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CORPORATIONS Wells Fall 2008 Note that goals of class are to know 1) rights and obligations of officers, directors,

and shareholders, 2) corporations role in society/economy, 3) lawyers role advising corporations I. AGENCY a. Creation: i. RST 3D 1.01: Agency is the fiduciary duty that results when: 1. one person (a principal) manifests assent to another (an agent) that the agent shall act on the principals behalf and subject to the principals control, 2. and the agent manifests or otherwise so consents to act b. Note that no K is required, parties need not have intent. Whether relationship is characterized as agency in agreement of context of industry or popular usage is not controlling i. Parties labels and popular usage not controlling RST 1.02 ii. Manifestation = written or spoken words or conduct RST 1.03 iii. Other Terminology RST 1.04 1. Co-agents 2. Disclosed Principal: 3rd party has notice agent is acting for a principal 3. Undisclosed Principal: 3rd party has NO notice agent is acting for a principal 4. Unidentified Principal: 3rd party has notice of principal, but not identity c. Consequences are both inward and outward i. Inward: Terms of K, fiduciary duty ii. Outward: Duty to 3rd party, principles of attrition d. Formation: US v. Cyberheat (D. Arz. 2007) i. Facts: DOJ sues Cyberheat to enforce rule requiring warning label on sexually-explicit email. Cyberheat claims not responsible for actions of affiliate promoters. ii. Issue: Was there formation of agency relationship? iii. Rule: The substance of the parties relationship, not the label they give it, controls iv. Factors to consider: 1. Principals right to CONTROL (give interim directions or instructions) 2. Alleged agents duty to act primarily for benefit of principal 3. Alleged agents power to alter legal relationships of principal v. Joint tortfeasor may be vicariously liable, if in apparent or actual agency vi. Outcome: remanded for material issues of fact 1) control over content and 2) knowledge of violations and was response reasonable? e. Fiduciary Duty: i. RST 3D: General Fiduciary Principal 1. 8.02: Duty not to acquire a material benefit from a third party through use of agent position 2. 8.03: Duty not to deal with principal as or act on behalf of an adverse party in a transaction connected to the agency relationship 3. 8.04: Duty to refrain from competition during duration of agency relationship 4. 8.05: Duty not to use principals property for agents own purposes of those of a

3rd party, and not to communicate confidential information for those purposes ii. Food Lion v. ABC
1. Facts: Food Lion sues for torts- breach of loyalty and fraud- against undercover employee-reporters, documenting unsanitary practices 2. Rule: RST 3D 8.01: An agent has a duty to act loyally for principals benefit in all matters related to agency relationship a. Note that this is the default rule, even when parties have not created duty in K 3. Breach of loyalty applies when: a. Competes directly with employer b. Misappropriates employers property, profits or biz ops c. Breaches employers confidence

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4. Courts Rule: An agent must have INTENT to act against interests of employer at a time when on the payroll iii. Covenants not to compete enforceable in most states for most professions (except attorneys, CA), usually must be limited in geography/scope Principals of Attrition i. In General: 1. Principals can be liable for torts or contracts of agents a. Contract Actual or implied authority (necessary, proper and usual) b. Torts Respondeat Superior: Short-cut to tort liability, only need show that actor was 1) agent and 2) acting w/scope of authority. No need to show principal acted wrongly. 2. Justifications (comment to RST 1.01) a. Control (ability to select, control, terminate) b. Benefit c. Consent (express or implicit) ii. ACTUAL AUTHORITY: 1. Castillo v. Case Farms of Ohio a. Facts: Case Farms contracts with ATC to recruit and hire migrant farmworkers. No written agreement between ATC and Case Farms b. Rule: Giving an agent express authority to undertake a certain act ALSO includes implied authority to do things proper, necessary, and usual while exercising that authority. c. Principal is liable whether or not he was aware of specific actions (so need to monitor express agent) d. So express delegation doesnt always make principal liable- must also see if acting w/in express scope, or implied b/c passes necessary, proper and usual test iii. APPARENT AUTHORITY: 1. RST 3d 2.03: Apparent authority is the power held by an agent or other actors to affect a principals legal relations with 3rd parties when the 3rd parties reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principals manifestations 2. Creation of Apparent Authority RST 3D 3.03: Apparent authority is CREATED by a persons manifestation that another has authority to act with legal consequences for the person who makes the manifestations, if a 3rd party reasonable believes the actor to be authorized and the belief is traceable to the manifestations 3. Bethany Pharmcal v. QVC a. Facts: QVC contracted with NTA, who solicited held from Il. State Agency (including Janis) for help organizing nationwide-showcase of vendors. Janis sent letters, Bethany claims didnt know it was an alternate, sues for breach of K. b. Issue: Could Janis letter serve as basis for K and bind QVC- was she an agent? c. Rule: Agent cannot unilaterally create an apparent agency relationship through words or conductMUST COME FROM PRINCIPAL d. IL Law Requires: i. Principal consents or knowingly acquiesces ii. 3rd party has reasonable belief iii. 3rd party relies, to detriment iv. (I think this is combining apparent authority and estoppel doctrines) e. Holding: A reasonable person would not believe Janis was agent of QVC who could contract on its behalf. QVC consistently stated that Purchase Order was only valid K, and that Bethany was an alternate. 4. General Def: One person may bind another in a transaction w/a 3rd party, even in the absence of actual authority, when the third party reasonably believes, based on manifestations by the purported principal, that actor is authorized to act on behalf of principal

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a. Can be basis for liability where 1) actors appear to be agents, or 2) are agents, but acting outside scope of actual authority R. 3d 1.02- Def. of Manifestations: A person manifests consent or intention through written or spoken words or other conduct if the person has notice that another will infer such consent or intention from the words or conduct. a. Implication of this new definition communications from the principal need not be directed to third persons before apparent authority is created. INHERENT AGENCY POWER: We are avoiding this b/c RST 3D folds it into apparent authority. This is a narrow doctrine that only applies to assuming actor has certain authority b/c it goes along w/their job position. a. Watteau v. Fennick: Man who owned and operated beer house sold it, continued to operate it, accepted items on credit for undisclosed principals. ESTOPPEL: Non-agency doctrine a. Requires: 1) unambiguous promise, 2) reliance to detriment, 3) reasonable belief and foreseeable b. Distinguished by: i. Requires 3rd party to change position in reliance ii. Allows 3rd party to hold principal liable, but does not give principal any rights against 3rd party RESPONDEAT SUPERIOR: a. RST 3D 2.04: An employer is liable for torts committed by employees while acting in the scope of their employment. b. Ware v. Timmons (Al. 2006) i. Issue: Should Dr. Timmons be liable as principal for actions of nurse, in brain-damaged patient case? Timmons was supervisors, but also coemployees of hospital. ii. Rule: Absent evidence that alleged master had power to selected and dismiss servant, liability does not attach. Test is degree of control, and is fact-question. iii. Rule: Doctrine of RS generally does NOT hold co-employee supervisors liable for acts of supervisees. iv. Dissent proposes liability in unique context of dr/nurse relationship. Problem 1.3: Competitive Intelligence, P&G v. Unilever a. Start w/agency, then run RS analysis. AN independent contractor CAN be an agent (labels not dispositive). Krispy Kreme Case Study a. General Rule: Typically, courts will NOT find an agency relationship (fiduciary duty, inward) when franchisee suing franchisor, but may find when 3rd party suing franchisor as principal for tort. i. Note that franchisors often take advantage of franchisees, take percentage of sales but not profits, can jack up equipment prices if selling to franchisees to boost corporate profits. ii. So remember can have distinction between K and tort liability (more likely). iii. For 3rd parties, issue is often NOTICE (would think KK is responsible for franchisees) versus inward fiduciary claims where labels not dispositive. b. System of UNIFORMITY: Control advertising, sell some equipment and regulate others, have covenants not to compete, training, employee qualifications, hours, advertising and public relations, software standards, reports on sales, rights to monitor or audit at any time c. Both product franchise (Swinger) and business format (McDonalds). d. Franchisors may want hands-off approach in particularly sensitive areas, like sex. harassment training.

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e. So, remember that answer changes based on who is involved and what theyre suing for. Always look for control first. Apparent authority may be harder to win b/c of notice (sign that franchisor is not responsible for franchise). But easier in tort context. ORGANIZING A CORPORATION a. Definition of Corp: A legal fiction with FOUR qualities i. Centralized management ii. Continuity of life iii. Transferability of ownership iv. Limited liability b. Three Roles: i. Officers (CEO, President, CFO) 1. Responsible for day to day operations 2. Corp. law says little about them, maybe b/c top officers are usually also members of BOD ii. Directors 1. Elected by shareholders to choose and supervise officers 2. Must act collectively 3. Model Act 8.01 and DGCL 141: Biz is managed under direction of BOD iii. Shareholders 1. Control rights, like to elect board and vote on fundamental transactions like merger 2. Financial rights: assets of company once liquidated, creditors paid 3. Vote, sell, or sue iv. Corp. law is designed to get these groups to cooperate c. There are TWO types of corporations: i. Closely-Held 1. small number of shareholders 2. not sold on public market a. no threat of outside takeover b. no public disclosure requirements 3. overlapping roles is the norm, not exception a. shareholders so dominant, can normally remove BOD, also make lots of Ks between themselves b. Shareholders are less diversified in risks c. Shareholders are ACTIVE participants in management ii. Public 1. Owned by a large number of investors 2. publicly-traded 3. 3 separate groups (separation btw. ownership and control) a. Shareholders NOT as active b. Diversified risks, can trade d. What Rules Govern Corporations? i. State Law of Incorporation: Internal Affairs Doctrine Rules governing relations btw shareholders, directors, and officers are taken from the state of incorporation 1. Model Biz Act 2. DGCL (50% of public corps incorp. here b/c of 1) large amount of control to directors and 2) predictability) ii. Federal law: regulations of public cos iii. Also sometimes state law where principal place of biz is located (cant ignore PA employment law, etc) e. Model Act 2.01: One or more persons may act as incorporator by filing AOI with SOS f. Charter (Articles of Incorporation) (Mozart Bakery) Model Act 2.02 i. NAME: Needs to include type of liability and meet other standards under 2.02 1. Must contain word corporation, incorporated, company, limited 2. may not contain language implying that the corporation is organized for a purpose other than that permitted by 3.01 and its articles.

