Corporations Outline:

Introduction to Corporate Law:

Participants in the Corporate Structure:.................................................1

Foundations for Corporate Law:.............................................................2
Management of Corporations.................................................................5
Fiduciary Duties......................................................................................6
Corporate Finance (could spend some additional time here)...............16
Disregarding the Corporate Entity (Piercing the Corporate Veil)..........19
Civil Liability – Rule 10(b)-5 Claims......................................................23
Insider Trading.....................................................................................29
Shareholder Voting:..............................................................................34
Corporate Acquisitions, Takeovers, and Control Transactions.............45
The Williams Act:..................................................................................56
Mergers:...............................................................................................57
Partnerships, Limited Partnerships, LLCs.............................................60

Participants in the Corporate Structure:

• Managers:
o Appointed by the Board of Directors to run the company
(can also be removed by the board)
o Encompasses the CEO, CFO, COO, etc
o CEO tenure has decreased in recent years as a product of
investor activism, global competition…
 This is one reason for the increased pay-rate
demanded by CEOs
• Directors:
o Independent Director
 Director that has no direct or indirect relationship
with the company
o Outside Director
 Directors that have no employment or consulting role
with the company outside of the director relationship
 An outside director may, however, have an interest
in the wellbeing of the company through another
relationship
o Audit Committee:
 Boards of Directors typically act through committees
– one being the audit committee
 Maintains oversight over the company’s accounting
and financial reporting processes
o Board of Directors:

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  Members of the board, individually, can do nothing –
the only power that exists is vested in the board as a
whole.
 The board only has the power to act when it is in a
meeting:
• The meeting must be duly called (according to
the rules outlined in the bylaws, charter, etc.)
• Action by Consent – If there is a resolution
that is signed by all the directors, it can have
the authority of the board.
o Not used in all situations because there is
no deliberation and consensus after a
thorough discussion (can pose a problem
in a lawsuit)
o Post-Enron:
 Revised listing standards from NYSE and Nasdaq
 Majority independent boards are required
 Listed companies must have a nominating
committee (for hiring) and a compensation
committee comprised entirely of independent
directors
 Tighter definition of an independent director (pg 12)
• Shareholders:
o Two basic features characterize ownership in public
companies:
 Ownership is dispersed among participants in the
market
 A significant percentage of the ownership lies with
institutional investors (pension funds and mutual
funds)
o Shareholder activism
 Different shareholders have different goals
• Pension funds are typically “buy and hold”
investors and therefore have more incentive to
engage in proxy battles and litigation
• Mutual funds are active traders and will simply
sell their investment in a stock and move the
money elsewhere

Foundations for Corporate Law:

• The fundamental place to start is State corporation law:
o Model Business Corporation Act
 Most states follow this act (some more closely than

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 others)
o Delaware:
 Not a model state, but the majority of corporations
and the value of those corporations dwarfs the rest
of the country combined
 Why is DE so popular?
• Race to the Bottom Theory:
o Delaware’s statute is designed to give
management leverage and flexibility in
designing corporate charters
o “Pro-management”
o Even though DE has a franchise fee,
corporations are willing to locate there
because of the benefits
• Race to the Top Theory:
o If a state made a rule that was too lax,
investors would not want to put their
money in a corporation located there
o Investors like investing in Delaware
corporations – therefore the rules must
be advantageous
• Other reasons:
o Delaware is very efficient in dealing with
all things corporate (filings, paperwork,
etc.)
o The court system has evolved to benefit
corporations and shareholders alike
(access to the courtroom, jurisprudence,
a court that is devoted to corporate law)
 Federal Laws:
• Basically deal with disclosure
• Securities Exchange Act of 1933 (302):
o Regulates transactions in securities
o Basic strategy:
 Create a mandatory system of
disclosure – limited to the initial
distribution of securities
 If investors were provided with all
the material information about a
security there would be no unfair
informational advantages
o SEE BELOW FOR MORE DETAIL
• Securities Exchange Act of 1934 (303):
o Created a continuous disclosure system

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 o A corporation is subject to the ’34 Act if:
 It lists its securities on a national
securities exchange, or
 Any class of its equity securities is
held of record by at least 500
personsand the corporation has
gross assets over a specified level,
or
 The corporation files a ’33 Act
registration statement that
becomes effective
o SEE BELOW FOR MORE DETAIL
• Sarbanes-Oxley Act of 2002
o Serves as an amendment to the
Exchange Acts
o A public company cannot loan money to
its executives or directors
o Created the Public Company Accounting
Oversight Board
 Oversees the audit of public
companies that are subject to the
securities laws
 The board has rulemaking
authority with respect to auditing,
attestation, quality control and
ethics
 Section 201 – prohibits accounting
firms from providing a variety of
non-audit services to an audit
client (controversial)
 Requires securities exchanges to
adopt listing standards under which
a corporation’s audit committee
must be composed entirely of
independent board members
 Stock Exchange Rules
• Self-regulatory organizations – hybrid public
private enterprises
• If you are listed on an exchange, you pay for
the privilege and the exchange actively
markets itself
• Stock Exchanges are strictly regulated by the
SEC – therefore they have to enforce their own
rules

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 o Prevents the inevitable conflict of
interest when an organization has to
regulate its own customers
 Charters:
• Certificate of Incorporation / Articles of
Incorporation
• Amendment requires both board and
shareholders
 Bylaws:
• Laws that the Board or Managers have enacted
and must abide by
• Either the shareholders or the directors can
amend the bylaws
• Bylaws cannot contradict the law above –
cannot contract out of the law by passing a
bylaw

Management of Corporations
• Management of the regular business affairs is vested in the
Board of Directors, who have been elected by the shareholders
• Officers of the corporation are normally appointed by the Board
• Fundamental corporate changes require approval by the
shareholders, usually on recommendation by the Board
• Officers of the Corporation:
o Authority:
 Menard (59):
• Actual Authority – Has the board given the
agent (officer) the authority to engage in a
particular act?
• Apparent Authority – Has the board implied (to
the third party) that the agent has the
authority to act?
o The board’s direct or indirect
manifestations to the third party and not
from representations of the agent himself
• Inherent Authority – The power of an agent that
is not derived from authority or apparent
authority, but solely from the agency relation
and exists for the protection of persons harmed
by or dealing with a servant or agent
 Authority is based on an individual’s office or station
within a company

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  General Rule – The court is going to find in favor of
the party that acted the most reasonably
 Treasurer’s Authority
• Goth v. Anaconda (63):
o Kraft, treasurer, signed a guarantee for a
friend
o Court found no actual or apparent
authority
o Cannot be inherent authority – this line of
dealing has nothing to do with the
business
o Bank should have acted more reasonably
and looked for confirmation from the
board or the CEO
 Ultra Vires Doctrine:
• Originally – A corporation could only act to
accomplish the specific goals it was established
to accomplish
o i.e. Coca Cola could not go into the real
estate business because it was
specifically formed to sell beverages
• To prevent overarching monopolies, corporate
charters included language stating the specific
line of business that the corporation intended
to engage in – and the corporation was limited
to this line of business
• Delaware eventually moved to broaden a
corporation’s abilities
• Ultra vires can still be raised in some contexts:
o Corporate guarantees of third party
debts that do not benefit the corporation
o Non-profits – excessive charitable
contributions may be viewed as wasteful
and ultra vires

Fiduciary Duties
• Fiduciary Duty:
o Generally defined as one who is given power that carries a
duty to use that power to benefit another
o The primary problems faced by shareholders are
mismanagement of the business or unfair self-dealing by
those in control of the corporation
o Sliding Scale:

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  There is a tension between the different analyses
that a court will use in a breach of fiduciary duty
case (ranging from the Business Judgment Rule to a
Fairness Analysis)
 Plaintiffs and Defendants want different levels of
scrutiny from the court (the ones that benefit each
party the most)
 The court “slides” along the scale of options to
provide the most amicable result based on the facts
presented in the case
• Duty of Care:
o Requires directors to perform their duties with the
diligence of a reasonable person in a similar circumstance
o Duty of Care issues typically come up in two contexts:
 There is a decision made in a negligent manner
 There is a failure to act or monitor where a loss could
have been prevented
o Business Judgment Rule:
 The Golden Rule of corporate law
 The Business Judgment Rule is a rebuttable
presumption that directors in performing their
functions are honest and well-meaning, and that
their decisions are informed and rationally
undertaken
 Justifications:
• Encourages corporate risk-taking – without the
business judgment rule directors may not take
the risks necessary to maximize profits
• Avoids judicial meddling – judges don’t want to
make business decisions
• Encourages directors to serve – w/o the Rule,
directors may not have the incentive to join
boards in the first place
o Overcoming the Business Judgment Rule:
 As a plaintiff, you must overcome the business
judgment burden in court
 Must show:
• The action by the board was not in good faith
o Fraud, conscious disregard, the act was
illegal, director had a conflict of interest
• The action lacked a rational business purpose
• Gross negligence on the part of the board
• Inattention – directors are not exercising their
oversight duties

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 o Director cannot sit by if he knows that
the CFO is embezzling money
o Cases:
 Wrigley:
• Shareholders want Cubs to play night-ball, but
the majority shareholder doesn’t believe
baseball should be played at night
• Court dismisses the plaintiffs argument
because Wrigley claimed the reason for not
playing baseball at night was the potential
degradation to the surrounding neighborhood
and loss of real estate value
o Even though this reasoning is relatively
ludicrous, the court didn’t want to take it
any further – the board had a reason, it
wasn’t entirely irrational, so it passes
muster
 Miller v. AT&T
• AT&T did not collect on a phone bill to the DNC
• While the board may have been able to come
up with a reason for this, there is a law in place
(campaign finance) that forbids such actions
• Because there was a financial DAMAGE to
AT&T because of the board’s actions, the
shareholders were allowed to bring suit –
otherwise fiduciary cases cannot be used as a
vehicle to get you into court
 Smith v. Van Gorkom (Trans Union)
• When are directors not informed?
• The court used the Gross Negligence standard
here
• The directors claimed they weren’t grossly
negligent:
o They got a substantial premium on the
company’s stocks over the current
market value
o The merger contract allowed for a
market test
o The board was knowledgeable about the
business
o The board had relied on counsel’s advice
that failure to accept the bid would result
in litigation
• The court did not agree:

