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Biz Orgs Outline


Business Organizations DePaul Law - Prof. Andrew Gold Fall 2010
Thursday, December 02, 2010 9:58 AM

Exam

Open Book - 3 or 4 essay questions o Potential claim or question - whether there is a claim or not Would the claim likely succeed? Are there any defenses? Must SHOW YOUR WORK! Demonstrate why a particular outcome is likely o Know the cases & statutes, don't need the names (but preferred) - but use them for Gold! o Jurisdiction - have a good idea of j-d, but might put some "case of first impression" questions in there where it is more of a survey

Course Review
Broad Themes 1. Three Basic Kinds of Disputes o Principal/Agent o Owner/Owner o Owners/3rd Parties 2. What happens when one person is given control of the assets of another person? o Fiduciary Duties - Care, Good Faith, & Loyalty 3. Planning Perspective - helping someone start a business, what kind of business form is good for a particular need? o General Partnership - small business, people know one another well Do you want everyone to have a vote? Do you want to make it easy to break up the firm? o Corporations Do you need to raise a lot of $? Do you need limited liability? o Closely-Held Corporations - kind of a blend between the pros/cons of corporations & partnerships Hard to sell stock, so centralized authority can create problems for minority SH o LLCs - hybrid 4. State Law v. Federal Law - how does these broad areas fit together? o State - internal governance o Federal - disclosure issues 5. Type of Rules - default or mandatory? o When do you have default rules, how are they adjusted, and how do courts address them? o Statutory law, Common law, Contracts, Corporate Charter & Bylaws

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6. Policy - what do we want this area of law to accomplish? o Efficiency o Predictability o Fairness to the Parties o Good for Society --------------

INTRODUCTION

Relational Contract - not as definite as a discrete K (all terms contained), people are attempting to put together very long term business arrangements/ relationships between the parties Commonly, parties decide on a governance mechanism to resolve problems when they arise instead - ex. Board of Directors, majority vote Business organizations is not a law of prohibitions, but a law of enabling rules ("default rules") State is providing "off-the-rack" rules that may need adjustments Way to benefit client is not to get a bigger piece of the pie, but to expand the pie so your client can feasibly get more. One way is to lower "transaction" costs & structure a better deal. Strategies to determine "off-the-rack" rules: Tailored Default - figure out what the business people would've wanted when they drafted the agreement Majoritarian Default - fill gaps in agreement w/ terms that most people would've chosen (majority of rule/outcomes) Penalty Default - fill gaps w/ terms that one or both of the parties didn't want = penalty for not being more specific in writing -----------------

AGENCY LAW

Rstmt 3d 1.101 - Agency is the fiduciary relationship that arises when one person ("a principal") manifests assent to another person (an "agent") that the agent shall act on the principal's behalf & subject to P's control Consensual agreement between A & P P has control of the agent, but also has risk of liability (respondeat superior) HYPO: Mary, bakery owner, needs to pick up flour on a daily basis. She can enter into a new K every day for a person to pick up the flour. Or, under agency law, Mary can call her agent and give direction w/o transactional costs of specifying terms each day. Even gains the benefit of relying on default rules to fill gaps. Advantages Default at-will employment Fiduciary duties of agent - loyalty, care, candid information, etc. Legal substitute for another person - expanded presence for principal Disadvantages Agents act outside of Principal's wishes - principal is vulnerable Agents act for themselves, on their own accord, etc. ********** Community Counseling Service (Fiduciary Duty) - R worked for CCS as a salesman of fundraising services for churches, but used position to leverage personal relationships & business contacts to

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solicit business for himself. Ct: For employer, R's primary duty while employed by CCS was to promote the interest of CCS, not his own = disloyalty to employer Employee duty to: 1) refrain from soliciting personal business; 2) candidly communicate with employer; 3) decline personal gain while employed Court won't let agent "keep the fruits of his disloyalty" = fiduciary breach Duty of loyalty that agent owes to principal exists ONLY while the agent is in the relationship

Hamburger (Fiduciary Duty 2 - limits to fiduciary duty to principal) - family wire business, fight breaks out between brothers & nephew is ultimately competing against his Uncle for the old business's contacts & employees. Ct: OK, an employee is free to make logistical arrangements while still an employee. Competition w/ a former principal is OK if competition started after agent left firm Business arrangements didn't start (& weren't solicited) until DH, the agent, left the family business = no "disloyal fruit" here Employee is allowed to make use of public & "remembered info" that is not confidential Foley (Principal's Fiduciary Duties to Agents?) - plaintiff in IT firm fired after telling current supervisor about former supervisor's (& current management's) FBI investigation. Ct: For employee, BUT ONLY on Contract law "good faith & fair dealing" Principals do not owe fiduciary duties to agents, but are bound by express & implied terms of contract = no powerful duty of loyalty like an agent owes F couldn't bring tort action b/c he was only protecting his PERSONAL interest, not a greater PUBLIC interest to qualify as a whistle-blower Employment K Factors (and overcome presumption of "at-will" employment): Personnel policies/practices of employer Employee's longevity of service Actions/communications by employer reflecting assurance of continued employment Industry practices Why doesn't a principal have a fiduciary duty to an agent? P has a great deal more at risk (capital in business), so he has incentives not to mistreat the agent ************** HYPO: Jake hires Sharon, explicitly at-will/ termination w/o cause, to sell beer for him. S has an exclusive territory & K provides that S receives: 1) 15% commission on all beer sold in her territory; 2) additional 5% bonus commission. On brink of large sale & commission, Jake fires Sharon. Should the court find that every K has an implied covenant of good faith? Could Sharon reasonably rely on not being fired before a big commission, given the explicitly "at-will" K? Does the covenant of good faith supersede the agreement or is it read into (implied) in the K? Varies by jurisdiction, but some courts have used GFFD to penalize P for firing A on the brink of a sale & earning commission QUESTION: Should a contract incorporate terms that were not agreed to at the inception? Employment relationship does not remain static, so neither should K Un-predictability for employer b/c may not know which terms were "impliedly" incorporated into K by employer

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Courts are willing to fill in gaps in long-term employment relationship w/ evidence of terms implied through relationship ---------

AGENCY & TYPES OF AUTHORITY

Who has authority to make decisions for the principal? Is the principal liable for the actions of the agent? Actual Authority - principal manifests his consent directly to the agent & agent reasonably believes that the principal wants the agent to act (Rstmt. 3d Agency 2.01) Doesn't matter what the 3rd party believes/knows Apparent Authority - the power held by an agent to affect a principal's legal relations w/ third parties when a 3rd party reasonably believes the actor has authority to act on behalf of the principal & that belief is traceable to the principal's manifestations (Rstmt. 3d Agency 2.03) May exist even if there is no actual authority - agent acts w/o actual authority, but worried about 3rd party's belief c. Inherent Authority - implied term in the K between P and all who deal w/ his agents. Gapfiller for situations that doesn't fit other categories well. View as a very extended version of apparent authority - A acts w/o explicit authority from P, but given A's position it is normal to expect that A's actions were authorized. Examples - Undisclosed Principal 1. General manager takes purchases on credit b/c it's not uncommon 2. Jack owns successful grocery store & Jill buys from Jack. Jill keeps the store name & hires Jack as an employee. Jack exceeds his actual authority & takes a major purchase on credit that is unauthorized by Jill. No apparent authority b/c 3rd party had no idea that Jack wasn't the principal to begin with, but "inherent" authority. Very inefficient for agent to constantly double-check everything w/ the principal = purpose of delegation to agents Rstmt. 3d Agency 2.06 - "Liability of Undisclosed Principals," but doesn't specifically recognize inherent agency power in Restatement. d. Agency by Estoppel - similar to apparent authority, applies when 3rd party isn't dealing w/ an actual agent of the principal. Example: Random person is selling furniture to customers in A's store, not her employee. A doesn't take any action. Random sells chair for $500, then pockets money and doesn't deliver to the customer (obviously). A may be hooked by estoppel b/c she didn't act to stop the imposter from defrauding the customer = theory of reasonable, detrimental reliance e. Ratification - no actual, apparent, inherent, or estoppel authority but the principal approves of the unknown deal afterwards & doesn't take any action to "correct" = If P acted like the deal was valid, they may be stuck with it Example: Agent signs K on behalf of the P, but had no actual authority to enter into K b/c P doesn't trust A's judgment. 3rd party never got any manifestations from P that A

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was authorized to deal. A signs for 10 widgets anyway. 3rd party sends widgets, upon notice P doesn't step in to stop deal, & accepts the widgets. P then contests deal upon invoice. P is bound to the deal under ratification. *************

Blackburn v. Witter (Apparent Authority - Protection of 3rd Parties) - Widow (B) hired an investment advisor (L), employed by W Co. & later D. Witter (DW), to suggest & broker stocks for her, actually fraud. Ct: L had APPARENT AUTHORITY to act for DW; brokers can't accept the benefits of L's sale of stock to B, but deny liability for L's fraudulent misuses of the money obtained. P liable even if "innocent" of A's independent decision b/c P put A in the position to defraud = 3rd party is "more innocent" than P Apparent Authority Factors - protection of 3rd parties 1. 3rd party reasonably believes that the agent has authority from P B had a reasonable belief that L was acting on behalf of DW - she hired a professional to take care of her finances precisely b/c she didn't have any experience "Reasonableness" is an objective standard, but depends on the context of the case - B hired a financial advisor b/c she was not financially experienced 2. Principal's manifestation to the 3rd party What did the company do to manifest intent of authority to L? L was an employee & had DW's stationery/ biz cards Sent statements every month "Research services" at brokerage house are used to instill trust Sennott v. Rodman & Renshaw (Apparent Agency) - Rogue securities trader (JR) convinced fellow trader to buy into non-existent stock options w/ elaborate scheme bartering on JR's father's firm's image (R&R). Ct: Is R&R vicariously liable for the damage caused to RS by JR, son of a partner in their firm? No, R&R didn't induce RS reliance on JR; RS was not "relying" on JR as an agent of R&R, RS was relying on JR personally. Unreasonable belief that JR was R&R's agent - RS was specifically trying to keep R&R out of the equation & no manifestations from R&R that JR was acting on their behalf Imputation of Knowledge - when an agent learns something, it is imputed to the principal (agent's duty of candor) through agency law. o Fraud requires intent to defraud - RS claiming that R&R had the necessary state of mind b/c WR, valid agent of R&R, knew of the scheme. Ct: Doesn't help in this case b/c WR found out about the scheme near the end of the problem - WR wasn't "in" on the fraud Apparent Authority easily defeated b/c RS, on numerous occasions, manifested that he knew JR was not an agent of R&R. RS even took steps to exclude R&R from the scheme entirely. JR really wasn't an agent of R&R. -------------------

PARTNERSHIP LAW - Intro to Partnerships & Other Biz Forms

Introduction General Partnership - association of two or more persons to carry on as co-owners a business for profit; imputed by law o No writing or gov't action required, only "mutual manifestation of consent" = commonly imputed by law

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"Off the rack" partnership rules that are ideal for small, intimate businesses w/ mutual trust & competence Partners split management & profits/losses of enterprise equally Partnership may only terminate association w/ another partner by dissolving association & cashing out expelled partner = every partner gets a vote Ordinary decisions made by majority vote, but extraordinary decision or changes in partnership agreement require unanimity All partners are joint & severally liable for the others - unlike a shareholder in a corporation Fiduciary duty to act "fairly & honestly" w/ other partners - agency relationship imposed b/c each partner has great authority to bind the other partners

-----o Very basic business entity that can be created in a very informal way o What does it mean to be "engaged in a business" together? Ex. One person has a business & calls a friend to perform a discrete service,

promises 10% of profit. Not partners b/c not co-owners, friend has no management/control. Partnerships do split profits, but management capability is key o Really emphasizes equality of partners - default rules are relationship reinforcing & equality based (UPA 401-02) o Easier to dissolve than other business models (ex. Corporations) o Each partner is an agent for the business & one another - ability to bind the partnership

Joint Venture - associates join together to exploit a particular opportunity Less complete & permanent merger than full general partnership Joint venturers are not agents of each other & are allowed to be more self-interested Ex. Two corporations united for a single purpose, like a joint research venture, but desire to maintain their individual identities as well ------o A lot like partnerships & courts basically apply the same rules, but they're not identical Short-term general partnership to obtain a particular objective/business opportunity = LIMITED SCOPE o No merger of individual interests Way to limit the scope of fiduciary duties in all other areas than that specifically worked on in the joint venture o Affects Agency & Authority Law - what is a reasonable belief when dealing with a joint venturer? 3rd party has to do more to double check if the agent has authority to bind the joint venture.
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Limited Partnership - business association composed of one or more general partners & one or more limited partners o Limited partners have no management authority or agency - General Partners run the show o Limited partners are not personally liable for business, general partners are liable General partners may withdraw @ will, limited partners may not --------

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o Hybrid between a partnership & a corporation Limited Partners - passive investors only face risk in terms of their investment,

but not liable for legal harms caused by partnership's actions (aside from loss of stock value) General Partners - control over the operations, but also personal liability for the harms o Ex. Family business - Parents run the business & children invest in the business, but don't have any management say b/c not ready yet. Limited Liability Partnership - LLC partners personally liable for LLC debts that cannot be satisfied out of the business assets o Principals in professional firms thought that it was unfair that corporate executives were not personally liable (no vicarious liability), but they were Trend is to protect General Partners fully from personal liability - like shareholders in a corporation --------o Business that looks a lot like a partnership, but investors & partners only risk what they put in = no joint & several liability for any partner o Governance structure of the firm is the same as a General Partnership, but w/o partners' liability ********************** Byker - Accountant (plaintiff; B) & real estate agent (defendant; M) join skills to go into business together. Agree to: engage in ongoing business enterprise, raise investment funds, share equally in the profits, losses, &expenses of the enterprise. Ct: What kind of business relationship did B & M have? Partnership, if the parties associate to carry on as co-owners of a business for profit, they will be deemed to have formed a partnership relationship, regardless of their subjective intent to form a partnership o Partnership - [UPA 202(a)] - association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intended to form a partnership. NOT interested in the parties' subjective intent or understanding of the label attached to their business association Course of conduct acted as an "umbrella partnership" for discrete investments Hynansky (Intent & General Partnership) - Plaintiff (H) & Defendant (V) enter into a business venture to develop land, but land couldn't be rezoned & was sold at a loss. H sues for V's initial capital contribution & pro rata share of the business losses. Court: What kind of business relationship was formed between H & V? Unresolved & remanded; need more facts to meet the strict standard of proof of intent to enter into partnership. o V's assertions of oral agreement subject to CONTRACT Parol Evidence Rule - prevent the use of extrinsic evidence of an oral argument to vary a fully integrated agreement reduced to writing Parol Evidence rule matters & the written agreement is strong evidence for H, but not decisive under Partnership law o Partnership law is concerned w/ the acts & conduct of the parties over time to determine "co-ownership", not just their K agreements (as in Contract law)

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When the controversy is between 2 parties, stricter proof of intent to create a partnership is required