ii. STOCK: 1. Number of authorized shares of stock 2. Always need to distinguish btw. common and par value a. Artificial number, usually $0.01, Model Act doesnt require b. Rule: A corp. not allowed to sell stock for less than par value 3. Modern trend toward elimination of capital requirement (sometimes state statutes require $1,000) iii. LOCATION: 1. Always need name of initial registered agent and registered office 2. Also need name and address of INCORPORATOR iv. PURPOSE: 1. Under Model Act, no longer need purpose (as opposed to 1900s) and this could be dangerouslimit expansion a. Model Act 3.01: Every corporation under Act has purpose of engaging in any lawful business unless more limited purpose is set forth in AOI 2. Under DGCL, still need purpose v. AMENDMENTS: 1. Power to amend bylaws should generally rest w/shareholders, NOT BOD, to encourage flexibility. 2. It is very difficult to amend charter (like constitution). Wouldnt want provision like this in charter 3. Most management provisions should be in bylaws or by statute, not charter vi. BOARD: 1. Number of directors should generally be in bylaws, not charter, b/c easier to amend. 2. Can name initial directors in charter, or call meeting after to elect (then appt. officers, sale of capital stock, other administrative tasks) vii. LIABILITY: Can include exculpatory clauses for directors in bylaws. 1. Example: No director liable except for a. Amount of financial benefit received by director to which he is not entitled b. Intentional infliction of harm c. Intentional violation of criminal law d. Violation of Model Act 8.33 2. Sometimes self-executing in states, sometimes optional and need to include viii. DURATION: Assumed perpetual unless otherwise stated ix. Optional under Model Act: Provisions not inconsistent with law re: 1. purpose 2. management of business affairs of corp 3. defining/limiting, regulating powers of corp, board, shareholders 4. par value 5. imposition of personal liability on shareholders for debts of corp to specified extent g. Model Act 2.15: Secretary of State shall file articles, and upon filing act of incorporation occurs h. INCORPORATION: i. Upon filing incorporation occurs ii. Model Act 2.05: Organization of a Corporation 1. After incorporation a. If initial directors are named in AOI, the shall hold an organizational meeting, at call of majority of directors, to complete organization- appoint directors, adopt bylaws, carry out other business, b. If initial directors are NOT named in AOI, incorporators shall hold an organizational meeting at call of majority of incorporators to i. elect directors and complete organization, ii. or elect a board of directors who shall complete organization 2. Or actions can be taken w/out meeting with signed written consent by each incorporator iii. Grant v. Mitchell (Del. Court of Chancery 2001) 1. Take-aways:

a. Corp law is high on formalities b. Incorporation and Organization are DIFFERENT acts 2. Facts: Grant, Mitchell and Melzter formed LLC w/1/3 ownership each. M&M came up w/software (but not sweat capital); later Grant invested more $ and took 42& of stock. Then incorporated. a. Court relies on 1) actions of attys and 2) important, yet unsigned, docs: i. Articles: List grant as sole incorp. ii. Directors Consent: Ratify action, list G&M as 2 directors, never signed 1. Can file this is lieu of meeting iii. FCC: List G&M as 2 officers, never signed iv. In 2000, Grant filed consent naming himself as SOLE director 1. Trying to argue he never organized co. until now- as sole incorporator, would have this power exclusively. 3. Holding: Grants attempt to name himself as sole director invalid and judgment granted for Mitchell. 4. Note: INCORPORATOR files charter, names board, who then decides bylaws. 5. DGCL 108(a): After filing AOI, the incorporator(s) or board if named in charter, shall meet 6. DGCL 108(c): Any action permitted to be taken by the incorporator(s) or board at organizational meeting can be taken by (unanimous) signed instrument (consent) iv. See Mozart Bakery- about filing articles of incorporation 1. Model Act 2.02(a): Articles must set forth: a. Name of corp (including Inc, etc) b. Number of authorized shares, including classes (common/preferred) and series c. Name and address of initial registered agent/office d. Name and address of incorporator e. OPTIONAL i. Names and addresses of initial directors ii. Provisions not inconsistent w/law re: 1. purpose 2. managing biz and regulating affairs of corp 3. defining and limiting powers of directors, officers, shareholders 4. par value 5. imposition of personal liability on shareholders for debts to certain extent/conditions 6. Can name initial directors a. If not incorporator can have meeting even with himself and elect directors iii. any provision required/permitted to be set forth in bylaws iv. exculpatory clause v. provision requiring or permitting indemnification of director for liability 2. DGCL 102(a) a. Also requires par value b. Requires purpose c. Provision eliminating personal liability of director for breach of fiduciary duty provided (Passed in wake of Van Gorkom) d. New provision allowing directors to take advantage of corp opps w/out first telling shareholders e. Requires provision naming directors if the powers of the initial incorporator are to terminate on filing of the charter 3. Only directors may propose changes to charter, then need shareholder approval vote to become effective (Model Act 10.03) 4. Remember even number of directors can lead to deadlock! 5. Duration, initial capital NOT required generally 6. Shareholders MUST have right to amend bylaws (Model Act 10.20)

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a. Directors CAN amend/repeal bylaws UNLESS power exclusively granted to shareholders in charter b. The incorporators or board of directors shall adopt initial bylaws, and the bylaws may contain any provision not inconsistent with law or the AOIModel Act 2.06 7. Foreign Corp Certificate: Foreign corp. must file notice that theyre doing biz in state CAPITAL STRUCTURE i. In General: 1. Equity- connotes power to control (slivers of ownership) a. CHARTER must include number of authorized shares, including if there are classes, how many per class and what rights attach to them (Model Act 6.01) i. Articles MUST authorize: 1. one or more classes or series of shares that together have unlimited voting rights 2. one or more classes or series that are entitled to receive the net assets of the corporation upon dissolution ii. Articles MAY authorize classes/series that have: 1. special, conditional or limited, or no voting rights 2. are redeemable/convertible as specified in the articles at option, for cash/debt/securities/other property, at prices specified or fixed formula 3. entitled holds to distributions calculated in any manner 4. have preference over any other classes or series with respect to distributions iii. Note: Series can be w/in classes b. Model Act 6.21 Issuance of Shares i. Power of directors to issue shares may be reserved to shareholders by AOI ii. BOD can authorize shares to be issued for consideration of any property iii. Sometimes approval of shareholder vote is required- (f)(1) c. Voting Entitlement of Shares: Model Act 7.21 i. Unless articles provide otherwise, each outstanding share is entitled to one vote d. CAPITAL STOCK: All of corps equity interests together e. OUTSTANDING shares have been sold (issued), as long as shareholders have f. TREASURY shares: Corp can re-purchase shares (so issued but NOT outstanding) g. Common Stock i. Unlimited voting rights (normally 1/share, but can be different) ii. Right to assets of corp if it winds up, after liquidation and creditors paid iii. Sometimes dividends h. Preferred Stock- Created by CONTRACT (or recorded in charter?) i. Model Act 6.01(c) ii. DGCL 151 iii. Blank check preferred 1. allows corp. to designate characteristics of series or class w/out shareholder approval iv. Rights 1. Dividends (might be promised as regular or cumulative) 2. Preference in liquidation (Stand in front of common stock) 3. Usually cannot vote (or maybe only on certain transactions) 4. Might have something else in bundle of rights, like right of conversion for corp. to buy back 2. Debt a. Corp raises money by:

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i. Borrowing through issuing bonds ii. Selling stock b. Bonds i. Contract is called indenture, btw. corp and trustee acting on behalf of bond holder 1. details terms for issuance, payment, redemption, and discharge 2. specifies event of default (which allows bondholder to accelerate) ii. Important Terms 1. registered v. bearer 2. redemption 3. priority 4. conversion (can get stock instead of cash) 5. Ratings (from agencies, investment grade v. junk grade) iii. Tradeable, and gets priority over equity c. Liquidation process: i. Employees get paid ii. Secured creditors iii. Bondholders get principal iv. Preferred stock holders v. Common stock holders ii. Grimes v. Alteon 1. Issue: Is oral promise by CEO to sell 10% of future private stock offering to third party enforceable, where there was 1) no written agreement and 2) no approval by board? 2. Holding: Agree w/lower court that this is NOT enforceable a. Rule: Board has exclusive, non-delegable right to regulate and govern capital structure, based on DGCL. i. Issuance of capital stock is fundamental part of that b. Rationale: i. Vitally imp. for corp to know status of capital stock & potential calls ii. Imp. of boards discretion iii. Stability, certainty 3. DGCL 152: Consideration for purchase of stock shall be made in form and manner determined by BOD 4. DGCL 157: Commitments regarding issuance of stock (rights or options) must be approved in writing by BOD a. Narrow interpretation of right: Something that is due to a person by just claim that is legally enforceable b. This agreement would be a right 5. DGCL 141: Fundamental principal that biz and affairs of corp shall be managed by BOD DIRECTORS AND SHAREHOLDERS i. In General: 1. Role of the Board a. Necessary for public corps, closely-held can do away w/by majority vote b. Charter or bylaws can prescribe qualifications of board (like stock or residency) c. Modern- only need 1 (traditionally 3) d. Hiring, advising, supervising, firing officers e. Meet 4-10 times/yr i. Can be regular or called specially, which requires NOTICE 1. Directors can waive notice by writing or by participating ii. Typically act by majority vote, unless charter specifies otherwise iii. Can also act w/out meeting, by consent 1. Unanimous under Model Act, or by number required to approve action at meeting under DGCL iv. Any means by which directors can simultaneously hear each other

2. Inside directors are also officers, outside directors are not 3. Terms of office a. Elected by shareholders at annual meeting, unless staggered (anti-takeover device) b. Can be removed, w/ or w/out cause, unless charter provides otherwise c. Vacancies can be filled by remaining directors or shareholders (power of board to create new directorships) 4. Board can form committees (audit, nomination, compensation) a. But generally cannot delegate to committee actions that need to be put to shareholder vote, nor can committees adopts, repeal, or amend bylaws 5. Voting: a. 1 share common stock = 1 vote b. Shareholders vote on i. Election of directors ii. Amending charter or bylaws iii. Merger or sale of corp/significant assets iv. Dissolution of corp v. Ratification of conflict-of-interest transactions c. IN person or by proxy i. Unless charter says otherwise, shareholders rep. majority must be present in person or by proxy to constitute a quorum d. Majority wins exception for board election, which requires only plurality e. Can be straight OR cumulative f. Annual meeting of shareholders required by statute, and calling of special meetings permitted by board or 10% of shareholders g. Set record date- people owning shares at that date can vote at meeting ii. Model Act 8.01: Requirement for and Functions of Board 1. Except as provided in a shareholder agreement, each corporation must have a board 2. Corporate powers must be exercised under power of board 3. Boards oversight in a public corp includes a. Business performance/plans b. Major risks the corp may be exposed to c. Performance/compensation of senior officers d. Policies to further compliance with law/ethics e. Prep of corps financial statements f. Effectiveness of corps internal controls g. Arrangements for providing adequate and timely info to directors h. Composition of board and its committees, taking into account important role of independent directors iii. Adlerstein v. Wetheimer (Del. Chancery 2002) 1. Facts: Directors go to Reich to invest in co. and get rid of Adlerstein b/c corp is financially deteriorating, disagree w/A regarding expansion of co, feel he is lying and undermines work of biz consultant, and faces sexual harassment claim. Adlerstein owns majority of voting shares, but not overall shares, so he could remove directors, although he could be fired as CEO b/c only gets 1 vote on board. a. Combined status as majority shareholder (by votes, not economically) AND director 2. Issue: Was the July 9th meeting property convened, and if so, were actions a breach of fiduciary duty owed to the director/controlling stockholder Adlerstein? 3. DGCL 255: Upon application of any stockholder or director, or any officer whose title to office is contested, or any member of a corporation without capital stock, the Court of Chancery may hear and determine the validity of any election, appointment, removal, or resignation of any director, member of the governing body, or officer of any corporation, and the right of any person to hold or continue to hold such office, and, in the case any