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 o Even though they got a substantial
premium, it was useless without
valuation information from elsewhere to
validate the offer price
o Market test was not useful – Trans Union
was not allowed to ask for other bids,
only accept them
o The directors had only discussed the
events of the offer briefly and never got
a financial consulting firm to validate the
deal
• Lessons:
o The court does not want to look at the
result of a decision, but the process
 Therefore, even if you get a good
result, the process leading up to it
needs to be good
o Any time a board is making an important
decision, they have to sit down and
genuinely deliberate
 All that matters if a decision goes
to court is whether the board
deliberated properly
• DGCL 102(b)(7)
o Enacted after Van Gorkom
o Eliminates monetary damages for breach
of duty of care cases
 Still liable for acts not in good faith
or breaches of the duty of loyalty
o Essentially takes the teeth out of the
duty of care

 In re Walt Disney:
• Post-DGCL 102(b)(7)
• The actions taken by the board weren’t great,
but they did not rise to the level of
recklessness
• After 102(b)(7), negligence is not enough to
recover, the board must hit recklessness
 Stone v. Ritter:
• Director Oversight is subject to review under
the duty of good faith – which is a subset of the
duty of loyalty
o This was unclear before this case

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 • Duty of faith issues arise when there:
o Is an intentional act in not advancing the
corporation’s best interest
o Is an intent to violate positive law
o Intentionally failing to act in the face of a
duty to act
• There are two categories:
o If the board fails to consider an option
that could be a threat or problem – this
could be a breach (ie forgets to follow the
law
o If the board considers the option, but
fails to implement anything to mitigate
the problem
• Duty of Loyalty (110):
o Requires the fiduciary to act for the best interests of their
corporation and in good faith
 Can involve intentional dereliction of duty, or actual
intent to cause harm to the corporation, or a conflict
of interest where an individual’s interests will be
elevated above that of the corporation
o Common law rule:
 A corporate contract with one or more of its directors
– or with another corporation or business enterprise
in which one or more of the directors was associated
as a manager, shareholder, or partner – was voidable
irrespective of fairness
 Became more liberalized over time
o Modern Rule:
 The general rule is that no transaction of a
corporation with any or all of its directors was
automatically voidable at the suit of a shareholder,
whether there was a disinterested majority of the
board or not; but that the courts would review such a
contract if it was found to be unfair to the
corporation
o Burden of Proof:
 Once a challenger shows the existence of a conflict
of interest, it is up to the challenged director to prove
the conflicted transaction’s validity (see below –
depends on state)
 Under a duty of loyalty analysis – the defendants are
not afforded the protections of the business
judgment presumption (bolster this)

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o Judicial Fairness Tests:
 Substantive Fairness:
• Did the director’s interest win out over the
corporation’s interest?
o Objective test – is the price paid
reasonable?
o Value to corporation – was the
transaction valuable to the corporation?
 Procedural Fairness:
• Whether the directors who approved the
transaction lacked independence and acceded
to their interested colleague? Elements to
consider include:
o Was everything disclosed to the board?
o What was the composition of the board?
o What role did the interested director play
in the transaction’s initiation, negotiation
and approval
o Statutes dealing with interested directors:
 Weak Form Approach:
• Follows the common law approach to an extent
• Contracts must be fair – the burden of proof
always falls to the fiduciary
• Cookies Food – Burden of proof belonged to
Herrig through the entire case to prove that he
had not breached the duty of loyalty
o The majority felt he carried that burden
o The dissent felt that he did not meet the
burden even though the court had
interpreted the law correctly
o This is arguably the hardest test to pass –
see below – and yet the court has
determined that Herrig passed it
• Iowa Statute:
o The contract or agreement shall not be
voidable if: the interest is disclosed and
the interested director does not vote; the
interest is disclosed and the shareholders
authorize the agreement; the contract or
transaction is fair and reasonable to the
corporation.
 Semi-Strong Approach:
• Statutory compliance with disinterested
director approval shifts the burden of proof

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 from the defendant to the plaintiff but retains a
fairness test
• New York Statute – 119
• California Statute – 120
 Strong Form Approach:
• Approval by the disinterested board would
generally limit judicial inquiry. Disinterested
board approval shifts the burden to the plaintiff
and removes the fairness inquiry

o Special Case – Parent Subsidiary Dealings

 Dealings between a controlling shareholder (the
parent) and the corporation (the subsidiary) raise
many of the same conflict-of-interest concerns as do
dealings between a director and the corporation.
 Wholly owned subsidiaries:
• Few problems here – virtually unfettered
discretion to do whatever you want with the
subsidiary
 Partially owned subsidiaries:
• This is where the problems can occur – if the
parent (as the majority stockholder) forces the
subsidiary to do something against its interest,
there may be grounds for a suit
o Unfavorable contract terms
o Dividend policy
 Judicial Review:
• Dichotomy:
o If the plaintiff can show clear parental
preference for a transaction (burden
starts with the plaintiff to show
preference) – the court should apply the
Intrinsic Fairness Test:
 Under this test, the burden then
shifts to the defendant to prove
that its transactions with the
subsidiary are objectively fair
o If the plaintiff cannot show that the
transaction is clearly preferential to the
parent, the court will apply the Business
Judgment Rule
 Sinclair Oil v. Levien (131):
• The court applied the business judgment rule
to the allocation of dividends because all

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 shareholders got their fair apportionment.
• It does not matter that the minority
shareholders were claiming that this aided the
parent – the minority did not effectively prove
that the transaction was clearly preferential to
the parent

o Special Case – Compensation of Managers

 Forms of Compensation:
• Salaries and bonuses – direct compensation
• Stock plans – incentive compensation
• Pension plans – deferred compensation
 Judicial Review of Compensation:
• Executive compensation plans have to be
authorized by the board – if this approval
comes after work by a disinterested,
independent compensation committee and it is
approved by informed, independent,
disinterested directors, it should avoid a
fairness review in court
• Courts often defer to the decisions of directors
when dealing with compensation – especially
independent directors
• Lack of good faith (which violates the duty of
loyalty) could provide a platform for plaintiffs if
it can be proven
o Backdating stock options is one example
• Waste Doctrine:
o If compensation is approved by a board
of independent, disinterested directors,
the plaintiffs may attempt to show that
there is no relation between the
compensation level and the executive’s
services only then will the court consider
interfering with the director’s approved
compensation level
o Rogers v. Hill – tobacco case (140)
o Walt Disney –
 “plaintiffs must shoulder the
burden to prove that the exchange
was so one-sided that no business
person of ordinary sound judgment
could conclude that the corporation
has received adequate
consideration

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 Corporate Opportunities Doctrine
• Subset of the Duty of Loyalty – balances the
corporation’s expansion potential and the
manager’s entrepreneurial interests
• Corporate managers have a duty to loyally put
corporate interests ahead of their own
o This includes taking a profitable business
opportunity away from the corporation
• Irving Trust Co. v. Deutsch (161)
o Company wanted to purchase stock of
affiliate to gain access to patents.
Company didn’t have the funds
necessary to purchase the stock – a
group of directors and employees came
forward and offered to purchase the
stock and provide the benefits of access
to the patents to Company. Company
agreed.
o Individuals later sold their stocks for a
significant profit, although Company was
not effected because it already had
access to the patents
o Issue: whether the prohibition against
corporate officers acting on their own
behalf is removed if the corporation itself
is financially unable to enter into the
transaction?
o Holding: No. Directors of a solvent
corporation are forbidden from taking for
their own profit a corporate contract on
the plea of the corporation’s financial
inability to perform.
 Policy: without this rule, directors
might not try very hard to get
funding before simply opting to
fund ventures themselves – and
capitalize.
 This rule does not apply to
employees who don’t have
fiduciary duties
• Rapistan Corp. v. Michaels (167):
o Guth Rule: If there is presented to a
corporate officer a business opportunity
 which the corporation is financially

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 able to undertake,
 which is, from its nature, in the line
of the corporation’s business and is
of practical advantage to it,
 is one in which the corporation has
an interest or a reasonable
expectancy, and
 by embracing the opportunity, the
self-interest of the officer or
director will be brought into conflict
with that corporation,
 the law will not permit him to seize
the opportunity
o Guth Corollary:
 When a business opportunity
comes to a corporate officer in his
individual capacity rather than in
his official capacity, and the
opportunity is one which, because
of the nature of the enterprise, is
not essential to his corporation,
and is one in which it has no
interest or expectancy, the officer
is entitled to treat the opportunity
as his own, and the corporation has
no interest in it
• Burg v. Horn (170):
o Court does not apply the line of business
test – here, one party had already been
investing in real estate when the
corporation was formed and that party
was also not a full-time or a fully-
invested member of the corporation.
Therefore, the corporation did not have
the expectancy that these opportunities
would belong to the corporation.
 Tests for whether Corporate Opportunities exist:

• Interest / Expectancy Test

o Corp has an interest in an opportunity if it has some contract

right regarding the opportunity

o Corp has an expectancy concerning an opportunity if existing

business arrangements lead it to reasonably anticipate being
able to take advantage of the opportunity.

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 • Line of Business Test

o Corporate opportunity exists if: closely related to the corp’s

existing or prospective activities

• Fairness Test

o Court measures the overall unfairness which would result if Dir.

Took Opp for himself.

