THE FIRM & THE LAW OF AGENCY
ISSUE RULE
Agency (1) One person (the Principal) consents that
another (the Agent) shall act on P’s behalf & is
subject to P’s control, & (2) A consents to the
act
Agent’s Fiduciary Agent has FD to Principal (duty of loyalty)
Duty
Employment at
Will
Manifestations of Actual Authority: when P manifests consent
Consent directly to A (express or implied)
Apparent Authority: When A is without actual
authority, but P manifests consent directly to
third party who is dealing with A (express,
implied).
E.g., Starbucks
Inherent Authority: Judicially created gap-
filling device that tends to arise when equities
favor person who suffers loss from agent’s
unauthorized actions.
Note: Usually, must show benefit to the P. If
not, look at economic rationale theory: who
should have known better?
1
CASE
CCS v. Reilly: Employee/agent of
CCS can’t solicit own business
during employment. (A has FD of
loyalty to P).
Hamburger: Employee’s
arrangement of financing/lease
space for new business is OK-
logistical.
BA/Merrill Lynch: D’s lied to
SH’s (As breached FD to Ps).
Foley v. Interactive Data Corp: F
had at-will k, which was amended
through time/type of relationship
(bonuses, promotions) breach
of implied-in-fact k’l obligation
to discharge for good cause only.
 Blackburn v. Witter (Farmer’s
wife): Farmer’s wife acted in
ordinary care; Witter/brokerage
house (P) placed Long (A) in
position to defraud their
customers. B had done business
with W before.
Sennott v. Rodman & Renshaw:
Court did not recognize agency.
Sennott had unclean hands, savvy
investigator-should have known
better. Lack of reliance on P
because S wouldn’t talk about
check endorsement with P
representative.
 PARTNERSHIPS
ISSUE STATUTE/RULE
Generally  Partnership = association of >2 to carry on as co-
owners of a business for profit (§101(6)), formed
under §202.
 Default rules = equal management & control
(§401(f); equal profit sharing (§401(b)), equal
losses (§401(b)).
 Can k around default rules with Partnership
Agreement (§202)
 Partner is agent of partnership (§301)

Formation  P-ship formed when P’s carry on business as co-
owners (§202(a))
 Intent to form partnership not needed (§202(a))
 Saying that you are partners is not enough, need
intent to share profit/losses equally.
Fiduciary  FD = legal obligation to act for benefit of another.
Duties o Obligation of good faith & fairness in
dealing with one another, & duty to act
in furtherance of p-ship
 Breach of FD = failure of fiduciary to observe a
standard of care exercised by professional of
similar education & experience. (Rest. Of Agency
§379).
 Each partner is an agent of the partnership
(§301(1))
 Partner owes partnership DUTY OF LOYALTY
(§404(a) & (b))
o (1) To account to partnership, (2) to
refrain from dealing w/p-ship in conduct
or winding up as or on behalf of party
having adverse to p-ship (3) refrain from
competing with p-ship in conduct of p-
ship business before dissolution.
(Note: Broad & can k around parts of it under
§103(b)(3)).
 Partner owes DUTY OF CARE (§404(c))
o Refrain from grossly negligent or
reckless conduct, intentional misconduct,
or knowing violation of law.
o Negligence alone is not enough.
(Note: Courts don’t ever recognize breach of duty
of care because such a high standard).
2
CASE
Byker v. Mannes: Focus on
whether parties intended &
actually “carry on business for
profit” & not on intent to form p-
ship.
Hynasky v. Vietri: Court looks at
action after partnership agreement
was signed & said that parties did
not act as joint owners of
business for profit. “Just because
you call goose a duck-it is not a
duck”.
Meinhard v. Salmon: P’s owe
finest duty of loyalty to each
other. (“punctilio of an honor
most sensitive”) (Treat JV same
as P). S had duty of disclosure (S
was manager-M would have not
known of offer).
Self-Dealing:
Vigneau v. Storch Engineers:
Should not go around secretly
entering relationships with p-ship.
V gets salary for work that he did,
capital contribution-but profits he
made must be paid back to p-
ship. Violation of FD of loyalty;
no disclosure; may not engage in
self-dealing.
Duty of Care/Negligence:
Ferguson: Negligence in
management of affairs of GP or
JV does not create right of action
against partner by p-ship.
Operating/  Each Partner has equal right to manage & control
Managing business (§401(f)).
P-Ship  Disagreement in “ordinary course of business” 
can be decided by majority of partners (§401(j))
 Extraordinary matters require unanimous vote
(§401(j)).
 Right to access to books & records (§403)
Contracting  Can’t k for near-absolute discretion in Partnership
for Absolute Agreement.
Discretion  Limitations:
o §103(b): PA may not (1) vary rights &
duties under §105 except to eliminate duty to
provide copies to all Ps (2) unreasonably
restrict right of access to books & records
under §403; or (3) eliminate duty of loyalty
under 404(b) or 603(b)(3) but (I) can id
specific types/categories that don’t violate
duty of loyalty…(4) unreasonably reduce
duty of care (5) eliminate duty of good faith
& fair dealing (6) vary power to dissociate
as partner & (7)-(10).
Profit Profit Sharing: §401(b)
Sharing
Partner  Partnership = agent of partnership (§301)
Liability  P-ship liable for loss or injury caused to person as a
result of wrongful act or actionable conduct of
partner acting in ordinary course of business
(§305(a)).
 Partners are jointly & severally liable for all
obligations of p-ship unless otherwise agreed upon
(§306).
 P-ship may sue and be sued in name of p-ship
(§307).
 Liabilities of purported partner (if person relying on
represent enters into txn with actual or purported p-
ship) (§308).
Dissociation  Dissociation occurs: §601-events that cause
o Partner leaves (at-will) (601(1))
o Some triggering event in PA occurs (601(2)
o Expulsion pursuant to PA (601(3))
o Expulsion by unanimous vote of other
partners (pursuant to 601(4))
o Judicial determination (601(5))
o Partner becomes debtor in bankruptcy, etc
(601(6))
o Partner’s death (601(7))
o (8)-(10)
 Effects of dissociation (§603)1
3
Covalt v. High: All partners have
equal rights in management &
conduct of business of p-ship. If
it is an un-resolvable issue, p-ship
should dissolve. High values his
FD to CSI more than his FD to
Real Estate Venture by refusing
to raise rent. Ct said they knew
about it before & should have
k’ed for it ahead of time under
§103(b)(3).
Self Dealing/Contracting for
Discretion:
Starr v. Fordham: When partner
has engaged in self-dealing, BoP
on partner to prove fairness.
Partners breach FD when they
make unfair profit distribution
(and determine their own) to
departing partner. Can’t k around
basic requirements of good
faith/fair dealings.
PA Properties Inc. v. B.S. Moss:
Court recognized inherent
authority when a GP JV, who is
not named in an agreement b/w a
co-venturer & a third party,
benefited from the agreement.
(Would have been actual
authority if not for JV agreement
provision.)
Haymond v. Lundy: Absent
evidence of contrary, plain
language of PA will be relied on
in determining whether partner
violated agreement.
Meehan v. Shaughnessy: by
engaging in preemptive tactics
like recruiting other attorneys
secretly and sending clients secret
letters that don’t present all
options, partners violated FD.
Must dissociate BEFORE
competing against partnership.
Unclear b/w time of notice and
leave, but still have duty of
loyalty in this window of winding
up affairs; limited under 603 and
 o Remaining partners buy out interest: §701 404(b)(3): non-compete term
(fair market value of accounts and any terminates when dissociate/give
interest) notice.
o Dissolution & winding up process of
business: §801 Bohatch v. Butler & Binion: a
 Dissociation partner no longer has right to law firm doesn’t owe partner a
participate in business except in wind-up §603(b)(1) FD not to expel her for reporting
 Dissociated partner’s FD narrows  has FD only unethical conduct (if PA allows
w/r/t matters before dissociation §603 (unless for expulsion).
partner participates in winding up of partnership
business)
 Withdrawing partner breaches FD if he acts unfairly
towards p-ship, causing p-ship harm. Liable for
damages (Meehan).
 Partners don’t violate FD for expelling partner in at
will p-ship (Bohatch) under 601(3).

Dissolution  Events causing dissolution & winding up of Page v. Page: A p-ship may be
partnership (listed in 801).2 dissolved by express will of any
(beginning o Disassociation of at-will  p-ship notice partner when no definite term or
of winding from P of express will to withdraw (801(1)) particular undertaking is
up process) (other than 601(2)-(10)).3 specified.
o Definite term ends §801(2)
o Event triggering in PA §801(3) Kovakic: K wants R to share in
o Unlawful 801(4) half of loss after
o Judicial determination that impracticable to dissolution/settling capital
continue business §801(5) accounts. Court: values R’s
service capital.
 Partnership continues during dissolution §802.
 P-ship terminated when business is wound up Shamloo: In settling capital
§802(a). accounts; no value for human
 Settlement of accounts §807 capital (§401).
o Liquidation, pay creditors (a)-like
employees and banks, other liabilities paid- McCormick: Judicially dissolved
like partners get back capital accounts. and no longer practical to
Anything that is left is profit and split continue doing business under
among partners (default rules = 50/50). 801(5). Under 807, must be
process of liquidation and full
Note: Under §401, human capital does not count as accounting. Must pay off
value. creditors, bid for control.
Wrongful  Partner’s dissociation is wrongful if: Drashner v. Sorenson: P-ship for
Dissociation o Breach of express provision of PA 602(b)(1) a term. If partner dissociates
o Before expiration of term if for definite term would be wrongful and may not
(On test, 602(b)(2) (if partner withdrew by express get any money at all/take time
don’t forget will, except w/in 90 days after another (701(h)). Court held S wrongfully
to start with partner’s dissociation by death. dissociated under 601(5) & not
basic rule  Partner who wrongfully disassociates is liable to p- practical to continue doing
601(1)- ship and other partners for damages caused by business.
partner is
1
§603  Article 7 (not wind up) OR Article 8 (dissolution (p-ship continues during this time), wind-up (p-ship terminated at this
time under 802(a)), and then 807 (settlement of accounts). Can’t switch from Track 7 to Track 8.
2
In p-ship at will, if 601(1) disassociation happens  801 Dissolution
3
Exclusions for dissolution are 601(2)-(1) as stated in 801(1); Death does not lead to dissolution (601(7)(i)).