Kovacik (Sharing Profits & Losses: Asymmetrical Capital Infusions (Capital v. Labor)) - Plaintiff (K) owned & operated a contracting business & asked defendant (R) to be job supervisor for Sears renovation job. Venture failed & K demanded contribution from R for losses, R refused categorically. Court: Is R (labor) liable for losses of the venture? No, K supplied the $ & R the labor; R is not liable for 1/2 the monetary loss of the venture b/c Capital is not entitled to recover lost $ from partner who entered only Labor. o UPA 401b (Loss Sharing Default Rule) - each partner is entitled to an equal share of the partnership profits & chargeable w/ a share of the partnership losses in proportion to the partner's share of the profits - default rule links profit & loss ratios BUT where the parties contribute asymmetrically (one invests $ and the other labor), neither party is liable to the other for contribution for any loss b/c both parties have already suffered a loss Services & capital are considered equivalent in terms of start-up capital Labor should not have to sustain a "double loss" - partner who entered labor/services already lost their time and effort, they shouldn't have to also pay 1/2 $ debts o Kovacik Rule for asymmetrical contributions - If the capital partner can't get all of their contribution back, service partner does NOT make up the difference = exception to general default loss-sharing rule Kovacik rule doesn't apply if (exceptions): Labor partner is getting salary = labor must've lost all compensation Labor partner puts in a mix of capital & labor What is the counter-argument to Kovacik? Labor is being compensated, but simply very high risk situation - no limit to compensation if firm does well, but could also be great loss. Labor can take great risks b/c no loss possible = incentive to take risk w/ no harm for labor (but great harm for capital partner) What if the partnership did really poorly and is in debt beyond original capital? Any losses that exceed the total capital that was contributed would be split equally Shamloo - Plaintiff (S) & defendant (L) enter into a partnership to manufacture fabric from yarn; L entered $150,000 - 1/2 startup "capital" & 1/2 loan $, S entered "sweat equity - labor, expertise in industry. Endeavor fails. Court: 1)Is S entitled to remuneration for his "labor" to G? No, no express agreement that S's "labor" contributions would be compensable upon dissolution. 2) Should a labor partner have a "right" to get money for their services upon dissolution (extend the Kovacik rule?) No, they're equal partners. Labor shouldn't get paid if capital isn't getting paid. o Tiffany v. Short - each partner entitled to capital contribution returned, pro rata if necessary. HOWEVER, if a partner only entered services into the partnership he is NOT entitled to capital upon dissolution, unless explicitly agreed otherwise. o UPA 401h - a partner is not entitled to remuneration for services performed for the partnership, except for reasonable compensation for services rendered in winding up the business of the partnership Default rule that partners can K around, but law is pretty straight forward that partners are not paid for their services above & beyond profits. Labor is never paid upon dissolution, but it does not pay debts either. --------------------

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FIDUCIARY DUTIES
Meinhard v. Salmon (Partner as Fiduciary - Common Law Duty of Loyalty) - Salmon (S) partnered with Meinhard (M) to lease a building (20 yrs.) from LG to put in shops & offices. After original 20 yr. lease was up, S signed a new lease w/ EG w/ many renovation obligations & big $ outlay - S personally guaranteed performance of the lease & new building. S didn't tell M about the new deal or lease w/ EG - kept all the negotiations to himself. Court: Did S breach a fiduciary duty to M by appropriating a lease renewal for himself rather than informing M? Yes, Joint Venturers owe one another the "finest loyalty" = stricter than "marketplace morals" o Joint-venture relationship, but fiduciary duty of loyalty is the same as for partnerships = HARDCORE LOYALTY S had a duty to give M an opportunity to compete for the second lease b/c M's contribution to the joint venture helped induce the renewal opportunity - S could've warned M of EG's offer & called "open season" on the project o Why does Cardozo find a fiduciary breach? Exclusion of chance to compete that stemmed from the joint venture - S new lease has a close enough subject matter relationship to old JV lease Managing venturer, w/ exclusive power, has an even higher duty of disclosure b/c greater access to more information - M is in a more vulnerable position As long as JV still exists, S has duty to disclose & can't take lease for himself ------------o Hypotheticals 1. Suppose S did give M opportunity to compete & S outbid him. Is this a breach of loyalty? Depends on duty: disclose or share? 2. Did Cardozo overstep by imposing a duty after the JV ended? No, the JV provided S with the opportunity to sign a new lease in the first place. 3. What if EG offered S an opportunity to invest in an office building in San Francisco? Too far removed from JV or anything to do with venture, so no breach. o Question: How would this case be decided under the revised UPA? UPA 404(b) - General Standards of Partners' Conduct: Partner's duty of loyalty is limited to specific acts/omissions, unless explicitly agreed otherwise (and "reasonable"), but cannot be waived entirely Parties can alter the unwavering duty of loyalty under the UPA if the parties are specific in their agreement & they're not manifestly unreasonable = the revised statute allows parties to carve out an exception to the loyalty duties.

Vigneau (Self-Dealing - acting on both sides of the deal) - V invested w/ JM, another Storch employee & head of operations, in real estate development business (HCA). V held 22% cut of HCA & worked as S's architect in charge of HCA job - kept circular relationship secret from S. Court: Is V entitled to his cashed out partnership interest in Storch even if V was self-dealing in other partnerships? Yes, V violated his fiduciary duty to the defendant by self-dealing in the HCA & G Assoc. projects & by concealing from the defendant those actions, but he is still entitled to cashed out partnership share. o Prohibition against self-dealing (acting as both vendor & purchaser) is "prophylactic" in nature to deter conduct harmful to any partnership Withhold information: duty of candor & "full disclosure" in partnership matters

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When disloyal P has "dual responsibilities" & serves interests adverse to his original partnership, injury to the partnership is non-determinative that S actually profited off of V's self-dealing Consequence of violating fiduciary duty is that original partnership is entitled to recover the "secret profit" that the disloyal partner realized Disloyal partner IS entitled to reimbursement for his vested interest/capital contributions Courts may be willing to give a self-dealer their capital contribution back, but court has discretion & will prevent self-dealer from actually profiting off of their disloyalty

Covalt (Management of Partnership's Business Affairs - Equal Voting) - C & H, corporate officers & shareholders in CSI, agreed to form partnership to buy real estate & build office/warehouse; CSI rents from H&C, renews on oral agreement to rent increase. C demands that H increase the rent charged to CSI, H declines. Court: Did the trial court err by ruling that H breached a fiduciary duty of fairness to his former partner (C) by failing to negotiate and obtain an increase in the rent from CSI? No, an act concerning the partnership business may not be compelled by the co-partner remedy is dissolution of partnership. o All partners have equal rights in the management & conduct of the business of the partnership, unless expressly agreed otherwise. Neither partner had the right to impose his will concerning the operation of the partnership on the other. Fact that a proposal may benefit the partnership does not mandate acceptance by all partners If the partners are equally divided by majority vote, those who forbid change must win out = keep status quo Starr (Partnership Agreement & Fiduciary Duties?) - IS, attorney, joined new firm over his own reservations about his rainmaking ability; quickly left new firm. Court: Did the founding partners @ FS violate their fiduciary duties & the implied covenant of good faith in their partnership agreement w/ IS? Yes, FS violated fiduciary duties & the implied covenant of good faith & fair dealing. o Self-dealing is not legally punishable in every context, case-by-case analysis to determine the harm caused, if any Party accused of self-dealing has burden to prove otherwise - FPs were self dealing b/c allocating $ to themselves & had direct effect on IS' compensation Business Judgment Rule - can the allegedly violating partner can demonstrate a legitimate business purpose for his action? o Possible that a partner has engaged in self-dealing, but partner can attempt to prove the fairness of his actions & to prove that his actions didn't result in harm to the partnership = quasi-defense One partner probably had to take charge of deciding the pay for the business, but the "self-dealer" must be transparent & must act fairly (and prove this) Ferguson (Partners' Fiduciary Duty of Care - Bad Management) - FW contacted Wi to help finance building venture when it ran low on cash - sold Wi 1/4 interest. FW venture failed b/c couldn't find construction financing, dismantled & sold buildings to pay debt. Court: Was FW's operation of the joint venture a breach of fiduciary duty to Wi? No, bad management is not a breach of fiduciary duty, only breach of trust/loyalty.

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Old Rule - As a matter of law, negligence in management of a GP or JV does NOT create a cause of action for one partner against another partner o UPA 404(c) (1994) - partners do have a duty of care to each other, but requires gross negligence or worse to bring a suit for breach of duty of care (ex. bad management) --------------------------

PARTNERSHIP DISSOCIATION & DISSOLUTION


Important Questions o What triggers partnership dissolution upon a partner's dissociation? Does the firm dissolve or not? Dissolve & "re-form"? o What is a dissociating partner's interest?

Dissociation - when a partner leaves the firm, either voluntarily or not. Does NOT necessarily mean the partnership is dissolved/terminated/ending. o Means of dissociation: 1. Partner chooses to leave the firm 2. Death 3. Judicial decree 4. Partnership expulsion Dissolution: complete end of the partnership & beginning of the "winding-up" process --------Very easy to confuse two terms, but very different meanings o UPA 1914 - when a partner left the partnership, this automatically dissolved the partnership (Old default rule) o Modern UPA- partner leaving does not automatically dissolve the partnership Dissociation can trigger dissolution, but it does NOT have to Partnership for a term is now a much more stable entity than partnership @ will

Statutory Analysis - modern UPA statute is attempting to make partnerships more stable so they do not fall apart as easily as under the old statute. o First, figure out if the partnership is 1) @ will or 2) for a term o UPA 601 - List of Events Causing Partner's Dissociation o UPA 603 - Effect of Partner's Dissociation If dissolution is triggered, 801 applies UPA 801 - Events Causing Dissolution 801(1) - one partner chooses to leave partnership @ will & explicitly notifies other partners 801(2) - partnership for a term categories Essentially means if a partner leaves, doesn't automatically mean dissolution UPA 807 - Settlement of Accounts Among Partners If dissociation doesn't trigger dissolution (firm continues), 701 applies UPA 701 - Purchase of Dissociated Partner's Interest If wrongful dissociation, partner may only get interest bought-out after partnership term is completed & may be liable for damages ************ McCormick v. Brevig (Dissolution case & UPA 807) - Plaintiff (J/sister) & defendant (C/brother) were partners in a family ranching business. J objects to TC's forced buy-out & appraisal of her

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contribution to the partnership, wants business liquidated. Court: 1) Was the trial court correct to allow C to buy-out J to avoid a judicial liquidation? No, the UPA requires liquidation upon dissolution when no longer reasonably practicable to carry on partnership = reduce to cash to satisfy outstanding obligations & distribute surplus. 2) Was J entitled to an accounting of the partnership's affairs? Yes, every partner is generally entitled to an accounting of the partnership's affairs, even w/o express K. o Partners don't have to dissociate in order to get dissolution, partners petition court to break up partnership w/o either having to "dissociate" on their own accord C's precedent was not on point b/c in precedent partner died (dissociation), in this case J is alive and willfully breaking up the partnership (dissolution) o UPA 807(a) - In settling accounts among the partners, the profits & losses that result from the liquidation of the partnership assets must be credited and charged in cash to the partners' accounts. Revised UPA text is relatively clear that a partnership auction is mandated and assets must be liquidated upon dissolution o Question: Why should a court liquidate the assets at auction? Policy decision to avoid judicial liquidation sale or mandatory liquidation? Pro - sale may net the actual, market value of the assets. Theory that whichever partner cares the most about the business will buy the business from the other partners Con - auction may not have many bidders b/c the partnership may be highly technical & the partners have the most intimate knowledge of how to run the business. Expensive to administer Drashner (Wrongful Dissociation - UPA 602(b)) - Plaintiff (D) & Defendant (S) co-own a real estate, loan & insurance business. Written agreement to continue business until S capital contribution repaid partnership @ will (partnership for a term). Court: Did D wrongfully dissociate from the partnership? Yes, D's insistent demands for more $ and "attendant conduct" (i.e. - drunkenness) rendered the business partnership reasonably impractical to continue. o UPA 602(b) - if one partner attempts to dissolve the partnership in contravention of the partnership agreement/K ("wrongful dissociation"), the other partners may carry on the partnership & buy out "bad" partner "Wrongful dissolution" is not part of modern law anymore, but wrongful dissociation is applicable o UPA 801(5) allows parties to seek a court order dissolving the firm, 601(5) allows a court order kicking someone out of the firm for wrongful dissociation. McCormick v. Brevig 2 (Wrongful Dissociation & Claim for Judicial Expulsion) - FACTS ABOVE. Court: Did C legally dissociate from partnership by "wrongfully" converting partnership assets? No, both parties were partially at fault for the deterioration of the partnership. o Ways Partner May Dissociate: Partner engaged in wrongful conduct Partner willfully/persistently committed a material breach of partnership agreement Not reasonably practical to carry on the business partnership o J's Appellate Arguments 1. C dissociated - Court simply disagrees 2. C's conduct merits a judicial expulsion - J didn't litigate properly & bring up the correct statutory provision @ trial = can't raise new issue on appeal

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2 Ways to Expel a Partner i. UPA 601(5) - expel individual partner ii. UPA 801(5) - dissolve partnership entirely -----------------

PARTNERS AS AGENTS

Page (Fiduciary Limits on Dissolution "@ Will") - P & D are brothers & partners in a linen supply business - oral agreement. Plaintiff, main creditor of the linen company while it wasn't profitable, holds $47,000 note on partnership & wants out of partnership. Court: Was the partnership for a term? No, defendant failed to prove facts from which a partnership from a term may be implied. o Old Rule - Implied Partnership for Term: Ps may impliedly agree to continue in a business until certain profit earned, Ps recoup investments, or until debts are paid - must be supported by evidence Using an implied partnership term to find wrongful dissociation is no longer allowed under UPA, must be an explicit breach of a term in the written partnership agreement People are always hoping to be profitable when they start a business, so every partnership would be for a term if this was the bedrock requirement o Plaintiff has power to dissolve partnership @ will, but can't do in "bad faith" &/or to appropriate the new prosperity of a partnership for his own use (fiduciary duty) = "wrongful dissociation" of P ******** o How long does the plaintiff have to carry his brother as a part of the business? Does the duty of loyalty in running the business carry over to the ending of the business? UPA 602(b)(1) - a partner's dissociation is wrongful only if it is in breach of an express provision of the partnership agreement = no more implied terms in general partnerships Partnership @ will can only be breached if an express provision of the partnership agreement is breached (Rule written to counteract Page) Bohatch (Fiduciary Limits on Expulsion of Unwanted Partners) - CB, partner in B&B law firm, became concerned that another P, McD, was over-billing client after reviewing P records - reported concern to RP, another P in firm. B&B denies CB year-end partnership share & reduced her compensation to $0 in 1991; CB sued - B&B voted to formally expel CB from the partnership. Court: Did B&B breach its fiduciary duty by expelling CB, a partner who reported suspected overbilling of another partner? NO, partners have no obligations to remain partners & may choose w/ whom they associate. Fiduciary duty does NOT extend to whistle-blowers. o Legitimate Reasons for Partner Expulsion - Common Law Partnership may expel a partner for purely business reasons Law firm may expel P to protect internal (employee) & external (client) business relationships Partner may be expelled w/o breach to resolve a "fundamental schism" No duty to remain Ps or answer for other P's torts o Dissent - B&B violated its fiduciary duty to CB by punishing her for compliance w/ the Court's promulgated legal rules of ethics Whistle-blowing in this case is not only to protect the firm, but also to protect the public interest = distinguishable from Foley. Still NOT protected?! NO o Partners have no obligations to remain partners & fiduciary duty does NOT extend to whistleblowers.