Corporate Finance (could spend some

additional time here)
Time Value of Money:
Present Value = Future Value / 1+r
This is present value for a future value of one year in the future
If you want to do multiple years in the future you take it to the
power of that number (see example on 181.
Present value is used to determine the feasibility of a project
If the net present value is a positive number, the project will
likely be a good one for the firm to undertake
Net Present Value
Takes account of the cost of money and produces an answer to
the question whether a project is worthwhile or not.
It will also indicate which of two or more projects of equal size is
the most profitable.
Expected Value
The return for an uncertain investment is called the expected
value, which is the average of all possible returns weighted by

• Stock Options:

o Calls:
 Gives the holder the right to purchase from the writer of the
option a specific asset at a specified price (strike price) at a
specified time.
• If the value of the asset is greater than the exercise price at
maturity, it is in the money and will be exercised
• Common stock in a corporation that has also issued debt has the
characteristics of a call option – if the debt comes due and the
corporation cannot repay it, the corporation goes into re-org and
there is a chance that the stockholders get eliminated

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 o Puts:
 A put option giver the holder the right to sell to the
writer of the option a specified asset at the exercise
price.
• If the value of the underlying asset is less than
the exercise price it is in the money and will be
exercised
o The Determinants of Option Value (Black Scholes(sp)
formula) (equations on 212-216):
 The current value of the underlying asset
 The exercise price
 The time value of money (see above)
 The variability of the underlying asset (this is
probably the most important element)
• Bond holders are much less accepting of
volatility
• Stockholders, on the other hand, are more
accepting of volatility (based on the potential
upside)
 The time to expiration
• Stock:
o Common Stock
 Can actually be a form of option
• If debt is issued it will come due at a certain
point
• At this time, the company will either be worth
more than the outstanding debt or less
o If the company is worth more than the
debt issued, the stockholders will pay
back the debt and take the remaining
upside and keep the business
o If the company is worth less than the
outstanding debt, the stockholders will
not exercise the option to repay the debt
and will instead hand the company over
to the bold holders
• Preferred Stock:
o Midway on the continuum between common stock and
debt
o Like stock in that its claim to income and assets is
subordinate to that of debt
o Like debt in that its claim to income and assets is superior
to stock
• Dividends:

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 o Payments to shareholders that represent a current return
on investment – paid at the discretion of the directors
o Legal requirements for payment of dividends differs among
states
o Basic Principle – don’t permit payment of dividends in
cases where the payment will adversely affect investors or
creditors
 If dividend payments deplete a company’s capital
creditors and stockholders could be harmed in the
future
• Efficient Capital Market Hypothesis:
o The share price set by the market can be a benchmark for
the performance of the business and its management
 In order for this to work, the shares must be traded in
an efficient market
o The Efficient Capital Market Hypothesis claims that the
numerous active traders in the stock market react quickly
and efficiently to information  whenever new information
is available about a company, it is immediately reflected in
the stock price.
o Three levels of market efficiency:
 Weak form efficient – prices reflect all information
about past stock prices (the idea that the price is
only indicative of historical information)
 Semi-strong form efficient – prices also reflect all
publicly available information such as financial
statements and earnings reports
 Strong form efficient – prices reflect not only public
information but private information as well
• There are significant arguments for the idea that markets are not
rational at all and therefore, do not encompass information from
sources
• Kamin v. American Express:
o AMEX made a bad business investment and purchased a
company whose stock later plummeted
o AMEX decided to issue a special dividend to shareholders
and give the company away to them
o Stockholders filed suit saying that AMEX should have sold
the stock at a loss and then written the loss off on their
books
o AMEX says it does not want the bad press from selling the
stock (will impact stock prices poorly)
o Court says that is fine
o This is a duty of care question – similar to Wrigley

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  The court does not want to look into the reasons
behind a decision, as long as there are reasons

Disregarding the Corporate Entity (Piercing the

Corporate Veil)
• Party attempts to hold the shareholders, directors and officers of
a company personally liable for some action
o Normally, the individuals behind a corporation are
protected by limited liability for the actions of the
corporation
• In these cases, the corporation has been legally formed – there
are no issues with incorporation
• A frequent example occurs where a party wants to hold an
individual, who is also the sole shareholder for a company, liable
for actions of that company
o Often the individual is another corporation – a wholly
owned subsidiary
• How to Pierce (Plaintiff bears the burden to prove these):
o Shareholder must control and dominate the corporation
o There must be fraud, injustice or unfairness
o The Plaintiff must show harm
• Factors in Piercing:
o Inadequate Capitalization – was the corporation purposely
structured so that there were few or no assets
o Corporate formalities observed – its easy to tell if the
corporation observed formalities
o Fraud or injustice – Was there a misrepresentation?
 Would the adherence to the fiction of a separate
legal entity sanction a fraud or injustice?
o Was the entity simply the alter-ego of the shareholder?
o Are you piercing to reach an individual or a corporation?
 Easier to reach another corporation because it
doesn’t defeat the idea of limited liability (as much)
 Easier to pierce to reach fewer shareholders rather
than more
• Perpetual Real Estate v. Michaelson Properties:
o Contract claim against individual
o Alter Ego Test
 The corporate entity was the alter ego of the
individuals sought to be personally charged
• Easily proven in this case
 The corporation was a device or sham used to

19
 disguise wrongs, obscure fraud, or conceal crime
• Hard to prove here
o Piercing not allowed
• Kinney Shoe Corp. v. Polan
o Contract claim against individual
o Suit to recover on sublease
o Test:
 Is the unity of interest and ownership such that the
separate personalities of the corp and the individual
shareholder no longer exist?
 Would an equitable result occur if the acts were
treated as those of the corp alone?
 Court assumes that the creditor has conducted an
investigation prior to entering into a contract –
otherwise it is on the creditor and piercing is not
allowed
o Piercing is allowed because of the failure to observe
corporate formalities
 Its important to observe formalities!!
• Sub-Topic – Parent Subsidiary Relationships
o Is it possible for a claimant to make a claim against a
subsidiary’s parent if the sub doesn’t have the assets to
fulfill a claim?
o Fletcher v. Atex
 Tort claim trying to reach the parent corporation
 Test: Plaintiff must show
• The parent and the subsidiary operated as a
single economic entity
• That an overall element of injustice or
unfairness is present
 Factors for whether parent and sub act as a single
economic entity:
• Whether the corporation was adequately
capitalized for the corporate undertaking
• Whether the corporation was solvent
• Whether the dividends were paid, records kept,
officers and directors functioned properly, and
other formalities were observed
• Whether dominant shareholder siphoned
corporate funds

Corporate Disclosure and Securities Fraud

• Why do we need securities fraud laws?
o Without them there would be very little trust in the

20
 marketplace and theoretically, the volume of trading that
takes place would be significantly diminished
o Required disclosure allows the market to accurately assess
information
 Securities markets are different than other markets
in that you cannot touch the product, you don’t want
the current product (the stock), you want the
promise of future returns
o There are general anti-fraud laws, but they don’t cover the
range of needs presented by securities
o Most individuals agree that some level of securities
regulation is necessary  the debate occurs when
discussing how much regulation is necessary
• Securities Act of 1933:
o Basic strategy of the act was to create a system of
mandatory disclosure to supplement the preexisting law of
fraud
 If investors were provided with all material
information about the security to be offered there
would be no unfair informational advantages and the
security would not be overpriced.
o INITIAL OFFERING REQUIREMENTS
o Expansion on common law fraud:
 Holds the issuing corporation strictly liable for
material misrepresentation or omission in its offering
documents
 Makes those who participated in the offering liable
for the issuer’s failure to disclose unless they could
satisfy the burden of proving that any such material
error or omission could not have been reasonably
detected by them
o Elements:
 Registration Filed with the SEC
 Prospectus
• Describes Business
• Risk Factors
• Financial Information
o What is not subject to the ’33 Act?
 Registration process is not applicable if the offering
is only available to funds or other corporations
 Registration process does not apply if the operation
and the transaction are small
• Starting a business in your garage and selling
stock to neighbors

21
  Ordinary market transactions – day-to-day stock
trading
• Securities Exchange Act of 1934:
o Continuous disclosure system
 Regulates the secondary market (trading among
investors)
o A corporation is subject to the ’34 Act if:
 It lists its securities on a national securities
exchange;
 The corporation has gross profits over a certain level
(currently 10,000,000); or
 The corporation files a ’33 Act registration statement
that becomes effective
o Reporting Requirements:
 Annual Reporting (Form 10-k)
• Audited financial statements
• Percentage breakdowns of the lines of business
 Quarterly Reports (Form 10-Q)
• Unaudited financials for each of the first three
quarters of the fiscal year
 Form 8-K
• Released when major contracts are signed
• Significant management changes take place
 Proxy Statement
• Sent out before annual meetings
• Explains the matters that will be up for vote
during the meeting
o Rule 10b-5
 SEE BELOW
• Blue Sky Laws:
o State regulatory laws
• Exchange Rules:
o Govern the members that list with an exchange (NYSE /
Nasdaq)
o Have rules that govern when a significant event must be
disclosed to the public
o Both major exchanges have relatively similar rules

• When does a disclosure obligation arise?

o Timing:
 Financial Industrial Fund v. McDonnell Douglas
• A corporation is entitled to withhold disclosure
until information ripens

22
 •Plaintiff has the burden to prove that it
exercised due care in purchasing stock, that
the defendant failed to issue appropriate
information when sufficient information was
available for an accurate release, and there
existed a duty between the plaintiff and the
defendant to release the information
o Merger Discussions
 Basic v. Levinson
• Whether merger discussions in any particular
care are material depends on the facts.
• Board resolutions, instructions to investment
bankers, actual negotiations between
principals or their intermediaries may serve as
indicia of interest
• Materiality depends on the significance the
reasonable investor would place on the
withheld or misrepresented information
o Duty to Update:
 Backman v. Polaroid Corp.
• Is there a duty to update projections after the
initial information is provided?
o There can be, but the information must
be material to the reasonable investor
(and probably information that cannot
readily be inferred through the other
information already released)
 There is no duty to update periodic SEC filings – they
“speak” only as of the day of publication


Civil Liability – Rule 10(b)-5 Claims

• A plaintiff potentially has a wide array of remedies available to
him if a corporation issues a material misstatement or omission
in connection with the purchase or sale of a particular security
o Bring action at common law or equity
o Assert a private cause of action under state “blue sky”
laws
o Assert a private cause of action under federal law – 10(b)-5

• Rule 10(b)-5
o Implied Civil Liabilities (basically judge-made rule)
o Applies to both a purchaser and a seller in securities

