Outline I

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-Chapter 11. Agencya. elements: i. A Voluntary relationship b/n two persons, i. one, the Principle, has a right to control the conduct of the other i. the Agent has the power to affect the legal relations of the principle. Neither a contract nor compensation are required. a. Principles: i. Disclosed Principle- The existence and identity of the principal is known to a third party. i. Partially Disclosed Principle- The existence of the principal is known to a third party, but the identity is not known. i. Undisclosed Principle- Neither the existence nor identity of the principal is known to the third party. a. Agentsi. General Agent- A person continuously employed to conduct a series of transactions for a principal i. Special Agent- A person employed to conduct a limited number of transactions for a principal i. Master/Servant- An Agent whose actions are subject to the control of the principle. i. Independent Contractor- An agent whose actions are not subject to the control of the principal. i. Subagent- An agent hired by another agent who has authority to do so. Servant v. Independent Contractor Servant Salary Continuous Employment Tools furnished by Employer Work's on Employer's premises Unskilled/Supervised Work Regular part of Business Independent Contractor Paid by the hour/project Works on specific projects, not continuously. Tools furnished by Contractor Works at Contractor's office/shop Skilled/Unsupervised Work Nonrecurring business, unique projects [1] Gorton v. Doty: D lost b/c she loaned her car to Garst for transporting P's team, Garst got in an accident, P injured, and D was held responsible as the Principle, Garst was the agent. Creditor's control If a creditor assumes control of his debtors business, he may be held liable as principal for the acts of his debtor in connection with the business (this includes day to day operations). Gay Jenson Farms Co. v. Cargill, Inc.: D1 in addition to loaning funds to D2, also took control of the day to day operations of D2. both Ds lose. a. (Contracts) Liability of Principle
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Actual Authority- express or implied Express Actual Authority- the statements that the principal made to the agent, orally or in writing granting power. Implied Actual Authority- Agent's additional authority inferred from the express authority granted. [1] Mill Street Church of Christ v. Hogan: P hired Hogan1 to paint its church. Hogan1 needed and got help from his brother, Hogan2, who broke his leg. Hogan2 held P responsible for injuries. Hogan had implied authority to hire Hogan2 because it was necessary to implement Hogan1s express authority as an agent of P to complete the painting. P loses. Authority from necessity an agent has implied authority to hire a subagent when such authority is necessary to implement agent's express authority. Apparent Authority- Whenever conduct of a principal causes a third party to believe the agent has authority, the agent will have apparent authority to obligate the principal. Three Seventy Leasing Corp. v. Ampex Corp.: A salesperson at D agreed to sell certain computers to P despite not having been given the authority to do so by D. D loses. buyers belief can bind a principal A salesperson binds his employer if he makes a sale which leads a buyer to believe that a sale had been made. Watteau v. Fenwick: D authorized Humble as purchasing agent, but only for specific items, an authorization which Humble then exceeded. D loses. Inherent Authority - (looks at agents status & custom)- Authority of an agent to perform tasks typically performed by that type of agent, even w/o specific instructions. incident matters to the agency When one holds another out as an agent, that agent can bind the principal on matters normally incident to such agency, even if he was not authorized for a particular type of transaction. agent acting within boundaries An agent acting within the usual boundaries of his role binds his principal even if the details of the transaction to which he agrees were not authorized. Ratified Authority- If an agent did not have either actual or apparent authority, the principal may nevertheless ratify an agent's past transaction. (Principal must have full knowledge of actions taken) Marital status Marital status cannot in and of itself prove an agency relationship. Agency by Estoppel (fairness) the appearance of authority must be shown to have been created by the manifestations of the alleged principal and not solely by the supposed agent. (Contract) Agents liability an agent becomes liable for not disclosing, or partially disclosing, his status as representative and principles identity. (actual knowledge is the test.) (Torts) Liability to 3rd Parties: Liability of Agent- Agents will always be liable for their own Torts, no matter where, when, how, or under whose employment their tort happened. Liability of Principal- Generally, the law requires that principals be responsible for all acts of a servant, but not for independent contractors. However, the servant must be in the Scope of Employment: The nature of the job the agent was engaged to perform; Time and space limitations concerning the agent's whereabouts and activities,
agent's frolics are not in scope of employment Harm caused while performing duties intended for principal. If force is intentionally used by the servant against another, the use of force is not unexpectable by the master. Servant v. Independent Contractor A Party may be liable for a contractors torts if he exercises substantial control over the contractors operations. Humble Oil and Refining Co. v. Martin: P injured when a car rolled out of a service station owned by D. P held D liable for the station operators negligence. Franchisee- Independent Contractor A franchisee is considered an independent contractor of the franchisor if the franchisee retains control of inventory and operations (the day to day operations). Agent Relationship by Franchisor Control - If a franchise contract so regulates the activities of a franchisee as to vest the franchiser with control within the definition of agency, a principalagent relationship arises even if the parties expressly deny it Restatement (2nd) of Agency 1 agency is a fiduciary relation resulting from consent of one person to have another act on his behalf. Billops v. Magness Construction Co.: D1 exercised substantial day to day control of its franchisee, D2. D loses. Scope of Employment Conduct of an employee is within the scope of employment even if the specific act does not serve the employers interests if the act was reasonably foreseeable. Ira S. Bushey and Sons, Inc. v. United States: When a drunk Coast Guard seaman turned wheels on a drydock wall, damaging a drydock owned by P, P sued the Federal Government, D, for compensation. P wins. Plaintiff's proof To recover damages from an employer for injuries from an employees assault, the Plaintiff must establish that the assault was in response to the Plaintiff's conduct, which was presently interfering with the employees ability to perform his duties successfully. Manning v. Grimsley: When P, while attending an Orioles baseball game, continuesly heckled the pitcher, D, D pitched a speed ball directly into the mesh screen in from of P. the ball went through the screen, injuring P, whereupon P sued both D and the Club (D), his employer, for battery and negligence. D loses. Liability for torts of independent contractors Although not ordinarily liable for the negligence of a hired contractor, liability ensues when the contractor performs inherently dangerous work (and the liability is absolute where the work is ultra-hazardous). Majestic Reality Associates, Inc. v. Toti Contracting Co.: D1 hired D2 (a gen. contractor) to demolish a building. The building fell and injured P's neighboring building. D loses. Fiduciary Obligations A legal obligation to act for the benefit of another, including subordinating ones personal interests to that of the other person. Breached Agency Fiduciary Duties: agent making his own profit - An agent who takes advantage of the agency to make a profit dishonestly is accountable to the principal for the wrongfully obtained proceeds. Reading v. Regem: When military authority took possession of bribe money obtained by P while an army sergeant, P filed a petition for its return, and won. agent drawing business away An agent who draws business away from his principal for his own enrichment is liable to the principal for his profits there from. General Automotive Manufacturing Co. v. Singer: D, a consultant and representative of P, solicited customers on his own behalf. Had to return $. Lack of Loyalty A directors duty to refrain from self-dealing or to take a position that is adverse to the corporations best interest. Abuse of Position- grabbing and leaving Former employees may not use confidential customer lists belonging to their former employer to solicit new customers.
Town and Country Housing and Home Service, Inc. v. Newbery: Certain employees of P left, formed a competing company, and utilized customer lists they had obtained from their former employer. They lost. CHAPTER 2 PARTNERSHIPS (UPA- Uniform Partnership Act 1914) Definition of Partnership- an association of two or more persons to carry on as co-owners of a business for profit (a legal entity) Partners v. Employees Partners have AUTHORITY AND CONTROL for operating the business. Right to share in PROFITS, Obligation to share LOSSES, ownership and control, combined w/ capital (very important) and held out as partner to 3rd parties, rights of the parties on dissolution, language of agreement not controlling. Employees Employee- Definition is Opposite of Partner no control, no authority Who are Partners? Fenwick v. Unemployment Compensation Commission: beauty shop employee not given raise but made partner w/ profit sharing-Without control and obligation for losses. is she a partner? NO Proving Partner status: Intention of parties; manifested intent (not conclusive); the right to share in profits Sharing profits is Prima facie proof of partnership, BUT NOT if received in payment of; debt by installments, wages of employee or rent to landlord, annuity to widow or rep or deceased partner, interest on loan (though amt may change w/ profits), or for sale of good will of business or other property by installments. obligation to share in losses; Ownership and control of property and operations; Conduct toward 3rd parties filing partnership income taxes; how they describe themselves to other parties (i.e., Unemployment Commission); registration as partnership; and, rights to assets in dissolution. Investors as Partners Totality Test- A partnership might be shown by a number of agreements that otherwise might not be enough, by themselves, to show a partnership,
However, sharing in profits is a sensible security for a loan to a partnership that doesnt establish a partnership. Some Element to the Totality of the Circumstances Test title of k; fixed term of k; sharing any operating costs; sharing in losses; shared management; conduct toward 3rd parties; partnership name; p-ship tax return filed; intentionally shared assets; Testimony on character of relationship. Southex Exhibitions, Inc. v. Rhode Island Builders Assocation, Inc. (p. 102) Facts: Southex was successor in interest to a contract with Rhode Island Builder's Association (RIBA). The contract described their relationship as a partnership, whereby Southex was to produce all RIBA home shows at a particular venue, but that if that were unavailable RIBA would be able to go elsewhere. The k was five years and renewable on mutual agreement. Holding: No partnership existed. Partnership by Estoppel Requirements to have a Partnership Estoppel (requiring a Partnership by law for fairness) Representation that one person is the partner of another Evidence of the person charged as representing themselves as a partner. Reasonable Reliance and Good Faith by a third party upon that representation Damage- A change in position with consequent injury by the third party in reliance. Young v. Jones (p. 110)- On the basis of a falsified financial statement done by a Bahamas Price Waterhouse Firm, plaintiff put $550k in a SC bank, from which the $ disappeared. Plaintiff sought to hold PW US Firm liable as a general partnerwhich licensed PW Bahamas to use the PW name. Rule: Partners by estoppel are jointly and severally liable to all persons who gave credit to the firm. Fiduciary Obligations Partners owes each other and partnership a duty of 1) loyalty and, 2) care. Duty of loyalty To account for and hold as a trustee the partnership's well-being. Can't perform in ventures against partnership's good Can't compete w/ partnership while partnership exists.
