Corporations Flashcards

Question

Common features among LPs, LLPs, LLCs

Answer 1

• Contractual flexibility – Preference for detailed ex ante contracting vs. ex-post adjudication – Statutory permission to contract around fiduciary duties – Limited liability as default term » But can opt out of default (e.g., “personal guarantee”) • Pass-through taxation—assuming ownership interests not public – Dramatic rise in LLCs since 1997 IRS “check-the-box” rules (i.e., could simply choose to be taxed as partnership) – As an alternative to LLC, can form corporation and elect pass-through taxation under Subchapter S of Internal Revenue Code. » Advantages: easier to convert to C-Corporation; more familiar to public; more legal precedent; possible tax benefits » Disadvantages: limited to 100 shareholders; shareholders limited to US persons; only 1 class of stock; less flexibility (e.g., more procedural formality, must distribute income proportionately to investment)

Answer 2

• LP: hedge funds, private equity, venture capital – Arguably easier to list on exchange than LLC – LPs recognized by foreign investors • LLP: law firms, accounting firms, medical practices – Some states (e.g., NY) allow Professional LLCs (PLLC) and Professional Corporations (PC) which are gaining popularity • LLC: other industries (“jack-of-all-trades”) – DE trying to parallel the lead it has in the market for corporate charters (TBD) – Might explain its willingness to grant significant contractual flexibility (above)?

Answer 3

* Artificial legal personality with indefinite life * Limited liability for investors * Free transferability of shares * Centralized management

Answer 4

Typically incorporated not to raise capital, but for tax and liability purposes – Shareholders tend also to be directors & officers (e.g., family members) – Might restrict transferability of shares

Answer 5

Shareholder (or group of shareholders) controls the corporate machinery (e.g., appointing majority of board, access to confidential information, relative shareholdings) – Controller need not necessarily be majority shareholder (TBD)

Answer 6

File charter (“articles of incorporation,” “certificate of incorporation”) with state Secretary of State—minimal requirements, typically: – Name and purpose of corporation – Incorporators and board – Address; if necessary, Registered Agent – Capital structure (number of shares x par value/share) • By-laws not filed – Operating rules—e.g., board committees and quorum, responsibilities of officers

Answer 7

Law of state where incorporated governs “internal affairs” of corporation Shareholder vote required to amend charter; relative power of board vs. shareholders to propose or modify by-laws remains contentious (e.g., DGCL § 109 vs. § 141) Shareholder agreements allowed (e.g., ability to buy or sell shares, voting) – Typically arise in close or controlled corporations

Answer 8

shareholders (investors) cannot lose more than they invest Plus side: – Creditors cannot seek personal assets – Decreases need to monitor management and other shareholders – Allows investor to diversify among investments (e.g., high vs. low risk) Lack of creditor protection • Creditors must contract ex ante to protect themselves • Involuntary creditors (tort victims)?

Answer 9

Managers can continue to run corporation even as share ownership changes • Otherwise, credit rating of firm would change every time shares transferred – Listing on capital markets becomes possible • Access to capital • But threat of possible takeovers – Default provision: can restrict by contract • E.g., shareholder agreement to limit ability to buy or sell shares in close corporation

Answer 10

to mediate between shareholders and management | • Board represents corporation => all shareholders

Answer 11

– Appoint, compensate, remove officers – Declare and pay dividends – Monitor and approve management decisions – Make major business decisions – Initiate and approve extraordinary corporate transactions (TBD)

Answer 12

– Board can act only at duly constituted meeting Board members cannot act alone. Board members are still agents however. But only can make decisions if they follow proper process at a duly constituted meeting. » Some states allow action without formal meeting if unanimous consent – Delegation to committees and sub-committees – Use of outside experts

Answer 13

Shareholders (P) elect--> Board (A) appoint --> Management (A) Management (A?) nominate --> Board (A?) dictate --> Shareholders (P?)

