, unless P is a “whale” and S is a “minnow” such that voting won’t
make a difference. Therefore, if seller is less than 20% of purchaser, then purchaser doesn’t need a shareholder vote.
ii) Seller: Yes.
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d) Appraisal Rights:
i) Purchaser: No
ii) Seller: Yes: Minority shareholders of seller can demand compensation where majority sells for
less than it would be appraised for.
2) Triangular Merger: P and S; P wants to acquire S. Instead of buying S directly, P will create a subsidiary, P1,
which merges with S.
a) Now S is a subsidiary of P.
b) Under most state laws, subsidiaries can be merged into parents without the approval of company
shareholders.
c) This is significant because P can acquire S without getting approval from P’s shareholders.
d) Structured under a merger agreement.
e) Do you have to submit to shareholders:
i) P: No, unless substantial change (i.e., 20%) — this part doesn’t make sense here.
ii) S: Yes.
3) Asset Sales:
a) Structured under an Asset Purchase Agreement/Sales Agreement.
b) Do you have to submit to shareholders:
i) P: Probably not.
ii) S: If selling all assets, then yes. See NYBCL § 901(a)(1)(B).
c) Appraisal Rights:
i) P: No.
ii) S: Yes. See NYBCL § 910(a)(1)(B).
4) Tender Offer:
a) Unlike merger, bypass the board and go straight to the shareholders and say this is what we can do for
you.
b) NO APPRAISAL RIGHTS IN TENDER OFFER.
c) But if want to finalize complete control AFTER tender offer by cashing out minority shareholders, then
there are appraisal rights.

B) Shareholder Power to Initiate Actions:


1) Shareholders are generally not thought of as initiators; to the contrary, actions are usually brought to the
shareholders by the Board.
2) Yet shareholders have the ability to make some recommendations.
3) The issue is, then, whether the commendations fall within the scope of shareholder authority.
4) Shareholders cannot initial corporate policy.
5) But it may be appropriate to bring something up for a vote, such as a vote on confidence in a former company
president.

Auer v. Dressel

Facts: Shareholders want Board to hold meeting so that it may vote on three things: (1) a resolution endorsing the former
President/demanding his reinstatement; (2) an amendment to the Articles of Incorporation that provides that vacancies on the
Board arising from removal shall be filled b shareholders only; and (3) the removal of four Class A Directors, as well as the
election of successors.

Issue: Should the Shareholders be allowed to vote on the aforementioned proposals?

Holding: Yes. Although hiring/firing is a board’s duty, shareholders may vote on resolutions because resolutions are just
recommendations showing what shareholders believe. It is well settled, moreover, that shareholders can amend bylaws.
Finally, shareholders have the inherent power to remove board members SO LONG AS THERE IS DUE PROCESS, which
includes notice

Rule: Shareholders can vote on resolutions, amend bylaws, approval new board members when there is a vacancy, and
remove board members for cause (so long as due process, which includes notice).

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CA, Inc. v. AFSCME Employees Pension Plan — Amending Bylaws

Facts: Board submitted relative proxy statements with the SEC. Before the meeting, D filed a bylaw amendment, which
would reimburse expenses in connection with nominated a candidate to the Board.

Issue:
1) Is the Bylaw amendment a proper subject for action by shareholders as a matter of Delaware law?
2) Would the Bylaw proposal, if adopted, cause the board to violate any Delaware law to which it is subject?

Holding:
1) Yes. Here, the court found that the bylaw was procedural. It is merely regulates the process for electing directors. Thus,
the Bylaw is proper shareholder action.
2) Yes. Here, however, the bylaw could prevent the Board from acting within the best interest of the corporation.

Rule:
1) The proper function of bylaws is to define process and procedures by which decision are made, not decide specific
substantive business decisions.
a) Substantive powers must appear on the certificate of incorporation.
b) Procedural powers, however, do not have to appear on the certificate of incorporation.
2) A bylaw provision may not limit a board’s exercise of its fiduciary duties.

Importance:
1) The proper function of bylaws is to define process and procedures by which decisions are made, not to decide
specific substantive business decisions.
2) To avoid the foregoing problem, when drafting such a provision, include a proviso that states nothing herein shall
preclude the board form taking actions it deems to be in the best interest of the corporation.
3) This case had to balance § 109(a) (shareholders may adopt, amend or repeal bylaws) with § 141 (provides that a
board manages the business and affairs of a corporation).

Campbell v. Loew’s, Inc. — Due Process

Facts: Vogel sent a notice calling a special shareholders’ meeting for the following purposes: to (1) fill director vacancies; (2)
amend the bylaws to increase the number of board members from 13 to 19, and quorum from 7 to 10; and (3) remove
Tomlinson and Meyer as directors and to fill those vacancies.

Issue: Are the motoins proper shareholder action?

Holding: All except for the motion to remove officers. There was “cause” for removal. A charged scheme of harassment,
which Vogel is claiming, is sufficient; however, there was no due process because the directors were not given an
opportunity to present a defense before proxy votes were solicited.

Rule:
1) Shareholders have the inherent right between annual meetings to fill newly created directorships
2) Stockholders have the power to remove a director for cause.
3) In addition to due process, there must be the service of specific charges, adequate notice, and full opportunity of meeting
the accusation.
4) A charge against a Director must be for “cause”; however, merely disagreeing with management or seeking to take control
is not cause for removal.
5) A reasonable opportunity to be heard means that proxies are solicited only after or at the same time the accused directors
are afforded an opportunity to present their case.

Importance:
1) The court does not discuss how much notice is sufficient.
2) It is important for shareholders to get both sides of a story.

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Blasius Industries, Inc. v. Atlas Corp. — Interference with Shareholder voting (will be on Exam)

Facts: P informed 9.1% of Atlas. P informed Atlas’s Board that it would attempt to (1) adopt a resolution recommend that
the board develop and implement a restructuring proposal; (2) amend bylaws to expand the size of to 15 members; and (3)
elect 8 named persons to fill the new vacancies. In response, Board created 2 new board spots and appointed 2 new members
of those spots.

Issue: Even if the Board acted in good faith, may it validly act for the principal purpose of preventing the shareholders from
electing a majority of new directors?

Holding: No. Even if decisions are, pursuant to BJR, correct, not enough. P asked that Board’s action be per se invalid. The
court, however, rejected this argument, noting that such an action could be appropriate given the correct circumstances. To
thwart a shareholder vote, must meet the high burden of COMPELLING JUSTIFICATION. This is not present. Board was
dealing with a 9% shareholder; this is de minimis. Board also had time to inform shareholders of its views on the proposals
and publish reports; it had plenty of time to make its case.

Rule: A board may only prevent shareholders from electing a majority of new directors in the narrow instance where it can
demonstrate a compelling justification for such action.

