Corporations 508-001 Fall 2008 Goals - to understand corporation law o agency law important because corps arent people.

. People need to do activities for the corp. o three groups as essential to understand in American corporation law shareholders owners of the company directors oversee the company officers appointed to run the company on a daily basis there is also a fourth player the corporation itself corporation is a legal fiction but it is a real entity other countries consider more than these three - to think about the corporations role in the economy and society o corporations have big impacts on community, politics, economy, culture, environment - to think about what lawyers can do for a corporation o can help to find the most efficient ways to accomplish goals o prevent litigation from occurring Agency - R3dA 1.01 defines agency as the fiduciary relation which results o 1) when one person (a principal) o 2) manifests assent to another person (an agent) o 3) that the agent shall act on the principals behalf and o 4) subject to the principals control and o 5) the agent manifests or otherwise so consents to it o In U.S. v. Cyberheat, Inc., Cyberheat hired a promotion company. The promotion company uses affiliates to promote websites. Affiliates are compensated by D fr each successful referral. P argued that these affiliates sent several hundred unsolicited, explicit e-mail with warnings that they were explicit. Court remands for further investigation of whether affiliates were agents of Cyberheat. Says several factors need to be examined including the extent of control Cyberheat had, the agents duty to act primarily for Ds benefit, and the agents power to alter legal relationships. What could Cyberheat have done if they were concerned about affiliates violating the law? disclaimer o but this is probably not enough tell affiliates much more forcefully that if they violate the law, there will be serious consequences regularly monitor affiliates - R3dA 1.02: Even if there is phrase in K stating that an affiliate is not an agent, this is not dispositive o need to look at actual relationship to determine if agency relationship exists - the essence of agency law is when one person asks another to do something for them o but this doesnt necessarily make someone an agent o R3dA 1.03 person needs to manifest intent or assent through written or spoken word or conduct

- agency relationship is a fiduciary relationship o R3dA 8.01 agent owes fiduciary duty to put the principals interests ahead of their own o R3dA 8.02 agent has duty not to acquire material benefit from third party in connection with transactions taken on behalf of principal or based on agents position o R3dA 8.03 agent has duty not to deal with principal on behalf of adverse party in connection with agency relationship o R3dA 8.04 agent may not compete with principal or help competitors or prepare for competition following termination o R3dA 8.05 agent cant use principals property or confidential information for their own purposes or to benefit a third party o In Food Lion, Inc. v. Capital Cities/ABC, Inc., reporters got job at P and secretly videotaped unsafe conditions. P claimed a tortuous breach of the duty of loyalty. Court held that reporters did breach a duty of loyalty. Employee intended to act adversely against employer. This is the default rule unless the K spells out something different. Loyalty extends as long as the agency relationship lasts. - Principal can be liable for things he didnt authorize - Figuring out whether someone is an agent for someone else will not always resolve the questions you need to answer o need to determine whether the principal will be bound by the acts of their agent also where they an agent for the purpose the plaintiff is claiming - there are a couple of approaches that are important in dealing with agency law o 1) Contract - have to look at the authority the agent has. Either actual in some way the principal gave the agent power to enter into a K apparent when the principal leads a 3rd party to believe an agent has authority, even when principal has told agent not to do something o 2) Tort generally wont look at actual or apparent authority will usually look to respondeat superior generally, parties have more luck in a tort claim much harder to show that someone is an agent, especially if there is a statement in K that they are not plus, under tort party often did not choose to work with the principal or agent o so courts may want to protect - two different parts o inward-looking consequences relationship between principal and agency o outward-looking relationship between alleged agent and third party courts are more willing to find agency in this circumstance - Why do we hold principals/employers responsible for acts of agents/employees o principal/employer has a lot of control over what happens o principal/employer is benefiting financially - Actual Authority o R3dA 2.01 agent acts with actual authority when, at the time of taking action that has legal consequences for the principal, the agent reasonably believes, in accordance with the principal's manifestations to the agent, that the principal wishes the agent so to act. o R3dA 2.02 Scope of Actual Authority

(1) An agent has actual authority to take action designated or implied in the principal's manifestations to the agent and acts necessary or incidental to achieving the principal's objectives, as the agent reasonably understands the principal's manifestations and objectives when the agent determines how to act. 1) express actual authority principal expressly tells agent what to do o R3dA 3.01 needs to be manifestation to an agent that, as reasonably understood by the agent, expresses the principal's assent that the agent take action on the principal's behalf. 2) implied actual authority agent must do what is usual, necessary, and proper to do some things to accomplish what principal wants them to do o In Castillo v. Case Farms of Ohio, Inc., Case used ATC to hire workers for their factory. ATC mistreated workers. Court held that ATC was clearly acting as Cases agent in hiring and transporting the workers. They had express authority to hire and implied authority to transport and house. Apparent Authority o R3dA 2.03 - power held by an agent actor to affect a principal's legal relations with third parties when 3rd party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principal's manifestations. o to establish apparent authority (R3dA 2.03) 1) needs to be a manifestation from principal to third party 2) which the third party needs to reasonably believe o there is also a reasonableness aspect o In Bethany Pharmacal Co. v. QVC, Inc., QVC hired NTA to serve as contact with states. NTA contacted Illinois. Janis worked for the IL DCCA and was in charge of the QVC contest. P was named as an alternate in contest, but received information from Janis that did not indicate that he was an alternate. P makes a claim against QVC under apparent authority. Court determined that there was no manifestation from QVC to P, only a manifestation from Janis. QVC said several times that you need to talk to QVC for information. QVC laid out express limitations. Inherent authority o because someone has a certain job, it is assumed they have the authority that would go along with that o removed from R3dA Respondeat Superior o Elements (R3dA 2.04) 1) agent was an employee someone is an employee when the principal controls the manner and means of their work dont actually have to control, as long as you have the right to employer has pretty detailed control rights over an employee distinction between employee and independent contractor o need to look at level of control independent contractor is doing a task for employer, but has much more control over how that task is done o how parties designate the relationship 2) acting within the scope of employment needs to be a connection between the actions an employee performs and their employment

shortcut to liability. No need to show employer did anything wrong. there are other ways to show an employer is responsible, but this is the easiest. o two categories employee everyone who is an employee is an agent respondeat superior only includes employees non-employee can be non-employee agents, but not an employee o In Ware v. Timmons, doctor advised nurse to remove a tube from patient. Patient went into cardiac arrest and died. P tried to hold doctor responsible through respondeat superior because he was supervising the nurse. Court finds against P in claim against doctor. Doctor did have control over nurse which would appear to indicate an employeremployee relationship. More than control is necessary, however. This court determines that consent was necessary. Doctor was assigned to work with nurse so he did not consent to work with her. Co-employees are not vicariously liable. Dissent feels that majority misinterprets precedent and applies a narrow area of this law concerning subagents to this situation. Estoppel o R3dA 2.05 o estoppel is based on fairness notions o if you know someone is saying they are acting as your agent, you cant just do nothing (reckless/negligent by doing nothing) o actual and apparent authority requires some manifestation by the principal estoppel does not Franchising o most issues turn on whether a franchisee is an agent of a franchisor o tempting to say that franchisee is always an agent (because of the amount of control), but courts are reluctant to hold that franchisee is an agent when franchisee is making a claim (because franchisee signed a K saying they are not an agent). o When a 3rd party is injured however, courts are more likely to say there is a principalagent relationship answer can change depending on the exact question, even if the same individuals are involved tort or K? o central question: courts will look at the right of control and how much control was exercised then move on to other aspects o