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Meehan (Fiduciary Duties Owed by Withdrawing Partners) - M & B were partners of PC law firm eventually quit PC to start their own firm (MBC). While planning MBC, M & B kept up their usual performance for PC. Unknowing to PC, MBC had already systematically contacted and removed many clients from PC. Court - Upon removal, departing P must pay "fair charge" to old firm to compensate for services already rendered under old firm. o Departing partners are allowed to make logistical arrangements for their new firm w/o fiduciary breach - establishing a "physical plant" is allowed On numerous occasions, M denied PC partners information about his future plans when they requested = breach of duty of disclosure MBC notice to clients didn't explicitly state that the client had a choice between PC & MBC = denial of business opportunity from PC o PC (old firm) entitled only to amounts that flow from MBC's (new firm of departed Ps) fiduciary breach Burden of Proof shifts to MBC to show that their fiduciary breach by removing clients from PC clandestinely did not prejudice PC - MBC has to prove that they would've gotten old PC clients w/o breach = substantial burden shift & very hard to show P.A. Properties (Partners as Agents & 3rd Party Dealings) - M & UA enter into joint venture (JV) to manage movie theaters in 1988: Written agreement makes UA "managing venturer" w/ "complete authority & responsibility to manage JV". UA subsequently K'd w/ PAP to provide lease recovery consulting services - financial analysis to determine if UA was paying too much rent. Court: Is M liable, under the JV contract w/ UA, to PAP for all of UA's outstanding debts? Yes, partners have inherent agency authority akin to implied authority of a "general manager" to bind the partnership & principal. o UPA - every partner is an agent of the partnership for the purpose of its business, and the act of every partnerfor apparently carrying on in the usual way the partnership business binds the partnership Partners ARE agents of the partnership Partners are jointly liable for all debts & obligations of JV o Inherent Agency (Rstmt. 2d 194) - undisclosed principal is liable for general agent's acts if done for the partnership, if usual and necessary in transaction, although the P may not allow. Liability of undisclosed P turns on the intent of the agent in entering into the transaction o Case Application - M liable for UA's debt to PAP, incurred for JV Inherent authority applies to protect 3rd parties, even if P explicitly forbids actions taken by A - partnership law trumps K law to protect 3rd parties o UPA 301 - partner's authority is equal to the implied authority of a general manager = broad authority to bind P Haymond v. Lundy (Partners as Agents & 3rd Party Dealings #2) - H&L, law firm, dissolved after 2 years. JK, plaintiff in PI case, retained F as atty., but switched to H&L after preliminary work done by F. H&L atty. (L) paid F for referral. Court: Did Lundy's oral (& later written) agreement to pay F a standard referral fee bind the partnership? No, L exceeded his authority under the partnership K by not obtaining his partners' consent to pay F referral fees. o Joint Venturers are NOT reasonably assumed to be authorized to act as general managers of the JV, not like partners in a general partnership Joint Ventures entail a narrower relationship & agency authority is likewise limited

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L acted unilaterally to dispose of material asset ($10,000+), K requires majority of partners approval for this type of transaction. L relies on customs of bar, but Court finds L breached the explicit terms of K. Did apparent authority exist in this case? Yes, b/c the 3rd party would reasonably believe that a founding partner of H&L had the authority to pay referral fees. L needs to show that there was actual authority so the partnership has to pay F, not L personally o Apparent & Inherent Agency powers are primarily designed to protect 3rd parties, not to exculpate partners who breach their partnership K. -----------------

INTRO TO CORPORATIONS Corporate Form & Roles Board of Directors - set corporate policy & exercise statutory corporate "power"
Attributes/Responsibilities "Control Rights" Select officers of the corporation Initiate changes in corporation papers Dole out dividends to shareholders Own stock to keep personal stake in business Do not share residual profits of corporation Do not have individual agency to act on corporation behalf - collectively act as Principal o Courts give board great deference - business judgment rule o Publicly-traded (PT) corporations need mix of internal (corp. officer) & external (volunteer) board members o DGCL 141(a) - business & affairs of every corporation shall be managed by board of directors except as otherwise specified in Articles of Incorporation. ----------o Articles of Incorporation ("Constitution") Set major framework of corporation governance Hard to amend - need Board to initiate & shareholder vote Publicly accessible document o Bylaws ("Statutes") More detailed & specific Easier to amend Not necessarily publicly accessible DGCL 109 - shareholders can vote on amendments to bylaws, but Board also has unilateral authority to block.
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Officers/Management - execute corporate policy & exercise statutory corporate powers


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Attributes/Responsibilities Agents of Board of Directors In charge of day-to-day decision making Duties designated by corporation's bylaws Own stock to keep personal stake in business President/CEO is the "fulcrum of corporate governance"

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Really the officers who know what is going on in the company b/c deal with issues day-to-day Top-level officers are often directors as well

Shareholders - infuse capital & vote on directors. "Vote, Sell, & Sue"
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Attributes/Responsibilities "Residual Claim Rights" Corporate risk-bearers & residual claimants (claim to $ if dissolution) Purchase shares, but risk limited to losing share price = no personal liability for corporate misdeeds Vote to elect Board of Directors Annual Meeting - corporate law requirement Special Shareholder Meeting - hard to call w/o being named on charter Written Consent (in lieu of meeting) - vote by proxy instead of physically showing up for the meeting. DGCL 228 Dependent on Articles - Boards usually cut back on this power to limit SH participation Limited management rights No ability to initiate changes to bylaws, articles, or corporation policy - power is "permissive, confirmatory," can only make recommendations Shareholders can make recommendations & vote (not seen as encroaching on Board of Directors' power), but can't initiate changes to bylaws or articles of incorporation Vote on fundamental corporate actions (initiated by the Board) - amending Articles/bylaws, mergers, dissolution, etc. ---------------o Shares - fungible ownership units that entitle the holder to a pro rata share of the firm's profits & net assets upon dissolution (or more likely, on sale to another) Common Stock - normal shares that combine both residual claimant status & voting rights. Identical rights, preferences, & voting rights. Preferred Stock - special shares that grant a dividend first over common shares , but usually don't have voting rights = highly dependent on individual K o Dividends - payment of corporation's profits, initiated by the Board of Directors. o Shareholder Derivative Suit - shareholders may have standing to sue the Board of Directors on behalf of the corporation itself. o Proxy - substitute for actual, in-person SH voting. 1) Actual substitute for in-person vote; 2) Person voting in-person on your behalf. Not possible to hold 5 million SH in one meeting room Average SH probably doesn't care about voting anyway Very common in large corporations ************** What are the advantages of starting a corporation over a partnership? o Limited liability for shareholders - only lose the value of their share o Easier to raise capital using stock - allows general public to participate & infuse $ Free transferability - can't bring on new partners @ will, but corporate stock can be traded @ will to anyone w/o others approval. Convenient Exit Right - don't like the way the business is going, sell your shares & leave o Corporations are indefinite & harder to break up than partnerships - encourages investment

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Important separation of ownership & control - shareholders have residual claims, but don't have management capabilities Centralized management structure b/c not feasible to have millions of "owners" making dayto-day decisions - vested in Board of Directors & Management (DGCL 141(a)) Corporation is legally more than the sum of its parts - legal fiction of a "person" w/ same rights as a person

Why is Delaware's role so significant in corporate law? DE has 50%+ US public corporations & ranks 49th in population Internal Affairs Doctrine - apply the law of the State of incorporation to matters/questions of corporate governance o DE corporate law is well-defined & predictable Courts have built up huge body of precedent Judges are former members of corporate bar = experts o Race to the Bottom ("sell-out" to management) v. Race to the Top (economic, "market efficiency" argument) Economists argue that SHs wouldn't buy into pro-management company, so DE can't be all that bad
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Voting Schemes Straight Voting - shareholder entitled to cast votes equal to their number of shares for Board of Directors candidates. (default rule) o Cumulative Voting - shareholder can cast total number of votes equal to the number of shares multiplied by the number of positions to be filled. Guarantees minority SH voting clout b/c ensures that a particular candidate may get on the board - put all your shares behind 1 candidate, not diluting your voting Equation: Shares Voting * Number of Directors Possible for Client/(Number of directors to be elected +1) = SX/(D+1) o Classified Voting - create different classes of shares w/ different voting rights HYPO: 4 director BD. Seats 1 & 2 only voted on by Class A shares. Seats 3 & 4 only voted on by Class B shares. Possible to have a majority of shares in a Class w/o having a majority of total shares in the company o Preferred Shares w/ Special Voting Rights - preferred shares get many more votes/share. Incentive to buy more expensive, preferred stock. Liquidation Preference - get investment back first at dissolution, before common stock holders o Staggered Board Voting - only 1/3 of board is elected in one particular year Keep continuity/institutional memory (experienced board members) Prevent sudden coup (new majority wants to takeover entire board) ability to influence entire board Very common defensive measure included in Articles of Inc. *******************
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Hoschett (Fundamental Shareholder Rights: Annual Meeting & Voting) - TSI did not ever hold a shareholder meeting. Court: Does a written consent filling vacancies on a corporate board excuse a corporation from holding a mandatory SH meeting? NO, the mandatory requirement that an

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annual SH meeting be held is not satisfied by written consent to elect a new board or re-elect an old one = TSI ordered to hold annual SH meeting. o May be efficient to allow 228 consent writings to stand in for meetings, as defendant argues, BUT annual meeting is one of "very few mandatory features of DE corporation law." Point of meeting is to afford SH opportunity to bring matters before the entire SH board o Court: possible to install directors w/ written consent power, but written consent power doesn't supersede mandatory annual meeting (so directors only serve until next annual meeting) - DGCL since amended by DE Legislature to allow written consent to stand-in, if unanimous Written Consent Board composed of space-fillers that need to be properly elected or removed at the next annual meeting o Efficiency v. Open Governance - Chancellor balances practicality/efficiency of consent provision against advantages of actually holding a meeting SH open discourse SH can make proposal to amend other corporate papers @ meeting Written consents put dissenting SH at a disadvantage b/c cant marshal others to their views Adlerstein (Removing Directors) - A, former chair & founder/CEO of SM Corp., sued 3 BD members (W,M,R) for ousting him from company. Court: 1) Was the BD meeting properly convened? Yes, bylaws do not require advanced notice or advance agenda before meeting. 2) Did the BD's secret plan breach their fiduciary duty to A, as the controlling director & SH, and invalidate the R deal? Yes, A was entitled to know ahead of time of R plan, hatched w/ purposeful intent of destroying A's voting control over SM Corp. Had A known, he could've exercised his lawful right to remove BD member to stop plan. = "actions of BD must be undone." o DGCL 225 - purpose is to provide a quick method of review of corp. elections to prevent corporate immobilization by controversies over proper officers o Del. Corp. law requires BD to conduct their affairs "in a manner that satisfies minimum standards of fairness" A was both SH & Director, so notice derives from his joint roles, not from his SH role only - secrecy + something A could do about preventing the coup Controlling SH at unlawful disadvantage when not informed about BD intent to remove him as CEO - controlling SH has no opportunity to use his controlling SH power to alter the BD & escape the coup = Fiduciary Breach of Loyalty o Board of Directors issues stock to R, A removed as CEO by the Board of Directors & removed as Board Chair by the shareholders (really just R w/ majority voting rights & executing written consent) Shareholders remove Board members, Board removes CEO ************ Common Law - BD had vested right to continue in office until term, only removed for cause. Modern DGCL 141(k) - SH may remove Director with or w/o cause = last resort Exceptions Staggered BD members/director cannot be removed by SH w/o cause Cumulative Voting BD - if a SH has enough shares to guarantee a director a board seat, this is the number of shares to trigger the "for cause" removal of a director

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Preserving the balance of power among the SHs - if a director elected by a minority could simply be removed afterward, not really a minority protection then c. Class Voting - majority of particular class of voters can remove w/o cause, but not entire SH body. Limits of "for cause" removal in DE: Campbell v. Loew's Inc. - removing a director "for cause" is not an easy task b/c so many substantive & procedural elements to overcome Substantive Scheme of Harassment of corporation's employees Obstructing the business of the corporation Policy disagreements do not support a for cause removal Procedural BD members need notice of specific charges BD members need opportunity to meet accusations/defend at corporation's expense

Centaur (Changing DGCL Default Rules - Interaction of Articles & Bylaws) - C, investment partnership, holds 16% share in N, pharmaceutical & metal company. C files w/ SEC, claims N stock is undervalued & N must sell off assets - attempt to take over N. N shareholders previously amended Articles of Incorporation to require 80% supermajority to amend articles or "similar provisions" in the bylaws. Court: Does C need 50%+ or 80% supermajority to amend N bylaws? N's Articles of Incorporation & bylaws are NOT ambiguous & they both require an 80% supermajority for amendment. o DGCL 216 - if Articles nor Bylaws don't set a % of votes necessary for election of director, defaults to plurality of the votes present (50%+) SH must be explicit (clear & unambiguous) if they wish to impose a supermajority requirement for voting, to overcome hard presumption of 50%+, "bare majority," default rule High vote requirement protects minority shareholders against squeeze-out techniques employed by insurgents commanding a bare majority, but provisions also give minority SH a veto on the will of the majority = disenfranchising majority o DGCL 109(b) - If Articles & bylaw contradict, Articles hold & Bylaw is null & void ****** o Why is C worried about amending the bylaws? Why not acquire 51% shares & elect a whole new board of directors? N has a staggered board, set up to prevent coups, so C can only replace 1/3 directors in one election (DGCL 141(k)) and needs "cause" to remove outside of elections - C can't get a majority quickly w/ a regular election o Court is protecting the vote of ALL shareholders - don't disenfranchise the majority & trying to protect the SH franchise overall If the Court found any ambiguity in the Articles or bylaws in this case, C would've probably won on default rule w/ 50%+ vote o When planning corporation, option to set forth governance rules in Articles or the bylaws - a lot easier to change the rules if placed in the bylaws = flexibility v. surprise -------------------------

SECURITIES & REGULATIONS - Area where Federal Law intersects w/ State Corporate Law

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Security - a fungible, negotiable instrument representing financial value. Classic kind of "security" is a share of stock in a corporation. Securities Exchange Commission (SEC) - Federal agency tasked w/ regulating securities markets o Focus on disclosure requirements to fully inform investors - risk factors, salaries, conflicts of interests, etc. "Blue Sky" Laws - State laws in 1920s & '30s attempting to address securities fraud issues, but after the Great Depression they weren't considered sufficient Periodic Reporting Requirement - public companies must file quarterly & annual reports Significant disclosures required if companies offer stock to the public o SEC provided a new mechanisms to go after fraud Key Securities Issues o Cost: Extremely helpful to shareholders & well-working market to have abundant information, but very expensive for smaller corporations to comply with (need to hire lawyers, accountants, insurers, etc.) - big issue is whether an exemption applies o Identification: Is the financial transaction involved really a security in the first place? Economic Backdrop to Disclosure Rules o Efficient Market Hypothesis: disclosure scheme based on the idea that markets are relatively efficient. Therefore, the stock price will absorb the disclosure information, and the stock owners can benefit from the distribution of this information for very low transaction cost. Market efficiency - the amount of time it would/does take new information to incorporate/absorb into the stock price Buying stock is not like buying a house or car, you're buying an intangible - no way to tell the value of a stock or "kick the tires" of the stock on your own (+) very expensive to do research on your own o Ex. Stock Market Crash of 1987 - no obvious piece of information to point to as the cause of the drastic drop "Bursting Bubbles" show flaws in the way the market is incorporating information o Why does this matter? Market incorporates Federally mandated disclosure information, so determines what regulations the government should promulgate People are more willing to invest in a more predictable, efficient market Our market is a "semi-strong form" efficient market = public info is incorporated, private "insider" info is often not SH benefit from disclosure b/c experts incorporate massive amounts of info into their trading, which affects the overall stock price = indirect benefit from information

Proxy Solicitations o SEC Rules are attempting to make sure that SH know what they're voting on - technical specifications of print, layout of proxy card, notice, etc. o SEC Rule 14(a)(8): permits a shareholder to force management to include the shareholders materials in their proxy solicitation