Answer 14

``` – Some risks creditors might face • Falsification of income and/or assets • Hiding or shifting assets subsequent to borrowing • Taking on more senior debt • Adopting riskier business model ``` – Most important line of defense is commercial law • Importance of ex ante contractual protections cannot be overemphasized – Creditor protections not focus of corporate law • Typically “last resort” when other avenues have failed

Answer 15

Corporate law makes little use of this • State corporate law does not require private corporations to prepare or file financial statements – Only small number of states require annual financial statements to shareholders

Answer 16

Minimum capital and/or capital maintenance requirements do not exist

Answer 17

Relatively clear at two extremes – Under normal circumstances, duty owed to shareholders – In bankruptcy, federal bankruptcy code applies • But what about director liability at or near insolvency? – Firm unable to meet its financial obligations (economic concept) – Some caselaw to suggest that directors owe a duty to creditors as well—i.e., maximize value of entire corporation (equity + debt) » But prioritizing obligations can be very difficult – seems to suggest only derivative claims and no standing if “zone of insolvency” but not (yet) insolvent

Answer 18

2 ways in which creditors can attack transfer – Actual fraud: “present or future creditors” can void transfers made with 1. “actual intent to 2. hinder, delay, defraud any creditor of the debtor” – Constructive fraud: “creditors” can void transfers made “without receiving a reasonably equivalent value” if the debtor is left with “remaining assets. unreasonably small in relation to its business” or the debtor “intended, believed or reasonably should have believed he would incur debts beyond his ability to pay as they became due” or the debtor is insolvent after the transfer

Answer 19

1. Argue fiduciary duties aren’t waived 2. Even if waived, argue covenant of good faith and fair dealing (Likely fails, but all you have.)

Answer 20

A corporation’s board of directors is not bound to carry out the resolution of a simple majority of the shareholders in violation of the articles of association. 55% not enough due to the articles

Answer 21

Informal meeting, no notice to the CEO Despite 3/3 board vote to fire Need formal process Obsessed with process Good decision with no process will lose Bad decision with good process will win

Answer 22

Boards can act as duly constituted board members at meetings. Board members cannot act alone. Board members are still agents however. But only can make decisions if they follow proper process at a duly constituted meeting. (Fogel) Bylaws will determine what the process is for the corp. (ie. meeting place, number of members required, voting majority required, etc.)

Answer 23

Not bankrupt but unhealthy companies. Can't meet obligations as they come due. Some caselaw that suggests creditors have standing to sue the board of directors. Must be insolvent, not "zone of insolvency"

Answer 24

Take a $12MM settlement? Or try for the $15.5MM? If under $12MM, lawsuit for not taking settlement from shareholders probably However creditors get paid first RULE: At least where a corporation is operating in the vicinity of insolvency, a board of directors is not merely the agent of the residue risk bearers, but owes its duty to the corporate enterprise.

Answer 25

Secured bondholders and other secured creditors Unsecured creditors (include bank lenders, employees, the government if any taxes are due, suppliers, and investors who have unsecured bonds.) Shareholders

Answer 26

If a corporation is close to insolvency, its directors owe duties to creditors as well as stockholders. Can't just think of stockholders especially if better for company to not. Taking a risk may not be right

Answer 27

Company has around equal equity/debt, but is in pain. Leverage buyout company takes the company private and makes it mostly debt (go to banks, borrow, buyout shareholders) Why? 1. Out of the limelight, no need to disclose 2. Take advantage of the tax subsidy, lower tax bill Then, take company public again. Sell the equity at a much more expensive price than bought. CREDITORS UNHAPPY as they are less likely to get paid, risk was increased, some say its fraud as it dramatically increases risk Courts by and large don't go for that. Should've made it contingent in the loan.

Answer 28

1. Controlling shareholder recharacterizes its position in the capital structure to gain priority (e.g., equity to debt, junior debt to senior debt) 2. Court uses its equitable powers to subordinate the debt–ie., “push” it back down in capital structure–where it would be unfair for controlling shareholder to have same priority as other creditors ostensibly now in the same position as controlling shareholder Courts typically look for under-capitalization, withdrawal of equity at time of business failing.(e.g., Costello v Fazio) Typically invoked in bankruptcy (e.g., § 510(c))

Answer 29

Two-part test (e.g., Sea-Land Services v Pepper Source) 1. Unity of interests and ownership (ie., failure to maintain corporate formalities, commingling funds, undercapitalization; “control” of subsidiary) (crucial prong) (strong alignment of interest between the shareholders and the business itself) The following factors are relevant: (i) if the corporation fails to observe corporate formalities; (ii) if the business fails to keep its assets separate from those of shareholders and each other; and (iii) if the business is undercapitalized. plaintiff must show that a shareholder used the corporation as his agent to conduct business in an individual capacity. (Carlton) 2. Injustice or fraud (sometimes embeds assumption of risk, but not explicit) Usually both needed, but in some cases only 2 if extreme circumstances Test applies both to voluntary creditors and involuntary creditors (tort victims) (e.g., Walkovsky v Carlton)

Answer 30

Can't jump up for debt payment, plumbers case Risk of starting a business ($6k in equity also super undercapitalized)

Answer 31

Most important applications – Electing directors – Fundamental changes (Dissolutions, changes to charter, typically: mergers, sale of assets) – Shareholder resolutions (SEC Rule 14a-8 process in public companies)

Answer 32

Venues – Annual meeting: Court will force annual meeting after 13 months (DGCL § 211) – Special meeting » Typical way to initiate action between annual meetings » DE allows board or person with authority in charter to call special meeting (DGCL § 211(d)) • Other jurisdictions also allow large shareholders (e.g., > 10%) to call meeting (e.g., RMBCA § 7.02)

Answer 33

» Written consent instead of meeting » Originally developed for close corporations, but also used by hostile bidders » DE allows any action that can be taken at meeting of shareholders to be taken by written concurrence • Other jurisdictions require unanimous consent (e.g., RMBCA § 7.04(a)

Answer 34