Organizing a Corporation - Corporation is a legal fiction with certain qualities - Qualities of a Corporation o centralized management shareholder do not necessarily have right to act on behalf of the company o continuity of life o transferability of ownership allowed to sell your part ownership of a corporation can be restrictions on this o limited liability

 can only lose the amount you invested - three groups as essential to understand in American corporation law o shareholders owners of the company broadly speaking, have three powers 1) can vote their shares at least once a year to elect directors or if there is a major decision 2) can sell their shares 3) if officers/directors do certain things that violate duties, can sue o directors oversee the company Model Act 8.01 - All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed by or under the direction of, its board of directors, subject to any limitation set forth in the articles of incorporation or in an agreement authorized under section 7.32. one director does not really have power to do anything on behalf of the company need to have a meeting and board has to agree to do it Model Act 8.21 - board can act without meeting as long as the action is unanimous. Otherwise, you need to have a meeting o 8.20(b) can have electronic meeting but has to be by a means where all directors can simultaneously hear each other o officers appointed to run the company on a daily basis o corporation law is designed to get these 3 groups to cooperate and benefit one another - Types of Corporations o publically-traded/held corporation have shares that you can buy on the public market typically, millions of shareholders 3 separate groups shareholders - worldwide board of directors nationally prominent businesspeople officers day-to-day employees o private or close corporation no public sale of shares a few people own the company individuals play part as shareholder, director, and officer goal of many close corporations is to have public corporations o major distinctions on how corporation can be run depending on if it is public or close - sources of corporation law o corporations operate in all 50 states all states have their own unique corporation law internal affairs doctrine a corporation based in one state can legally reincorporate in another state and the internal affairs will be governed by the laws of that state corporation still has to follow the state law of the state they are in o Delaware typically big corporations slightly over 50% of publically traded companies are incorporated in DE, more than 60% of Fortune 500 Why Delaware? 100 years ago most state corporation laws were very restrictive

o needed specific purpose o limits on limited liability o couldnt own subsidiaries some states began to loosen corp. law first theory, o DE gives directors lots of power and can get away with more (benefit directors at shareholders expense) second theory, o if above theory is true, why would shareholders buy shares in DE corps? o DE actually has stable corp. law and large body of cases and chancery court (dont have to face jury, instead face highly trained lawyers)

federal law only important for companies that sell securities to the public o most states follow the Model Act typically smaller corporations Starting a Corporation o all companies need to include some term in their name to signify they are a corp o Articles of Incorporation (charter) to form corporation, need to file charter with the Secretary of State (MBCA 2.01) must set forth (Model Act 2.02) corporate name number of shares the corporation is authorized to issue; street address of the corporations initial registered office and the name of its initial registered agent at that office; and the name and address of each incorporator. may contain (Model Act 2.02) (1) the names and addresses of the initial directors; (2) provisions not inconsistent with law regarding: o purpose; o managing the business and regulating the affairs o defining, limiting, and regulating the powers o a par value for authorized shares or classes of shares; Amount each shareholder initially pays for it's shares Showed that everyone was legally required to pay at least that amount Guarantee to creditors - tells them that the company has at least that amount set aside Limits the company for what they can charge for shares Par value is almost negligible now Model Act lets you get rid of par value But in some states need to set a par value If you forget it all goes into capital Some state corp. taxes are based on par value so if don't set it low pay more tax o

o imposition of personal liability on shareholders for debts of corp.

to a specified extent and upon specified conditions; (3) any provision under Act required/permitted to be set forth in bylaws; (4) a provision eliminating or limiting the liability of a o (A) amount of financial benefit received by director to which he is not entitled; o (B) intentional infliction of harm on corporation or shareholders; o (C) a violation of section 8.33; or o (D) an intentional violation of criminal law; and (5) a provision permitting or making obligatory indemnification of a director for liability to any person for any action taken, or any failure to take any action, as a director, except liability for o (A) receipt of a financial benefit to which he is not entitled, o (B) intentional infliction of harm on corporation or shareholders, o (C) a violation of section 8.33, or o (D) an intentional violation of criminal law. difficult to change like a Constitution changes must be approved by directors and by shareholders

o Bylaws

incorporator or board named in charter adopts bylaws (Model Act 2.06) bylaws may contain any provision for managing business and regulating affairs of corporation not inconsistent with law or charter (Model Act 2.06) easier to change shareholders have to have independent power to change o states dont have a lot of discretion to tell people when and when not to form a corporation Articles just need to meet requirements of the law upon filing, act of incorporation occurs (Model Act 2.03) In Grant v. Mitchell, 3 people formed a corporation. Eventually the person who incorporated the company tried to force out the other two. Incorporator claimed he had never organized a board with himself and one other as directors. Court found that a board had been organized. In other signed documents, the two-person board had been identified. The board had begun to hire employees, law firm treated both as directors. after incorporation, incorporator/board named in charter organizes (MBCA 2.05) American philosophy: can start any corporation as long as it is not illegal Capital Structure o composed of debt and equity (stocks and bonds) two different ways to raise money o equity (shares) little slices of ownership in the company most large companies now have multiple classes of shares charter can prescribe different classes of shares (MBCA 6.01) o with limited voting rights (Model Act 7.21) o are redeemable or convertible o entitle holder to distributions/dividends

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o have preference over other shares o company can buy back 1) Common stock simplest kind of share o company needs to have at least one share of common stock o get a vote to elect directors and for extraordinary transactions o sometimes different types of voting power attaches to different types of common stock o can give people ownership, but not voting rights may get paid a dividend if company chooses to if company folds, you are the residual claimant. o get whats leftover after everyone else is paid off. Recorded in charter. Charter says how many shares there are. (MBCA 6.01) o details of the shares can change o just because company is authorizes a lot of shares, doesnt mean they have to distribute all of them 2) preferred stock a share is preferred if an owner gets to stand in front of a common stockholder when the company winds up usually created by a quasi-contract o but are also recorded in charter or doc attached to charter preferred stock may vary a lot depending on its qualities usually cant vote directors owe duties to shareholders

sold by the company usually takes the form of a bond (K entered into by bondholder and company) completely contractual usually pay a fixed fee to start, and company will pay you a certain amount for a certain number of periods bond gets paid off before equity want provision saying when you will get paid some bonds have a conversion right directors dont owe duties to shareholders. Rights are set out in K liquidation preference company folds, everyone wants to get paid employees will probably get back wages people who made secured loans will get their part after this, the first people to get paid off are the bondholders then the preferred shareholders then the common stockholders o will benefit most if company grows, but has the most risk governance of the capital structure is the exclusive right of the board Model Act 6.21 board can issue new shares In Grimes v. Alteon Inc., company wanted to issue more stock. CEO had allegedly made promise to 9.9% owner that he could buy enough share to

maintain that percentage. Court found that the agreement was unenforceable. Board has the exclusive right to govern the capital structure. If board were required to give P 10% of new stock that would seriously encumber their business judgment. Rights such as this have to be granted by the board. despite control by the board of capital structure, there still needs to be fairness board needs to conduct activities with minimum standard of fairness In Adlerstein v. Wertheimer, members of the board decided that Adlerstein, director and CEO is hurting the company. Board comes up with a plan to fire Adlerstein, issue a lot of new shares, and then use their new voting majority to kick Adlerstein off board. But Adlerstein owned majority of voting stock. So directors can fire Adlerstein as CEO, but he can them remove them from board. While the court determined that proper standard were followed in giving notice of meetings, the actions of the board removing Adlerstein were not valid. P was deliberately kept unaware of the plan to bring in the new shareholders so to remove him. While law was properly followed, the result was obtained through trickery and unfairness. courts sometimes impose ethics on top of the law

Piercing the Veil - properly formed corporation normally shields stockholders from personal liability (MBCA 6.22) - in a few very extreme cases, court sometimes pierce the corporate veil and holder some or all of the shareholders personally liable for the corporations debts o not really an elegant doctrine with good logic - Why do we have limited liability? o good economic reasons encourages people to finance a business smaller companies may still need to make personal guarantees encourages investors to diversify if no limited liability, each company you purchased would open you up to liability permits free transfers of shares if no limited liability, wouldnt be able to value shares because there would always be a danger of catastrophic loss - disadvantages of limited liability o debt costs more because lender can only go after assets of company o may encourage recklessness since losses are capped - occurs when a court disregards separate existence of corp. and holds shareholder personally liable o used when there is no other theory to get at the person. o not really present in the MBCA o no good way to decide when a court will pierce always connected with the idea of injustice - What are the preconditions for piercing? o 1) no publically traded company or any company with more than 10 shareholders has ever had the veil pierced will occur either in a close corporation or in case of a corporate subsidiary (where a parent company owns all the shares) o 2) will find when individuals take active roles in running a company - Elements that the courts most often talk about o 1) lack of separation between corporation and shareholder