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Proxy solicitations are not cheap, so Rule makes corporation pay for your distribution of proposal materials to other SHs Limits right to "qualified shareholders" - SH w/ significant investment in company & who have a stake in the outcome of the vote If proposal infringes on the authority of the board, management may keep that proposal out = interferes with BD power under 141(a) Federal SEC Rules leave the same balance of power in place between BD & SH Precatory Language -SH, however, can use precatory language to frame the proxy as a recommendation/request of the BD, not as an encroachment on the BD's statutory power BD can simply ignore SH requests, but probably at their own peril b/c they lose many votes in the next election Ordinary Business Exception to allow management to exclude SH proposal from ever being sent to other SHs Cracker Barrel Case - SH attempt to pass precatory proposal to disallow company from discriminating against gays in hiring. SEC passes "no-action letter," tells CB that they will not prosecute (1992), but SEC changes its mind 6 years later (1998) Social Issues Exception (exception to the exception) - SEC determines that it will take social issues into account when determining ordinary business exception. SECs position has changed over the years SEC recognizes that some social issues could exist and analyzes on a case by case basis What counts as "significant"? Vague rule that is hard to rely on when planning But SHs do care about social issues, and paying attention to SH is good for the company's profits Economic Relevance Exception - Lovenheim Case

********** Edwards (Is this transaction a "security" covered by SEC?) - Charles Edwards founded a company that sold pay telephones and then leased them back from the purchasers for a fixed monthly fee. After Edwards filed for bankruptcy, the Securities and Exchange Commission (SEC) sued him for selling securities (considering the telephones to be investments on the part of the purchasers and therefore securities) in violation of the registration and anti-fraud provisions of the federal securities laws. Court: Does the Securities Exchange Act's (1934) term "investment contract" include an investment scheme in which the promoter promises a fixed return or the investor is entitled to a particular rate of return? Is the defendant liable under Federal SEC law (not worried about State fraud laws)? Yes, an investment scheme promising a fixed rate of return can be an "investment contract" and thus a "security" subject to federal securities laws. o "Investment Contract" Test (Howey Test) - whether the scheme involves an: Investment of money in a common enterprise With expectation of profits (financial returns) to come solely from the efforts of others o CE is trying to remove investment from SEC regulation by arguing that the investment is not a security Court doesn't buy E's argument & wants to prevent securities scams, so Court carves out "exception" for fixed rate returns = doesn't matter whether the return on investment is fixed or variable, there is still an "investment" subject to the Howey Test

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Ralston-Purina (Exemption from SEC Registration?) - Without complying with the registration requirements of the Securities Act of 1933, a pet & animal feed corporation offered shares of its stock to a number of its "key employees." These employees were not shown to have had access to the kind of information which registration under the Act would disclose. Court: Was the offering of shares to "key employees" exempt from SEC Act b/c not a "public offering"? No, transactions were not exempted under 4(1) of the Act as non-public transactions b/c offer is considered "public" if employees still feasibly require SEC protections due to their lack of information. o Purpose of the SEC statute is to protect buyers who wouldn't have access to important information - uses SEC purpose to figure out if an offer is public The number of offerees involved is not determinative of whether an offering is "public" under SEC laws If employees to whom corporation offered its common stock do not have knowledge obviating the need for SEC protection, corporation is required to register the "public offering" o Sheer numbers are evidence, but test for a "public offering" is not a quantitative issue looking to whether the offerees need SEC protection b/c they lack access to important information No issue about whether a security is involved, but the level of disclosure that is required - is this an offering "to the public" or not? Yes, b/c employees still need SEC protection/lack info. If offering was only to Purina high-level executives w/ access to information, this would be a "private offering," w/o need to register under SEC o HYPO: Under Purina, Gold makes an offering of stock in his corporation to everyone on the left side of the classroom. Is this a "public offering"? Yes, b/c the students in the class still need SEC protection b/c no way to know important information about Gold's corp. Lovenheim "Foie Gras Case" (Governance Proposals - Proxy Solicitations) - Plaintiff, Peter Lovenheim, sought a preliminary injunction against Defendant, Iroquois Brands, Ltd., in order to insert a proposal to determine whether a supplier of pate de fois gras force-fed the geese in order to enlarge their livers. Court. May a company refuse a shareholder proposal for a proxy statement if the proposal concerned less than 5% of the business sales, and the proposal was not economically based? No, precedent demonstrated that Rule 14a-8(c)(5) would only omit proposals that were 1) less than the minimum 5% of sales and 2) not significantly related to the business. o Economic Relevance Test - Rule 14a-8(c)(5) only allows BD to omit shareholder proposals, under this exception, that are: Less than a minimum of 5% sales; and Not significantly related to the business. o In this case, the fois gras issue was significant to its business regardless that it did not comprise greater than 5% of sales. CA, Inc. (Persuasive Shareholder Communications) - AFSCME, CA, Inc. SH, submitted a shareholder proposal to amend CA's bylaws (proxy) to require that CA reimburse the reasonable expenses incurred by a dissident nominating a rival slate of directors, provided that at least one nominee from the dissident slate was victorious. Court: May BD exclude SH bylaw proposal by proxy under SEC Rule 14a-8 b/c illegal? Yes, SH have right to propose & adopt bylaws, but SH proposal can't violate DE law. o Court makes distinction between procedural & substantive changes to bylaws

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Court determines that proposal (dealing w/ amending bylaws) was proper for SH b/c bylaws are intended only as procedural means to run the business. SH, however, can't introduce substantive bylaws b/c would encroach on BD's power. 109 - allows SH to amend bylaws 141(a) - BD has authority over business of corporation Procedural bylaw proposed by AFSCME is overbroad & implicates substantive provisions that could prevent the BD from carrying out its fiduciary duties Question: what happens if the SH tie the BD's hands & prevent BD from doing something in the future that they have a fiduciary to do?

Kistefos (SH Majority Voting Bylaw v. Board Discretion) - K is a 22% stockholder of T; K submitted to T a proposal designed to give "teeth" to the issuers existing majority vote requirement for the election of directors, provided that an incumbent director who received only a plurality of votes would no longer be qualified to serve on the board, and such director's term would be deemed to expire immediately, creating a vacancy on the board of directors. Court: K's proposal should be presented for a stockholder vote at T's annual meeting in the same manner as any other proposal. o Court balanced Delaware corporations' interest in maintaining control over the annual meeting process v. SH interest in preserving a meaningful opportunity to have their proposals considered by the electorate o New SEC Rule 14(a)-11 (2010)- makes easier for SH who disagrees w/ management to put together a slate of directors, at company's expense, to vote out current BD Minimum 3% shares for 3 years - not intended for small-time SHs, but institutional SHs Seems to democratize corporate voting, but most of the large SHs are other corporationsso voting may not practically change much. Previously, relatively difficult for a SH to get directors on the ballot b/c needed to work through the BD & get information out to other shareholders with BD assistance 14a-8 Conservative Caucus v. Chevron (Access to Corporate Records - DGCL 220 "Proper Purpose") CC (SHs) request corporation's shareholder list & seek support for a resolution that the corporation terminate all business in Angola unless the government "abandons the communist system." Court: Shareholder's proper purpose was to communicate with other shareholders about the economic risks of doing business in Angola. o SEC Rule 14(a)(7)-ordinary business proposal, SH can ask for assistance from corporation at their own expense, and still allows management to keep proxy out. Possible way under federal law to get a SH list Court: As long as SH has stated a proper purpose, any other tangential purpose is irrelevant o Burdens of Proof - Corporation seeking to avoid a SH request for stock list has the burden to prove that SH is not motivated by a proper purpose. Why is the burden of proof on Chevron in this case? Because DGCL favors providing SH list by minimal burden of proof CC followed rules set out under DGCL 220 to request SH list, burden is on corporation to show improper purpose = relatively easy to get names of other SHs to foster communication If SH wants corporation's internal documents, burden is on the SH = tougher burden to get access to corporation's internal records

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If SH is only requesting SH list (stock ledger), hard for the corporation to show an "improper purpose" May also be used as a litigation tool to gain access to corporate records if discovery is bogged down or improper Westland Police & Fire Retirement System A recent Delaware Supreme Court decision has
significant implications for corporations with majority voting standards where incumbent directors fail to receive the required level of support and tender their resignations to the board of directors. The decision,City of Westland Police & Fire Retirement System v. Axcelis Technologies, Inc. , provides stockholders with a roadmap for inspecting a corporations books and records after a board refuses to accept the directors resignations. Background In Axcelis, the corporation had a plurality plus governance policy in which directors were elected by a plurality of the votes cast but were subject to a board policy that required directors to tender their resignations if the votes cast withheld were greater than the number of votes cast for such persons. At its 2008 annual meeting, the three directors who sat on the corporations classified board of directors failed to receive majority support from the stockholders and tendered their resignations. The board, however, refused to accept their resignations, noting that one of the directors was the corporations lead independent director and each of them sat on key board committees. Whether to permit inspection of documents relating to the boards decision to reject the proffered resignations of three directors. In rejecting that demand, however, the court suggested that such a rejection would not ultimately be tested under standards of judicial review more demanding than the business judgment rule.

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BUSINESS JUDGMENT RULE & DIRECTOR'S DUTIES


Business Judgment Rule - significant judicial presumption that corporate directors have acted in accordance w/ their fiduciary duties of care, loyalty, and good faith to collective shareholders & corporation = broad discretion given to corporate executives o Rule that applies in litigation & very difficult to rebut o Tool courts use to avoid hindsight-bias in business decisions Why do we have the business judgment rule? Judicial efficiency - courts do law, not business experts Deter frivolous lawsuits - shifts burden onto challengers, make sure suit is legit "Business Judgment" is not black & white - hard to second guess a decision where reasonable minds can legitimately differ Hindsight Bias - past decision seems obvious nowbut wasn't so obvious then Centralized management efficiency - if courts step in all the time, authority is shifted to SHs & courts Risk-taking is desirable - business is an area where innovation is necessary, overcautious board is detrimental to corporation as well ******** Shlensky (Business Judgment Rule) - Plaintiff, William Shlensky, filed a derivative action against Defendant director, Phillip Wrigley, to force the installation of lights @ Wrigley Field for night Chicago Cubs baseball games. Although every other major league team had installed lights,

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Defendant did not install them at Wrigley Field because he was concerned that night baseball would be detrimental to the surrounding neighborhood. Court: A court will not interfere with an honest business judgment absent a showing of fraud, illegality or conflict of interest. o Business Judgment Rule - judicial presumption that corporate directors have acted in accordance w/ their fiduciary duties of care, loyalty, and good faith to collective shareholders & corporation = broad discretion given to corporate executives Court takes a strict view of the business judgment rule - no evidence of fraud, illegality, or conflict of interest, so not going to overturn decision of executive May be valid business reasons to protect the neighborhood, plaintiffs didn't prove W wrong (carry their burden) Dodge v. Ford (Limit of Business Judgment Rule? -Executive Discretion to Consider Non-SH Interests) - Plaintiff SH, Dodge brothers, brought an action against Ford Motor Company to force Ford to pay a more substantial dividend, and to stop Ford from hiring more employees instead of issuing dividends. Court: Business Judgment Rule does not extend to the reduction of profits or the non-distribution of profits among stockholders in order to benefit the public, making the profits of the stockholders incidental to SH value. Court requires Ford BD to declare an extra dividend of $19 million. o The purpose of a corporation is to make a profit for the shareholders, but a court will not interfere with decisions that come under the business judgment of directors. Because this company was in business for profit, Ford could not turn it into a charity. o Example of Business Judgment Rule, but unique b/c Court forced a dividend - dividends are normally business judgments themselves o Court was willing to force dividend b/c Ford testimony that he was intentionally screwing Dodge Bros. by limiting Ford's profits - semi-charitable institution now, but court forces to act like profit-making corporation ------------

DUTY OF LOYALTY & CORPORATE OPPORTUNITIES


Corporate Waste - an expenditure of corporate funds or a disposition of corporate assets for which no consideration is received in exchange & for no business purpose. Narrow exception to the business judgment rule. o Irrational expenditure of $ o Wonderful opportunity for the corporation which the BD rejects w/o explanation o Very difficult claim to bring b/c otherwise would gut business judgment rule ******** Northeast Harbor Golf Club (Corporate Opportunity Doctrine) - long-time director of golf course bought land adjacent to the course & the BD, after waffling for years over whether to purchase & develop the same parcel of land, objected. Court: Did the Director usurp a business opportunity from the golf club that she directed? No. The proper standard by which to judge a corporate opportunity is the ALI test. o ALI Corporate Opportunity Standard- provides a clear procedure whereby a corporate officer may insulate herself through prompt and complete disclosure form the possibility of a legal challenge = "vaccination" Corporate opportunity (ALI) - opportunity that is 1) closely related to a business in which the corporation is engaged or 2) one that accrues to the fiduciary as a result of her position within the corporation.

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The fiduciary must make a full disclosure prior to taking advantage of any corporate opportunity. Various Corporate Opportunity Analyses Line of Business Test (DE) - l "Fairness" Test - look at totality of circumstances to determine if "fair" for director to take corporate opportunity. ALI Approach - much more rule based, heavily emphasizes disclosure Defines what counts as a "corporate opportunity" Imposes disclosure requirements on directors Costs Officer may miss business opportunity b/c mandates BD disclosure = slow Disincentive to encouraging entrepreneurship & taking advantage of outside opportunities. Benefits Predictable Heavily Incentivizes disclosure

Broz - Broz (B) owns RFBC & sits on BD of CIS, both cell phone companies. B devotes vast majority of his energy to RFBC, simply sits on BD of CIS, which was fully aware of B's involvement in RFBC. B interested in purchasing a cellular license for his personal business (RFBC), but license wasn't offered to CIS b/c offeror thought CIS wasn't financially capable. PC (purchaser of CIS) claims B had a fiduciary duty to CIS and, as such, was required to look out for PC as the prospective buyer of CIS when purchasing the cell license. Court: Did B violate a fiduciary duty to CIS (and successor PC) buy winning the bid on a contested cellular phone license for B's personal company, RFBC? NO o Guth Test = totality of the circumstances test May NOT take opportunity if: Corp. is financially able to exploit the opportunity Opportunity is within the corp.'s line of business Corp. has an Interest or Expectancy in the Opportunity Corp. fiduciary would breach his duty by taking the opportunity as his own MAY take opportunity if: Opportunity is presented to officer/director in individual capacity Opportunity is not essential to corporation Corp. doesn't have interest/expect opportunity Officer/Director hasn't wrongfully used corp. resources to take the opportunity personally o Case Application Opportunity wasn't ever presented to B in his role as director of CIS - not offered to CIS at all CIS lacked financial capability to take opportunity CIS is moving away from similar business opportunities - divesting themselves of similar cell licenses Parties knew that B was in similar business & court is not concerned w/ conflict b/c B didn't work for PC Presentation to Board provides a powerful defense, but not an absolute requirement = divergence from ALI approach -----------------

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COMMON LAW & DIRECTOR CONFLICTING INTEREST STATUTES


Conflicting Interest Transaction - where a director seeks to transact business with the corporation Corporate Opportunity - where a director (fiduciary) seeks to take an opportunity from the corporation. *******

Globe Woolen (Common Law Conflicting Interest Statute) - GW sues UG for stopped delivery of electricity; UG says JM K'd unfair terms w/ GW to provide E too cheap b/c JM is on both BDs. JM brought G's proposed K to BD of UG, presented "opportunity," but abstained from vote. Market price of E provided to GW worth $69,000, but given K, UG actually owed GW $. Court: May UG elect to void K with GW b/c inequitable & b/c JW was on both sides? Yes, the K is voidable at UG election b/c "unfair" to make UG pay GW for E that is clearly undervalued & hostage to a one-sided K. CONTRACT VOIDED. o Historical Common Law Rule: If director has conflicting interest, per se void b/c can't act as a loyal fiduciary. "Can't serve two masters at the same time." = likely that outcome could be manipulated & not possible to be completely impartial/neutral A trustee may abstain from objection if K "fair," but has a legal duty to act if deal is "oppressive" "Refusal to vote does not nullify an influence & predominance exerted w/o a vote." Example of an Entire Fairness Analysis = close scrutiny & burden on director to prove fairness
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Entire Fairness Test (Modern) - Conflicted Director has the burden of showing that the transaction was entirely fair to the corporation = process leading up to the transaction & the substance of the K Possible that having a director or officer on both sides can be fair, but a high risk that it's not = Entire Fairness Standard is court's response Why did the rule change? DGCL 144 Full disclosure gives others the opportunity to take subsequent risks into account May be necessary to proceed - ex. only 1 supplier for specialty part Economy became more complex b/c interrelated HYPO: Suppose that JM didn't know that he was going to change the way he produced wool? Probably doesn't matter b/c JM still getting an unfair advantage over UG & JM must've known about the risk to UG Court is concerned with ex post fairness & huge losses of gas company as well as ex ante unfairness of bargaining process