Meinhard v. Salmon (p. 111)[Partner sold subject of Pship W/out Consulting Partner]- Partner kept opportunity to himself, sold it, and made lots of money and left his partner out in the cold. Rule: Opportunities made available to a partner must be offered to both partners while the partnership exists (i.e., while the fiduciary obligation exists.) Furthermore, the managing partner has a greater duty of loyalty to the financing partner. uncompromising ridigy has been the attitude of the courts of equity when petitioned to undermine the rule of undivided loyalty by the disintegrating erosion of particular exceptions. Duty of Care- a breach in the duty of care is usually in winding down, and limited to gross negligence, reckless conduct, intentional misconduct, or knowing violation of law. Acting in own interest doesnt necessarily violate duty or obligation. Partner may lend money and transact other business w/ the partnership same as non-partners. After DissolutionDuty of care in winding down limited to gross neg and reckless conduct, intentional misconduct, or knowing violation of law. No duties to former partners. Bane v. Ferguson (p. 117)- A law partner retired, but the firm afterwards dissolved the firm, which resulted in a termination of his retirement benefits. Rule: Partners have no fiduciary duty to former partners (unless unanimously agreed upon). Grabbing and Leaving (p. 119) Rule: Partners owe each other a fiduciary duty of the utmost good faith and loyalty. Rule: Partner has obligation to render ON DEMAND true and full information of all things affecting the partnership to any partner. UPA 20. Meehan v. Shaughnessy (p. 119)-: Defendant Partners in a firm should have given 3 months notice for quiting, but only gave 30 days and also lied to other partners about their plan to leave. Rule: When a partner intends to leave a firm he has an obligation to let his current partners have an opportunity to compete for the clients he seeks to take with him. Rule: Former partners must pay former partnership any profits from clients obtained through the former partnership. Expulsion of Partner (p. 127)
Expulsion involuntary expulsion must be bona fide or in good faith to not violate partnership agreement (Partnership Agreement controls). Lawlis v. Kightligner & Gray (p. 127)- Lawlis was a drunk senior partnerinvolved in the partnerships management. He was given two chances to clean up. He had signed the partnership agreement which had a "no cause termination." The firm fired him for no cause. Rule: The partnership agreement sets out the terms for the involuntary expulsion of partners; Pship agreement had legal no cause termination clause. Partnership Property (p. 134)- (Ss401) Rule: Partnership assets owned by entity not individuals. (although individual personal property is owned by the individuals, not the partnership) A Partner has: rights in status of being partner in the partnership; interest in the property (a right to share in profits and an obligation to share in losses); and right to participate in management. Rule Ss26- If a partner sells his partnership interest to an assignee, it does not dissolve the partnership, nor give the assignee a right to management or administration (unless otherwise agreed by all partners), but only entitles the assignee to the profits previously accorded to the old partner. However, although a partner may assign his partnership interest to an assignee, he cannot sell his rights as a partner, nor can the new assignee become a partner without the unanimous consent of all partners. Putnam v. Shoaf (p. 134)-: Frog Jump Gin Company, partner dies and wife gets his share, she wants out and gets out. Later assets are found, she wants a cut. I: Did Mrs. Putnam intend to convey her interest in the partnership to the Shoaf? A: YES, and she did not retain any interest in an admittedly unknown courses of action to convey or retain. She cant participate in new windfall. Rule: Partnership assets belong to the entity not individuals. Raising Additional Capital (p. 136-38) There are partners who initially give capital, and others who give capital and services. A Partnership account- a running account of the running balance of a partner's account.- profits and personal withdraws are shown in this account Partnership profits- partners share equal in profits, even if the partners give initially different amounts. Loses are shared in proportion to profits. Rights of Partners in Management (Ss) 307
Liability- In absence of other arrangements, all partners are JOINTLY and SEVERALLY LIABLE for acts and obligations of partnership. Management- In absence of agreement to contrary all partners have equal rights in the management and conduct of the partnership business" Majority- any differences in the course of ordinary business are decided by a MAJORITY of partners, (1/2 the partners is not a Majority) Unanimous- New partners, and extraordinary changes in business require unanimous vote Business- Each partner has authority to bind the partnership in transactions in the usual course of the partnership business unless the partner has no actual authority and a third party has knowledge of this fact. Partnerships and other partners are liable for acts of any partner within scope of business and certain breaches of trust. National Biscuit Company v. Stroud (p. 142)- Two partners nearing end or pship, one says I wont be liable for bought bread, the other buys $171.04 in bread. Ruled- part of ordinary business. Rule: each partner has power to bind other if w/in ORDINARY and LEGITIMATE business Ratification of Partners Action Summers v. Dooley (p. 144) trash collectors; Summers hires help over objections of Dooley (who, although rejecting, reaps the benefit of Summers hired work). Summers pays out of own pocket, now Summers is out of luck, no contribution from Dooley is required. If one owner benefits from another partners actions, ratification? A: NO. Rule: Receiving benefits from unilateral action taken by other partner is NOT ratification. Moren ex rel. Moren v. JAX Restaurant (pg.144): Partner brought son into restaurant while she finished an extra shift. Sat him on the counter next to her while she rolled pizza dough. Remington put his hand in the roller and got it crushed. Is P'ship solely responsible, or is the Mother contributorily responsible? Rule: Partner was acting as partner at the same time she was acting as mother. So, the partnership cannot indemnify her because she was doing her partnership duty while also doing her motherly duty, of which there was no controlling rule (in bringing remington into the kitchen). Without Provision In P-Ship K No Right to Status Day v. Sidley & Austin (p. 146) A partner in a firm lost his control over his position as sole chairman in the firm when the firm merged. He was not part of the executive committee which made the day-to-day decisions. The p-ship k had no provision for his
maintaining of control in that position. He sued for breach of k, conspiracy, wrongful dissolution and breach of fiduciary duty. Rule: Unless otherwise agreed, there is no right to a status w/in a partnership. The p'ship contract did not give any leverage to P's status, so P had no ability to control the merger. He knowingly signed a well-defined contract, and partners acted in conformance with that contract. For mergers, the partners need only consent by majority vote to a merger. Partnership Dissolution (p. 154) (learn to navigate the statutes- see art. 6-8 and Ss103) Introduction - not the same as going out of business (winding up) Disassociation- When one partner ceases to be a partner Dissolution (of the partnership)- When all partners stop acting as partners- (if a partnership dissolutes, the partnership is not ended until the "winding up" of partnership affairs is completed. Dissolution is caused without violating the agreement: By the termination of the definite term or particular undertaking By the express will of any partner when no definite term is specified By the express will or all the partners who have not assigned their interests or suffered them to be charged for their separate debts, and By the expulsion of any partner from the business bona fide in accordance with such a power conferred by the agreement between the partners. Any partner can dissolve a partnership in contravention of the agreement but would be liable for damages resulting from this breach of the partnership agreement. Dissolution also occurs through unlawful activity, death, bankruptcy or by court decree. Winding Up- selling p-ship assets and finalizing all responsibilities. Wrongful Disassociation if: Breach of partnership agreement, or before definite term completes. (partner will be liable for damages caused by disassociation.) Buy Out (701)- ?????? 802b- a partner who wrongfully disassociates cannot have any say in the dissolution. Partnership at will 101.8- can quit or be fired for any reason at any time. To disassociate Can dissolute the company and take profits, etc, or Sell the partnership to others
Partnership for Term- explicit or implied- when a project or time period completes. To disassociate 801.2- if the dissolution was under 601.6-10, you have to dissolve, or under 602.b you have to disassociate, or Otherwise you have the ability to: Can dissolute the company and take profits, etc, or Sell the partnership to others Uniform Partnership Act- (different than the above, and not as good) The Right to Dissolve (p. 154) Owen v. Cohen (p. 154) Partners could not get along in running their bowling alley. Court dissoluted the partnership. Court can decree dissolution whenever: A partner is guilty of acts against business. willfully or persistently breaches partnership agreement, Acts so that carrying on business is unreasonable. other circumstances render dissolution equitable. Collins v. Lewis (p. 157): Partners created cafeteria business. One P financed, and the other managed. The financing P did not provide the necessary financing. The cafeteria exceeded expected cost to start up, and it did not become profitable. Financing P wanted to dissolute the partnership. Rule: A partner may not obtain a judicial dissolution of the partnership if his own interference causes the partnership to be unprofitable. No Dissolving Partnership to Steal other Partners Share in Opportunity Page v. Page (p. 162): P'ship lost $ for eight years. When P'ship began making $ after 8 years, the one P wanted to dissolute. The other P said the P'ship was for a "term" (a reasonable amount of time to make back $. Rules: Partners may dissolute a business any time, but they at least must wait, in good faith, to dissolute the Partnership until business debts are paid back. Consequences of Dissolution Partners of Dissolved Firm Allowed to Bid on Its Assets Prentiss v. Sheffel (p. 165): 2 partners didn't get along w/ third. The 2 sought dissolution. The Partners and held an auction for the P'ship assets. The 2 bought the assets and continued business w/o the third. Rule: A partnership-at-will is dissolved as a result of a freeze-out (exclusion of a partner
from the management and affairs of the partnership). Rule: Wrongful exclusion from participation in the management and control of the firm doesnt prevent (in equity) the excluding partners from bidding on the assets, or using them in the purchase. Pav-Saver Corporation v. Vasso Corporation (p. 171)- P wrongfully terminates P'ship w/ D. P wants patents and trademarks back, but K allows non-dissoluting party to continue business, and D cant continue business w/out tmarks and patents. D gets Patents and T'marks. Rules: when dissolution is caused in contravention of the p-ship agreement, the rights of the partners shall be as follows: Innocent Party's Rightsright to damages from guilty partner's breach continue the business, and possess partnership property (w/bond in court), and pay wrongful dissolver his partnership interest minus recoverable damages. indemnify him against all present or future p-ship liabilities. Wrongfully Dissolving Partner's rights: To receive value of Partnership interest minus damages to non-breaching party. (good will not calculated) Note: if a partner wrongfully w/draws from a partnership, the p-ship does not necessarily dissolve. If the P'ship does not dissolve, it must buy-out the w/drawing (dissociated) partner for an amount equal to his or her share of the value of the assets of the p-ship. ( However, there is no reduction for the value of goodwill. ) "Goodwill" = a $ amount for the image the business has in the community and its clients, which good image affects the ultimate profits. This amount of money can be calculated and divided b/n partners who leave a business. The Sharing of Losses (p. 177) Rule unless otherwise agreed, co-adventurers share equally in profits and losses. Kovacik v. Reed (p. 177) There was no discussion of what to do if losses were sustained. Reed contacted K to say that they lost money. Reed sued Kovicek for restoration of the money he lost from the failed venture. Rules: Where one partner or joint adventurer contributes the money capital as against the others skill
and labor, neither party is liable to the other for contribution for any loss sustained. Losses are proportionate to shares in profits. Buyout Agreements Definition of Buy Out- When a partner has a right to end his relationship w/ the other partners and receives a cash payment, or series of payments, or some assets of the firm, in return for her or his interest in the firm. Trigger Events causing Buy Out Death Disability Will of any partner Obligation to buy out versus option Firm Other investors Consequences of refusal to buy if there is an obligation If there is no obligation Price Book Value Appraisal Formula (e.g., five times earnings) Set price each year. Relation to duration (e.g., lower price in first five years) Method of Cash payment Cash Installments (with interest?) Protection against debts of partnership Procedure for offering either to buy or sell First mover sets price to buy or sell First mover forces others to set price. G&S Investments v. Belman (p. 181)- G & S wanted to dissolve the partnership pursuant to the buy-out provision in their agreement due to Nordales wrongful conduct (drugs and disruption of residents), but then continued the partnership after Nordale died. Rule: Death terminates partnership, filing for dissolution doesnt Rule: A p-ship buy-out agreement is valid and binding even if the purchase price is less than the value of the partner interest, since partners may agree among themselves by contract as to their rights and liabilities. Jewel v. Boxer (p. 185) After partners, Jewel, Leary and Boxer dissolved their law firm by mutual agreement, forming two new firms, they appealed a judgment awarding post-dissolution income, on cases active at the time of dissolution, on a quantum meruit basis. Rules: Absent a contrary agreement, any income generated through the winding up of unfinished business should be allocated to former partners according to their respective interests in the partnership. Rule: Each partner has duty to wind up and complete unfinished business. Limited Partnerships (p. 196)
has two classes of partners (Limited and General) Limited partnerslimited management, and limited profit sharing Not personally liable (like Gen. Partners), unless they take part in control of Business. General Partners- Share equally in: Management, and Profit sharing Personal Liability. (Joint and Several Liability- to the extent of capital put into the P'ship.) (could become a limited partner by making a corporation of himself as the sole member, and then make the corporation the general partner.) Holzman v. De Escamilla (p. 196) farmers. Limited partners take active part in business and thus are liable as general partners. Rule: Limited partners are NOT liable as general partners unless they take part in control of the business. Rules: If a limited partner exercises control over the partnership business, he becomes a general partner. CHAPTER 3 the Nature of the Corporation Business Organization Choices Sole Proprietorship Small, easy, modest capital needs General Partnership Two or more carrying on business while sharing control and profits. Dissolves upon death, bankruptcy or withdrawal. Can be formed without knowing. Informal no legal documentation required. Not double taxation- each partner pays their share of taxes from their profits. (can deduct losses) All partners must consent to admission of new partner All partners have equal voice (unless otherwise agreed upon) All partners individually liable for pship debts. E.g. law, acting, medicine. Dissolved by death or withdrawal of partner Limited Partnership Must have 1) written agreement, and 2) formal document filed w/ state. Lmt partners can provide capital only (not management), then liable for amount of investment. Tax advantages and limited liability. All general partners have equal voice in control, but limited partners may not participate in management. Gen partners individually liable for all partnership debts. Limited Partners only liable for their share (unless they actively participate in management, then they are considered General partners) Dissolved w/ death or withdrawal of Gen. Partner, but not of limited partner. Limited Liability Partnership (LLP)
Each partner may participate fully w/o becoming personally liable (most states allow LLPs) Each partner may participate fully w/o becoming personally liable Limited Liability Company (LLC) Hybrid between corp and partnership Members may elect to be taxed as a corp or p-ship. (thus having ability to avoid double taxation) Cant raise as much money as corp. Own interests not freely transferable. Member make a written "operating agreement" expressing the form of transferability, votes, selling, etc. (the LLC is bound by this agreement, so members may sue LLC for breach of agreement) Members only liable for the amount of their capital contribution (even if actively manages), (in otherwords, LLC is liable, not individuals, but veil may be pierced as w/ corps) Corporation Taxed as a separate entity (double taxing-- taxes on corporation profits, then again on shareholder dividends) (A sub-chapter S corp. can avoid double taxation- each shareholder pays his portion of the taxes for the corp.) Shareholders may sell stock transferring ownership Shareholders elect board of directors who supervise corp's affairs. Dayto-day control rests on high-level "officers". "Perpetual Existence" (despite deaths, etc.) Close Corps Partner like duties to sholders.?
Corporations Nature of Corporations Structure stockholders , board, and officers are NOT generally liable for debts of the corporation. A Corp. is a legal entity formed under state statute by filing Articles of Incorporation (AOI) w/ proper state office. Stockholders OWN corp. Corp can sue or be sued, own property, pays taxes on its income. Shareholders also taxed on dividends. Limited personally liability of owners Shareholder not personally liable for corp. acts, but may become so through personal acts. (unless otherwise provided for in Articles Of Incorporation) Corporation is independent of owners Legal personality distinct from owners (entitled to due process, bill of rights protect corps.) Separation of ownership and control. Shareholders: elect board of directors
Shareholders DO NOT MANAGE day to day affairs generally Vote on amendments and bylaws Vote on Certain fundamental transactions (mergers) Approval of independent auditor, etc. Flexible capital structure Debt v. Equity Securities Debts- bonds held by creditors (who are not owners) Equity Securities- represent units of the corporation (shares) Shares- The articles of incorporation must state the number of shares authorized. There are Four Types: Regular Shares- bought and owned??? Outstanding shares- numbers of shares sold and not repurchased. Authorized, but un-issued shares (yet) Treasury Shares- once issued and outstanding, and since repurchased. Issuance of Stock Board of Directors prerogative Shareholders only involved if board wants to issue more than authorized by articles of incorporation. Rights of Shareholders Right to receive dividends Right to inspect books of the incorporation Receive distribution after dissolution issues taken care of. Proportionate shares must be allowed to be bought if new ones issued. Right to file suit for wrongs committed by Corp. Public Corp. v. Closed Corp. ??? Look in CrunchTime Degree of ownership Government control Ownership of Shares Delaware is main state for Corps??? Look in Crunch Time No minimum capital requirement Only requires one incorporator Corporation may be incorporated Favorable franchise tax No corp income tax No sales tax No inheritance tax on non-residence holders May have a principle place of business outside of Delaware. Process of Incorporation File articles of incorporation (AOI) Mandatory provisions (2.02a?) Discretionary Provisions Direct the By-laws 2.06 Organizational Meeting Adopt bylaws Nominate leaders Issue stock
Internal Affairs Doctrine You are governed by the laws of the state where you are incorporated. Pre-Incorporation Issues Promoter- person who identifies opportunity and tries to put together the incorporation Owes fiduciary. Duties to shareholders and those reasonably depending on corp formation Unless otherwise agreed upon, all persons acting for corporation when no corporation is made yet, are personally liable. Ks entered into w/ corps, even those w/ defects in formation, will be honored. Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc. Improper corp. formation. D cant escape performance of K to furnish a ship regardless of character of org, unless substantial rights involved. Parties treated like a corp, so legally defined as corp (unless substantial rights might thereby be affected). Corporation Liability from Promoter's actsRule: corp is only liable for promotor's acts which it adopts (explicitly or implicitly) The Corporate Entity and Limited Liability Default Rule: A shareholder of a corp is not liable for corps acts except for his own acts or conduct, unless otherwise agreed upon. Piercing the Corporate Veil (aka- alter ego) Rule: If corp. is treated as corp, there is no chance for personal liability (observe corporate formalities- have meetings, officers, minutes, don't mingle funds) Rule: If separate existence of corp is not observed, the law is unclear. Fraud or Injustice- The court will "pierce the corporate veil" and hold individuals liable if there is Fraud or Injustice. Its not necessary for the shareholders to have knowledge of corp. uncompliance Factors courts will look to Corp. fomaliites Mixing personal and corp affairs. Inadequate capitalization (needs to meet reasonably expected liability) Was the corp. entity made solely to avoid personally liabilities. Corp. is solely instrumentality of shareholders Corp is closely held (studies show there is little or no corp veil piercing this way- less control, greater oversight. Shareholders held with joint and several liability Piercing the corporate veil to prevent frauds or the achieve equity, follows the general rules of agency, when one uses control of corp to further his rather than corps business he is liable for corps acts by respondeat superior extends to neg dealings as well.