2) undercapitalization company seems to not have enough assets to continue business probably the single most important factor o 3) failure to follow corporate formalities/using corporation as alter ego o 4) fraud or misrepresentation o 5) trying to right an unfairness also often comes in o In Soerries v. Dancause, bar served person who then died in car accident. Soerries is so shareholder of the bar. Court holds that the veil can be pierced. Soerries violated corporate practces by intermingling money, paying employees under the table, not paying rent to company. Court rules based on sense of injustice. If he is not willing to follow corporate formalities, neither will the court. Soerries should pay for the death of the girl. odd case because corporate malfeasance/fraud really had no connection to injury piercing the veil seems to occasionally focus on righting an injustice Just as individual shareholder may be held liable, there are situations in which parent corp. may be liable for the debts of subsidiary or brother and sister corp (enterprise liability) may be liable. o Factors leading to veil piercing 1) intertwined operations/no separate corporate formalities 2) unified business and subsidiary undercapitalized 3) misleading to public 4) intermingling assets 5) unfair manner of operation enterprise liability doctrine under which individual entities can be held jointly liable for some action on the basis of being part of a share enterprise o usually occurs when someone creates several corporations. There is a judgment against one of the corporations, but that corp. doesnt have any assets. simplest method is to pierce veil against shareholder then try to grab assets in other corp o In Minno v. Pro-Fab, Pro-Fab contracted See-Ann to do work. P was injured. See-Ann did not carry liability insurance, but Pro-Fab did. Companies shared the same ownership. Court found that a genuine issue exists as to whether the two companies are alter-egos. Corporate fiction is to be disregarded when 1) control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will, or existence of its own 2) control over the corporation by those to be held liable was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity 3) injury or unjust loss resulted to the P from such control and wrong. In this case, corps. had same employees, same shareholders, same safety programs. forming two corporations isnt wrong. Court doesnt really establish that there is complete control, fraud, or undercapitalization. Court in this case looks to the Belvedere test. Corporate fiction is to be disregarded when 1) control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will, or existence of its own 2) control over the corporation by those to be held liable was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity 3) injury or unjust loss resulted to the P from such control and wrong. Reverse veil piercing o in rare cases courts will try to go through an individual to get assets of a corporation o factors have to be similar to that of regular veil piercing o

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 1) lack of separation between corporation and shareholder 2) undercapitalization 3) failure to follow corporate formalities/using corporation as alter ego 4) fraud or misrepresentation 5) trying to right an unfairness also often comes in o In In re Phillips, bankruptcy trustee sought to prevent transfer of certain assets of corp. in which debtor was dominant shareholder. Court found law permits reverse piercing when corp. and shareholder are alter egos and court must disregard to obtain equitable result. The Closely Held Corporation - A close corporation is a corporation that has the following characteristics: o a small number of shareholders (usually fewer than 20, and often only 1 or two) but some close corporations can be huge o lack of any real resale market for corporations stock o usually, a controlling shareholder who actively participates in the day-to-day management of the business shareholders, directors, and officers are not always distinct o shareholders are generally undiversified. a lot of their worth is sunk into the corp. - Whoever controls a majority of the board, generally, controls the company o if other shareholders dont like you, they can kick you out of day-to-day operations o dont have a lot of protections like shareholder in public corps. do - Planning techniques can be used to manage disputes. Variety of legal mechanisms have been developed to allow close corp participants to privately order their business without having to abide by the laws that publically held corporations have to o Shareholder Agreements o Transfer Restrictions o Voting Trusts o Classified Shares o Staggered Terms for Directors o Cumulative Voting o Supermajority Requirements o Preemptive Rights - Shareholder Agreements (Model Act 7.32) o can be very broad and reach into how the corporation is run o Model Act 7.32 - (a) An agreement among the shareholders of a corporation that complies with this section is effective among the shareholders and the corporation even though it is inconsistent with one or more other provisions of this Act in that it: (1) eliminates the board of directors or restricts the discretion or powers of the board of directors; (2) governs the authorization or making of distributions whether or not in proportion to ownership of shares, subject to the limitations in section 6.40; (3) establishes who shall be directors or officers of the corporation, or their terms of office or manner of selection or removal; (4) governs, in general or in regard to specific matters, the exercise or division of voting power by or between the shareholders and directors or by or among any of them, including use of weighted voting rights or director proxies; (5) establishes the terms and conditions of any agreement for the transfer or use of property or the provision of services between the corporation and any

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shareholder, director, officer or employee of the corporation or among any of them; (6) transfers to one or more shareholders or other persons all or part of the authority to exercise the corporate powers or to manage the business and affairs of the corporation, including the resolution of any issue about which there exists a deadlock among directors or shareholders; (7) requires dissolution of the corporation at the request of one or more of the shareholders or upon the occurrence of a specified event or contingency; or (8) otherwise governs the exercise of the corporate powers or the management of the business and affairs of the corporation or the relationship among the shareholders, the directors and the corporation, or among any of them, and is not contrary to public policy. (b) An agreement authorized by this section shall be: (1) set forth (A) in the articles of incorporation or bylaws and approved by all persons who are shareholders at the time of the agreement or (B) in a written agreement that is signed by all persons who are shareholders at the time of the agreement and is made known to the corporation; (2) subject to amendment only by all persons who are shareholders at the time of the amendment, unless the agreement provides otherwise; and (3) valid for 10 years, unless the agreement provides otherwise. (e) An agreement authorized by this section that limits the discretion or powers of the board of directors shall relieve the directors of, and impose upon the person or persons in whom such discretion or powers are vested, liability for acts or omissions imposed by law on directors to the extent that the discretion or powers of the directors are limited by the agreement. o should make provisions very clear so as not to lead to confusion o In Ronnen v. Ajax Electric Motor Corp., agreement gave brother the ability to vote the stock of his sister and her children, except for major corporate decisions. Tension developed. Sister wanted to be able to vote for certain directors. Brother refused and adjourned the meeting by voting her shares. Brother leaves. Sister says bro didnt have right to adjourn meeting. She and remaining shareholder vote for directors. Court finds that the election is invalid. Voting for directors is ordinary business, and not a major corporation decision. Shareholder agreement is clear that voting on these matters goes to brother. Agreement could have been clearer on when sister gets to vote. o limits needs to be approved by all shareholders existence of agreement has to be noted on front and back of physical shares buyers need some sort of notice Transfer Restrictions (Model Act 6.27) o The articles of incorporation, bylaws, an agreement among shareholders, or an agreement between shareholders and the corporation may impose restrictions on the transfer or registration of transfer of shares of the corporation. A restriction does not affect shares issued before the restriction was adopted unless the holders of the shares are parties to the restriction agreement or voted in favor of the restriction. o A restriction on the transfer or registration of transfer of shares is valid and enforceable against the holder or a transferee of the holder if the restriction is authorized by this section and there is notice o Restrictions need to be reasonable

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In Capital Group Companies, Inc. v. Armour, company had restriction regarding what husband could do with shares. He and wife were divorcing. Wife proposes, since she cant get shares, that they remain in her husbands name, but she gets half the dividends and half of the value if they are sold. Court disagrees with wifes plan. Wife would be getting a right that the shareholder holds so it would be a transfer of an ownership right, which is restricted. Wife argued that agreement is unreasonable because she will not increase the number of shareholders and other nonemployees hold shares, but court says it will only look at whether the agreement itself is reasonable, not each individual case. Voting Trusts (Model Act 7.30) o One or more shareholders may create a voting trust, conferring on a trustee the right to vote or otherwise act for them, by signing an agreement setting out the provisions of the trust (which may include anything consistent with its purpose) and transferring their shares to the trustee. o Voting trusts are valid for 10 years from their effective date to extend for another 10 years, all parties must agree in writing Why? voting trusts used to be disfavored o In Warehime v. Warehime, Chairman and CEO established voting trusts to manage shares of his children in the company. When father retired then died, son 1 took over and continued to manage voting trust. Siblings were not satisfied with brother and wanted voting trusts to expire. The company, however, needed money, but investors were worried about control. Company issued 10,000 more shares to 401(k) plan to maintain stability. For 5 years, if there is dissension in the family, 401(k) gets 35 votes per share to serve as a tiebreaker. Son 1 appoints 401(k) board. Siblings claim brother is extending voting trust by 5 years. Son 1 has duty of loyalty to do what is best for trustees, but as officer he has duty to do what is best for the company. Court rejects the notion that son had an absolute duty of loyalty to the trust; he just needs to show good faith. He was trying to do what was best for the shareholder. If trustees wanted more protection, absolute duty of loyalty would have to be mentioned in trust. o shareholder voting agreements shareholders can always sign agreements agreeing to vote together voting trust goes a step further and gives power to vote to one trustee some agreements expressly provide how votes will be cast. Others just commit the parties to vote together. if shareholder goes against the agreement, can be held liable for breach of K Classified Shares o Model Act 6.01 charter may set out different classes of shares o Shareholders may reallocate their voting power (and give minority holders a bigger voice) by using classified stock. corporation sets up two or more classes of stock, and gives each class different voting rights or financial rights can separate voting power from economic power o In Benchmark Capital Partner IV, L.P. v. Vague, Benchmark was an initial investor in Juniper. Gave funds twice and received Series A and Series B stock. Later on Juniper needed money. Benchmark didnt want to give more so CIBC did instead. CIBC received Series C stock which makes Benchmark a junior preferred stockholder and allows CIBC to control a majority of the board. When Series C are issued, special protection is granted to juniors such as a guaranteed class vote before new senior stock is issued, separate class

