BA Flashcards
When faced with an agency liability fact pattern:
- Is there an agency relationship? (analysis based on control)
- If YES -> P may be liable -> step 2
- If NO -> P not liable - Is this liability in K (step 3) or in torts (step 4)?
- If K: Was agent acting with authority?
- If YES -> Bound in K
- If NO -> P not liable - If torts: Employee or IC? (analysis based on control)
If employee and
* acting within the scope of employment -> P is liable
* NOT acting within scope of employment -> P not liable
If IC and
- occurs in area over which P exercises control -> P may be liable
- occurs in area over which P has no control -> P not liable unless exception applies
Agency Law serves 2 primary functions
i. Aligns interest of P & A (by setting default rules correcting incentives when parties fail to
do so by K)
ii. Creates legal relationships between P and 3Ps with whom P’s A interacts (with rules
governing relationships between parties w/o chance to make K to control dealings)
Agency Relationship
An agency relationship arises when a principal manifests assent for the agent will act on the principal’s behalf subject to the principal’s control (Restatement 1.01).
a. Manifestation does not require written agreement or understanding of agency law; mere
acts/circumstantial evidence ok
Buyer-supplier relationship?
NOT agency relationship; need to show
i. Fixed price for property irrespective of price paid by supplier
ii. Acts in own name and receives the title to the property which he is to transfer
iii. Independent business in buying and selling similar property
Agency Liability in K
A principal may become bound in K with a third party through the actions of the agent by actual
authority, apparent authority, estoppel, undisclosed principal, and ratification.
Actual Authority
Actual authority is based on A’s perceptions of P’s express or implied authorization (A reasonably interprets P’s wishes)
Apparent Authority
Apparent authority is based on 3P’s reasonable belief traceable to P’s manifestations
(i.e., there is some level of culpability on the part of P) (Restatement 2.03).
1. K is enforceable by P against 3P under apparent authority
2. E.g., P imbued A with a LOT of authority by allowing A to ___, thus creating the
impression that A was a “supercharged” A.
Undisclosed Principal
P is liable for rogue A’s actions if P has notice and doesn’t try tonotify 3P that A is acting outside scope of A’s authority OR P is undisclosed P and A acts within normal scope of authority for someone in A’s position
- P can’t rely on secret limiting instructions as defense
- Watteau - Humble transferred beerhouse to Ds but stayed as manager & Humble’s name painted on door. Agreement: Humble could buy onlyales/water -> Ds still liable for additional goods Humble bought bc within industry standard
- Doesn’t matter if 3P believes A is acting on own behalf and not P’s behalf if
above elements met
Ratification
A purports to act for P, needs P’s intent to ratify and knowledge of full material terms between 3P and A (Restatement 4).
- Accomplished by express or implied affirmation by P (implied: accepting benefits when possible to refuse, silence/inaction, suing to enforce K)
Estoppel
3P reasonably believes A has authority, P intentionally/negligently through
conduct (affirmatively or failure to act) permits belief, and 3P materially and negatively
changes position in reliance on belief (Restatement 2.05).
1. Estoppel is one-way binding on P only (i.e., K enforceable by 3P but not P)
Is the Agent liable?
key issue is disclosure
i. Partially or undisclosed P: A is liable on K if A failed to disclose agency relationship to 3P
1. A has duty to disclose. If A wants to protect self, must actively negotiate that protection into K.
a. However, the best approach to limiting one’s legal liability isn’t always the optimal strategy from a business standpoint
ii. Disclosed P: A only liable on K if (1) parties so intend or (2) A acted without authority
and without P’s ratification
Liability in Tort
(aka vicarious liability)
a. A is always responsible for own torts. Question is whether P is also liable for A’s torts.
b. Under respondeat superior, an employer is liable for torts committed by its employees within the scope of employment. An employer is a principal who has control over the manner and means of an agent’s work.
Courts place special emphasis on whether such control is exercised in the specific part of the business where the tort occurred (Miller).
Step 1 employer-employee relationship test: Does P control or right to control the manner and means of A’s work?
1. Manner and means test is broadly conceived in most cases we read. Harder test is Miller v. McD where P controlled manner and means of precise part of
biz where tort occurred
2. Formal legal right or practical control both count against P
Step 2 - scope of employment test: does the act serves any purpose of the employer?
Restatement specific factors for determining employer states
Extent of control over details of
work
Whether employer supplies
instrumentalities, tools, & place of
work
Kind of work – is it usually done
under direction of employer or
by specialist w/o supervision?
Skill req’d in particular
occupation (low =’ee; high =IC)
Whether one employed engaged in
distinct business
Method of payment, whether by
time/job
Whether work performed is part
of employer’s core biz
Whether parties believe creating
relation of master & servant
Whether P is/not in business
Independent Contractor and Tort
When a fact pattern involves IC, if the tort occurs in an area over which the principal
exercises some control, the principal might still be liable.
1. However, if tort occurs in an area P does not exercise control, then P not liable
except when it involves inherently dangerous activities, non-delegable duties,
and negligent hiring.
Apparent Agency
P can be liable if the agency relationship is held out
as causing the third party to justifiably rely on a purported A’s care and skill.
i. P must have a reputation that induced 3P reliance on purported A
ii. Cf. Apparent authority: Q is re: a particular act is held out as traceable to P; K
iii. Miller v. McDs – By demanding so much uniformity, company may create impression
that business belongs to them & not some franchisee’s
1. D had right to control 3K (franchisee) in precise part of business allegedly
resulting in P’s injuries. Actual agency issue bc McD had the right to exercise
control over 3K’s daily operations. Apparent agency issue bc McD’s reqs were
imposed to maintain an image of uniformity (same ads, common signs &
uniforms, menus, appearance & standards). The level of Miller’s reliance on
McD’s reputation was also not unreasonable as a matter of law.
Partnerships Basics
A pshp is an association of two or more people to carry on as co-owners of a business for profit.
a. Governed by statute and common law: UPA (1914) & UPA (1997) aka RUPA
b. Each partner is deemed to be agent (RUPA 301) and fiduciary of other partners (RUPA 404)
c. RUPA provisions are just defaults that the partners can, and often do, adjust
d. Pshp cannot be another entity under state law (such as an LLC)
Partnership - Formations
is the intent of the parties to carry on as co-owners a definite business?
a. A pshp is an association of two or more people to carry on as co-owners of a business for profit.
- Courts focus on shared profits (RUPA 202) and shared management (Fenwick) as key indications of partnership.
- Under the first prong, factor supporting the sharing
of financial risk/reward include profit sharing, capital, and risk of loss.
b. Pshp test: focused on sharing of
i. Financial risk/reward: Partners generally each contribute capital and share the profits
and risk of financial loss
1. Existence of pshp: strong «_space;sharing profits & losses < sharing profits < sharing “gross returns” aka revenues «_space;weak
2. The lack of profit-sharing is virtually always dispositive that pshp doesn’t exist
3. Neither joint venture or profit sharing alone, sharing gross returns alone, nor
giving capital to an enterprise alone sufficient to create pshp
4. Sharing profits in a biz is prima facie evidence that a pshp exists, except where those profits are received as debt service, wages/payment of services of IC, rent
or annuity.
ii. Control/authority: Partners jointly share the management, but equal votes or control is
not necessary; other individuals can be hired
Pshp or Employer-Employee Relationship?