Importance:
1) The court gives no insight regarding what is a “compelling justification; however, using negative implications,
one can draw the following as compelling justifications:
a) A large shareholder, e.g., 45% ownership.
b) Timing of proposal, e.g., coming right at deadline of scheduled meeting.
c) No time to make case or get together to make reports/recommendations to shareholders.
2) It is critical to note, as a Board, that you are preserving shareholders’ right to make an informed decision and
make an informed vote by preventing a premature vote.

Quickturn Design Systems, Inc. v. Shapiro — Diminishing Board’s Power

Facts: P wanted to acquire Quickturn. P made a tender offer and was going to solicit proxies to replace the Board. In
response, the Board (1) changed the bylaws regarding a shareholder calling a special meeting so it could determine
time/place of meeting and (2) amended its “rights plan”/poison pill to add a Deferred Redemption Provision (DRP), under
which no newly elected board could redeem the Rights Plan for six months after taking office

Issue: Did D breach its fiduciary duty by adopting the DRP?

Holding: Yes. Any limitation on a board must be in certificate of incorporation. See § 141(a). This was not done. Indeed, §
141(a) confirms upon a newly elected board full power to manage and direct the business and affairs of the corporation. In
so doing, the directors have a fiduciary duty to shareholders and the corporation. No provision can prevent the board from
performing this duty. Even if redeeming the DRP were in the company’s best interests, a newly elected board could not do
anything; this is a breach of fiduciary duty.

Rule: A board cannot limit its ability, or a future board’s ability, to exercise its fiduciary duties.

XI. SHAREHOLDER INFORMATION RIGHTS:

State ex rel. Pillsbury v. Honeywell, Inc. — Shareholder Inspection Rights

Facts: P wanted to stop Pillsbury from producing bombs. So P bought 100 shares of Pillsbury for the sole purpose of getting
a voice in the company. Then P requested a shareholders’ list in order to solicit proxies for the election of new directors, but
was denied.

Issue: Is soliciting a shareholders’ list for the sole reason to solicit proxies for the election of new directors to cease making
bombs — a personal political motive — a proper purpose germane to his or her business interests?

Holding: No. There must be a bona fide interest in the corporation to inspect. Here, P had utterly no interest in the affairs of
D before he learned of the bombs. He only purchases to stock to cease this activity. Such a purpose is not germane to P’s
15
economic interest. His sole motivation was to change a decision incompatible with his political views. There was NO
MOTIVIATION REGARDING P’S or PILLSBURY’S LONG OR SHORT-TERM EOCNOMIC INTERESTS.

Rule: A stockholder is entitled to inspection for a proper purpose germane to his or her business interests; while inspection
will not be permitted for purposes of curiosity, speculation, or vexation, adverseness to management and a desire to gain
control of the corporation for economic benefit is a proper purpose.

Importance: Not an absolute right to shareholder inspection.

Saito v. McKesson HBOC, Inc.

Facts: D and HBOC merged. P argued there was corporate wrongdoing. Therefore, P wanted to inspect documents. D
declined. These documents included documents before P was a stockholder; 3rd party documents, and subsidiary documents.

Issue: May P inspect the foregoing documents?

Holding: Yes. Time is irrelevant because the claim may involve a continuing wrong. Second, a post-purchase action may
have foundations in pre-purchase activities. The source of the document is therefore not controlling. The issue is whether
the documents are necessary and essential to satisfy the stockholder’s proper purpose. P can finally get pre-merger HBOC
documents because P needs to understand what his company’s directors knew and why they failed to recognize HBOC’s
accounting problems.

Rule:
1) § 220: Stockers may investigate matters reasonably related to their interest as stockholders, including, among other things,
possible corporate wrongdoing.
2) The date on which a stocker first acquired the stock does not control the scope of records available under § 220.
3) The source of the documents and the manner in which they were obtained by the corporation have little or no bearing on a
stockholder’s inspection rights.
4) This rule applies to relevant documents that HBOC gave to D before merger, as well as the merged company’s documents
after the merger.
5) Stockholders of a parent corporation are not entitled to inspect a subsidiary’s books and records, absent a showing of a
fraud or that a subsidiary is in fact the mere alter ego of the parent.

Importance: Information rights can be used as a way to foreclose litigation from the outset.

1) Proxy Statements:
a) Public Corporation in Proxy Content: In this regard, there are SEC requirements that define a public
corporation, including at least $10 million.
b) See book for what must be included in a proxy statement.
c) Important to remember that there is a dual system (state/federal) when soliciting proxies.
d) A shareholder receives a packet of information when he or she receives a proxy request.
e ) Several trouble if proxy information is incorrect.
f) 14(a): When soliciting, must tell shareholder for what you’re soliciting; these disclosure requirements say
you must be very clear and give a shareholder proper information such that he or she can make an informed decision.
2) Proxy Fraud Elements:
a) False or misleading statement;
b) Is it material;
c) Reliance; and
d) Causation.

Virginia Bankshares, Inc. v. Sanderg — Proxy Fraud Under § 14(a)

Facts: P sued VBI for soliciting proxies in violation of § 14(a) and 14a-b because there were materially false and misleading
statements. VBI solicited proxies to merge with its subsidiary. It essentially conducted a freeze-out merger. Although there
was evidence that it was $60 a share, VBI stated that $42 a share would be a “high” value. The jury awarded $60 a share.

Issue:

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1) Whether a statement couched in conclusory or qualitative terms purporting to explain directors’ reasons for recommending
certain corporation action can be materially misleading within the meaning of Rule 14a-9?
2) Whether causation of damages compensable under § 14(a) can be shown by a member of a class of minority shareholders
whose votes are not required by law or corporation bylaw to authorize the corporation action subject to the proxy
solicitation?

Holding:
1) Yes. Here, the board did not believe what it said, and there was evidence to support that its statement was incorrect.
2) No. A proxy statement issued in connection with a cash merger could not be made the basis of a federal claim under the
SEC proxy regulations if the votes being solicited by the proxy statement could not affect the outcome of the vote. A
statement couched in terms of opinion may nevertheless be materially misleading.

Rule:
1) There is an implied private right of action for the breach of § 14(a) as implemented by SEC Rule 14a-9, which prohibits
the solicitation of proxies by means of materially false or misleading statements.
a) There is a buttable presumption that what directors say is correct.
2) Materiality: A fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important
in deciding how to vote, even if it is conclusory.
3) Misleading: Must (1) not be believed by the board and (2) not supported by facts.
a) Mere disbelief or undisclosed motivation will not suffice
4) Causation: An implied private right of action under § 14(a) CANNOT be demonstrated by a member of a class of minority
shareholders whose votes are not required by law or corporate bylaw to authorize the transaction giving rise to the claim.
a) Causation can be established by showing the proxy statement was an “essential link” in the transaction

XII. SHAREHOLDER LITIGATION:


1) Derivative Litigation: Suing as a representation of the corporation.
a) Suing on behalf of the corporation.
b) Corporation recovers.
c) Can be brought against anyone, including a director of a board.
d) E.g., Board is not doing its job, so sue to make it do its job.
2) Direct Litigation: Suing in one’s own name.
a) Suffered a loss; suing for loss directly.
b) Individuals recover; usually class action.
c) E.g., inadequate disclosure, disclosure fraud, etc.
3) Discerning whether it is derivative or direct:
a) Ask who is injured: shareholder or corporation?

