BA Flashcards

Question

Economic Rights of Partners

Answer 1

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

Answer 2

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

Answer 3

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

Answer 4

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.

Answer 5

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”),

Answer 6

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

Answer 7

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

Answer 8

ID the type of alleged fid breach and then apply the correct standard of review

Answer 9

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

Answer 10

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.

Answer 11

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.

Answer 12

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.

Answer 13

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

Answer 14

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

Answer 15

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

Answer 16

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)

Answer 17

1. 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 2. Quorum? Majority of qualified directors 3. Required vote? Maj. of votes of qualified directors (but no fewer than 2) at meeting

Answer 18

1. 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 2. 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. 3. Required vote? Majority of votes case by holders of all qualified shares but voting power depends on shares held by each SH

Answer 19

1. 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.

Answer 20

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

Answer 21

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

Answer 22

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.

Answer 23

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…

Answer 24

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)

Answer 25

1. Smith v. Van Gorkum a. Need to satisfy the duty of care 2. 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) 3. 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.

Answer 26

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.

Answer 27

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

Answer 28

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.

Answer 29

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)

Answer 30

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

Answer 31

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

Answer 32

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

Answer 33

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))

Answer 34

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

Answer 35

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

Answer 36

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)

Answer 37

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

Answer 38

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

Answer 39

(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

Answer 40

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.

Answer 41

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) 2. 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. 3. Sophistication of the offerees a. We want to limit the sale to people who don’t need the protection of securities law 4. Dollar amount of offering: larger (in terms of $$ raised) à more likely public 5. 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? 6. 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

Answer 42

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

Answer 43

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 3. 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).

Answer 44

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

Answer 45

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.

Answer 46

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.

Answer 47

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).

Answer 48

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.

Answer 49

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.

Answer 50

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

Answer 51

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)

Answer 52

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

Answer 53

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 1. 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 2. 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. 3. Complements classical theory à deception/nondisclosure key in finding liability under Section 10(b) & Rule 10b-5

Answer 54

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

Answer 55

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

Answer 56

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.

Answer 57

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

Answer 58

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

Answer 59

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.

Answer 60

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.

Answer 61

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