Pshp or Employer-Employee Relationship? Hierarchical or collaborative?
i. Separate or overlapping spheres of management (decision-making authority?) vs.
shared control
ii. Treatment of returns of biz and who bears the risk of financial loss
Partnership by Estoppel
Representation of pshp by D -> liable to P who reasonably and in good faith relies on such representation to P’s detriment
Partnership Attributes
a. Liabilities: Each partner is joint and severally liable for the debts of the pshp (i.e., each partner is
personally liable for ALL debt)
b. Control: Each partner has ability to participate in control and management of the pshp
c. Returns: Profits shared equally among partners regardless of how much money was contributed
by each partner
d. Tax treatment: Profits/losses of pshp are passed through to partners
e. Fiduciary duties: Partners owe fiduciary duties to each other and to the pshp
f. Partnership Property
i. Upon dissolution, pshp prop must be used to pay liabilities of pshp in following priority:
1. Debts to 3P credits of pshp
2. Debts to partners for contributions other than for capital and profits
3. Debts owed to partners in respect of capital contributions
4. Debts owed to partners in respect of profits
Fiduciary duties: Partners
i. Default rules: pshp agreement may NOT
1. Unreasonably restrict a partner’s access to books and records of pshp
2. Eliminate general duty of loyalty (subject to some state exceptions)
a. Actions of partners always subject to obligation of good faith and fair
dealing
3. Unreasonably reduce duty of care
4. Vary power of a partner to dissociate
5. Vary the right of a court to expel a partner under specific circumstances
6. Restrict the rights of 3Ps under RUPA
Partnership - Fiduciary Obligations
a. Joint venture: like pshp, but typically limited in scope and duration
b. RUPA §404(b): Duty of loyalty encompasses the obligation of each partner to account to the pshp for property, profits, or benefits from the conduct (or winding up) of the pshp business or the use of pshp property, including the appropriation of a pshp opportunity
i. Meinhard v. Salmon – duty to disclose to other partners of business opps. Salmon violated fiduciary duty by failing to discloseextension of lease.
ii. Pshp fiduciary obligations: Partners owe each other a higher duty than the marketplace; partners also have as a part of their duty of loyalty not to take opportunities that belong to the pshp for their personal benefit.
c. Pshp opportunities: What is the nature of the opportunity presented to pshp?
i. If opp falls outside scope of pshp business à disclosure might be enough
ii. If opp falls within the scope of pshp business (arises from or relates to pshp business), managing partners must
1. Disclose biz opp to other partners
2. Decide whether to act on behalf of pshp and take the opp
a. Note: A decision by any partner whether to take dvantage of opp must be made in good faith.
Management Rights of Partners
With certain limits, relations among and between partners and pshp governed by pshp
agreement (RUPA 103). However, the partnership agreement may depart from default rules
(Sidley).
all partners have equal rights in management and conduct of pshp business
i. Matters in ordinary course of business -> decided by majority
1. If deadlock -> maintain status quo!
ii. Matters outside ordinary course of business -> requires unanimous consent
Partnerships and Authority
each partner has actual and apparent authority to bind pshp
i. Statutory actual authority: Unilateral authority for each partner UNLESS
1. Particular, unusual, or big decisions should not be made unilaterally
2. Known disagreement and RUPA §401(j) can’t solve
ii. Statutory apparent authority: Unilateral authority to bind the pshp UNLESS
1. The decision is outside “ordinary course” of business of pshp
2. 3P on notice
iii. Rogue partner liability: If partner breaks or exceeds their actual authority but has
apparent authority, rogue partner is liable and pshp is liable to 3P if 3P reasonably
believes that rogue partner was acting with actual authority
Economic Rights of Partners
a. RUPA §401(b): Partners share equally in profits and losses
b. RUPA §401(a): “pshp” or “capital” account (CA = equity interest that each partner would receive
from the pshp if the pshp were to liquidate and creditors, etc. take their cut)
i. Starts out equal to property or cash contributed
ii. Is increased by profits allocated to partner
iii. Is decreased by losses allocated to partner
iv. Is decreased by distributions to the partner
c. RUPA default is that profits/losses are allocated equally among partners despite their
contributions (both capital and otherwise)
i. These defaults do not ordinarily remain in place, esp in a law firm
ii. “Eat what you kill” = your receipts – overhead allocation = your profit allocation
1. Alternative: have committee that considers each lawyer’s ongoing contributions
to the firm and set profit allocation %s (i.e., special allocations in pshp
agreement) based on that subjective determination
Corporations Key Attributes
a. Legal personhood: fictitious person, can sue/be sued, own property, enter Ks, file tax returns
b. Limited liability for investors: SHs’ risk only covers the amount of money they invest in corp, no
more; chief purpose is to encourage investment in equity securities, making capital more
available for risky ventures
i. Limited liability is not a secret or a trick. It is the intent behind the design of the
corporate structure. People who know an entity is a corporation are on notice that they
are dealing with a corporation and not with its owners personally.
c. Freely transferable shares: bought and sold on the market; allows the company to operate
without interruptions due to changes in ownership
d. Centralized management: BOD hire managers, source of agency problem; main goal is to
maximize shareholder interest
e. Appointment by Equity Investors: SHs (principals) vote the Board (agents); the board (quasiprincipals)
hires officers (agents) to run the company
PCV
In order to pierce the corporate veil, the creditor must first show that the separate
existence between the shareholder(s) and the corporation has not been respected—that is, the
owner(s) were operating corporate entity in “individual capacity.” Two types of transgressions
must be established: (1) unity of interest/control (e.g., lack of formalities, commingling,
undercapitalization) and (2) an injustice if limited liability is respected.
i. There must be such unity of interest and ownership that separate personalities of corp
and individual no longer exist. à this prong often occurs by mistake/sloppiness
1. Not following formalities (e.g., no annual meetings, no Board)
a. Note: Lack of formalities, while usually an important factor in corporate
PCV, is less important for an LLC as meetings (etc.) are not required for
LLCs in general.
2. Failure to maintain separate accounts (commingling)
3. Undercapitalization (corp doesn’t have sufficient funds to cover its liabilities)
ii. Second, there must be some injustice (culpability)
1. Fraud-ish conduct or
2. Unjust enrichment
iii. Note: respecting corp formalities (holding board meetings, keeping corporate/personal
assets separate & adequate records) = very reliable way to avoid PCV
Enterprise Liability
Joins “sister” corps – entities with same shareholder/member owner
ii. Co-mingling corporate $, employees, and operations
iii. Avoidable through recordkeeping
1. Not uncommon for corps under common ownership to share resources, but
usually some documentation of that action and often some compensatory
transfer of funds à can tell where one corp ends and another begins
If X is the parent of Y and creditor
wants to recover money owed by Y, use PCV not enterprise
liability. To argue enterprise liability, need to explain why
you thought X and Y were sister entities.
Corps - Charitable Donations
In general, corporate giving is protected by the BJR unless the gift involves
(1) a conflict of interest (e.g., no pet charities),
(2) no nexus whatsoever to shareholder profit, or
(3) a donation amount or scope of action that is way too big for the stated business purpose.
i. Three grounds for rejecting corp donations
1. Conflict of interest issue: no pet charities
2. Not trying to even justify action/cannot reasonably be beneficial (anon
donation doesn’t help goodwill)
3. Amount of donation or scope of action way too big for biz purpose described
ii. Approaches to charitable donations: DE (courts respect board’s BJ – power to make
donations but may be abused if not acting in corporate interest), CA (regardless of
“specific corporate benefit”),
Corporate Purpose Doctrine
Corporations should be operated for the financial benefit of SHs,
but with courts giving wide discretion to the board in deciding what is in the SHs’ interests
i. Dodge v. Ford – businesses can have humanitarian efforts but not to detriment of
business itself (b/c primary purpose to make money)
1. Ford explicitly stated goal to share benefits of cars with public by decreasing
price and increasing production (“I do not believe we should make such an
awful profit on our cars”)
2. How to avoid Ford’s problem: say action is, in Board’s judgment, in long-term
interest of corp & SHs
BJR
Courts will not step in and interfere with honest business
judgment of directors absent a showing of fraud, illegality, or conflict of interest.
i. Schlensky v. Wrigley – Cubs only MLB team without lights for night games (tended to
draw more spectators, particularly on weekends) & Cubs were losing money
1. Cubs’ rationale for playing baseball games only during the day: (1) better for
surrounding neighborhood and (2) creates a distinct ambiance that sets the
team apart from other baseball experiences. Court concluded long run interest
of corp in prop value at Wrigley Field might demand all efforts to keep
neighborhood from deteriorating
BoD Fiduciary fact pattern process
ID the type of alleged fid breach and then apply the correct standard of review
BoD Duties
A. Under DE law, board is an agent for owners of corp (SHs). Directors and officers are obligated to act in
the corporation’s best interest, principally for the benefit of shareholders.