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vote before merger (except with subsidiary), vote for any action that would seriously change rights, preferences, privileges. Juniper needs more cash. CIBC agrees to give for Series D stock, but in order to do this would need to change charter and have a vote. To get around, Juniper does a 100 to 1 stock split, then merges with a subsidiary that they just created, which allows them to get a new charter after merger, which can be used to issue Series D. Benchmark sues. Court finds against Benchmark. The parties are sophisticated and should understand the terms. DE law says shareholders cannot be protected from merger unless specifically mentioned in agreement. Even after merger is allowed, Benchmark tries to argue that they should get to vote because their rights are being reduced. Court says rights arent being diminished. If rights are given a broad meaning, power given to CIBC under Series C is probably meaningless. Rights should be read narrowly. Benchmark bears burden of showing what these rights are. generally, courts will talk about protecting shareholder voting rights, but there are times when they will circumvent the vote this is very fact specific (in Benchmark, both sides were sophisticated) Staggered Term for Directors (Model Act 8.06) o anti-takeover device since if bidder acquires a majority of shares, they will not be able to take over a company immediately. Have to wait a few years. Cumulative Voting o default rule in corporation law is straight voting each share may be voted for as many candidates as there are slots on the board, but no share may be voted more than once for any given candidate directors are elected by a plurality o under cumulative voting, each shareholder gets to pool their votes and vote them to whichever candidate they want to figure out how many votes a shareholder gets multiply the number of share by the number of directors to be elected can focus all these votes on one or more directors directors elected by plurality o formula to determine how many shares a shareholder needs to have out of the total to elect one member of the board [shares voting/(directors to be elected + 1)] + 1 = shares required o powerful tool that is very common in close corporations All states permits. Some require. o why do we want minority representation on the board? can use the one board member to monitor the board if you combine cumulative voting with a supermajority requirement, minority can have an effective veto over board activity Supermajority Voting o there are numerous variations on this technique, all of which require more than the usual simple majority vote or quorum o requirements can be applied either to shareholder or director actions shareholder supermajority Generally shareholders voting on directors or major transactions One way to restrict a board is to put a requirement for more than 50% vote into the corp documents - so if worried about merger or sale of company - could require supermajority of shareholder votes Put this in the charter - only place under the MBCA (Charter) In either charter or bylaws - under DGCL (Bylaws or charter)

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director supermajority Board is more active in day-to-day operations So could be general requirement for everything or supermajority for extraordinary things - changing the bylaws or merger, etc. Both MBCA and DGCL allow for charter or bylaws o 3 things to keep in mind: Utility of supermajority requirements Why you might want one as shareholder or director Difference b/w director and shareholder supermajority requirements Serve different functions Put in different places Importance of careful drafting so that issues you want to be covered by supermajority voting are need to make sure that a supermajority vote is needed to amend the provision requiring a supermajority o In Kimberlin v. Ciena Corporation, provision gave Series B investors the pro rata right to shares. However, it also gave shareholders of Series A and B stock to nullify those rights with a 67% vote. Kimberlin tries to claim there wasnt sufficient notice and that supermajority was obtained by fraud. Tries to argue violation of duty of good faith. Court held other shareholders had right to vote as they see fit. There was no ambiguity in the waiver provision. Parties had negotiated the term so there was no breach of good faith. Preemptive Rights o a right sometimes given to a corporations existing shareholders that permits them to maintain their percentage of ownership in the corporation, by enabling them to buy a portion of any newly-issued shares

Deadlock - Deadlock refers to a scenario in which the corporation is paralyzed and prevented form acting. Usually deadlock arises from some aspect of the control structure that the shareholder have adopted. o Three common occurrences two 50% holders even number of directors minority holder has veto through shareholder voting agreement, supermajority requirement, etc. - If deadlock occurs at the shareholder level, the result is not usually immediately catastrophic o holders may not be able to elect new directors, but in most states the directors elected before the deadlock will remain in office until successors are elected - Deadlock at the director level is more dangerous o boards inability to take action may prevent the corporation from functioning - Remedies for deadlock o buyout o judicial dissolution almost all states have statutory provisions allowing shareholders to approach courts and ask that corporation be dissolved under the courts equitable powers corporation ceases to exist as a legal entity

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corporations assets are sold off, its debts paid, and any surplus distributed to the shareholders Model Act 14.30 shareholder may obtain dissolution if the directors are deadlocked in the management of the corporations affairs, in a way that is causing injury to the corporation or its shareholders directors or those controlling the corporation have acted in a manner that is illegal, oppressive, or fraudulent shareholders are deadlocked in voting power and have failed to elect successor directors for a period that includes at least two consecutive annual meeting dates corporations assets are being misapplied or wasted In Conklin v. Perdue, P and D formed a corp. P provided more capital. Conklin eventually decided corp. was out of money and not economically feasible. Disputes arise as to whether D owes money. Neither takes legal steps to dissolve. Court finds that the situation falls within the scope of proper judicial dissolution from the first day of their deadlock. Conklin had no fiduciary duties after this date. Money given to Perdue was compensation, not loan. Model Act 14.32 - court in a judicial proceeding brought to dissolve a corporation may appoint one or more receivers to wind up and liquidate, or one or more custodians to manage, the business and affairs of the corporation. How can deadlock be avoided? o Some kind of tie-break in the corporate documents - charter or bylaws o Negotiate a shareholder agreement o Don't have two shareholders or two directors o Arbitration provision

Closely Held Corporations and Minority Oppression - basic concept - When a majority shareholder or shareholders prevents a minority shareholder from enjoying the economic benefit of their investment o freeze out - only happens in closely held corporations because in public corporations, you can sell your shares o Wall Street Rule can sell your shares if you dont like what is going on o In Elmaleh v. Barlow, P alleged that new agreement with preferred stock investors diluted his shares. Court finds that this is not a close corporation. While there was no ready market for the stock, there were more than 70 shareholders and a lack of shareholder participation in management. no case has ever found a close corp. with more than 21 shareholders - usually defined by case law, not statute - How do you respond to minority oppression? o Most often rule - Donaho & Wilkes Cases Two prongs of duties owed by majority to minority: 1) Must be good reason - legitimate business reason for action o If majority proffers this then the minority has to respond 2) Minority must respond that there is a less harmful alternative DE doesn't take this approach Their response to minority oppression is "too bad"