Tooley v. Donaldson, Lufkin, & Jenrette, Inc. — Derivative v. Direct Litigation

Facts: CS acquired DLS, for which Ps were former minority shareholders. The deal had several extensions, of which CS
availed itself. As a result, Ps claim they suffered losses, which improperly benefited AXA — the majority shareholder of
DLS.

Issue: What is the proper legal inquiry to determine the difference between direct and derivative claims?

Holding: See Rule. This is a direct claim. There was no injury to the corporation and no benefit would go to the corporation.
Instead, Ps suffered injury: as a result of the delay, they lost value of shares, i.e., they lost the time-value of money.
Nevertheless, this was harmless error because Ps’ claim was not ripe; only ripe after merger is complete.

Rule: The issue of whether a claim is direct or derivative turns solely to the following questions: (1) who suffered the alleged
harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other
remedy (the corporation or the stockholders, individually).

Importance: The lower court applied the wrong analysis — the special injury test, i.e., need “special injury” for a direct
action. The court noted this was too confusing.

4) Limitations on Derivative Litigation:

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a) There is a problem with these suits, that is, shareholders taking action on behalf of corporation.
b) Remember, it is the Board who managed day-to-day activities.
c) So these suits go against the corporate structure.
d) As a result, there are limitations.
e) The principal limitation is shareholders must first make a demand to the board.

Aronson v. Lewis — Demand Requirement in Derivative Litigation

Facts: Ps, a shareholder, challenged transactions between Meyers and one of its directors, Fink. P claimed that these
transactions were approved only because Fink personally selected each director and officer of Meyers. The transaction was
that Prudential, which all of Meyers’ shares, transferred them to its shareholders. In so doing, created an employment
agreement with Fink, which give him a lifetime job and interest free loan. P brought a derivative suit, and claimed demand
would be futile.

Issue: Would demand be futile?

Holding: No. For the first element, the court could not conclude that the complaint particularized any circumstance of
control and domination to overcome the presumption of board independence rendering a demand futile—his stock ownership
alone, even if majority, and picking directors, is insufficient and not sufficiently particular. Of the second element, there
were no particularized facts supporting a breach of fiduciary duty; directors have broad power to compensate officers.

Rule:
1) The complaint in a derivative suit shall allege with particularity the efforts, if any, made by the plaintiff to obtain the
action plaintiff desires from the directors and the reason for the plaintiff’s failure to obtain the action or for not making the
effort.
2) No shareholder, in actuality, makes a demand because if the board refused, a court would apply the BJR to the decision.
3) Therefore, an exception to the demand requirement is when the demand would be futile, which occurs when a reasonable
doubt is created that:
i) the directors are disinterested and independent; and
ii) the challenged transaction was otherwise the product of a valid exercise of business judgment.

Importance: The court notes that the fact that the directors would have to sue themselves has also been rejected by other
courts and is therefore not relevant.

5) Independent Committee: To get around futility, particularly when a board will lose on element 1, it can appoint an
independent committee to make an independent investigation:

Einhorn v. Culea — Independent Committee

Rule: A corporation may create a special litigation committee to determine whether a derivative action is in the best interests
of the corporation. When the SLC acts in (1) good faith, and (2) conducts a reasonable inquiry upon which it concludes that
a derivative action is not in the best interests of the corporations, the court shall dismiss the action. Therefore, the SLC must
be independent. Such an analysis is an objective test based on the totality of the circumstances given the following factors:
1) A committee member’s status as a defendant and potential liability;
2) A committee member’s participation in or approval of the alleged wrongdoing or financial benefits from the
challenged transaction;
3) A committee member’s past or present business or economic dealings with an individual defendant;
4) A committee member’s past or present personal, family, or social relations with individual defendants;
5) A committee member’s past or present business or economic relations with the corporation;
6) The number of members on a SLC; and
7) The roles of corporate counsel and independent counsel.

6) Plaintiff requirements in derivative suits:


a) Adequacy:
i) Don’t have to be terribly sophisticated.
ii) There is a fear, however, that lawyers will control, and that professional plaintiffs won’t be
supervising lawyers properly.
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iii) But just need to determine if a P has a legitimate interest.
iv) Low standard.
v) Adequacy could be limit if a P has no idea and no potential idea of what’s going on, and
probably not supervised by someone to help.
b) Standing. Elements:
i) Nature of Holding: Shareholders or creditors. Most of time, must be a shareholder; no fiduciary
duties to creditors.
ii) Timing: Must have owned stock when the event occurred; if period of time, must owned for
entire period; have to hold onto shares until litigation end (which is bad because stock will likely tank).

In re Fuqua Industries, Inc. Shareholder Litigation — Plaintiff Adequacy

Facts: With help of husband, P brought derivative suit. But her husband died. She is now ailing and can’t remember basic
facts of case. The other P just purchased stock and taught himself all about the case (he has brought many suits before).

Issue: Are both of these plaintiffs adequate?

Holding: Yes. The first P is properly supervised and the second P meets Rule 23.1 minimum adequacy.

Rule: A representative plaintiff will not be barred from the courthouse for lack of proficiency in matters of law and finance
and poor health so long as he or she has competent support from advisors and attorneys and is free from disabling conflicts.

XIII. BOARD DECISION MAKING: BUSINESS JUDGMENT RULE AND DUTY OF CARE:

A) Business Judgment Rule:


1) Directors are better than shareholders or courts at making business decisions.
2) As a result, there is the BJR: rebuttable presumption that directors acted in good faith and exercised reasonable
diligence in making a decision.
3) If this presumption is not rebutted, courts will not interfere/second guess a board’s decision with the benefit of
twenty-twenty hindsight.
4) This is so even if courts don’t agree with decision or think it was a good decision.
5) Rather, the concern is did the board act in good faith and exercise reasonable diligence.
6) To overcome BJR, essentially need to prove corporate waste, which will be discussed below.

Shlensky v. Wrigley — BJR

Facts: Chicago Cubs’ Board refused to have night games, which caused financial problems. So shareholders brought
derivative action against Board.

Issue: Whether P’s complaint states a cause of action?

Holding: No. Just because other corporations do something doesn’t mean D must follow suit. This is not negligence, as P
contends. Courts may not decide such a question absent a clear showing of dereliction of duty on the part of the specific
directors; the mere failure to follow the cord is not such a dereliction. Because this doesn’t constitute a breach of good faith
by directors, the BJR protects the Board.

Rule: A court may only intervene in a business decision if there is fraud, illegality, conflict of interest, all of which constitute
a breach of good faith.

Importance: Although this case is old, it is important because it notes that even if really bad buseinss decisions are made in
good faith/reasonable diligence, they are still protected under the BJR.