Combine the following piercing doctrine w/ this previous summary. Walkovszky v. Carlton Guy runs 10 taxi cab corps under his own corp. Rule: To pierce the veil of a corp, you must particularize the lack of corp formalities and intermingling of funds. Rule: Whenever anyone uses control of the corp. to further his own rather than the corp.s business, he will be liable for the corp.s acts. Upon the principle of respondeat superior, the liability extends to negligent acts as well as commercial dealings. (Respondeat Superior - Rule that the principal is responsible for tortuous acts committed by its agents in the scope of their agency.) Sea-Land Services, Inc. v. Pepper Source Shipments of Jamaican sweet peppers. : When P could not collect a shipping bill because D Corp. had been dissolved, P sought to pierce the corporate veil to hold the D Corp.'s sole shareholder (M) liable. Rule: Van Dorn Illinois Test Corp. and Individual must be so intermingled, that there is no separate identity, and Circumstances must be such that adherence to the fiction of separate corp. existence would sanction fraud or promote injustice. Some elements of unfairness, something akin to fraud or deception or the existence of a compelling public interest must be present in order to disregard the corporate fiction Pederson. Kinney Shoe Corporation v. Polan Rule: De Facto corp. doctrine. A Corp that is partially but deficiently formed is treated as a Corp if: formed in good faith, had legal right to incorporate, and thought they had legal right to incorporate. Incorporation by EstoppelIf 3rd party thought entity was corp, and would earn a windfall if that person was allowed to argue that the entity was not a corp. Parent Company Liability If Corp owns all shares of the common stock, Parent-subsidiary relationship. Generally, the Parent (shareholder) is NOT liable for the debts of the subsidiary. However, veil can be pierced with enough control, or negligent undertaking. In re Silicone Gel Breast Implants Products Liability Litigation Corp veil pierced! Liability found, substantial control AND name on packaging shows CONTROL. List of control factors. P. 226. Some factors of control are:
The parent and the subsidiary have common directors or officers The parent and the subsidiary file consolidated financial statements The parent finances the subsidiary The parent caused the incorporation of the subsidiary the subsidiary operates with grossly inadequate capital the parent pays the salaries and other expenses of the subsidiary The subsidiary receives no business except that given to it by the parent The parent uses the subsidiarys property as its own Does keep separate books. Rule: The totality of the circumstances must be evaluated on determining whether a subsidiary may be found to be the alter ego to mere instrumentality of the parent corp. Each state requires a showing of substantial domination. Frigidaire Sales Corporation v. Union Properties, Inc. P attempted to hold the limited partners (Ds) generally liable after Commercial Corp. breached its contract with them. They were limited partners in Commercial corp and also joint directors for Union Corp. Union acted as the general partner (while they were the limited partners) for Commercial. Rule: Limited partners do not incur general liability for the limited partnerships obligations simply because they are officers, directors, or shareholders of the corporate general partner. Application: D only acted in the day to day activities of the corp. D never acted in any direct, personal capacity. D controlled the limited partnership but, they did so only through its board of directors, officers, and agents. Shareholder Derivative Actions (p. 232) Direct v. Derivative Suits- two kinds of lawsuits: Eisenberg test to determine which type of suit (two elements): who suffered the most direct injury? if corp derivative if shareholder direct to whom did Ds duty run? If corp derivative If Shareholder --> direct Eisenberg v. Flying Tiger Line- Action by SH on behalf of himself and other SH to enjoin effectuation of a plan of reorganization and merger. argues that reorganization will unfairly diminish the voting power of himself and other public stockholders by preventing them from directly influencing the affairs of the operating company
Rule: Suit is a direct, not derivative action. Rule: The injury P is complaining of is an injury to his voting rights and is thus an injury to him personally rather than to the corporation. Direct suits Brought by the SH in her own name c/a belonging to the SH in her individual capacity Arises from an injury directly to the SH Examples: Prevented from exercising voting rights Dividend payment compulsion Anti-takeover defenses Compelling inspection Protection of minority SHs, esp. in close corporation. Shareholders will prefer direct suit over derivative suit Derivative suits Brought by a SH on corporations behalf c/a belongs to the corp. as an entity Arises out of an injury done to the corp. as an entity Procedural Hoops in derivative suits Contemporaneous ownership (Must be a shareholder when wrong was committed) Some states require a security deposit for expenses usually no jury because it is equitable Demand requirement- must first make a demand, by which the corporations regains control of the suit and through a special legislative committee, terminate the suit. Examples Embezzlement Breach of due care Breach of duty of loyalty Excessive compensation Self-dealing Corporate Opportunity SHs are harmed secondarily- enough for a SH to allege that challenged conduct resulted in a drop in corps stock price Pro for Derivative Suits Allows SH to hold directors accountable Remedy for insider wrongdoing remedy born of SH helplessness Insiders are reluctant to turn on their own Deterrent effect Legal fees Corp must pay Ps legal fees if there is a substantial non-monetary benefit (ct liberal in finding those)
Any recovery goes to corporate treasury, whether by settlement or trial victory Directors cant be trusted to sue themselves Con for Derivative Suits There may be a good business reason not to sue Waste of corporations time- (Resulting benefit is usually less than what the corp would have received) Risk adverse managers- (Managers will become needlessly risk-adverse to the detriment of the company) Strike suits- (Nuisance suits brought for settlement value. Only enriches attys.) Meritorious suits against insider settled too easily Indemnification: Corp must reimburse dirs expenses if successful defense. Mgmt has incentive to settle in ways that ensure indemnification. Settlement in which dir doesnt pay anything deemed a success Plaintiff's Requirements in Derivative Suits: Standing - MBCA 7.41 limits standing to shareholders Must be a holder of an equity security in the company Does not include Bondholders or creditors Contemporaneous Ownership MBCA 7.42: Must be a shareholder when the suit commenced Many states require that the SH also must remain through final judgment. MBCA 7.41(1): Must be a shareholder at the time of the alleged wrong. Exception: If A inherits the stock via operation of law, and original SH had right to sue, then A has such right as well Reasons for rule Discourages litigious people from bringing frivolous suits; prevents them from looking for wrongdoing and then buy shares to support a suit A person who buys after the wrong with knowledge of it may pay a lesser price and obtain a windfall from corporate recovery. Criticism: Contemporaneous ownership rule would bar p from suit if he purchased the shares after the wrongdoing, even if neither p nor
anybody else knew of the wrongdoing at the time of purchase. Fair and Adequate Representative - MBCA 7.41(2) Named P must be a fair and adequate representative of the corporations interests Grounds for challenging ps fairness or adequacy: Conflicted interests, e.g., bringing suit for unrelated strategic purpose Unclean hands (approved or participated in the wrong doing) Security for Expenses statutes Some states require that the P pay for the reasonable expenses of a corporation (pre-litigation security) if Ps claim fails upheld as constitutional in Cohen (policy focus on strike suit) Choice of law Cohen v. Beneficial Industrial Loan Corp. USSC Federal court sitting in diversity applies forum state choice of law All states apply law of the state of incorporation to substantive merits of a case. Federal law governs procedural issues Substantial or Procedural Test If it creates a new liability, as well as a condition on standing, then it is substantive. Ct found that security statute was substantive Erie Doctrine: state law for substantive issues fed law for procedural issues Demand Requirement Rule: SH must make a demand to the Board of Directors before filing suit demand asks the BoD to bring a suit or take other corrective action to redress the wrongdoing DEMAND IS REQUIRED, Unless EXCUSED demand is excused when futile Pro of Demand Requirement c/a belongs to corporation (Like all assets, litigation should be under the control of BoD.) SH may have interests diverse from those of corporation. Thus, BoD should have some say. Relieve courts from deciding matters Provide boards protection against harassment Discourage strike suits. The BJR gives the demand requirement teeth (esp. for last two) Con of Demand Requirement
Derivative suits are a mechanism of managerial accountability Theres a potential for bias b/c dirs cant be expected to sue themselves Role of Demand Requirement: serves as a procedural step to separate cases in which board is allowed to control suits from those in which SH (SH atty) controls. Complex law Law not uniform state to state Demand Futility: MBCA 7.42: No SH may commence a derivative proceeding until a written demand has been made and 90 days have expired from the date the demand was made unless irreparable injury to the corporation would result by waiting for the expiration of the 90-day period. Implies that demand itself can be waived. FRCP 23.1: The complaint shall allege the efforts, if any, made by the p to obtain the action the p desires from the directors and the reasons for the ps failure to obtain the action or for not making the effort. Implies that only the waiting period can be waived Delaware Standard for Demand Futility Letter must be submitted to BOD stating Identify wrong doers Basis for wrongful facts Harm caused to corp. Request for remedial relief Board actions may include: Refuse demand (BJR- business judgment rule- P must overcome BJR) Accept demand (take care of it on its own) Demand excused (not made), because it is futile (P doesn't need to demand BOD for anything, b/c it would be futile) So P must allege particularized facts (pre-discovery using the tools at hand[2]) creating a reasonable doubt[3] that the board is capable of making a good faith decision on whether to file suit. Test for excusing demand- 3 ways to prove that the board is disabled by a conflict of interest (need to show only one): Majority of board has material financial or familial interest, or
Majority of board lacks independence (domination and control by wrongdoers), or Challenged transaction not the product of valid exercise of business judgment Std is difficult to prove b/c must plead in particularity! If you make a demand before you file a lawsuit, you will usually lose. A rational p will file a derivative suit b/f making demand b/c the consequences are trivial If demand is required, then court will stay proceedings and theres a slight delay for you to make demand. Preserves right to litigate: Whether or not the suit is direct or derivative Demand futility In close cases where it is difficult to decide if direct or derivative, ctr treats case as direct if P seeks non-monetary relief Rule: By making a demand, one is later precluded from arguing demand futility NY standard for demand futility Demand is Futile if: Majority of directors interested in challenged transaction; or Board member has personal stake in challenged transaction AND loss of control because another director has control over him Directors failed to inform themselves to degree reasonably appropriate; or Challenged transaction so egregious that it could not have been the product of sound business judgment of the directors. Demand will be excused if a majority of the board is charged with breach of due care instead of loyalty Mark v. Akers CB 259 (NY)- alleges a breach of fiduciary duty due to excessive director and
executive compensation during a period of declining profits Rule: It is not sufficient to have demand excused simply because the board is a named party in the suit. As a practical matters: Most derivative cases end up at futility motions If a P wins the futility motion, D has an incentive to settle SPECIAL LITIGATION COMMITTEE (SLC) How SLCs work (Emmanuels) When p files suit, the board appoints a supposedly independent committee of directors to investigate ps allegations (See derivative litigation decision tree*) Committee must be made of disinterested directors (no financial stake) If all of the board is implicated, then the board may vote to enlarge itself and appoint additional directors. Dismissal is usually recommended Rarely will an SLC find that ps complaint has NO merit. It is mostly dismissed because the burden of recovering outweighs the merits. This is done to give the SLCs decision the protection of the BJR SLC ProsScreens out frivolous or strike suits at early stage Independence of SLC will insure good faith SLC ConsThere is a structural bias in having a nominally independent committee selected by the board that is being accused. Directors will have to face their fellow directors again Board will not select a committee of independent SLC who are going to screw them over. NY SLC Standard (few states) Auerbach v. Bennet CB 265- GTE made $11M in illegal bribes 4 directors personally involved; SH derivative action against GTE, all directors and outside audit for breach of duties to corp. BoD responds by appointing a SLC challenged transaction could not have been the product of sound business judgment - Court assumed demand was excused - SLC concluded no violation and recm dismissal of suit Look at NY std for demand futility: (Akers) majority of directors interested, OR directors failed to inform themselves, OR Rule: P must show that the: members of the SLC were not in fact independent (i.e., dominated by controlling shareholder accused of wrongdoing) and/or
that the SLC did not use reasonable procedures in reaching its conclusions (i.e., shallow investigation) The Tootsie Pop Defense First Tier = illegality (first bribes must be proven) BJR means court has to defer to SLC: As long as there was a disinterested committee with reasonable procedures, then the BJR protects the first tier Second Tier = committee recommendation (the committee's decision cannot be scrutinized until after passing tier 1.) Filing Cabinet Analogy Court can look into the SLCs filing cabinet to make sure all the proper paper trail is there, but cant read any of the docs (including smoking gun memo) Delaware SLC Std (most states) Zapata v. Maldonado CB 270- excessive compensation case. demand not made. demand excused as futile. BoD appoints a SLC which recommends a)new BoD and b) dismissal of case. Look at Del Std for demand futility(Grimes): Reasonable doubt as to: majority of board has material interest, OR majority of board lacks independence, OR challenged transaction not product of valid exercise of business judgment Holding/Rule: twostep analysis: Corporation has the burden of proof to show (2 things) independence and good faith of SLC, and inquiry into the bases supporting SLCs recommendation. (reasonable investigation)**** (only where corp. succeeds on step 1)- court may go on to apply its own business judgment as to whether the case is to be dismissed this makes the Del std different from NY std in Del court gets to decide whether there was a reasonable basis for the decision this means that the court can look into the cabinet AND read docs in it! Practice Point: In Delaware the SH has a much better shot at succeeding in a derivative suit than in NY On exam for NY corp in Del, apply NY law! Empirical findings:
Derivative cases that go to trial: shareholder-plaintiffs lose 90+ % of the time Most derivative suits settle Only of settlements entail monetary recovery by corporation or shareholders Average recovery < $6 million 90+% of such settlements, legal fees > monetary recovery Derivative litigation has no positive effect on stock prices: Adoption of a 102(b)(7) liability limitation provision does not have a negative effect on stock prices (stock prices remain unchanged when derivative litigation brought) Role and Purpose of Corporations: (pg 283)these cases deal w/ the BJR. Cts dont want to interfere in BJR w/out fraud or violation of good faith. Can businesses do other than wealth maximization? YES, but must be able to articulate business reasons. You must articulate PLAUSIBLE business reasons for charity & beneficence. DUTY OF CARE and the BJR (Business Judgment Rule) Operational Decisions A.P. Smith Mfg. Co. v. Barlow 1953 (p. 270)- Fact summary: D and other shareholders of P corp. Challenged its authority to make a $1,500 donation to Princeton University. Rule: Corp. can give donation because long history of help to communities detailed and good for USA. Even a tenuous connection to the good of the corp will make the donation OK. Cant be a pet charity. NOW you must be able to make claim it will be good for business (and maybe bottom line). Courts wont interfere w/ business w/out FRAUD or misappropriation of funds or refusal to declare dividends where it is no detriment to business MBCA 8.30(a): The Duty of Care :Each member of the board of directors, when discharging the duties of a director, shall act: (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interests of the corporation Dodge v. Ford Motor Co (FMC). Ford wants to stop paying special dividends to shareholders & build smelting plant. Holding: Corp can build plant but cant arbitrarily deny dividends. Rule: You must articulate PLAUSIBLE business reasons for charity & beneficence. Ford admits his decision not based on business reasons. Standard of review for dividends: Rule: Generally, distribution of dividends is left to the directors' discretion, Unless there is an abuse of discretion (fraud or breach of duty of good faith)
Shareholder Primacy: A corporation is meant to primarily benefit the stockholders and the directors energy should be spent in that regard. Limits- There are limits on for the profits of the SH Corp must comply with law Charitable giving is OK if connected w/ business purposes. Business Judgment Rule (BJR) BJR Rule- "In the absence of a showing of fraud, illegality or self dealing by the directors, their decision is final and not subject to review by the courts." Note: BJR is unique in the sense that corporations have a duty to maximize profits, yet unless there is fraud, illegality or false dealings, the court will not intervene (duty exists, but it not looked at!) BOD owe Duty of Care: A standard of conduct, requiring: Good faith Reasonable care Chapter 5- The Duties of Officers, Directors, and Other Insiders DUTY OF CARE BJR and the Requirement of Informed Decision BJR goes un-scrutinized, unless there is: Fraud Illegal Conduct Self-dealing Egregious misconduct, or Un-informed decision (No protection for an uninformed decision) The Obligations of Control: Duty of Care (p. 316) Kamin v. American Express Company -Kamin (P) brought a shareholders derivative suit claiming American Express (D) had engaged in waste of corporate assets by declaring a certain dividend in kind. Rule: Whether or not a dividend is to be declared or a distribution made is exclusively a matter of business judgment for the board of directors, and the courts will not, therefore, interfere as long as the decision is made in good faith. Rule: The business judgment rule allows a director to maintain his duty of care while exercising business decisions in honestly and rationally; imprudent decisions will not overcome the business judgment rule. Smith v. Van Gorkom- The board of directors (D) of Trans Union Corporation (D) voted to approve a merger agreement based solely on the representations of Van Gorkom (D), one of its directors- Smith and other shareholders filed a class action suit against Trans Union and the board. Rule: The business judgment rule shields directors or officers of a corporation from liability only if, in reaching a business decision, the directors or officers acted on an informed basis, availing themselves of all material information reasonably available.
Rule of abstention: Court will not review substance of decision, but will examine the decision making process (extent to which BoD made an informed decision.) Alternative Defense in addition to BJR: Under DGCL 141(e), the board may rely on its officer's report. (but they at least must inquire to the officer's basis of information.) Brehm v. Disney- Compensation package for Michael Ovitz was ridiculous- 1995 Disney board hires Ovitz as President, salary of $1M, bonus, stock options on 5 M shares Waste Rule-BJR doesn't protect when there is waste- Transaction that is so one-sided that no business of ordinary, sound judgment could conclude that the corporation has received adequate consideration (usually arises with corporate compensation, disposition of corp assets, and chartity) Rule: Directors (and members of committees appointed by BoD) are fully protected when relying in good faith on an expert who was appointed with reasonable care as professional or an expert on the matter Substantive due care (Brehm v. Disney D liable) v. Process due care (Van Gorkom D not liable) Process due care = ctr looks at rational process to decision making, not its merits irrationality is the outer limit of BJR and functionally equivalent to waste irrationality does not mean stupidity, but rather selfdealing (decision is so bad that no one acting in good faith would have made it) rarely occurs Substantive due care = ctr evaluates the reasonableness of decision (is this the right decision that a reasonable person would have made?) Egregious board decisions- Directors can only be liable for egregious decision only where directors acted in bad faith or followed an irrational decision making process Francis v. United Jersey Bank (p. 349) Lillian Pritchard (D), a director of Pritchard & Baird along with her two sons, was completely ignorant as to the fundamentals of the reinsurance business; ignored her duties as a director; and allowed her sons to withdraw over $12 million from client trust funds. Rule: BJR does not protect director when directors have failed to exercise business judgment (here the directors failed to act, therefore the BJR does not apply) where BJR does not apply, duty of care will apply.(supports profs abstention view of BJR) Rule: Director has an obligation of basic knowledge and supervision: Duty to be informed Read and understand financial statements Object to misconduct and, if necessary, resign Does not require a detailed inspection of day-today activities Causation re liability of dissenting directors: A director who is present at a board meeting is presumed to
concur in corporate action taken at the meeting unless his dissent is entered in the minutes of the mtg or filed promptly after adjournment. In re Caremark International Inc. Derivative Litigation (p. 355)Facts: Caremark, a managed health care company, settled federal civil prosecution for violations of anti-referral laws (250M). SHs sued derivatively BoD for breach of duty of care (if the BoD had paid attention, then Dr.s that referred clients would not have gotten consulting contracts). Judicial approval required for derivative settlements. Rule: BJR does not apply b/c there was no action by the board. However, if the issue arose, then they dismissed the idea of taking action, they would be protected by the BJR. The Supreme Court has said that where there is no basis for suspicion, directors cannot be liable. (So, the question is whether the BoD had reason to believe they needed a system.) Rule: Corp must attempt in good faith to assure a corporate information and reporting system. (The details are left to business judgment.) Adequate law compliance program could include: Policy manual Training of employees Compliance audits Sanctions for violations Provisions for self reporting of violations to regulators ask how could we violate the law, and try to prevent it; but it could be costly Potential liability for directorial decisions- 2 contexts: Rule: Liability may be said to follow from a board decision that results in a loss because that decision was ill-advised or negligent. The court will only look at the process of the BoD decision and not the substance of the decision. The BJR protects the BoD Rule: Liability for failure to monitor- circumstances in which a loss eventuates not from a decision but from unconsidered inaction. Rule: Legally, the board itself will be required only to authorize the most significant corporate acts or transactions. Rule: Basically- you only need a system of checks if you have had problems in the past, or you should reasonably expect problems from the info you have. DUTY OF LOYALTY- Directors must act in the best interest of Corp. 3 Categories of ConflictSelf Dealing, Corp. Opportunity, Corp. Competition Self Dealing
2 Types Direct Interested director transaction - Director contracts with the corporation Indirect Interested director transaction - Director is an officer of another corporation. When the corporation contracts with another corporation, then a conflict of interest exists. (issue: which corp interest does the director take into account?) Elements Where Director is on both sides of the deal/transaction (where does loyalty lie?) Director influenced the corporations decision to enter the transaction, and Directors personal financial interests are in conflict with the financial interests of the corporation. A self-dealing transaction found by the court to be fair, will be upheld whether or not it was approved by a disinterested board or not. If the transaction is so one-sided that it amounts to waste or fraud, the court will void the transaction If it is neither fair, nor does it amount to waste, the court will probably use director approval and/or shareholder ratification as a factor Corp. Opportunity- Directors come across valuable deals, and exploit the opportunity for the directors benefit instead of the corporations. (more below/later) Corp. Competition- Director engages in business venture which seeks to exploit the same market as the corp. (more below/later). Self-Dealing Bayer v. Beran (p. 368) In order to promote the product, company created a radio program featuring opera music sung by the CEOs wife. Shareholder sued for conflict of interest (this is indirect interested director trans) Rule: In cases where directors enter into personal transactions with their companies, such transactions are rigorously scrutinized and, upon the showing of any unfair advantage, will be voided. Rule: When issues of Loyalty arise, the BJR does not apply. In other words- Duty of Loyalty considerations trump BJR protection. Lewis v. S.L. & E., Inc.- Donald Lewis (P), a shareholder of SLE (D), claimed that its directors (D) had committed waste by undercharging LGT, a tenant. Rule: The general rule is that directors of a corporation may make decisions in the ordinary course of business without review by the court- business judgment rule. However, when the directors have a personal interest in the transaction, they are no longer immune from review, and must demonstrate that the transaction was fair and reasonable to the corporation at the time it was entered. Handling Issues w/ interested Director involvement.
QuorumDGCL 141(b): In order to act on a matter, there must be a majority of directors present. Majority = quorum DGCL 144(b): Even if one or more director is interested in the transaction, his presence will be counted in determining a quorum Approval of actions DGCL 141(b):Approval for any transaction must be had by a majority of directors present DGCL 144(a)(1):If material facts (interested partys relationship or interest in the action) are disclosed and the board authorizes in good faith, a majority of the disinterested directors present is sufficient for approval, even though the disinterested directors be less than a quorum. this means that interested director must disclose his self-interest (b/c for the BJR to protect the BoD decision, it needs to be informed) means that interested director may vote, but his vote doesnt count for approval DGCL 144(a):Participation by the interested party in the meeting that approves that transaction, including voting, will not by itself void director approval Once it is shown that a majority of the disinterested directors have approved the transaction, the burden shifts to person attacking to show that the transaction was unfair. as a practical matter: interested director is better off abstaining to prevent appearance of impropriety. Forms of presence DGCL 141(i):If directors cannot all physically meet, then hearing each other through the telephone is sufficient for presence (but note: this means that email, and IM is not sufficient) Broz. v. Cellular Information Systems, Inc.- Broz (P) utilized a business opportunity for his wholly owned corporation instead of a direct competitor, Cellular Information Systems, Inc. (D) for which he served as a member of the board of directors. Rule: A corporate opportunity is usurped (and director is liable) where: Corporation is financially able to take the opportunity Opportunity is in the corporations line of business (closely related to corporations existing or prospective activities)
Corporation has an interest or expectancy in the opportunity Interest: A contractual right to property (i.e K right) Expectancy: a reasonable anticipation of an opportunity due to existing business arrangements (i.e. renewal rights) Embracing the opportunity would create a conflict of interest between directors selfinterest and that of the corporation Note: must have all 4 factors to be called a corporate opportunity and hold a director liable. (In Broz, D didnt usurp corporate oppty because (2) oppty was not in corps line of business.) Dominant Shareholders Rule: Generally, shareholders acting as shareholders Do NOT owe one another fiduciary duties. However, controlling shareholders owe fiduciary duties to the minority (cf. vicarious liability- controlling SH could elect BoD which could then act as his agent) Parent and subsidiary corporations (exists when one corp has enough shares of another corp to control it) DGCL 123: Corporations can own shares in other corporations Wholly owned subsidiary (Parent owns 100% of shares) Majority-controlled subsidiary (Parent owns 50.1+%) Minority-controlled subsidiary (Parent owns <50%) Transactions b/w Parent and Subsidiary Corporation: (subject to Intrinsic fairness test) Sinclair Oil Corp. v. Levien- Sinclair Oil owns 97% of stock in Sinven. Minority SHs objected to 3 aspects of Sinclairs relationship with Sinven. Intrinsic fairness- Places Burden on D to show transaction was fair to minority Majority shareholders can get their just benefits, but cannot benefit at the expense of the minority shareholders. Application: Dividends: An argument that there is selfdealing in the dividend policy will likely fail if the minority has received a pro rata share, If it satisfies the BJR, the policy is upheld Preferred v. Common Stock could have improper self-dealing where different dividends issued to different types of stock DGCL 141(a)(1) a disinterested ratification of a conflict of interest transaction involving an interested director has no effect (b/c interested directors must elect the noninterested directors)
CB 718 fn. 7: having disinterested directors approval is not dispositive but it is strong evidence that the transaction meets the test of fairness Rule: The intrinsic fairness test should be applied only to business transactions where self-dealing accompanies a fiduciary duty; If self-dealing is not present, then the burden remains with the plaintiff under the business judgment rule. Rule- Controlling shareholders must make full disclosure when they propose a transaction with those fellow holders. Common Stockownership in co.; generally have voting rights; but no guarantee of dividends; but it gets control usually 1 vote for 1 share (if bankrupt, creditors will be paid first) Preferred Stock- like a product that investor bankers createclass of ownership gives a stated dividend- a stated amount at a stated time usually, no control; no vote upon dissolution- they take priority; if co. is liquidated, they get paid first; advantages- you get to participate in the future, but you dont get to vote; and you some protection that you will get paid out before other shareholder. Callable Stock (redeemable shares) The co. has the right to buy back the shares Rule: Majority shareholders owe a duty to minority shareholders that is similar to the duty owed by a director, and when a controlling stockholder is voting, he violates his duty if he votes for his own personal benefit at the expense of the stockholders. Ratification Fliegler v. Lawrence- Shareholders (P) of Agua brought suit against its officers and directors (D) claiming the officers and directors (D) wrongfully usurped a corporate opportunity belonging to Agua and profited thereby. Basically, Agua buys up USAC shares for a buys out; Rule- Ratification of an interested transaction by a majority of independent, fully informed shareholders shifts the burden of proof to the objecting shareholder to demonstrate that the terms of the transaction are so unequal as to amount to a gift or a waste of corporate assets. 3 part test (summarized) under 144: ratified by, full disclosure by disinterested board necessary; but not disinterested majority of shareholders. In re Wheelbrator Technologies, Inc. Shareholders LitigationShareholders (P) of Wheelabrator Tech, Inc. (WTI) (D) filed a class action suit alleging that WTI (D) and its directors breached their fiduciary obligation to disclose material information concerning a corporate merger.