``` Every corporation must have board (even if it is 1 person) (§ DGCL 141(a)) + at least 1 class of voting stock with 1 share/1 vote default (DGCL § 212(a)) – Directors must be elected annually (DGCL § 211) ``` – Variations: Staggered (classified) boards (~40% large public companies) Cumulative voting

Answer 35

Only a fraction (e.g., one-third) of board up for election each year => takes at least 2 election cycles to gain control of board • Simple and powerful takeover defense • Empirical research suggests companies with staggered boards have lower shareholder returns

Answer 36

* Each shareholder gets to vote # shares owned x # directors to be elected * Facilitates representation of minority shareholders because allows shareholders to cast their votes for one or more candidates

Answer 37

At common law, directors could only be removed “for cause” (e.g., Campbell v. Loew’s (DE Ch. 1957)) Right to be heard by shareholders first – Today, distinction between “for cause” and “without cause” most relevant in employment law context (e.g., severance benefits) – Shareholders, courts can remove directors » Some statutes permit shareholders to give the board power to remove individual directors

Answer 38

Allows shareholders to vote without attending annual meetings Shareholders receive proxy statement and proxy ballot (“proxy card”) Shareholders return proxy card by mail, indicating how their shares should be voted Proxy holder must vote as directed Proxy battles can be extremely expensive, deters insurgents Froesell rule can discourage hostile takeovers

Answer 39

(Fairchild): win or lose, incumbent board can be reimbursed from corporate treasury, however insurgents only reimbursed if win (Rosenfeld v Fairchild Engine)

Answer 40

``` Each class must approve (e.g., majority of outstanding shares) (some shares have higher voting power) Designed to make sure decisions are fair to sub-groups, but gives each class a veto (“hold-up” problem (5 classes say yes but 1 says no, torpedoes deal)) ```

Answer 41

``` Easy to get stockholder list (DGCL 220) Books and records? More difficult. --Also opens up suspicions --Company will fight back --E.g., Ps carry burden of showing “proper purpose” ``` (all over the map on using this for litigation info) Shareholders must be informed to vote, but state law leaves this to the market No mandatory disclosure (above) Shareholders have right to inspect books and records “for proper purpose” Courts broadly grant access; typically don’t look if additional “improper purpose”

Answer 42

Robust Case Law goes to both Duty of Care and Duty of Loyalty (stronger) Sparse Case Law goes to both Duty of Good Faith and Duty of Candor --Good faith standard is very light, really only applies to intentionally or consciously neglecting duties or hurting the company

Answer 43

1. Care 2. Loyalty 3. Good Faith 4. Candor

Answer 44

“intentional dereliction of duty, conscious disregard for one’s responsibilities” (Disney) Abysmal and useless standard

Answer 45

Lower than good faith. Really no attention spent on it. Should there be a duty to disclose?

Answer 46

Under the business judgment rule, a business determination made by a corporation’s board of directors is presumed to be fully informed and made in good faith and in the best interests of the corporation. However, this presumption is rebuttable if the plaintiffs can show that the directors were grossly negligent in that they did not inform themselves of “all material information reasonably available to them.” (Van Gorkam) Result: extremely difficult for plaintiff to succeed on duty of care claim

Answer 47

Directors and officers insulated if: act in good faith and meet minimal proceduralist standards of attention” (Gagliardi v Trifoods (DE Ch. 1996)) Effectively a “gross negligence” standard per business judgment rule (BJR) Follow process to avoid being hit by a duty of care suit Process for analyzing: de-emphasize feelings, go into process basically entirely

Answer 48

Statutory techniques - -Indemnification - --Insurance Common law: BJR: Takes negligence and makes it gross negligence (can’t be if following proper process) Statute and charter: 102(b)(7) waivers

Answer 49

Delaware’s statute provides that a corporation may indemnify any director or officer if he or she: acted in good faith acted in a manner reasonably believed to be in or not opposed to the best interests of the corporation, and, had no reasonable cause to believe that his or her conduct was unlawful, in the case of a criminal action or proceeding.

Answer 50

Corporate statutes prescribe mandatory and elective indemnification rights Corporations can reimburse director, officer, employee, agent for reasonable expenses from actual or threatened judicial proceedings or investigations (e.g., attorney’s fees, settlements) Actions must be undertaken in good faith on behalf of corporation and in criminal cases no reasonable cause to believe conduct unlawful

Answer 51

Purchased by corporation Uniformity of coverage, less expensive, tax deductible Cases typically settled to insurance limit Typically requires confluence of events to trigger personal liability beyond indemnification and insurance (e.g., WorldCom, Enron)

Answer 52

Can basically eliminate liability for directors provided that such provision shall not eliminate or limit the liability of a director: 1. For any breach of the director’s duty of loyalty to the corporation or its stockholders 2. For acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law “lack of good faith standard”, very hard to meet

Answer 53

Quick Analysis Common Law: BJR makes standard “gross negligence” Statutory: §102(b)(7) makes standard “lack of good faith standard” which essentially means: “intentional dereliction of duty” “conscious disregard”

Answer 54

The directors of a corporation have a duty to make good-faith efforts to ensure that an adequate internal corporate information and reporting system exists. "The duty of care owed by corporate directors may be breached either by active decisions which are negligent, or by negligent failure to act." No internal system.