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If someone invests and doesn't bargain for protections then that's their fault In Leslie v. Boston Software Collaborative, Inc., three people formed a corporation. One shareholder made less than the others. Issues arose between this partner over a variety of things. Eventually partner issued a threat. Other two partners put him on leave and offer him a severance package. Later notified him of a shareholder meeting. At meeting they voted to remove him as 401(k) trustee, director. Also, there was later a director meeting of which he was not notified where he was removed as officer. After he is removed other 2 directors give themselves bonuses. Court finds, since this is a close corp., he has special protections. Look to the Wilkes test. Majority here could have taken much less harmful steps. Court wants to ensure that he keeps his seat on board, receives better severance, and is ensured the benefits of a director. Buyout would probably be economically destructive. How to determine if oppression is occurring o look at the allegedly oppressive actions of the majority In Kiriakides v. Atlas Food Systems & Services, Inc., three sibling were shareholders. Brother Alex had the most shares and dominated the company. Disuptes arose of Alexs management. Court found Alexs conduct to be oppressive and order buyout. Determines by looking at the allegedly oppressive actions of the majority shareholder rather than the reasonable expectations of the minority. Looking at reasonable expectations would require the court to microscopically examine the workings of the corp. Looking at the majoritys actions though, this is a classic example of a freeze out including termination of employment and dividends and siphoning off of corporate assets. o look at the reasonable expectations of the minority o sometimes courts are more willing to get into the interworkings of close corporations In Naito v. Naito, corp. is run by 2 brothers with equal voting shares. After one brother dies, 5 voting shares are supposed to go to the other brother until his death. After first brothers death, the 5 shares are not delivered to him. There is a breakdown in relations between the families because dead borthers family thinks living brother is trying to assert dominance (dispute about widows stipend, a son wants to get involved in company). Dead brothers family also wants a way to get money out of the company. Also, living brother decides to give voting rights to non-voting shares (which his family holds more of), in case there is deadlock in voting shares. Court finds that a lot of what happened was not minority oppression. Living brother was supposed to have control until his death. Not everything the living brother did was ok. The company was making enough money to issue dividends so the family can get some benefit. Court is reluctant to intrude so just suggests dividends be paid (but would probably force the company to if it doesnt). When minority oppression occurs - shareholder can approach court and ask for the dissolution of the company o MBCA 14.34 provides that when you approach and ask for dissolution for deadlock/oppression, other shareholders have option to buy your shares instead this is what will often happen

Control of the Publically Held Corporation - courts are more willing to get involved in the innerworkings of close corporations

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in public corporations, courts are more willing to defer to corporate management in corporate decisions separation of ownership and control is the main issue in public corps o shareholders own the corporation but their only powers are to vote, sell, and sue also, can generally inspect corporations books and records traditionally, only a few people owned a lot of stock eventually more people were persuaded into buying common stock in the 1920s up until the 1980s, shareholders were traditionally hundreds of thousands of little guys who owned a few shares so management got to do what it wanted because there were no large blocks of shareholders to interfere Wall Street Rule if you dont like what is happening in a corporation, you can sell your shares starting in the 1980s, institutional investors developed any sizeable institution which holds assets on behalf of someone else now control more than half of outstanding stock of major public corporations o but individual institutional investors usually hold only a small percentage of stock but management is still more willing to listen to someone who holds a percentage in the corp., rather than an individual o institutional investors are looking to do whatever necessary to make money and may also have social goals may lead to conflict with the board o directors and officers run the corporation DGCL 141(a): every corporation organized under this chapter will be managed by or under the direction of a board of directors MBCA 8.01: all corporate powers shall be exercised by or under authority ofa board of directors In Unisuper Ltd. et al. v. News Corporation, corp. wanted to reincorporate in DE. During the negotiations, management sought to have poison pill privilege added, but, to win over shareholders, promised not to renew it after one year. Shareholders did not want it in charter. Later, a hostile takeover attempt appeared, and board extended poison pill. Shareholders bring suit under breach of K. Court allows case to go forward because there may be a K. Corp. claimed that directors have the power to manage the corporation. Court says this is usually the case, but here the board handed over power to shareholders. are supposed to put the shareholders interests ahead of their own In Blasius Industries, Inc. v. Atlas Corp., Blasius bought 9% of Atlas. Blasius delivered shareholder consent seeking to restructure, expand the size of Atlas board from 7 to 15 and fill those spots with Blasius people. To prevent, Atlas expanded board to 9. Court found that Atlas interfered with the shareholders right to vote. Board is an agent for shareholder, but cant take decisions out of their hands.

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shareholders ability to vote is one of the primary justifications for giving power to the board kind of like an agency relationship with an agency relationship there are always agency costs to ensure directors put shareholders first, there are legal mechanisms and other means to force them to do this legal mechanisms o fiduciary duties o public companies are required to provide information to shareholders o give management some ownership in the company so their interests align with the shareholders non-legal mechanisms o financial journalists o stock analysts o forced testimony to Congress Shareholder voting o shareholders cant choose officers, determine day to day activities, cant easily overturn decision by the board o Who can vote? for a particular vote, company will have to set a record date always occurs before annual meeting whoever owns shares before this date can vote corporation cant get a record list of all shareholders easily o in a lot of cases, corp. can only see the brokers, who act as beneficial owner, rather than the specific shareholders o what do you do if corp. needs to find out names of shareholders? shareholders can agree to let the corp know who they are broker can give corp. a list (Nonobjecting Beneficial Owners NOBO list) o some very large shareholders (more than 5%) have to make public disclosure to the SEC also large money managers and mutual funds usually have to disclose how many shares they own o When can they vote? all publically traded companies have to have an annual meeting after meeting is called, board has to give shareholder notice special meetings can be called by the board or by shareholders in certain special situations o under DE law, only board can call meeting unless charter says otherwise o under Model Act, shareholder who owns more than a certain percentage can call o What do you vote on? directors (Model Act 8.03) at least 1/3 of the board has to be elected every year o in some corps, directors are up for election every year board members cant hold position for more than 3 years

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o o

extraordinary transactions merger above a certain size, sale of the companies assets, charter change, shareholder proposals How do shareholder vote? 100 years ago shareholders just went to the meetings sometimes there were laws that prohibited shareholders from giving their power to someone else at a meeting now, the vast majority of voting occurs through proxy proxy giving someone right to vote your shares on your behalf realistically, corporation will request your proxy o corp asks to asks to act on your behalf Will usually seek your proxy every year and will usually get them usually the directors are unopposed contested elections are fairly rare committee of the board will usually nominate all the directors o unless someone else is willing to put up a lot of money for a proxy contest, this will usually work How are votes counted? a quorum of votes need to be represented at a meeting for action to be taken for most proposals, a majority vote (a majority of the shares present at the meeting) is required to pass present includes electronic communication directors are elected by a plurality people who gets the most votes as director become directors want corporation to be able to act which it cant do without directors most of the above is governed by state law federal regulation of shareholder rights and voting originally, the only laws you needed to worry about was state law after Great Depression, state laws were seen as insufficient to protect investors Congress adopted a new set of federal law for public corps o Securities Act of 1933 o Securities Exchange Act of 1934 o these laws apply only to publicly traded corporations o the big requirement in all of these laws is disclosure so long as you disclose the risks involved in a company, the government cannot stop you from selling your securities to the public but every minor error is not cognizable under federal law needs to be a test of materiality federal securities laws tell you the rules about how to vote (specific rules for asking for ballot for directors). State laws will set down the substantive rules of what youre going to vote on. extends to any solicitation, by any person, of any proxy or consent or authorization in respect of any security that is registered with the SEC very broad consequences of making a proxy solicitation o liable for misstatements

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violation of SEC 1934 Rule 14a-9 for a company to make a false statement of material fact or to omit material facts in its proxy statement key concept is whether statements are material o information a reasonable shareholder would consider important in deciding how to vote. o there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available o not protected as free speech o have to file additional documents with SEC In Long Island Lighting Co. v. Barbash, third party launches proxy contest against P. Third party puts an add in a magazine attacking LILCO. Court finds that the ad could be considered a proxy statement. Doesnt have to be a direct solicitation. SEC is allowed constitutionally to clamp down on proxy solicitations. Shareholder Power over Directors o Shareholder Proposals proponents of shareholder of proposals usually want the company to pay to send their message to shareholder shareholders can always pay the company to send their proposal but this is very expensive o board is allowed to reimbiurse for a successful proxy campaign but if you dont win a majority of board, probably wont Rule 14a-7 requires the company to give a shareholder list or mail a proposal directly to shareholders, but you still have to pay for it Rule 14a-8 requires a company to mail a shareholder proposal when shareholder approach the company beforehand with significant time and asks the company to mail the proposal 1) Shareholder group approaches the company 2) Negotiations 3) If company decides agreement is appropriate for shareholders, it will go in. If it doesnt agree, company will send letter to SEC o No action Letter says that SEC will take no action if proposal is excluded from proxy doesnt say it is okay to exclude it, just that SEC will not force them to o SEC looks at reasons in the exclusion why shareholder agreement can be excluded if corporation accepts, proposal is included in managements own proxy o proposal is also accompanied by companys commentary on why the proposal should not be adopted Eligibility o 1) own $2,000 in securities in company