B) Duty of Care:

Smith v. Van Gorkum

Facts: Cash-out merger by Pritzner to buy TransUnion. Van Gorkum, TU CEO, is friends with Pritzner, but didn’t tell
Board. Board hastily approves transaction with no documentation, just Van Gorkum’s explanation. Van Gorkum signs deal
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without reading it. Although “seek” other offers, and get higher offer, Van Gorkum does not give the company the time to
get financial, despite the fact that he did so for Pritzner. A large majority approved the transaction, after which P claimed
that the directors breached their duty of care to shareholders.

Issue: Did the board breach its duty of care to shareholders such that it is not protected by the BJR?

Holding: Yes. The directors were grossly negligent because: 1) failure to inform themselves and 2) failing to disclose all
material information such as a reasonable stockholder would consider important in deciding whether to approve the offer.
Van Gorkum even admitted he was uniformed. The directors didn’t even review any documents, didn’t ask questions, and
approved the merger hastily. For these reasons, the directors breached their duty of care to shareholders.

Rule:
1) Under the BJR, director liability is predicated upon gross negligence.
2) Under § 251(b), a director has a duty to act in an informed and deliberate manner in determining whether to approve a
merger.

Importance:
1) As a result of this case, Ps can just plead duty of care and that directors were not informed in order to survive 12(b)(6) and
summary judgment.
2) Companies now put out fairness opinions to show that they did a proper evaluation. A fairness opinion is an opinion from
a valuation expert that says based on this model, it was a fair price range.

C) Exculpation:
1) In response to Van Gorkum, Delaware promulgated § 102(b)(7), which provides that a corporation can exculpate
directors for personal liability to corporation and shareholders.
a) In New York, NYBCL § 402(b)(1).
2) Exculpation actually bars a P from suing!
3) By contrast, indemnification is where the corporation/insurance will pay off the verdict.
4) There are some EXTREMELY important exceptions to exculpation: not applicable when:
a) Loyalty breach.
b) Bad faith.
c) Intentional misconduct.
d) Knowing violation of thelaw.
5) As a result of this, Van Gorkom is irrelevant because those directors acted in good faith, albeit they were careless.

XIV. BOARD OVERSIGHT, DUTY OF LOYALTY, AND CONFLICTS OF INTEREST:


1) Must balance the fact that directors are in a good position to oversee company with the fact that directors can’t
see everything.

Francis v. United Jersey Bank

Facts: Directors include Widow and her two sons. The two sons are “borrowing” large amounts of money from the
corporation. Shareholder sues claiming Widow didn’t exercise proper oversight.

Issue: Was Widow’s oversight proper?

Holding: No. Widow made no effort to inform herself. Widow had a duty of care in managing the business. She did not have
to know every detail of day-to-day operations, but she needed to have a baseline understanding of the finances and important
activities. If she did not understand the activities, then she was obligated to consult counsel for advice.

Rule: A director can be personally liable, even to third parties, if they neglect to provide the ordinary care of staying current
with corporate affair.

A) Caremark Duty of Loyalty:

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In re Caremark International Inc. Derivative Litigation — Caremark Duty of Loyalty

Facts: Caremark had to pay $250 million in government fines. Caremark was in violation of several federal laws.
Shareholders sue Board because of failure to conduct proper oversight.

Issue: Whether the Board exercised an appropriate level of attention to the possibility of ARPL violations.

Holding: No. The Board had a monitoring system in place. Such a system, however doesn’t have to be perfect. Before the
litigation, the system appeared to be fine. Moreover, since the litigation, the Board has improved it. Perfection is not the
standard.

Rule:
1) A board has a duty to ensure that there is a reporting system that is reasonably designed to provide to senior management
and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to
reach informed judgments concerning both the corporation’s compliance with the law and its business performance.
2) Only a sustained and systemic failure till establish liability.
a) A mere short circuiting/de minimis problem is insufficient.
3) Conditions for Caremark liability:
i) The directors utterly failed to implement any reporting or information system or controls; or
ii) Having implemented such a system or controls, consciously failed to monitor or oversee their operations thus
disabling themselves from being informed of risk or problems requiring their attention.

Importance:
1) This case quasi-clarified Chalmers, under which many boards were under the impression that if they doesn’t see
it, i.e., red flags, they can’t be held liable.
2) Can hire a compliance specialist to help establish a system.
3) Many people tried to label this a duty of care case, but its origins are cases like Francis and Van Gorkum. But
because this was conceptually problematic, courts have interpreted it as a duty of loyalty.

Stone v. Ritter

Facts: D had an internal ponzi scheme, which cost the company a lot of money. Ps, who are shareholders, bring a derivative
action against Board. Ps claim they can’t make a demand because demand would be futile because Board not disinterested
because would be personally liable.

Issue: Did Ds act in bad faith such that a demand would be futile because Ds face a substantial likelihood of liability
(remember, personal liability only arises when directors act in bad faith; good faith protects them)?

Holding: No. Here, the record is clear that Ds put in place numerous procedures to attempt to ensure compliance with
corporate laws. Ds also heard annual reports in this regard. This is not a sustained or systemic failure of the board to
exercise oversight. Accordingly, Ds acted in good faith and could not be personally liable. As such, demand is required and
would not be futile.

Rule: A derivative action will be dismissed for failure to make demand where alleged particularized facts do not a create a
reasonable doubt that the corporation’s directors acted in good faith in exercising their oversight responsibilities.

Importance:
1) Ps have to plead “bad faith” to get around the exculpation clauses.

In re Citigroup Inc. Shareholder Derivative Litigation

Facts: Ps claim that the Board breached its fiduciary duties by failing to properly monitor its investments in the subprime
market. In support of this contention, Ps cite to several red flags, which include articles predicting subprime problems. Ps
bring derivative action and claim notice futile because Board not disinterested because would be personally liable.

Issue: Did the Board ignore red flags such that a Caremark Duty of Loyalty claim is appropriate?

Holding: No. These red flags were not sufficient. They are not particularized, particularly in light of the fact that the Board
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had procedures and controls in place to monitor risk.

Rule:
1) Pleadings: Ps must demonstrate particularized factual allegations demonstrating bad faith by the director defendants.
2) Bad Faith: A P can show bad faith by properly alleging particularized facts that shows that a director CONSCIOUSLY
disregarded an obligation to be reasonably informed about the business and its risks or CONSCIOUSLY disregarded the duty
to monitor and oversee the business.