Answer 55

Subset of duty to care Cannot “abandon office” –ie., board must assume some monitoring responsibilities Caremark: 1. The directors utterly failed to implement any reporting or information system or controls; or 2. Having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.” (Stone v Ritter) Basically same as duty of care, gross negligence

Answer 56

Directors may be liable for consciously failing to monitor a reporting or information system. Adds on to the Caremark duty to monitor.

Answer 57

BlueBell recent case. Corporate directors must make good-faith efforts to implement and monitor compliance systems at the board level. Sprinkle this in for extra points

Answer 58

Federal securities laws increasingly significant General antifraud provision: §10(b) of 1934 Act Specific requirements to maintain books and records, internal controls - -Foreign Corrupt Practices Act (FCPA)(1977): §13(b)(2) of 1934 Act - ----Follow the money to find the fraud Sarbanes-Oxley (SOX) § 404 (2002): 15 USC § 7262 Includes auditor certification requirement Certification requirements is controversial → exemptions for smaller companies Like FCPA with 3rd party verification which increases compliance costs

Answer 59

Corporate and individual criminal liability, not individual (e.g. director) civil liability Stricter because requires “reasonably effective” compliance program June 2020 DOJ guidance high-level (e.g. Well-designed? Resource and empowered? Works in practice?) More like a reasonable standard like torts

Answer 60

Loyalty to whom? Shareholders (e.g., Dodge v. Ford Motor (MI 1919)) Fiduciaries—directors, officers, controlling shareholders—must exercise their power to advance corporate interests Despite complexities, analogous to problem explored in agency Can affect both conflicted transactions (e.g., self-dealing) and fundamental transactions (e.g., mergers, sale of assets)

Answer 61

A company cannot take actions that harm its shareholders and are motivated solely by humanitarian concerns, not by business concerns. Should have used BJR, may have won due to massive discretion under rule So remember this case does not involve BJR decisions

Answer 62

A corporation may take any action including authorizing contributions as long as it is consistent with state law. Articles of incorporation are malleable at any time, and it is a good thing overall to help the public

Answer 63

Fiduciary is on both sides of the transaction Disclosure as prerequisite: if not disclosed, difficult to argue the transaction is “fair” Extent of disclosure? “Material” information 1. “Material” if a reasonable shareholder would consider it important 2. Would have to disclose to all contractual parties (ie. in case would be all people with financial interest in transaction) Doesn’t matter if no injury, fraud, etc. Must disclose. No fairness without disclosure (Keypoint Oyster)

Answer 64

Baseline judicial standard of review for duty of loyalty claims: fairness, with burden on defendant to show transaction is “fair” Doesn’t matter if no injury, fraud, etc. Must disclose. No fairness without disclosure (Keypoint Oyster) Still possible for defendants to win (e.g., Cookies Food Products v. Lakes Warehouse (IA 1988))

Answer 65

If defendant is director or officer: BJR (with burden on plaintiff) If defendant is controlling shareholder: fairness, but with burden shifted to plaintiff to show the transaction is “unfair” Theoretical exception: disinterested approval cannot cure wasteful transactions However, even these transactions might be cured by unanimous shareholder approval

Answer 66

Threshold question: who is a “controlling” shareholder? – Majority (>50%) shareholders typically treated as controlling – However, can be controlling shareholder even without majority position—look to: • Relative ownership vis-à-vis other shareholders • Ability to control “corporate machinery” (e.g., elect board, access to confidential information)

Answer 67

Directors Officers and controlling shareholders Doctrine that applies to all is identical and BJR only difference is conflicted transactions with disinterested approval (because director v shareholder)

Answer 68

1. Fair dealing/process 2. Fair price (mostly just negotiated) Perfection not expected, but outside independent committee could have avoided problem

Answer 69

• Fiduciary takes an opportunity and unilaterally preempts corporation (opportunity brought to them and they didn't tell corp) – Unlike self-dealing, no transaction with the corporation 1. Is the opportunity “corporate”? 2. If so, can the fiduciary still take it?

Answer 70

Fairness: classic multi-factor test i. How did fiduciary learn of opportunity? (on company time or business?) ii. Whether the fiduciary used corporate assets in exploiting the opportunity?; (on the company expense?) iii. Other indicators of good faith and loyalty?; (don't overanalyze it, generic) iv. Relation to company line of business? (same type of company?) How concrete does the opportunity need to be? (maybe mention for fun)

Answer 71

Two examples in order to take it: 1. A few courts have said fiduciary can take if corporation financially unable to do so (e.g., Miller v. Miller (MN 1974)) – But odd defense for a public company that has access to capital markets 2. Many courts look to see whether board has decided not to pursue opportunity in good faith – In Delaware, disclosure is not per se required, but provides a safe harbor

Answer 72

Control shareholders have a fiduciary duty to the minority shareholders to act with “good faith and inherent fairness.” As such, majority owners have a fiduciary responsibility not to use their influence to engage in self-dealing, including actions that are unfairly prejudicial to the minority shareholders.