B. Primary duties of Board of Directors
a. Duty of care: gross negligence, oversight failure -> exculpable (corp can eliminate personal
liability of directors)
b. Duty of loyalty: self-dealing, corporate opportunities, good faith -> non-exculpable
Fiducuary Duties - Review Standards
a. BJR (deferential)
b. Intermediate scrutiny (applies to certain M&A transactions)
c. Fairness (rigorous)
i. Courts apply the fairness standard where directors face a direct conflict of interest (and where the transaction wasn’t ratified by a majority of independent directors or SHs). The burden is then on the board to show the court that the transaction was entirely fair to the corp. This is the toughest standard for a board to meet as the court goes beyond the threshold questions asked in Unocal and applies its independent business judgment to evaluate the substantive fairness of the transaction. It is a higher standard bc the COI is seen as potential more severe than that posed in the entrenchment context.
Duty of Care
a. DOC is req that bd makes decisions with reasonable diligence and prudence. A bd must assure
they have the right information to act and devote sufficient time to review the information; this duty cannot be delegated.
b. Hasty decision -> BJR unless D shows gross negligence in becoming informed; presumption of BJR rebutted and fairness review applied
c. BJR is presumption that in making business decision, Ds acted on informed basis and in GF and honest belief that action taken is in best interest in company and SHs.
i. Protects Ds from liability for honest and careful decisions regardless of outcome (Amex)
ii. “Informed basis” = Ds was engaged, informed themselves of all material info reasonably available to them before making biz decision, and had ample time to deliberate (VGK)
1. If bd grossly negligent à BJR lost à fairness standard of review applies
2. If bad faith à BJR lost à fairness rev applies
3. If action not in best interest of co/SHs (disloyalty) à BJR lost à fairness rev
iii. Rationale: The role of court should be to judge whether the board has acted reasonably in coming to a decision to check rather than override board actions.
1. BJR thus gives directors wide latitude in taking steps to benefit corp. Bc many
strategic decisions are judgment calls, the law enables directors to use their
best judgment w/o fear that a court will attempt to second guess their decision.
BJR Case
Van Gorkom v. Transunion – VG (Transunion CEO) looking for home for his company after his retirement. Goes to P (takeover specialist) with $55/sh offer. Ct says Ds didn’t reach informed decision bc Ds:
(1) didn’t adequately inform themselves of VG’s role in forcing sale of co & establishing $$/share;
(2) were uninformed as to intrinsic value of co; &
(3) grossly negligent in approving sale of co upon 3 hrs’ consideration without prior notice
i. Concrete problems: short meeting on little notice, no chance to review proposed
merger agreement before/during meeting, no analysis/Qs re: price, inadequate market
check (no solicitation of bids nor proprietary info to other bidders)
ii. Bd’s counter: Not committing to $55/sh; only starting process of selling at $55/sh;
assumed merger agreement included good market check & Bd could go with higher bids
iii. Held: Directors violated DOC -> directors are personally liable for damages and
corporation can be enjoined
DE Aftermath
allows Delaware corporations include in their Articles a provision to eliminate the duty of care for directors. Breaches of duty of care are exculpable under §102(b)(7), but
breaches of duty of loyalty and duty of good faith (whether treated as part of
duty of loyalty or not) are not.
Duty of Loyalty
a. DOL necessitates that the board act in the best interest of SHs rather than personal interests. Directors can’t have an undisclosed interest in the transaction that is diff from SHs.
b. Self-dealing
c. Corporation opportunity
d. Cleansing (Ratification)
e. Bad Faith
f. Failure of Oversight
g. Certain M&A Transactions
h. Takeover defenses
i. Sale of control
Self Dealing
Self-Dealing -> fairness unless ratified by disinterested directors or SHs; BJR once ratified
i. Fairness review has 2 components: procedural analysis (was process involved in
undertaking transaction fair?) and substantive fairness analysis (was outcome fair?)
1. Bd can be saved from liability under fairness review if bd somehow stumbles
into a good result despite procedural problems
ii. Bayer v. Beran – CEO who serves on BOD hires his wife, a single, for a radio program intended to advertise the co’s products. Court held procedurally (use of form contract, negotiated thru agent, consult w/ ad experts) and substantively (success of program, cost vs. industry standard/historical practice/co. revenue, singer’s comp vs. other performers) fair transaction à no breach of DOL despite self-dealing transaction
Corporate Opportunity
Broz 4-part test; if CO, must offer to corp & defer if corp pursues
i. Broz v. CIS 4-part test for whether something qualifies as corp opp:
1. Financial capability to take opportunity? [no, CIS in precarious financial
position]
2. Opp in same line of business as corp in question? Does opp fall within corp’s
current or anticipated future biz? [yes]
3. Did corp have an interest or expectancy in opp? Court wants to see some
concrete interest, some indicia of corp taking steps/plans to attain opp in Q. [no,
CIS’s articulated biz plan didn’t involve new acquisitions]
4. By pursuing opp individually, would director be in continuing conflict of interest
vis-à-vis corp? Competition? Insider info?
ii. If no -> corp opp doctrine does not apply and individual may take the opp [Broz not
obligated to refrain from competing; license not offered to CIS bc not viable purchaser]
iii. If yes -> must offer to corp and defer if corp pursues. Ask: was the opp
“misappropriated” per facts? If so, are there any defenses?
iv. Note: no one factor dispositive, but 1 & 2 seem to weigh most heavily per case law
1. If corp opp, formal presentation = safe harbor; if something is corp opp, must
offer to bd first & bd must reject before director can take for self
Cleansing (Ratification)
reinstitutes BJR
MBCA 8.61: Cleansing of self-dealing; 3 ways for directors to avoid liability for COI trans
1. Approval by qualified directors (MBCA 8.62)
2. Approval by qualified SHs (MBCA 8.63)
3. Prove fairness (take chance at court under fairness standard of review)
Cleansing - Director’s Action
- Who’s qualified to vote? Disinterested directors (i.e., those free from taint).
a. Those who have COI cannot attend the meeting where qualified
directors deliberate and vote. Cf. SH cleansing -> no such req - Quorum? Majority of qualified directors
- Required vote? Maj. of votes of qualified directors (but no fewer than 2) at
meeting
Cleansing - Shareholder’s Action
- Who’s qualified to vote? SHs who (1) don’t have COI and (2) are not a related
person of director with COI
a. SHs with COI can attend meeting re: cleansing vote; cf. director cleanse - Quorum? Majority of votes entitled to be cast by holders of all qualified shares
a. Most quorum requirements mandate that 50% plus one of the shares,
NOT of the shareholders, entitled to vote at a meeting, be present. - Required vote? Majority of votes case by holders of all qualified shares but
voting power depends on shares held by each SH
Cleansing of Corporate Opportunity
- Director with COI brings opp to attention of corp and discloses all known
material facts concerning biz op. Transaction ratified when corp’s interest in
opp is disclaimed via director (MBCA 8.62) or SH (MBCA 8.63) action.
v. Hypo: C is an officer and bd member of FTI. C’s husband H wants to license FTI’s
proprietary software. Terms: license for 12 mos. @ $5k/mo. Does H have to cleanse
under (1) MBCA 8.60-8.63 or (2) MBCA 8.70?