B) Caremark Duty of Loyalty Exam Strategy:


1) The first real issue is Did the board even have a duty to oversee this problem.
a) E.g., if there are two truck accidents resulting in faulty trucks, should a board of a billion dollar company
have known about this—no way! Then move to the following analysis:

1) Was the Board aware of the problem.


a) If Yes, did they take an adequate response to stop the problem.
i) If response was adequate, no liability for subsequent acts.
ii) If response was not adequate, liability for subsequent acts.
b) If No, was there a reasonably designed reporting system (use experts).
i) If reasonably designed reporting system, no liability for subsequent acts.
ii) If no reasonably designed reporting system, liability for subsequent acts.
2) Red Flags: If reasonable system, and red flags come to light that system is not catching activity, a board MUST
follow up on red flags:
a) Was there a reasonable response?
b) Did board reasonably reevaluate system?
i) Under Caremark, if board didn’t do this, liability for subsequent acts.
3) Reporting System: If reasonable system and no red flags, but getting reports and not reviewing the reports:
a) Still liable if something bad happens for something the board should have been aware of, i.e., didn’t
review reports that would have alerted board.
b) If, however, reasonable system and no red flags, but are reviewing reports, no liability for subsequent
acts.
4) Legal Standard: Any harms proximately caused by directors’ failures will result in liability.
5) BJR: With regard to adequate response, the BJR will protect a business decision but it never protects knowingly
illegal conduct.
6) Remember, this was once called a Duty of Care Analysis; then a Caremark Duty of Loyalty analysis; and now
just a Caremark Duty analysis.
7) Remember, this cause of action is rooted in bad faith so that directors can’t claim exculpation clauses for
protection; to prove a breach of a Caremark Duty is to prove bad faith.
8) And do not forget about the particularized pleadings to show bad faith!!!

C) Traditional Duty of Loyalty:


1) Self-dealing.
2) Weren’t independent from a beneficiary of a transaction.
3) In short, conflict of interest.
4) But remember, self-dealing is sometimes in the best interest of a corporation.
5) § 144(a): Deals are not voidable if they involve a fiduciary with interest in transaction if:
a) Informed disinterested board vote; or
b) Informed disinterested shareholder vote; or
c) The deal is found to be substantively fair when a reviewing court conducts a fairness analysis.
i) Indeed, this is a high standard.
6) Entire Fairness Standard:
a) Look at procedure: was the process fair?
b) Look at substance: compare fair market value of transaction to what one would expect the cost/return for
the transaction.
c) In short, under entire fairness, must show that the transaction satisfied both fair dealing and fair price to
the cashed-out minority shareholders.
d) Often competing valuation models.
e) If it’s close, the party with the BoP will lose; this is why BoP is so important — for the valuation
dispute.
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f) Three factors to consider:
i) Terms of transaction; range of prices, not specific point. No court will say that the fair price
should have been X. Will say based on a valuation, it should have been in X range.
ii) Benefit to corporation: The extent to which is advances corporate interests. Might be perfectly
fair deal, but does nothing for corporation.
iii) Process of decision making: Having a process that looks like intended to bring best result for
company is often what cases comes down to.
6) Interest v. Independence:
a) Interest: Director personally receives benefit.
b) Independent: Director controlled by another party.
i) Being friends with interested party is not sufficient to question independent; need to plead more.
ii) A sexual relationship could destroy independence.

Lewis v. Vogelstein — Shareholder Ratification/Corporate Waste

Facts: Board approved stock option plan, under which the directors received various one-term stock-options. The
shareholders approved the plan. Ps, a group of shareholders, claimed that the directors breached Duty of Loyalty.

Issue: Is there an issue of fact regarding corporate waste?

Holding: Yes. Because the shareholders were disinterested and informed (all materials were disclosed), P’s only option is
overcoming the BJR and proving corporate waste. Court notes that this is virtually impossible and a very high burden.
Nevertheless, the court concluded that the onetime option grants to D were sufficiently unusual as to require further inquiry
into whether they constituted waste.

Rule:
1) Corporate waste entails an exchange of corporate assets for consideration so disproportionately small as to lie beyond the
range at which any reasonable person might be willing to trade; a corporate waste transaction may only survive an action if it
was unanimously ratified by the shareholders
2) For ratification to be effective, the board must fully disclose all relevant circumstances with respect to the transaction to
the shareholders prior to ratification.

Importance: This case should be taken in perspective; Ps just got past the first procedural barrier. Ps will still have a tough
time ultimately winning.

Harbor Finance Partners v. Huizenga

Facts: Harbor Finance acquired AutoNation. Ps contends this was self-interested by D Board because the directors owned a
substantial block of AutoNation; the transaction was unfair; and the Proxy Statements were insufficient. An overwhelming
majority of shareholders ratified this transaction.

Issue: Does the complaint plead facts demonstrating that no reasonable person of ordinary business judgment could believe
that the transaction was prudent?

Holding: No. Essentially, under corporate waste, only an idiot would approve the transaction. To say that all of the
shareholders are idiots for approving it, even though they were informed and disinterred, is insane. It is hard to find that a
majority of shareholders approving a transaction constitutes people who are of not sound business judgment.

Rule: Once the shareholders ratify a transaction, the BJR standard of review is invoked and the Merger may only be attacked
as corporate waste.

Importance: The court is fighting against weak corporate waste claims trying to survive 12(b)(6) and summary judgment.

D) Traditional Duty of Loyalty Exam Strategy:


1) No Controlling Shareholder Voting (Lewis):
a) If not informed and disinterested:
i) P does not automatically win.
ii) Still have to determine whether it was a good deal.
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iii) BoP on board.
b) If informed and disinterested:
i) BJR.
ii) Therefore, P’s only opinion is corporate waste.
iii) This is P’s burden.
2) Controlling Shareholder Voting (Harbor Finance):
a) If not informed and disinterested:
i) Goes to entire fairness standard.
ii) BoP on board.
b) If informed and disinterested:
i) Entire fairness standard.
ii) BoP on P.
3) It is important to note that there is a heightened risk for a controlling shareholder; thus, even if
informed/disinterested, still go to entire fairness standard.
4) With regard to burdens, it is very hard to prove a deal is unfair versus having a board prove its fair.
5) As such, whoever has the burden will likely win — the burden is often dispositive.

E) Corporate Opportunity Doctrine:


1) Pursuant to § 122(17), can waive corporate opportunity doctrine.
a) But when there is a waiver, this doesn’t mean one can just go and rip off a company.
2) Important to show that the company “could” have done something; if it is on the verge of bankruptcy, won’t win
on this claim.
3) A company can reject a corporate opportunity if:
a) It was rejected;
b) Rejected based on full disclosure; and
c) Voted on by disinterested shareholders.
4) Corporate Opportunity Doctrine Elements:
a) Corporation is interested;
b) Corporation has capacity; and
c) Corporation has not rejected it.
d) If meet these elements, fiduciary owes the corporation his or her gains.

Farber v. Servan Land Co. — Corporate Opportunity Doctrine

Facts: Servan’s Board discussed buying abutting land to build an additional golf course. After discussion, took no action.
S/S — Servan’s majority shareholders and board members — then bought the land. They then entered into an agreement
with Servan to sell Servan’s land and that land for $5 million, of which S/S would receive $3.3 million. P, the only
dissenting board member, brought a derivative action against Servan under the corporate opportunity doctrine.

Issue: Did S/S usurp a corporate opportunity?