Sinclair Oil (Transactions w/ a Controlling "Parent" Corp.) - Sinclair Oil (S) owns 97% stock in Sinclair Venezuela (Sinven; SV) & seats almost all members of SV BD - undisputed that S owes SV a fiduciary duty b/c of "domination" of subsidiary. Issue 1: SV paid out huge dividends to SH, in excess of profits, arguably b/c S needed $, which hampered SV's expansion effort. Issue 2: S caused SV to K w/ Int'l & agree to sell all of SV's crude to Int'l at specified prices. Int'l then breached the K by failing to buy on time or at specified prices, but S stopped SV from pursuing payment from Int'l. Court: 1) Does the intrinsic fairness or business judgment rule apply to dividends? Business

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Judgment; 2) Was SV contract with Int'l self-dealing by S? Yes, clearly S' act of K'ing w/ dominated subsidiary was self-dealing. Self-Dealing Test: if transaction involves a controlling parent on both sides & parent has received a benefit to the exclusion of, and detriment to, the subsidiary's minority SH. If parent reaps no benefit from the subsidiary, then no self-dealing = business judgment rule applies Normally SH are not fiduciaries, but dominating SH is a fiduciary Case Application - In this case, S (parent) didn't get any benefit that didn't also accrue to SV (subsidiary) = Business Judgment (BJ) rule applies Clear instance of self-dealing, so Entire Fairness standard applies. - S is getting benefit from subsidiary Int'l to the exclusion of SV shareholders Special Rule - if SH dominates BD of subsidiary, put transaction to vote of minority SHs. (Citron) Still a risk of retaliation by majority, so does not restore business judgment rule but shifts burden of proof to minority to show unfairness Example of court using self-dealing & fiduciary duties to protect minority SH from a dominating/ controlling SH

Shapiro (Conflicting Interest Statute) - SH derivative suit by Greenfield (G) against Charles Shapiro (S), operating officer for College Park Woods, Inc. (CP). Joint venture of S & J create numerous legal entities, ultimately CP ends up w/ no mgmt or voting rights in new partnership, but is completely shielded from liability for any failures - attempt to attract new investors w/ limited risks. Court: 1) Did S & J partnership usurp a corporate opportunity from CP? No, b/c not a "corporate opportunity" that was taken, simply an interested director transaction. 2) Was there a vote of "uninterested directors"? Unsure, not enough info from trial; remand. 1. Conflicting Interests statutes updated to align w/ realization that a director's conflicting interests are not per se detrimental to his duties to corporation Safe Harbor of Disclosure: Director may 1) fully inform BD and/or SH of his conflicting interest & allow opportunity for ratification or; 2) Non-disclosed transaction may still be valid if "fair & reasonable to corporation" 2. Interested Director Analysis - 1) is the director able to exercise independent judgment (JUDGMENT ABILITY) & 2) what is the influence of the relationship on the director (RELATIONSHIP STATUS)? Directors only required to avoid self-interested transactions that come at the cost of the corporation When a director does not personally benefit from a transaction, but has a relationship to a party involved in the transaction and, if the director's independent judgment is reasonably expected to be compromised, director is an "interested party" = REASONABLENESS standard o Interested Director Analysis doesn't only rely on STATUS of relationship to director, but director's ability to exercise INDEPENDENT judgment = would director be a neutral decision maker? DGCL 144 - no conflicting interest transaction shall be void or voidable solely by reason of the conflict if the transaction is 1) authorized by a majority of disinterested directors; 2) approved in good faith by the SH; 3) fair to the corporation at the time authorized.

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No status-based disqualification based on family relationships, but director interrelationships do matter in conflict of interest cases. Courts, however, have supplemented w/ additional conflicting interests that are not expressly defined in DGCL 144

------------Tracey Collins & Don Bridges:

CORPORATE DIRECTORS' DUTY OF CARE

Van Gorkom (Corporate Director's Duty of Care & Candor in Decisionmaking) - Trans Union (TU) was a publicly-traded, diversified holding company that made its money on railcar leasing. VG, president of TU, unhappy w/ plan to keep acquiring other businesses to keep TU's income up, met w/ Senior Mgmt. (SMgmt.) of TU & discussed options . VG unilaterally decided to meet with J. Pritzker (JP), a well-known corporate takeover specialist & friend, to propose leveraged buy-out @ $55/share - VG acted w/o SMgmt. OK, tells one TU staffer that ran some numbers to keep quiet. VG called a special SMgmt. & BD meeting - SMgmt. rejects plan, tells VG that price proposed is too low, R vociferously objects to merger as an "inside job" & a "lock-up"- probably want to keep their jobs. Court: o Is the business judgment rule applicable to the special meeting called by VG? NO Business Judgment rule only protects INFORMED business judgments - did the directors inform themselves, prior to making a business decision, of all material information reasonably available to them Director's informed decision making derives from fiduciary duty - affirmative duty to protect interests of other people's money by being informed Under the business judgment rule, liability is predicated on GROSS NEGLIGENCE = also proper standard for assessing whether BD made an "informed decision" DGCL 141(e) - "Directors are fully protected in relying in good faith on reports made by officers." this case b/c VG didn't give a "report" BD was completely uninformed of TU's intrinsic value good faith o Are any of TU's defenses appealing? NO, TU BD was grossly negligent in failing to act w/ informed reasonable deliberation in approving JP merger. BJ Rule "pierced" if mgmt. doesn't give BD an opportunity to make a reasoned decision 3. Did SH ratification cure BD of their lack of an informed decision? NO, only a majority of INFORMED SH may ratify BD's actions & TU SH were not fully or properly informed = BD breached fiduciary duty of candor to SH Corporate directors owe fiduciary duty of "complete candor" w/ all material facts to SH ************ o Leading decision on corporate BD duty of care - plaintiff can get around business judgment, but must be gross negligence & only attack procedure of BD's decisionmaking, not substance Two Fiduciary Breaches: 1) Duty of Care for Uninformed Decisionmaking (Bad PROCESS); 2) Duty of Candor for failing to disclose material facts to SH before vote Entire Fairness is often an available defense for BD to show that conduct was fair, even after business judgment rule is breached o Modern SH Ratification of Board's decisions (Gantler v. Stephens): SH votes do not extinguish the duty of care claim, BUT they may restore the business judgment rule o How do we know the directors have full satisfied their duty to be fully informed? Hard line to draw

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Joy v. North - Corporate directors are NOT liable in negligence for breach of corporate duties = business judgment rule o Why is the Business Judgment Rule good? SH voluntarily buy stock & take risks to make $ - invest somewhere else if you don't like risk Business decisions are quick & ex post litigation doesn't work to accurately recreate fear of hindsight bias Point of a business is to take risks & be rewarded w/ $ - risks are in SH's interests (if personally liable will be too cautious) o Huge losses are SH fault for not diversifying their holdings, "courts need not bend over backwards" to give SH special protection who fail to protect themselves - SH "shouldn't put all their eggs in one basket" o Business Judgment Rule is inapplicable when: Business purpose for decision is lacking Conflict of Interest Corporate waste - "egregious no-win decision" for corporation Obvious failure or lack of any management -------------

DIRECTOR EXCULPATORY PROVISIONS & DUTY OF GOOD FAITH - DGCL 102(b)(7)


Reaction to Van Gorkom Decision - surprised a lot of people in DE, uproar among corporate lawyers & boards of directors, destabilized BD duty of care law Changed the Director & Officer (D&O) Insurance Market b/c made more expensive b/c director liability for their decisions was put into flux Lobbying by Corporate interests & Insurance companies got DE Legislature to pass DGCL 102(b)(7) DGCL 102(b)(7) (Director Exculpation for Breach of Duty of Care) - limits or eliminates director's damages liability for a fiduciary breach of duty of care, if put into Articles of Corporation. Does NOT overrule Van Gorkom Directors "not protected for acts or omissions not in good faith" - but what is "good faith"? Most public companies now have an exculpatory provision in their charters Can't exculpate the duty of loyalty OR knowing violations of law ONLY limits the risk of paying monetary damages to mitigate some uncertain personal liability risk to directors - injunctions still possible for duty of care breach -------------Malpiede (Statutory Duty of Care Exculpation Provisions - Application of DGCL 102(b)(7)) - SH brought breach of fiduciary duty and due care claims against corporation's board of directors following a merger - BD agreed to a deal, but other parties offered more $. Court: Stockholders' claims were based solely on duty of care, and thus were properly dismissed once corporations' charter provision (DGCL 102(b)(7)) was invoked. Malpiede is useful b/c it gets rid of due care claim at the outset of litigation, but doesn't cover claims that are 1) based in loyalty; or 2) when loyalty & care are intertwined = falls into different precedent

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Defendants might FAIL to show that transaction was entirely fair, so TC deems it "unfair" & TC must make a finding of what fiduciary duties have been violated (Emerald Partners) Fiduciary Duty of Good Faith is now very important b/c of DGCL 102(b)(7) - puts "good faith" into statute Caremark (Duty of Good Faith - Directors' Oversight Responsibilities) - Caremark International, Inc., provides health care services and products to patients who are often referred to them by a physician. Since the business is reliant on referrals, there is a temptation by companies such as Caremark to compensate physicians. A federal law was passed to prevent such a system; plaintiffs initiated this suit that year, alleging that the Board of Directors breached their duty of care by failing to put in place adequate internal control systems. This in turn was said to enable the companys employees to commit criminal offences, resulting in substantial fines and civil penalties. Court: Did the Board exercise an appropriate level of attention (duty of care) to the possibility of ARPL violations? Yes, no evidence that the directors knew that there were ARPL violations, and there was no systemic or sustained failure to exercise oversight - lenient settlement approved. Breach of "Good Faith" Test (stemming from a breach of Duty of Care) Knew or should have known that employees were violating the law; Declined to make a good faith effort to prevent the violation; and the lack of action was the proximate cause of damages. "Absent cause for suspicion, there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists." (Graham v. Allis-Chalmers Mfg. Co., A 2d 125 (Del 1963)) Breach of duty of care is more difficult to prove than a breach of the duty of loyalty. "A director's obligation includes a duty to attempt, in good faith, to assure that a corporate information and reporting system, which the board concludes is adequate, exists" ******** Expanded vision of the duty of oversight Different Liability under Duty of Care Van Gorkom - lack of care in making a decision Caremark - unconsidered inaction/lack of oversight as a violation of duty of care - failure to monitor = the Board is asleep Now a duty on the Board to implement a reporting system to find out about significant problems, but the details of the reporting system fall under the business judgment rule If a plaintiff succeeds under the Caremark test, plaintiff has shown a lack of good faith (Stone v. Ritter) Matters b/c DGCL 102(b)(7) only exculpates for breach of due care, NOT good faith or loyalty Distinguishes good faith from loyalty Showing a breach of the fiduciary duty of good faith is a way to bring a FD loyalty case - violation of good faith is a way of showing disloyalty Brehm v. Eisner "Disney Case" (Role & Nature of Substantive Review - Duty of Due Care, Good Faith, & Waste) - Ovitz (O), friend of Disney CEO Eisner, was hired as President despite his lack of experience running a corporation - did have experience & connections in the entertainment industry. O's employment K gives O big severance pay if his Presidency was terminated for anything other than "good cause" (gross negligence, malfeasance, or O's voluntary resignation). New Board of Directors approve "non-fault" termination of O = O gets his huge severance package. SH

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Argument - WASTE, b/c $140 compensation is "shocking" for 14 mos. work. Court: Does the Disney Board of Directors' decision to award O a lucrative employment contract w/ lucrative severance, and the new Board's approval of a "non-fault" termination of O's employment, constitute waste or a protected business judgment? Business Judgment, mere SH disagreement w/ BD decision grounds for liability. SH Argument #1 - BD violated its procedural duty of care in approving O's employment agreement. No, BD relied in good faith on their expert's opinions (DGCL 141(e)), no due care violation. SH Argument #2 - OBD committed a substantive duty of due care breach & waste. No, no such thing as "substantive duty of due care" violation = business judgment rule. Waste Test - an exchange that is so one-sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration - transaction serves no corporate purpose & is, in essence, a "gift" Business Judgment absolves if any reasonable business basis for decision & the decision is made in good faith - waste is "outer limit" of business judgment ("Unconscionable case where directors irrationally squander or give away corporate assets.") No such thing as "substantive duty of due care" - courts don't measure, weigh, or quantify directors' judgments = duty of due care is PROCEDURAL only 3. SH Argument #3 - NBD committed waste in giving O a "non-fault" termination. O should've been fired for cause (gross negligence, malfeasance, voluntary resignation). No, BD had arguable grounds for the decision they made. No gross negligence or malfeasance in O's performance - although O's presidency was disappointing, no gross negligence or "cause" alleged ****** o Case is an example of how Corporate Waste doctrine works & how hard it is for plaintiffs to claim - "shock the conscience" standard "Waste" is a test of irrationality, not simply bad judgment Duty of Care is concerned w/ process of BD, not the substance of their decision (must show corporate waste), BUT waste is only area where court will look at BD's substantive decision o Is the court right to say that a substantive due care claim is not available? Yes, to preserve the teeth of the business judgment rule & keep from hindsight evaluations

In re Walt Disney (Breach of Fiduciary Duty of Good Faith) - Same facts as Brehm v. Eisner. SH amended their complaint - BD approved O's contract w/o informing themselves of the full magnitude of possible severance payout to O = breach of duty of due care. Court: Is intentional dereliction of duty, a conscious disregard for one's responsibilities, the correct standard for bad faith corporate fiduciary conduct? Yes, hybrid/intermediate category of fiduciary misconduct is appropriate. o Breach of Duty to be Fully Informed Breach of Duty of Good Faith, but a Breach of Due Care o What is a "bad faith" activity in the fiduciary duty of good faith? Subjective Bad Faith - intent to do harm & clearly disloyal conduct Lack of Due Care - no malevolent intent, but grossly negligent action Without more, grossly negligent acts cannot necessarily be "bad faith" 3. Intentional dereliction of duties & conscious disregard for responsibilities intermediate, hybrid category of breach of "good faith" & due care

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Fiduciary conduct which doesn't involve disloyalty, but is qualitatively more culpable than gross negligence Ex. Director acts contra to corporate interests, but does not personally gain from actions o Duties of "Due Care" & "Good Faith" overlap? NO, distinct categories DGCL 102(b)(7) allows BD exculpation from breaches of duty of due care, but NOT breach of good faith = overlap would defeat statutory purpose b/c now alleged due care breaches (exculpatory) can be shifted into good faith (non-exculpatory) DGCL 102(b)(7)(ii) - legislative recognition of hybrid, intermediate category of fiduciary misconduct o Breach of Fiduciary Duty of Good Faith Middle ground is probably correct b/c duty of loyalty already covers subjective badfaith & duty of due care covers lack of due care - if they made a new category, it needs to fit in among the others More than gross negligence - must be intentional or deliberate acts ---------------------