4
dissociated dissociation, 602(c). McCormick: Note: Sister could
from p-ship  Wrongful dissociation owes 701(c) (damages) have gone with judicial expulsion
upon notice  Partners who wrongfully dissociate are not entitled under 601(5), but forgot to/gave
of express to payment of any portion of the buyout price until up right. Expulsion  brother
will to leave. expiration of term, unless partner shows undue wrongfully dissociates and she
Then, is it hardship to business of p-ship (701(h)). would not have to pay him right
wrongful?) away (or go through process of
dissolution/liquidation, etc).

Benefits of partnerships:

1. Equal management power

2. Ability to share profits/losses
3. Ability to force a dissolution
4. FD: Duty of loyalty (even during dissolution process)
a. Can exclude certain activities under 103(a).
5. No duty of care
6. Pass through tax (Partners are taxed), not corporate entity. (What LLC gets so not taxed 2x).

Why do you want to dissolve?

1. bid for control

2. determination of actual value of interest
3. get back initial capital account

5
 4. JOINT VENTURES, LIMITED PARTNERSHIPS, AND LIMITED LIABILITY PARTNERSHIPS

ISSUE STATUTE/RULE CASE

JV Generally Less permanent and less complete merging E.g., If S and J set up joint
of asses and interests than GP. venture for 2010 Superbowl
venture, its business relationship
Corporate firms unite for single purpose. for limited period of time, so if J
Limited purpose and limited time. wants to sell beer for 2010 World
Series-no FD to Sharon.
JV Fiduciary Duties Joint Ventures: For limited time, limited
purpose (can treat as GP or not depending
on if it leads to fair results) still owe finest
duty of loyalty to each other (Meinhard).
LP  Must file form with the state.
 Separation of ownership and management
functions (Limited partners cannot
manage. General partners must manage.)
 Limited liability for limited partners.
(General partners have joint and several
liability).
 Firm’s continuity/adaptability to changed
circumstances favored. In short, limited
cannot leave at will. General can leave at
will. Dissolution is not automatic when
general partner leaves.
LLP  RUPA 306©: Partner’s liability Dow v. Jones: Law firm. General
 Designed for professional partnerships. rules of GP apply to LLP, but
 Must register with Secretary of state to partners don’t have unlimited
become LLP. liability. Here, D was convicted
 1001: Statement of Qualification. ©- and sued J for malpractice.
statement may contain: name, address, Partners argue firm dissolved 2
statement that partners elect to be LLP months before trial (but during
 1002: Name (must end with RLLP or wind-up still LLP). Got rid of
LLP. LLP certificate 1 month before
 1003: Annual Report trial (Now a GP). Still have duties
 Once created, governed by GP law in all after dissociation. (306).
respects except for special liability and
distribution provisions defined by statute.
o 2 categories:
o Rules extending limited liability
to LLP’s GP
 Rule limited the partnership’s ability to
distribute assets to general partners.

6
 CORPORATIONS

DELAWARE RULES, DGCL

ISSUE STATUTE/RULE CASE

Basics  Separates ownership/managed into 3: Officers, Directors,
and Shareholders.
 Corporations governed by state law (including most FD)
 But Federal law covers disclosure, proxy voting, fraud, etc
(SEC Act of 1934 and SEC Rules).
Formation/  Formation: how corporation formed, file with Dept of State CA v. AFSCME: 109(a)
Incorporati (§101) allows SHs to pass certain
on  Certificate of Incorporation (name, address, nature of kinds of bylaws, entitled to
business, class of stock) (§102) vote w/r/t bylaws and
o To Amend: §242 requires that board adopts propose amendments to
resolution first, then SH majority vote bylaws, but (b) says that
 Bylaws may contain any provision relating to business of bylaws can’t be
corporation, conduct of its affairs, and rights or powers of inconsistent with law or
SH’s (§109(b)). with certificate. Proposal to
o To Amend, if corporation hasn’t received $ for reimburse SH for proxy
stock, directors can amend bylaws, if have received contest for put up own
$, SH vote (§109(a). Can put in articles that directors  if adopted,
directors can amend (so then both can). could cause directors to
 Board  management powers under §141(a) violate FD. Proposal
 Officers  Directors delegate power to officers who run would be inconsistent with
corporation (§142) (but SH may be able to put into bylaws 141(a) that says D’s have
an officer position bc of 142(a)). FD to corporation and SH.
 SHs: provide capital by buying shares; elect directors, vote
on fundamental changes. Also, Bylaws can’t
 Classes of Stock: §151 (preferred stock §151© mandate how board should
 Issuance of stock §151, Consideration for Stock §153 (par decide substantive business
value) decisions, but may define
 Rights/Options respecting Stock: §157 process/procedures by
which those decisions are
made.
SH Voting  Default: 1 share = 1 vote (212(a) Adlerstein  advance
 Default re quorum  majority shares needed for quorum notice to controlling SH/D
216(1), bc certificate of incorporation can change as long required bc SH had right to
as not less than 1/3 (216). vote and D have FD to SH
 Election of Ds (he was controlling so
o Straight voting = Default- plurality of votes of Agency applied). Actions
shares present in person or represented by proxy at meeting were bad
and entitled to vote (§216(3)) faith/breach of FD.
o Note: IN CA, default = cumulative
o Cumulative Voting  SH cast votes = stock x
number of positions available (§214) Murray (Indiana): but in
 [(total shares voting*seats you want to elect)/ DE, only shareholders can
(directors to be elected + 1) +1] remove directors under
o Class  Each class of stock elects specified # of 141(k).
D’s (§141(d))
 Majority of outstanding shares for class or Problem 3-8/way to get
series required for quorum (216(4)). around the default rules: If
 Classified with staggered terms  ensures articles of incorporation
D’s in office because constrains SH from otherwise provide, the
replacing. board or shareholders can
amend articles to remove

7
  Removal of Directors director w/o cause or
o SH can remove Ds w/o cause by majority vote of declassify the board.
outstanding shares that can vote (141(k)) except:
 Where board is classified/staggered
(141(d)) SH may effect removal for
CAUSE ONLY (141(k)(1).
 If cumulative voting, no D may be removed
w/o cause if there are enough votes to
against his removal that could have elected
him. (so go through formula).
 Approval of Fundamental Changes (Mergers -251©,
dissolutions, substantial sale of assets, amendments to
articles of incorporation -242(b)- (Majority of outstanding
shares that can vote)
 Voting trusts & voting agreements:
o SH may by agreement in writing, deposit capital
stock to any persons authorized to act as trustee for
vesting in persons the right to vote for any period
of time determined by agreement. Must register
agreement w/state office, fact must be in stock
ledger of corporation. Stock may be voted in
person or proxy. Trust shall incur no liability
except for own individual malfeasance. (218(a).
Amendments must be filed with state (218(b)).
Meetings  Meetings of SH (§211) Hoschett v. TSI Software:
o Annual meetings (§211(b)) Election of Ds by written
o May act by written consent/remove communication consent didn’t satisfy
(§211(a)(2)) obligation to hold annual
o §228 allows stockholders to take action by written meetings. BUT DGCL 211
consent w/o a meeting…(a) unless otherwise overruled this right after.
provided in certificate of incorporation.
SH Right to  List of SH entitled to vote; penalty for not producing Conservative Caucus v.
Information (§219) Chevron: SH’s wants
 Must be made available to SH 10 days before every stockholder list under
meeting, alphabetical. 220(b)(i)-for purpose
 Inspection of books and records  §220: SH must reasonably related to being
establish: a SH. BoP that SH’s
o (1) is SH purpose is improper (high
o (2) complied with form and manner required to burden) (220(c)). Court
make demand held that warning of
o (3) Proper purpose: reasonably related to SH’s economic risks of foreign
interest (220(b)). operations is a proper
purpose for the lists.

Benefits of Corporations:

1. Perpetuity: can’t force entity to dissolve

2. May want more say and have limited liability.
3. Easier because have certain goals on how to grow business.

8
 4. CORPORATIONS

SEC RULES

1933 = Securities: Do you have an initial issuance of securities? Must meet registration requirements.
1934 Act: Reporting; proxy solicitation; empowers SEC with regulations. Are you a publicly held corporation? Must
meet these requirements.
ISSUE STATUTE/RULE CASE
Background of Securities Act of 1933: Regulates offering and sale of new
1933 Act securities.

Requires that all securities for sale must be registered with

the SEC or meet an exemption.

Purpose: Focus on Disclosure

What is a Securities Act §2(a)(1): any note, stock, bond, debenture, SEC v. Edwards:
security? investment k, or in general, any interest or instrument broad definition of
commonly known as a “security”. security, page 193.
Buy and lease back
phones fixed return
could be a security.

E.g., Leasing out

timeshare: giving you
portion of rent could
be a security. (Helping
with transactions).
Registration Statement: prospectus and other prepared documents
required by the SEC prior to an Initial Public Offering
(IPO).