1. H is potentially taking a corp opp for himself. While unclear whether corp opp
under Broz test, it seems at least plausible that it is, so safest to have bd official
disclaim opp under MBCA 8.70.
Bad Faith
BJR rebutted, fairness review
i. Stakes: Directors can be indemnified by corp for damages in fiduciary lawsuits BUT not if directors acted in bad faith
ii. Bad faith requires particular culpability (some overlap between oversight failure and bad faith, but not 1:1)
1. Gross negligence without more NOT bad faith (Van Gorkham)
2. Subjective bad faith = actual intent to do harm (not alleged in Disney)
3. Something between (1) & (2): intentional dereliction of duty or conscious
disregard for one’s responsibilities (aka they should know better)
iii. Disney – Ovitz hired & fired 1yr later entitled to $150M payout -> plaintiffs brought suit
(claims below) -> Court held bd did not breach fiduciary duties
Failure of Oversight
MBCA 8.31(a)(2)(iv) states that a director may be liable when facts would alert a
reasonable director to the need for a timely and appropriate inquiry.
a. Ds accorded broad immunity & not insurers of corporate activities but must discharge duties in GF & w/ degree of diligence, care & skill ordinarily exercised under ~ circumstances in like
position but may be liable when D violates duty
i. Upon discovery of illegal course of action, D must: object, resign, or file suit
b. Oversight standard
i. DE: common law principles // Francis - Mother liable for breach of fiduciary duty as she ignored the business while the sons were stealing from it
ii. MBCA 8.31(a)(2)(iv): sustained failure to devote attention (pattern of conduct) & facts that would alert reasonable director
Certain M&A Transactions
intermediate (enhanced) scrutiny
a. Definitions
i. A poison pill thwarts hostile acquisitions by making them prohibitively expensive. To
cancel a poison pill, an acquirer must either find a friendly board or get one elected.
1. A diversified SH may not like the poison pill bc she is as likely to hold target
stock as acquirer stock. On average and over time, for deals that go through,
such a SH is as likely to lose from an extra dollar paid by the acquirer as she is to
gain by it. But such a SH will want as any value-enhancing deals to go thru as
possible; to the degree poison pill kill some such deals or deters some valueenhancing
bids, the diversified SH may not like it.
ii. A hostile tender offer usually targets a company whose shares are priced lower than they should be due to management inefficiencies. It allows for investors to take an underutilized asset and turn it into a more profitable company by trimming the fat from the company. It is essentially the market coming in and regulating poor management of a resource, and it goes to the one who can maximize the profit of the company.
Takeover Defenses
enhanced scrutiny; BJR if Unocal (motive and proportionality) test met; fairness
otherwise
a. Trigger: When board is trying to impede takeover attempt, it bears the burden of making certain
threshold showings before the court will apply the BJR. Specifically, it must there was (1) legitimate motive and (2) that the takeover defense is proportionate to stated motive.
i. Rationale: Takeover defenses occasion higher level of scrutiny than any other bd action bc courts are concerned about entrenchment—worried bd members more interested in keeping their jobs than interested in maximizing SH interest
ii. Defensive measures: poison pill, poison debt, self tender offer, seek out “white knight”
b. Unocal – Pickens, thru entity called Mesa, offers $54/sh for Unocal through tender offer. Bd rejects offer and adopts takeover defense: if Mesa reaches a certain ownership threshold, every SH other than Mesa has right to $72/sh for a certain number of shares (flip side of poison pill)
i. Court held defense appropriate: (1) legit motive bc coercive offer and price inadequacy and (2) proportional bc including Mesa in self-tender offer would help fund takeover, which would ultimately be harmful to SHs
1. Court held Pickens’s offer in Unocal involved a cash offer on the front end, with
plans to cash out the other shares with junk bonds on the back end to be
coercive.
2. In Unocal, the stock was trading at $38 prior to Pickens’s offer of $54, and the
court accepted Unocal’s argument that the offer was grossly inadequate. Here,
the premium is smaller/larger…
Sale of Control
enhanced scrutiny; BJR if Revlon duty met (reasonable efforts to enhance short term
value); fairness otherwise
a. Trigger: In the context of change of control (i.e., cash deal or stock sale resulting in controlling SH), the board must take efforts to achieve the highest value reasonably attainable for SHs.
i. If merger between two publicly traded corps with dispersed ownership, nobody controls combined entity. Control still resides with market à no Revlon duties
ii. Rationale: last great opportunity for SHs to realize the premium that they should get for selling control of the company
b. Revlon – Act I: Revlon ’s bd resisted Pantry Pride offer of $45/sh for co with poison pill & poison debt (exchange share for high interest notes and preferred stock; SHs then own debt
instrument). Poison debt has restrictive covenants that impede acq’s ability to complete hostile takeover
i. Ok under Unocal? Yes. (1) Motive: Price inadequacy; (2) Proportionality: effectively bid up price
c. Revlon – Act II: After PP increased offer to $56/sh, Revlon bd finds another buyer they like better and offered generous deal protection devices that effectively ended competitive bidding
i. Revlon duty: once “break-up” of co inevitable, Ds’ role changes from defenders of corp bastion to auctioneers charged w/ getting best price for SH (at this point, defense
measures/favoritism no longer appropriate)
1. Bd may consider non-SH interests if rationally related benefit to SH exists, but
can’t once auction among active bidders in progress
a. Deal protection devices (i.e., lock-up, no-shop, termination fee) for
noteholders = problem; no rationally related benefit
2. Duty kicked in once Pantry Pride increased its offer to $56 (became apparent to
all that break-up of co inevitable)
Tests for Contests for Control
- Smith v. Van Gorkum
a. Need to satisfy the duty of care - Unocal
a. Did the directors have legitimate motive for believing a danger to corporate policy and effectiveness existed? (look at the process and the threat)
b. Was the director’s defensive response proportionate? (i.e. not preclusive or coercive) - Revlon (if a change in control OR break-up of corporate entity)
a. When a “sale” or “breakup” of the company becomes “inevitable,” “the directors’ role [is] changed from defenders of the corporate bastion to auctioneers charged with getting the best price for SH at a sale of the company.
Controlling SH Duties
a. Controlling SH: SH with >50% voting control or >25% voting control & other influence over bd); possible for group of SHs to be single SH for the purposes of test (e.g., agrmt to act in concert)
b. Disproportionate benefit (transaction involves only controlling SH not all SHs) à fairness review
i. Sinclair – Sinclair maj stock owner of Sinven à declared dividends (ok proportionate
benefit + decision to wind down biz afforded BJR) and orchestrated Sinven’s lack of
enforcement of breach of K by Sinclair (not ok b/c disproportionate benefit to
controlling SH Sinclair)
c. Controlling SHs owe DOL to minority SHs to avoid certain kinds of self-dealing (Sinclair)
d. In the absence of self-dealing (a benefit for the majority that excludes the minority or works to minority’s detriment), the transaction is reviewed under BJR (Sinclair)
e. The court applies fairness review to self-dealing resulting in disproportionate benefit to controlling SH. Fairness review considers both the quality of the decision-making process and fairness of outcome (substance) of transaction.
SH Agreements
a. SH agreements commonly cover SH voting and share transfers
b. SH agreements cannot dictate board votes, unless unanimous
i. Shareholder agreements are generally enforceable, subject to some restrictions.