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such office is claimed by more than 1 person, may determine the person entitled thereto a. Purpose: to provide a quick method of review of the corporate election process in order to prevent a corporation from being immobilized from controversies as to who are its proper officers and directors. b. Procedure for giving notice is typically set by bylaws 4. NOTICE: Requirements set forth in bylaws 5. Rule: Boards must conduct affairs to meet minimum standards of fairness 6. Court finds that directors didnt violate bylaws by not providing notice of meeting, but still hold actions invalid due to trickery- court looks to fairness, imposes duties not to deprive majority stakeholder on top of black-letter law. a. Duty owned not only to creditors as insolvent co, but also to shareholders iv. Problem 4.2: Bigmar 1. Tramontana calls meeting to oust May, gives 2 days notice and meets via teleconference. 2. Was meeting validly convened? a. Secretary was supposed to call meetings under bylaws, May is secretary b. But court holds she did not have power to block meeting 3. Can board meet electronically? a. Model Act 8.20: Board can act w/out meeting, but only by unanimous consent b. Model Act 8.20(b): Board can meet electronically, but only by means of communication by which directors can simultaneously hear each otherensures debate i. In contrast, shareholders can act independently, w/out consulting each other PIERCING THE VEIL; THE CLOSELY HELD CORPORATION a. Limited Liability i. Advantages 1. Encourages investors to invest in risky biz 2. Encourages them to diversify investments 3. Reduces monitoring costs 4. Encourages free transfer of stock ii. Disadvantages/costs 1. Increases cost of debt (higher interest rate, creditor knows cant go after other assets) 2. Could encourage recklessness (moral hazard and social costs on involuntary creditors, like tort victims) b. Piercing the Corporate Veil i. Always: 1. Closely-held corp or corp. subsidiary (NEVER public co) 2. Active role (shareholders helping to run corp) ii. Elements 1. Lack of separation btw shareholder and corp 2. Undercapitalization 3. Failure to follow corp formalities (meetings, records) 4. Fraud or misrepresentation c. Model Act 6.22(b): Unless otherwise provided in the AOI, a shareholder is not personally liable for the acts/debts of corporation except that he may become personally liable through his own acts/conduct d. TRADITIONAL PIERCING: Soerries v. Dancause (Ga. 2001) i. Facts: D sole shareholder of corp that operates a nightclub, underage patrons ID not checked, and she died in drunk driving accident afterwards. Although D did not let her in or serve her alcohol, should he be held liable? ii. Court finds he disregarded separateness of legal entities by commingling personal and corp. 1. paid employees under table w/own funds 2. waived corp. rental payments 3. used personal funds to pay corp expenses (while operating at loss)

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4. used corp. funds to pay his personal mortgage note iii. Rule: If principal shareholder or owner conducts private and personal basis on an interchangeable basis, he is w/out standing to complain when injured party does the same iv. Note: This is a FACTUAL question for jury v. Rationale: Fairness, encourages separation and attention to corp. rules, good records e. ENTERPRISE LIABILITY: Minno v. Pro-Fab (Ohio App. 2007) i. Issue: Should Pro-Fab be liable for injuries of employee of subcontractors employee? Are they sister companies, or is See-Ann a mere instrumentality of Pro-Fab? ii. General Rule: Parent corp. is not liable for actions of its subsidiary, even if wholly-owned. HOWEVER, they may be treated as a single entity under certain circumstances (BELVEDERE TEST): 1. Control so that corp. doesnt have separate mind, will, or existence a. Here had same management, biz purpose, equipment, customers, ownership, training 2. Exercised to commit fraud or illegal act a. Lack of liability insurance raises issue of material fact re whether Pro-Fab was undercapitalized; sole shareholder closed corp after receiving judgment against it 3. Resulting in injury/unjust lost a. Causal connection btw training, equipment and injury iii. Holding individual shareholders or related corps liable is a distinction w/out a difference iv. Dissent: Didnt have common parent, not undercapitalized, must do triangular pierce (Minno not going after shareholders 1st), not required to have liability insurance f. REVERSE PIERCING: In re Phillips (Colo. 2006) i. Does Colo. Law permit reverse piercing, to reach assets of entity due to acts of dominant shareholder/inside officer? ii. Rule: A corporation may be liable for debts of controlling shareholder or corporate insider where shareholder or insider treated corp as alter ego to commit fraud or defeat rightful claim and equitable result is achieved by piercing THE CLOSELY HELD CORPORATION a. SHAREHOLDERS AGREEMENTS i. 1st way shareholders in CHC protect themselves is through shareholders agreements. Usually to protect minority shareholders. 1. Can be vote pooling agreements, usually upheld, or to control actions of directors (more controversial- right to employment, certain salary, name certain officers, or veto certain transactions) 2. Model Act 7.32: Validates shareholders agreements, even when they limit board power in certain enumerated ways a. (a)(8)- agreement removing boards duties of care or loyalty would violate PP b. (b)(1)- agreements must be unanimous, and included in charter, bylaws, or separate agreement c. (b)(3)- limits duration to 10 yrs, unless otherwise specified in agreement d. (c)- requires legend on share certificate to notify transferees e. (d)- limits availability of this section to close corps f. (f)- shareholders will not have personal liability, even if effect of agreement is to create partnership ii. Ronnen v. Ajax (NY. Ct. App. 1996) 1. Facts: Brother and sister own equal shares, have agreement that brother can vote boths shares regarding daily operations, sister reserved right to vote on reorganizations. Brother voted boths shares to adjourn meeting, sister and other directors then voted to elect new director after he left. 2. Outcome: Court interprets shareholders agreement to guarantee right of brother to vote shares on all matters relating to corporate management, which necessarily entails majority voting rights to elect a board favorable to continuation of his biz policies a. Cant render other parts of K meaningless or ineffective

3. Shareholder agreements will never give to a shareholder the right to vote on everyday business decisions this right belongs to the officers. a. SO, court fails to apply a provision giving to a shareholder the right to vote on everyday matters b/c such a provision is a nullity. b. A shareholder agreement is unenforceable under the DGCL if it violates 202 or is otherwise unreasonable. DGCL 202 c. Shareholder agreements could include negative convenants, like right to veto certain transactions, or affirmative rights to certain salaries or dividends. 4. So need to ask: a. Does agreement violate statute (see DGCL 202) b. Was it an effective purchase? c. Would it be otherwise unenforceable for PP reasons? i. Would it cause directors to violate duty of care, loyalty, waste? b. TRANSFER RESTRICTIONS i. In General 1. Used to control selection of biz associates, provide certainty in estate planning, ensure compliance w/close corp statutes, S statute regulations, or securities act exemptions 2. Imposed in charter, bylaw, or separate agreement 3. Must pass 2-part test: a. Formal requirements relating to adoption and must be conspicuously noted on share certificates (DGCL 202(a), Model Act 6.27(a) and (b)) b. Must be for a proper purpose: REASONABLENESS c. 4. General types laid out in DGCL 202(c) and Model Act 6.27(d) a. Shareholder must offer corp option to repurchase shares at a specified price or that offered by a 3rd party i. Provides liquidity, eases planning ii. Price based on: 1. fixed price 2. book value (historical cost) 3. appraisal 4. formula (complicated) b. Corp obligated to purchase shares (buy-sell agreement) c. Corp must approve transfer (prior approval/consent agreement) d. Prohibition on transfer to certain class/people (might be unreasonable) 5. Dont affect shares issued before restriction adopted, except by vote ii. CGC v. Armour (Del. Chancery 2005) 1. Facts: SRA prevents transfer to wife of any legal or beneficial interest in stock. In divorce proceedings, wife is asking court to order award stock from trust to husband/employee, and then order him to make payments. 2. Court applies two-part test from above for 1) formal requirements and 2) proper, reasonable purpose a. Reasonableness Test: Is restriction reasonable to achieve a legit. Biz purpose? b. Court looks at restriction on its face, not as applied, and upholds 3. Court holds that this IS reasonable: a. Restricts number of shareholders to avoid public filing/disclosure requirements b. Ensures alignment of employees interests w/ those of corp- loyalty c. VOTING TRUSTS i. In General: 1. It is an agreement among shareholders to give their shares to a trustee who will have voting power a. Created to overcome rule against irrevocable proxies b. Trustee retains exclusive legal title, shareholders are beneficiaries c. Work to ensure continuity of management d. Modern view is that theyre valid unless violate PP 2. Formal requirements to prevent abuse:

a. Must be in writing b. Trustee has to file the information w/the corp c. Model Act requires they be no longer than 10 yrs unless otherwise agreed 3. DGCL 218 4. Model Act 7.30 5. Often implemented as reorg plan or to prevent dissention among various factions ii. Warehime v. Warehime (Pa. 2000) 1. Issue: What is the standard of care for a trustee? 2. Facts: Allen W. created corp. HFC, made son John president and voting trustee (shares divided evenly among 3 children), trust set to expire in 1998. HFH needs to raise capital, adopts charter amendments suggested by consultants to provide continuity, would create new class of shares w/increased voting rights, independent directors to vote in case of disagreement btw. siblings, and basically extend Johns control of corp. 3. Rule: Voting Trustee does NOT owe an absolute duty of loyalty. Instead, owes lower level of fiduciary duty. 4. Concurrence: John acted not to entrench himself in a seat of power, but to ensure stability at corp. Trade-off. 5. Note that these trusts are much more restrictive than other agreements. d. CLASSIFIED SHARES i. In General 1. Corps can create more than one class of stock, with each having multiple rights. a. Purpose is to allocate control- note than voting power can be separated from economic power. b. Example: A contributes 20% of capital, B 80%. Want to have 50/50 control, so create Class A stock w/voting rights of 1 vote/share, and divide 50/50. Then create Class B stock w/economic rights attached, divide 20/80. 2. Model Act 6.01: SEE ABOVE 3. DGCL 151 4. Model Act 8.06: AOI may provide for staggering terms of directors by

dividing the total number of directors into two or three groups, with each group containing one-half or one-third of total. Chosen at annual meetings for terms of 2-3 years.
5. Model Act 8.03: Number and Election of Directors a. A board must consist of one or more individuals, with the number specified in the AOI or bylaws b. The number of directors may be increased or decreased by amendment to, or in the manner provided, in the articles or bylaws c. Directors are elected at 1st annual meeting and each thereafter unless staggered under 8.06 ii. Benchmark Capital v. Vague (Del. Chancery 2002) 1. Facts: Corporation (Juniper a financial company) needs additional capital. Benchmark was venture capitalist. CIBC agreed to provide additional investments. Preferred stock CIBC owns Class C and majority; Benchmark owns Class A and B and minority. Benchmark has PROTECTIONS IN CHARTER (granting a series (A and B separately) vote on corporate actions that would materially adversely change the rights, preferences and privileges of the series of junior preferred stock; and a class (A&B together) vote before Juniper may authorize or issue, or obligate itself to issue, and other equity security SENIOR to the junior preferred stock; class vote on merger, EXCEPT where whollyowned sub.). Gave Benchmark what it thought was a VETO on the issuance of new preferred securities or on any actions that would materially adversely affect is rights/preferences/privileges. Note: CIBC also has a Series C Trump (can waive certain of the protective voting provisions) with the EXCEPTION where it cannot waive A&Bs vote if it would violate the law or when the vote to be taken is going to impact the liquidation preferences, or financial or economic rights of the Series A or Series B preferred stock. The company is effecting a merger which will result in a NEW