23
 transactions
o Based on Sec. 10 of the 1934 Securities Exchange Act
 The Rule does not explicitly provide for a private
cause of action, however, courts easily implied one,
first in 1946 and then explicitly in 1964
 Without the implication that the rule applies to
private actions, it would be left solely for the SEC to
utilize
o Elements of a Cause of Action under 10b-5
 Elements:
• Standing
• Materiality
• Causation
• Scienter
• Damages
 Standing: (if time, read more from this section – 353-
368)
• Birnbaum Doctrine – Purchasers and Sellers
o Only actual purchasers and sellers may
recover damages in a private 10b-5
action
o Therefore, if a false or misleading
statement leads a person not to buy or
sell, there is no 10b-5 liability
o Blue Chip Stamps v. Manor Drug Stores:
 The rule does not cover offers to
sell, but only actual sales or
purchases
• Mergers:
o Traditionally mergers have been
recognized as sales for purposes of Rule
10b-5, even when the shareholder does
not make or vote on any investment
decision – Forced Seller
 This theory is in dispute now
 Materiality:
• Defendant affirmatively misrepresented a fact,
or omitted a material fact that made his
statement misleading, or remained silent in the
face of a fiduciary duty to disclose a material
fact
• Materiality = % chance of issue occurring (P) x
the magnitude of the event (M)
o This must also be compared against the

24
 size of the company – what is material
for a little company may not be for a
larger one
• Bespeaks Causation Doctrine:
o The inclusion of sufficient cautionary
statements in a disclosure document
renders misrepresentations and
omissions unactionable
o It is incumbent on investors to read all
information available to them and make
a deliberate decision based on that
information (not just the information that
works in their favor)
o “Total Mix”
o Private Securities Litigation Reform
Act of 1995:
 Amends the ’33 and ’34 Acts
 Fortifies the Bespeaks Causation
Doctrine
 Apparently, under the Act, even if a
knowingly false statement is not
actionable if it is accompanied by
appropriate cautionary statements
• SEC v. Texas Gulf Sulfur:
o Executives purchased stock based on the
information they received from an
exploratory search
o If the materiality of the event is such that
other investors would likely want to
pursue the same strategy, then it is
material enough that it should be
disclosed.
• Virginia Bankshares v. Sandberg:
o Holding company wants to buy out its
minority shareholders
o Board comes up with a price and
represents it as a “good” price
o Shareholders sue under 10b-5 on the
premise that the board does not believe
this statement to be true
o Court:
 Statements of the board, even
conclusory ones are actionable
under 10b-5
 Must allege facts that make this

25
 believable
• Here there were numerous
facts disclosed to the board
that were not shared with
shareholders
 Causation (reliance):
• There must be a link between the plaintiffs
decision to buy or sell and the defendant’s
actions (this is the reliance piece)
• There must also be a link between the
misrepresentation and the plaintiff’s loss (this
is the causation piece)
• Affiliated Ute Citizens v. United States:
o In a case where the defendant fails in a
duty to speak, courts will dispense with
proof of reliance if the undisclosed facts
were material
• Basic v. Levinson:
o In the case of false or misleading
statements in an open and developed
securities market, courts have created a
rebuttable presumption of reliance
o If material misinformation artificially
distorts the market price of a security,
courts will infer that investors have relied
on the misinformation
• Dura Pharmaceuticals v. Brouda
o The plaintiff must prove that the fraud
produced the claimed losses to the
plaintiff
o Plaintiffs cannot simply allege losses
caused by an artificially inflated price
due to “fraud on the market” but must
allege and prove actual economic loss
proximately caused by the alleged
misrepresentations
 Scienter:
• The mental state requirement – plaintiff must
show that the defendant’s mental state
embraced the intent to deceive, manipulate, or
defraud
• Ernst & Ernst v. Hochfelder:
o Accounting firm was negligent when it
failed to audit company’s books and
uncover a corrupt CEO’s actions  this is

26
 not enough for a 10b-5 action
o There must be an intent to deceive on
the part of the defendant
o The court did not address whether
recklessness would trigger 10b-5
(however, CoAs have since found
recklessness sufficient to trigger 10b-5)
• Pleading scienter:
o Tellabs v. Makor
 You have to plead with particularity
the facts that give rise to a strong
inference of fraud
 In order to survive a motion to
dismiss, your claim must have a
cognizant change of success in
light of all the surrounding facts
 Damages:
• According to class, there are three types of
damages:
o Rescission:
 Allows the defrauded plaintiff to
cancel the transaction
 Pg 419 – court allowed for damages
beyond loss where the defendant’s
profits from the transaction
exceeded the plaintiff’s loss (under
the idea that the defendant
shouldn’t profit at all from
fraudulent actions
o Cover Damages:
 Only applies when the plaintiff, in
an attempt to mitigate losses, sells
the stock
 The difference between the price at
which the plaintiff transacted and
the price at which the plaintiff
could have transacted once the
fraud was revealed
o Out-of-Pocket Damages:
 Most common
 Plaintiff recovers the difference
between the purchase price and
the true value of the stock at the
time of purchase

27
 o Defenses to a 10b-5 claim:
 Statute of Limitations:
• Two-year statute of limitations for private 10b-
5 actions
o After discovering facts that constitute a
violation
• Implemented under Sarbanes-Oxley
 Contribution:
• Defendant can seek contribution from others at
fault
• Based on percentage of responsibility

• Transactions not covered by Rule 10b-5

o Corporate Mismanagement
 Santa Fe Industries v. Green
• Santa Fe short-formed a minority shareholder
out of its shares
• Hired a financial firm to propose a good price –
firm came back with $150
• Minority shareholders were told of their
appraisal rights
• Minority instead tried to file a claim under 10b-
5
• Court:
o There was no lack of disclosure in this
case and therefore, no fraud
o Causes of action based on breach of
fiduciary duty without a disclosure claim
belong in state court
 However – Superintendent of Insurance v. Bankers
Life
• Here a corporate mismanagement claim also
included elements of fraud – if that is the case,
then a 10b-5 claim may be formulated
o Aiding and Abetting fraud in the sale of securities
 Central Bank of Denver v. First Interstate Bank of
Denver
• Secured bonds require that the “secured”
property be worth 160% of the outstanding
principal plus interest
• Bank got an appraisal that said the land may
have declined in value but the bank did not
check into the situation and the bondholder
defaulted on the loan

28
 • Court:
o The scope of §10b is broad, and can
reach all who are involved directly or
indirectly with deceptive practices
o However, the defendant must engage in
actual fraudulent behavior and not
merely provide collateral assistance

• The Private Securities Litigation Reform Act of 1995 (423-429)

o In relation to Rule 10b-5
o Passed partially in response to the belief that plaintiff’s
attorneys were taking advantage of the current rule
structure and were benefitting more from the litigation
than the plaintiffs
o The Act seeks to make conditions more favorable for
plaintiffs than plaintiff’s attorneys, and rid the courtrooms
of frivolous lawsuits
o The volume of post-Act litigation has been close to the
same as pre-act litigation, however, the parameters that
plaintiffs use to get into court are slightly different (428-
429)

Insider Trading
• There are multiple sources of law that deal with insider trading:
o Rule 10b-5: the federal “abstain or disclose” rules
o §16(b) of the exchange act: intended to chill short-term
speculative trading by insiders
o State laws
o Sarbanes-Oxley: new rules on insider trading
• What is insider trading?
o Utilization of non-public, material information to purchase
stocks by insiders
 Does it apply to outsiders?
• Why is insider trading inappropriate? (theories for regulating)
o Fairness
 It is not fair for those who trade without access to
material, non-public information
• Not generally accepted by state corporate law
o Market Integrity
 Outsiders will be more leery of acting because they
are unsure of what the insiders know

29
 • Only somewhat acceptable (ECMH posits that
more information is better for everyone)
o Cost of Capital
 Insider trading leads investors to discount the stock
price of companies when insider trading is permitted
making it harder to raise capital
o Property
 Those who trade on confidential information reap
profits without paying for the information (through
research/risk-taking/other admirable traits in the
market)
• Federal Law:
o Rule 10b-5
 In re Cady Roberts & Co.
• First case that suggests insider trading might
violate Rule 10b-5
 Chiarella v. United States:
• Individual was prosecuted for using information
obtained in a copy room to trade on.
• Supreme Court reversed – Rule 10b-5’s
obligation to disclose or abstain arises only
when there was a fiduciary duty owed to the
corporation or its shareholders (in this case,
the copy-boy had no fiduciary duty to anyone)
• Rule 14e-3:
o Modified post-chiarella
o Discussed at length in US v. O’Hagan
o Any person in possession of material
non-public information about a tender
offer is prohibited from sharing or trading
on such information
 Dirks v. SEC
• A breach occurs when an insider gains some
direct or indirect personal gain or a
reputational benefit that can be cashed in later
o In this case, Secrist was not divulging the
information to gain from it – but to warn
of fraud taking place in his company
• A tippee (someone that has received
information from an insider) assumes a
fiduciary duty to the shareholders of a
corporation only when the insider has breached
his fiduciary duty to the shareholders
• Post-Dirks:

30
 o Insiders:
 Traditional – directors, officers,
employees, controlling
shareholders
 Temporary – accountants, lawyers
o Outsiders (with a duty to the source)
 Outsiders with no relationship to
the company have a duty to
abstain or disclose when they are
aware of material, non-public
information obtained in a
relationship of trust or confidence
 Is this 10b-5(2)?
o What must a tippee know to be liable?
 Those without an inherent
confidentiality duty inherit one
when they knowingly receive
improper tips from an individual
who breached a confidentiality
duty
o Tippers:
 Insiders and outsiders with a
confidentiality duty who knowingly
make improper tips are liable as
participants in insider trading
 HOWEVER, the tipper must expect
some reciprocal benefits for the tip
(Dirks)
• (this is different from the
liability under 14e-3)
 Regulation FD:
• This is the Post-Dirks rule
• Fair Disclosure
• Purpose - Forbids companies from selectively
disclosing material non-public information to
important members of the investment
community
• Reasoning – Selective discussions with
securities analysts (etc) is essentially
systematic tipping of valuable insider
information
• There is no private cause of action under FD
• Bars disclosure only to market professionals
and shareholders likely to trade