Includes:
 Description of business
 Description of Security to be offered for sale
 Information about the company’s Directors and Officers
 Current financial statements

Purpose: To be given to investors to make sound

investment decisions
Exemption from  A lot so that small companies don’t have to incur costs of
Registration registration fee
 Regulation D provides 3:
o Rule 504: Firms who sell up to $1M of securities in
12-month period. Receive restricted securities.
o Rule 505: Offer up toe $5M in any 12 month
period. Only to accredited investors and 35 others
(should be sophisticated enough to know). Receive
restricted securities.
o Rule 506: Safe Harbor under §4(2) of 1933 Act.
Raise unlimited amount of capital to accredited
investors and 35 others (sophisticated). Ust give
non-accredited investors disclosure documents.
Financial statements same as Rule 505. Receive
restricted securities.

9
Background of 1934 Act created SEC: independent agency, enforce
1934 Act securities laws, promulgate rules and regulations to
implement those laws more effectively.

TO REGULATE PUBLICLY HELD CORPORATIONS

Role of Federal Disclosure
Law for Public  Issuing securities (’33 Act, Registration Statement)
Companies  Periodic reporting: covered by ’34 Act, Required by SEA
of ’34 Act. E.g., 10-K, 10-Q, 8-K
 Proxy solicitation (e.g., at annual or special meeting)-
required by ’34 Act
 Tender offers (Person/entity (buyer) goes straight to
target SH of public entity and asks to buy shares.
 Insider Trading (Info that managers/officers have to
provide to investors.)
SEC Power SEA §14(a): It shall be unlawful for any person…as the E.g., BA didn’t
Commission may prescribe as necessary or appropriate… disclose to SH before
for protection of investors…” merger vote.

Purpose: TO govern securities/prevent management from

tricking sH from voting for things when didn’t give enough
information.
Typical Annual  Nominating committee of incumbent (current) board
Meeting nominates slate of directors to be elected at next annual
meeting. Id’s other things to vote on.
 At company expense: Management prepares proxy
statement and card; Management solicits SH votes
(usually with proxy solicitor’s help).
 Proxy refers to 3 things: Relationship, Document,
Person.
 Annual report (10-K) gets sent to SHs, proxy statement
and card sent to SH, free writing w/o statement to them,
then they vote while incumbents are still on the board.
The proxy solicitor tries to gather cards/votes far in
advance.
Proxy voting  SH appoint proxy (proxy agent) to vote shares at
meeting.
 Appointment effected by means of proxy (proxy card).
 Revocable (before vote happens, SH can take vote back)
 Lawyers need to make sure card is done correctly.
 If SH holds shares at brokerage; broker fills out card and
gives to proxy agent.

SEC Proxy Rules  Rule 14a-3: Incumbent directors must provide annual
(regulates SH’s report before soliciting proxies for annual meeting.
access)  Rule 14a-4: Form of proxy card requirements.

Proxy statement:
 14a-5: form of proxy statement
 14a-6: filing obligation.
 14a-7: mailing
 14a-9: fraud

*Very expensive-must hire lawyers –which is why want to

10
 include on co’s statement to save funds.

Proxy disclosures  Information about the meeting

(what must  Background info directly related to issues to be voted on
directors disclose Increased use of “therapeutic disclosure”
to SHs?)  Executive compensation (how much they make; why
determine salary was proper)
 Audit Committee reports (how much $ is corporation
making? How involved is the audit committee with the
accountants’ work/financial statements-oversight?)
Note: Most boards (public corporations require all) must
have at least 3 committees: compensation, nominating,
audit. Members of the committees must be officer
independent. (CEO can’t be on compensation committee).
 Corporate governance guidelines and practices (how do
we communicate w/SH why we have this person as
CEO, how will global warming will affect our business).
 SH are owners and thus should have lots of information.

SEC Proxy Rules  Rule 14a-7: solicitation assistance to SHs.that are Conservative Caucus
making an independent NON 14a-8 proposal) v. Chevron: Didn’t use
o Company must provide SH list of security 14a-8 or 14a-7 because
holders/mailing list, OR mail soliciting material 7 gives option of
to them. (CHOICE) giving list, and 8 limits
o Expensive so usually only used by institutional 500 words. THUS,
investors. went with DGCL 220
o What is difference b/w this process and state law
process? (DGCL 220)? NOTE: State corporate
law trumps federa here. State law says you
can get list anyways-so most sophisticated SH
don’t use 14a-7 to get the list-they just use
state law.
o Advantages of doing yourself: Don’t have to go
through 14-a8 exclusions; can write more than
500 words, can talk to other SH, control timing.

 Rule 14a-8: SH proposals (on company’s proxy

statement)
o Allows qualifying SHs to put a proposal before
their fellow SHs;
o AND have proxies solicited in favor of them in
the company’s proxy statement.

14a-8 Exclusions  Procedural exclusions: Lovenheim: Wants

(SH Proposals) o Proponent does not meet ownership/format board to form
guidelines (14a-8b2)-continuously held at least committee to study
page 297 of $2,000 in market value or 1% of co’s securities how supplier produces
statute book entitled to be voted on the proposal at the mtg for foie gras. Proposal is
at least 1 year by date you submit the proposal. precatory/nonbinding
Must continue to hold those securities through phrased because of
date of meeting. 14a-8(i)(1) which
o No more than 1 (c) states that must be
o <500 words (d) action that is proper
o Proposal not timely for SH to initiate-must
o Issuer must provide proponent with look to state law to

11
 opportunity to cure most errors w/in 14 days decide that question.
after submission. (f)(1) So look at DGCL
o Must appear to present (h) 141(a). if SH not
 Substantive exclusions: allowed to initiate, still
o Improper under law of issuer’s domicile (i) ok if phrased as
(1)-(2) proposal.
o Personal grievance/special interest (i)(4)
o Management functions: (i)(7)  BIGGEST Board refuses to
EXCLUSION. include proposal
 “If proposal deals with a matter relating because of 14a-8(i)(5):
to the company’s ordinary business “Company may
operations” exclude proposal if it
 (Can’t ask for new slate of board) relates to operations
o Relevance: (i)(5) that account for less
o Substantially implemented (i)(1) than 5% of assets and
5% of net earnings
Note: Management trumps relevance. So if you can’t AND is not “otherwise
exclude under relevance because significantly related to significantly related”
business, then see if can exclude under management. to the company’s
business. Court holds
that it IS “otherwise
significantly related”
because still making
some money on its-
broad view. It
includes ethical/social
significance. Thus,
includes it.
Examples of What Not ordinary business, so include in SH proposal:
Courts think  Disinvestment in South Africa
Ordinary Business  Get out of tobacco business
Is  Get out of nuclear power business
 End/Start affirmative action
 Non-discrimination on basis of sexual orientation or
veteran status
 Executive compensation

Ordinary Business, so don’t include in SH proposal:

 Employee (everyday) compensation

Company  Attempt to exclude on procedural OR substantive

Responses to grounds.
Proposals  Must have specific reason to exclude that is valid under
(5 possible Rule 14a-8
responses)  Include with opposing statement.
 Negotiate with proponent.
 Adopt proposal as submitted.
Excluding a STEPS: US Bancorp, Request
Proposal Process 1. Management files notice of intent to exclude with SEC. for No Action Letter.
Accompanied by counsel opinion if any of stated
reasons rely on legal issues.
2. Under Rule 14a-8(f), management must notify SH-
proponent of remediable deficiencies in the proposal
and provide opportunity for them to be cured.
3. A copy of the firm’s notice/statement must also be sent

12
 to proponent, who may (but need not) reply.

SEC Response  Staff determines if can be excluded: issues a no-action

(3 different letter (won’t fine or take action)
possible  Staff determines should be included: notifies issuer of
responses) possible enforcement action if proposal is excluded.
 Intermediate position: proposal not includible in present
form, but can be cured.

If SH or Management is unhappy, can appeal to

Commission or Court.

13
 CORPORATIONS

FIDUCIARY DUTY OF LOYALTY

Note: D’s and O’s are fiduciaries of the corporation and have Duty of Loyalty and Duty of Care.
Duty of Loyalty: Self –dealing, Usurpation of corporate activity (bad faith thrown in)
ISSUE STATUTE/RULE CASE
FD to SH 2 Aspects:
(1) FD of Loyalty constrains D & O in their
pursuit of self-interest
a. Actionable wrong for O/D to compete with
corporation or divert to personal use assets or
opportunities belonging to the corporation.
b. D must be fair and candid to SHs in pursuing
their personal interest
(2) FD of Care  Focus on D’s official conduct in
directing and managing business/affairs of the
corporation.
FD to 3rd Board has FD to SH, but can consider 3rd party Dodge v. Ford: SH suing D for
Party interests if there is “some rationally related benefit upgrading facilities and lowering
Constituencie accruing to the SH” or if it bears some reasonable price of cars rather than
s relation to general SH interests.” distributing dividends to SH’s.
Court will intervene re dividends
if refusal to pay amounts to “such
an abuse of discretion would
constitute a fraud or breach of
good faith.” This is rare that court
would second-guess D’s decision.
Facts of case are peculiar-closely
held entity.
Business BJR:
Judgment  “Presumption that in making business decisions, Aronson v. Lewis: quoted
Rule the Ds acted on an informed basis in good faith language
and in the honest belief that the action taken was
in the best interests of the company.” Shlensky v. Wrigley: To
o Absent abuse of discretion, fraud, overcome BJR, SH must rely on
illegality, conflict of interest, or gross fraud, illegality or conflict of
negligence, the judgment will be interest.
respected by the courts.
o Burden on party challenging decision to
establish facts rebutting presumption.
§141(a): business and affairs of corporation managed
and under discretion of the board.
FD of D’s must favor corporation’s interest over his own Broz v. CIS, Inc: CO doctrine
Loyalty: whenever interests conflict. implicated only where D’s
Usurpation of seizure of CO results in conflict
Corporate DE Approach  Broz, using Guth factors b/w D duties to corp. and D’s
Opportunity -D or O may not take a CO for his own if: self-interest. Held that he did not
Doctrine (CO) 1) Corp financially able to take CO usurp CO.
2) CO is w/in corporation’s lien of business
DELAWARE 3) Corporation has an interest or expectancy in the
CO
4) By taking CO for his own, D will violate his FD to
corporation.
-D or O may take CO if:

14
 1) CO is presented to D or O in his individual, not
corporate, capacity
2) CO is not essential to corporation
3) Corporation holds no interest or expectancy in CO
4) D has not wrongfully employed resources of Corp
in pursuing CO
-Note: Not a checklist-just guidelines
-Presentation to board not required. “Of course,
presenting to board creates ‘safe harbor’ for D,
removes specter of a post hoc judicial determination
that D has improperly usurped CO.” 
IMPORTANCE OF LEAVING PAPER
TRAIL/PROCESS
Corporate Rejection of CO = CW if CO was of “such obvious
Waste (CW) important and value to corporation that no person of
ordinary sound business judgment would have
rejected CO.” Waste = Breach of FD. SH would
bring derivative suit.
FD of Dual Board Memberships: (E.g., Globe Woolen)
Loyalty: Duty to disclose. Silence = betrayal of loyalty too.
Conflicting
Interest
Transactions
(CIT)
(Use Entire Self Dealing
Fairness, not -Definition: If 1 person, or set, controls both sides of
BJR) the txn, and that party receives corporate assets to the
EXCLUSION of other SHs.
-Test: Intrinsic Fairness Test used when parent
entity has received a benefit to exclusion of minority
SHs of subsidiary and at expense of minority SH of
subsidiary.
-Must show 1) Fair price; 2) fair process.
-Burden: on party standing on both sides of the txn.
(Sinclair)
15
 Broz quote
Globe Woolen Co. v. Utica Gas
& Electric: Maynard is GW
controlling SH, CEO, and
Chairman of the Board. Also
Utica’s D and Chair of the Board
(but owns no U stock). M is
wearing GW hat and wants to
give GW good deal. At board
meeting, M doesn’t say anything.
Court held that can betray
through silence. Has a duty to
warn if duty of loyalty. He had a
duty to disclose. Importance of
process: M should have spoken
up at meeting, given details, or
don’t attend mtg at all if not
going to say anything so others
can ask Q’s).
Sinclair Oil v. Levien:
Note: General rule that SH don’t
own FD to one another; erosion
of this rule when there is a
controlling SH.
Rule:
-Not self-dealing unless SH is
receiving something other SH is
not receiving.
-S was self-dealing bc S benefited
from k bc Sinclair Oil was
benefiting and S owned 100% of
outstanding stock of Sinclair Oil.
At exclusion of other SHs bc SO
isn’t actually paying/complying
 with k.

DGCL §144: “Cleansing Mechanism”- Interested Shapiro v. Greenfield

Directors: No CIT shall be void solely by reason of Court: just bc sister, doesn’t mean
conflict if CIT: she is interested director. CIT
1) If after full disclosure to the board, is case uses fairness test (DGCL
authorized by majority of disinterested 144(3)) you can show it is fair
directors, or (144(a)(1)) to the corporation.
2) Full disclosure to the SHs, is approved in
good faith by SH, or (144(a)(2))
3) Is fair to the corporation at time
authorized/ratified by Board or SHs (144(a)
(3))? (Fair dealing and fair price).
a. Note: If you win under this prong,
don’t need disclosure to board or
SH.
(Shapiro v. Greenfield)
Note: CA follows DE’s model
Note: Important to create the paper trail!

Self-Compensation: Byrne v. Lord:

-§141(h): D’s have authority to fix D compensation
unless Articles of Incorporation provide otherwise.
-§157: In absence of fraud, board allowed to issue
rights/options in stock
Stock Options Test: Under 157(a)
1) Identifiable benefit to the corporation?
(Value Prong)
2) Value of options reasonable in relation to
value of benefit passing to corporation?
(Benefit Prong)
***157(b) says that directors’ valuation is
conclusive, so only first prong has real
meaning D’s must only show benefit.
(Bryne)
Note: If corporation issues stocks in general, falls
under BJR. But if they issue stocks to themselves,
then must use the stock options test.
Board issues equity stock options
(form of compensation).
Minority SH’s sued bc board
were beneficiaries of the
challenged stock option plan.
Potential conflict of voting rights
because dilutes their rights (so
many shares). Court uses DGCL
157(a) analysis-2 prong test.
Held: Failed 2-prong test here.
Note: Recipients have right to
buy stock at set price
(exercise/strike price). Right vests
in the future. Can backdate stock
options so that you buy at a lower
price, so then when you cash out-
it’s a lot.

Kind of Issue under Duty of Loyalty Cases Which Test to Use

If Conflict of Interest Txn. 1) Is this a CIT txn?
a. Are there interested directors?
b. DGCL 144(a): “k or txn b/w corporation
and 1 or more of its D’s or O’s or b/w a
corp and any other corp…or have a
financial interest…”
2) If YES, doesn’t matter how much research they
have done. The question is: can it be cleansed?
(Meaning is it not voidable/still valid).
3) Is it cleansed under 144(a)(1)? Was there
disinterested board vote after full disclosure

16
 presentation?
4) Is it cleansed under 144(a)(2)? Was there a SH good
faith approval after full disclosure presentation?
5) Is it cleansed under 144(a)(3)? Was the txn fair to
the corporation?
a. Fair dealing? (Did they go through process
of fairly?)
b. Fair price?
Note: In DE, usually if you can show fair price, courts
will say it is FAIR!!
If Self-dealing case…If 1 person, or set, controls both Use Intrinsic Fairness test: Fair dealing, fair price.
sides of the txn, and that party receives corporate assets
to the EXCLUSION of other SHs, then
If self-compensation, stock options test Use stock options test
If Corporate Usurpation Case Use Broz/Guth Factors

17
 CORPORATIONS

DUTY OF CARE

ISSUE STATUTE/RULE CASE

FD of Care Definition  Ds should act w/the care that a person in a similar
position would think is reasonably appropriate under the
Focus on circumstances.
procedure
-Breaches of care are rare and reserved for egregious conduct.
-Apply BJR but if plaintiffs overcome presumption, apply entire
fairness (price/process) test.
 Joy v. North: policy
Policy for Limiting: Voluntary assumption of the risk, institutional reasons for duty of care
competence, incentives to innovate/take risks. given.

Ways to Violate:
 Uninformed decisions
 Failing to investigate
 Lax board procedures
 No expert appraisal
 No formal market vetting
Van Gorkom: No protection
Breach: breach duty of care, use entire fairness test: for an uninformed decision. 2
(1) Fair Process: when txn was timed, how was it initiated, hour meeting for fundamental
structured, negotiated, disclosed to Ds, and how change (merger). BoD didn’t
approvals of Ds and SHs were obtained. know how set prices, what
(2) Fair Price: economic and financial considerations of price was based on, what
proposed action: assets, market value, earnings, future control is worth to buyer.
prospects, and any other elements that affect the intrinsic Once rebut BJR, Ds can still
or inherent value of corporation’s stock. win if show entire fairness
(price/dealing). Held: BoD
DGCL 141(e)  Response to Van Gorkom- Bd protected if failed entire fairness test.
relying in good faith on corporation’s records, or on opinions,
reports, or statements presented to the corporation by any
corporation’s O’s or employers or committees of board of D’s, or
by any person as to matters the member reasonably believed are
w/in person’s professional competence Weinberger v. UOP (note
case): describes fairness test.
FOR TEST: Note case: Brehm v. Eisner: page 321-duty of care (page 322).
violation complaint must show that 1) D didn’t rely on expert 2)
reliance wasn’t in good faith 3) didn’t reasonably believe E’s
advice was w/in E’s professional competence 4) E not selected
w/reasonable care and faulty selection process was attributable to
Ds 5) subject matter was material and reasonably available was so
obvious that board’s failure to consider it was grossly negligent
regardless of E’s advice or lack of advice or 6) decision of board
was so unconscionable as to constitute waste or fraud.

FD of Care Definition: Limits or eliminates director’s liability for breach of Malpiede v. Townson:
FD of care only (not loyalty). Fredricks case: Breach of FD
Board Defenses of care dismissed when
Against
§102(b)(7): Exculpatory Clauses must be included in Articles of corporation has exculpatory
Litigation
incorporation; valid as long as they don’t limit liability for: clause.
Exculpatory -breaching duty of loyalty
Clauses -acts or omissions done in bad faith
-any transaction where director gets improper benefit

18
FD of Care Duty of Care: In re Caremark Int’l: SH
Duty to Monitor 2 kinds of lapses of care: derivative suit. Held: A
1) Liability for decisions (like Van Gorkom); BJR board of directors has an
presumption applies (page 337) affirmative duty to attempt in
a. Focus on the process-even if decision is stupid- good faith that corporate
court won’t interfere if board went through information and reporting
proper process. system exists and is accurate.
2) Liability for inaction/failure to monitor (page 339)-no Board has duty to monitor,
business decision. but not have to spy. Only
a. Caremark says duty to monitor. systematic failure standard.
b. If are put on notice and then fail to act, liability
may follow-shouldn’t have to spy on employees, Rationale:
but should have processes in place to figure out 1) Increase emphasis in
illegal activity (Graham) case law on role of
director primacy
When is there a breach of duty to monitor? 2) Van Gorkom
-This is only breached if a ‘sustained or systematic failure of board requirement that
to exercise oversight.’ boards make
-‘Such as an utter failure to attempt to assure a reasonable informed decisions
information and reporting system exists-will establish a lack of 3) Federal sentencing
good faith that is a necessary condition to liability.” (page 342). guidelines create
incentives for law
Effective monitoring/compliance program: compliance
Assess risk, establish, revise policies to address risks, establish programs.
procedures to ensure compliance with company policies (training,
reporting, monitoring, enforcement) board and management
oversight, implement improvements.