Holding: Yes. First, there was a corporate opportunity because there was strong evidence that Servan needed the land.
Second, the stockholders did not decline the opportunity by failing to act because S/S normally initiated investigations on
behalf of D. Because the other stockholders relied upon him to this, he may not now translate his own inaction into a
corporate rejection of the opportunity, thus allowing him to by the land personally. Third, the stockholders did not ratify the
actions—even though a majority approved—because S/S voted, which renders ratification improper. Finally, even though
S/S’s actions raised the value of the sale, this does not save D. The fact remains that a corporate opportunity existed,
meaning D would have been entitled to the sale of both parcels!

Rule:
1) If a director occupying a fiduciary relationship to a corporation acquires, in opposition to the corporation, property in
which the corporation has an interest of tangible expectancy or which is essential to its existence, he or she violate what has
come to be known as the doctrine of corporate opportunity.
2) The opportunity must fit into the present activities of the corporation or fit into an established corporate policy which the
acquisition of the opportunity would forward.
3) Corporate minutes constitute “best evidence.”

Importance: Is this really fair — the risk was shifted from Servan to S/S.
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XV. EXECUTIVE COMPENSATION:

In re The Walt Disney Company Derivative Litigation

Facts: Ovitiz is recruited as Disney’s President. In total, he will receive $140 million. If terminated without cause, he
essentially gets his entire salary. Ultimately, things don’t work out, and he is terminated without cause, upon which he
receives $140 million. Ps shareholders bring a derivative suit against Disney’s Board. Ps argue notice is futile; therefore,
argued bad faith to get around exculpation clause.

Issue: Whether the directors should be held personally liable for a lack of due care in their approval of the agreement or for
corporate waste?

Holding: No. The business decision may not have been the best. But D did not act in bad faith. The Chancery Court’s
intermediate definition is affirmed. Finally, the payments did not meet the high burden of waste; they had a rational business
purpose—to induce Ovitz to leave his other business.

Rule:
1) Two categories of bad faith:
i) Subjective bad faith: actual intent to do harm.
ii) Lack of Due Care: Fiduciary action taken solely by reason of gross negligence and without any malevolent intent.
2) There is, however, as the Chancery pointed out, an intermediate category:
iii) Intentional Dereliction of Duty: Intentionally acts with a purpose other than that of advancing the best interests
of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary
intentionally fails to act in the fact of known duty to act, demonstrating a conscious disregard for one’s responsibilities.

Importance:
1) This looks a lot like Van Gorkum and gross negligence, which exculpation was designed to prevent.
2) When looking at a case that is a bad business decision, not oversight/misconduct/illegality, arguably Disney is
more applicable.

XVI. DUTIES WITHIN CORPORATE GROUPS:

A) Parent-Subsidiary Fiduciary Duties:

Sinclair Oil Corp. v. Levien — Intrinsic Fairness and Corporate Opportunity Doctrine

Facts: Sinven was a subsidiary of Sinclair. Sinclair owns 97% of Sinven, from which it received high dividends.
International was another subsidiary, which sold resources to Sinven. International blatantly breached its K with Sinven. 3%
minority shareholders brought derivative action against Sinclair alleging breach of duty and corporate opportunity doctrine.

Issue: Whether Sinclair breached its fiduciary duty to Sinven?

Holding: Yes, but only regarding the breach of K. With regard to the high dividends, the minority shareholders received the
same thing. Therefore, no self-dealing and BJR applies, under which motives (controlling high return) are not relevant. The
K, however, was self-dealing. And under intrinsic fairness, blatantly breaching K violates the duty. Finally, there was no
corporate opportunity. Sinclair commonly achieved expansion through other subsidiaries; in fact, Sinven was specifically
limited to Venezuela.

Rule:
1) A parent owes a subsidiary a fiduciary duty when there are parent-subsidiary dealings.
2) When a situation involves a parent and subsidiary, with the parent controlling the transaction and fixing the terms, the test
of intrinsic fairness, with its resulting shifting of the burden of proof, is applied; that is, the burden lies on the parent to show
it was intrinsically fair to minority shareholders, after which it shifts to the minority shareholders.
3) In order for the intrinsic standard test to be invoked, it must be accompanied by self-dealing on the part of the parent;
otherwise, the BJR applies. Self-dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the
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subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to,
the minority shareholders of the subsidiary.

Importance:
1) Corporate opportunity rule regarding parent/subsidiary: Absent fraud of gross overreaching, i.e., clearly taking
opportunities without a rational basis, then the transaction can be challenged as a taking of a corporate opportunity.
2) It is important to note that intrinsic fairness is a lower standard than entire fairness.
3) Parents can make decisions that subsidiary’s minority shareholders will hate.
4) This duty appears to be one of self-dealing.

B) Case-Out Merger Fiduciary Duties:

Weinberger v. UOP, Inc.

Facts: Signal initiated a cash-out merger to acquire UOP. Signal got a rushed fairness opinion, which stated that $21 a share
was fair. High approval by both boards and minority shareholders. But Signal failed to disclose a feasibility study, which
provided that $24 a share was fair.
Issue: Did Signal breach its fiduciary duty to UOP?

Holding: Yes. Signal failed to disclose that the fairness opinion was rushed, and more importantly, the feasibility study.
Signal therefore doesn’t meet its initial burden. The case is remanded to determine what is a fair price, upon which all
relevant factors should be considered.

Rule:
1) Entire Fairness Standard: In order for a P to challenger a cash-out merger, he or she must allege specific acts of fraud,
misrepresentation or other items of misconduct to demonstrate the unfairness of the merger terms to the minority.
2) The majority has the initial burden to show that it completely disclosed all material facts relevant to the transaction; there
must be complete candor, and anything germane to the transaction should be disclosed; a germane document is one that a
shareholder would consider important in making his or her decision.
3) Where corporate action has been approved by an informed vote of a majority of minority shareholders, the burden shifts
entirely to the P to show that the transaction was unfair to the minority; where it has not, however, then a D has the entire
fairness burden.
4) The burden of proof then shifts to the majority shareholder to show by a preponderance of the evidence that the transaction
is fair

Importance:
1) If not a cleansing vote (or independent committee as we see below), then a D would have the burden.
2) Delaware Supreme Court later clarified that a parent doesn’t have to disclose all internal documents, but that these holding
was because Signal appointed directors to UOP’s board, who stood on both sides of the transaction, violated their
undiminished duty of loyalty to UOP.
3) Remedies: Appraisal, unless fraud, misrepresentation, in which case equitable relief or rescissory damages are appropriate.

C) Shareholder-to-Shareholder Fiduciary Duties:

Kahn v. Lynch Communication Sys., Inc.

Facts: Lynch wants to acquire Telco. But Alcatel — not a majority, but substantial shareholder—doesn’t approve of this.
Instead, wants Lynch to purchase Cellwave. The record is clear that Telco is the best deal. Alcatel just doesn’t want his
shares diluted. After an independent committee rejected Alcatel’s idea, cash-out merger. Alcatel made a final offer of
$15.50, and noted that if the committee didn’t accept it, it would initial a hostile takeover.

Issue: Is the independent committee sufficiently independent such that the entire fairness burden shifts to P?