CHARTER, but not subject to Benchmarks veto (same result, different process, circumventing veto) Series D transaction (with reverse stock split); wholly owned sub. Merger. Results in new series A and Series B with REDUCED rights; authorized NEW Series D preferred. a. Players: i. Juniper: Credit Card Company ii. Benchmark: Initial investor, capital venture firm iii. CIBC: Canadian bank, larger investor in Juniper 2. Issue: Does issuance of a previously authorized senior security diminish/alter junior preferred shares economic rights? 3. Rule: Protective rights mustbe clearly expressed and will not be presumed. 4. For a merger to occur in Del, you need: a. Plan of merger b. Approval of board and majority of shareholders c. Restated charter d. Exchange securities 5. Holdings: a. Protective provisions dont apply b/c they didnt use word merger so Benchmark cant vote on merger i. Probable rationale: Benchmark is sophisticated investor, and Juniper will go under if merger doesnt go through. b. After merger, Benchmark cant vote on issuance of senior preferred stock diminishment of Benchmarks economic/financial rights hasnt happened yet b/c terms of junior security have not been changed yet e. CUMULATIVE VOTING f. SUPERMAJORITY VOTING (ex: 80% approval required) i. In General: 1. DGCL 242(B)(4): Supermajority requirements can be adopted by simple majority vote, a supermajority is required only to amend, alter, or repeal an existing supermajority requirement (that is in CHARTER, not bylaws?) 2. Model Act 7.27(b) provides that any amendment to charter or bylaws that adds a greater quorum or voting requirement must meet the same quorum requirement and be adopted by the same vote as required by the proposed provision ii. Mason Capital v. Kaman Corp. (D. Conn. 2005) 1. CT Statute requires supermajority voting in specified circumstances- requires 2/3 vote of disinterested shareholders for business combinations, so Kaman familys votes would be excluded as interested shareholders and Mason could block recapitalization proposal and acquire control of company. 2. Issue: Is recapitalization proposal a (A) business combination involving a merger, consolidation, or share exchange w/an interested shareholders w/in meaning of CT Biz Combo Act, or (E) reclassification of securities which increases by 5%+ of total outstanding shares, the amount owned by an interested shareholder? 3. Court finds this complies w/5% savings clause of (E), and therefore supermajority requirements do NOT apply 4. Come back to this: difference btw shareholder and director supermajority requirements, also whether needs to be in charter or bylaw under DGCL vs. Model Act g. Issuance Restrictions PREEMPTIVE RIGHTS. DGCL 157(a); MBCA 6.30 i. In General: 1. Right of shareholders to subscribe to portion of any increase in a corps capital stock necessary to maintain the shareholders relative voting power 2. Not inherent, but can be granted or denied by Articles 3. DGCL, Model Act: Opt in b/c can complicate issuance of new shares, dont want as default 4. Not common in public cos, but VERY common in CHC ii. Definition

1. Rights of a shareholder to subscribe to the portion of any increase in a corporations


capital stock necessary to maintain the shareholders relative voting power against other shareholders, grants CONROL iii. Default rule 1. No preemptive rights. There is no right in Delaware to maintain pro rata ownership. Kimberlin (since the contract was not unconscionable, shareholders could legitimately waive their preemptive rights). 2. Opt in corporation may provide for preemptive rights by including a provision to that effect in the articles of incorporation. DGCL 157(a); MBCA 6.30 iv. Types1. Right of first refusal gives an existing shareholder a right to say yes or no when new stock is issued before the corporation may issue to new shareholders 2. Right of first offer corporation merely has to negotiate with the existing shareholders before issuing to other new shareholders v. Limits 1. Who may not exercise a preemptive right? a. Shareholder who hold preferential rights to distribution or assets but no general voting rights. MBCA 6.30(b)(4) 2. What kind of preemptive rights are not allowed? a. Preemptive rights for shares issued as compensation to directors, officers, or employees. MBCA 6.30(b)(i) b. Shares issued to satisfy conversation or option rights created to provide compensation to directors, officers, or employees. MBCA 6.30(b)(ii) c. Shares issued within 6 mos from the effective date of incorporation. MBCA 6.30(b)(iii) d. Shares sold otherwise than for money. MBCA 6.30(b)(iv) 3. Duty of good faith and fair dealing will NOT be eliminated/overridden by terms of K h. DEADLOCK i. In General 1. Model Act 14.30: Court may dissolve a corporation a. In proceeding by AG if obtained articles through fraud or continued to exceed/abuse legal authority b. In proceeding by shareholder if i. Directors are deadlocked, shareholder unable to break it, and irreparable injury to the corp is being threatened or suffered, or business affairs of corp can no longer be conducted to advantage of shareholders ii. Directors or those in control are acting in illegal, oppressive, fraudulent manner iii. Shareholders are deadlocked in voting and have failed, for at least 2 consecutive annual meeting, to elect successors to board, iv. Corporate assets are being wasted/misapplied c. In proceeding by corp to have its voluntary dissolution continued under court supervision 2. Model Act 14.32: Receivership or Custodian: Court can appoint receivers to wind up and liquidate, or custodians to manage. 3. Model Act 14.34: Election to Purchase in Lieu of Dissolution: Corp may elect, or one or more shareholders may elect, to purchase all shares owned by petitioning shareholder at fair value. This is irrevocable unless court determines that it is equitable to set aside or modify. ii. Conklin v. Perdue 1. Mass. Rule: After petition by not less than 40% of stock holders, court can order judicial dissolution if deadlocked, even if corp. is operating at a profit, if it is in the best interests of stockholders. a. Corp. can continue for up to 3 yrs to settle affairs, suits, sell property, etc. b. BUT NOT for purpose for which is was established

i.

2. Judge retroactively dissolves corp back to Jan. 1996, when it determines deadlock 1st occurred, using its equitable powers. Rejects claims: draw was a loan, and did not breach fiduciary duties b/c returned records. 3. So steps outside the statute b/c: a. Dissolves corp when neither party petitioned for/ requested it b. Does it retroactively VENTURE CAPITAL i. Red Hat Case Study 1. How did it start? a. 1995, Ewing and Young started Red Hat in NC b. Staged Financing- multiple rounds of preferred stock (like in Benchmark- series A,B,C) c. Angel investor, Batten, 2 venture capital firms, Strategic partner, Intel d. So 4 individuals own 55% of company through preferred stock, but dont own common stock e. Rights attached to preferred shares will be recorded in charter- differ f. Dividends: No dividends will be paid to common stock unless equal to preferred g. Provision to avoid dilution by stock split- double common shares could make preferred have smaller % 2. Liquidation: a. Preferred stockholders get preference in liquidation b. For merger, acquisition, etc. c. Option: original payment or common stock 3. Voting Rights: a. Could get general voting rights i. Same as common holders ii. Commonly given to venture capitalists b. OR targeted voting rights i. Series of veto power over big transactions, like M&A- need 2/3 to vote c. Ask why the VC want this power, and why entrepreneur would give it to them? Not just $, but also name recognition of investors, could serve on board and bring more advice and prestige- so its more than $ to table 4. Conversion Rights: a. Mandatory conversion provisions triggered by Red Hats IPO, and all of the holders of preferred stock became holders of common stock when the IPO was complete b. Normally VC have power to force company to buy back their shares c. Normally optional conversion provision to allow VC to convert at their discretion d. Weapon of VC- can sink company, make them buy back such a large part of stock, but rarely exercised 5. Redemption: a. At some point co will make it possible to have shares publicly traded b. Also rights of 1st refusal ii. Before IPO 1. Who had power over products? Officers working under Board direction 2. What power could VC exert over company? a. Say theyre going to walk away from next round of investment b. VC can sell shares privately 3. Adlerstein case- fear he could kick people off board iii. Illustrates 1. How venture capital works 2. They have a lot of power 3. BUT entrepreneur has power in ONE way a. By taking company PUBLIC

V.

b. As soon as co goes public, all rights attached to preferred stocks go away, automatically convert to common stock, soon probably will sell and not even own majority 4. Ways that protect VC while INCENTIVE for entrepreneur to take co public CLOSELY HELD CORPORATIONS AND MINORITY OPPRESSION a. PLIGHT OF MINORITY SHAREHOLDER i. In General: 1. Classic scenario: Majority shareholder terminates minoritys employment and refuses to declare dividends 2. Usually not defined by statute, need to look at state case law ii. Donahue: 1. Majority owes minority a heightened duty (utmost good faith and loyalty under Meinhard) a. So established duty w/two prongs 2. Holding: If the stockholder whose shares were purchased was a member of the controlling group, the controlling stockholders must cause the corp to offer each stockholder an equal opportunity to sell a ratable number of his shares to the corp at an identical price. iii. Nixon v. Blackwell: 1. Del. court responds negatively to Donahue 18 yrs later 2. Minority holder makes biz judgment to buy into minority position- can bargain for specific protections through charter or bylaws, or use other remedies like shareholder agreements, voting trusts, etc. 3. Refuse court-imposed stockholder buyout for which parties have not contracted a. Fidelity to written agreements, too bad attitude iv. Wilkes (Mass. 1976) 1. Also expressed reservation w/Donahue- limit legit actions by controlling group, hamper effectiveness of management 2. ADD MORE ABOUT WILKES 3. Holding

a. Majority must show a legitimate business reason b. Minority must show a less harmful alternative
v. Elmaleh v. Barlow (Mass. 2005) 1. Court applies mechanical test for close corp: a. Small number of stockholders i. Molecule fails, has 80+ stockholders b. No ready market for stock i. Passes c. Substantial majority participation in management, direction, operation of corp i. Fails, 6 directors only own 16% of stock, original founder Elmahel owns 32%, but no longer participates 2. Fails 2/3 prongs, so denied relief vi. Leslie v. Boston Software Collaborative, Inc. (Mass 2002) 1. Facts: BSC is a CHC, Leslie is one of 3 founders and shareholders who are also employees. Friction about different compensation based on different skills, also credible complaints from other employees about Leslie. Leslie received notice of shareholders meeting where he was removed as director, but not of directors meeting directly before, where the directors removed him as treasurer. Directors then pay themselves disbursement bonus, which is a disguised dividend, without paying to Leslie even though he is still a shareholder 2. Court applies the Wilkes test a. Court must weigh legitimate biz purpose, if any, against less harmful alternative b. Not meant to impose a straightjacket, but majority should act in best interests of all concerned