Rule: A fully informed shareholder ratification does not extinguish a duty of loyalty claim, but it serves to make the business judgment rule the applicable review standard with the burden of proof resting on the plaintiff stockholder. FEDERAL SECURITIES LAW Security- any note, bond, stock, or debenture (backed by nothing but the companies earning potential), etc. OR "evidence of indebtedness, investment contracts, or any instrument commonly known as a security. Securities law issues generate more malpractice cases than any other issues (easy to over look) 7 Statutes regulating the securities law industry (we only care about 2) Securities Act of 1933- mainly deals with primary markets (regulates the offerings and sale of new securities to the investing public) File w/ SEC- Requires Corporations, wishing to sell securities, to file a statement with SEC (security exchange commission) (very expensive- avg. cost- $943K) Scope is Procedural- Not worried about weather the corp is thriving or not, it's only worried about weather the corp. follows certain steps so people can have fair chances at the stock. Reporting Requirement- Periodic reporting requirements (yearly, quarterly, special event)- only apply to registered companies (major publicly traded corps.) Securities Exchange act of 1934- mainly deals with secondary market trading (inside trading, securities fraud, short swing profits, proxy voting, etc; also includes periodic disclosure requirements) Created the Securities and Exchange Commission (SEC) SEC is the primary federal agency charged with administering various securities laws SEC is an independent agency it enforces securities laws SEC promulgates rules and regulations to implement securities law more effectively Purpose of Securities Law- full disclosure and prevention of Fraud Full disclosure: make sure that investors have all the information they need to make informed decisions US congress adapted a rotten egg statute corporations can sell their rotten stock, as long as they properly disclose it (no inquiry into merits) V. Many other countries have merit based securities regulations (ask whether company is viable and whether its stock is meritorious) Prevention of fraud: agency cost problem re disclosure how to make a credible bond? There is information asymmetry b/w issuer and investor how to persuade the investors that disclosure is truthful- have fraud prevention Disclosure- Requirement to help make sure that investors have all the information they need to make informed decisions Transactional Registration statement filed with SEC (prospectus and registration statements filed with SEC)
Prospectus distributed to investors (requires information to be provided to investors for particular transaction (balance sheet, income statements, directors and officers, use of proceeds, ect) Periodic Form 10 (once) Fork 10-K (annual) Form 10-Q (quarterly) Form 8-K (episodic) filed upon certain important events Required in connection with any public sale Only required of registered companies Selling Securities under the Securities Act of 1933 (focus on primary market!) General Rules: Securities Act prohibits the sale of securities unless the company issuing the securities (issuer) has registered them with SEC A security cannot be offered for sale through the mail or by use of other means of interstate commerce unless a registration statement has been filed with the SEC securities cannot be sold until the registration statement has become effective the prospectus must be delivered to the purchaser before the sale Important civil liabilities: See Ss 11(a) 1933 Act 11(b3a) fraud in the registration statement (no fraud in connection with any disclosure cant be used with exempt offerings (because misrepresentation or omission must be in connection to registration statement due diligence is not an affirmative obligation, but it is generally the only viable defense to 11(in practice, due diligence is generally delegated to lawyers) there is a right of private action! 1933 Act 12 (a)(1) strict liability for illegal offers and sales; rescission remedy this makes the decision whether or not required to register that much more important 1933 Act 12(a)(2) fraud in prospectus or oral sales communication can be used with exempt securities can be used whether or not security is registered std of review: negligence seller is not liable if he can show that he did not know, and in the exercise of reasonable care should not have known, of such untruth/omission Implied private rights of action exists 1934 Act 10(b) and SEC Rule 10b-5 10(b) is the principal anti-fraud provisions of Securities Law (used to regulate insider trading) 1934 Act 14(a) and proxy rules 14(a) regulates shareholder voting Regulatory Arbitrage in the Primary Market public offerings can be useful, but expensive. Therefore, congress provides 2 exemptions to the registration requirement: Some securities are exempt entirely (no need to ever register) Exemptions are Affirmative Defense!
Exempt Securities- 1933 Securities Act 4(2): 5 shall not apply to transactions by an issuer not involving any public offering (non-public offerings) Sales to institutional investors- Insurance companies or pension funds -- Such institutions are powerful and sophisticated enough that they will insist on appropriate disclosure as a condition of sale Sales to key employees- E.g., top senior executives would have sophistication of companys affairs Acquisition of closely held corporation- Assuming that close held stockholder is sophisticated, the transaction will be exempt Money-raising offerings to small numbers of peopleelements" How many offerees not buyers Degree of sophistication and knowledge about the companys affairs possessed by the offerees. Private Placement Exception: Securities Act 4(2) Provisions of Section 5 shall not apply to transactions by an issuer not involving public offering but public offering is not defined in statute Doran v. Petroleum Mgmt Co, Petroleum Mgmt Co organized a limited partnership to drill for oil. It contacted a few people, but only Doran bought an interest. Doran agreed to assume one of the firms debts. The business started losing money and eventually defaulted on the note that Doran guaranteed. Doran sued for rescission arguing Petroleum did not register. Petroleum argues the were exempt and did not need to register Private placement test: Four factors are relevant to whether an offering qualifies to the exceptions# of offerees (not purchasers) and the relationship to issuer. Number must be below 25 a total consistent with a private placement" Relationship to issuer (is the offerees relationship to the issuer such that the offeree in the context of the offer is able to protect himself and look out for his own interest in the transaction). broken into: are these sophisticated investors? goes to legal and business sophistication are these knowledgeable investors? goes to access to information: amount of information required = the information a registration statement would have afforded
Required from all offerees (not all investors) ! number of unites offered size of the offering (how much money is being offered) manner of the offering (private means no general advertising or soliciting) NOTE: Only investors can attempt to rescind the sale by challenging whether corporation was properly exempt. Corporations are not allowed to do this! Regulation D safe harbors: rule 504: is an issuer raises no more than $1 million through the securities, issuer may generally sell them to an unlimited number of buyers without registering security Rule 505: if an issuer raises no more than $5 million through the securities, issuer may generally sell them to up to 35 buyers without registering the security Rule 506: if an issuer raises more than $5 million through the securities, issuer may generally sell them to up to 35 financially sophisticated buyers without registering the security Regulation D and 4(2) generally exempt only the initial sale! RULE 10b-5 Exchange Act 10(b): It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. purpose was to create a catch all for any new deceptive devices that were not already covered by the 1934 Act. Exchange Act Rule 10b-5: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security treat as thou shall not commit fraud
Elements: Unlawful for violation of the rule: Justice dept: a willful violation is a felony and the SEC may prosecute you criminally 1934 Securities Exchange Act 32(a) SEC bring civil action Private parties allowed: while there is no express private right of action, courts have implied that private rights exist Judicial nexus there needs to be a link b/w Congress, the SEC, and interstate commerce commerce clause was inserted b/c the idea that congress could regulate fraud (state law) was somewhat controversial. interpreted very broadly if in defrauding your neighbor, you sent a letter confirming sell that only states I sold you it is sufficient; even face-to-face transactions could be included if you drove in your car, ect Transactional nexus [in connection with the purchase or sale of any security] any securities stock and bonds purchase or sale must be a purchase or seller in order to have standing (Blue Chip Stamps CB 427 P did not have standing to sue where because of fraud he decided not to buy stock) Only purchaser and sellers have the right to sue/mere right to exercise an option does not give standing in connection with fraud only needs to touch and concern a purchase or sale (eg., misappropriation theory of insider trading where the fraud on person A taints the transaction with person B) Material misrepresentation or omission [untrue statement of a material fact or to omit to state a material fact] materiality exists where there is a substantial likelihood that a reasonable investor would consider the fact important TSE Industries CB 429. as to contingencies (where possibility of occurrence is important to investors, but nonetheless only contingent): courts apply a highly fact-dependent probability/magnitude balancing approach Basic CB 426, 432 probability that event will occur board resolutions, instructions to investment bankers, hired
atty, capital to finance further development, even did insiders start to buy stock magnitude of event size of the corporate entities, how much money will the co make, potential for premium over mkt value so if not material, then can lie about it!!! there is a difference b/w a material misrepresentation and omission with omissions, it is permissible to keep silent so long as there is no duty to disclose (ft.17 Basic CB 432) most courts rule that there is no duty to disclose until the co have reached an agreement in principle (announce only where agreement as to deal and its basics; prior to such agreement give no comment) USSC rejects this agreement in principal std for determination of materiality with contingencies note that if no comment follows a denial highly suspicious (better off adapting a no comment policy to avoid sending the wrong signal) with material misrepresentations, you are screwed! Reliance reliance is presumed in omission cases (otherwise would be impossible to prove) Affiliated Ute Citizens of Utah v. US (1962) reliance is rebbutably presumed in misrepresentation cases (otherwise requiring individual reliance from each member of the proposed P class would prevent Ps from proceeding with class action) USSC adapts fraud on the market theory it is presumed that investors rely on the integrity of the market price (therefore investors need not prove they have seen the reliance) Basic CB 433 Assume reliance where: There is a material public misrepresentation
With a stock that is traded in an efficient market (so that stock price will reflect the misrepresentation) D could rebut presumption of the fraud on the market theory by any showing that severs the link b/w misrepresentation and the market price Basic CB 435 Market is not deceived: if the market makers know about the merger, they will set the price accordingly (Market maker is a broker who makes the market in a securities that agent which matches buyers and sellers market maker determines the price at which a particular transaction will be executed) Corrective statements- there is a duty to correct inaccurate statements. Specific plaintiffs would have sold anyways (this is bogus b/c no one would depose 3M Ps) Causation there are two types of causation: Transactional causation but for the fraud, plaintiff would not have invested (or sold, ect) closely related reliance loss causation akin to proximate cause fraud caused the loss (e.g., market doesnt believe the misrepresentation, stock tanked due to market declined) could be very tricky: how do you prove causation where a false statement denying merger coincides with fall in market prices for all stocks battle of the economic experts where reliance is presumed, court will also assume transaction causation (omissions/fraud on the market) but loss causation is not presumed (how would Basics P prove loss causation on remand seems like the market did not believe the denial b/c the market price went up anyways; proving loss causation may be tricky - perhaps could argue that if Basic had told the truth, the price might have gone up even more; but Comb might have also walked out)
Scienter is required scienter is state of mind - intent to defraud (Sup Ctr) - reckless disregard of falsity of statement (all circuits) -pure intend is not required b/c reckless may suffice required in private party litigation (Ernst & Ernst v. Hochfelde, 1976) and SEC actions (Aaron v. SEC, 1980) Negligence is not sufficent INSIDE TRADING (order of insider Trading info might be backwards) Rule 10b-5: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. Insider trading liability is premised on an omission of material fact Problem: Liability for omission can only be imposed where D had a duty to disclose Silence is not fraudulent absent a duty to speak. Agassiz (state law) Whence comes insiders duty to speak? SEC v. Texas Gulf Sulpher: first circuit case to deem insider trading illegal!- Exploratory hole drilled; visual assay promising. Based on core sample results, TGS begins land acquisition. President orders drilling be kept secret until it could buy land. Meanwhile, Ees bought stock and call options and told their friends. When news got out, the company sent a misleading press release. Four days later, official statement made at 10 AM. At 10:54 AM, news appeared on Dow Jones ticker. (arguably insider transaction caused increase in stock price!) Rule: where an insider has material nonpublic information, the insider must either disclose it or abstain from trading until material information has been publicly disclosed rationale for rule: the federal inside trading prohibition was intended to assure that all investors trading on impersonal exchanges have relatively equal access to material information a janitor working for TGS who found the geologist memo is covered by the insider trading rule a farmer who realize the TGS is purchasing their land would probably not be covered do insiders really have an option? TGS did not have duty to disclose material info before April 12 press release. After April 12, they had duty to correct misleading statement (Basic). see ft. 12 (CB 465) If TGS wanted the information kept confidential, insiders dont have the right to disclose it Agency 365 cannot use/disclose information that comes to EE in the course of ee-er relations. therefore, it is really a duty to abstain (abstention rather than disclosure rule Who is an insider? 1933 Act 16(a) and (b): Officers, directors and 10% shareholders Rule 10b-5: TGS director - yes TGS secretary - yes TGS geologist - yes