Answer 73

– Median pay of S&P 500 firm CEO approximately $12M (2018) | • Some estimates suggest 300-400 times median employee compensation in their firms

Answer 74

• “Clawbacks” – Sarbanes-Oxley § 304 (2002): if financial results are restated, all performance-based compensation over 12 months following original statement must be repaid • Requires “misconduct,” applies to CEOs and CFOs – Dodd-Frank § 954 (2010): public companies that restate financial results due to material noncompliance must seek repayment of excess incentive-based compensation of any current or former executive over 3 years preceding restatement • Applies to current and former corporate officers; does not require misconduct • Disclosure – Dodd-Frank § 954: any solicitation of shareholder votes to approve corporation transaction requires disclosure of executive compensation (“golden parachute”) – Dodd-Frank § 953: instructs SEC to adopt rules to disclose relation between executive compensation and company performance, as well as relation between CEO and median employee compensation • Governance (Dodd-Frank §951) – Advisory “say-on-pay” vote at least every 3 years (>90% shareholder support) – “Golden parachute” payments regulated via disclosure and shareholder approval • Prophylactic ban – Sarbanes-Oxley §402: prohibition on loans to directors or officers

Answer 75

Core doctrine and policy – Exceedingly deferential doctrine • Compensation decisions protected by BJR • “Waste” standard (e.g., Lewis v. Vogelstein (DE Ch. 1997)) – Policy • Difficult for court to assess level of executive pay • Will not second-guess “unconflicted” board

Answer 76

“exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade”

Answer 77

Lack of good faith is intentional dereliction of duty and conscious disregard Nearly impossible to meet Sets "bad faith" for breach of duty of care new potential standard via Disney’s § 102(b)(7) waiver

Answer 78

Derivative: assert claim on behalf of corporation with recovery going to corporation—technically, 2 claims i. Director or officer failed to sue on corporate claim; and ii. Underlying claim of corporation Direct: asserts claim on behalf of shareholders (class action or individual)

Answer 79

Derivative: assert claim on behalf of corporation with recovery going to corporation—technically, 2 claims i. Director or officer failed to sue on corporate claim; and ii. Underlying claim of corporation – Plaintiffs must give notice to absent interested parties – Other parties can petition to join suit – Settlement and release only after notice – Judicial determination of fairness of settlement Substantial benefit rule

Answer 80

Improper exercise of business judgment? Decision as to how much compensation is appropriate to retain and incentive employees “is a core function of the board exercising its business judgment” Reform via elections, not courts

Answer 81

To defend, challenge standing first. Board is in control and didn’t fail to act properly

Answer 82

Recovered attorneys fees despite no real recovery Substantial benefit rule: attorneys fees recovered if corporation gets a substantial benefit (doesn’t have to be pecuniary)

Answer 83

Plaintiff must: 1. Be shareholder for duration of action 2. Have been shareholder at time of alleged wrong (“contemporaneous ownership”) 3. “Fairly and adequately” represent the interests of shareholders 4. Specific action taken to obtain satisfaction from the board or why did not take this action (“demand” requirement) --Complaint must “allege with particularity the efforts, if any, made by plaintiff to obtain the action he desires from the directors or comparable authority. . . or the grounds for not making the effort”

Answer 84

When can shareholder-plaintiff force corporate claim out of board’s hands? 2 timeframes, where defendant: 1. moves to dismiss; 2. attempts to dismiss or settle once litigation is underway make a demand on the board or allege facts sufficient to demonstrate that such a demand would be futile.

Answer 85

a large payment or other financial compensation guaranteed to a company executive should the executive be dismissed as a result of a merger or takeover.

Answer 86

1. Whether threshold presumption of director disinterest or independence rebutted; (JUST COUNTING) (DON'T DEMAND NOW) or 2. Whether plaintiffs have pled sufficient facts to create a reasonable doubt that challenged transaction falls under business judgment rule (grossly incompetent) Basically, conflicted (is majority of board not disinterested not independent? Outside BJR, grossly incompetent 1st prong: analysis typically not very nuanced (e.g., simply counting number of inside vs. outside directors) E.g., are 7/15 or 8/15 directors “impartial” (Marchand v. Barnhill (Del. 2019)) No crazy duty of loyalty analysis here, just counting! 2nd prong: very difficult for plaintiffs to meet If number of conflicted directors (numerator) divided by total number of board members, if less than 50% defense wins. If more than 50% plaintiff can continue the lawsuit. If even, interesting problem but probably works for plaintiff Best bet is to not make the demand at all in Delaware due to DE’s Universal non demand rule.