Shareholders may agree in advance how to vote shares but cannot bind how directors
will then act, as such an agreement may be contrary to their fiduciary duties to the
corporation/shareholders (McQuade).
ii. Exception: ok if all SHs of corp in agreement (Clark)
iii. AC: If SH wants to ensure employment as officer of corp, need two agreements: SH
agreement and standard employment contract between SH and corp
SH Inspections Rights
a. Basic Rights: obtain copy of SH list, other books/records (financial statements, board minutes)
i. SH list typically lists intermediates (brokerages, who hold shares for SHs)
ii. Under DE law, not required to provide NOBO list (beneficial owners of shares)
b. SH may inspect books/records and obtain SH list for proper purpose related to biz of corp.
c. A proper purpose under DGCL §220 must be focused on the economic returns to investors.
Purely social/political issues are not proper purpose (Honeywell).
i. Honeywell – SH buys shares specifically for purpose of voicing opposition to Vietnam
War. Court rejects SH’s attempt to obtain SH list and other records relating to
Honeywell’s manufacture of weapons to run publicity campaign against the war.
De Facto LLC/Corp
when incorporators –
1. Under valid statute
2. GF attempt to comply
3. Conducted business in corporate name
à De facto corp instantly comes into being
- MBCA: no LLC/corp if knowledge articles are
rejected (i.e., if articles are executed and
submitted but not yet approved à LL applies)
LLC/ Corp by Estoppel
Those who behave as if corp exists estopped from
denying corp existence.
Cf. de facto corp: corp by estoppel does NOT
establish existence of corp to rest of world
(*important re torts: no corp by estoppel for tort bc
a tort victim doesn’t treat a corp
LLC Liability
a. Limited by ULLCA 303(a)
b. Possible LLC veil piercing à test same as PCV except following corp formalities not really part of LLC VP: unity of interest (commingling, undercapitalization) and injustice (fraud-ish conduct, unjust enrichment)
i. ULLCA 303(b): Failure of LLC to observe usual company formalities not grounds for
imposing personal liability on members/managers for company’s liabilities
LLC Management
a. Articles of Organization: must designate the LLC as member-managed or manager-managed
i. Members-managed
1. Unilateral actual authority UNLESS really weird issue or known disagreement
and ULLCA 404(a)&(c) can’t solve
2. Unilateral apparent authority (but is limited) UNLESS outside ordinary course or
3P on notice
ii. Managers-managed
1. Only managers have unilateral actual authority UNLESS really weird issue or
known disagreement and ULLCA 404(b)&(c) can’t solve
2. Unilateral apparent authority (but is limited) UNLESS outside ordinary course or
3P on notice
b. Operating Agreement
i. Can fine-tune actual authority of members if members-managed and managers if
manager-managed to some extent in OA
1. But apparent authority cannot
ii. OA cannot change Articles of Organization – AO is binding
c. LLC Agency Law
i. ULLCA 301(a) gives each member of a member-managed LLC actual authority as agent
ii. ULLCA 301(b) gives each manager of a manager-managed LLC actual authority as agent
iii. OA can limit actual authority BUT it cannot alter statutory apparent authority
1. 2-member member-managed LLC & LLC OA limited individual actions members
could take (e.g., no execution of leases over $10k) but 1 member did so anyway
-> K still enforceable bc even though no actual authority, there is still apparent
authority if within ordinary course of biz and 3P not on notice
2. BUT if manager-managed LLC, member would lack both actual and apparent
authority to bind company to K
iv. What recourse if member defies restrictions on their actual authority?
1. Breach of contract (i.e., operating agreement) -> liable for damages
2. Thus, still reason to fine tune actual authority even if entity will ultimately be
liable under apparent authority bc some recourse among members themselves
LLC Fiduciary Duties
a. If member-managed, members have DOL and DOC (ULLCA 404(a))
i. Like pshp: each and every partner has fiduciary duties
b. If manager-managed, only managers have DOL and DOC. Members have NO fiduciary duties from the get-go (ULLCA 404(b))
i. More like corp: designated people in charge who have fid duties (directors, officers) and
mere owners (shareholders) who don’t have fid duties
c. McConnell (NHL franchise case) – no breach of fiduciary duty bc agreement specifically allowed
for competition (DOL waivable) & no evidence McConnell acted in secretive manner/used CHL assets for personal gain (competing in bad faith or an unfair way would = its own DOL violation)
d. DOL and DOC may be reduced but not eliminated by operating agreement (ULLCA 103(b))
Choice of Entity
Partnership - unlimited liability, managed by each partner, single tax
LP - LPs are passive investors
LLC - member or manager managed, limited liability, single tax
Corp - SH are passive - Corp - limited liability, double tax
Rarely advise Partnership b/c liability expanding. and joint and several liability
LLC Tax Attributes
a. LLC is pass thru entity that incurs single level of tax at individual level vs. Corp incurs double tax:
(1) pay corp tax on net profits; (2) SHs pay tax on dividends
i. 3 relevant tax rates: corporate < ~ capital gains < personal income
ii. Disadvantage of double taxation of corps may be mitigated by:
1. Differing rates in relevant tax categories
2. Deferred taxation of SHs à requires SHs to defer receiving distributions
b. Some advantages to using LLC over corp if biz incurs gains/losses
i. To the extent person/entity has tax losses, can apply them against sources of income to
reduce tax bill
ii. Advantageous for pass-thru entity bc large losses can be used to offset income that
might otherwise be taxed at high individual income tax rates for partner
c. BUT LLC allocates gains/losses when g/l arises, not when g/l is distributed
i. Careful LLC planner will ask for “tax draw” in LLC agreement that mandates a certain
level of distribution to at least cover tax bills
ii. Timing issue: Preference for tax when g/l incurred or defer tax in corporate entity?
d. On Asset Movement
i. Corps are like lobster traps: easy to get assets in, hard to get them out
1. Assets must be distributed to SHs or corp must be converted into other entity
2. In general, tax law will treat that distribution/conversion as if there had been
some sale of the assets at FMV and that might trigger tax liability
ii. LLCs don’t have this problem
1. Contributed assets can be distributed or withdrawn without tax consequence
2. LLCs can generally convert to other entity without triggering any tax liability
Securities Laws
Securities laws set forth parameters by which directors and officers must conduct themselves
when the corporation’s securities are involved.
i. Sources: Federal (’33 and ’34 Act) + state (aka “blue sky laws”; often preempted/similar
to fed law)
ii. Primary features: Registration, periodic disclosure, fraud liability (amped up from C/L)
33 Act
i. Focus: primary market – when issuer/co-created securities sells to investors (e.g., IPO)
1. Must register any “offer or sale” (any issuance, e.g., formation, capital raising)
of “security” UNLESS exempt private offering
2. Average underwriting cost for registration in 2014 = $20M, so a lot of time is
spent making offering exempt
ii. Disclosure-based regime: no federal merit review; junk ok to sell if full disclosure its junk
34 Act
created SEC
i. Covers much broader range of subjs than ’33 Act
ii. More focused on secondary market– when investors trade securities among themselves
iii. Mandates periodic public disclosures by public corps
1. Securities filings: 10K (annual report) + 10Q (qtrly report) + 8-K
2. Public cos must file 10K: (1) stating responsibility of mgmt for
establishing/maintaining adequate internal control structure/procedures for
financial reporting; and (2) containing assessment of effectiveness of internal
control structure. Public accounting firm preparing/issuing audit report shall
attest to/report on mgmt’s assessment
iv. Governance reqs: majority independent directors, audit, comp, nominating committees
v. Also covers: insider trading, proxy solicitations of SH votes (Rule 14a), tender offer rules
Securities Fraud
(from both ’33 and ’34 Acts) à discussed in securities regulation course
i. Most famously, Rule 10b-5 prohibits: (a) fraudulent devices & schemes; (b)
misstatement/omission of material facts; and (c) acts/practices that operate as
fraud/deceit, in connection w/ purchase/sale of any security
ii. (Private) claim to recover damages under § 10(b) & Rule 10b-5
1. elements of common law fraud
2. + material misstatement or omission
3. + scienter (knowledge/recklessness): intent to deceive, manipulate/defraud
4. Reliance
5. Loss causation (loss bc of mispresentation)
iii. SEC/DOJ enforcement of private causes of action
What is a Security?
instruments in Section 2(1) of the 1933 Act’s definition of a security, or it must fall under one of
the catchall terms, “investment contract” being the most common used.
i. Enumerated: Stock, bonds, notes, options, debentures (an unsecured loan certificate
issued by a company, backed by general credit rather than by specified assets)
ii. Investment contract is a contact, transaction, or scheme whereby a person makes an investment in a common enterprise with reasonable expectation of profits to be derived primarily from the efforts of others (Robinson).