Holding: No. The committee was not independent. The committee was required to achieve the best price. The power to say
no is significant. And the fact that it was pressured questions if they could bargain at arm’s length with Alcatel.
Accordingly, the committee was not independent and the burden stays with Alcatel.

Rule:
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1) A shareholder owes a fiduciary duty only if it owns a majority interest in or exercise control over the business affairs of
the corporation.
2) Weinberger Entire Fairness Test applies to these cases: The burden of proving entire fairness in a parent-subsidiary merger
is held by the controlling shareholder.
3) But the burden of proving entire fairness can be shifted to a P only if (1) an independent committee or (2) an informed
majority of the minority shareholders approves the transaction.
4) A committee is independent where its actions as a whole are sufficiently well informed and aggressive to simulate an
arms-length transaction.

Importance: Entire fairness will always apply in these cases because there is a controlling shareholder!

In re Emerging Communications

Facts: One of the outside directors didn’t speak up even though he had expertise on the subject.

Holding: An outside director breaches duty of good faith when he or she fails to speak up on something about which he or
she is an expert. Can achieve this finding in two instances:
1) An outside director makes a deliberate judgment that to further his or her personal business interests, he or she
will ignore his duty to the corporation.
2) An outside director consciously and internationally disregards his or her responsibilities to stockholders.

D) Alternative to Cash-Out Mergers:


1) Short-Form Merger: If you won 90 percent of shares, can automatically cash out minority shareholders.
2) Tender-Offer/Short-Form Combination: Do tender offer in order to gain 90 percent of shares.

In re Pure Resources, Inc., Shareholders Litigation — esaCoercive Test

Facts: Tender-Offer/Short-Form Combination. Unocal trying to get Pure.

Issue: What equitable standard of fiduciary conduct applies when a controlling shareholder seeks to acquire the rest of the
company’s shares?

Holding: See Rule. Unlike cash-out mergers, in the case of totally voluntary tender offers courts do not impose any right of
the shareholders to receive a particular price. It simply looks to coercion or misleading/false disclosures. After all, the
controlling stockholder is only on the offering side and the minority is free not to sell thus avoiding inherent coercion. Here,
it is coercive because some of the majority officers/directors comprise the minority in the vote. The court said if they redo it,
it will likely be approved.

Rule:
1) A controlling shareholder is free to make a tender offer at whatever price it chooses so long as it does not: (1) structurally
coerce the minority by suggesting explicitly or implicitly that injurious events will come to those shareholders who tail to
tender; or (2) mislead the minority into tending by concealing or mistaking the material facts.
2) There must still be equitable reinforcement via the following means: a tender offer is non-coercive when (1) it is subject
to a non-waivable majority of the minority tender condition; (2) the controlling stockholder promises to consummate a
prompt § 253 merger at the same price if it obtains more than 90% of shares; and (3) the controlling stockholder has made no
retributive threats.

Importance:
1) Must disclose adequate information to shareholders or committee so they can make an informed decision.
2) Subject to entire fairness review where the other aspects of the tender offer are non-coercive and full disclosure has been
made.

XVII. CORPORATE SALES:

Harris v. Carter — Duty to Inquire

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Facts: Carter Group selling its controlling shares in Atlas to Mascelo. Mascelo is making false statements in deal documents.
Atlas minority shareholders sue Carter Group.

Issue: Whether the facts alleged in the amended complaint would permit the finding the limited duty arose in connection with
the sale to the Mascolo group and was breached?

Holding: Yes, as pled, it is possible that the Carter Group was so alerted. Therefore, Carter Group’s motion to dismiss is
denied.

Rule:
1) Generally, a shareholder has a right to sell his or her stock and in the ordinary case owes no duty in that connection to
other shareholders when acting in good faith.
2) But when the circumstances would alert a reasonably prudent person to a risk that his buyer is dishonesty or in some
material respect not truthfully, a duty devolves upon the seller to make such inquiry as a reasonably prudent person would
make, and generally to exercise care so that others who will be affected by his or her actions should not be injured by
wrongful conduct.

Importance:
1) If you’re a controlling shareholder, “dot your Is and cross your Ts.”
2) The court declines to say whether this limited duty is ordinary negligence or gross negligence; although it appears to be
ordinary, it is probably gross negligence.

Perlman v. Feldman

Facts: Steel shortage. Newport manufactures steel. Controlling shareholder and CEO Feldman sold controlling Newport
shares to Welport for $8 premium. Newport minority shareholders claim that Newport could have realized more profits and
improved Newport’s long-term position. Minority shareholders want some of this $8 premium.

Issue: Is Feldman liable to minority shareholders for selling his control of the steel market?

Holding: Yes. The court looks at this as a corporate opportunity. This opportunity doesn’t have to be clear cut. Only have to
establish that there was some possibility of a gain. Here, there was a clear opportunity, and there were a lot of ways to
improve long-term gain of the company. So Feldman must account for selling his interest in this control
premium/opportunity.

Rule:
1) Where dominant stockholder in and principal officer of steel corporation, at time of steel shortage, sold controlling stock
to steel users, together with consequent right to control distribution of steel, he was accountable to minority stockholders to
the extent that the price paid represented payment for right to control distribution.
2) The court places the burden on the D!

Importance:
1) The question isn’t whether Feldman can sell his stock but whether he can sell control; he had a lot of power in this regard
to decide whether steel was going.
2) Most states do not follow this case.

Essex Universal Corp. v. Yates —Selling Corporate Office

Facts: K for buying interest (28.3%) in corporation. K required resignations of a majority of directors and to cause the
election of persons designated by the purchaser — this election would normally occur 18 months after the sale.

Issue: Pursuant to New York law, is it legal to give and receive payment for the immediate transfer of management control to
one who has achieved majority share control but would not otherwise be able to convert that share control into operating
control for some time?

Holding: Yes. This is simply beneficial to the economy and pragmatic. And 28.3% constitutes control; doesn’t have to be a
majority for this rule to apply. On remand, may only challenge whether or not 28.3% constitutes a control majority

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Rule: It is permissible for a seller to contract for the immediate transfer of management control as a condition of the sale so
long as the purchaser is obtaining “majority control” — this doesn’t necessary mean an absolute majority as large block
soften have de facto control.

Importance:

1) The normal rule is one can’t sell his or her corporate office; principal may decide who agents are.
2) But the resignation and replacement of officers is different; this is just reflecting actual interest in the company.

XVIII. ANTITAKEOVER DEVICES:


1) Poison Pills.
2) Staggering board.
3) Share repurchases:
a) Greenmail: Corporation buys back shares from hostile party at a premium.
4) Lock-up.

Cheff v. Mathes — Greenmail

Facts: Motor Products slowing accumulating shares of Holland. Motor Products likes to liquidate companies, albiet evidence
showed it wasn’t doing well financially. Consequently, to avoid a hostile takeover, Holland bought Motor Product’s shares
in excess of market price (Greenmail). Holland’s minority shareholders brought derivative action and claimed directors only
did this to stay in power; thus, wanted to set aside deal.