janitor - yes farmer hypo - no When can an insider trade? - Insiders must wait until the information is effectively disclosed in a manner sufficient to insure its availability to the investing public (at that time a broad tape) to prove that market knew at that time refer to market maker or the specialist in stock Materiality TGS rule whether a reasonable man would attach importance to the information (this is different from the modern test) Modern rule whether there is a substantial likelihood that a reasonable investor would consider the omitted fact important in deciding whether to buy or sell security re contingent facts: probability/magnitude balancing (Basic) factors nature of the information Company response Market response (brokers opinions) Conduct of the insiders Practice of the industry was to buy on one good sample Balance probability that event will occur against the anticipated magnitude of the event in light of the totality of the company activity INSIDER TRADING WHY DO WE CARE? There are two kinds of inside trading: classical insider trading: Director/EE has fiduciary duties both to entity and investors; and then trades with a investor based on material nonpublic information outsider insider trading (misappropriation) a trading employee (no relationship with entity or investor) trades both types of illegal but why?: to keep current law we need a theory with normative power, as well as positive ability to predict what will happen in the future (theory that has both justificatory and explanatory power) or should be just repeal illegality of inside trading Economic Analysis of Inside Trading Deregulation Deregulatory arguments: (1) market efficiency (2) executive compensation arguments Regulation Regulatory arguments: (1) fairness (2) property rights THE MODERN DISCLOSURE OR ABSTAIN RULE There are essentially two options to regulating insider trading (IT): as in CL, think of IT as self-dealing so that IT becomes part of the same problem of corporate opportunity, OR treat IT as problem of securities fraud that there is information asymmetry dont analyze these as though one is wrong and the other is right. Just ask what is the purpose of securities regulations? What are we trying to achieve Different kinds of inside trading: Classical IT: involves insider who owned fiduciary obligations to both the corporation and the investor with whom they trade But with time, more sophisticated IT developed:
Chiarella - USSC use of nonpublic market information- Facts: D worked for a printer that was charged with printing financial documents and he used information that he deduced from the documents to buy stock in target company. No relationship at all with target company. Client was the buyer company, not company whose stock he traded. --> D only had market information Rule: The mere possession of nonpublic market information does not create a duty to disclose. (Note: departs from TGS in which fairness and equal access to information is the key.) -> equality of access does not survive Chiarella Market information v. Inside Information Inside information: originates within the firm and relates to the firms earning power or assets (e.g., earnings, products, assets, plans and the like) Market information: is everything else note that nothing in the opinion distinguishes b/w the two Duty to disclose or abstain arises from a relationship of trust and confidence between parties to the transaction. Who is an insider past Chiarella and Dirk: Exchange Act 16(b): Officers, directors, and 10% SHs Rule 10b-5: - Those with fiduciary duties Janitor is an Eee, thus agent, so subject to insider trading liability. Farmer not someone whom investors would place trust and confidence, not agent, no fiduciary relationship. Hypo: Acme Mining and XYZ Corp are negotiating a merger. During negs, material nonpublic info about Acme is disclosed to XYZ. Merger negs fail. XYZ then begins buying stock on the open mrkt in anticipation of making a hostile takeover bid for Acme. Liability? No. (Dirk FN 22) arms length relationship does not imply an obligation or an expectation of confidentiality Constructive Insiders (Dirks FN 14): Obtain material information from the issuer with an expectation on the part of the corporation that the outsider will keep the disclosed information confidential and
the relationship at least implies such a duty. Tipping Dirks v. SEC: received a tip from Eee that corporation was engaging in fraud. Investigated and learned more about fraud. Then tried unsuccessfully to get the NY Times to write about it. Dirks tells his clients about his investigation into corporation; clients sold. Eventually, media and SEC action caused stock to collapse and fraud was exposed. In most tippee chains, all the tippees trade. Here Dirk did not, but his clients did Tipping: When an insider tips and outside tippee (not a fid or an agent of corp; complete stranger) who tips another tippee who tips another tippee (aka tipping chain) In general, the tippees liability is derivative of the tippers, arising from his role as a participant after the fact in the insiders breach of fiduciary duty Rule: A tippee can be held liable only when: Tipper breached a fiduciary duty by disclosing information to the tippee[6], AND For a tippee to be liable: tipper must have breached a fiduciary duty tippee knew or should have known of breach The tippee knows or has reason to know of the breach of duty. Note: In tipping chain, knowledge is more attenuated at Tippee 2, 3, etc. Also, you can have a tipper who breaches, Tippee doesnt know of breach, so hes not liable. Pecuniary gain; enhanced reputation that will translate into future profits; or gifts. Liability arises for either making the tip or for insider trading the fact that D tipped without trading is irrelevant if all the other conditions are satisfied. Could have tipper liability without tippee liability Here tipper was a whistle blower and did not get any personal benefit Penalties: Administrative hearings against Ds under the SECs direct regulation (brokers, dealers, etc.) Equitable relief in civil case brought by the SEC: Injunctions; e.g., forbidding violater from being employed in the securities industry Disgorgement of profits Treble money sanction under ITSA
Criminal indictment: 20 yrs jail and up to $5 mill fine for individuals and $25.5 mill for corp Ds per count (Exchange Act 32 makes it a felony) Private suits--rare MISAPPROPRIATION Misappropriation: based on breach of a fiduciary duty not to the co in which you trade, but to the source of information Need for misappropriation theory: b/c Chiarella premised IT on a relationship of trust and confidence, it left a big gap in law could IT without facing any consequence USSC came up with misappropriation theory to save the day U.S. v. OHagan: /partner of a law firm who took info from other attys working on Grand Mets hostile take over of Pillsbury. bought Pillsbury stock. (note that is not liable under Dirk b/c Dirks abstain theory requires fiduciary duty to the entity whose stock are being purchased and had none..) Rule: A fiduciarys undisclosed use of information belonging to his principal, without disclosure of such use to the principal, for personal gain constitutes fraud in connection with purchase or sale of a security and thus violates Rule 10b-5 OHagan should have disclosed to both law firm and Grand Met (b/c he owes fiduciary to both). Grand Met might have approved OHagans buying stock, so that it could squirrel away the stock into friendly hands (warehousing). In theory, if Grand Met and law firm had approved, OHagan would not have been liable. Public policy: We want to encourage wide participation in the securities markets. Although informational disparity is inevitable, investors would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law. Significance: Anyone who misappropriates confidential information from anyone can be liable for trading on that information. Chiarella would have been decided differently. Sup Ct had rejected misappropriation theory b/c it hadnt been presented to jury, but Burger dissenting said that it was misappropriation. SWING PROFITS Law- statute has two primary sections: SEA 16(a) - Every person who is directly or indirectly the beneficial owner of more than 10 per centum of any class of any equity security . . . OR who is a director OR an officer of the issuer of such security . . . within ten days after the close of each calendar month . . . shall file with the Commission . . . a statement indicating his ownership at the close of the calendar month and such changes in his ownership as have occurred during such calendar month only SH are subject to the 10% requirement
SEA 16(b) - any profit realized by [such beneficial owner, director, or officer] from any purchase and sale, or any sale and purchase, of any equity security of such issuer . . . within any period of less than six months . . . shall inure to and be recoverable by the issuer In the event the corporation doesnt sue for recovery under 16(b), there exists a provision allowing a shareholder to sue the beneficial owner, director, or officer derivatively on behalf of the corporation SOL = 2 yrs SEA 16(b) This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase, of the security involved SH must have 10% for both purchase and sale. The transaction that places one over the threshold is not a matchable one (Provident Securities) Directors/Officers are subject to 16(b) if they are an officer or director at the time of either the purchase or the sale Analysis of 16(b): This is a form of SL if you violate the rule, you are liable irrespective of intent or purpose Parties affected: 16(b) only applies to insiders (no misappropriation issues) that are: shareholders with more than 10% of the stock beneficial owners - directly or indirectly have the power to dispose, vote, ect officers (no 10% requirement) Statutory officer prez, CEO, CFO, ect and Anyone who exercises significant policy making functions directors (no 10% requirement) 16(b) is narrower than 10b-5: smaller group of insiders than under 10b-5 no tipping liability, no misappropriation liability, no constructive insiders 16(b) applies only to companies that must register under the 1934 Act 10b-5 applies to any security to any company (public or private) v. 16b only applies to publicly held co & only applies to equity securities (stocks, or securities convertible to stock) Sale and Purchase: 16b applies whether the sale follows the purchase or vice versa therefore shares are fungible it is irrelevant for analysis when you bought or sold the same stock so long as it meets the 6 mth and other requirements; the fact that the shares you sold are not the same ones that you bought
is irrelevant so long as there is sufficient stock to match If a trader sells 10 shares of stock and buys back 10 different shares of stock in the same company at a cheaper prices, he or she is still liable Hypo: 1/1- Buy stock @ $9 1/2 - buy stock @ $11 1/3 sell stock @ 10 trader cant argue that he lost money because he sold the 1/2 stock so long as we could match the 1/1 and 1/3 transactions, trader is liable for the difference 11 10 (see also maximizing) The sale and purchase must occur within six months of each other Recovery: Any recovery goes to the company shareholders can sue derivatively, and a shareholders lawyer can get a contingent fee out of nay recovery or settlement courts interpret the statute to maximize the gains the company recovers: hypo: 12/31 buy stock @ 5 1/1- Buy stock @ $9 1/2 - buy stock @ $11 1/3 sell stock @ 10 courts will max corporate recovery: first will use 12/31 price 10 -5 then, any residual will go to the next transaction that will yield most liability, and so on A court will not imply step transactions: A 10% SH can sell enough shares to go below 10% threshold, and then in a separate transaction freely sell the rest without being subject to 16b Reliance Elec v. Emerson Elec. CB 491- USSC Facts: 6/16 - E buys 13.6% of dodge 8/28 - E sells some shares; reducing holdings to 9.96% 9/11 - E sells remainder Issue/Holding: Was the 6/16 purchase a matchable purchase? USSC doesnt answer Assuming that it was a matchable purchase, can it be matched with 9/11 sale? - No, because E was not a 10% owner on 9/11 What is a matchable transaction: Officers and directors are subject to 16(b) if they are an officer or director at the time of either the purchase or the sale Shareholder:
In a purchase-sale sequence, the transaction by which the shareholder crosses the 10% threshold is not a matchable purchase. Only purchases effected after one becomes a 10% shareholder are matchable Foremost-McKesson v. Provident Sec CB 493- USSC Facts: 9/20 Prov acquires debentures convertible into > 10% of Foremost stock This is not a matchable transaction because places Prov over top 9/24 Prov distributes some debentures to shareholders Potentially matchable transaction 9/28 Prov sells remaining debentures Potentially matchable transaction Is2 22. Issue: Can we match 9/20 acquisition with 9/24 disposition? Holding: NO HYPOS: CB 503-504 B is the CEO of a company registered with SEC that has 1M outstanding shares of stock CB 1(a) 1/1 purchases 200K shares @ 10 Dont worry about % because B is CEO 5/1 sells 200K shares @ 50 Liability: because B is the CEO, 16(b) applies to all of his transaction a purchase occurred within 6 months, and B owes (200K)($50) - (200K)($10) = $8M CB 1(a) variation Years ago purchases 200K shares @ 10 Dont worry about % because B is CEO 1/1 sells 200K shares @ 50 5/1 buys 200K shares @ 10 Sale/purchase v. purchase sale distinction not imp Liability: because B is the CEO, 16(b) applies to all of his transaction a purchase occurred within 6 months, and B owes (200K)($50) - (200K)($10) = $8M CB 1(b) 1/1- purchases 200K shares @ 10 Dont worry about % because B is CEO 5/1- sells 110K shares @ 50
5/2- sells 90K shares @ 50 Liability: because B is the CEO, 16(b) applies to all of his transaction A purchase and two matching sale occurred within 6 months, and Bill owes: (200,000)($50) - (200,000)($10) = $8,000,000 The percentage of shares Bill owns is irrelevant because he is an officer CB 1(c) 1/1- purchases 200K shares @ 10 Dont worry about % because B is CEO 5/1- sells 110K shares @ 50 Resigns 5/2- sells 90K shares @ 50 Liability: RULE: Officers and directors are subject to 16(b) if they are an officer or director at the time of either the purchase or the sale Despite the fact that B was not on officer on the 5/2 transaction, because he was on officer during the transactions on 5/1 & 1/1, they are matchable with 5/2 A purchase and two matching sale occurred within 6 months, and Bill owes: (200K)($50) - (200K)($10) = $8M Note: it works the other ways as well (if he gets hired after the sale) rules are designed to max liability Rene is an investor with 200K shares of public corp stock that she has held for several years. She is not an officer or a director (therefore need the 10% threshold): CB 2(a) Years ago purchases 200K shares She is now a 10% holder (200K/1M) = 20% Not a matchable transaction because places over threshold 1/1- Sells 200K shares @ 50 She loses 10% hold 5/1- Buys 50K shares @ 10 She gets 10% not a matchable transaction (Provident Securities) 5/2- Buys 110K shares @ 10 Potentially matchable transaction
Liability: RULE: This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase, of the security involved R is not liable because was a 10 percent shareholder when she sold, but not when she bought either block CB 2(b) Years ago purchases 200K shares She is now a 10% holder (200K/1M) = 20% Not a matchable transaction because places over threshold 1/1- Sells 200K shares @ 50 This was made at a time when she was 10% SH!!!!!!- matchable despite fact that it causes her to lose 10% 5/1- Buys 110K shares @ 10- She gets 10% (110K/1M) not a matchable transaction (Provident Securities) 5/2- Buys 50K shares @ 10- Potentially matchable transaction Liability: Yes, because could match the 1/1 and 5/2 [sell/buy] Accordingly, she is liable for her gain on 50K shares: ($50 x 50K) ($10 x 50K) = $2M CB 2- Years ago purchases 200K shares- She is now a 10% holder (200K/1M) = 20% not a matchable transaction (Provident Sec) 1/1- Sells 110K shares @ 50- She loses 10% hold still matchable? 1/2- Buys 90K shares @ 50- She gets 10% not a matchable transaction (Provident Securities) 5/1- Buys 300K shares @ 10Potentially matchable transaction Liability: Renee was not a 10 percent shareholder when she bought her stock. Accordingly, we cannot match a purchase with her sale of her first 110K shares, and she is not liable. CB (4) Suppose an investor has convertible debentures Years ago purchases 5K shares debentures- convertible into 100 shares/debenture- She is now a 10% holder 5K debentures = 500K shares she is treated as owner of more than
10% of equity -> not a matchable transaction 3/1- Buys 100 debentures @ $800Matchable 4/1- Sells 100 debentures @ $900matchable Liability: she is liable for her $10,000 profit on the purchase and sale of the 100 debentures. Bainbridge Hypo; 6/16- 13.2% purchase @ $ 10- cant use because places you over 10% (Provident Securities) 6/19- buy + 3.3% @ $10- Yes 10% Potentially matchable 8/28- sell 6.6% @ $11 (takes you down to 9.9%)- Yes was 10 % - potentially matchable LINK 6/19 and 8/28 9/11- sell the remainder @ 20- Below 10% - Not Matchable (Reliance) Liability: she is liable for her $10,000 profit on the purchase and sale of the 100 debentures. Summary of Rules: USSC interpretation of 16b has been remarkably rigid: intended as a bright-line statute, yet draconian Is there a sale/purchase OR purchase/sale within 6 mths If yes, go on Order is irrelevant: sale/purchase or purchase/sale rule applies to any sale (tender, stock, open mkt, ect) Is it by a director or a SH? Directors and Officers need not satisfy the 10% requirement (10% rule applies only to people whose only link is stock ownership) Officers and directors are subject to 16(b) if they are an officer or director at the time of either the purchase or the sale So if gets hired after sale, or if gets fired before still liable With beneficiary SH - this subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale
only purchases effected after one becomes a 10% SH are matchable!!!!! if you are 10% shareholder, you can go below 10%, pay your liability and sell the rest freely but sales that reduce your holdings to below 10% are matchable! Max gains for corporation Bottom line: most of time, an insider cant sell/purchase OR purchase/sell within 6 mths without violating 16b [except qualified compensation plans which are not covered by 16(b)] Indemnification and Insurance Liability Limitation Statutes DGCL 102(b)(7) provides that a corps articles of inc may (but need not) contain: A provision eliminating or limiting the personal liability of a director to the corp or its SHs for monetary damages for breach of fiduciary duty as a dir. Provided that such provision shall not eliminate or limit the liability of a dir: For any breach of duty of loyalty to corp or its SHs; For acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; liability for unlawful dividends; or for any transaction from which the dir derived an improper personal benefit only applies to directors, not officers (BJR applies to both) although officers also are subject to a duty of care, they are denied exculpation by charter provision Arnold v. Society for Savings Bancorp if D is both a director and an officer, a 102(b)(7) provision applies only to actions taken solely in his capacity as a director only eliminated monetary liability, it does not eliminate equity remedies (class actions) the effect of the statute is to wipe out monetary liability for breach of fiduciary duties distinguishes self dealing (improper personal benefit) from duty of care Indemnification Statutes: At CL, corporate EEs were entitled to indemnification for expenses incurred on the job, including certain legal liabilities, but directors were not. Today, most states have statutory provisions covering the authority or obligation of a corporation to indemnify officers and directors for any
damages they might incur in connection with their corporate activities and for the expenses of defending themselves. Different situation where directors might be subject to liability Claims by third parties (i.e. director hits pedestrian with company car) Claims by shareholders (for injury to the corporation) Claims by EEs (i.e. sexual harassment, ect) Claims by customers (i.e. sale of harmful drugs) Claims by competitors (i.e. violations of anti-trust laws) Claims by governmental agencies Indemnification is important b/c even though the risk of liability might be remote, the amount of damages and the expenses incurred to litigate the claim could be substantial, especially in proportion to officers/directors wealth. Delaware law: Coverage: 145(a) indemnification for third party actions - expenses, judgments, fines, and amounts paid in settlement where the officer acted in good faith good faith + believed in the best interest 145(b) indemnification for derivative suits allowed but for expense only (more narrow than a) where D is found liable to the corporation only with judicial approval * requires good faith Mandatory v. Permissive Indemnification 145(c) the corporation must indemnify a director or officer who has been successful on the merits or otherwise in the defense of the action. if successful mandatory indemnification if not successful discretionary * doesnt require good faith Advancement of expenses 145(e) allows a corporation to advance expenses to the officer or director provided the latter undertakes to repay any such amount if it turns out he is not entitled to indemnification. Sacrbane Oxley prohibits loans by corporation to officers and directors. Some think this provision may affect advancement of expenses - Sacrane Oxley may preempt 145(e)?!? Purchase of insurance by corporation authorized - 145(g) Indemnification by agreement allowed: a corp can K for protection above that of the statute 145(f) authorizes the corporation to enter into written indemnification agreement with officers and directors that go beyond the statute: statutory indemnification rights shall not be deemed exclusive of any other rights to indemnification created by bylaw, agreement, vote of the stockholders or disinterested directors or otherwise
if statute is silent by agreement, the parties can provide for indemnification 145(f) clearly authorizes indemnification agreements mandating payment of expense that the statute merely permits 145(f) clearly authorizes indemnification agreements mandating advances 145(f) likely allows indemnification of certain expenses not contemplated by the state (i.e. for expense beyond those of atty fee) Whether a provision could mandate indemnification in a situation which statutory indemnification is not permited? - Waltuch Waltuch (P) v. Conticommodity Services, Inc (D). Waltuch (P) was the VP and chief metal trader for Conticommodity (Conti). Waltuch sues Conti for indemnification of 2M for legal expenses incurred in defending himself for his alleged fraud and manipulation of the silver market (Cornering a market is manipulation and is against CFTC rules) against civil lawsuits ( P had incurred 1.2M in expenses and was dismissed from suit with no settlement contribution; Conti paid $35M in settlement) CFTC enforcement proceeding ( P incurred 1K in legal expense before he settled - paid 100K fine and 6-month ban on future Ks) Conticommoditys articles of inc provided the corp shall indemnify and hold harmless each of its incumbent and former dirs, officers, Ees and agentsagainst expenses actually and necessarily incurred by him in connxn with the defense of any action, suit or proceeding threatened, pending or completed, in which he is made a party, by reason of his serving in or having held such position or capacity, except in relation to matters as to which he shall be adjudged in such action, suit or proceeding to be liable for negligence or misconduct in performance of duty HELD: Indemnification rights may be broader than those set out in the statute, but they cant be inconsistent with the scope of the corps power to indemnify, as delineated in the statutes substantive provisions. consistency rule OUTCOME: Waltuch not indemnified per agreement. Where the statute requires good faith, as it does in both sub a and b, an agreement that purports even by implication to authorize indemnification for bad faith conduct is inconsistent with the statutes scope. Good Faith: (thinking back on the truck hypo) Interpreting CA law, 4th Cir. has held that a dir or officer who intentionally participates in illegal activity cannot be deemed to have acted in good faith even if the conduct benefits the corp. Thus, no indemnification. Fees on Fees
If an officer or dir is obliged to sue the corp seeking indemnification, is a prevailing officer or dir entitled not only to indemnification of atty fees incurred in the underlying litigation but also those fees incurred in the indemnification suit? Baker: NY indemnification statute bars recovery of fees on fees. But the NY statute authorizes corps to provide indemnification of fees on fees in bylaws, employment Ks or through insurance. Stifel Financial Corp: Del. says that an atty representing a former dir who is being denied statutorily authorized indemnification must seek compensation from his client or remain uncompensated, a result inimical to the interests of the former dir and contrary to the express purpose of 145 to protect dirs from personal liability for corporate expenses. Indemnification statute should be broadly interpreted to further goals it was enacted to achieve.
CHAPTER 6 Problems of Control (p. 539) Proxy Fights (p. 539) Proxy: shareholders may appoint an agent to attend the shareholder meeting and vote on their behalf. That agent is the shareholders proxy holder, sometimes simply called the shareholders proxy (or proxy card). Proxy Card: Incumbent managers at large firms solicit other shareholders for proxy status, asking the other shareholders to sign a proxy card which will allow the managers to vote on their behalf. Proxy Fight: Proxy fights result when an insurgent shareholder group (a group of shareholders who want to wrest control of the company away from the reigning Board) tries to oust incumbent managers by soliciting more proxy cards than the incumbent managers, then electing themselves and their allies to the Board. Strategic Use of Proxies Levin v. Metro-Goldwyn-Mayer, Inc. Rule: Incumbent directors may use corporate funds and resources in a proxy solicitation battle (proxy fight), if 1) the sums are not excessive and 2) the shareholders are fully informed. In this case, element 2) was satisfied because the incumbent managers sent letters to all the shareholders which itemized the major costs which they intended to spend on the proxy fight, including $15,000 or a law firm, $5,000 for a public relations firm, and gave an estimated total of the entire cost: $125,000. Element 1) was satisfied because those expenses were reasonable and very small in amount compared the firms annual gross income of $185,000,000. Fully informed SEC rule 14a-9 prohibits solicitation of a proxy by a statement containing either: a false or misleading declaration of material fact, or an omission of a material fact that makes any portion of the statement false or misleading. An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.
Reimbursement of Costs Rosenfeld v. Fairchild Engine & Airplane Corp. Rule: In a contest over policy, corporate directors have the right to make reasonable and proper expenditures from the corporate treasury for the purpose of persuading the stockholders of the correctness of their position and soliciting their support for policies that the directors believe, in good faith, are in the best interests of the corporation. Application: The incumbent mangers properly spent $106,000 out of the firms treasury on a proxy fight, but they lost. After the fight was over, they spent another $28,000 on turning over control, which was also reasonable, so the new Board reimbursed the old Board for $28,000. One shareholder, alone, had a problem with this, so he sued for the money to all be returned to the firms treasury, but it turned out that he was just a stupid jerk, because this was all kosher. Notes on the Regulation of Proxy Fights (p. 547) Soliciting Proxies- Soliciting proxies includes merely asking for other shareholders to help in obtaining a list of all the shareholders for the purpose of soliciting proxies (Studebaker Corp. v. Gittlin). However, only shareholders who are actually soliciting proxy cards are required to file with the SEC; the other shareholders who merely help by campaigning or helping obtain a list of shareholders do not need to file with the SEC (SEC rule 14a-2). Proxy Statement- People who solicit proxies must furnish each shareholder with a proxy statement, including any conflicts of interest and major issues that he intends to raise at the shareholder meeting, and the current managers must also give an annual report. Everybody who solicits proxy cards has to file a copy of all these letters with the SEC (SEC rules 14a-3, 4, 5, 6, 11). Rule 14a-7 says that when an insurgent group wants to solicit proxy cards, the incumbent Board has two choices: 1) The incumbents can mail the insurgent groups letters to all the shareholders for them and charge the insurgent group for that cost; or 2) The incumbents can give the insurgent group a list of all the shareholders and make the insurgents mail the letters themselves. Usually the incumbent group does #1, because that keeps the list of shareholders confidential. Private Actions for Rule Violations J.I. Case Co. v. Borak Rule: Where a federal securities Act has been violated, but no private right of action is specifically authorized or prohibited, a private civil action will lie and the court is free to fashion an appropriate remedy. The Securities Exchange Act has an implied private cause of action for individuals damaged by violations of the Act. This means that plaintiffs are not limited to state law relief (which often requires that the plaintiff post a large $ bond), but instead may seek relief in federal courts for violations of this federal law. Mills v. Electric Auto-Lite Co. Rule: when a proxy solicitation is misleading, and then a shareholder gets hurt by that same vote, the causal connection between the shareholders damage and the misleading proxy statement will be presumed. The shareholder doesnt have to prove that he would have voted a different way but for the misleading proxy solicitation. Seinfeld v. Bartz Rule: Valuations of option grants to outside directors are not material information which must be included in a corporations shareholder statement to solicit proxy votes. Such
valuations are not material as a matter of law. An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote (SEC rule 14a-9). Shareholder Proposals Lovenheim v. Iroquois Brands, Ltd. Rule: A shareholder proposal can be significantly related to the business of a securities issuer for no economic reasons, including social and ethical issues, and therefore may not be omitted from the issuers proxy statement, even if it relates to operations which account for less than 5% of the issuers total assets. By the way, the issue should have enough social/ethical import that it would have a substantial effect on a reasonable shareholders decision, and ideally thereby affect the value of the company to a degree of more than 5% if the shareholders knew about it. Analysis- Lovenheim is a member of PETA. He only bought the shares in the first place so that he could be a shareholder so that he could advertise the animal cruelty in the companys proxy materials to get people to sell and hurt the value of the company. Thats Tenacious D. The New York City Employees Retirement System v. Dole Food Company, Inc. Rule: Corporations may omit shareholder proposals from proxy materials only if the proposal falls within an exception listed in Rule 14a-8(c). The general rule is that a shareholder notifies the corporation of his intention to introduce a proposal at the annual meeting, the corporation is required to include that proposal within its proxy materials (SEC Rule 14a-8(a)). Exceptions: 14a-8(c): When a firm does NOT need to include a shareholder proposal in its proxy statements: [i](5) - if the proposal relates to operations which account for less than 5% of the (firms) total assets at the end of its most recent fiscal year, and for less than 5% of its net earnings and gross sales for its most recent year, and is not otherwise significantly related to the (firms) business. [i](6) - if the proposal deals with a matter beyond the (firms) power to effectuate. [i](7) - if the proposal deals with a matter relating to the conduct of the ordinary business operations of the (firm). There is an exception to this exception. In this case, the court found that the issue of which health care plan to support held significant financial implications for the firm, thus removing the proposal from the category of ordinary business matters. Austin v. Consolidated Edison Company of New York, Inc. Rule: In attempting to exclude a shareholder proposal from its proxy materials, the burden of proof is on the corporation to demonstrate whether the proposal relates to the ordinary operations of the company. Its not so much that the information would hurt the companys value, its that it could hurt the companys value, and the directors have a duty to protect that value for the shareholders. (First thing to review in Chp. 6- everything else before may not be on the exam.) Shareholder Inspection Rights- Federal law does not provide a shareholder with access to the shareholder list, but does not prohibit access to the shareholder list, either. Although an incumbent Board may elect to mail an insurgent groups proxy materials for them,
thus keeping the shareholder list confidential, the insurgent group may be able to obtain the shareholder list under state law.