1. “Common enterprise” = means investment arises and falls with others
2. Note: CEO can own secs issued by co (bc enumerated in definition of securities),
but not “investment Ks”
3. Per Robinson, Robinson’s LLC interest was not an investment contract per
Section 2(1) of ’33 Act because he was actively involved in the company and
thus it is not a passive investment by which he’d hope to profit from the efforts
of others.
a. LLC interest not listed as stock, so not a security
4. Note: LPs are structured so that the limited partners are passive and rely on the
efforts of the GP, so LP interests are generally presumed to be investment contracts. GPs, on the other hand, are presumed to take part in the business
and thus their interests are not investment contracts.
Registration Exemptions
a. A security generally cannot be offered unless a registration statement is filed with the SEC and is in effect, and the prospectus must be delivered to the purchaser before the sale. However, there are exceptions to registration. One such exception is if it is a private placement, such that the
transaction by the issuer does not involve a public offering.
b. The Registration Process – ’33 Act § 5
i. Security may not be offered unless registration statement (copy of prospectus +
additional techical info) filed w/ SEC
ii. Security may not be sold until registration statement in effect (requires SEC sign-off)
iii. Prospectus (sales comm in prescribed form) must be delivered to purchaser before sale
c. Exceptions to Registration under § 5 – ’33 Act § 4
i. Two types:
1. Certain categories of securities exempted entirely (e.g., govt secs such as
Treasury bonds/municipal bonds)
2. Certain transactions exempt (1-time exemption: transferee, if wanting to sell,
must register/seek another exemption)
’33 Act § 4(2) exemption -> “private placement” if transactions by issuer doesn’t involving public offering
i. “Public offering”: application turns on whether particular class of persons affected need protection under Act -> offering to those able to fend for themselves is a transaction “not involving any public offering”
ii. Purpose of ’33 Act: protect investors by promoting full disclosure of info thought
necessary for informed investment decisions so exemption question turns on knowledge of offerees
iii. Under Doran, the following factors are among those relevant to whether an offering is private and therefore qualifies for exemption under § 4(2).
1. Number of offerees
a. 8 is “entirely consistent with 4(2)” (Doran)
- Relationship between offerees and to issuer
a. Is the relationship meaningful enough that we can use it to evaluate
propriety of a financial relationship?
b. Relationship is strong if it would give buyer insight to the soundness of
the investment (e.g., a pre-existing business relationship). Otherwise,
weak relationship
c. Business school colleagues = likely strong relationship bc they are more
sophisticated vs. customers of biz who are familiar with the product
but are unlikely to be familiar with the business operations/investment
proposition itself. - Sophistication of the offerees
a. We want to limit the sale to people who don’t need the protection of
securities law - Dollar amount of offering: larger (in terms of $$ raised) à more likely public
- Manner of offering
a. If one engages in general solicitation (such as putting ad in papers) à
likely public
b. Is promo material superficial or does it focus on financial and business
information? - Amount of disclosure
a. All material information must be made available. For those who don’t
have automatic access to such information (such as an executive at the
firm), this requirement can be satisfied by the actual provision of the
information, or by the promise to open books and records and answer
all material questions.
.Note: to qualify for § 4(2) exemption, issuer must show all offerees, whatever
expertise, had available info registration statement would offer
a. Availability = disclosure or effective access
Securities Exemption Case
Doran – Doran invests in oil venture & things go south à wants out/claims LP
interest = sec + sold in violation of ’33 Act § 5
a. PMC: sale qualified for exemption under § 4(2)
b. PMC satisfies (1), (4)-(6): number of offerees good, small # units for
small $ amt, & no general solicitation
c. Fails (2)-(3): even though Doran sophisticated investor, we need to
know 8 offerees’ bus & legal sophistication & info available to them
Rule 506
Because Doran is a fact specific, indeterminate test, it is hard to make plans based on
this type of judicial standard à SEC promulgated Rule 506 to provide a bright-line safe
harbor under Section 4(2).
1. Attractive because it’s more concrete and Rule 506 preempts state securities
registration requirements which Section 4(2), outside of Role 506, does not.
2. Key concept: accredited investor
a. Any D, exec O / GP of issuer
b. Person w/ net worth > $1mil (excluding primary residence)
c. Ppl w/ annual income > $200k individually / $300k filing jointly
- Three different avenues
a. Most common: restrict purchase of security to only accredited
investors (self-certification of status) and no general solicitation is
allowed
b. If purchase limited to accredited investors, Rule 506(c) allows general
solicitation so long as issuer performs extra verification (e.g., checking
account statements or W-2 to verify income).
c. Rarely used: Rule 506(b) allows some non-accredited investors if there
is no general solicitation, and the issuer provides onerous disclosure
(including audited financial statements).
Shareholder Proposals
what’s an appropriate kind of proposal under this rule?
a. SEC Rule 14a-8 gives shareholders in publicly traded companies the right to include a shareholder proposal and brief supporting statement in company’s proxy statement.
i. Very advantageous for shareholders to piggyback off the company’s proxy statements
rather than going through the considerable expense of preparing and sending own
proxy statement to shareholders.
If I have complied with the procedural requirements, on what
other bases may a company rely to exclude my proposal?
i. prohibits shareholder proposals that are improper under state law
ii. prohibits proposals that violate the law
iii. prohibits propsals that are not relevant
iv. prohibits proposals that company lacks the power or authority to implement
v. prohibits propsals that deal with management functions
vi. prohibits propsal that is trying to influence a particular director election
SH Proposal - improper under state law
Rule 14a-8(i)(1) prohibits shareholder proposals that are improper under state law (i.e.,
if the proposal is not a proper subject for action by shareholders under the laws of the
jurisdiction of the company’s organization)
1. CA – The bylaws of CA shall be amended to provide for reimbursement of
expenses for successful dissident proxy campaigns.
2. Focus is on what shareholders can do directly: e.g., DE statute says shareholders
can only make procedural amendments to bylaws à violates Rule 14a-8(i)(1)
3. Solution: Under SEC interpretations, as long as a proposal is phrased as a mere
recommendation (i.e., not binding), then it cannot be excluded under state law.
SH Proposal - prohibit propsals that violate the law
Rule 14a-8(i)(2) prohibits shareholder proposals that violate the law: if the proposal
would, if implemented, cause the company to violate any state, federal, or foreign law
to which it is subject.
1. CA – The bylaws of CA shall be amended to provide for reimbursement of
expenses for successful dissident proxy campaigns.
2. Because DE law gives board discretion for dissident expense reimbursement,
proposal would take away board’s ability to faithfully execute its duties (i.e., to
consider whether dissident representative on the board was acting in the
company’s interest) and thus this proposal violates the law.
3. Cannot be cured via framing proposal as recommendation because if executed
it would violate the law.
SH Proposal - prohibits SH Proposals that are not relevant
prohibits shareholder proposals that are not relevant (i.e., proposal
does not relate to operations that account for <5% of the company’s total assets, net
earnings, gross sales for the most recent year and is not otherwise significantly related
to the company’s business).