Procedures/Programs must be:

-closely tailored to co’s particular business and associated legal
risks
-currently verifiable and effectively understood by employees

BUT…Stone Holding: Changes Caremark standard to one of loyalty and not Stone v. Ritter:
v Ritter duty of care. 2 FD:
1) Care
Director oversight liability: 2) Loyalty
“(a) the directors utterly failed to implement any reporting or a. Violations of duty
information system or controls; or (b) having implemented such a of good faith or
sx or controls, consciously failed to monitor or oversee its acts of bad faith
operations thus disabling themselves from being informed of risks (beyond grossly
or problems requiring their attention. In either case, imposition of negligent/reckless
liability requires a showing that the directors knew that they were in decision) now
not discharging their fiduciary obligations.” under loyalty.
-Knowing violation standard, rather than negligence standard. SH b. Usurpation of
have to show more for court to find the board liable. corporate
opportunity
Implications: Depending on how you argue this, can take situation c. Conflict of
away from a straight breach of duty of care (where corporation’s interest
exculpation clauses can protect them under 102(b)(7)) to breach of Turns Caremark from
FD of loyalty (which corporation can’t have provisions against). informed decision-you should
be doing your work as a
director-to a known showing
of bad faith standard by

19
 shareholders (duty of
loyalty). It is not a knowing
violation standard, rather than
a negligence standard.
Audit Post-Enron Requirements Book
Committees New securities laws, eg Sarbanes-Oxley Act of 2002
-Requires corps to include compliance procedures in their annual
reports
-Federal requirement w/re to monitoring

Major focus on Sarbanes-Oaxley and changes in NYSE &

NASDAQ. Changes focuses on increasing (1) independence and
expertise of audit committee members (2) audit committee’s
control over the financial audit process, including selection of
outside auditor (3) communication between audit committee and
the board and (4) internal communications between AC, CEO,
CFO and others
FD of Care Under Sarbanes Oaxley Act, CEO and CFO are central to integrity Miller v. US Foodservice:
Monitoring of a corporation’s financial reporting sx, yet under state law it is Miller CEO sued former
Duties by CEO
still the BoD’s responsibility to ensure that the corporation has Company for failing to
Officer’s adequate controls and system in place. provide him w/ post-
Oversight and termination benefits.
Reporting Duties Company countersued,
claiming violation of FDs.
Miller overstated revenue 
accounting fraud. He should
have suspected wrongdoing.
Liable because he had
incentive to overstate revenue
because bonuses depended on
revenue stated. He acted in
bad faith. He knew there were
weak controls and he lied and
said they were being fixed.
Held: company has claims
against Miller, not vice versa.
Is Good Faith Confusing if separate duty because shows up in BJR, 141(e), and Walt Disney Case: Allegation
an 102(b)(7). that board failed to exercise
independent oversight over contract. Held:
standard of BUT NO-no obligation to act in good faith. actions not enough to
liability? constitute violation of bad
Bad faith is put under duty of loyalty. faith.
-Court declined to decide
whether there was FD of
good faith. Ppl started
bringing cases as violation of
good faith but court said that
you can’t bring these because
liability threshold is much
higher in good faith cases
than in care cases.
-No court has found liability
under this cause of action.

BJR TEST (1) Is it a business decision? Page 321

20
STEPS!! (2) Pl has burden/must overcome/rebut BJR to show that
Board didn’t act on informed basis in good faith.
(3) But absent abuse of discretion, fraud, illegality, conflict
of interest, or gross negligence, courts will go with the
board.
(4) Pl must show:
a. Breach of duty of care, OR
b. Breach of duty of loyalty (self-dealing,
usurpation of corporate opportunity, bad faith
thrown into the mix)
(5) Even if Pl’s are able to overcome the presumption,
directors don’t necessarily have liability.
(6) The Directors must now show fairness:
a. Fair Price
b. Fair dealing

21
 CORPORATIONS

DERIVATIVE SUITS

ISSUE RULE/STATUTE CASE

What is a If you’re mad as a SH, you can: wait until next cycle and
derivative suit? put in new set of D’s, unless it is classified board. Can’t
put in SH proposal bc of exclusion (management); would
have to put in new slate by own proxy statement; can sell
shares, can litigate!

Policy  D’s responsible for managing corporation

(141(a)) including determining which litigation is in
corporation’s best interest. Presents problem when
deciding whether or not to pursue lawsuit against Ds.

Definition: Suit where SH commences and manages FD

litigation on corporation’s behalf. 2 actions:
1) Action against corporation for failing to bring
specified suit, and/or
2) Action on behalf of corporation for harm to it
identical to one corporation failed to bring
Requirements PRE-SUIT DEMAND (Del. Chancery Rule 23.1) DE
requires SH to make pre-suit demand before the board,
explaining claims she wishes investigated and remedied.
Up to board to decide how to deal.
If board rejects  SH may challenge decision as breach of
FD because has no right to pursue original claim directly
now unless board action was not under BJR.
EXCUSE DEMAND: (Aronson) where making pre-suit
demand would be futile. Demand futility: must show that
there is a reasonable doubt created that this is not true:
1) Directors are disinterested and independent
a. Independence = when D’s decision is
based on corporate merits of subject
matter before board rather than
extraneous considerations or influence
(In re the Limited).
b. Test = “subjective actual person”
2) Challenged txn was otherwise product of a valid
business judgment
a. Really hard to show that D’s didn’t
make informed business decision.
What you want to show:
(1) Independent/disinterested: show some kind of
relationship with person who benefited to create rsbl doubt
about loyalty level.
(2) Informed business judgment: show CEO had
Dementia, payoff, etc.
Aronson v. Lewis: futile demand
requirements. If you create
reasonable doubt of either one of the
two parts, then demand is excused.
In re the Limited: Board trying to
complete self-tender via agreement
b/w Limited and Wexler Trust. Self-
tender would require creating debt
for company. P argued that 6/12
Board members making the decision
“could be” interested as they were
close to Wexler.
Holding: Sufficient that there was a
reasonable doubt of
disinterested/independence, so met
demand. Able to show that at least
half the board was interested in the
txn or lacked independence from
Wexner. Std for determining
independence: Subjective actual
person test.
Re: Breach of FD of Loyalty claim:
Not enough of finding of corporate
waste/duty of care breach.

What is the Test to tell what kind of suit it is? Tooley Test:
1) Who suffered alleged harm, the corporation or
the suing shareholders, individually?

22
 2) Who would receive the benefit of any recovery
or other remedy, the corporation or the SH’s,
individually?
Derivative Suits Direct Suits
Most suits are derivative Unless complaining SH have suffered a separate and
distinct harm from that suffered by other SH or is based
on k’l right.
Brought on Corporation’s behalf. Brought by SH in his name

Cause of action belongs to corporation as an entity
Arises out of injury done to corporation as an entity
Note:
Cause of action belongs to SH in his individual capacity.
Examples are claims based on:
1) SH voting rights
2) Preemptive rights
3) Right to inspect books, etc.
Arises from injury directly to the SH
If Dan is a D, O, and SH. Indicted by government for
antitrust violations in setting A’s product prices. A
refuses to advance legal expenses to Dan. Dan sues
seeking advancement of expenses under De’s
indemnification statute.

This is not direct or derivative suit, because Dan is

bringing it as his role as the officer/director (not as SH).

Indemnification, DGCL §§102(b)(1) and 145

1. Today, all states have statutory provisions authorizing director indemnification to some degree.
2. Always keep derivative suit separate from criminal case.

DGCL 145(a) DGCL 145(b) DGCL 145(c)

“Corporation shall have the power”
Suits brought by SH or Third Parties
Gets expenses, attorney’s fees, and
all money in settlement.
Includes
Officer/Director/Employee/Agent of
Corporation, OR serving at the
REQUEST of the corporation as a
D/O/EE/or Agent of ANOTHER
corporation.
“Corporation shall have the power”
Derivative suits: brought by or on
behalf of the corporation
Gets expenses and attorneys fees
incurred (does not get judgments or
settlements)
“Must indemnify…if “has been
successful on the merits or
otherwise”.
Mandatory vs. Permissive
Indemnification.
Gets all expenses and attorneys’
fees.
Note: If can establish that the Df
acted at request of another
corporation, then would have to
indemnify here too.

Thus, if Co. 1 asks Df to serve on

Co. 2’s BoD, then Co. 1 may be
liable.

23
 CLOSELY HELD CORPORATIONS

CLOSE CORPORATIONS

ASK:

1) What kind of business is this? (statutory CC?)

2) What capacity is the party acting in?
3) Is the party violating some kind of k? Sterilizing k, SH voting agreement? Or FD of care or loyalty?
4) Should this be a direct or derivative suit?
Some courts will allow SH to bring direct suit if if it will not:
1) Unfairly expose the corporation to a multiplicity of actions.
2) Materially prejudice the interests of creditors
3) Interfere with a fair distribution of recovering among all interested parties
Richard v. Bryan note case, page 455-57

ISSUE RULE CASE

Basics DE  must meet statutory requirements to be CC (§§342, 343) Must fit CC often restrict share
101, 102, and 103, in addition to these requirements. transfers (locked in)-Transfer
o <30 SH (342) restrictions: right of first
o Stock not offered publicly (342) refusal, first option, buy/sell
o Not transferable to others unless otherwise contracted for agreement
(transfer restriction) (342)
o Certificate of incorp. shall have heading that says is CC (343)
o Registered as CC in articles of incorporation with state (§344)
Voluntary Termination  by amending certification of incorp. (346)
Implications  easier to squeeze out minority SH bc no liquidity
-No secondary market for shares: not publicly traded. Note: If you fail to meet the
-Stock is held in hands of a few people. statutory requirements under
-Courts pay special attention to minority SH DE, then you just become
-If meet CC requirements, can k around default rules (350, 354) regular corporation and
default rules apply.
Note: CA requires less than 30 SH also.