3. Court finds there WERE less harmful alternatives: more training, less client contact, work from home a. Classic freeze out- take salary and divide it among other directors as a distribution b. Note Wall St. Rule doesnt work in CHC context: cant just sell shares and walk, no ready market. Also, he is not just any regular employee that can be fired. 4. But remedy is NOT a forced buyout- court has equitable powers a. Shows length court will go to enforce relationships, agreements active role b. Leslie not reinstated as officer, but put back on board, compensated for wrongful termination and loss of dividends b. THE MEANING OF OPPRESSION i. Note that results of case will differ based on definition: 1. burdensome, harsh, wrongful conduct that is visible departure from fair dealing a. focuses on CONDUCT of MAJORITY shareholder 2. breach of fair dealing, enhanced in CHC context 3. Frustrations of reasonable expectations of minority shareholder a. Focuses on PERSPECTIVE of MINORITY ii. Kiriakides v. Atlas Food Systems, Inc. (SC 2001) 1. Facts: Minority shareholders/brother and sister bring judicial dissolution action, after rejecting buyout offer following dispute with other brother who is Chairman and majority holder, about real estate transactions and decision to remain a C corp after shareholders decided to become S corp. 2. COURT rejects lower courts broad definition of minority oppression a. Departure from standards of fair dealing, b. Breach of fiduciary duty of good faith, c. Frustration of minoritys reasonable expectation, i. NC statute does this- MINORITY VIEW d. Lack of probity and fair dealing to prejudice of some members, OR e. Deprivation by majority of participation in management by minority 3. Rationale: This is too sweeping, also focus on reasonable expectations requires judicial interference at microscopic level, overprotects minority. 4. Instead, focus on ACTIONS OF MAJORITY standard based on SC statute 5. Outcome: Although NEW rule, SAME result: This is classic freeze-out a. Termination of minority shareholders employment b. Refusal to declare dividends i. Here Atlas had a lot of cash/liquidity to offer buyout, dividends c. Removal of minority from position of management d. Siphoning off corp. earnings through high compensation to majority management c. REMEDIES FOR MINORITY OPPRESSION i. Types of Remedies 1. buyout 2. appointment of custodian or provisional director 3. canceling, altering charter or bylaws, or corp. resolution 4. directing or prohibiting any action of corp, shareholders, directors, others 5. selling all property and franchises of corp to single person 6. paying dividends or damages 7. Some statutes empower courts to employ ANY equitable relief 8. Model Act a. 1430: Shareholders may seek judicial dissolution if i. Directors and shareholders deadlocked, irreparable harm ii. Control engaging in illegal, oppressive, or fraudulent actions iii. Shareholders cannot elect directors for 2 consecutive yrs iv. Corporate assets being misapplied/wasted b. 1432: Receivership to wind up or custodian to stay course c. 1434: Permits corp or shareholders to purchase shares of those petitioning for dissolution- avoid strategic use

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ii. Naito v. Naito (Or. App. 2001) 1. Facts: Although court finds that Sam had right to exercise authority from Buy-Sell Agreement after brother Bills death, and that decision to allow Class B shares to breack deadlock was a reasonable solution to a real problem where it is difficult to see how voters will align, there was no justification for declaring such low dividends and instead doing stock repurchase plan- increases power of majority at low price. 2. Rule: Fiduciary best approaches duties if considers beneficiaries interests and not his own personal interests. 3. Outcome: court suggests family adhere to dividend plan discussed earlier but abandoned a. Court usually leaves this to corp boards discretion- biz judgment based on future profitability, needs b. BUT must be made in good faith and reflect legit biz interests rather than just those of who is in control CONTROL OF THE PUBLICLY HELD CORPORATION a. Introduction i. Greater deference to public than CHC less judicial deference, Wall St. Rule ii. Separation of ownership from effective control: Berle and Means 1. centralization of authority economizes information costs, but increases agency costs (ALTHOUGH THIS ISNT AGENCY LAW!) iii. Focus on mechanisms to force directors to put interests of shareholders first 1. Legal: Fiduciary duties of care, loyalty 2. Options to tie compensation to corp. performance 3. Public reporting disclosure 4. Financial journalists, legislative oversight, stock analysts (buy/sell!) iv. State law governs WHAT ISSUES shareholders can vote on v. Federal law governs PROCEDURE 1. Securities Act of 1933 (primary market transactions- corp to public) 2. Securities Exchange Act of 1934 (secondary and more comprehensive, among investors) 3. Note: These laws focus on DISCLOSURE, not on meritsas long as you disclose the risks to the public, the government wont stop you from selling your stock vi. WHO are shareholders? 1. more individuals (1920s-1980s) Now rise of institutional investors (mutual, retirement, hedge funds) vii. WHAT can shareholders vote on and WHEN? 1. Can vote on a. Directors b. Extraordinary transactions (like mergers) c. Change t charter or bylaws d. Shareholder proposals 2. AT a. Special meeting b. Annual meeting c. Need record date, and notice beforehand d. Can vote in person or by proxy 3. HOW are votes counted? a. Most decisions require majority vote b. Can impose supermajority requirements c. Directors are elected by a plurality viii. Note: A TENDER offer is an offer to buy a controlling block of shares (like 51%) b. K-Mart Case Study i. Institutional investors opposed CEOs plan for heavy capital investment in old stores, and targeted stock proposal to raise capital by issuing classes of common stocks tied to K-Marts subsidiaries, like Sports Authority. ii. Plan failed, CEO removed from board, K-Mart went bankrupt. Did institutional investors play good role?

iii. DGCL 141(a): Every corporation organized under this chapter will be managed by or under the direction of a board of directors. iv. MBCA 801: All corporate powers shall be exercised by or under authority of a board of directors. v. Case shows modern trend- increase in corporate governance activism by large shareholders like private equity funds and public pension/labor funds, and socially-responsible investment funds c. Shareholder Voting i. Unisuper v. News Corp (Chancery 2005) 1. Issue: Do shareholders have power over decision to sell company? a. Poison Pill: If new shareholder approaches to buy more than 20%, existing shareholders have right to get stock at cheaper price- dilutes and dissuades. OR until someone buys 20%, corp can buy back your right for 1 cent- for friendly takeover. 2. Facts: Corp is re-incorporating in DE, where shareholders dont have control over poison pills, from Australia, where corp. needs permission from shareholders to do this worried about loss of control. Board decides to extend poison pill beyond sunset provision in violation of agreement, plaintiff shareholder sues. Court doesnt reach issue of whether this is enforceable K, just dismissed motion for summary J. 3. Rule: Under DE law, board POLICY is revocable at any time. 4. But here there might be a CONTRACT: a. DGCL 141(a): Limitations on powers of board MUST be in certificate of incorporation. b. BUT doesnt say boards cant enter into Ks c. Shareholders are the ultimate holders of power- right to vote on fundamental changes d. So court says there might be a K and remands, w/ a little speech about corp. governance ii. Blasius v. Atlas (DE 1988) 1. Facts: Blasius is new shareholder of Atlas, bought 9% through junk bonds, now wants Atlas to engaged in leveraged restructuring and declare dividends- clearly not a good idea, but Blasius wants to pay back bonds. Blasius delivers consent recommending transaction and expansion of board. Atlas puts 2 more people on, staggered terms, to block board takeover. 2. Issue: Does board fulfill fiduciary duty when it acts for main purpose of preventing a majority of shareholders from expanding board and electing new majority? 3. Outcome: Although court decides that Atlas actions were in good-faith, not selfish, and not in violation of black-letter law, uses EQUITABLE powers to overturn a. No matter how bad Blasius proposal is, shareholders have right to vote on it b. Importance of democracy, educating shareholders, division of powers 4. Rule: Board can take certain steps to defeat change in corp. control a. Board can normally take steps advisedly, in good faith, and if reasonable to legit biz purpose i. But for some reason here there is CLOSER SCRUTINY ii. Both Unisuper and Blasius are odes to shareholder power d. Federal Proxy Regulation i. Definition of Proxy Solicitation 1. Set out in 14(a) of 1934 Act a. Regulates information (3) b. Format (4) c. Preliminary and Definitive proxy must be filed w/SEC (6) d. Shareholders list for direct communication (7) e. Procedural and substantive requirements for including shareholder proposals in company proxy (8) f. Cause of action for false/misleading statements of material fact/omissions g. Prohibits certain solicitations (10)

h. Exceptions to sending written proxy statement before solicitation, procedures for communicating w/certain entities (like banks), and other regulations 2. What is a proxy solicitation? BROAD definition a. Includes both direct and indirect communications b. Request for a proxy, request to execute or not, or to revoke a proxy, furnishing of a form, or other communication reasonably calculated to result in procurement, withholding or revocation of a proxy 3. LILCO v. Barbash (2d Cir. 1985) a. Facts: Defendants are unsuccessful candidate for county executive and a citizen committee who oppose LILCO for construction of a new nuclear plant, mismanagement, and other reasons. They ran an ad in the paper criticizing LILCO and saying the public would get lower rates if public. Matthews (D) ALSO bought shares in LILCO- enough to launch contest. Shareholder meeting is coming up- TIMING can be important. LILCO argues this is a proxy solicitation, w/false and misleading info. b. Issue: Can a newspaper ad constitute a proxy solicitation? c. Rule: Definition of proxy solicitation is broad- includes communications reasonably calculated to achieve such result, directly or indirectly, or constitute a step in the chain of communications designed to ultimately accomplish such goal (SEC v. Okin), based on a totality. i. So this does NOT mean only things that are directly targeted at shareholders (would permit easy evasion) or that only deals w/matters of general public concern (like Napalm during Vietnam) d. Note that implications are that Ds would need to file solicitation w/SEC, could be liable for false/misleading info or omissions, wouldnt have 1st amendment protection. Remanded for further discovery. e. DISSENT argues that this is political debate during election season, aimed at effect on customers and not shareholder profits/internal reform, should get 1st amendment protection. ii. Liability for Misleading Proxy Disclosure 1. Found in 14(a)(9) 2. Definition: Material fact is: a. Information a reasonable shareholder would consider important in deciding how to vote- a substantial likelihood that it would alter the total mix of info available. (TSC Industries v. Northway) b. Always fact-specific, generally financial facts, but also can be environmental 3. Problem 8.1 a. Astoria Bank offering $18/share, North Fork offering $19, to Greater NY, which is in serious trouble b. North Fork was serious, motivated investor who already owned part of Greater NY, had ability to compete w/Astoria c. BUT the board may have preferred Astoria over North Fork, because of offer of continuing employment, doesnt give shareholders a lot of info about other offer d. Holding: Court decides that this was an omission of material information, but no damage b/c shareholders would have voted that way anyways. iii. Shareholder Proposals: Intro to Rule 14a-8 1. These are one of shareholders few proactive powers- can require corp. to include resolutions in companys proxy statement 2. Rule: A shareholder can force a corp. to include a resolution in the proxy statement if: a. Requirements i. Shareholder must own lesser of 1% or 2,000 shares in company ii. For at least one year prior iii. And must submit proposal at least 120 days before date of proxy solicitation