31
 • If disclosure is intentional – it must be done
simultaneously with the entire market
• If disclosure is unintentional – the company
must promptly disclose information to the rest
of the market (within 24 hrs)
• Exclusions from the Rule:
o Does not apply to IPOs
o Normal course of business
o Disclosure to media or government
officials – under normal circumstances
o “road shows” or other SEC permissible
venues
o Misappropriation Theory:
 Under misappropriation theory, Rule 10b-5 liability
arises when a person trades on confidential
information in breach of a duty owed to the source of
the information, even if the source is a complete
stranger to the traded securities.
 United States v. O’Hagan:
• Partner in a law firm purchased stock in
company that used the law firm to make a
tender offer
• Lower court convicted him of misappropriating
information
• Supreme Court:
o Confirmed misappropriation theory:
 The unauthorized use of a
deceptive device under §10
 In connection with securities
trading
 Is a violation
 Rule 14e-3
• One violates the rule if he trades on the basis
of material non-public information concerning a
pending tender offer that he knows or has
reason to know has been acquired directly or
indirectly from an insider of the offerer or
issuer
o Without regard as to whether the trader
owes a pre-existing fiduciary duty to the
information’s source
• There is no need to prove that the tipper
breached a fiduciary duty for a benefit under
14e-3

32
o Family and Business Relationships – Rule 10b-5(2) (497)
 Prevents family members from trading on material,
non-public information acquired from a family
member that was an insider
• Can’t claim information was inadvertently
leaked
 Also, prevents persons who have a history or practice
of sharing confidences (both business and personal)
so the recipient had reason to know the
communicator expected the recipient to maintain the
information’s confidentiality
 Doesn’t cover people that are just living together
o Use / Possession Distinction– Rule 10b-5(1) (486)
 Prevents people who are “aware” of material
nonpublic information from buying stocks on that
basis
 Forecloses potential problems when individuals
“know” of information, but don’t necessarily “use”
the information in their decision
 Auto-trades would get around this  even awareness
is trumped because the transaction is occurring
outside of the individual’s capacity
o Damages in a Tipping Case:
 Elkind v. Liggett:
• Disgorgement:
o The trader, tipper, or tippee’s liability is
capped at the amount of profit made or
loss avoided
o Section 16(b) (Short-Swing Transactions):
 Requires specified traders to report their trading in
their company’s securities, and authorizes the
corporation to recover from these insiders any profits
made on stock purchases and sales in a 6-month
window
• Basically, individual can’t make a “matching
trade” within 6 months that creates a profit for
the individual
o Must invest for longer than 6 months or
buy-sell at different volumes of stock
 Applies to trading in equity securities
 Imposes automatic, strict liability on qualifying
officers, directors, and 10-percent shareholders who
make a profit in short-swing transactions within a 6-
month period

33
 • A 16(b) violation is not a “crime”, it just creates
liability to the corporation
• Loss avoided is the same thing as profit earned
• The offending director or 10-percent
shareholder has to disgorge profits to the
corporation
• The 10-percent shareholder:
o The application of the rule requires that
the shareholder be a 10%+ shareholder
on every leg of the transaction
• If you have a sub-10% shareholder that has
“deputized” an individual on the board, you
may be held liable for 16b disgorgement
 Mechanical Application:
• You can actually go “into the whole” if you
make multiple transactions and accrue a loss
(example from E&E book)
• Always go “lowest in, highest out”
• Always “zero out” as many of the shares as
possible

Shareholder Voting:
• Overview:
o Purpose of Shareholder Voting (when is a vote typically
required?):
 Elect directors to the board
• Plurality has been the standard in the past
(majority of the shareholders that participate in
the vote)
• The majority standard is becoming more
prevalent because it gives shareholders a
greater voice (need an actual majority of the
shareholders, not just the majority of those
who choose to vote)
o Plays a big role when only the incumbent
is on the ballot – under plurality
standard, a single vote would be
sufficient to get the director back on the
board
• SEE BELOW – Straight v. Cumulative Voting
 Pass fundamental corporate changes
• Usually limited to ratifying or vetoing the
board’s recommendation

34
 • Generally, stockholders have no power of
initiative
• Some statutes authorize corporation to require
a supermajority vote to enact a change
 Initiate limited changes to the corporate governance
structure
• Amendments to bylaws
• Amendment of Articles of Incorporation (limited
number of statutes)
 Shareholder Proposals:
• Rule 14a-8
• Allows the shareholder to attach a proposal to
the corporation’s own proxy statement
o A good avenue to trigger negotiations
with the company
o Shareholders can only recommend
actions by the board – cannot try to
dictate
• There are several exclusions to the rule that
allow a corporation to deny a stockholder
addition to the proxy statement:
o If the proposal is political in nature or has
a social agenda
o If the proposal is overly broad
o If the proposal effects less than 5% of the
corporation’s business
• The board cannot deny proposals that are
primarily related to corporate success
however:
o Cracker Barrel – not hiring homosexuals
is bad for public relations and bad for
business. This is such a significant issue
in society that the shareholders should
have the right to say something about it
o Medical Committee – selling napalm is
bad for business. Committee was able to
overcome Dow’s contention that this was
a political proposal. Court also
disallowed subsequent denial of a
proposal as too broad, saying that Dow
was effectively trying to have it both
ways
o Veto Power
o Voting belongs to the shareholders:

35
  (DE allows bondholders to vote as well – if the
corporation adds it to the bylaws)
 Shareholders have paid for the privilege to vote – not
employees or officers
 Ultimately, no one can take over control of a
corporation without first acquiring the right to elect a
majority of the board of directors
 Critics have long claimed that shareholder voting
fails to properly hold individuals accountable in
corporations
• Low participation rates
• Normally, ownership is so varied that working
control of a corporation can be maintained by a
small minority of the shareholders
o Why isn’t shareholder voting like a democracy?
 Proxies:
• Corporation solicits proxies at corporation’s
expense
• Individuals must fund their own efforts
• Individuals may feel that they aren’t informed
enough and therefore opt to side with
management – regardless of the circumstances
 Rational Apathy Problem
• It’s too much work for a single shareholder or
group of shareholders to act against
management
 Free Rider Problem
• Shareholder assuming that another
shareholder will effect the change needed at a
corporation
• Potentially allows a shareholder to take on no
additional effort and expense to get the
desired result while another expends time and
money
• Will freeze action by all parties  everyone is
assuming someone else will do the work
 Institutional Investor Problem:
• Not retail investors
• These investors hold significant stakes in a
company
• However, they hold large stakes in a significant
number of companies – creates a problem for
the institutional investor to be present at all
corporate functions and speak on issues

36
 effectively
• Pension Funds – more active, more likely to
stick around and wage a fight
• Mutual Funds – more willing to sell and reinvest
elsewhere
o Mechanics of Shareholder Meetings:
 Types of Meetings:
• Annual
o Corporations are required to have an
annual meeting
o Hilton v. ITT Corp.
 Meeting does not have to be
exactly every 12 months
 Statutes can determine the window
of time a corporation has to have
its annual meeting
 “Annual” meeting really means
“regular” meeting
• Special Meetings:
o Directors can call special meetings
o Usually called to vote on an important
issue that cannot wait until the annual
meeting
o When can shareholders call a meeting?
 Delaware:
• Look to the charter and
bylaws
• Default state, the corporation
does not have to permit for a
shareholder-called meeting
 Colorado:
• 10% of the shareholders can
always call a meeting
 Notice:
• Stockholders must receive appropriate notice
o Must be timely (more than 10 days, less
than 60)
o Must contain enough information to
make a decision
o Record Date – must be the owner of the
stock as of the record date to vote on the
matter provided in the notice
 Quorum:
• Must be quorum to be a valid meeting

37
  Appearance in person or by proxy:
• If you can’t be there in person, you must sign a
valid proxy statement giving another entity the
right to cast your vote in a specific manner
 Types of Voting:
• Majority Vote:
o Many statutes require a majority vote of
all the outstanding shares (not just the
shares that are present) to pass board
initiated transactions (mergers, sale of
assets, dissolution)
• Simple Majority Vote:
o If the statute does not require an
absolute majority, it likely requires a
simple majority – a majority of the votes
that are present
• Plurality Vote:
o Used in director elections
o The director gets elected if he gets more
votes than the next guy
 If there is only one candidate, one
vote gets him on the board
 Action by Consent:
• Under most statutes, shareholders can act
without a meeting by giving their written
consent for an action
• The appropriate majority must still be obtained
(what about a simple majority vote?)
• Datapoint Corp v. Plaza Securities Co (DE)
o Board enacted bylaws that limited the
effect of a shareholder consent initiative
in the faece of a hostile consent proposal
by a shareholder
o Court struck down bylaw
o However, DE § 228 does not necessarily
prevent a corporation from adopting
bylaws that would provide some
structure around consent initiatives
o Judicial Oversight:
 Schnell v. Chris-Craft Industries:
• The fact that the charter, bylaws, and statute
allow the board of directors to change the date
of the election does not mean that the board
can do it simply to increase their chances of

38
 winning a contested election
o This violates the fiduciary duties of the
board
• Under normal circumstances, a judge will not
interject and determine the proper time for a
shareholder meeting or director election during
an annual or special meeting
 Hilton Hotels v. ITT
• ITT restructured itself into three different
corporations
•
 Stroud v. Grace
• Individual family owns the majority of the
shares in a company and desires to change the
corporate charter and bylaws
o The changes would essentially give the
family permanent control over the
company
• Minority shareholders protested the change
• At the time of the proposal, there is no threat
to management
• Court finds that the decision only needs to pass
the business judgment test and easily
accomplishes this
o This is not a situation where the board
needs to meet the compelling
justification standard (Blausius) – since
there is no threat
o If the court required the compelling
justification standard here, basically any
decision made by a board in the future
could be seen as judiciable
 MM Companies v. Liquid Audio (NEED TO DO WORK
HERE)
• Blausius Standard:
o Unless the board can articulate a
compelling justification for its action,
courts intervene to protect established
principles of democracy
o Applies when the primary purpose of the
board’s action is to impede shareholder’s
opportunity to vote
• Reconciling Blausius with Unocal:
o Assess Blausius first – is there a