Ways 1. Sterilizing Agreements McQuade: S promised M

Minority SH a. Traditional approach:  Ds can’t give away FD through SH agreement that he
can Have because power to manage belongs to corporation. would retain M as director
Say: b. Modern approach  SH can agree to limit D’s and officer, but later fires
discretion to prevent abuses. him. Held: SH agreement not
Agreement i. DE: Can k to sterilize Ds ONLY if CC is enforceable because S
relating to statutory CC (§350). couldn’t give away his
limitation on 1. §351: Certificate of incorp of CC authority to hire and fire.
board’s may provide that business shall be Directors have FD to SH’s
discretion. managed by SHs. and represent the company.
ii. NC/Others: Ct upholds SH agreement unless D’s can’t give away FD
Agreements it violates laws, exhibits fraud, or oppression because power to manage
relating to to minority SHs, or were made to give 1 party belongs to the corporation.
voting of a personal benefit.
shares. Clark v. Dodge: Court
enforced SH agreement
because was in corporation’s
best interest and they were
the only SHs and had both
signed the agreement.
Different than McQuade bc

24
 only 2 SH here-no
oppression.

Zion v Kurtz (NY applying

DE law): Doesn’t fall under
DE 342 requirements of CC.
Court still enforces k-
2. Shareholders’ Voting Agreements (Minority SH approval of
a. §212: voting rights of SH, proxies, limits corp activities is
b. 2 Kinds: enforceable). Contrast with
i. Vote Pooling Agreements: SH can agree to Nixon.
vote in certain ways, seen as enforceable K’s
ii. Voting Trusts + Other Voting Agreements: Blount v. Taft (NC): If put
§218. Copy of trust document must be filed SH agreement into bylaws
w/corporation’s registered DE office. that says SH can amend
bylaws by majority, then
must follow it. Practice Point:
Put agreement into separate
agreement instead of bylaws.

Ramos v. Estrada: Bound to

SH agreement; if you say you
are going to vote shares a
certain way, court will hold
you to that.
Partnership DE: DOES NOT RECOGNIZE Zidell: Illustrates oppression
Analogy o Must be statutory CC and also have agreement to treat CC like of minority SH; hard for him
P-ship/duties: §354: Operating as P-ship. (Nixon) to overcome BJR.

MASS: Allows courts to say expectations of CC similar to p-ships. Donahue v. Rodd: (Mass.)
o Sh have same rights to participate in management of Company bought Rodd’s
corporation like partners, have FD to each other, can dissolve at (majority) shares back at
will because CC have trust relationships like P-ship. (Donahue) $800/share, but wouldn’t buy
Donahues’ at same price.
Vague Mass definition of
CC: small number of SH, no
read market for shares,
majority SH has substantial
participation in operations o
the corporation. Rule:
Resembles p-ship so SH owe
each other FD.

Nixon v. Blackwell (DE):

Not a statutory CC. If you
want majority SH to have FD
to minority SH, you have to
be a 1) statutory CC and 2) k
for it. ALL ABOUT K.
(Contrast with Zion).
Involuntary CA: CGCL §1800: CA allows SH to petition for dissolution. In CC, if
Dissolution liquidation is reasonably necessary for protection of the rights or interest

25
 of the complaining SH.
CGCL §2000: Avoiding dissolution by purchasing shares.
Some states
have allowed
statutes for this NY: NYGCL: §1104: allowed if there is fraud, oppression, illegality by
in CC. majority to minority. In re Kemp (NY):
-NY has 20% threshold: SH must own more than 20% to do this. (CA Reasonable expectation test:
2 Responses to
illiquidity
doesn’t have one). Disappointment is not enough
problem: to constitute oppression.
-legislative Note: Minority SH that push for dissolution can’t vie for control in CC Oppression = conduct that
grounds for (unlike p-ship). States that allow this allow the corporation or majority to substantially defeats rsbl
judicial
dissolution
avoid dissolution by purchasing minority shares at fair value. expectations held by minority
-direct, SH.
individual SH
action for breach Gimpel v. Bolstein (NY):
of FD. Court held not oppressive
because 1) No violation of
reasonable expectations bc he
inherited his shares and 2)
Not issuing him dividends is
not burdensome, harsh, and
wrongful conduct (they just
never issued dividends for 50
years). BUT Court bails him
out bc doesn’t want him to be
an outcast, so lets him be
bought out for a reasonable
price.

Note: Reasonable price could

be anything, even the lowly
book value ((assets-
liability)/# of shares)

Note: CA uses buying shares

at fair market value. In CA; if
Majority/Minority can’t agree
on FMV, court decides.
Share Re- -Specifies in advance conditions/price for corporation to re-purchase Concord Auto Auction:
purchase stock (Mass) “Each price shall be
agreements -look at stock legend to see if corporation has one reviewed at annual
meeting…” but no annual
Purpose: can provide for orderly liquidation of SH investment after mtg was held. Example of
retirement/death; give majority SH ability to exclude a discharged or poor drafting of purchase
prematurely withdrawing SH from further participation in corporation’s agreement, but court will
profitability. hold you to it. Important to
draft clearly/fairly (neutral
Pros: third party decides in good
-prevent deterioration in SH relationships, know what to expect, prevent faith).
litigation

Cons: Gallagher v. Lambert: (NY)

-Ks are costly, human rationality is limited, k may present possibilities Mandatory buyback
for oppression. provision. Court will hold a
sophisticated person, esp if
has attorney to draft, to

26
 Reminder: IN DE, can’t push for share repurchasing agreement because
no p-ship analogy.
Note: IN p-ship when person dies, other partners can purchase the
disassociated partner’s shares; this is like that in CC.
On test: Grapple with facts. What has corporation been doing all along? How have minority SH been treated? Did
they have share of corporate earnings or place in management? If court accept p-ship analogy-look at TYPE of
conduct going on.
Note: No equities/fairness in DE hard line rule. Also, no equities in RUPA (like human capital).
LLC’s
ISSUE RULE
What is an LLC? -Business organization with tax advantages of
partnerships (pass-through tax)
-Limited liability of corporations; no personal
liability for members; members stand to lose
capital contributions but personal assets are not
part of it.
-None of the restrictions of CCs. (#, type of SH)
-Members contribute capital
-Management
o Member-Managed: (like p-ship): equal
rights of management, absent contrary
agreement, most matters decided by
majority vote, significant matters require
unanimous.
o Manager-Managed: (like corp): can be
structured as BoD, CEO, or both. Must
be specified in articles.
Financial Interests:
-Profit and loss sharing: absent contrary
agreement, most statutes allocate profits/losses on
basis of value of member contributions.
-Withdrawal: member may withdraw and demand
payment of interest upon giving notice specified in
statue or LLC’s operating agreement.
Formation:
1. File Articles of Organization in
designated state office: ULLCA §203:
Articles of Org.
a. Name (with LLC), address,
address of agent, organizer,
whether it is member-managed
27
agreement.
Pedro v. Pedro (MN):
Brothers embezzlement case:
court recognizes p-ship
analogy and gives brother
FMV of shares and favorable
decision on lifetime
employment. Prof says court
overstepped here: could have
sued brothers for FD of
loyalty violation; push in new
directors; k for rights.
CASE
Gottsacker (Wisconsin): 2 brothers + M
formed LLC. 2 took only property and
transferred it to a new LLC they created
w/o asking M Conflict of Interest. K
interpretation 1st “collective” is what
parties contemplated. Court: Txn okay so
long as M and 1B dealt fairly.
Importance of the k, courts will construe
ambiguous k as to reject construction that
leads to unreasonable/unfair result. Even
if you are in LLC, you may have
background FD that come into play (like
p-ship-good faith)-not like corporation
where you must have cleansing (144)).
VGS, Inc.: (Court of Chancery of DE):
Managers under LLC agreement must
exercise duty of loyalty by acting in good
faith to one another (Compared to
Adlerstein-acting without giving notice is
acting in bad faith). Court-made FD
duties to add to LLC agreement.
 or manager-managed, whether
members liable for debts and
obligations,
2. Operating Agreement ULLCA §103: can
regulate affairs of co and conduct of
business, govern relations among
members, managers, and company.
a. Have articles of incorporation
and also this, where internal
governance/how money gets
paid/winding up is discussed.

DE DE: 6 Del. C. 18-1101(b): “it is the policy of this

chapter [LLC ACT] to give maximum effect to the
principle of freedom of k and to the enforceability
of LLC agreements.

A member’s rights include (operating agreement

says this): financial interest (right to distributions
and liquidation participation) and management
rights.

DE S.Ct: the basic approach of the Del Act is to

provide members with broad discretion in drafting Elf Autochem (note page 496)
agreements and to furnish default provisions when
the members’ agreement is silent.
Exit and Liquidity Similar problems as CC. Love v. Fleetway: What does dismissal
mean? Is it included in withdrawal or in
Liquidity is a problem. retiring? Court uses dictionary.

Haley v. Talcott: Can an investor force

remaining member or enterprise to
buyback departing member’s interest?
Where co-equal members of an LLC
cannot agree on a course of action, and if
an exit mechanism in the operating
agreement is inequitable, the court may
order dissolution.

Note: Corporations get taxed twice: on corporate income and on dividends to its SHs.

28
 CORPORATIONS

CORPORATION AS A DEVICE TO ALLOCATE RISK

Protects Creditors By (1) Capital Legal Requirements (Equity) or (2) Piercing the Veil

Equity Purpose: reduce riskiness of extending credit to corporations. Problem 6-1 (handout)
Cushion
Formulas:
o Equity = assets – liabilities
o Surplus = equity – capital
o Capital = par value * # of shares outstanding (§154)

-Par value = minimum price/share that shares must be issued for in

order to be fully paid.
-DE requires minimum equity (par value * # of shares) IF
corporation’s certificate states a ‘par value’ for stock.