Answer 87

if plaintiff makes demand, viewed as conceding first prong (Spiegel v. Buntrock (Del. 1990)) As a consequence, litigators in Delaware do not make demand

Answer 88

1st prong analyzed at time complaint is filed 2nd prong determined not to be applicable But why not still analyze 2nd prong at time of underlying transaction?

Answer 89

a board of directors, when challenged by a shareholder derivative litigation, may appoint an independent special litigation committee to consider whether the corporation's best interest is to pursue or terminate the derivative litigation against the directors.

Answer 90

Some states say decision of independent and informed committee entitled to BJR deference Delaware: 1. Inquire into the independence and good faith of the committee; if met, then court may “in its discretion” 2. Apply its own independent business judgment to see if the motion should be granted (usually cost/benefit) Talk about the first prong and spend NO MORE than a sentence or two on the second prong UNLESS something really egregious is going on.

Answer 91

Designed by defense bar to designate forum to litigate corporation’s “internal affairs” Deemed valid Boilermakers v. Chevron (Del. Ch. 2013) Court says procedural in nature + binding on shareholders DE legislature validates selection of DE as forum (2015) => validity questions recede

Answer 92

“a bylaw that seeks to regulate the forum in which such ‘intra-corporate’ litigation can occur is a provision that addresses the ‘management of the business’ and the ‘conduct of the affairs of the corporation,” and is, thus, facially valid under Section 102(b)(1).”

Answer 93

Acquire shares from controlling shareholder | Purchase and aggregate shares of many small shareholders

Answer 94

State corporate law focuses on seller’s duties – Regulating premia from sales of control – Sale of managerial power without transfer of controlling shares (“sale of corporate office”) – Screening out buyers who are potential looters • Federal securities regulation focuses on buyer’s duties in tender offers

Answer 95

“Market rule”: sale of control creates rights between parties (i.e., only between acquirer and controlling shareholder) “[A]bsent looting of corporate assets, conversion of corporate opportunity, fraud, or other acts of bad faith, the controlling shareholder is free to sell, and purchaser free to buy, that controlling interest at a premium price” (Zetlin v. Hanson Holdings (NY 1979)) Market rule, “it’s not yours to sell, minority shareholder, can’t get premium under these circumstances”

Answer 96

Trading managerial power without selling controlling shares, might set off red flags (ill get my buddies to resign from the board) Sale of small block of stock at a premium by corporate insiders in exchange for transfer of control to buyer Consider: 1. relative size of sale 2. premium obtained smaller sale and higher premium raises red flags * E.g., sale of 9.7% block at slight premium upheld (Carter v. Muscat (NY App. 1964)) * E.g., sale of 4% block at 35% premium deemed “contrary to public policy and illegal” (Brecher v. Gregg (NY 1975))

Answer 97

1. Corporate opportunity: by selling, controller is foregoing a corporate opportunity that belongs to all shareholders 2. Controlling seller as fiduciary: emphasizing that successful transaction requires some form of corporate action by controller * challenge controller as fiduciary using corporate machinery, not controller as shareholder selling shares (In re Digex (Del. Ch. 2000) re: waiver of DGCL § 203) * E.g., “non-ratable” benefits to controller, threats that contravene committee “approval” (In re Straight Path Communications (Del. Ch. 2018))

Answer 98

Steel manufacturer sells shares at massive premium due to shortage of steel rule: Where the sale of a corporation’s controlling interest commands an unusually large premium due to a market shortage of the corporation’s product, a fiduciary may not appropriate to himself the value of that premium. LOSS OF CORPORATE OPPORTUNITY (ie. "the sale price contained higher premium than sale of the controlling interest in Newport would under ordinary market conditions")

Answer 99

Challenge not as a controlling shareholder, but as a fiduciary who has control. Lead with this argument, stronger than the other * challenge controller as fiduciary using corporate machinery, not controller as shareholder selling shares (In re Digex (Del. Ch. 2000) re: waiver of DGCL § 203) * E.g., “non-ratable” benefits to controller, threats that contravene committee “approval” (In re Straight Path Communications (Del. Ch. 2018))

Answer 100

Under Delaware law, a controlling shareholder is generally permitted to obtain a premium for his or her shares, but the controlling shareholder may give up this right by contract or a charter provision.

Answer 101

– Seller’s duty to screen against selling control to looter – Murky tort-like duty that resembles negligence. . . --> • When transferring control, controlling shareholder sometimes has duty to “investigate the bona fides of the buyer. . . 1. to take such steps as a reasonable person 2. would take to ascertain that the buyer does not intend or is unlikely to plan any depradations of the corporation.” (Harris v. Carter (DE Ch. 1990) REAL NEGLIGENCE STANDARD OF REASONABLE PERSON

Answer 102

Prove my client did something wrong Tell client to disclose

Answer 103

the controlling shareholder owes the other shareholders a duty of care. Carter lost for not being reasonable If circumstances surrounding a sale of control would alert a reasonably prudent person to a risk that the buyer is dishonest, the seller has a duty to make a reasonable inquiry to ensure that the buyer does not intend to defraud the other shareholders.