39
 compelling justification for the board’s
actions
o If there is a compelling justification for
the board’s actions – Apply Unocal /
Unitrin
 There must be a threat
 The reaction to the threat must be
reasonable
• It cannot be coercive or
preclusive
o Director Elections:
 State statutes don’t require that directors own
shares, but only that they be individuals and meet
qualifications outlined by the corporation’s bylaws
and charter
 Voting Methods:
• Straight Voting:
o The top vote-getters are elected to the
board for the open vacancies
o Shareholders vote their shares for each
open directorship
 Therefore, a shareholder holding a
majority of the shares can elect the
entire board of directors
 If you have 100 shares and there
are 3 open positions, you cast 3
votes of 100 shares
• Cumulative Voting (598):
o Allows shareholders to accumulate all of
their votes and allocate them to the
director they choose (or directors)
 Increases the chance that a
minority shareholder will get a
director on the board over a
majority shareholder’s vote
o Shareholders must be careful to allocate
votes such that they don’t accidently
provide other shareholders an edge
 Applies to both majority and
minority shareholders
o Calculations:
 Number of shares required =
• Number of shares voting /
Number of Directors to be

40
 elected + 1
o Director Removal and Vacancies:
 Common law:
• Directors could only be removed for cause
• Commentators criticized this notion – why
should a director have some sort of vested
interest in their directorship?
 Modern:
• Slowly adopted by more jurisdictions:
o Directors may be removed without cause
if the certificate or bylaw adopted by the
shareholders provides.
o DE, CA, and Revised Model Business
Corporation Act go further and allow for
removal even if the cert. and the bylaws
are silent
o DE allows corporations to remove
directors through written consent
 However there must be unanimous
consent in this instance
o DE caveats:
 If the board is staggered, the
director can only be removed for
cause
• However, shareholders can
amend the organization of
the corporation, eliminate the
staggered board, and then
immediately remove
directors without cause
 If the corporation has cumulative
voting a director can only be
removed for cause unless the
entire board is going to be
removed
 Directors have no inherent ability to remove another
director from the board
 Vacancies:
• Common law:
o Shareholders were required to fill director
vacancies
• Statutory:
o Vacancies can be filled by the board
 Unless the vacancy was caused by

41
 a removal without cause
o Staggered Boards:
 The board is classified into groups of directors – each
with multiple year terms that expire at different
times
 This can serve as a protective measure – an activist
shareholder cannot replace the entire board in one
year
o One Share / One Vote:
 Do you have to have “one share, one vote”?
• No, as long as the certificate of incorporation
provides for the different classes of shares
• It is more restrictive if the corporation attempts
to institute new classes of shares after
incorporation
• Corporate boards cannot enact stock
classifications after incorporation
o Unless the plan is enacted after a
shareholder vote w/ full disclosure
o However, a shareholder vote approving
the measure is invalid if it was only
approved through coercion
• Dual classification can be easily obtained at
incorporation – there is no coercion or “sneaky
dealings” on the part of the board at that point
 State Regulations:
• Lacos Land v. Arden Group (DE)
o Implied threats that unless the proposed
amendments were authorized, a
controlling shareholder would oppose
transactions which could be determined
by the board of directors to be in the best
interest of the shareholders – are
impermissible
• When is coercion permissible?
o If a controlling group of shareholders
asks for something specific, but does not
threaten retribution if they don’t get their
way – the court will likely find this to be
permissible
o Street Name Ownership:
 Individuals don’t own a “paper” stock certificate
anymore – brokerage firms possess the stock
certificates and the shareholders own shares

42
 underneath the brokerage firm
 In the early 70’s the Depository Trust Company was
formed and the DTC holds global certificates for all
publically traded companies
• Brokerage firms have equitable interests in
these global certificates and they, in turn, pass
owner ship of that portion down to the
individual consumer (shareholder)
• The DTC knows which brokerages own how
many shares of a particular company, but the
DTC does not know who personally owns the
stocks
o This prevents the DTC from being able to
produce a list of stockholders for a
particular company (for things like a
proxy contest)
o It can be difficult for the corporation as
well as individuals that wish to
commence with a contest
 What is the process for individuals
to get ahold of a stockholder list?
o Vote Buying:
 Historically vote buying was per-se illegal
 Over time, courts have cautiously started to accept
the premise of vote-buying
• Courts will still look closely for fraud or
disenfranchisement (anything that disparately
impacts other shareholders)
 Schreiber v. Carney:
• Company loaned money to an individual to pay
off debt so that the company could merge with
another and the individual would not face
adverse tax consequences
• Court:
o Transfers of voting rights, without the
underlying economic interest (basically,
selling the vote) is not necessarily illegal,
 Unless the object or purpose is to
defraud or in some way
disenfranchise the other
stockholders
o Since this action was done in the open
and fully disclosed to shareholders, there
is no fraud
o Vote buying is so subject to

43
 disenfranchisement and fraud, however,
that it will always be subject to the
intrinsic fairness test
o Proxy Contests:
 Requirements:
• A disclosure must accompany every proxy
solicitation (contents regulated by fed.)
• The format of the proxy card is outlined in
federal regulations
• The disclosure and the proxy card must be pre-
filed with the SEC for review
• False and misleading proxy solicitations are
prohibited
 Proxy statements will either be sent out by
management, a group of shareholders, or an outside
group
 Proxy Contest Expenses:
• Management traditionally charges the
expenses of a proxy statement and contest to
the corporation, while non-management
groups must fund the effort themselves
• Why don’t challengers get reimbursed?
o If management had to reimburse any
challenger, there would be the
opportunity for a minority shareholder
who has minimal chance of success to
charge the corporation with significant
costs
o Forcing challengers to pay their own way
ensures that only valid challenges will be
brought
• Rosenfeld v. Fairchild Engine:
o The expenses of a proxy contest can be
reimbursed
o The incumbent management can
reimburse themselves when they win a
proxy contest
o Challengers:
 Can be reimbursed if they win a
proxy contest
 If they do not win the contest,
there will not be any
reimbursement – the corporation is
under no obligation to reimburse a

44
 challenger
 Election Inspectors:
• Individual shareholders can sign multiple proxy
cards during a proxy solicitation – it is
permissible to flip-flop sides during the
solicitation process
• However, only the last card signed should
count as the “shareholder’s vote”
• State statutes authorize corporations to assign
an “election inspector” to cut off potential
controversies. Duties include:
o Ascertaining the number of shares
outstanding
o Determining the shares represented at
the meting and the validity of all proxies
and ballots
o Counting all votes and ballots
o Producing and retaining a record of the
determinations and challenges
o Certifying the determinations and their
count of all votes and ballots

Corporate Acquisitions, Takeovers, and Control

Transactions
• Policy Considerations:
o Governance of Corporations poses a fundamental agency
problem
 Shareholders delegate decisionmaking for certain
transactions to management because managers
have greater expertise; however, giving managers
the discretion to deploy that expertise on behalf of
shareholders also gives managers discretion to favor
their own interests at the expense of the
shareholders
o Takeovers and acquisitions illustrate this agency problem:
 Shareholders are charged with making the final
decision of whether to merge or purchase a large
asset, but this requires expertise that usually resides
with the managers of the corporation
 There is a constant threat of conflict of interest for
management because what is “best for
management” may not be best for the shareholder –
how can the shareholder be sure that management

45
 will bring the best options forward?
• Takeover Strategy:
o There are several options for initiating a takeover of a
corporation:
 Merger
 Sale of Assets (the company can sell itself off)
 Tender offer
 Proxy Contest
o Some options are considered “friendly” in that they are
done with management’s approval (mergers and sales of
assets will typically be the result of a friendly takeover
transaction)
o Others are more conducive to a hostile takeover, where
management opposes the proposed transaction (tender
offers and proxy contests are normally used in hostile
takeovers)
o There are federal regulations that can come into play with
each of these strategies
• Defensive Tactics of Targets:
o Many tactics are implemented prior to the arrival of a
hostile bidder (these all require shareholder approval w/o
evidence of coercion or fraud):
 Staggered Boards:
• Requires a shareholder vote
• Draws out the length of time required to
initiate a takeover through proxy elections
• In DE removal on a staggered board is only for
cause
 Majority voting (or super majority voting ) provisions:
• Requires the hostile bidder to truly get a
majority of shareholders on board
 Article Provisions:
• Fair price in a freeze-out merger
 Recapitalization:
• Providing two classes of shares where one
class is given significant voting rights in lieu of
good dividends
o Tactics that can be implemented during a takeover bid:
 Restructure of the target to make it less desirable
 Granting of an option to sell off a crown jewel
 Selling a block of shares to a “white knight” that will
side with management
 Increasing debt through various means – makes the
target less desirable, and may prevent the hostile

46
 bidder from using the target as collateral once a
takeover is achieved
 Take the corporation private – usually through a self-
leveraged buyout
o Poison Pills:
 The most significant of the defensive tactics
 Has the ability to thwart an unfriendly takeover and
give control to the target directors
 Do not require a shareholder vote!
 Basic Structure:
• Corporation issues to shareholders a class of
convertible preferred stock that is originally
priced well outside market levels so that they
are effectively useless
• Upon a triggering activity:
o A hostile bidder acquires a certain
percentage of the corporation, or
o A hostile bidder makes a tender offer for
a certain percentage of the corporation
• The board then has a specific amount of time
to redeem (nullify) the convertible shares
(which essentially would let the offer go
through)
• If the board does not redeem, the convertible
shares become “poison” and if the hostile
offeror makes further moves for the company,
the rights become exercisable and permit
shareholders to purchase large amounts of
shares at a discounted price (in a flip-in
scenario, shareholders buy the target’s stock,
in a flip-over scenario, shareholders buy the
acquirer’s stock)
o This significantly increases the costs for
the acquirer
• The reasoning behind the pill’s issuance is to
get the acquirer to talk to the board before
commencing with an offer
 Types of Poison Pills:
• Flip-in:
o Entitles the holder to buy discounted
target securities and excludes the
acquirer from participating
• Flip-over:
o Entitles the holder to buy discounted