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o 2) have held shares for at least one year prior to submission o 3) proposal needs to be submitted 120 days in advance Reasons to exclude shareholder proposals o improper under state law In CA, Inc. v. AFSCME, proposal was submitted to amend bylaws that those mounting proxy contests could be reimbursed for their expenses. SEC refused to issue no action letter because it is an unsettled area of DE law. Court held that the shareholders could mount a proxy contest to amend the bylaws under 109(b) [bylaws can include any provision not inconsistent with the law or charter, relating to the business of the corp]. However, this proposal would cause board toviolate fiduciary duties to other shareholders. o would result in violation of law o not significantly related to company business needs to relate to something that affects 5% of sales o beyond companys power to implement o relates to the conduct of ordinary business operations In Apache Corporation v. Nycers, shareholders submitted proposal for equal protection of homosexuals. Proposal discussed means that company could do this. Apache got No Action letter. Court found that Apache properly excluded the proposal. Some of the means mentioned didnt deal with social policy, but got into ordinary business. Proposal micromanaged. o relates to the elections of directors In American Federation of State, County & Municipal Employees v. American International Group, Inc., P wanted to include shareholder proposal to amend bylaws so that shareholder nominated candidates cnabe included in proxy statement. SEC issued no action letter. Court ruled in favor of P. Procedure by which shareholdernominated candidates may be included on the corporate ballot does not relate to an election under the Rule. There were two SEC interpretations of the Rule. 1976 interpreation seemed to just say a proposal couldnt seek to appoint someone to board. 1990 interpretation seemed to say proposal couldnt relate to anything regarding an election. Court adopted 1976 interpretation because the SEC never explained the 1990. today this would probably come out the other way since SEC released interpretation of 1990 o is moot o relates to specific dividends o violates proxy rules o relates to a personal claim or grievance o counter to a proposal to be submitted to company o duplicates proposal of another shareholder

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substantially the same subject matter as a prior shareholder proposal made at a recent prior meeting Two classes of proposals socially responsible proposals corporation governance proposals usually dont win o free advertising for the shareholders cause o may embarrass the company, even if it doesnt win o may lead to negotiations with the shareholders to see what company can do to keep the shareholder proposal out o

Sarbanes-Oxley o SOX changed the balance between state and federal law stepped into a lot of traditional state areas o created substantial requirements that applied to all publicly traded companies PCAOB Public Company Accounting Oversight Board sets standards for audits and oversight for auditing firms internal controls (404) requires annual assessments CEO certification (and CFOs) required to certify the accuracy of their financial statements and that they had certified the internal financial controls of their company auditor independence companies used to hire their auditors to do a lot of other things for them audit committee committee of board of directors o must be all independent directors o directly responsible for supervising the audit lawyers responsibilities model rules require lawyers report of securities law violations or violations of fiduciary duties, even all the way up to the audit committee

Duty of Care - a director or officer must, in handling the corporations affairs, behave with the level of care that a reasonable person in similar circumstances would use o Model Act 8.30 o Model Act 8.31 - Business Judgment Rule o makes the Duty of Care much less burdensome o assumes the director acted in an informed matter, in good faith, and in the best interest of the company In Gagliardi v. Trifoods International, Inc., P complained that company had deteriorated since his ouster as president because of bad decisions. Court dismissed the action. Corporate director is not responsible for losses as long as there is not self-dealing or improper motive. o courts will not second-guess the wisdom of directors and officers business judgments, and will not impose liability for even stupid business decisions so long as the director or officer 1) had no conflict of interest when he made the decision

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2) gathered a reasonable amount of information before deciding and 3) did not act wholly irrationally o Why the business judgment rule? we want directors and officers to take risks to make money no one would want to be a director if they were held responsible for losses o need to jump over the business judgment rule before can accomplish anything in court if business judgment rule is jumped, burden shifts to the corporation to show entire fairness of deal courts will generally not judge the substantive basis for a decision, unless wholly irrational, but may find a violation of the duty of care if certain procedures are not followed. o board needs to adequately inform themselves about transaction board needs to be careful and diligent follow procedures need to carefully keep good records of everything you do can rely on experts and committees needs to be reasonable based on surrounding circumstances o In Smith v. Van Gorkom, Van Gorkum held a sizable stake in company. The company was looking for ways to take advantage of tax benefits. VG wanted to sell his shares before he retired. VG had CFO did reports finding a sale could be done for $50 a share. VG then proposed to Pritzker, without consulting board, to sell company for $55 a share. VG did not try to get other offers nor did he get a formal study of value. VG went to board to get approval, but did not invite investment bankers. Pritzker wanted an answer in 3 days. Some board members thought price was too low. Board was not shown agreement or any of the valuing documents. Board approved based on VG gave an oral presentation, CFO said price was in low range, lawyer said they might get sued if they did not accept offer. Court held that the board had been grossly negligent in approving deal. They had not adequately informed themselves of transaction. Substantively, they did seem to get good price, there was no self-dealing, and acted in good fiath, and had put company out on free market. But the agreement with Prtizker really prevented them from shopping company. The board approved the deal after a 2 hour meeting, without prior notice. The board needed to press for more information. o directors who show insufficient care may be grossly negligent seems to mean failing to inform yourself/not following proper procedures o after Van Gorkum, people were more hesitant to serve on boards DGCL 102(b)(7) and Model Act 2.02(b)(4) and Model Act 8.51 address this corporation can put into its charter a provision stating directors are not liable for monetary damages for breach of fiduciary duty o but cant eliminate liability for certain things breach of loyalty, acts and omissions not in good faith o most corporations have adopted out now, a standard part of charter boards can also be potentially passively negligent o many courts today hold that, while the boards duty of care may not require it to install a system of espionage to ferret out wrongdoing that duty of care does require that reasonable control systems be put in place to detect wrong o In In re Caremark International, Inc. Derivative Litigation, employees of Caremark were violating federal law by giving kickbacks. Baord was not accused of wrongdoing. Board reached a settlemtn with shareholders who sued. Court approved the settlement, but also

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discuses duty of care. Directors obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists. Failure to do so may render a board liable. Here, there was no evidence that Ds were guilty of a sustained failure of oversight before this case, the rule was that, unless there is cause for suspicion, director dont have a duty to have a reporting system in place o only a sustained or systematic failure of the board to exercise oversight will establish the lack of good faith necessary for liability. either a failure to construct a recording system or failure to follow system mere fact the corporation committed a criminal violation does not establish failure of oversight o in Caremark, duty of good faith was a duty of care claim, but after Stone, it becomes a duty of loyalty claim if board gets an informed shareholder vote in favor of a transaction, duty of care claims are automatically extinguished Executive Compensation o people tried to think up ways to control executive compensation. Smart executives try to get around them. o IRS imposed regulation want to get tax deduction, if less that $1 million dollars can get it, but anything more than that is not performance based corps. tried to get around by giving stock options SEC required to publishing the salaries of the top 4 executive of company theory of SEC and IRS actions were supposed to reign in salaries but just led to excs getting a lot of shares that were not subject to the regulations o and other ways to get around the regulations o In In re The Walt Disney Company Derivative Litigation, board approved an employment K for president. He leaves after 14 months and gets $140 million in severance. Disney shareholders sue board. Court finds that there isnt enough evidence to show that board showed lack of due care. Court will not second guess the boards substantive decisions unless wholly unreasonable. Board had formed a compensation committee to decide what to give, had hired outside experts to judge, had kept a lot of records. Ovitz had made a lot previously, so he was going to make a lot at Disney. Court also does not find for Ps on bad faith claims (which would get them around 102(b)(7). Court states that the definition is intentional dereliction of duty or a conscious decision not to do you job (not making a decision carelessly or without proper info). Good faith is different from due care. Waste o can only succeed if no reasonable business person would have entered into the transaction attacks the substantive decision o if board raises an expenditure which can not be attributed to any rational business purpose, this constitutes waste a senseless expenditure of money o if board is found to commit waste, board will owe money to company o very rarely succeeds o DE corporation law and MBCA permit reasonable charitable contributions what is reasonable is governed by the business judgment rule