1. Lovenheim v. Iroquois – shareholders recommend that board form a
committee to study whether the production of foie gras is cruel
2. A shareholder proposal that has significant political, social, or ethical
implications cannot be excluded becSH Pause the importance of those implications
outweighs its small quantitative impact (Lovenheim).
SH Proposal - deal with management functions
prohibits shareholder proposals that deal with management functions
(e.g., matter relating to the company’s ordinary business operations) unless there are
transcendent implications involved and the proposal does not micromanage (WalMart).
1. Trinity Wall St. v. WalMart – We recommend WalMart’s board review
company policy regarding the sale of [guns]
a. Note: recommendation inclusion means not improper under state law
Held: Court feels that the proposal singles out a particular product and is thus
too much in the weeds and is thus excludable because it relates to a
management function.
SH Propsal - director election
prohibits a shareholder proposal that is trying to influence a particular
director election. It doesn’t prohibit something like a bylaw amendment that will change
the process for elections going forward (AIG).
1. AIG – the bylaws of AIG shall be amended to permit shareholder nominees
access to the company’s proxy statement.
Soliciting proxies
SEC Rule 14a-7 gives corps choice when insurgent slate of D candidates communicate w/ SH to
solicit proxies:
i. Can mail insurgents’ materials to all SHs & bill them for cost; or
ii. Can provide insurgents w/ SH list for them to communicate directly
1. Corps usually choose option 1, whereas insurgents prefer option 2
Insider Trading
a. Stock trading on basis of material nonpublic info (MNI) creates liability under Rule 10b-5 only if
in violation of fiduciary(-like) duty.
b. Classical Theory (rooted in fraud law)
i. Insiders (Texas Gulf): Os/Ds/employees of co whose shares traded
1. An insider with material nonpublic info (MNI) must disclose that information
before she buys/sell shares or abstain (Texas Gulf). Because disclosing would
typically violate duty to corporation, this rule means that insiders who sit on
MNI may not trade in the company’s stock.
a. Material: info important to reasonable investor; (probability of event x
magnitude of effect)
2. A trader who is not an insider (either through traditional, tippee or
misappropriation theories) has no duty to disclose or abstain.
ii. Temporary Fiduciaries: E.g., consultants, investment bankers, lawyers, accountants
1. Those who temporarily work for a company become a fiduciary to that
company and by extension to corp’s shareholders and future shareholders.
iii. Tippees (Dirks): those who “inherit” duty from insiders/temporary insiders
1. Tipper must breach fiduciary duty to shareholders by disclosing information in
exchange for personal benefit, and tippee must know/have reason to know the
information is ill-gotten (Dirks).
a. Tippee liability derivative of tipper liability
b. Personal benefit can be pecuniary gain (e.g., sell stock tips),
reputational benefit (translating to future earnings), or providing a benefit to a relative/friend (providing financial benefit to someone
close to you is like providing to yourself)
Insider Trading Cases
iv. Texas Gulf – SEC maintains that TGS’s press release painted misleading and deceptive
picture of drilling progress at time of its issuance in violation of Rule 10b-5; TGS execs
didn’t disclose b/c served corporate purpose (keeping land cost down) -> TSG
employees begin buying the company’s stock
1. TSG argues that info is not a sure thing when employees were buying shares, so
not material info. Court holds that if there is a potentially large effect, even a
relatively modest change of it coming to be is material -> SEC fraud violation
v. Dirks – Secrist is whistleblower, but regulators don’t take him seriously. Secrist
convinces stock analyst Dirks to look into potential fraud. SEC eventually finds fraud and
accuses Dirks of aiding/abetting insider trading -> Dirks not insider bc Secrist didn’t
disclose for personal gain nor intend to make Dirks gift of info -> no breach by Dirks
Misappropriation Theory
One who misappropriates confidential info from any source, not just
the corp, is engaging in deception per Section 10(b) & Rule 10b-5 and is in breach of duty owed to source of info (O’Hagan).
i. O’Hagan – Fiduciary’s undisclosed, self-serving use of principal (P) info to purchase/sell secs, in breach of duty confidentiality, defrauds P of exclusive use of info -> O’Hagan guilty b/c he misappropriated info for own benefit and breached duty to Grand Met
- Premises liability on fiduciary-turned-trader’s deception of those who
entrusted him w/ access to confidential info
a. E.g., when one agrees to maintain the info in confidence; when there is
a pattern or practice of sharing confidences such that the recipient of
the info knows or should reasonably know that the they are expected
to maintain confidentiality; when recipient is close family member of
source - At a newspaper, information gathered is meant to be shared publicly, so it
cannot be said to be confidential info. BUT if there is an explicit or implicit
expectation for the newspaper employees that they refrain from trading on
MNI learned from news-gathering activities, misappropriation case would work. - Complements classical theory à deception/nondisclosure key in finding liability
under Section 10(b) & Rule 10b-5
Direct v. Derivative Claims
a. DE Tooley test: Did the corp or individual SHs
i. Suffer the alleged harm?
ii. Receive the benefit of any recovery?
1. If answer = corp -> derivative lawsuit; if SH -> direct lawsuit
b. Direct claims – brought by shareholders in own name
i. Shareholder level rights tend to be direct claims
ii. E.g., corp that sells substantially all its assets to buyer must first obtain SH approval. If no SH approval, direct claim bc it is the SH’s voting rights that have been violated and remedy would be awarded to SH
c. Derivative claims – initiated by SH on corp’s behalf
i. Mechanism for enforcing director/officer fiduciary duty claims as corporation suffers
direct harm from management failings
C. Chart: Decision to pursue derivative suit lies within BJ of bd
Demand Requirement
To bring a derivative suit, the shareholder plaintiffs must first either make demand or request
demand excusal on the basis of futility.
i. Make demand on bd to pursue claim, or
1. BJR applies to bd’s decision to dismiss (extremely hard to overcome), so P will
virtually never make demand.
2. Indeed, it is better for the shareholder not to make demand, as that can lead to
a waiver of ability to request demand excusal later on as the action implicitly
acknowledges a belief that the board would have been able to make the proper
decision.
ii. Request demand excusal on basis of futility: To claim demand is futile, under the
Aronson standard, shareholders must allege particular facts that create a reasonable
doubt that the board is capable of making a good faith decision as to whether to pursue
the claim.
1. Demand futility test: Under Grimes, DE courts will find demand futile (i.e.,
demand will be excused) if either a majority of the board (1) received personal
material benefit from alleged misconduct being challenged; (2) would face
substantial liability on any of the claims in the demand (aka DOC failures); or (3)
is incapable of acting independently from tainted directors.
2. This is a very high standard to meet à must plead assertions based on facts at
hand (no discovery)
3. If demand excused, SHs file lawsuit themselves even over objection of bd
b. Demand requirement + demand futility strikes balance between
i. Preserving discretion of directors to manage corp w/o undue interference
ii. Permitting SH to bring claims on corp’s behalf when evidence directors will wrongfully
refuse
Special Litigation Committees
a. After demand excused, corp has one more option to wrestle back control: form a SLC to review
merits of suit and decide whether to dismiss the claim. In response, SH can challenge SLC
b. Zapata 2-step test to determine if SLC rather than SH should control derivative suit
i. First, is the SLC truly independent? Factors: operational and financial independence;
good faith of committee; bases supporting recommendation
1. Burden entirely on corp to prove SLC is independent
ii. Second, what is court’s own business judgment on whether litigation should continue?
Factors:
1. Does corp have “compelling interest” in suit being dismissed? (e.g., suit
meritless, bad publicity/expensive suit with small potential benefit)
2. Even if yes to 1st Q: Are there matters of law and public policy that might make
it important for lawsuit to continue? (e.g., revelation of corp scandal to restore
confidence in corp America, lead to discovery of criminal conduct)
c. Zapata test is hard to meet! SH has already been able to argue that bd can’t be trusted to
decide whether to handle litigation or not under Aronson, so demand was excused. Thus, we
should be skeptical of SLC as a creature of that original board.