1. so that corp can review, get no-action letter from SEC b. Exceptions (13) i. Improper under state law (infringes on managerial authority) ii. De minimis requirement: not relevant if relates to less than 5% of total assets, net earnings, or gross sales, 1. unless it is a significant social policy issue that relates to business iii. Relates to ordinary business & management functions 1. This is most litigation exception 2. Cracker Barrel: in 2002, shareholders succeeded in including a proposal for EP of homosexual employees, and board complied iv. Relates to elections 1. BUT sometimes okay- like if any board member doesnt receive 51% of positive vote, should resign- depends v. Also NOT personal grievances 3. Note that under 14(a)(7), shareholders can request shareholder list and mail it at their own expense, but this is very costly and time-consuming 4. ALSO: Any proposal is still ONLY a PROPOSAL- even if it gets 95% of shareholder vote, board doesnt have to act on it if doesnt want to. But if dont pass can be free advertising, embarrass corp into acting. 5. Two general classes of shareholder proposals: a. Socially-responsible proposals i. See Cracker Barrel example above- about employment policies ii. Problem 8.2: 1. Proposal that CVS reformulate its cosmetics to be free of chemicals linked to cancer, birth defects, mutation, and encourage other manufacturers/distributors of products sold at CVS to do the same. 2. Some companies in the industry have already done this (like Boots in UK), EU has directive, CA just passed similar bill. b. Relating to Corporate Governance i. Note that both have a trend towards more success 6. SEC No-Action Letters a. Corp must get this before making decision, by submitting the issue to SEC along w/its reasons for possible exclusion and maybe opinion of own atty. b. Generally, SEC wont tweak it- doesnt want to become editor c. Rationale of limiting proposals: Efficiency, and state corporate law (business affairs of corp are managed by directors, NOT shareholders) iv. Shareholder Proposals: Bylaw Resolutions 1. General Rule: Shareholders have right to vote on board of directors, fundamental transactions, amendments to charter/bylaws, and conflict of interest transactions. 2. BUT these voting events must be initiated by the BOARD, w/the exception of bylaw amendments. a. So remember shareholders ALWAYS have the power to change bylaws under state law. The charter (and other things discussed above) can only be changed by initiation of directors first. 3. So proposals must pass 14(a)(8)(i)(1) to have success- SEC must interpret state law 4. Apache v. NYCERS (S.D. TX 2008) a. Facts: Ps are NY pension funds and NYC comptroller, submitted a (very detailed, interesting construction) proposal for inclusion in proxy statement regarding company discrimination policy. b. Issue: Does this relate to ordinary business functions and therefore should be excluded as an exception, and what weight does SEC no-action letter get? c. Rule: SEC no-action letter is non-binding, persuasive authority (no force of law)

d. Rule: If shareholder submits proposal in accordance w/regulations, must be


included unless it falls w/in one of the substantive exceptions to 14(a)(8) i. Business function exception: This is a case-by-case basis, but must be mundane in nature, and not relate to any substantial policy. ii. Also, the proposal must be read as a WHOLE, not by parts. e. Outcome: The court EXCLUDES this proposal as micro-managing. While 1-6 are aimed at discrimination, the rest deal w/ordinary business functions (marketing, sales, corporate charitable donations. v. Shareholder Proposals: Nomination of Directors 1. AFSCME v. AIG (2d Cir. 2006) a. Issue: Can a shareholder proposal requiring a corp to include certain shareholdernominated candidates for the board on the ballot be excluded because it relates to an election under 14(a)(8)(i)(8)? i. Ps are trying to argue that this relates to elections in general, the exclusion under 14(a)(8) uses an, so means specific election b. Rule: Election exclusion under 14(a)(8) applies to shareholder proposals that relate to A PARTICULAR election, not a proposal (like AFSCMEs) that would relate to election procedure in general c. BUT: A year later, SEC issues statement that the election exclusion applies to any proposal that could result in an contested election- rejects the 2d Circuits interpretation. i. Rationale: Integrity of election process: want to know who is responsible for information, dont want to make it easier to slip names through? 2. CA v. AFSCME (Del. 2008) a. Facts: Shareholders want to include proposal to amend bylaws to reimburse candidates for board for reasonable expenses (printing, mailing, legal, etc) b. Holding: Court finds that this proposal violates DGCL 141(a) that affairs of corp should be managed by directors, and is a contractual agreement that could cause the directors to violate their fiduciary duties (back-stop) c. Rationale: A director could be nominated for BAD reasons (personal, petty, or w/interests adverse to corp). This rule would take away boards discretion to deny reimbursement in these cases, and therefore violate fiduciary duty to corp. i. So this mandates the decision itself, not just the process. ii. Board cant contract away its fiduciary duties d. Compare to Unisuper- comes out differently? Court discusses Paramount v. QVC, where no shop provision of merger agreement violated fiduciary duties. e. Enron and Sarbanes-Oxley i. Facts: Enron was an energy-trading corporation, lobbied for deregulation, announced it was off on income reported by $586 mil, and eventually announced had over $34 bil in debt (including off-balance sheet). ii. Problems 1. Special Purpose Entities a. Created entities that posed as partnerships w/independent investors, but actually financed by Enron and controlled by Enron employees, to keep them off the books (like CHEWCO) 2. Fraudulent Asset Sales 3. Derivatives-Trading (not always illegal, but here it was) 4. Braveheart Deal (technology, rights dont exist) iii. Enron showed failure of system: employees, investors, analysts, accountants, law firms- all didnt point it out iv. Regulatory Response: SOX 1. Standards for Audits (Peek-A-Boo) a. Public Company Accounting Oversight Board- 5 members appointed by SEC for 5-yr terms b. Authority to establish rules for audits, and consider standards suggested by professional orgs

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2. Internal Controls 404 3. CEO Certification a. CEOs and CFOs must certify accuracy of companys financial statements 4. Auditor Independence a. Conflicts of interest between audit services and other services (consulting, setting up system) as business for Big 5 accounting firms b. Prohibits auditors from providing non-audit services (except for tax), board can make specific exemptions 5. Audit Committee w/independent directors a. Every public company must have one, disclose whether there is at least one financial expert 6. Increased lawyers responsibilities (to report violations) 7. Federal government stepping into area of traditional state control 8. Also include rules for disclosing material off-balance sheet transactions, must state if have a code of ethics, rules for reporting restatements of financial results, real-time disclosure, whistleblower protection, expanded SEC power to remove officers, securities analyst independence, and enhanced criminal penalties for destruction of docs and securities fraud CONTROL OF THE PUBLICLY HELD CORPORATION; DUTY OF CARE a. Directors Duty of Care and the Business Judgment Rule i. Model Act 8.30: Standards of Conduct for Directors 1. Each director shall act in good faith and best interests of corp 2. When discharging duty of oversight, must be with care a person in similar situation would reasonably believe appropriate 3. in discharging board duties director must disclose to other board members information material 4. board members entitled to rely on officers, public accountants, legal counsel, committee under certain circumstances ii. In General: 1. Directors have two duties a. Care b. Loyalty (which includes good-faith (see Disney), but used to be associated with Care (see Caremark) i. WHY IT MATTERS: EXCULPATION 1. Cant exculpate against duty of loyalty: for acts/omissions in bad faith(DGCL) or intentional harm to corp (Model Act) 2. Found in a. Model Act b. Not DGCL, but DE case law (and most states interpret their statutes based on DE case law in this area) 3. Who is principal? 4. BUT directors have protection: BJRliability rarely imposed for bad judgment, because law presumes directors act informed, in good faith, and in best interests of corp a. This is a hurdle for Ps to overcome b. Rationale: Encourage directors to serve, limit judicial interference 5. So claims are a. Waste (Disney) b. Bad decision (Van Gorkom, but Gagliardi) c. Oversight- must be sustained and systematic (Caremark, Stone) d. Bad faith/malice e. Disloyal/interested 6. If loyalty, will get day in court. If care, probably get exculpated. 7. And responses are from BJR: a. Informed manner b. Rational business purpose c. In good faith

d. Without personal interest iii. Gagliardi (Del. 1996) 1. Shareholders claim director violated duty of care by buying a new plant and research facility, buying Steak-Ums, spending money on business consultant, shipping inferior products, and failing to pay certain manufacturers/suppliers 2. BJR: Where director is disinterested and independent, there can be no liability for corporate loss, unless facts are such that no rational business person could authorize such a transaction if attempting to act in good-faith a. RULE: DIRECTORS CANNOT BE LIABLE FOR A MERE BAD DECISION i. But see Van Gorkom- can be liable if not informed, deliberate ii. And note that 99% of time, will be exculpated against this (b/c is part of duty of care) 3. Outcome: These are poor business decisions, but director is NOT liable 4. Rationale This case is good for WHY WE HAVE BJR: a. Shareholders are in best position to diversify risks b. Shareholders dont WANT directors to be risk-adverse- they benefit, higher return on investment c. Officers typically have little financial stake in corp- disjunction between risk and reward would deter service b. The Decision-making Context i. Smith v. Van Gorkom (Del. 1985) 1. Facts: Trans Union looking for ways to take advantage of potential tax benefits, decides on merger deal to sell at $55/share, shareholders overwhelmingly approve. 2. Rule: Directors have duty to act in an informed and deliberate manner, and cannot abdicate that duty to shareholders alone. DGCL 251(b) a. Compare with Gagliardi b. And remember exculpation will protection against this duty of care claim 3. Rule: Directors are protected from relying in good-faith on reports made by officers under DGCL 141(e) 4. Outcome: Court holds that decision to merge and subsequent efforts to amend/cure merger were NOT an informed business decision a. Role: Board was not adequately informed as to Van Gorkoms role in the transaction- proposing the sale/price (also close to retirement!) b. Price: Were uniformed regarding value of company- $55/share based on calculations for LBO, not actual value. Cant look just at historical value (which this price exceeded)- company historically undervalued. c. Haste: Board was grossly negligent for approving merger after only 2 hours of deliberation, w/out prior notice, no emergency, w/out documentation. i. This deal went through in only a week! ii. Market test was never going to work, couldnt really consider other options c. The Oversight Context i. In re Caremark (Chancery 1996) 1. Issue: Should board be liable for violations of ARPL (paid fees for monitoring patients, including Medicaid/Medicare, and sometimes monitoring physicians were also referring physicians). Pled guilty after two indictments to mail fraud and criminal/civil damages. What is a board of directors duty of oversight? 2. Old Standard: Courts interpreted prior case law (Graham) to mean that absent suspicion, board has no duty to install and operate a system to ferret-out wrong-doing- can assume integrity. 3. Court decides this is too narrow. Instead, directors have a duty to ensure an info and reporting system. 4. BUT here doesnt result in liability: a. Settlement fair and reasonable- Board informed actions were legal b. ONLY A SUSTAINTED AND SYSTEMATIC FAILURE WILL RESULT IN LIABILITY- must rise to grossly negligent statement

d. The Waste Standard


i. Disney (2006 Del.) 1. Outcome: Court affirms Chancerys decision that Disney/Ovitz did not breach K, fiduciary duties, or commit waste. 2. Claims Against Ovitz a. Before taking office? NO- generally no duty to negotiate a fair K w/someone else, not a de facto officer b. Based on conduct during termination? Ovitz had not duty to suggest board terminate him for cause, and was unwillingly terminated. 3. Rule: If business judgment rule is overcome, burden will shift to board to show ENTIRE FAIRNESS a. But here Ps dont overcome this (if they did, Disney probably would have settled) 4. Claims Against Disney a. Care i. Court holds there was NO error in failing to gather information, make an informed business decision. ii. Board hired independent consultants, ran analysis, papered decision. Just because you dont follow best business practices doesnt mean you violate duty of care. Also, believed Ovitz was good idea- great reputation in Hollywood, good public reaction to press release. b. Good Faith i. Threw this in to get around exculpation clause in charter ii. Argue over definition of good-faith (Ps are trying to define it like D of C) 1. Intent to harm? YES 2. Lack of due care/gross negligence? NO 3. Intentional, conscious disregard of duty? YES c. Waste i. Definition: An exchange so one-sided that no business person of ordinary, sound judgment could conclude fair consideration- rare, unconscionable, need to squander/give away assets. 1. So this is a TOUGH standard- almost no one ever wins. 2. Probably falls under duty of care 3. BUT overcomes BJR (if it is true, no rational biz purpose exists) ii. Here, had rational business purpose for executive compensation packageinducing Ovitz to leave current job- and he didnt purposefully get fired/board considered firing for cause and couldnt find reason (not insubordinate, liar, taking gifts wrongly). e. The Role of Good Faith i. Stone v. Ritter (2006 Del.) 1. Issue: Need to determine whether this is a good-faith claim, or due care- that will affect whether board can be exculpated or personally liable, which will determine whether they are disinterested for purposes of excusing demand in derivative suit. 2. Facts: AmSouth paid fines for failure of employees to file Suspicious Activity Reports as required by Bank Secrecy Act and anti-money laundering statutes. What is the duty of oversight? 3. Rule: Good-faith is NOT an independent fiduciary duty, but rather part of loyalty. a. So loyalty has TWO components i. conflict of interest (disloyal/interested), and ii. good faith b. AND NOW DUTY OF OVERSIGHT IS PART OF LOYALTY, NOT CARE! c. SO, NOW YOU CANT EXCULPATE FOR OVERSIGHT FAILURE 4. Discusses Caremark standards for Oversight a. Directors utterly failed to implement any reporting or info. systems/controls, OR b. Having implemented system, consciously failed to monitor it