SHAREHOLDER DERIVATIVE SUITS

What is a derivative suit? SH bring suit on behalf of corporation - damages go directly to corporation, not individual SH who brought suit o Concern that the BD might have to sue itself - doesn't seem likely o Developed in equity to enable SH to sue in the corporation's name where BD refused to assert a claim it could assert. SH suit to compel corporation to sue Suit by corporation, brought by SH, to fix legal wrong o Why not simply bring a direct suit instead of dealing with a derivative suit & demand futility? Couldn't show that harm was directly to SH rights, only a harm to the corporation itself (ex. corporate waste) Tension between balancing BD's management authority & their reluctance to sue themselves? = demand requirement o SH Demand Requirement - SH must first demand that BD bring suit on behalf of the company. Gives both SH & BD a role, BUT what if the BD must sue itself? Will the BD simply go through the motions & then "decide" against suing itself? OR o Demand Futility Requirement - SH knows the outcome beforehand, know that the BD will ignore their request b/c of BD's conflicting interests. In DE, demand is NOT universally required - plaintiffs may choose to pursue demand futility from the beginning Plaintiffs almost always allege demand futility rather than make demand first. Why? IF demand is made, BD might refuse, but now you must go after the BD's choice to reject your demand & get past the business judgment rule = hard & time consuming If plaintiff can show demand is futile from the outset, easier path to take *******

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Aronson (Derivative Litigation & the SH Demand Req. - Aronson Test) - LF, previous CEO of Prudential, assumed BD chair of MPS & picked his fellow Directors. LF only required to give "best effort" to MPS & MPS has K'd away ability to terminate LF for his inability to perform his job. Plaintiffs allege grossly excessive compensation b/c LF is 75 years old & can't perform his job. Plaintiff didn't demand MPS board remedy issue b/c "futile": 1) All BD members acquiesced & approved LF K; 2) All BD members personally liable for damage done by K; 3) LF dominates BD b/c all BD members selected by LF; 4) BD won't sue itself. Court: When is a stockholder's demand upon a BD, to redress an alleged wrong to the corporation, excused as futile prior to the filing of a derivative suit? Plaintiff SHs failed to make such a particularized complaint. o Demand can only be excused where facts are alleged w/ particularity which creates a reasonable doubt that the director's action was entitled to the protections of the business judgment rule. Futile SH Demand - where officers & directors are under an influence which sterilizes their discretion, they cannot be considered proper persons to conduct litigation on behalf of the corporation Aronson "Demand Futility" Test - have the pleading's particularized facts alleged a reasonable doubt that: the Directors are disinterested & independent; OR Independence - a director's decision is based on the corporate merits of the subject before the board, rather than extraneous considerations or influences To allege domination, need facts to demonstrate that "through personal or other relationships the directors are beholden to the controlling person" the challenged transaction was otherwise the product of a valid exercise of business judgment (corporate waste fulfills this prong) Plaintiffs can succeed under either prong of the Aronson test, don't have to show both o Fact that BD would have to "sue itself" is not legally cognizable unless independence is negated & BJ Rule pierced w/ particularized facts this case Rales v. Blasband - case that doesn't quite fit standard Aronson situations. Plaintiffs must, instead, show a reasonable doubt that the BD could've properly exercised its independent and disinterested business judgment in responding to a demand. o Where a biz decision made by a board, but majority of directors have been replaced What good is it to show that the old BD wouldn't approve your demand request if all new BD members? o Where subject isn't a business decision of the board o Where the challenged decision was a decision of another company's board o Rales Test - If Aronson Prong #2 doesn't apply or fit (no business decision being challenged OR new BD), use Rales In re The Limited (Fiduciary Duty & Aronson Prong #1) - Plaintiff SH contend that The Limited Co. (Ltd.) authorization of a self-tender offer to itself & a rescission of CEO's kid's stock option agreement constituted corporate waste & breach of fiduciary duty. Court: Did the SH's complaint properly allege that Ltd. Board committed corporate waste & breached their fiduciary duty in a manner sufficient to withstand the derivative suit standard & their lack of demand? NO

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Demand Futility (Aronson Prong #1) - SH must plead particularized facts to show directors had: 1) financial interest in the challenged transaction; 2) entrenchment concerns (desire to stay on the BD); 3) were dominated by a party interested in the transaction Must use Subjective, "actual person" test to determine whether a particular director lacks independence - assessing totality of circumstances to determine if each individual director has a material interest/is being "dominated" A feeling of "owingness" or gratitude for past actions may cast reasonable doubt on a director Can't claim a director isn't independent simply b/c they sit on the BD or get BD fees from corp. If an even numbered BD & 1/2 the BD is called into question, plaintiffs have meet Aronson #1 = enough to allow plaintiff's case to continue & survive demand futility Is a reasonable doubt created that a majority of the BD is disinterested or independent? Disinterest & Independence are distinct! Disinterest - is there a conflict of interest? Independence - can the director make their own decisions?

Ryan v. Gifford (Demand Futility - Aronson Prong #2 & Rales Test) - Independent study found that executives at Maxim Integrated Products Inc. realized extraordinary returns of 249% annually, compared with the market average of 29%. Plaintiff SHs sought to show backdating mostly by emphasizing the coincidence that the exercise price was usually determined at lows for the months or year. Court: Aronson, rather than Rales, provided the applicable standard, although he ended up applying both. o Backdating - corporation issues stock options to executives indexed to past (lower) prices by providing fraudulent documents, to make options more lucrative o Due to backdating, officers are getting paid substantially more $, but at the expense of the corporation o Does Business Judgment Rule apply to backdating? NO BD had no discretion to contravene the terms of the SH-approved stock option plans valid exercise of BJ rule Altering the actual date of the grant so as to affect the exercise price contravenes the plan = the unusual facts alleged raise a reason to doubt that the challenged transactions resulted from a valid exercise of business judgment. o Backdating options is an egregious act that doesn't get BJ Rule protection Stone v. Ritter (Demand Futility in a Caremark Claim - BD illegally failed to exercise judgment)SH brought derivative action on behalf of corporation against BD alleging that they had failed to ensure that a reporting system existed to prevent the bank from being used as an intermediary in a huge Ponzi scheme. o Rales Test: No Affirmative Business decision, but could the board of directors have properly exercised its independent and disinterested business judgment in responding to a demand? Why isn't this an Aronson case? There is not BD "business decision" being challenged o Caremark claims are always going to end up falling under Rales b/c you're suing the BD for "unconsidered inaction"so they didn't take any action o Prerequisites for BD Oversight Liability:

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the directors utterly failed to implement any reporting or information system or controls; or having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. In the absence of red flags, good faith in the context of director oversight must be measured by the directors' actions to assure a reasonable information and reporting system exists and not by second-guessing after the occurrence of employee conduct that results in an unintended adverse outcome.

Zapata (BD Response to Derivative Action - "Independent Special Litigation Committee") - BD created an independent "special litigation committee" to recommend whether the corporation should sue the old BD - instigated by SH. Court: Board of directors' decision to cause a derivative suit to be dismissed as detrimental to corporation, after a demand has been made and refused, will be respected unless it was wrongful. o Zapata "Smell" Test 1. Burden is now on the corporation to show that it is acting in good faith, w/ independence business judgment rule o Court's option to dismiss the case if it finds the committee was acting in good faith, not go to Step 2 2. But court should also weigh the equities to "smell out" whether BD is simply skirting legal system - includes consideration of matters of law & public policy o BD wants to show that demand is not "futile" b/c an "independent committee" would review the demand, and once the committee makes a decision not to sue, shove the plaintiffs under the BJ Rule NY Approach - defer to the "independent" committee b/c the "interested" BD is out of the picture Iowa Approach - no deference to the committee, they're structurally biased b/c the interested directors appointed them & they're not going to vote to sue their friends DE Hybrid Approach: a. Corporate BD committees retain all corporate power to make litigation decisions b. Balancing SH nuisance cases against committee's obvious bias in "dismissing" litigation - derivative suits are important o Special litigation committees? Use Zapata Test! --------------

CLOSELY-HELD CORPORATIONS

Common Law Close Corporation o Small number of SH o No ready market for the corporate stock o Substantial majority SH participation in management, direction, and operations of the corp. Statutory Close Corporation - special kind of close corporation, more than a small number of SH, but must meet more requirements & file w/ Sec. State (& Articles must reflect close corporation status) Typical closely-held corporation simply refers to limited number of investors DE does allow statutory close corporations What is a "freeze out"? Majority uses its clout to block any efforts of minority SH & blocks minority SH compensation

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Forces minority to sell to no-one or take no $ = lose-lose situation

Approaches to Closely Held Corporations

Look to ordinary corporate law - CC is still a corporation! Standard Business Judgment Rule analysis Oregon - Zidell v. Zidell Delaware - Nixon v. Blackwell (Ex Ante Planning) Unless you choose to form a statutory CC, court won't step in = ex ante solutions Clearly rejects MA approach Remember that DE is A LOT LESS DOMINANT IN Closed Corporations Massachusetts approach - judge-made approach (Fiduciary Duties) Donahue- partnership analogy & equal opportunity rule Wilkes - can the controlling party meet its burden of showing a legitimate business purpose for action? If yes, "harmed" party may still show less harmful avenue & court will balance. More protective of minority SHs than DE Scrutinizing the legitimate business purposes of majority SH 3. New York - legislative solution (Liquidity) Possible to petition for dissolution, but seen as drastic remedy Courts may choose less severe solution Buy-out option - majority group may decide to simply buy-out minority SH Reasonable Expectations Test - concerned with RE of minority SH **************

Zion (Contracting to Limit Majority's Discretion) - Minority stockholder (1 out of the 2 SHs) of Delaware corporation sought declaratory and injunctive relief alleging violation of a stockholders' agreement prohibiting business or activity on the part of the corporation without the consent of the minority shareholder. Court: Shareholders' agreement that no business or activities of corporation shall be conducted without consent of minority stockholder barred corporation from entering into interest and escrow agreements without consent of minority stockholder. o Common Law Doctrines McQuade v. Stoneham - SH agreement that limits BD's control of corporation is void = "sterilizing" BD Clark v. Dodge - no reason to void legal SH agreement, especially if no attempt to "sterilize" BD & no harm to 3rd parties. Statutory law has moved past these cases to allow SH to limit BD DGCL 141(a) - BD runs corporation, "except where otherwise provided in chapter or incorporated into Articles" o Case is not binding on a Delaware Court b/c a New York decision, applying DE law Ramos (Shareholder Voting Agreements) - Shareholders brought action to specifically enforce shareholder bloc voting agreement against shareholder who allegedly breached the agreement. E, party to SH voting agreement, voted to remove another SH, also party to agreement, as president. Court: Agreement was a valid SH vote pooling agreement, rather than creating proxy which had been validly revoked. o Voting Pools are another way that Minority SH may attempt to protect themselves - minority SHs may "team-up" to create a new majority, as long as they all stick together

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Did Estrada break the K by voting out another SH in the bloc? No, decision to vote 2 other SH out didn't violate any agreement b/c she was acting in her role as a DIRECTOR, not as a SHAREHOLDER

Zidell (Fiduciary Duty - Traditional Judicial Deference to Majority's Discretion) - A minority stockholder in four related, closely-held corporations brought an action to compel the directors of the corporations to declare dividends. He was previously an employee drawing a salary, but resigned b/c of animosity among family in the business. Court: Plaintiff had not discharged his burden of showing bad faith on the part of the directors in determining the amount of corporate dividends. o BD & officers have fiduciary duties of good faith and fair dealing toward minority shareholders in corporation (similar to Sinclair) SH Dividends - duty of BD to exercise good faith and fair dealing toward minority SHs is discharged if decision is made in good faith and reflects legitimate business purposes rather than private interests of those in control = Business Judgment Rule o Minority SH voluntarily resigned, but what if he was fired in an employment at will? Should court still give business judgment deference or see "bad faith" in firing? No change, not unless there is something to remove facts from the business judgment rule & keep the court from deferring Donahue (Partnership Analogy & Basis for Enhancing Minority SH Rights) - D is a minority SH in Rodd who wants corp. to rescind Rodd Corp's purchase of shares from controlling SH H b/c alleged fiduciary breach to her. H wants to retire (health concerns), gradually giving shares to his children & sells back a significant # of shares to the corporation, but D also wants to sell back her shares, & company will only buy at a lower price than H's shares. Court: D should get the same price for her shares as H's deal. o Stockholders in a close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another. SH in close corporations must discharge their management and stockholder responsibilities in conformity with this strict good faith standard = SH may not act out of avarice, expediency or self-interest in derogation of their duty of loyalty to the other stockholders and to the corporation. o Equal Opportunity Doctrine - when one SH in a close-corporation gets a sell-back deal, other SH are allowed to sell a proportionate percentage of their shares at the same price as the original OR first SH would have to give back his profits from the deal. Wilkes (Partnership Analogy & Basis for Enhancing Minority SH Rights #2) - Businessmen agreed to open a nursing home, profits from the business were large enough for them to each draw a salary. One of the Defendants wanted to purchase part of the property for his own business use, and Plaintiff (W) forced a higher price for the property than what was expected - created bad feelings between the partners until finally W notified the other shareholders that he wanted to sell his share. A month later, but prior to the sale of his shares, Defendants voted to terminate W from his position and took away his stipend . Court: Did Springside violate a fiduciary duty when they removed Plaintiff from his position after a falling-out between the parties? Yes, shareholders in a close corporation owe each other a duty of acting in good faith. o Breach of their duty of good faith when they terminate another SH's salaried position, when the SH was competent in that position, in an attempt to gain leverage against that shareholder = FREEZE-OUTS AREN'T ALLOWED

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Did the management decision that severely frustrates a minority owner has a legitimate business purpose? Alters Donahue - if Equal Opportunity is applied too stringently, it may actually harm the close corporation

Nixon (Delaware's Close Corp. Response - Statutory Close-Corp. Necessity) - Minority SHs, nonemployees, of closely held corporation sued directors, the majority shareholders, alleging breach of fiduciary duty as result of allegedly discriminatory policy (Employee Stock Option Plan) that unfairly favored Class A employee stockholders over Class B nonemployee stockholders. Court: o (1) Entire Fairness Test, rather than business judgment rule, applied to determine whether directors, as conflicted corporate decision makers, breached their fiduciary duty Doctrine of entire fairness does not lend itself to bright line precision or rigid doctrine; and yet, it does not necessarily require equality, it cannot be matter of total subjectivity on part of trial court, and it cannot result in random pattern of ad hoc determinations which could do violence to stability of corporation law. Whether creation of employee stock ownership plan (ESOP) and key man insurance programs necessarily require equal treatment for nonemployee stockholders, is matter for legislative determination. When there is no independent corporate decision maker, court may become objective arbiter in dispute regarding decision of directors of corporation. DEL is trying to specialize in large corporate law: we want big corps and do not want partnershipswe want regular corporate norms/they also get taxes from share issuance/ o (2) liquidity afforded to employee stockholders by ESOP and key man insurance programs did not require substantially equal treatment for nonemployee stockholders Reasonableness of business judgment of conflicted directors' decision must be examined searchingly through principled and disciplined analysis. Class B stockholders who had no voting rights were simply passive investors entitled to be treated fairly but not necessarily to be treated equally. It makes no sense to include nonemployees in ESOP benefits. Class B stock was given no voting rights because those stockholders were not intended to have direct voice in management
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(4) closely held corporation at issue was not statutory close corporation so as to be subject to special rules under Delaware general corporation law. Corporation was not designated as close corporation in its certificate of incorporation and did not include limitation to 30 on number of stockholders or require that all classes of stock have at least one restriction on transfer Entire fairness scrutiny applied b/c conflicting interest, not because of close corporation