Issue: Whether Holland’s decision was protected by the business judgment rule?

Holding: Yes. Just because individual directors were willing to advance personal results doesn’t mean the action is improper.
The fact is there was a valid corporate interest: to preserve business and value of corporation. And it was reasonable to pay a
higher than market price for a control share.

Rule:
1) To avoid a takeover, the burden is on the directors to show that the purchase primarily served a corporate interest; staying
in power is not a corporate interest.
2) A director satisfies this burden by showing good faith and reasonable investigation.
3) In short, this falls under the BJR.

Importance: It’s extremely easy to plead a valid “corporate interest.” As such, a P will rarely win on this argument.

Unocal Corp v. Mesa Petroleum Co.

Facts: Mesa, which had a greenback reputation, accumulating shares of Unocal. Mesa then made tender offer, which
included junk bonds. Consequently, Unocal proceeded with a self-tender offer, which would take effect when Mesa obtained
49% of the shares. Mesa was excluded from this offer.

Issue: Did Unocal have reasonable threats for believing a threat existed to which it acted proportionally?

Holding: Yes. Unocal thought the threats were coercive and inadequate. Indeed, its shareholders would be forced to accept
junk bonds otherwise. For these reasons, the response was proportional. Consequently, the BJR takes effect.—the decision
will be affirmed if the board acted in good faith and with due care, a review of which is abuse of discretion (BJR standard).
Mesa can’t overcome this presumption. Just because the board financially benefits doesn’t create a disqualifying personal
pecuniary interest disqualifying the operation of the BJR; board is getting same benefit as all shareholders.

Rule:
1) To determine whether a self-tender offer is in good faith and serves a corporate interest, a reviewing court must perform a
two-part inquiry: (1) whether the board has reasonable grounds for believing a threat to the corporation existed; and (2)
whether the defensive measures taken were reasonable in relation to the perceived threat.
2) If the board satisfies this burden, then the BJR takes effect.

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3) To rebut, a plaintiff must show by a preponderance of the evidence that the directors’ decision were primarily based on
keeping power, or some other breach of fiduciary duty, such as fraud, overreaching, lack of good faith, or being uninformed.

Importance:
1) Page 944 lists some well-settled “reasonable grounds.”
2) Contrary to Mesa’s belief, the board didn’t violate its duty to him. The duty is to entire corporation/shareholders. If Mesa
doesn’t like something, it was vote, sue, or sell. Will not frame a duty to each individual shareholder, particularly because
shareholders have many different interests.

Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.

Facts: PP planned to effectuate a hostile takeover to acquire Revlon. Revlon then sought out another buyer, to which PP said
it would top “any price.”

Issue: Whether the agreement should be enjoined because it is not in the best interests of the shareholders.

Holding: Yes. Revlon’s directors owed a fiduciary duty to the shareholders and the corporation, but once it was evident that
Revlon would be bought by a third party the directors had a duty solely to the shareholders to get the best price for their
shares. By preventing the auction between Pantry Pride and any other bidders, the directors did not maximize the potential
price for shareholders. More importantly, the Unocal doctrine that outlined a director’s duty to the corporation and the
shareholder no longer extended to the corporation once it was determined that the corporation would be sold.

Rule: Once a company is inevitably for sale, a board must act to maximize the value of the corporation in a sale for the
benefit of the shareholders.

Discussion:
1) When a company reaches the point where it will inevitably be sold, switch from Unocal analysis to Revlon analysis.
2) The tough issue is at which point does it shift form a Unocal situation to a Revlon situation.
3) The directors here were more focused on the note holders; they didn’t want to be personally liable if the notes went sour.
a) In this context, can’t consider other constituencies, but can in Unocal situation.
4) If a really high offer comes in, a board is allowed to weigh a high offer against possibility of a higher offer in making a
decision.

XIX. DEAL PROTECTION DEVICES:


1) Go-Shops: Can shop for a limited period of time.
2) No-Talk: Can’t talk if someone comes and offers money.
a) Courts don’t like this.
3) No-Shop: Can’t shop for other offers/deals.
4) Lock-Up: Gives the acquirer the right to buy certain assets of the target company for a bargain price. These
assets are then locked up — not other potential acquirer can buy them for a comparable price. Lock-ups frequently target the
most valuable assets of a target. This makes the target less attractive.
a) Will have “Small L” and “Big L.”

Paramount Communications Inc. v. Time, Inc.

Facts: Time approves stock-for-stock merger with Warner. Three months later, Paramount makes offer, and the increases
offer.

Issue: Did Time’s board, having developed a strategic plan, come under a fiduciary duty to jettison its plan?

Holding: No. Revlon did not come into play because there was no proof Time was “for sale.” Time was not for sale because
Warner as not a suitor, even though its shareholders would eventually own a majority of the new corporation’s stock. And it
was not inevitable that Time would dissolve or breakup, such as Revlon. So for BJR to apply to defensive measures, look at
Unocal. Of the first element, directors investigated threat and found the conditions to be uncertain. Of the second element,
this didn’t prevent Paramount for coming in after merger! So reasonably related to defined threat.

Rule:

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Discussion:
1) Remember, the Revlon test is whether there is an inevitable change of control based on its course; so although a company
is legally for sale, this is not dispositive because this doesn’t necessarily mean a change in control.
2) BJR rule governs Time’s decision to merger with Warner.
3) For the first Unocal element must do enough investigating to determine if a threat; MUST DEFINE THREAT.
4) A company is for sale for the purposes of Revlon when it is committed to a course that will lead to:
a) Break up.
b) Change in control.

Paramount v. QVC

Facts: Paramount agreed to merger into Viacom. No-sho provision, unless unsoliscted proposal forma third party. Also
termination fee if Paramount backs out. Finally, te most isngincat defensive measure was a stock option agreement, which
gave Viacmo an toption to prucahse 19.9% of Paramount’s outstand common shop if termaitnof ee was triggered. QVC
wantso to acquire Paramount. Parmoutn ignored propsaol without INVESTIANG TIS VALUE. Therefore, WVC movedto
enjoin the paramount Viacom merger. Parmount’s offer was 80 dollars. 10 more than Viacmom.

Bidderin gwar between Viacom and CV. Rejected QVC’s higher bid! Paramount’s erger agreemen gconstitued a sale of
control, triggered the board’s Revlon duties to auction corporation.

Benihana: A statutory safe harbor for transactions involving interested directors is satifsed where the disitnereted directors do
not know that the interested director negotiated a ifnacing transaction on behalf of apotnetila buyer, but know that ht
eintrested director is a principal of the ubyer and approached the company on a behalf of the buyer about entering into a
transaction.

An interested directord eso nto breach his ficuiary duty of loyalty where the director neither sets the temrs of the atransction
nor deies nor controls or dominates the disntereste director’s approvalof the transaction.

A board validly exercise BJR where it subjectively believes a trsanction it is approving is in the company’s best interests and
for a proper corporate prupose.

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