Indemnification and Insurance
a. Potential Plaintiffs
i. Unrelated 3rd parties: where officer negligently injures someone while driving co car for
work purposes
ii. SHs: injuries to individual interests/corp
iii. Employees: wrongful discharge/violation of anti-discrimination laws
iv. Customers: product liability
v. Competitors: for violations of anti-trust laws
vi. Govt agencies
b. Further points
i. Risk of liability may be remote but magnitude of potential damages/expenses of
defense can be large in relation to wealth of individual directors/officers
ii. Corps can (& often do) buy insurance to cover damages and expenses of defense
(particularly valuable to directors/officers if corp insolvent)
iii. Obligatory indemnification prevalent, as directors/officers concerned corp taken over by
people hostile to them
iv. Pros: Indemnification allows directors to take intelligent risks for the company. If
directors had their personal money at stake for almost any challengeable corporate
transaction, there is a strong chance it would render them overly risk adverse, and as a
consequence the corp may pass on potentially profitable opportunities that it might
otherwise pursue.
v. Cons: Indemnification shifts the burden of paying for fiduciary duty breaches to the
shareholders. If the company indemnifies directors or buys insurance policies to protect
them, it can be argued that the company and its shareholders are essentially subsidizing
the breaches of fiduciary duty engaged in by its directors.
c. DGCL § 145
i. DGCL § 145(a) permits corporations to indemnify directors against costs incurred in
defending against third-party actions, including expenses, judgments, fines, and
amounts paid in settlement.
1. Requires: act in GF & rsnbly believed to be “not opposed” to corp’s interest
ii. DGCL § 145(b) permits corporations to indemnify directors against expenses incurred in
defending against derivative lawsuits that do not result in adverse judgment.
1. Requires: act in GF & rsnbly believed to be “not opposed” to corp’s interest
2. No indemnification if adverse judgment; settlement = can still indemnify
3. What is the rationale for the more limited scope of coverage under §145(b)
versus §145(a)?
a. Bc derivative suit involves a harm to the corporation, any amount paid
in judgment or settlement would go to the corporation, and so having
the corporation indemnify its agents for such sums would amount to a
circular payment: from the corporation to the agent and back.
b. Additionally, a successful derivative suit generally involves a breach of a
duty to the corporation itself, which means the agent was acting
contrary to, rather than in advancement of, the principal’s interests.
Thus, it makes much less sense for the principal to indemnify the agent
for such damage.
iii. DGCL §145(c) requires corporations to indemnify Ds & Os when they are “successful on the merits or otherwise.”
1. No GF requirement; applies to Ds and Os only
2. Settlements with no fines/restrictions meets this standard
3. If fines or restrictions, not successful on merits
iv. DGCL §145(e) allows advancement of reasonable expenses to D/Os with a commitment
to pay back if not ultimately entitled.
v. DGCL §145(f) provides that an indemnification agreement can make mandatory what
would be permissive.
1. Indemnification and advancement of expenses provided by [this statute] shall
not be deemed exclusive of any rights under any bylaw, agrmnt, or otherwise
2. Language means that wherever there was discretion under the statute, corp
can decide right away to exercise that discretion (whatever is discretionary you
can pre-commit to doing)
a. § 145(f) is thus a pre-commitment device that makes what is
permissive mandatory
b. § 145(f) can’t be inconsistent with § 145(a)/(b)
vi. DGCL §145(g): Corp empowered to purchase and maintain insurance on behalf of any
D/O/employee whether the corp would have the power to indemnify such person
against such liability under this section
Indemnification Checklist
Waltuch v. Conti – two claims against Waltuch (silver trader) by CFTC enforcement & speculators
(private actions) à outcome: Waltuch settled for $100k liability & $1M expenses to CFTF and
$1.2M expenses to private actions; Conti to pay $39M in connection with claims à Waltuch
suing Conti to recover defense expenses (no GF req’d in indemnity)
i. Indemnification Checklist
1. 3P or derivative suit? [3P]
2. Statutorily permitted per DGCL §145(a)/(b)? [No, indemnification of expenses in
3P action not allowed bc Waltuch admitted he acted in bad faith]
3. Did corp agree in advance to indemnify (via articles, indemnification
agreements, bd action)? [Articles purport to indemnify per §145(f), but §145(f)
can’t be inconsistent w/ 145(a) à invalid]
4. Required by statute aka DGCL §145(c)? [Waltch settled; Court says success on
merits = escape from adverse judgment/other detriment]
ii. Held: Waltuch may recover expenses defending private
Quasi-CA Corps
a. CA Corporations Code § 2115: mechanism thru which CA tries to impose its corporate law on
entities that are incorporated in other places
b. Trigger: If majority of business in CA (sales, employees, property) AND majority voting shares
held in CA -> CA law applies for election of directors, voting on mergers, appraisal/dissenter’s
rights, etc.
i. Not applicable to publicly traded corps
c. CA Corporations Code § 708: Director Elections
i. SHs may cumulate votes (until publicly traded)
ii. Straight voting.
1. 3-person board elected annually
2. 3 candidates w/ the most votes win –> system of straight voting
3. A –> 199 shares
4. B –> 101 shares
5. Each voter votes up or down on each, A would choose all three members of the
board… A WILL ALWAYS WIN
iii. Cumulative voting
1. Each holder gets votes = # of shares held x # of eligible bd spots
2. A –> 199 shares, 597 votes
3. B —> 101 shares, 303 votes
4. Votes can be stacked on one candidate
5. B would be able to win 1 of the board seats
6. Designed to give minority SH at least some proportionate representation on bd
d. Voting on mergers (“reorganizations”)
i. DE: preferred and common vote together
ii. CA § 1201 & MBCA: separate voting by class; majority of each class must approve trans
iii. Internal Affairs Doctrine: “The internal affairs doctrine is a conflict of laws principle
which recognizes that only one State should have the authority to regulate a
corporation’s internal affairs.” It is chaotic for corp with operations in multiple states to
have lack of certainty regarding how it will be governed internally. Thus, CA 2115 invalid
per DE court. (VantagePoint Venture Partners v. Examen)
1. Status in CA: still on the books, but recent dicta suggest 2115 may be invalid
2. In practice: Make sure vote obtained satisfies both DE and CA reqs
3. Doctrine is important because all theories of why firms incorporate in DE
assume that DE law will be applied irrespective of the forum of litigation, an
assumption that is supported by the Internal Affairs Doctrine.
Hybrid Entities
a. CA one of few states with both benefit and social purpose corps, and it adopted them early.
b. Hypo: A local gun range wants to incorporate as a hybrid entity. The organization wants to make
money for its owners. But it also wants to promote gun safety. Would it have an easier time as a
social purpose corporation or a benefit corporation?
i. Social purpose corp is more flexible. Org can choose to improve society or the
environment or other qualifying constituencies and management can assess progress
towards those goals as they see fit. So, putting it all together, the organization could
take the position that it is benefiting society through increasing gun safety, and
management can decide for themselves how to measure if that’s really happening.
Corp v. Benefit Corp v. Social Purpose Corp
Corp
- max sh value
Benefit Corp
- Serving a general public benefit = having a “material positive impact on society and
the environment, taken as a whole.” Corp may ID and add additional specific public
benefits.
- must consider ESG in decisions
- adhere to 3p standard
- stringent annual reporting
- benefit proceedings to enforce purpose
Social purpose corp
- one or more specific purpose
- consider spec purpose in decisions
- no 3p eval, eval based on mgmt analysis
- less stringent annual reporting
- traditional enforcement methods e.g. deriv lawsuit