i. In either case, requires KNOWING violation


5. Rationale: This encourages director oversight and good faith by limiting exculpation, but making standard high (knowingly) to ALSO encourage service by qualified people. a. So here, doesnt result in liability- had compliance dept and oversight committee, hired independent consultant, written polices and procedures, therefore not liable for employees criminal violations. f. The Shareholder Primacy Norm i. Dodge v. Ford 1. Facts: Dodge brothers were minority shareholders and sued to enjoin Ford from expanding production/cutting prices of cars, and to force them to declare dividends a. Minority oppression remedies for CHCs didnt exist at this time- now could use b. Want to sell their stock, Ford is making it hard 2. Rule: A business is organized and carried on primarily for the benefit of its SHAREHOLDERS. a. Powers of directors should be employed to that end, and not confused with duties to general public. 3. Outcome: Court forced Ford to declare dividends, but did not enjoin production/price plans. Although corp must benefit shareholders primarily, there is still some discretion for directors to consider non-shareholder interests, as long as there is some long-term connection w/shareholder interests. ii. Kahn v. Sullivan (Del. 1992) 1. Issue: Waste and CHARITABLE CONTRIBUTIONS. Board decided to make charitable contribution to start art museum to house former CEO and founders collection. Shareholders argue that decision was not deliberate or informed (duty of care) and that constituted waste of corporate assets. Also note there was a formation of an independent committee, because technically Dr. Hammer is on both sides of transaction- CEO and personally owns collection- but this isnt really a duty of loyalty case?? 2. Rule: Charitable contributions are expressly authorized by DGCL 122(9) (and Model Act in parallel provision) a. Authorizes ANY REASONABLE gift for charitable/educational purposes b. Reasonable is defined by provisions of IRC (corp can donate up to 10% of revenue and still receive tax deduction) 3. Outcome: Given net worth of company, annual net income and tax benefits, this was reasonable. Court rejects lack of due care/gross negligence argument for decision. iii. Problem 9.4- Marriott 1. $50 mil of $940 mil in profits come from selling porno movies in hotels 2. Should it consider banning these movies, like Omni hotels has done- also founded by Mormons, markets itself generally as family hotel. 3. Note that in the area of charitable donations, corporations have enormous leeway, but does this always help public image? Is this a good thing? DUTY OF LOYALTY a. Model Act 8.60-8.63 discusses Conflict of Interest Transactions b. Conflict of Interest Transactions Generally i. Introduction 1. There is a general rule for directors to put the corporations interests over their personal interests as directors 2. This includes a rule against self-dealing, along with special rules for majority/controlling shareholders, and expropriation of corporate opportunities. 3. Statutory procedures can remove the taint 4. These claims get more scrutiny than duty of care claims, dont get initial protection by BJR. 5. AND even when corps follow company procedure, courts will still be skeptical: majority shareholders can threaten to remove directors. 6. What is the courts response? a. Used to be that transactions were voidable b. BUT now courts see

VIII.

i. Advantages of some of these transactions ii. Modern-day realities that often directors serve on several boards 7. Steps to take: a. First, identify someone on BOTH SIDES of transaction i. This eliminates BJR b. Then, look for procedures- did they try to CLEANSE the transaction? i. See Kahn- forming independent committee w/outside legal counsel c. Successful w/cleansing transaction? i. BJR could pop up, or a different standard ii. Hollinger Int., Inc. v. Black (Chancery 2004) 1. Facts: Black is a controlling shareholder (voting rights based on control of other entities, although personal economic stake only 15%). Also, most of internationals executives, including Black, were directly employed and owned stock in Ravelston, a company that Black controls. There is dispute about non-compete agreements, and Strategic Proposal (some sort of sale of Hollinger assets). Black shares confidential information w/potential buyer, Barclays, pursues negotiations outside scope of proposal, and represents to others that company has only minor liquidity problems. 2. Holding: Black diverted a corporate opportunity for himself and violated the duty of loyalty by: a. Purposely denying International and corp. op and diverting it to himself i. False assurances, sharing of confidential info, inducing Barclays to go outside of process b/c of time and competition b. Misleading fellow directors and failing to disclose dealings c. Improper use of confidential info to advance his personal agenda d. Using Barclays to pressure Lazard 3. This case shows BLATANT self-dealing: Induces Barclays to buy Inc., instead of Telegraph (asset of International) c. Majority or Controlling Shareholders i. General Rule: 1. A majority or controlling shareholder on both sides of the transaction bears the burden of proving ENTIRE FAIRNESS of its actions, that of the fairness of the procedures developed to approve such a transaction, and the fairness of price (Weinberger) 2. Issue: WHAT is a controlling shareholder ii. Williamson v. Cox (Chancery 2006) 1. Issue: Were cable companies (Comcast and Cox) controlling shareholders for purposes of this transaction and was transaction unfair to minority shareholders? 2. Rule: When a controlling shareholder stands on both sides of the transaction, the transaction will be viewed under the ENITRE FAIRNESS standard, as opposed to more deferential BJR 3. Control Test has two prongs: a. Owns more than 50% of voting power in corp, b. OR exercises control over the business affairs of the corp i. Must be actual control, not just potential ii. And need not be over daily operations- just PARTICULAR transaction being challenged. 4. Here, 3 factors combined (no one controlling) make cable companies controlling: a. Appointed directors to board (together could elect 4/5 Series B directors needed to approve this transaction) b. Were At Homes only significant customers- dependent on revenue- leverage c. Had veto power- although never used it, was still coercive- also leverage 5. Note Prof. Wells thinks this still was a close call d. Procedural Mechanisms to Limit Judicial Review i. DGCL 144 1. No transaction shall be void or voidable if a. Material acts are disclosed and majority of disinterested directors or shareholders vote, and it is

b. fair ii. Benihana of Tokyo, Inc. v. Benihana, Inc. (Del. 2006) 1. Facts: Board approves issuance of preferred stock to finance restaurant upgrades and needed capital renovations. BUT this will dilute familys (BOT) control, kids afraid second wife will gain control. a. Who is on both sides of transaction: Abdo is on board at Benihana, also owns 30% of BOT, and is director at BFC, who wants to buy new stock. And is conducting negotiations. 2. Outcome: Court applies DGCL 144: a. Made proper disclosure to board, or board knew b. And all directors, except Abdo, voted to approve transaction c. And no proof that Abdo misused confidential info 3. So transaction scrubbed clean, but court still applies BJR (but deferential) a. Court defers to Chancerys determination that board approval of this transaction was a valid exercise of business judgment, for a rational purpose. iii. Problem 10.2 1. Facts: CALPERS claims breach of loyalty after Lone Star repriced its executive stock options- re-incentivizes managers when stock is under water. There are committees of employees that approve directors option repricing and vice-versa, but is this quid pro quo? 2. CALPERS proposes shareholder resolution to limit conflicts of interest- people working for Lone Star that also work for other companies that work w/Lone Star, or for companies owned by CEO Coulter. 3. Shows how you need to think through duty of loyalty claims- sometimes there will be an obvious person on both sides, sometimes need to show another way people are interested, even if cant point out someone specifically on both sides. iv. In re Wheelabrator Tech, Inc. Shareholders Litigation (Chancery 1995) 1. Facts: Waste bought shares of Wheelbrator (WTI) and put 4 people on board, then decide it better fish or cut bait- merge. Board approved transaction, and then shareholders. Also got independent fairness opinion. 2. Duty of Care Claim a. Court grants summary J dismissing it- vote by majority of disinterested shareholders who are informed of material facts. 3. Duty of Loyalty Claim a. There are two kinds of duty of loyalty claims: i. Run of the mill: director and corp 1. Rule: If you have approval by majority of disinterested shareholders OR directors under DGCL 144, you get BJR review instead of entire fairness ii. Corp and controlling shareholder (WHICH IS THIS CASE) 1. Rule: Remains entire fairness standard, but burden switches to plaintiff if there is approval by majority of minority shareholders. 2. Rationale: even w/vote, we want a closer eye on this type of transaction- majority could pressure minority- power deferential. 4. So: ANALYSIS TO RUN CHECK a. First, look for conflict of interest i. This rebuts the BJR b. Next, look for a controlling shareholder i. YES 1. Then look for informed and disinterested shareholder or board vote a. NO total fairness on defendants b. YES total fairness on plaintiffs ii. NO

IX.

1. Then look for informed and disinterested shareholder or board vote a. NO total fairness on defendants b. YES BJR standard (waste is only claim left- get to jump over BJR, but court might still reject, see Disney) CORPORATE OPPORTUNITIES; LITIGATION TO ENFORCE DUTIES a. In General i. Corporate opportunities are under the duty of LOYALTY, in addition to general self-dealing ii. Analysis 1. First, was there a corporate opportunity? DONT OVERLOOK THIS! Term of Art 2. Second, did the corporation properly reject it? b. Three Tests i. Interest or Expectancy Test 1. precludes acquisition by corp officers of opportunities in which the corp has a beachhead- legal or equitable expectancy growing out of a preexisting right or relationship ii. Line of Business Test 1. whenever a managing officer becomes involved in an activity intimately or closely related to existing or prospective activities iii. Fairness Test 1. ethical standards- what is fair and equitable under the circumstances? iv. ALI Test 1. AN op that the director becomes aware of through a. In connection w/performance of functions as director or under circumstances which would reasonably lead officer/director to believe person offering op expects it to be offered to the corp, or b. Through use of corp property or information, if resulting opportunity is one that director should reasonably expect to believe would be of interest to corp 2. Any op to engage in biz activity of which senior exec becomes aware and knows is closely related to a biz in which the corp is engaged or expects to be engaged 3. Note that ALI also suggests mandatory disclosure, giving corp opportunity to reject, and specifying that the rejection must either be fair or approved in a manner satisfying the BJR, or rejection is ratified by disinterested shareholders, and rejection is not a waste of corp assets. c. DGCL 122(17): Every corp shall have power to renounce in certificate of incorporation or by action of board, any interest or expectancy of corp in specified business ops or classes of them i. Hasnt really been litigated, not sure what this will lead to d. Broz v. CIS (Del. 1996) i. Facts: Broz is President and sole shareholder of RFBC, also on the board at CIS. Enters into a transaction to acquire a cellular license called Michigan-2. Pre-Cellular was contemporaneously involved in acquiring CIS, and also interested in Michigan-2 opportunity. ii. Issue: What is a directors duty of loyalty regarding corporate opportunities, particularly where corp in its current mode did not have an interest, but might have changed b/c of acquisition? iii. Rule: Guft v. Loft Test for Corporate Opportunities (NO ONE factor is dispositive) 1. Officer or director may not take opportunity for his own if a. Corp is financially able to take advantage of op b. Op is w/in line of corps business c. Corp has an interest or expectancy in the op d. By taking op, officer will be in position inimitable to his fiduciary duties 2. But may take if a. Op is presented to director in his individual capacity b. Op is not essential to corp c. Corp holds no interest/expectancy d. Director did not wrongfully employ corp. resources to pursue op