47
 acquirer securities
• Dead-hand:
o Response to a combined tender
offer/proxy contest
o Seeks to block the redemption of the
poison pill by directors who were not in
office at the time of its adoption
o Invalidated in DE
o Can only be redeemed by directors in
office at the time of its adoption – or their
nominees
o Following successful proxy fight, the pill
cannot be redeemed, but must expire
• Slow-hand:
o Like the Dead-hand pill, but just slows
the redemption by a new director by a
certain period of time (normally 6
months)
o Invalidated in DE
 Shareholder Response:
• Shareholders – particularly institutional
shareholders – have come to dislike poison pills
• Amendment of bylaws to prevent poison pill
from being adopted without shareholder
approval
• Amendment of bylaws to do away with
implemented poison pill, immediately, not at
expiration date
• State Law:
o All DE unless otherwise specified
o When a target company’s management and directors
institute actions to defend the corporation from a hostile
takeover, what should the standard of review be when
shareholders take them to court?
 Business Judgement Standard – doesn’t work
because it would almost certainly require the court to
stand by the director’s decision 100% of the time
 Intrinsic Fairness – isn’t called for because
theoretically, management is applying its skills to the
situation and should be given some deference
 Thus the Unocal test (below)
o Cheff v. Mathes
 Board of directors made a “greenmail” offer to a
stockholder (offering premium over the current stock

48
 value) in order to keep the stockholder from making
a hostile tender offer
 Minority shareholders brought suit saying the board
did not have the right to take on the substantial debt
necessary to buyback the shares
 Court opted not to apply the business judgment rule
or the duty of loyalty standard:
• Court shifted the burden to the defendant
directors to show whether there were
reasonable grounds to believe a danger to
corporate policy or effectiveness existed
• Directors were able to satisfy this burden 
the potential hostile bidder had a bad record of
previous business decisions
o Unocal Corp. v. Mesa Petroleum
 Mesa owned a 13% portion of Unocal and
commenced with a two-tier takeover (first acquiring
51% of the company and then engaging in a freeze-
out merger)
 Unocal commenced with a stock buy-back in an
effort to prevent Mesa from taking over control of the
company – in order to do this, Unocal issued a
significant amount of debt and ended up being
heavily leveraged (which worked against Mesa as
Mesa would need to use Unocal’s assets to cover its
debt after a takeover)
 Mesa challenged Unocal’s self-tender as beyond the
power of the board and a breach of fiduciary duty
 Court:
• When directors implement a defensive tactic
there arises an omnipresent specter that a
board may be acting primarily in its own
interests, rather than in those of the
corporation or its shareholders
• If a defensive measure is to fall under the
business judgment rule, it must be reasonable
in relation to the threat posed
• The directors must analyze the nature of the
takeover bid and its effect on the corporation
and determine that harm will take place
 Test:
• The defensive board must prove:
o That it had reasonable grounds for
believing that a danger to corporate
policy and effectiveness existed (the

49
 threat), and
o The defensive tactic was reasonable to
the threat posed (the response)
• Only then will the court apply the business
judgment rule to the board’s decision
o Revlon v. MacAndrews
 A company made a hostile attempt for Revlon and
Revlon took defensive steps to rebut the hostile
takeover, eventually Revlon found a white knight to
buy the corporation (instead of the hostile)
 Friendly merger
 Lock-ups:
• “no-shop” provisions
• crown jewel sale
• cancellation fee
• In the court’s view, lock-ups are permitted
under DE law when their adoption is untainted
by director interest
 Court:
• Revlon mode:
o A company enters into Revlon mode
when it has announced that it is for sale
 Here the target found a white
knight, and therefore has
effectively announced that it is for
sale
• While Unocal suggests that directors can be
concerned with other corporate interests
during a takeover, once a company enters into
Revlon mode, those concerns are only valid if
they are rationally related to getting
shareholders the best price
 Exception:
• When the bidder is a “strategic buyer” the
board does not have to make as thorough an
“attempt” to canvas the market for the best
price
o Strategic buyers may be better for the
stockholder in the long run
o Paramount v. Time
 Time negotiated a friendly merger with Warner to
pursue a plan of strategic expansion
 Paramount entered and offered Time up to $200 per
share in a takeover bid, and Time directors feared

50
 that shareholders would reject the merger with
Warner in favor of Paramount
 Time then switched its agreement around and
purchased 51% of Warner (which did not require
shareholder approval) and then effected the merger
with Warner
 Paramount brought both Revlon and Unocal
arguments against Time
 Under Time – there does not appear to be a general
obligationto sell a corporation simply because there
happened to be a substantial premium in cash
offered to shareholders in a tender offer when such a
sale would upset a business plan
 Unlike Revlon, there was no planned breakup of
Time, just the merger
 Revlon:
• Time’s negotiations with Warner did not put
the company up for sale (a dissolution or
breakup of the company was not inevitable)
such that it entered Revlon mode – and in the
end, Time did the purchasing
• If Time was being “purchased” by Warner, it
would be a different scenario
 Unocal:
• Using the two-part test:
o The court found that there was a “threat”
in that Paramount’s offer was designed
to confuse shareholders and prevent
them from adequately considering the
Warner merger plan
o The directors were therefore allowed to
react with a proportionate response –
which was to protect the pre-existing
plan
• The court decided that determining which was
the better deal for the shareholders was a
question for the directors in this case – and
therefore, the directors did not violate their
duty
o Paramount v. QVC
 Paramount agreed to be acquired by Viacom in a
friendly acquisition with a no-shop provision
• If Paramount terminated the agreement, or
stockholders did not approve the transaction,
or Paramount’s directors recommended a

51
 competing transaction – Viacom would receive
$100 million termination fee and the option to
buy 24 million Paramount shares
 Paramount shareholders would own shares of the
new merged company, but the controlling
shareholder would still be Sumner Redstone (70%)
 QVC made an offer for Paramount but Paramount
viewed the merger with Viacom as a better long-term
fit for the company and shareholders
• Basically structured the same as the Time deal
 QVC sued to enjoin Viacom’s offer and Paramount’s
use of defensive tactics
 Court:
• The Time decision did not apply and Revlon
was triggered in this case because there would
be a change of control when the merger took
effect
• In the Time case, both companies were public
companies with widely dispersed shareholder
bases
• In this case, after the merger, there would be a
controlling shareholder and the Paramount
shareholders would effectively be minority
shareholders
• Rule:
o If the transaction will involve the target
shareholders turning into minority
shareholders, then the court should use
enhanced scrutiny to determine whether
the target board adequately examined all
proposals and sought the best price for
shareholders
 Essentially, in QVC the court has said that Paramount
put itself up for sale because the effect was going to
be a significant change for shareholders – not unlike
a cash sale
• Therefore, the board had the obligation to look
for the best deal possible for shareholders
o Unitrin v. American General Corp.
 American General instigated a two-step unsolicited
bid to replace the incumbent Unitrin board and then
make a tender offer
 Unitrin, in response, implemented a repurchase
program whereby the corporation repurchased
shares on the open market, but directors did not take

52
 advantage of the offer – the result was that the
directors ended up with a larger percentage of the
outstanding votes and were able to withstand a
merger proposal which needed a supermajority of
the outstanding shares
 AmGen argued that the buy-back plan, in addition to
Unitrin’s poison pill and the supermajority
requirement made any tender offer basically
impossible
 Court:
• Reviewed the repurchase program under the
Unocal Test:
o Is there a threat to corporate policy?
o Was the reaction to the threat
proportionate?
• The court determined that the buy-back
program did not conclusively prevent AmGen
from winning a proxy contest or eventually
winning support for a merger – the price would
simply have to be right
• Therefore, the reaction of the target board was
not disproportionate (and the court said that
the bid was a low-ball bid)
o The buy-out plan probably helped Unitrin
buy out short-term speculators
(arbitragers) who just wanted to get in on
the merger profits
o OmniCare v. NCS Healthcare
 NCS is insolvent and looking for a buyer
 Omnicare approaches first and offers a fire sale for
the company – shareholders will get very little if
anything
 NCS continues to look around and Genesis agrees to
purchase for a reasonable share price – but only in a
lock-up agreement
• Agreement required that the merger
agreement be brought before the shareholders
• Agreement also required that the two major
shareholders sign irrevocable proxy
agreements to vote for the merger
 Omnicare comes back around and makes a better
deal than Genesis and the board may want to side
with Omnicare now
• However, the effect of a change in sides is null,
the merger with Genesis is essentially locked

53
 down
 Court:
• Unocal Analysis:
o Is there a threat to corporate policy?
o Are the actions taken by the board
proportionate in the face of that threat?
 New element (Unitrin) – Are the
actions coercive or preclusive?
• Here, the board’s actions were entirely
preclusive because there was no option for
Omnicare to present a better offer once the
agreement with Genesis was signed – the
terms of the agreement took any option away
from the shareholders to make a decision, or to
receive the best offer
o Perlman v. Feldmann
 Newport Steel case
 Fiduciary obligations of controlling shareholders
 Feldmann owned 37% of Newport Steel and sold his
shares for a premium
• This was during the Korean War and there were
price controls on steel
• Feldmann had created a way around the price
controls (the Feldmann Plan)
• The purchaser of the stocks wanted to get
ahold of Newport’s steel without the Feldmann
Plan process, which made the steel more
expensive to the purchaser
 Court:
• Feldmann violated a fiduciary duty to the
company by selling the ability to charge profits
through the Feldmann plan
• The court held that Feldmann, in this case, had
to share the premium received for his shares
 Premium sharing (controlling block of shareholders)
• Generally, a controlling shareholder is under no
obligation to share the premium his controlling
block of shares commands
o Mendel v. Carroll
 Carroll family owns a controlling share in Katy
corporation and makes a move to take the company
private by making a tender offer to shareholders
 Outsider makes a higher offer for shares of the
company and wants the Katy board to exercise an