Answer 104

Federal securities laws regulate tender offers to shareholders of public companies Give shareholders time and information. Meant to stop very sudden sales to avoid boiler room situations. 1. “Early warning system”: public disclosure if acquire more than 5% of voting stock (§ 13(d)) - -Typically within 10 days of acquiring shares (Rule 13d-1(a)) 2. Disclosure of offer: offeror must disclose identity, financing, future plans (§ 14(d)(1)) - -Target board must comment on bid (Rule 14e-2) - -Corporation must make similar disclosures if tendering for own shares (Rule 13e-4) 3. Antifraud (§ 14(e)) - -Specific prohibition against insider trading (Rule 14e-3) 4. Substantive terms of offer: timeframe, price - -Offers must be left open for at least 20 business days (Rule 14e-1) - -Tender offer must be open to all shareholders at the same price (Rule 14d-10) You can set conditions! But can't change among shareholders

Answer 105

– “Tender offer” not defined (e.g., Brascan v. Edper Equities (SDNY 1979) • Federal courts look to factors such as whether: solicitation, purchase contingent on minimum number of shares, fixed price • SEC has 8-part test which has been criticized by courts – Hart-Scott-Rodino Act (antitrust) can also affect timing of transactions • Wait 30 calendar days after notification, during which government may request more information • Timeframe shortened to 15 calendar days for cash tender offers

Answer 106

– Merger: unites to existing corporations in toto – Asset acquisition: purchase of target’s assets – Share acquisition: purchase of target’s shares

Answer 107

Typical estimates: TARGET SHAREHOLDERS: 15-20% returns ACQUIROR SHAREHOLDERS: -2% to 2% returns

Answer 108

Requires shareholder vote because shares bought pursuant to charter

Answer 109

Look after the transaction (ex post) to see whether shareholders in question will still have similar power (governance rights) in corporation? – If yes, unlikely to be given vote ex ante; if no, likely to be given vote ex ante

Answer 110

Can also affect timing of transactions Wait 30 calendar days after notification, during which government may request more information Timeframe shortened to 15 calendar days for cash tender offers

Answer 111

Need majority consent of shareholders to approve

Answer 112

Purchase assets of target • Picking and choosing assets can minimize liability • But high transaction costs (e.g., going through titles)

Answer 113

Purchase 100% of stock

Answer 114

Common stock of target always has voting rights; common stock of survivor has voting rights unless under DGCL §251(f): • Charter not modified; • Securities held not exchanged or modified; and • Outstanding common stock not increased by more than 20%

Answer 115

Goal: minimizing liability • Technique – Acquiror (“A”) forms subsidiary (“NewCo”) – NewCo merges into Target (“T”) (“reverse” triangular merger) or T merges into NewCo (“forward” triangular merger) – Merger consideration distributed directly from A to T’s shareholders

Answer 116

Concept that if transaction achieves same results as merger, then should be treated as merger—even if transaction not formally structured as merger. But most jurisdictions, including Delaware, have not adopted the doctrine

Answer 117

In some mergers, shareholders can dissent and ask court for fair going-concern value of corporation. a plaintiff may bring both appraisal action and fiduciary claim

Answer 118

Plaintiff argues defective disclosure impedes ability to seek appraisal (e.g., Berger v. Pubco (Del. 2009))

Answer 119

• Shareholders in private firm (with 2,000 or fewer shareholders) always get appraisal rights, assuming they have the right to vote on the merger • Shareholders in public firm (or private firm with more than 2,000 shareholders) do not get appraisal rights in where receive stock in surviving corporation or other shares traded on national exchange – But do get appraisal rights if receive cash as consideration » Unless receiving cash in lieu of fractional shares

Answer 120

– Baseline: 1. controlling shareholder must show transaction is “fair” 2. If approval obtained from disinterested body (board or shareholder): plaintiff must show transaction is unfair (i.e., burden shift).

Answer 121

Fuzzy concept, focused on ability to use corporate machinery • In practice, look to influence on board elections and committees, access to confidential information, relative size of shareholdings Can have “control” even if not majority shareholder controlling shareholder effectuating a merger has duty of fairness

Answer 122

Duty of fairness does not attach => offer is permissible as long as it is not “coercive” (e.g., In re Siliconix (DE Ch. 2001)) “Non-coerciveness” more defendant-friendly standard than fairness Typically look to: absence of retributive threats (e.g., threaten to discontinue paying dividends), commitment to consummate short-form merger at same price if obtain 90% or more of shares, use of non-waivable majority of minority tender condition

Answer 123

Well-informed lawyers tend toward structuring controlling shareholder buyouts as tender offers in post-Siliconix era

Answer 124

BJR presumed if freeze-out merger or tender offer is: 1. Negotiated and approved by independent directors; and 2. Conditioned upon approval by majority of minority shareholders

Answer 125

DE suggests § 102(b))(7) waiver allows dismissal of independent directors only if Plaintiffs plead duty of loyalty

Answer 126

1. Must be “ab initio. . .at the start of economic negotiations” 2. As well as during actual negotiations

Answer 127

(a) Specifically deals with insider trading Directors, officers, greater than 10% shareholders (“statutory insiders”) must disclose when achieve insider status, as well as subsequent trades Report due by end of second business day following the transaction (b) Profits from purchases and sales of company stock by statutory insiders within a 6- month period must be disgorged Both over- and under-inclusive

Answer 128

DCF, Something between unaffected market price and something between the deal price.