General Context: in the process of bringing a derivative suit, DL law requires particularized pleadings in the complaint in order to excuse demand; the get facts before discovery, SHs use inspection rights the tools at hand to get the names and contacts of fellow SH (so as to conduct own mailing) while fed rules allow the corp to mail out proxy material without disclosing it proxy list, SH want the list for strategic target mailings there is nothing in the federal proxy rules that require a corp to give SH a SH list. Policy Concerns: Shareholders have a legitimate interest in using the proxy system to hold the board accountable Nobody wants a junk mail distributor to get access to the shareholder list or a competitor to get access to the corporations trade secrets and other proprietary information There are trade secrets and confidential records that should not be open to inspection by any shareholder In addition to the federal requirements for disclosure, there are state CL and statutory rights to inspection Delaware statute - CB 562 220(b) - Shareholder must make a written demand setting forth a proper purpose A proper purpose is one reasonably related to such persons interest as a stockholder (to prevent use of inspection rights to harass or use in hostile takeovers) 220(c) allocates the burden of proof in accordance to the info requested If shareholder only seeks access to the shareholder list, the burden is on the corporation to show that shareholder is doing so for an improper purpose If shareholder seeks access to other corporate records, burden is on shareholder to prove requisite purpose. sometimes, corporations will purposefully deny access to information (even when they know that SH is legally entitled) Determining proper purpose Proper purposes Evaluation of investment To determine whether there has been mismanagement (if there are some initial grounds for reasonable suspicion) To determine whether the stocks market price currently reflects intrinsic value To determine why dividends are not being paid To investigate other aspect of the corporations financial condition The desire to deal with other shareholders as investors Soliciting proxies, even if hostile to management (as long as shareholder can show a motivation to maximize value) Crane v. Anaconda CB 558 NY Crane announced a tender offer for Anaconda stock, and asked for a SH list. Anaconda refused list. HELD: communicating with other SH about offer was a proper purpose
Rule: A shareholder wishing to make a tender offer to the other shareholders should be permitted access to the companys shareholder list, unless the shareholder list is sought for an objective adverse to the company or its stockholders. The NY statute permits access to qualified shareholders on written demand accompanied by an affidavit stating that the inspection is related to the business of the company and that the shareholder has not sold a shareholder list within the previous five years.
Improper purposes
Pursuit of only social and/or political goals unrelated to the corporation (non-economic purpose) Pillsbury v. Honeywell CB 561-Minn: P lacks proper purpose for requesting info b/c purpose was solely on Pillsburys pre-existing social and political views rather than an economic interest DL requires as an interest of a SH but P admitted his only purpose was to end the war.
Rule: In order for a shareholder to inspect shareholder lists and corporate records, the shareholder must demonstrate a proper purpose relating to an economic interest.
suit might be appropriate when a SH has a bona fide concern about the adverse effects of abstention from profitable war contracts on his investment in Honeywell If he had wanted to save the company from bad publicity, would have won therefore, as long as one can assert that there is a meaningful economic interest, that will suffices even if the economic interest is secondary! Contrast with SH proposal where ethical or social significance alone is OK Which List Record list: List of the depository trust in which the stocks are held CEDE Street name list: List of the brokers who trade in stocks placed in depository trust (gives ID of brokers, but not actual SH) NOBO (nonobjecting beneficial owners) list: Actual beneficial owner who does not mind being contacted (this is what you want!!! Gives the names of SHs) Sadler v. NCR CB 564- 2nd Circ.- Rule: A state may require a foreign (out-of-state)
corporation with substantial ties to its forum to provide resident shareholders access to its shareholder list and to compile a NOBO list (nonobjecting beneficial owners), in a situation where the shareholder could not obtain such documents in the companys own state of incorporation. AT&T (a NY corp.) wanted to take over NCR (a MD corp.). Although AT&T couldnt get NCRs shareholder list under MD law, AT&T could get NCRs shareholder list under NY law. So, AT&T asked Sadler (a NY resident who owned shares of NCR) to get NCRs shareholder list under NY law, and then give the list to AT&T and AT&T and Sadler got away with this scam.
but note that absent an exception, the internal affairs doctrine prohibits a state from applying its corporate governance laws to corporations incorporated elsewhere NY law gives any shareholder of a non-NY corporation doing substantial business in NY the right to a NOBO list; Under NY law, if a NOBO list is required to put both sides in a proxy contest on equal footing, the corporation may be required to compile the list if it does not already have one The problem is that NCR had CEDE list, but not the NOBO list ctr said too bad, go and get it! Note: DL law only requires preparation of CEDE list (not NOBO list) Shareholder Voting Control: common stock, which represents equity and ownership interests, can be properly understood as consisting of a set of two distinct rights: economic rights receive dividends (distribution of profits) when and as declared by the B.O.D. residual claim on assets in liquidation voting rights: elect directors approve some extraordinary matters Packing Rights ( MBCA is a very liberal approach. Other states are much more limiting)- Look this Up!! MBCA 6.01(a) the articles of incorporation must prescribe the classes of shares and the number of shares of each that the corporation is authorized to issue MBCA 6.01(b) the articles of incorporation must authorize:
at least one class with unlimited voting rights at least one class with residual claim these may be the same, but need not be this reflects that there are two distinct economic and voting rights. MBCA 6.01(c) - Authorizes nonvoting stock and other variants on one share-one vote (discretionary) Voting Rights: shareholders vote at: meetings: annual where B.O.D. is elected (see MBCA 7.01) special emergency issues that cant wait till annual meeting (i.e. merger) Who may call a special meeting: MBCA 7.02(a) - a corporation shall hold a special meeting of shareholders: 7.02(a) (1) on call of its B.O.D. or the someone authorized to do so under the bylaws (usually chair of directors or secretary of corp), OR 7.02(a) (2) shareholders acting together may call a special meeting default rule- at least 10% of the vote holders (note that we are counting holders of shares, not shareholders!) articles of incorporation may affix a lower % or a higher percentage not to exceed 25% demand must be in writing most state track the MBCA in requiring a provision for some number of shareholders critique of MBCA: only flexibility is in the requisite number of shareholders; corporation has no right to take away SHs right to call special meetings could be problematic with hostile takeovers DGCL 228(a) allows you to repeal the shareholders right to call a special meeting and eliminate danger of takeover
Action without meeting (aka written consents): MBCA 7.04- written consent my be used only where all of the shareholders agree (must be unanimous) rationale: if some SH dissent, they should have the opportunity to have a meeting at which they get to talk others into changing their mind DGCL 228(a) - action by consents okay if same # of shares consent as would be needed at a meeting. (prof thinks this is a more sound approach Meeting Rules: MBCA default rules Extend to which default rules may be varied Quorum for a meeting Quorum= A majority of the shareholders entitled to vote MBCA 7.25(a) (count shares, not people) hypo: A = 51; B = 35; C = 14 shares A alone sets quorum b/c majority shares B + C are not a quorum b/c no majority of shares (even if majority of people) 7.25(a) V. 7.27 articles of incorporation may require smaller OR larger quorum 7.25(a) says unless the articles provide otherwise 7.27(b) articles of incorporation can provide for a greater quorum nothing said for lesser Comments to sections clarify: 7.27(a) is a special authorization for a super majority voting right OR quorum 7.27(b) is for amendments Once you have a Quorum, to approve corporate action MBCA 7.25(c) the yes must exceed the nos Hypo: 1000 outstanding shares; 800 present for meeting quorum; Vote is 395 yes, 394 no, and 9 abstain The proposal has passed b/c yes>no (abstains dont count) So proposal passes even though majority of shares did not approve & majority of present shares did not approve Most decisions can be made by the vote of a majority of the shares present at the meeting in person or by proxy and voting on the issue
MBCA 7.25(c) the articles of incorporation may require only a greater, not a lesser, number of affirmative votes
State of Wisconsin Investment Board v. Peerless System Corp. Rule: A shareholder need not attend a shareholders meeting and record an objection in order to challenge the propriety of the vote. Rule: Where the primary purpose of an adjournment of a shareholders meeting is to ensure passage of a proposal by interfering with the shareholder vote, corporate directors breach their fiduciary duty of loyalty. Peerless wrongdoing on this issue was that Peerless did not inform all of its shareholders that, although Peerless had called for the adjournment on the other issues, shareholders could still vote on the controversial proposal 2. Peerless did this just to interfere with the voting turnout, and that action interfered with the vote, and it was illegal.
Stroh v. Blackhawk Holding CB 573- IL
Rule: A corporation may prescribe whatever restrictions or limitations it deems necessary in regard to the issuance of stock, provided that it not limit or negate the voting power of any share. Illinois law merely requires that every share have the same voting power. In this case, Blackhawk got around the law by diluting the economic value of the stock rather than the voting power, keeping 3,000,000 cheap shares with one vote each for themselves, and offering only 500,000 expensive shares with one vote each to the public. Still, this is okay because it conforms to the letter of the IL law: that every share have the same voting power.
terminology: Stock split: used to increase the number of stock outstanding without changing anything else about the company which is still worth the same (done when stock price is too high odd lots are expensive!) effected by changing part value through amendments to articles (here par value cut from $1 to 50 and new shares issues on 2-1 basis Policy: Why Shareholder Voting Rights shareholders own the corporation unsure shareholder wealth maximization (rising tide lifts all boats) shareholders have most to lose authority v. accountability rational apathy why should I bother to be informed (when cost is higher than pol)
Transferability CONTROL IN CLOSE CORPORATIONS Close Corporation- a corporation in which the stock is held in a few hands, or in a few families, and wherein it is not at all, or only rarely, dealt in by buying or selling (Galler v. Galler) no secondary market for shares A controlling shareholder usually actively participates in the day to day management of the business Potential Decision-making Problems in Close-Corporations Deadlock (2-2) Oppress (3-1) Shareholder Agreements Solutions to Problems in Close Corps. Voting Trust/ee: Shareholders relinquish their voting power to a voting trustee: The trustee: becomes the nominal (name only), record owner of shares often agrees to cast the votes in a prescribed way (via trust agreement), (i.e.- to elect certain stockholders to the board). Is responsible for distributing any dividends to beneficial owners of the shares. ProThe shareholders retain economic interest in the business Eliminates the possibility of deadlock among shareholders (since all the shares are held by trustee who is a fiduciary of the SH) Conloss of control duration (most states limit to ten years) The law doesnt like them Imposes onerous limitations Most statutes require public disclosure of the trusts terms so that the existence and terms will not be hidden from other shareholders If no limit, trust is invalid Nearly all states require a writing still possible for board to oppress (trustee elects board, board may fire SH, ect) Vote pooling agreement (VPA): Agreement in which two or more shareholders agree to vote together as a unit on certain or all matters. Shareholder Agreements
Voting Agreements b/n shareholders are okay. Shareholder agreements which restrict director action are more strictly scrutinized, b/c directors have more info and need to act independently. Directors owe duty to corporation, not shareholder.
Ringling Bros: Cumulative Voting: # of Shareholder's votes = (# of board vacancies) x (# of shares owned) may cast all votes for one (or more) members of the BoD Ringling and Haley families factions had a written agreement under which they were to vote together, and in the case of a deadlock, an arbitrator would decide.
Rule: A group of shareholders may lawfully contract to vote in any manner they determine.
SH agreements relating to limitations on the B.O.D. discretion very common- agreements may include requirement of certain person as officers, specify compensation and/or dividend policy; require SH approval of board action, ect. General RULE: Agreements that substantially fetter the discretion of the board are unenforceable McQuade v. Stoneham and McGraw- McQuade and McGraw (both had small equity interest in Giants) agreed to elect/keep each other as officers at specified salaries. McQuade was fired and sued for specific performance HELD: Ctr says that agreement invalid because board must be able to exercise its own business judgment (in deciding how to vote) Directors must exercise their independent business judgment on behalf of all SH If Directors agree in advance to limit that judgment, then SHs do not receive the benefit of their independence. Agreement is therefore void as against public policy
Rule: A contract is illegal and void so far as it precludes the Board of directors from changing officers, salaries, or policies, or retaining individuals in office, except by consent of the contracting parties.
Problem: This is inconsistent with the basic principle of freedom of contract. However, contracts should not be allowed if there is some kind of externality. In this case, minority shareholders who are not part of the agreement. Clark v. Dodge- Where there are NO minority SH, you
CAN limit board of directors w/ agreement b/n themselves. Rule: Where the directors are also the sole shareholders of a corporation, a contract between them to vote for specified persons to serve as directors is legal The difference between this case and McQuade is that in McQuade, the directors had a duty to protect the interests of the whole company, which included other shareholders. In this case, Clark and Dodge were the whole company, so no one else could be
adversely affected by their agreement to protect each other.

Gallar v. Gallar (CB 598)- Brothers agreed to pay certain dividends each year and to pay, in the event either should die, a specified pension to a widow.
Rule: In a close corporation, shareholder management agreements are valid, including agreements to elect directors, absent a complaining minority interest, fraud, apparent injury to the public, and apparent injury to creditors.
Application: the agreement did not have an unreasonable duration company was to pay dividends only if it had sufficient earned surplus death benefit was reasonable Rationale: An investor in a close corporation often has a large total of his entire capital invested in the business and has not ready market for his shares should he desire to sell. He feels, understandably, that he is more than a mere investor and that his voice should be heard concerning all corporate activity. Without a shareholder agreement, specifically enforceable by the courts, insuring him a modicum of control, a large minority shareholder might find himself at the mercy of an oppressive or unknowledgeable majority.
Ramos v. Estrade (p. 632)Rule: Voting agreements binding individual shareholders to vote in concurrence with the majority constitute valid contracts. This rule is applicable even though Broadcast Group did not qualify as a closely held corporation.

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