54
 approved option to issue new shares that would be
purchased by the outsider (and would take the
Carroll family out of control of the company)
 Mendel and other minority shareholders brought suit
to force the board to issue the shares  giving the
shareholders a better offer
 Court:
• The plaintiffs are comparing apples to oranges
• In the first case, the Carroll family already
owns controlling stock of the company and is
simply trying to gain the rest of the shares of
the company
• In the second case, the Outsider is attempting
to gain controlling stock in the company
• The Outsider’s offer should be worth more
because he is purchasing controlling stock in
the company
o A controlling block is worth more than a
non-controlling block
 Takeaways:
• If there is a control group that owns more than
50% then the fact that an outsider responds to
the freezeout by offering to buy the
corporation for a higher price does not mean
that the control group has to sell or give up the
freezeout
o In Re Digex Shareholders Litigation
 Intermedia owns 60% of Digex and the public owns
40%
 Worldcom wants control of Digex
• Two options:
o Purchase Digex
o Purchase Intermedia (and gain the 60%
contol of Digex)
 Worldcom decides to purchase Intermedia
• Intermedia and Worldcom asked the Digex
board to take affirmative action to facilitate the
sale of Intermedia to Worldcom
• If Worldcom was purchasing Digex, it would be
up to the board to throw up some road-blocks
and insure the best price for shareholders
• That obligation does not go away just because
Worldcom is purchasing Intermedia
o Digex directors should have critically

55
 assessed the proposed deal to make sure
it was the best possible option for Digex
shareholders – and if not, then the board
should have refused to recommend

The Williams Act:

• Overview:
o Amends the 1934 Securities Exchange Act
o Designed to regulate stock purchases that effect corporate
control
o Mandates disclosure for stock accumulations of more than
5% of a target’s equity securities
o Mandates disclosure by anyone who makes a tender offer
o Provides for enforcement of these
• Schedule 13d Disclosure:
o Disclosures must include:
 The acquirer’s identity and background
 The source and amount of funds for making the
purchases
 # of target’s shares held by the acquirer
 the acquirer’s purposes for the acquisition and his
intentions with respect to the target
o Beneficial ownership means that you have share voting or
investment control of a stock
o Beneficial ownership also relates to group ownership – if
you agree to act together with another shareholder with
respect to your shares – you are deemed to be a group and
must disclose any 5%+ ownership in a corporation
o Disclosure rules are designed to prevent a “secret”
accumulation and takeover attempt
• Section 14d and 14e:
o Applies to tender offers
o The acquirer has to hold the tender offer open for at least
20 business days
 If the acquirer changes the terms of the tender offer,
a new 20 day window is triggered
o The acquirer has to treat all target shareholders the same –
must deal equally with everyone
o The acquirer has to maintain the same price for all target
shareholders
o Target shareholders have the right to withdraw during the
20-day window
• Considerations:
o Acquirers typically want to get the largest share of stock

56
 possible before word leaks about an acquisition attempt –
once word leaks, the stock price is likely to rise
significantly
 Will likely attempt to get the largest share possible
before the 10-day reporting requirement arrives
o Hedge funds often work in similar manners (Wolfpack
situation):
 Purchase a measurable portion of stock in a
company, agitate so that the stock price rises, and
sell at a profit
 If hedge funds pursue the same company with the
same motive, but are not acting in conjunction, there
is no duty to disclose (unless one of the funds
reaches disclosure levels on its own)
 However, if the funds formally agree to work
together for the common goal of spiking a stock
price, then there is a duty to disclose if the group
reaches the appropriate levels
o Acquirers will try to avoid the statutory disclosure
requirements and the statutory tender requirements:
 Wellman v. Dickinson:
• Acquirer made 39 simultaneous telephone calls
to large holders and offered to buy their stock
at a substantial premium, but left the window
for consideration open for a short period of
time
• The court concluded that there had been a
public solicitation in this case
• Wellman Factors for a Tender Offer:
o An active widespread solicitation of
public shareholders
o Solicitation of a substantial percentage of
the target’s stock
o The offer of a premium price
o Non-negotiable terms
o Conditioning the offer on the acquisition
of a specified number of shares
o The offer being open for a limited period
of time
o Pressure on the shareholder to tender
o Substantial publicity concerning the offer

Mergers:
• Freeze-out Mergers:

57
 o Controlling shareholder and the board of directors (this is
often a parent subsidiary relationship) agree to a merger
where minority shareholders will get cash for their shares
and the majority shareholder will retain its shares, making
it the sole shareholder
 This is different than a short-form merger
o Court Review:
 The court will ask whether the majority shareholder
offered both: Fair Dealing and a Fair Price (This is the
ENTIRE FAIRNESS STANDARD)
o Purchasers typically don’t like the increased rigor of the
entire fairness standard – one way to avoid this test is to
utilize a tender offer rather than a freeze-out merger
 If the purchaser can acquire more than 90% of the
shares, then it can commence with a short-form
merger, which will only be subject to the appraisal
standard on review (see below)
• Long Form and Short Form Mergers:
o Long Form:
 Must be approved by the board and then the
shareholders
 This is a traditional merger
o Short Form:
 There is a majority shareholder that possesses 90%+
of the corporation
 There is no vote required to effect a merger – the
majority shareholder can simply buy out the
remaining shareholders
 Court:
• In determining validity of a short-form merger,
the court will:
o Evaluate the corporation and determine
whether the offer to the remaining
shareholders is legitimate (This is the
APPRASIAL METHOD)
 To get to a short-form merger application, it is
typically necessary to make a freeze-out tender offer
first.
 Under Pure Resources, that tender offer must meet
the test for a fair price:
• In re Pure Resources Inc.
o The essential duty of the court is to
ensure that majority shareholders don’t
bully around minority shareholders

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 o Test for tender offer:
 The tender offer must be subject to
non-waivable majority of the
minority tender condition
 The controlling stockholder must
promise to consummate a prompt
short-form merger at the same
price if it gets 90%+ of the
outstanding shares through the
tender offer
 The controlling stockholder cannot
make any threats to the minority
stockholders
•
• Weinberger v. UOP, Inc. (fair dealing case)
o Company is a significant shareholder in UOP and decides to
engage in a tender offer and eventually a merger
o Company has some individuals on UOP’s board (this makes
them conflicted when dealing with the transaction)
 UOP also did not set up an independent committee to
review the proposal from Company
o Court:
 Utilized entire fairness standard:
• Was there both fair dealing and a fair price?
• Court says no to both:
• There could not be fair dealing because of the
conflict of interest and the haste with which the
deal was put together
• Therefore, there is a good chance that this is
not a fair price
• Kahn v. Lynch Communications (fair dealing case)
o Kahn made a merger offer to Lynch
o Kahn owns 43% of the company
o Kahn threatens the board that if the merger offer proposed
to the board is not accepted, Kahn will issue a tender offer
to shareholders
o Court:
 Looks to entire fairness:
• To review a deal proposal, there must be an
independent committee or at least a majority
of the minority to approve the deal
• However, the independent committee must be
effective and cannot be beholden to the
purchaser

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  Court find’s Kahn’s offer to coercive
 Court did not look to business judgment review, b/c
the controlling shareholder has inherent potential to
coerce the shareholder vote for the merger
• Kahn II (fair price case)
o Fair value can be based on opinions of the parent’s
investment banker, even though the subsidiary’s
committee has received opinions of higher value from
other investment bankers
o Court:
 When parent bears the burden of showing entire
fairness, the parent must come forward with
credible, persuasive evidence of fair price under
recognized valuation standards

Partnerships, Limited Partnerships, LLCs

General Limited
LLC
Partnership Partnership
Nature ? Entity Entity
Formation Unintentionally File w/ State File w/ State
GP - Unlimited; LP
Liability Joint & Several Limited
- Limited
Owed to all
Same
Fiduciary Duties partners, can be Same
varied

• Partnerships
o Two or more individuals carry on a business together as co-
owners
o A partnership is not a tax-paying entity
 Income and losses from the partnership are treated
as income or losses of the partners individually
o Fairway Development v. Title Ins. Co of Minnesota
 FD had two partners and entered into a contract with
Title Ins.
 FD added another partner
 FD later had an issue and filed for an insurance claim
which Title Ins. denied because the addition of a new
partner created a new entity – which Title was not

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 under contract with
 Court:
• Agreed with Title
 This decision created a lot of uncertainty and was
later overturned statutorily in the RUPA (I think it still
stands under the UPA)
o Voland v. Sweet
 Sweet worked for Vohland
 Over the course of time became a valued employee
and moved into a different compensation structure
 At points, Sweet’s 20% commission was partially
invested back into the business before Sweet
received his take-home pay
 Sweet brought action that he was a partner to the
business
• Court agreed
 Takeaway:
• A partnership can be formed unintentionally
• Even if both partners are intent on not creating
a partnership, it can exist based solely on
circumstances
o Fiduciary Duties:
 Meinhard v. Salmon
• Salmon managed a property leased from Gerry
• Meinhard was an investor with Salmon on the
project
• Salmon re-signed a lease with Gerry but did
not included Meinhard
• Meinhard sued
• Takeaway:
o Fiduciary duties are owed to all partners
• Limited Partnerships
o Entirely a creation of statute
o Serves two aims:
 Limited liability for investors
 Avoidance of double taxation for partners
o General Partner:
 Same as a partnership – unlimited liability
o Limited Partner:
 Not personally liable directly or indirectly by way of
contribution for an obligation of the limited
partnership – even if the limited partner participates
in management and control of the partnership

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 o Formation:
 Can only be formed by filing a certificate of limited
partnership in the office of the secretary of state
 Under RULPA – a partner that erroneously, but in
good faith, files paperwork for a limited partnership,
will be treated as a limited partner
o Liability:
 RULPA:
• Limited partner is liable only to persons who
transact business with the limited partnership
reasonably believing based upon the limited
partner’s conduct, that the limited partner is
the general partner
 ULPA:
• Limited partner will not be liable as a general
partner unless he takes part in the control of
the business
o Gotham Partners v. Hallwood Realty Partners
 The Partnership has essentially adopted the entire
fairness test through bylaws – even though the entire
fairness test is not necessarily applicable to the
situation
 Based on this case:
• DE has said that it is ok to not only restrict
fiduciary duties, but a limited partnership can
also eliminate fiduciary duties
• However, the implied covenant of good faith
and fair dealing still exists and will be followed

LLC
• Member-Managed - looks more like a partnership
• Manager-Managed - looks more like a corporate form
• In all cases - There will be an operating agreement, and you can
come up with any kind of operating structure you want
• The LLC is more a "creature of contract" than the other types of
partnerships - the general partnership is more a creation of
common law
• Westec v. Lanham and Preferred Income Investors
o

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