Answer 129

Rule 10b-5: “It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange: a. To employ any device, scheme, or artifice to defraud, b. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

Answer 130

1. Material misstatement or omission 2. In connection with the purchase or sale of a security (“standing”) 3. Made with intent to deceive (“scienter”) 4. Upon which there is reliance 5. Causing 6. Injury (e.g., damages) Government can’t show 1-3, mostly precedent. Private must show 1-6. SC has not explicitly said this but lower courts have

Answer 131

A fraudulent transaction under § 10(b) of the Securities Exchange Act of 1934 must involve conduct that is manipulative or deceptive. Supreme Court refuses to allow complaint about merger transaction to be brought as 10b-5 claim Argues separation between federal securities regulation (which deals with deception practiced on investors) vs. state corporate law (which deals with fiduciary duties of corporate officers and directors)

Answer 132

Merger (board and shareholders vote) and tender offer (no vote, direct to shareholders). Different requirements. Merger: “fairness” (with burden on controlling shareholder) Tender Offer: “non-coerciveness” ~BJR You can pretty much now forget about “non-coerciveness” Now: M&F Worldwide and CNX: “unified standard”

Answer 133

If it’s a misstatement, quick analysis you got a fraud claim If it’s an omission, need a bigger analysis for fraud or insider trading

Answer 134

Defined as unlawful trading by persons possessing “material non-public” information Perhaps ironically, most important enforcement tool is section 10(b)/Rule 10b-5 general antifraud statute

Answer 135

Court says no general duty between participants in market transactions to forego actions based on material non-public information (i.e., no parity of information rule) – Seems to argue that to be liable for insider trading, defendants would need to be a corporate insider owing fiduciary duty to corporation – Significantly more defendant-friendly than “equal access” theory Might be gone now?

Answer 136

Original Tipper: 1. Was there a violation of Fiduciary duty? 2. Did he receive a personal benefit? (likely has to be pecuniary) Tippee: 3. Knows or should have known of breach? As tippees become more remote, more difficult to prosecute Ask “knows or should have know of breach” at each tippee level

Answer 137

“Equal access” rule in context of tender offers • Once “substantial step” toward commencement of tender offer taken, bars anyone (other than bidder) from acquiring securities while in possession of material information that the person knows or has reason to believe is non-public and acquired from bidder, target or person associated with these entities

Answer 138

– Prohibits selective disclosure by issuers; for example, to preferred analysts and investors

Answer 139

Supreme Court adopts in US v. O’Hagan (US 1997) Fraud committed “in connection with” securities transaction when misappropriate confidential information for trading securities, in breach of duty owed to source of information Policy: protect markets from insider trading by those who might not necessarily owe fiduciary duty to shareholders Deception through nondisclosure

Answer 140

Overall concept: material if “substantial likelihood reasonable investor would consider it important” – Material if affects “total mix” of information • For forward-looking information: balance probability event will occur with magnitude of event

Answer 141

Simple rule: need to be actual purchaser or seller of securities (Blue Chip Stamps v. Manor Drug (US 1975)) i.e., no holders or potential purchasers Note: Must have an actual purchase or sale

Answer 142

“Mental state embracing intent to deceive, manipulate, defraud” Most courts treat “recklessness” as enough to constitute scienter for purposes of § 10(b)/Rule 10b-5 Typically, strong inference arises upon showing of possession of info SEC adopts Rule 10b5-1 with its affirmative defenses (“10b5-1 plans”) Note: Usually possession of the information is enough to show “scienter”

Answer 143

Assumes price of stock determined by availability of material information As such, misleading statements distort stock price, even if purchasers don’t directly rely on misstatements. Investor who buys or sells stock at price set by market does so in reliance on integrity of that price But any showing that severs link between misrepresentation and price paid sufficient to rebut presumption (e.g., privy to information, bought/sold for other reasons)

Answer 144

Analogous to “proximate cause” in torts – Inquiry into foreseeability Seems to require that plaintiffs demonstrate price movements caused by fraud, as opposed to other factors Note: Very high burden on the plaintiff

Answer 145

Generally, two possibilities – Compensation? “Put the plaintiff in the position plaintiff would have been in had there not been fraud” • “Out-of-pocket” measure: compare price paid to value of stock were there no fraud – Deterrence? Punish the defendant for wrongdoing • E.g., disgorgement • But what if this overcompensates the plaintiff?