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o In Kahn v. Sullivan, corp. was being used to fund museum for founders art collection.
Shareholders sue claiming breach of duty of care and waste. Court finds duty of care claim is defeated by the formation of a special committee that had been formed to study the project. Waste claim is also dismissed. Ds had claimed that the building of the museum would result in good press and good will. Court decides not to get involved in companys business decisions, especially since there seems to be alegitimate reason. Duty of Good Faith (Loyalty) - in Caremark, duty of good faith was a duty of care claim, but after Stone, it becomes a duty of loyalty claim o can get around 102(b)(7) clauses - In Stone v. Ritter, banks paid millions in fines to resolve government investigations. Ps claimed lack of oversight. D had knowledge of their duties and failed to act. Court finds that duty of good faith is not an indepednet claim, but is rather part of the duty of loyalty. When a director disregards their duties, they violate their duty of loyalty. Court found that D had not vilated duty of good faith/loyalty. There were considerable controls - need to claim director knew or should have known their responsibilities. Some sort of intentionality that led them to violate the duty of loyalty to the corporation - Director knew what his duties were and chose not to fulfill them Duty of Loyalty - Shareholder Primacy Norm corporations are intended to benefit the shareholders o In Dodge v. Ford Motor Co., Ford decided to stop paying dividends because he was afraid minority shareholders were using them to build a competitor. Ford claimed he wanted ot pay workers more and spread wealth around. Court ordered Ford to pay dividends. Buiness is organized to benefit shareholders not to benefit mankind. - traditionally, self-interested transactions were voidable o even if a fair deal at the time, later on if the deal doesnt work out, the corporation can cancel it without reason o but people began to see advantage of allowing these transactions - modern duty of loyalty (Model Act 8.60) o 1) Who is on both sides of the transaction? can be any director, no matter what his power director is on both sides even if he just has an interest in a company o 2) Once you have identified a director or officer who is on both sides, this erases the business judgment rule presumption o 3) Board will attempt to cleanse the transaction to try to avoid the problem raised from the duty of loyalty o 4) What standard is used to judge if the business judgment rule is erased but the managers cleanse the transaction? - officers/directors are fiduciaries and have to put corporations interest ahead of their own - In a transaction where the two-sider and the corporation are on opposite sides, the transaction may be voided by the court, and the two-sider required to pay damages to the corp, unless the conflict is disclosed in advance o In Hollinger International, Inc. v. Black, D effectively controls corporation through his ownership interest in other corps. After early conflict of interest problems, Black enters into agreement with board to be removed from management but help corp. develop valuemaximizing transaction. Later, Black is approached to buy a newspaper. Instead Black suggests they buy a company that controls International in which he has a larger interest.

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Court found violation of duty of loyalty. Black took away opportunity from the board, lied to directors, used confidential information, and failed to devote his time to selling International. Controlling shareholder o what you want to figure out in any duty of loyalty case is whether there is a controlling shareholder actual test to apply varies depending on whether there is a controlling shareholder involved In Williamson v. Cox Communications, Inc., AT&T, Comcast, and Cox owned major parts of At Home. AT&T decides it wants control. Other corps. transferr control to AT&T. Later, corp. went bankrupt. Shareholders claimed earlier deal benefited the other corps. but not At Home. Claimed Comcast and Cox breached duty of loyalty. Court denied Comcast and Cox motion to dismiss. 4 of 5 board members were required to approve decisions so Comcast/Cox had veto power and were only significant customers. o A shareholder does not owe a fiduciary duty to the companys other shareholders unless she is a controlling shareholder owns more than 50% or exercises control over the business and affairs of the corp o when a shareholder stands on both sides of a transaction and is found to be controlling, transaction will be viewed under entire fairness standard courts will ask whether transaction was fair allows courts to get a lot deeper than they normally would business judgment rule usually gets in the way Steps to determine whether an interested transaction is acceptable. o DGCL 144, Model Act 8.61 o Three ways to determine if a transaction is voidable under DGCL 144(a) 1) Director Vote (Model Act 8.62) 1) material facts have to be disclosed 2) approval by majority of disinterested directors 2) Shareholder Vote (Model Act 8.63) 1) material facts have to be disclosed 2) approval by majority of disinterested shareholders 3) or transaction is fair to the corporation at the time it is ratified by board or shareholder but corp. doesnt want to get into court and have to prove this o dont want court determining o and corp. has to prove entire fairness if there is no vote o After getting through 144(a), however, the inquiry is not over if there was no controlling shareholder and an proper board or shareholder vote, business judgment rule is resurrected if challenging party can get around BJR (waste), they have a claim Corp. only has to show entire fairness if there is no cleansing In Benihana of Tokyo, Inc. v. Benihana, Benihana sought to raise money by issuing preferred stock with voting rights. P claims one director was on both sides because he was director of Benihana and a company that wanted to buy. Court held that there was no duty of loyalty because transaction had been properly cleansed. Majority of informed,

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disinterested directors had approved. Further, boards approval was valid exercise of business judgment. if there is a controlling shareholder, entire fairness always comes in in order to protect minority shareholders and directors who may feel threatened by controlling shareholder if there are proper cleansing actions (disinterested shareholder or director vote), the burden is on P to show entire fairness if there are not proper cleansing actions (disinterested shareholder or director vote), the burden is on the corporation to show entire fairness In re Wheelabrator Technologies Inc. Shareholders Litigation, Wheelabrator and Waste seek to merge to avoid conflict problems. Waste owned a large stake. Disinterested shareholders and directors approve. Some shareholders claim that Ds failed to disclose all material facts in proxy statement. Court decides they were fully informed and thus there is no duty of care violation. However, since there was a controlling shareholder, standard for duty of loyalty is different. Even though there was cleansing, still need to show entire fairness. The burden is on P to show no entire fairness, however, since there was cleansing.

Summary of Kinds of Claims - business judgment rule is the first thing you need to get over in all these claims o Presumption that directors have acted (1) informed manner (2) with rational business purpose (3) in good faith (4) without personal interest - Bad Decision (Gagliardi) o business judgment rule insulates o mere claim that a decision didnt work out or was foolish will never get you a day in court - Waste o to make a waste claim in court that no rational businessperson would have made the decision o probably falls under due care o need to provide bases to get over business judgment rule if make the claim with duty of loyalty, may get your day in court - Bad Decision (Van Gorkom) o need to argue no informed reasonable deliberation in making the decision in most cases, this claim will be defeated by an exculpatory clause (102(b)(7)) since all you are usually arguing is a duty of care violation. o will never get or win trial duty of care claim basically a dead path - Oversight Failure (Caremark, etc.) o utter failure to implement a system to monitor or sustained failure to monitor that system categorized as a loyalty claim after Stone can jump over the business judgment rule with this o to make a claim like this, you have to attack the directors good faith

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need to claim director knew or should have known their responsibilities. Some sort of intentionality that led them to violate the duty of loyalty to the corporation Bad Faith/Malice o also duty of Loyalty/Good Faith/Bard Faith Argument gets day in court because it gets over the idea that the decision was made in good faith loyalty claim [Disloyal/Self-Interested] o Elements of Duty of Loyalty claim in an initial duty of loyalty claim, all you need to show that someone was on both sides of the transaction this will get you over the business judgment rule and into court company will then claim that steps were taken to protect shareholders o Violation of good faith is a violation of the duty of loyalty there are two extreme bad faith/malice and carelessness Dont end claims saying there is a violation of a duty. o Still need to show damages.

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A corporation shall indemnify a director who was wholly successful, on the merits or otherwise, in the defense of any proceeding to which he was a party because he was a director of the corporation against reasonable expenses incurred by him in connection with the proceeding. (Model Act 8.52) A corporation may purchase and maintain insurance on behalf of an individual who is a director or officer of the corporation (Model Act 8.57)

Corporate Opportunities - involves the Duty of Loyalty - courts will jump very hard if they see a violation of the duty of loyalty o will often tug corporate opportunity doctrine to reach an equitable result

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involves when an actor takes some business opportunity or property that is found to belong to the corporation want to strike a policy balance o dont want every opportunity to be a corporate opportunity so directors have to offer everything waste of time, cumbersome, could discourage people from servng on boards, corp. may try to steal a really good opportunity, could harm competition DGCL 122(17) either in charter or board resolution, company can renounce opportunity to participate in specified business opportunities or specified classes of business opportunities o but also dont want directors to pocket every opportunity Two questions to address o 1) Was it a corporate opportunity? look to tests in Guth when corporate officer/director may not take business opportunity 1) corporation is financially able 2) opportunity was within corps line of business 3) corporation has an interest or expectancy in the opportunity 4) will fiduciary be placed in a position inimicable to his duties to the corp. If all these prongs are met, director cannot take corporate opportunity without approval when corporate officer/director may take a business opportunity 1) opportunity is presented to the director/officer in individual, not corporate capacity 2) opportunity is not essential to the corp. 3) corp holds no interest or expectancy in the minority 4) director has not wrongfully employed the resources of the corp. in pursuing or exploiting the opportunity o agents cant use their capacity in company to get opportunities o 2) Did the corporation properly reject the corporate opportunity? if there is a possibility that something is a corporate opportunity, should present it to the board rarely clear if something is a corporate opportunity or not o In Broz v. Cellular Information Systems, Inc., D was on the board of P. D was also president of another communications company. D purchases a cell phone license. PriCellular had been trying to buy P and also wanted the license. After PriCellular bought P, it sued D. Court held D had not taken a corporate opportunity, under the Guth test. D hadnt obtained the opportunity through his position on the board and company was not in good financial shape. So it wasnt a corporate opportunity. Beyond this, D had notified several board members who showed no interest.