In re Kemp & Beatley (Modern Approach to Involuntary Dissolution) - Minority shareholders commenced a proceeding seeking dissolution of a corporation on the grounds of fraudulent and oppressive conduct by the company's board of directors - fired & min. SH used to draw bonuses from corp., but policy changed to only pay "compensation" = min. SH is getting no more return. Court: When majority shareholders of close corporation award de facto dividends to all shareholders except class of minority shareholders, such policy may constitute oppressive actions and serve as basis for order dissolving the corporation

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Involuntary Dissolution only when majority conduct substantially defeats minority SH's expectations that, objectively viewed, were both: Reasonable under circumstances (OBJECTIVE), and Central to petitioner's decision to join venture (SUBJECTIVE) Majority conduct should not be deemed oppressive simply because minority shareholder's subjective hopes and desires in joining venture are not fulfilled. Minority SH need only show prima facie case of oppressive conduct by BD & BD must demonstrate existence of adequate, alternative remedy to stave off dissolution Every order of involuntary dissolution of a corporation must be conditioned upon permitting any shareholder of corporation to elect to purchase complaining shareholder's stock at fair value

Gimpel (Modern Approach to Involuntary Dissolution #2) - After SH was fired from the family corporation for embezzlement, he received no benefits from his ownership position. He alleged that he was excluded from corporate participation, that the profits only were paid out in salaries and not dividends, and that he was excluded from examining the corporate books. Court: Reasonable expectations of the parties' test for oppressiveness and found that the facts did not warrant dissolution Lack of fair dealing test of oppressiveness and found that the shareholder's discharge and his later exclusion from corporate management were not oppressive. ***************** Share Repurchase Agreements in Close Corporations Why is predictability in this setting so important? Why do people enter into these SRPAs in the first place? Effort to make sure that only particular people will have ongoing control of the company - bring the stock back to the company Way of guaranteeing liquidity Allows for budgeting - parties planned their stock valuation in conjunction with their life insurance planning Guarantees minority SH that their shares can be sold back for at least a price that they can tolerate & majority SH incentive to talk about SRPA anyway Trying to avoid litigation in the future by contracting now = protects majority If the whole point was to avoid litigation, but courts are going to re-open the deal anyway = pointless exercise to K in the first place o Key ex ante solution to close corporation liquidity problems Concord Auto (Share Repurchase Agreements) - C (car auction) & A (title guarantor), two separate corporations, owned in 1/3 by siblings C, P, & T. Owners enter into Stock Purchase & Restriction Agreement (SRPA) - all shares owned by SH at death shall be re-acquired by corps., through life insurance policies taken out for this reason. No dispute that bylaws call for yearly evaluation, that evaluation wasn't done, or that FMV for C's stock is 2x as much as last evaluation price. Court - Must C estate be forced to sell his shares back to C&A under the SRPA? YES, C's estate was "unambiguously obligated" to tender C's shares back to C&A at SRPA price. o Mere fact that remaining SHs profit from the enforcement of SRPA does not create an obligation on their part to act to review the SRPA price = no special responsibilities o Need more than disparity between option price & FMV to prove an invalid SRPA = fraud, overreaching, undue influence, duress, or mistake at the time the deceased entered into the agreement

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Gallagher (Share Repurchase Agreements #2 - Repurchase & Employment Agreement (+) Fiduciary Duties) - G, employee of E Co. (a close-corporation), bought 8.5% stock in company w/ mandatory SRPA buy back. G was fired 1 month before his stock would shift from book value to earnings index. G claimed that he was fired BECAUSE of the pending flip from book value to earnings index, requests index to earnings anyway - not complaining about the firing itself, but the firing as it relates to the devaluing of his stock as a SH. Court: Should G get the book value or earnings index for his stock under the mandatory buy-back provision? Book value, no dispute that E Co. had discretion to fire G at any time, court won't "redefine the precise measuring device & scope of the agreement." o Minority SH in close corp. who agrees to SRPA as an employee has NO right against corporation or majority SH against at-will firing = must keep duties to SH and duties to EMPLOYEES distinct Focus on ex ante contracting - parties K in advance for reliance, predictability, and definitiveness o G bringing claim as a SHAREHOLDER under Breach of Good Faith & Fair Dealing - he was fired because of the pending flip from book value to earnings index o Scope of Fiduciary Duties is defined by the contract? Are fiduciary duties changeable like this? Is this NY court allowing parties to contract around fiduciary duties? Courts want to encourage people to contract = saves court time Pedro (Share Repurchase Agreements #3 - Employment, Fiduciary Duties, & Share Repurchases) - A, C, & E (brothers) own 1/3 share & run TPC, Co., a luggage & leather products company w/ $6 million in sales; all brothers worked for TPC for decades - A worked for TPC for 45 years. SRPA entered into by brothers & their father in 1968 to provide liquidity on death or transition. Decades later, A found a $330,000 discrepancy in the books & wanted an independent investigation - C & E eventually fire A & completely cut him off from benefits & salary. Court: Did C&E breach their fiduciary duty as SH in CC to A? YES, C & E didn't act openly, honestly, or fairly w/ A - didn't pay out on SRPA, hired private investigator to stalk A, conjured false allegations against A, & admit their prejudice against A o An action depleting the corporation's value is not the exclusive method of breaching one's fiduciary duties - loss in value of SH's stock isn't the only measure of damages o Reasonable Expectations of SHs? Start at inception & developed during course of SH's relationship w/ CC & one another Courts must consider "nature of employment" when assessing the "reasonable expectations" of employee of future employment o Other Cases: Evangelista v. Holland - mutuality of risk for each investor subject to SRA King v. Driscoll - buyback agreement doesn't completely relieve SH of fiduciary duties SH can challenge the actions invoking the SRPA -------------------

LIMITED LIABILITY COMPANIES


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What is an LLC? Not simply a corporation or a partnership = HYBRID Limited liability Tax advantages of a partnership, even w/o all criteria of partnerships - "pass-through" treatment LLC isn't taxed itself, but the members are taxed for their money derived from the LLC

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Big reason why LLC was created - check the box treatment Contractual flexibility - don't need too many "off the rack" rules Statutory default rules, but may be contracted around Many gaps in statutes purposely left to the parties to work out = fewer rules than corporate "off the rack suit" If parties contract well, may be a means to avoid litigation. If they don't contract well, higher possibility of litigation Very complicated & intricate agreements = usually sophisticated parties Useful for parties that are litigation averse NOT ALWAYS, though - small mom & pops also choose LLCs for limited liability & flexibility New Business Form = less case law to draw on in disputes Courts turn to contract, corporation, & partnership law Analogous to Close Corporations, but with MUCH more emphasis on party contracting ex ante Often associated with closely-held corporations, but changing Now publicly held LLCs - so do we want law that fits small businesses or bigger, publicly held corporations

Types of LLCs Member Managed (default rule) - much like a general partnership Fiduciary Duties Manager Managed - similar to corporate BD/officers & members (SH) &/or limited partnership Passive investor members & active managers Questions o Who wants to form an LLC? o Why pick an LLC over a partnership or corporation? o When would you want contractual flexibility? o How should courts deal w/ LLCs? Corporate, partnership, contract or none of the above? *************** Elf Atochem (Intro to DLLCA - Environment of private ordering w/ contract flexibility) - EA worked w/ J to fund his eco-friendly alternative to the aerospace industry's chemical solvent-based maskants. J gets EA's market & $, agrees to Joint Venture w/ LLC as vehicle; parties also draw up a governance and operation agreement (Step #2) which J & EA both sign - BUT, LLC itself didn't sign the agreement. Court: Fact that LLC itself didnt sign governance contract is not important. o Purpose of LLC - to permit persons or entities (members) to join together in an environment of private ordering to form and operate the enterprise under an LLC agreement w/ partnership tax benefits & corporate form limited liability = HYBRID Basic Purpose of LLC: Freedom of Contract Furnish default provisions where the LLC membership agreement is silent o Courts only step in where 3rd party might potentially be harmed - courts won't protect parties contracting under LLC from themselves or each other unless egregious o Agreement on how to address disputes involving the LLC, but the LLC didn't sign the agreement? Not a problem b/c both parties have signed & LLC is really just the vehicle, but is this really honoring the "contract"

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Since updated by DE Legislature - mandates LLC organization & internal structure to DE courts

Olson (Planning for the LLC - intricate agreements & fact patterns that must be interpreted by courts) - Ol, a founder of a successful hedge fund (V), brought an action against his two co-founders (H & Ot) & various legal entities created to run the fund, claiming that they failed to pay him for his equity interest in the enterprise after he was let go. Co-founders agreed at start-up that if any one of them left V he would only be entitled to his earned compensation & his capital account = "Cap & Comp" agreement. Court: Was Ol entitled to an equity interest in V beyond his cap & comp agreement terms? NO, Ol only entitled to his accrued compensation & the balance on his capital account. o Default is that partner is entitled to fair value of his membership interest upon departure "if not otherwise provided in the partnership agreement" BUT, in this case, contracts spoke to this issue & default rule gives way to party contract o Sophisticated parties should be stuck with the consequences if they didn't contract fully Bay Center (Fiduciary Duties in LLCs - Manager-Managed LLC) - PKI (owned by N), defendant, was the managing partner of EB, LLC, a failed condo development project. The LLC management agreement designated EB as the manager of the project, giving PKI both certificate & constructive governance authority. PKI mismanaged project (excessive budget overruns, vendor complaints, poor sales, & squatters/vandalism), lost $, & defaulted on a construction loan to a 3rd party - BC sues for breach of contractual good faith & fair dealing, breach of fiduciary duty. Court: May a party be held to the contractual duty of Good Faith & Fair Dealing if it didn't actually sign the LLC contract in question? It depends, don't like to imply GFFD, apply sparingly when parties have complex K b/c don't like judicial intervention in complex contracts. Implied covenant of GFFD functions to protect SH expectations that the BD will properly perform the contractual obligations they have under the organizational agreement - BD must employ their discretion in good faith PKI was required to carry out its contractual duties in good faith, can't engage in "arbitrary or unreasonable conduct" to prevent BC from realizing the "the fruits of the bargain" Contract Duty of Good Faith & Fair Dealing = CANNOT be eliminated Explicitly tied to the agreement - not a fiduciary analysis, a contract analysis Did the LLC agreement dispense with Fiduciary Duty completely? NO, traditional fiduciary duties still remain. DLLCA allows members to K to limit or eliminate Fiduciary Duties (FD), but default rules if K is silent on the issue Drafters must make their intent to eliminate FD plain & unambiguous - if the parties act in an ambiguous way, the court will protect the less-protected party Court will read the agreement very narrowly Delaware - able to completely contract away any substance of fiduciary duties = complete elimination Associates/affiliates of a general partner, who exercise control over the partnership's property, owe fiduciary duties to both the partnership & its limited partners Duty NOT to use control over the partnership's property to advantage the corporate director at the expense of the partnership

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CORPORATION AS A RISK-ALLOCATION DEVICE - 3rd Party Rights


How does (or doesn't) corporate law protect Creditor's Rights? What is the difference between being a creditor of a corporation and a SH? o Creditor SH's are residual claimants - Creditors get paid first, before SH Minimum Capital requirement - legal capital rules Creditors are more able to contract than SH - bargain for terms that are favorable to creditor Do creditors benefit from fiduciary duties? Creditors do not benefit directly from BD fiduciary duties o Shareholder SH has a vote & governance role in corporation SH has less risk b/c can move their shares easier & on their own volition - more liquidity Both creditors & SHs want the business to do well, but conflicting interests when the corporation is getting into trouble o SH prefer more risk to pull the company out of the mess & keep from paying the creditors, creditors prefer less risk to get their $ back first after the company fails Risk from the creditor's perspective - BD will prefer to look out for the SH b/c SH vote for the BD, the BD has shares, & the BD doesn't owe any fiduciary duties to creditors DE still has a legal capital requirement, indexed to par value? Par value is not as protective as it once was = limited protections in Delaware o Par value - historically, was the same price that the stock was initially sold for which gave creditors an idea of the $ that the corporation couldn't touch to assess their risk If par value was impaired (less than the legal capital requirement), company wouldn't be allowed to issue dividends or repurchase stock o Over time, companies started issuing stock with tiny par values (stock sells for $20/share, with a par value of .01), which made the par value less useful In DE, BD can set the par value at whatever price it wants to, but the aggregate par value cannot be touched by the BD with dividends or stock repurchases Anything above aggregate par value is surplus & BD can issue dividends out of surplus ************* Klang (Statutory Rules Governing the "Equity Cushion" - Limits on SH distributions in a merger) SFD, supermarket chain, K'd w/ Y, Co. to repurchase SFD CEO's (JS) shares & merge SFD into Y. In order to make the transaction work, SFD had to recapitalize which put it into new debt. Court: Did SFD improperly tap into capital to make the transaction work, under DGCL 154? NO o Corporation can't repurchase its shares unless out of "surplus" - DGCL 154 A repurchase impairs capital if the funds used in the repurchase exceed the surplus Balance sheets are not conclusive indicators of a surplus or a lack thereof o Corporations may revalue assets to show surplus & perfection in this process isn't required Directors have reasonable latitude to depart from the balance sheet to calculate surplus, so long as in good faith, w/o fraud, & by methods that they reasonably believe reflect present values

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Limits of the Par Value - BD can revalue assets & liabilities over time, if reasonable = gives corporations leeway to "find" extra money to issue dividends In MBCA jurisdiction, insolvency is a way to limit BD's ability to issue dividends - BD may distribute assets to SH only if it will remain solvent Possible to lower par value after the fact - amend the articles or drastically change business

Consumer Co-Op (Piercing the Corporate Veil to Reach REAL PERSONS - Contract Case) - ECO was incorporated by Olson (CO) w/ his parents as 1/2 SH & only BD members. Within a few years, ECO defaulted on the Co-Op credit card - about $200,000 in debt. Co-Op continued to give ECO credit even after ECO was clearly in default, against Co-Op's own stated policy of cutting off credit to defaulters. Court: Should the corporate veil be pierced to reach CO personally for ECO's credit card debt to Co-Op? NO, Co-Op has failed to show that corporate formalities were egregiously ignored, or that CO dominated to a point of perpetrating fraud. o Court may "pierce the corporate veil" or disregard the corporate fiction if the corporation is used for a fraudulent purpose, to perpetrate a constructive fraud, or to cause a strong equitable harm Alter Ego/ Instrumentality Test (Piercing the Veil Test) - trying to assess if the corporation is indeed a separate entity or if it's just being used by an individual for wrongful purposes ("shell corp.") SH complete domination, "so that the corporate entityhad no mind of its own, no will of its own." Control must be used to commit a wrong - unjust, fraudulent, or wrongful actions Proximate Cause of plaintiff's harm Piercing the Corporate Veil is an Ex Post Solution - allow the creditors to go after the SH after the harm is suffered As if the corporation didn't exist, allow the creditors to go directly after the SH o No continuing requirement to maintain "adequate" capital - assessing capital @ start-up, not subsequent losses that dent the corporation's capital b/c businesses lose $ While significant, undercapitalization isn't an independently sufficient ground to pierce the corporate veil May reassess adequacy of capital if business changes the nature or magnitude of the business Informal BD meetings aren't a big deal - OK under close corporation law, meant to facilitate the "special needs" of closely held corps. o Creditor may have waived the right to assert undercapitalization as a basis to PTV if it continues to provide credit to the debtor even after aware of defaults - continuously doing business w/ ECO, but NOW claiming undercapitalization at the beginning? K.C. Roofing (Piercing the Corporate Veil to Reach REAL PERSONS - Contract Case #2) - KCR, roofing supplier, sued OT & owner N to recover $ for unpaid roofing supplies delivered to OT - PTV to make N personally liable for damages. N created and shut down numerous corporations, ostensibly to keep avoiding his debts. Court: Is N personally liable for the debts of OT? Should the court PTV? Yes, through his domination and control, N was using the corporation to unfairly/inequitably avoid his legal obligations. o Alter Ego/ Instrumentality Test - trying to assess if the corporation is indeed a separate entity or if it's just being used by an individual for wrongful purposes ("shell corp.")