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iv. Rule: A presentation to the board re the op is NOT a necessary pre-req to finding of nonliability, although it can provide a safe harbor 1. Here Broz spoke w/CIS board members, who said it was okay (note board was replaced after acquisition) v. Rule: Directors right to appropriate a corp op depends on circumstances at time, w/out regard to later events 1. Rationale: a. Certainty, predictability b. Right of director to engage in biz affairs outside of fiduciary capacity would be illusory if they needed to consider every future potential event- unduly restrict vi. Outcome: Here, Broz became aware of this in his individual role. CIS was in CH. 11 proceedings and divesting itself of these licenses. Pri-Cellular had junk bond financing, and hadnt yet closed deal to acquire. CIS knew Broz was sole party in interest in CIS, and Broz told them he was talking to Mackinac. 1. But is this so one-sided? What if we think about it as making CIS a more desirable acquisition target? 2. Note that test focuses on extremes, but often behavior will fall in middle of spectrum e. Problem 10.4: E-Bay i. Corporate Opportunities: Goldman Sachs funneling potential corp ops to directors of E-Bay to get in on lucrative IPOs it is underwriting, possibly to reward and encourage continued business between the companies. ii. What Chancery Court said 1. E-Bay financially able to invest 2. E-Bay is in line of financing (had over $550 mil in securities, many big companies like Google, Microsoft do this) 3. And op to invest is integral to cash management 4. E-Bay did not have an opportunity to reject as too risky iii. So basically court thinks this is a clear appropriation of corp opportunity iv. Shows court tugging equitable doctrine to fit this behavior LITIGATION TO ENFORCE DIRECTORS DUTIES a. In General i. Really two suits: 1. Action brought against corp by shareholders to compel corp to sue- steps into shoes of corp, for harm done to corp 2. Then corp suing directors on behalf of shareholders a. Third party almost always board, but doesnt have to be ii. See Kahn, Disney iii. Although shareholder gets only small benefit (based on ownership stake, damage is to corp), get attorneys fees if successful iv. Requirements1. Sue to enforce a right of the corporation 2. Contemporaneous ownership (must be shareholders at time) 3. Standing requirement (must hold stock throughout action) 4. Demand requirement- NOT mandatory a. If demand is made and refused, get wrongful refusal case BJR standard b. OR demand can be excused based on showing that it would be futile Not BJR i. Need particular facts: not just majority ownership or that nominated by controlling shareholderdepends on care, attention, and individual sense of responsibility ii. Only game in town, board is almost never going to sue itself 5. Court Approval v. Issues: 1. Is there a reasonable doubt that directors are not disinterested and independent? 2. OR that challenged transaction was not product of valid business judgment? b. The Demand Requirement

i. Model Act 1. REQUIRES demand, cant be excused (board gets 90 days to respond) 2. Rationale: save time and money on litigation, type of ADR ii. Beam ex rel. Martha Stewart Living v. Stewart (Del. 2004) 1. Facts: Shareholder Beam sues Stewart for breach of loyalty/care by insider trading of another company stock and mishandling media attention that follows. Claims other directors are not disinterested and therefore demand excused based on various factors: relationship w/MSO before coming to board, personal friendships, actions to pressure publishing company to withdraw unflattering bio, same social circles. 2. Rule: Complaint must create reasonable doubt that director is so beholden to interested director a. Friendship is NOT enough b. There is presumption that directors faithful to fiduciary duties, can overcome by reasonable doubt c. Depends on personal benefit/detriment, or decision based on something other than corporate merits d. Fact intensive, must go director by director e. Economic benefits, even if significant, not enough (even though compensated by company owned 94% by Martha Stewart) f. Rationale: Consider risks directors would be taking to professional reputation by putting friendships ahead of corp-sit on other boards, presume want to preserve independence 3. Note: Although not entitled to discovery to demonstrate demand futility, derivative plaintiffs can used Rule 220 to inspect books, records (here Beam failed to do so and court criticizes her) c. Direct versus Derivative Claims i. As a general rule, shareholder has NO right to sue directors for stupid decision ii. Chancery Rule 23.1 1. Have to act to enforce right of corporation 2. Must be shareholder then and now 3. Demand requirement a. Excused if i. Not disinterested/independent ii. Not BJR (see Disney- derivative waste claim) b. Discovery not available until AFTER court determines you can proceed w/suit 4. Settlement approval by court iii. Tooley v. Donald, Lufkin and Jenrette (Del. 2004) 1. Facts: Class action brought by shareholders against directors for delay in closing proposed merger, claim damages as use of money they would have received ($90/share) for 22 days 2. Issue: IS this a direct or derivative suit? 3. Outcome: Court finds that the lower court incorrectly analyzed the derivative/direct dichotomy (rejects special injury test), but error was harmless b/c plaintiffs dont meet Rule 23.1- lost standing by tendering their shares in merger. Not derivative b/c corp not injured here, payments for shares went through shareholders, not corp. 4. Test for determining if direct or derivative a. Who suffered alleged harm? b. Who would receive benefit of recovery/remedy? i. Derivative recovery must go to corp alone 5. Compare to Lipton (precedent discussed in case) a. Board manipulation blocked shareholders attempt to take control of corp- this would be different from injury obtained by other shareholders- so found direct claim b. So under special injury test, would depend on whether the injury falls equally on all shareholders- then derivative (Bokat) c. Note court pats itself on the back, but this is still difficult to apply

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6. NOTE: Shareholders will prefer DIRECT, because recovery goes straight to their pockets d. Special Litigation Committees i. What happens if demand is EXCUSED? ii. These popped up in 1990s, now derivative suits must go through them 1. Led to a reduction in derivative claims- even if get over demand hurdle, another step 2. Rationale for limiting a. Keep business affairs in hands of directors b. Also perverse incentives- legal fees c. Want to balance, preserve shareholders rights w/out letting these run rampant iii. Components 1. 2+ independent directors (already there or added) 2. Carefully review claim 3. Then go back to court that has oversight- will say not going to file suit 4. Decision by committee is NOT protected by BJR a. Important distinction 5. Instead, corp needs to show a. Committee is independent b. Acted in good faith, and c. Made a reasonable investigation iv. But EVEN after this, court still doesnt need to defer to committee 1. Court can make its own independent decision (although often will defer in practice) FRIENDLY TAKEOVERS a. Structuring an Acquisition i. Merger or Consolidation 1. Merger- surviving company is one of two that entered transaction 2. Consolidation- two companies form new one 3. in both, all assets and liabilities transfer automatically when a. directors of both companies approve plan b. shareholders w/voting rights approve plan c. surviving company files plan of merger in state of incorporation 4. consideration can be stock, bonds, cash (if more than 50%, taxable), etc 5. B/c involves fundamental transaction, shareholders of target get right to vote, except for short-form 6. Selling shareholder might get right to vote if a. Charter will be amended b. Rights or privileges attached to surviving co will be changed c. Surviving co is going to issue shares = to 20% of common stock outstanding 7. voting rights can be destroyed by triangular merger, or short-form (parent co acquires more than 90% of stock) ii. Purchase of Assets 1. Assets and liabilities dont transfer automatically- more discretion 2. Shareholders get to vote if selling substantially all of assets 3. If selling part but not all of assets a. Shareholders dont get to vote b. But might get right of appraisal i. Model Act- YES, unless publicly traded and receiving cash or publiclytraded shares- market ii. Delaware- No 4. Once sale is approved, selling board adopts resolution dissolving corp, pays creditors that havent agreed to substitute debtor, cancels outstanding stock, and distributes any remaining proceeds to selling corp shareholders iii. Purchase of Stock 1. Acquirer can gain control of majority or all shares by making tender offer directly to shareholders, at premium 2. Governed by Williams Act 3. Can resist w/rights plan or poison pill

4. If get more than 90%, can consummate short-form merger iv. Appraisal 1. shareholders given voting rights usually get right to appraisal 2. always get right to appraisal in short-form merger, unless involves 2 publicly-traded cos 3. to exercise appraisal rights a. vote against transaction b. notify corp w/in specified time that might exercise appraisal rights c. actually assert those rights in time specified by statute b. Fiduciary Duties in Friendly Transactions i. Entire Fairness Standard 1. Weinberger v. UOP (Del. 1983) a. Facts: Involves merger between UOP and majority shareholder (owns 50.5%), Signal. Both publicly-traded corps. Signal makes offer based on feasibility study at $24 using UOP docs, but doesnt share w/UOPs outside board members and offers only $21/share. Get hurried fairness opinion from Lehman. Negotiates regarding stock plan/loss of personnel and payment to investment bankers, but not purchase price. Directors on both sides. b. Issue: What is the fiduciary duty of a controlling stockholder in a friendly takeover? c. Rule: ENTIRE FAIRNESS standard is required (as opposed to BJR) where directors stand on both sides of transaction. i. Fairness has TWO components (but examined as WHOLE) 1. Fair dealing- procedural a. Consider timing, initiating, disclosure, negotiation 2. Fair price- substantive a. Can use proof of value by ANY technique considered generally acceptable by biz community (discounted cash flow or other, court wont impose just one) d. Note: In footnote, court says you should have formed an INDPENEDENT COMMITTEE! e. Remember conflict of interest by itself doesnt mean transaction is voidable or punishable- 144 f. Outcome: Court says there shareholder vote was not informed because there wasnt true disclosure. This wasnt procedurally fair, because there was almost no bargaining, serious time constraints, entirely initiated by Signal, Signal directors didnt know about $24/share price. This is not fair price, because P can show $26/share based on comparative analysis and discounted cash flow. g. Remedy: Here court will give damages b/c transaction too difficult to undo. i. Can be 1. undoing transaction (although prob not if complicated?) 2. damages 3. Normally APPRAISAL a. Vote against merger b. Refuse to tender shares c. Then go to court to get appraisal ii. Independent Board Committees 1. Kahn v. Lynch (Del. 1994) a. Facts: Alcatel owns 43% of Lynch, but controls because has proportional rep on board and need 80% approval for any business combination. Lynch wanted to acquire Telco for fiber optics, but Alcatel suggested a combo w/another company, which was an indirect subsidiary of Alcatels parent co. Lynch formed Independent Committee and rejected offer, Alcatel then tried to take over, threatens hostile take-over if IC doesnt approve takeover as friendly. b. Rule: A shareholder owes a fiduciary duty ONLY if it owns a majority interest OR exercises actual control. A controlling shareholder standing on both sides of transaction has burden of showing ENTIRE FAIRNESS.

i. BUT approval of transaction by an independent committee of directors of informed majority of minority shareholders shifts burden ii. BUT NOT by mere existence of committee! Must have 1. majority shareholder must not dictate terms of merger 2. AND committee must have real bargaining power it can exercise on an arms-length basis c. Outcome: Here, burden shouldnt have shifted. Alcatel exercised actual control. Although Lynch rejected offers, eventually forced to concede b/c couldnt shop around- Alcatel could block anything. i. BUT despite sketchy behavior, on remand Chancery determines this was a fair price- so Ps dont end up getting anything anyways. 1. More generally, people probably care more about price than procedure. ii. See also American General: Committee was truly independent and formed tasks properly, but at end of negotiations issued ultimatum anyways.

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