Note: Can have negative equity.

Note: Capital & surplus are not liabilities.
Note: Surplus is not profits.

Types of 1) Dividends,
distributions (2) Redemption of shares-corp has right to redeem shares –agreement
(ways with SH-, and
corporation (3) Repurchase of shares-go out and ask SH to repurchase shares, like
distributes $ to Limited case.
SH)
Limits on Minimum Initial Capitalization Requirements Klang v. Smith’s Food
Distributions  DGCL §154: permits a corp’s D to specify by resolution what & Drug Centers: Ds
to amt of the consider paid for shares shall constitute capital. Only can use FMV as
Shareholders limit is that capital can’t be less than amount equal to aggregate appropriate reference
par value of issued shares having par value. point; deference to d’s
 §153: requires shares w/par value be sold for at least that method of calcuating
amount. surplus unless Pls can
Quality & Valuation of Consideration paid for Shares show D’s used
o §152: Consideration selected left to discretion of directors: “unacceptable data”,
“consisting of cash, any tangible or intangible property, or any bad faith, or fraud in
benefit to the corporation…” evaluating value of
assets. Corp’s balance
Limits on Distributions to SH sheet not conclusive of
o §154: Determination of amount of capital (Capital = par value * whether DE statute
shares outstanding) forbidding impairment
Dividends o §244: Reduction of Capital (244(a)(4) permits d’s, acting by of capital has been
resolution, to transfer to surplus some or all of the capital violated.
represented by outstanding shares, which is in excess of the
aggregate par value of such shares) can change par value to
something lower so that your capital is lower and surplus is
higher.
o §170: Dividends & Payments: must be paid out of the surplus, Note: Problem 6-1:
OR if entity has no surplus, must be paid out of net profits that Under §152, board has
the fiscal year dividend is declared or the year before. (If capital discretion to determine
is less than aggregate amt of capital represented by stock, D may what consideration is
not declare/pay dividends.) worth; and doesn’t’
matter if later deemed

29
 o §173: Declaration and payments: no corp shall issue dividends worthless Ds will argue
other than in accordance with this chapter (§170). it was informed
o §174: Liability of D for unlawful payment of dividend or decision at the time it
stock purchase. (a): willful or negligent violation of §173, d’s valued it.
shall be jointly and severally liable w/in 6 years after paying
such unlawful dividend to the corp and to its creditors in the Note: Problem 6-1:
event of its dissolution or insolvency to the full amt of the board can revalue fixed
dividend unlawfully paid. (So if d’s paid $100,000 out of assets, using FMV,
$20,000 surplus, must pay extra $80,000 themselves). before declaring
*Note the willful/negligent provision. dividend, so that
corporation has a lot
more surplus.

2 Approaches 1) Legal Capital Test (DE)

to Limitations a. Idea of separate account of collateral to protect
on creditors.
Distributions b. Problem: small amount of money/capital: doesn’t do
much to protect creditors. We care more about fair
market price (capital is so minimal bc of par value).
2) Insolvency Test (most states)
a. No distribution may be made if immediately
afterwards corporation would be insolvent.
Piercing the o Removing legal fiction of corporation/limited liability and Consumer’s Co-Op:
Corporate Veil reaching to SH sitting behind veil. Application of the test.
o Creditors sue to make SH liable for corporate debts. Ct didn’t pierce veil bc
o Very fact specific. no unjust reason
Black Letter Law (undercapitalization
o Veil Piercing “rule: a court will pierce the veil when Pl proves alone is not unjust)
that:
o SH had COMPLETE domination and control Western Rock Co.: Ct
o SH used control of corporate form in unjust, pierced veil bc
fraudulent, or wrongful way; and controlling SH used
o SH ‘s unjust use of control caused actual harm to the corp’s existence to
perpetrate tortuous
Pl.
conduct. Passed 3-part
o What is the use of the test?
test.
o Equitable test
o Really about working through the facts/Application Baatz v. Arrow Bar:
important. Tort case: go through 3-
K Cases: part test. Arrow Bar
o Courts more reluctant to pierce veil since they assumed third served drinks to person
parties can negotiate and adjust terms accordingly. Power to who hit someone in car.
avoid it. Pre-existing relationship before the loss. Voluntary Are SH’s liable? Ct
decision to become a creditor, so creditors may have didn’t pierce veil. Did
bargained for the risk. not use control in a
o Exercising control is not enough, must show fraudulent way.
injustice caused
o Look at whether there is a complete lack of
formalities
o Look at whether SH leads 3rd parties to believe he is
operating corporation legitimately.
Tort Cases:
o Courts more willing to pierce veil when person/corporation is
directly involved in causing tort to occur.

30
 o Who should bear the risk? Who is in a better position to
prevent the costs? No ability to avoid. Sue everyone.

Parent/Subsidiary Relationships: court will pierce veil if:

1) Parent dominated subsidiary so that s had no separate
existence, AND Craig v. Asbestos:
2) Parent abused relationship with S to commit fraud or cused Potential control over
harm. subsidiary not enough
to pierce. Likely, OK if
can show separate
boards, financials,
books, records,
elections. To pierce
parent, must show that
through policy/business
practices, that
parent/subsidiary are
working as 1 enterprise.
*Importance of
formalities.

US v. Bestfoods: Did
the parent own/operate
the subsidiary? Must
show total domination
and control. Unless veil
pierced, parent
corporation not liable.
Piercing in Page 587-88 Kaycee (Wyoming):
LLC Cases SH’s argument is an
exception to the veil
piercing. If LLCs are
not like corporations,
then should not apply
corporate veil piercing
doctrine in LLCS and
should allow full
limited liability in the
LLC context. Court:
Want to encourage
same equitable doctrine
and use the same 3-part
test.

BALANCE SHEET

31
 CORPORATIONS

MERGERS & ACQUISTIONS

FRIENDLY

Basics Process: Hewlett v. HP: Importance of

o Board adopts a resolution approving agreement of merger Process (contrast to Van
in favor of merger (251(b)) Gorkom). Need SH vote to
o Agreement shall state (1) Terms & Conditions of merger increase authorized stock for
(2) mode of carrying the same into effect (3) if merger: merger/amend certificate of
amendments or changes in certificate of incorporation of incorporation. Claim of vote
surviving corporation (4) if consideration (5) manner of buying and claim of disclosure:
converting shares (6) other details. Court said both were fine: not
o Board submits resolution and agreement of SH to vote at enough evidence for 1st and
annual or special meeting if vote is required. estimates are fine for 2nd (not
o Vote required: Acquiring/Target companies generally material fact that needed to be
(251(c)). Need a majority of outstanding share entitled to disclosed).
vote.
o Not required, Acquiring:
o De minimis merger: 251(f): if no dilution (Paid in
cash), or if minimal dilution (shares acquired
don’t exceed 20%)
o Merger of parent & subsidiary: Short-form:
253(a): If parents owns 90%+ of shares, no vote
needed.
Who votes? §251: Both constituent corporations ratify:
o Board
o SH, Majority required
o What needs to be sent to SHs?
o Public co-proxy statement
o Private company-documents as required by state
corporate law.

Types: Merger: Acquired entity disappears and acquiring entity inherits

liabilities by law.

Consolidation: new company is the surviving entity.

§259: Legal effects of merger.

Voting & If SH voted no on a merger, SH can exercise appraisal rights:
Appraisal o If, vote was needed to approve §262(b)(1) gets appraisal.
Rights o Given to dissenting SH the right to demand that
corporation buy shares at judicially determined FMV.
o Given to selling firm SH, buying firm SH; UNLESS:
o Market out exception (262(b): I
o Bought-out shareholders: No appraisal rights
if stock was publicly traded/listed on
National Securities Exchange (or held by >
2000 shareholders) at time of merger and
shareholders were offered as consideration
for their shares either stock in the survivor or
stock that is publicly traded (or held by >
2000 shareholders)
o Continuing shareholders: No appraisal rights

32
 if stock was publicly traded/listed on
National Securities Exchange (or held by >
2000 shareholders) at time of merger
 Exception to market out: if target
received cash as consideration (§262),
or stock in private company gets
appraisal
o If vote was not needed to approve 262(b)(1)-NO
appraisal.
o Perfecting Appraisal: 262(d)

HOSTILE

Basics Normal process: Note: Federal Securities Laws

1. Acquirer buys shares of Target on public that apply here:
market, less than 5%. o SH voting in public
2. A expresses intent to take over T. companies: federal
3. T rejects. proxy regulations:
4. A gives bear hug letter. §14(a) of ’34 Act,
5. T uses defensive tactics. SEC Regulation 14A.
6. T’s SH (including A) sue T for breach of FD, o Tender offers for
and/or shares of public
7. Tender Offer, and/or companies: Williams
8. Proxy fight Act: 3rd party tender
If T’s directors refuse to open gate to acquirer, what can offer: §14(d), (e), SEC
A do? (usually do both). Rules.
o 2 Tier Tender Offer: Cash deals-sometimes
stock. Bidder offers a lot of money to target
SH’s. Acquire enough shares to control board
through tender offer and then acquire
remaining shares through merger.
o Proxy Fight: launch a proxy fight/send out
proxy statement to other SH convincing them
to vote out old board (expensive since must
sent out own statements).