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Complete domination, "so that the corporate entityhad no mind of its own, no will of its own." N clearly dominated OT & every other corporation he started - sole SH & made every business decision Control must be used to commit a wrong - unjust, fraudulent, or wrongful Satisfied, shell corporation 3. Proximate Cause of plaintiff's harm Satisfied, shell corporation N was operating an intricate corporate shell game in which he would cease doing business as one corporate entity when he was unable to pay the corp.'s creditors and then form another corporation in place of the prior one in order to gain a "fresh start" Prime Example of corporate actions that allow a court to PTV = FRAUD RN would simply start a new corporation to get past his financial difficulties - designed to fool creditors into thinking that they were dealing with a solvent business Note: Passive Investors may avoid liability under PTV b/c they didn't do anything wrong

Western Rock Co. (Piercing the Corporate Veil to Reach REAL PERSONS - Tort Case) - Plaintiff sued WR Co. & officers for negligent blasting in a rock quarry that damaged their nearby homes. After GS & F considered the pending lawsuits and the lack of insurance, they decided to continue blasting anyway - continued for another 4 months. Court: Should the court pierce the corporate veil to make the board member/lead investor & president of the blasting company personally liable for the damages caused by their rock blasting company? Yes, F & GS were legally responsible for their negligent conduct which was the proximate cause of damages sustained . o PTV may be appropriate, but F & GS might be liable on their own w/ direct liability, too Direct Liability - if an agent of a corp. commits a tort, the agent himself is directly liable for committing a tort & the corp. can be liable, too Agent may be directly liable himself as a tortfeasor Corporation may also be liable under PTV o Not going to run into defenses like waiver or estoppel b/c a victim of a tort hasn't waived their ability to collect, most likely Baatz v. Arrow Bar (Piercing the Corporate Veil to Reach REAL PERSONS - Tort Case #2) - KB injured by RM, drunk driver; RM uninsured, so KP goes after Arrow Bar (AB), the bar that negligently served RM after he was drunk. N's didn't have dram shop insurance b/c lawyer told them that if they were a corporation they'd be insulated from personal liability. Court: May KB pierce the veil of AB to reach E&L N personally for her injuries? No, no evidence that the Ns treated the corp. in any way that would produce the injustices & inequities necessary to PTV. o Court concludes that if KB wants to use RS to get to Ns, she must show that one of the Ns personally served the alcohol to RM o Pierce the Veil Factors Fraudulent misrepresentation by corporate directors Undercapitalization Failure to observe corporate formalities Absence of corporate records Payment by the corporation of individual obligations Use of the corporation to promote fraud, injustice, or illegalities o Dissent - the corporation is NOT separate from the Ns "A corporation haveth no soul, and its hind end you can kicketh not."

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Craig (Piercing the Corporate Veil to Reach CORPORATE SH- Tort Case) - Asbestos PI case, C suing all producers of asbestos for his exposure @ work w/ Owens Corning. When the asbestos suits began, Cape decided not to contest them at all, to default, and make the plaintiffs attempt to enforce their default judgments in the UK = impossible b/c English courts required entirely new trials. Court: Is the evidence sufficient to show that Cape is the alter ego of Charter, allowing plaintiff to PTV of Cape? NO o Alter Ego Test - actual fraud isn't required, only that "the privilege inherent in incorporation is abused & a subsidiary used to perpetrate injustice." Can't PTV unless parent completely dominated subsidiary - sub. was simply a conduit for the parent Court really wants to see domination to PTV, involvement in day to day business decisions isn't enough Only PTV if: 1) Parent completely dominates the sub. & 2) Parent is used to perpetrate a fraud/injustice o Ventron - officers of parent owned 100% of subsidiary shares & conducted its day-to-day operations PTV b/c no "dominance" (degree of control, not utter domination) & sub's purpose wasn't illegal Charter's publicly announced intentions to "control" Cape is expected - majority SHs obviously seek control of the subsidiary, that's why they have a majority of the shares o "A court must not PTV when presented with nothing more nefarious than the interest and involvement that properly may be demonstrated by an active parent corporation." Bestfoods (Piercing the Corporate Veil to Reach CORPORATE SH- Direct Liability if the SH is a Corporation) - Ott Co. polluted MI site w/ hazardous chemicals in the '60s. Gov't pays for clean-up immediately, then sues anyone who operated facility to replenish fund under CERCLA. Court: Was derivative liability appropriate under CERCLA? No, DC's focus on the relationship between parent and subsidiary (rather than parent & facility), combined with its automatic attribution of the actions of dual officers and directors to the corporate parent, erroneously treated CERCLA as if it displaced common law rules of corporate limited liability. o Parent corporation is not liable for the acts of its subsidiaries - deeply ingrained in economic & legal systems o Corporate veil may be pierced & SH liable for corporate conduct if the corporate form is misused to accomplish wrongful purposes (i.e. fraud on SH's behalf) o Not interested in the relationship between the parent and the subsidiary, but whether the parent controlled the facility that polluted Direct - alleged wrong can be traced to the parent through its own personnel & mgmt = parent is a direct participant in the wrong Parent is itself responsible for the agent's wrongful actions Direct Liability - going after a tortfeasor who committed a tort, who also happens to be a SH Indirect - liability based on the relationship between two corporations Veil Piercing Analysis Derivative Liability - SH liable based on their relationship to the corporation they've invested in o Management alone is not enough to expose the parent corp. to liability for its subsidiary's actions Corporate officers may "change hats" to represent both Parent & subsidiary separately

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Look to corporate norms to see if P is supervisor or really operating the subsidiary - are the dual officers/agents' actions eccentric when judged against corporate norms?

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DEFECTIVE ALLOCATION OF LOSS RISK


No corporation, so unlike veil piercing b/c no corporation - can investors avoid liability anyway? Two Scenarios Parties are bargaining in recognition that there isn't a corporation yet Promoters planning & putting corporation together, just haven't formally done it yet RKO Stanley case - contract meant to protect promoter after corporation comes into existence If any ambiguity, courts will read against the promoter Don't want people to take advantage of corporate form 3rd party wouldn't rationally enter agreement unless it could hold someone liable Black Letter Law - if someone attempts to bind a principal before it actually exists, the corporation also gets to make its own choice whether to assume the promoter's risk after creation - corporation does NOT automatically take the place of the promoter Penalty Default Rule - requiring promoters to be very clear & disclose information to stave off their own liability Parties don't know that the business isn't a corporation De Facto Corporation - meant to protect people who believed in good faith that they've created a corporation REJECTED by many states: unpredictable & very easy to figure out if you've actually created a corporation ACCEPTED by a few states Corporation by Estoppel - applies where the 3rd party thought that they were dealing w/ a corporation, not with individual SHs 3rd party never thought that the SH were personally liable to creditors, so shouldn't get to go after them now Timberline Case No true limited liability under de facto or estoppel, who's liable? Courts split Investors are like partners = joint & several liability rule Operating Parties only have liability, passive investor gets limited liability protection - unfair to hold a passive investor joint & severally liable

Agency Law - is there actual, apparent, or inherent authority of an agent to bind the principal? o GOF Case: K had no actual authority to bind Anaconda, but he is the treasurer of a corporation w/ a large amount of authority in the bylaws - is there apparent authority?

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Looking for the reasonable belief of the 3rd party based on the principal's manifestations 3rd party has duty of inquiry if the transaction is out of the ordinary Menard Case: outer limits of authority doctrines S is president, but doesn't have actual authority b/c BD limited his ability to contract But does S have apparent authority? Unclear, but doesn't appear so b/c S was contracting for land but the company is in the electronics business = outside their ordinary business Menard did have notice that S needed BD approval Inherent Agency power applies - focuses heavily on STATUS of S as president Inherent Agency Test: Usually accompanies transactions that the agent is normally authorized to conduct Other party reasonably believes that the agent is authorized Other party does NOT have notice that agent isn't authorized Also looking at reasonable belief of 3rd party based on manifestations of AGENT Inherent Agency power is a Rstmt. 2d concept, but it is diffused in Rstmt. 3d under apparent authority

Ultra Vires Doctrine - covers conduct that the corporation wasn't legally allowed to do in its charter o Not so prevalent in the modern era b/c Articles now allow the corporation to take any actions legally possible o Covers circumstances where the BD tries to have the company do something illegal or in cases of corporate waste o Two Circumstances where UV Doctrine Applies Suit by SH to enjoin the corporation from performing an UV act Derivative or Direct suit against the persons who took the UV act on behalf of the corporation ---------------

INTRO TO SECURITIES FRAUD (SEC RULE 10b-5)

What is common law fraud? Intentionally deceiving another person and causing her to suffer a loss. o Securities Fraud isn't identical to Common Law fraud b/c common law didn't do enough to prevent securities fraud in the first place Federal Securities Fraud problems are distinct from State Corporate Governance laws o Issues not directly concerned with internal governance, but relationship between buyers & sellers of stock o Supplement to corporate governance law, although SEC 10(b)(5) Elements Material misrepresentation (or omission) (Basic) Scienter (Ernst) In connection w/ the purchase or sale of a security (Blue Chip) Reliance (transaction causation/FOTM theory) (Basic 2) - did the fraud make somebody buy or sell stock?

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Economic loss Loss causation (Dura) - did the buyer lose $ on the stock caused by the fraud? ********

Blue Chip Stamps (Limiting the Private Cause of Action under SEC 10b-5) - Blue Chip Stamps settled an anti-trust action w/ the Feds by opening up stock to retailers who had previously used the trading stamp service, but weren't current SH. Only 50% of the offered stock was purchased & Manor sued for a class 2 years later, claiming that the reason only 50% of the stock was purchased was that BCS had made its initial offering prospectus very pessimistic in order to mislead potential buyers - BCS played down the value of the stock. Manor never actually bought any BCS stock claiming a missed opportunity to buy stock. Court: May stock offerees maintain a private cause of action under SEC 10b-5 if they've never actually purchased or sold any of the stock at issue? NO, the Birnbaum Rule applies, so plaintiffs can't sue unless they actually bought or sold the security at issue. o Birnbaum - private 10b5 action only available to plaintiffs who've actually bought or sold securities at issue Judicially constructed cause of action shouldn't reach beyond express causes of action actually written into legislation Potential purchasers alleging a fraud b/c of a gloomy representation may still bring STATE cause of action o What does 10b "in connection with" language mean - must've bought stock Santa Fe (Does SEC 10b-5 action require "manipulation" or "deception"?) - Santa Fe originally held 60% of Kirby Lumber's stock, eventually purchased 95% of KL's shares in a 30 year period - SF uses DGCL 253 short-form merger to merge w/ KL: NO MINORITY SH CONSENT REQUIRED & Any SH dissatisfied w/ the merger may sue in Delaware Chancery for fair value. Minority SH object to merger, bring derivative suit on behalf of Kirby Lumber to set aside merger OR pay them FMV for their shares - claim $772/share. Court: Does a majority SH's use of a short-form merger to eliminate the minority interest in the company violate SEC 10b-5? NO, the short-form merger transaction was neither deceptive nor manipulative & therefore didn't violate SEC 10b-5. o Statutory language shows that Congress only meant to prohibit conduct dealing with manipulation or deception = only means to bring suit Manipulate - practice intended to mislead investors by artificially affecting market activity o No allegation of manipulation, deceit, misrepresentation = mere mismanagement & unfairness isn't enough to bring 10b5 cause of action (COA) SH also had built-in State COA that they chose not to bring = can't now bring a federal suit! Basic, Inc (Elements of Common Law Fraud & SEC 10b-5 - Materiality) - CE, Inc., manufacturer of chemical refractories for steel production, wanted to buy B, Inc. B made 3 public statements denying merger negotiations, but eventually issued a statement that they'd been approached by another company about a merger. Plaintiff sold B's stock after B originally denied the merger in public statements - alleging that B's false statements injured plaintiff b/c plaintiff sold shares prematurely, at artificially low price, relying on B's statements about no merger. o Court adopts TSC materiality test - "must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available."

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But how does this apply to information about a transaction that may never occur in the future (contingent event)? BALANCING TEST BALANCING TEST: Materiality will depend on balancing the 1) probability that the event will occur & 2) the anticipated magnitude of the event in the light of the totality of the company's activity." Probability - look at the management's interest in the transaction to see if the information is likely to occur Magnitude- merger is highly important, but consider size of company eating & being eaten - probably greater magnitude to SH that small fish is being eaten, not that big fish is eating small fish Seems like a hard test to apply & hard for business to plan around

Ernst & Ernst (SEC 10b5: Defendant's Mental State) - Suit against EE that had been based on the firm's alleged negligence in aiding and abetting fraud committed by the president of a small brokerage firm whose books were audited by EE. Court: Can a plaintiff succeed in a private 10b5 cause of action if there are not allegations of scienter? Can 10b5 be predicated on simple negligence? NO o Intent ("scienter") is a necessary element in a securities fraud case, but doesn't rule out recklessness - "Manipulative" & "Deceptive" terms in the statute = INTENT o Negligence is NOT enough for 10b5 violations b/c statute includes "manipulative" & "deceptive" devices - cannot "accidentally" manipulate someone, but can accidentally deceive Basic, Inc. #2 (Reliance & Causation - Fraud on the Market Theory) - Prior Facts. Court: May a person who traded shares after the issuance of a materially misleading statement by the corporation invoke a rebuttable presumption that he relied on the integrity of the market price when he bought or sold stock (fraud on the market)? Yes, where materially misleading statements have been disseminated into the impersonal market, individual reliance on the integrity of the market price is presumed. o Reliance - necessary element in securities fraud claim, but unrealistic to require showing of reliance for every investor in a class action = FOTM Theory FOTM is a very powerful judicial presumption Court is accepting the economic theory that markets are semi-strong efficient o How can the defense get around the FOTM presumption? Break the link between the purchaser & the false statement The plaintiff didn't get a worse/better price b/c of the fraud - they knew the information, just not directly Decision to trade at FMV, but for other reasons - monthly divestment plan, wanted out of the stock market altogether, etc. Company has a small, inefficient market in the first place Dura Pharma (Reliance & Causation 2 - Private SEC 10b5 plaintiff must prove fraud caused an economic loss) - Dura made false statements that its drug profits & future FDA approval were good; D stock eventually lost $ & never gained FDA approval. Plaintiffs argue that their reliance on the artificial market price shows that they suffered harm. Court: Must a private plaintiff claiming securities fraud under SEC 10b5 prove that the defendant's fraud caused the economic loss? YES, the law requires plaintiffs to show that the defendant's misrepresentation (or other fraudulent conduct) proximately caused the plaintiff's economic loss.

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SEC 10(b)(5) Elements 1. Material misrepresentation (or omission) (Basic) 2. Scienter (Ernst) 3. In connection w/ the purchase or sale of a security (Blue Chip) 4. Reliance (transaction causation/FOTM theory) (Basic 2) - did the fraud make somebody buy or sell stock? 5. Economic loss 6. Loss causation (Dura) - did the buyer lose $ on the stock caused by the fraud? Must show that the economic loss was caused by the fraud Inflated purchase price doesn't automatically mean that buyer suffers a loss -ex. buyer buys artificially high, but also sells at high rate before misrepresentation is generally uncovered "To touch upon a loss is not to cause a loss, and it is the latter that the law requires." Congressional intent to require BOTH causation & loss, not simply showing an inflated purchase price Fraudulent inflation of purchase price, alone, cannot satisfy loss causation (proximate cause) element Pleading Issue - plaintiff must allege an economic loss due to the fraud = must notify the defendant of their loss & the cause