Litigation to Enforce Duties - Derivative Suits o a shareholders derivative suit is a suit in which the shareholder sues on behalf of the corporation, on the theory that the corporation has been injured by the wrongdoing of a third person, typically an insider really involves two suits

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shareholder sues the company to force them to sue company sues a third party o pretty much all previous cases described were derivative suits o when you win a derivative suit, the award goes to the company not the person who brought the suit o to file a derivative suit (demand standing) [under DE law] 1) need to be making the claim on behalf of the corporation two lawsuits idea 2) need to be shareholder when injury was done and need to be a shareholder now 3) demand requirement Model Act 7.42 plaintiff must make a written demand on the board before commencing a derivative suit when demand is excused o need to have well pleaded facts o 1) majority of directors were not disinterested directors were directly involved with harm o 2) majority directors not independent directors are beholden to individuals who caused harm mere friendship will not destroy presumption of independence o 3) assert whatever decision you are challenging is not a product of valid business judgment need to plead specific facts that board breached duty of loyalty or care. and need to do it before discovery. but shareholder can do limited discovery and demand to see books and records beforehand o really you want to get demand excused or else the decision to sue will be made by the board o In Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, shareholder claims Stewart committed insider trading and mismanaged media coverage, which violated her duties to the company. P claims exemption from demand requirement because directors werent disinterested/independent. Court held directors were independent/disinterested. 6 board members. Stewart and president of company were obviously interested so only need one more director. However, the other directors only really had personal relationships with Stewart. Also, things they may have done to help Stewart were really to help the business. While directors do get paid a lot of money, this is not enough to show lack of independence. Most directors want to keep their independence for reputations sake and sake of other business. 4) court will supervise any settlement because of court skepticism about derivative suits (see above) Distinguishing Derivative Suits from Direct Suits o most cases brought against insiders for breach of fiduciary duties are derivative o P will usually prefer to proceed as a direct suit

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because the procedural requirements are much simpler does not have to make demand on board can probably keep a lot more of the award o Test for determining difference between derivative and direct 1) Who suffered? if shareholder suffered directly, it is a direct suit if corp. suffered the harm, it is derivative 2) Who will receive the benefit? o In Tooley v. Donaldson, Lufkin, & Jenrette, Inc., corp. was about to close on a merger, but both sides agreed to a 22-day extension before final agreement. Ps sued for the loss in value of their investment during those 22 days. Court finds this was a derivative claim. Thus, Ps dont have standing because they tendered their shares for cash. Court finds that Ps did not have a right to the money until the end of the 22 days period, when deal would close. Special Litigation Committee o traditionally, if P could show demand excused, board would have no standing to consider Ps decision to sue and suit could proceed o in 1970s, Special Litigation Committees developed can be appointed by corp. after demand has been excused corp appoints two or more independent directors may add new directors to board to put them on committee SLC carefully reviews the claim then goes back to the court and can say they studied it and we are not going to file the lawsuit o important difference between SLC and other corporate decisions 1) corporation has to show that committee is independent burden is on corporation 2) acted in good faith 3) and made a reasonable investigation often demonstrated by hiring a law firm to do thorough investigation 4) even if court finds corp. meets the above, court still has to use its independent business judgment to decide if lawsuit should be terminated usually, court will defer to SLC o derivative actions have sharply declined since SLCs became common Reigning in Derivative Suits o courts are hesitant to allow could allow shareholder to control corp. o perverse incentives in derivative suits shareholders dont have much financial incentive to bring derivative suit but it is economically rational for shareholders attorney to pursue o to stop suits from running rampant, courts and states created demand requirement if you want to get into court, need to make claim that demand is excused how do you show board is not qualified to make a decision whether to pursue a lawsuit

Friendly Takeovers - Poison pills/rights plan o way for management to resist a takeover offer

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either for selfish reasons, because the deal is not good, or because they want to negotiate a better deal o Issues every shareholder a very small right if someone approaches the corporation and purchases a certain percentage of stock, all holders of the rights are entitled to more common stock cheaply, except for the someone who is trying to takeover company will issue additional shares until someone buys that percentage, the board can buyback the right for $.01 per right. if board likes the offer (friendly takeover), they can simply buy back the rights Model Act 11.02 Model Act 11.04 Most mergers today are friendly Shareholder Protections in Corporate Mergers o appraisal rights give a dissatisfied shareholder in certain circumstances a way to be cashed out of the investment at a price determined by a court to be fair o Courts will sometimes review the substantive fairness of a proposed acquisition or merger. much more likely when there is a strong self-dealing aspect o if a transaction has no hint of self-dealing, courts may still review the substantive fairness However, there are two important requirements that the P must meet in order to have the transaction set aside 1) P must bear the burden of proof on the issue of fairness 2) P must show that the rpice is so grossly inadequate as to amount to constructive fraud courts rarely strike these down o if a transaction involves self-dealing, the court will give much stricter scrutiny. no liability automatically attaches for entering into a conflict of interest transaction as long as proper procedures are followed to cleanse and protect shareholders proponents must demonstrate entire fairness two aspects to entire fairness o 1) fair dealing procedural o 2) fair price substantive if D gets a fair price, its unlikely that anyone will complain about unfair dealing several methods to determine Weinberger abandons older line of cases to determine fair price and uses a more flexible method o proof of value by any techniques used o so P can hire any expert to find a price using techniques used to determine price appraisal rights

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in many instances, shareholder have right to refuse to tender their shares have to vote against and refuse to tender shares then can go to court and try to get an appraisal remedy but these often take years o inquiry is totality of circumstances. Need to look at both factors together o In Weinberger v. UOP, Inc., Signal had excess capital to invest. Sought to merge with UOP. Signal already owned some of UOP. Directors who served on both board tried to find a good price. Signal directors, using confidential UOP information, found that up to $24 would be a good price. When the offer is made, it is only $20-21. UOP doesnt really negotiate a better price. Court finds that the deal does not pass entire fairness test. Fair dealing procedural was lacking because no indepdent committee was ever formed, two corps. didnt make efforts to separate themselves in transaction, Signal used UOP info to prepare report. Price may have been fair, but court abandons old test and finds that P can prove fair value by any means. burden is on D to show entire fairness. If D can show proper procedures were taken to cleanse, burden shifts to P o A controlling or dominating shareholder standing on both sides of a transaction bears the burden of proving its entire fairness. o In Kahn v. Lynch Communication Systems, Inc., Alcatel is controlled by CGE. Alcatel owns Lynch stock. Lynch had supermajority requirement for any business combination (gave Alcatel a veto). Lynch wanted to merge with Telco, but CGE did not want them to. CGE wants them to merge with Celwave. Lynch formed independent committee and rejected Celwave plan. Alcatel then decides to buy Lynch. Eventual price is $15.50 and Alcatel threatens hostile takeover to independent committee if bid is rejected. Court finds that deal needs special scrutiny because Alcatel is controlling shareholder. Indepdentn committee was not really independent because of bid. Burden of entire fairness is on Alcatel because they are on both sides of transaction. Independent committee in this case was not independent so it could not to proper cleanse. o

Steps to Answer a Corporations Question - 1) grasp larger principles - 2) then connect the specific rules to them understand why a particular rule exists o what is the policy? Why does something exist the way it does?

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