Defensive Tactics 1. Director-related provisions, like staggered

board, no cumulative voting, limits on removal
2. Board discretion over capital structure;
authorize/unissued stock, blank check preferred
stock.
3. SH restrictions: limits on ability to call special
mtg, no action by written consent, advance
notice.
4. Supermajority voting requirements
5. Super-voting stock
6. Greemail
7. White Knight
8. Change of control employment k’s (golden
parachutes)
9. Pac-man defense
10. Poison pills
11. Litigation (sue for FD breach-sue board of
hostile bidder for wasting $)

33
 12. Acquisitions of asset that hostile bidder doesn’t
want
13. Regulatory protective measures
Are defensive tactics The Unocal test begins with burden of proof on Unocal v. Mesa
OK? Directors.
1. Was action w/in power or authority of the
Unocal Test board?
a. Does the statute authorize this defense
and
b. If it is okay, does the firm’s charter
impose any restriction on defense use?
2. Reasonableness: Did the board have reasonable
grounds for believing that a danger to corporate
policy and effectiveness existed? (Burden on
board to show good faith and reasonable
investigation-process important). [rare to prove
not reasonable]
3. Proportionality: Was the defense
proportional/reasonable in relation to the threat
posed?
a. Factors to consider: Will it make the
co so unattractive that nobody would
want it? Inadequacy of price offered,
nature and timing of takeover,
illegality, impact on constituencies
other than SH, risk of non-
consummation, quality of securities
being offered in exchange.
4. If the directors pass the 2-pronged test, then
kicks back to the BJR rule (BoP on Pl)
5. If the directors do NOT pass, they will be able
to have the chance to go through the fair
process and price test to escape liability.
Poison Pills Aka SH Rights Plan, signed by company. Moran v. Household: No
Rights become exercisable upon some triggering event explicit provision in DGCL that
such as: acquisition of specified percentage of target says directors can adopt poison
shares, or announcement of tender offer for some bills, but Court holds that 157
specified percentage of shares. gives d’s ability to grant rights
and options for whatever reason
Flip in Provision: Target’s SH’s have right to buy they want. Court holds that
additional Target company stock at discount: company BoD can make Poison Pills.
has more stock outstanding so that co is more expensive Then goes through Unocal test
but it is getting little cash for amount of stock it is and finds for Board. Power
selling. under § 151(a), § 151(g) and §
157 to do these devices.
Flip-Over Provision: Gives SH right to receive Buyer
stock in a 2nd stage freeze-out merger (buy stock in
merged entity): stops buyer from being able to control
entity because can’t squeeze out the minority SH, bc
then they have right to buy stock at discount.

Note: Company has redemption features: gives board

option of redeeming rights at nominal cost to allow
desirable acquisitions to go forward.
Revlon Rule: When board puts up company for sale or there is a

34
 change in corporate control, board has duty to maximize
company’s value by selling to the highest bidder.

“Directors’ role changed from defenders of the

corporate bastion to auctioneers charged with getting
best price for SH at a sale of the company”.

DE Rule: When board decides to sell, duty to maximize

the co’s value by selling to highest bidder. But if they
don’t’ decide to sell, has FD to the corporation-so can’t
do whatever you want as a director to make the stock
prices go up.

Note: Revlon only applies in change of control

transactions-not just txns where board has decided to
find a white night. “I am selling my co to him. SH rights
are being converted to $5 a share”- this is a txn.

Are you in Unocal Land? (Defense tactics)-then use 2-prong test.

Are you in Revlong Land? Has the board made a decision to sell the company? If yes, it is ALL about maximizing
SH profits.

Note: May be facts where both standards apply (e.g., Revlon). Put up initial defenses. Then once found white knight,
role changes to auctioneer.

35
 FEDERAL LAW AFFECTING CORPORATE TRANSACTIONS
DISCLOSURE
Remember to first ask: Is alleged misconduct connected to purchase or sale of a security? (Merger counts too-money
for shares)
Why important? o Provide information for SH to make
informed voting decision. Helps d’s do
better job, used by investors, enhances
monitoring by accountants, facilitates
enforcement actions by gov’t.
Mandatory Disclosure
Rule 10b-5 Section 10(b)
It shall be unlawful for any person to use or
employ, in connection with the purchase or sale of
any security registered on a national securities
exchange or any security not so registered…any
manipulative or deceptive device or contrivance
Rule 10(b)-5
-It shall be unlawful for any person:
A. to employ any device, scheme, or artifice to
defraud
B. To make any untrue statement of a material
fact or to omit to state a material fact necessary in
order to make the statement made, in the light of
the circumstances under which they were made,
not misleading, or
C. To engage in any act, practice, or course of
business which operates or would operate as a
fraud or deceit upon any person
-In connection with the purchase or sale of any
security
Who may bring a 10b- SEC, Dept of Justice (criminal), Private parties
5 action? (no express private remedy under §10, private
cause of action implied under R10b-5
36
In the Matter of Informix:
Violations: false, misleading books,
records, accounts, insufficient
internal accounting controls. Civil
punishment/remedy: C & D order
(stopping future violations).
Blue Chip Stamps: Private cause of
action: no clear Congressional intent
for private cause of action, so take it
as OK. (Judicial oak out of
legislative acorn).
Santa Fe: Short-term merger: didn’t
get to vote. SH argue no chance to
vote (but merger process is state
process-federal rules don’t apply
here), as long as you comply with
state corporate statutes, process of
DGCL 253 satisfied. If don’t like it,
can bring FD claim in state court-
CAN’T bring a 10b5 claim over a
state law. The evaluation/appraisal
action statement remedy covered by
state law-being forced to sell
securities. UNFAIRNESS IS NOT
FRAUD.
Limits the reach of 10b-5: should
not create federal cause of action for
conduct traditionally covered by
state law.
 INSIDER TRADING

Rule 10(b)-5
-It shall be unlawful for any person:
(a) To employ any device, scheme, or artifice to defraud
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the
statement made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon
any person
-In connection with the purchase or sale of any security
SEC Definition Refers generally to buying or selling a security in breach of FD to other
of Insider relationship of trust and confidence while in possession of material,
Trading non-public information about the security.

Violates SEC Rule 10-b

“Material”:
Modern definition: Whether there is a substantial likelihood that a
reasonable investor would consider the omitted fact important in
deciding whether to buy or sell securities.

TGS court: whether a reasonable man would attach importance to the

information.
“Insider” §16b of SEC Act of 1934:
Defined -prohibits insiders (directors, officers, and owners of 10% or more)
from making short swing profits
-By prohibiting insiders from purchasing and selling stock within 6
months (hard line)

OVERINCLUSIVE
Corporation can sue the insiders and make them return profits.
Tests for Insider Texas Gulf Sulphur: Texas Gulf Sulphur:
Trading o ANYONE in possession of material non-public information FN 12: not saying
must that corporation has
o Disclose it, or to disclose the
o Abstain from buying or selling (while information information. Timing
remains undisclosed) is based on BJR. But
either disclose or
Materiality factors: abstain.
1. Nature of information
2. Company response
3. Market response
4. Conduct of insiders

Note: Rule 10b-5 definition of insider includes: TGS director,

secretary, geologist, janitor (FD to corporation).

Compare to §16b of SEC Act of 1934: Officers, directors, 10% SH

Non-Insiders No 10b liability where purchaser of stock who has no duty to a Chiarella v. US:
prospective seller because he is neither an insider nor a fiduciary. Has mark-up guy found
no obligation to disclose material information he has acquired, and his out corp will launch
failure to disclose information does not constitute a violation of 10b. takeover and shares
will go up so bought
shares and sold post

37
 takeover. He made
$30K in 14-month
period. He had
material-nonpublic
info. SCOTUS said
no liability because
no FD to SH of target
entity. Not every
financial unfairness is
a violation of 10b-5.
10b-5 is not based on
equal access to
information.
Constructive 1. Where they obtained material, non-public information from Dirks, FN 14
Insiders issuer with
2. An expectation on the part of the corporation that the outside
will keep disclosed information confidential, and
3. Relationship at least implies such a duty (some relationship of
trust).
Note: If you are a janitor who gets info at a law firm, you have a k with
the firm, thus you may be considered a constructive insider.
Examples: Someone who has a duty for a period of time (lawyers,
accountants).
Tippees Liable when: Dirks
1. Insider/tipper breached his FD by disclosing material non-
public information for personal gain (objective standard);
AND
2. The tippee knows or has reason to know of the breach of duty

Tippee’s liability is derivative of the tipper’s; arising from role as

participant after fact in insider’s breach of FD.

Note: Dirks adds benefit layer: Tipper must get a benefit, which could
be anything: $, reputation, gift, etc.
Misappropriatio Definition: O’Hagan
n Theory A fiduciary’s use of undisclosed information belonging to his principal,
without disclosure of such use to the principal, for personal gain
constitutes fraud in connection with the purchase or sale of a security
and thus violates Rule 10b-5 (page 1088).

*If person tells principal before trading on the information, can’t get
them under 10b-5.

Rule 10b5-1: Trading on Basis of Material Nonpublic Info (after O-

Hagan, added this).
Purchase or sale of security "on basis of awareness of" material non-
public information anytime there is a breach of trust, confidence
directly, indirectly to the issuer or the shareholders of that issuer or to
any other person who is the source of the material non-public
information. (captures classic, constructive, and tippers, or anyone
who gave you material nonpublic information –even w/o
relationship…)

10b-5(2): Non-exclusive list of 3 situations in which person has a duty

of trust or confidence for purpose of misappropriation theory.

38
 1. Agreement to maintain confidence exists
2. History or pattern of sharing confident info, such that recipient
knows/should know that communicator expects confidentiality
a. Captures romantic relationships/sharing, etc.
3. Info is obtained from spouse, parent, child or sibling
a. UNLESS recipient shows history w/ no expectation
of confidentiality

Unlawful Tender Prohibits ANYONE connected with the tender offer from tipping
Offer Purchases material, non-public information about it. (not insider or otherwise).
14e-3

Chiarella and Dirks: 10b-5 liability for insider trading is now premised on a duty to disclose arising from a
relationship of trust and confidence b/w parties to the transaction.

Classic Trading: Insider has FD to corporation and investors/SHs. Insider uses information himself.

Tipping (Dirks): Insider has FD to corporation and gives tip to another person. That other person who doesn’t have
FD with corporation actually trades on information. Tippee buys shares from SHs.

39