Corporations: Shareholder Duties

Question 1

Direct Suit

Answer 1

Suit alleging a direct loss to shareholder

Question 2

Derivative Suit

Answer 2

A suit alleging a loss to the shareholder caused by a loss to the corporation.

Two suits in one:
- Corporation against the directors for their failure to carry out fiduciary duties
- Suit by the plaintiff arguing that he or she should substitute for the directors in managing this particular aspect of the corporation’s business

Question 3

Basis for Direct v. Derivative Claims

Answer 3

Basis for Direct Claims:
○ Force payment of promised dividend
○ Enjoin activities that are ultra vires
○ Claims of securities fraud
○ Protect participatory rights for shareholders

Basis for Derivative Suits:
○ Breach of Duty of Care
○ Breach of Duty of Loyalty

Question 4

Remedy in Derivative Suit

Answer 4

○ Remedy from principal suit goes to corporation;
○ Corporation is required to pay shareholder attorney’s fees if suit is successful or settles

Question 5

Duties, Liabilities, and Roles of Corporate Actors

Answer 5

Board of Directors
Duties: Fiduciary Duties of Care and Loyalty
Liabilities: Breach of Fiduciary Duty
Roles: Manage Business

Shareholders
Duties: None, unless controlling (Controlling shareholders owe fiduciary duties to the minority )
Liabilities: Only if pierce corporate veil
Roles:
- Sue (Direct or Derivative)
- Vote
- Sell

Question 6

Procedural Hurdles of a Derivative Suit

Answer 6

1) Bonding Requirements (A derivative claimant with “low stakes” must post security for corporation’s legal expenses [deters frivolous lawsuits])

2) Demand Requirement

3) Special Litigation Committees

Question 7

Demand Requirement

Answer 7

Most states require shareholders to approach Directors and demand they pursue legal action (unless the shareholder can claim a valid excuse)

Letter from SH to directors includes:
- Request that the board bring suit on the alleged cause of action
- Specific facts to apprise the board of the nature of the alleged cause of action and to evaluate its merits

Court of Chancery Rule 23.1: The complaint shall allege “the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors … and the reasons for the plaintiff’s failure to obtain the action OR for not making the effort”

Question 8

What to ACTUALLY do in Deleware

Answer 8

A rational plaintiff will file derivative suit before making demand

• Consequences of not making demand trivial (if required, slight delay while you make demand)
• Preserves right to litigate

Question 9

How to Excuse Demand

Answer 9

Post-Aaronson:

Demand excused if it is shown that demand is futile. Do this by showing there was a reasonable doubt that:
(a) Majority of directors are disinterested, or
(b) The challenged transaction was product of valid exercise of business judgment.

NEW TEST under Zuckerberg
To excuse demand, a complaint must allege that at least ½ of the members of the board:
(1) received a material personal benefit from the misconduct
(2) face a substantial likelihood of liability, or
(3) lack independence from someone who received a material personal benefit from the alleged misconduct

Question 10

Derivative Suit Decision Tree

Answer 10

Direct Suit:
- Plaintiff sues

Derivative Suit:
- “Demand” Decision
- If Demand excused, then Plaintiff sues (may still face Special Litigation Committee)

• If Demand required, Demand Made

Question 11

Special Litigation Committees

Answer 11

NEW YORK: Aurebach v. Bennett
Substantive decision by the SLC fall squarely within the business judgment doctrine. However, judicial inquiry is permitted with respect to:
- Disinterested independence of SLC members
- Adequacy of SLC’s investigation
- Burden of proof on plaintiff

DELAWARE: Zapata v. Maldonado
STEP 1:
■ Inquiry into the independence and good faith of the committee
■ Inquire into the bases supporting the committee’s recommendations

STEP 2
■ Court applies its own business judgment as to whether the case should be dismissed

Question 12

Shareholder Voting: Default Rule

Answer 12

Default Rule is one share = one vote, unless Articles of Incorporation provide otherwise

Question 13

When do Shareholders Vote

Answer 13

Shareholder Meetings
○ Annual meetings (MBCA § 7.01)
■ Time set in bylaws
○ Special meetings (MBCA § 7.02)
■ By request of Board of Directors, or
■ At written request of at least 10% of shares

If there is unanimous written consent, shareholders may take action without a meeting, unless CoI provides otherwise

Question 14

How Many Votes do You Need

Answer 14

MBCA: Majority of shares present at a meeting at which there is a quorum. (e.g., if 100 shares outstanding and 60 shares present, only need 31 votes)

Delaware: Default is a majority of shares entitled to vote. Certificate or bylaws can opt out of default, but never less than ⅓ of the shares. (e.g., if 100 shares outstanding and 60 shares present, need 51 votes)

Question 15

Who Nominates Directors: Default

Answer 15

Default: Incumbent Board nominates a slate of directors
- Company sends out official proxy solicitation materials
- A competing slate can be offered in separate proxy materials
- Dodd-Frank / SEC allows direct nomination if shareholder owns >3% of shares for 3 years

Question 16

Straight v. Cumulative Voting

Answer 16

Straight voting (DE): when a shareholder votes, the number of votes the shareholder has is accorded to each slot that is up for election/being voted upon

Cumulative voting (CA): each shareholder’s # of votes is multiplied by the number of director positions up for election and the shareholder can split their votes any way they like

Question 17

Plurality Voting v. Majority Voting

Answer 17

Plurality: whoever gets the most votes for the seat wins in plurality

Majority: must get majority of votes to receive seat

Question 18

Voting for directors v. filling vacancies

Answer 18

Delaware: SHs may act by written consent to elect. directors in lieu of an annual meeting only if:
(i) action is by unanimous written consent or
(ii) action by non-unanimous consent is exclusively to fill director vacancies

Question 19

Froessel Rule

Answer 19

incumbent board proxy costs paid regardless of outcome; insurgent costs may be reimbursed if insurgents win

Question 20

SH Voting to Amend AoI and Bylaws

Answer 20

MODIFYING ARTICLES OF INCORPORATION
MBCA:
● (a) Amendment must be adopted by the board of directors, and
● (e) approved by a majority of the votes of the SHs present (as long as a quorum)

DGCL:
● The directors shall adopt a resolution and holders of a majority of the outstanding stock must vote in favor of the amendment.

MODIFYING BYLAWS
MBCA:
● (a) Shareholders may amend or repeal, and
● (b) Directors may amend or repeal, unless pertaining to director election or bylaws prohibit

DGCL:
■ The power to adopt, amend, or repeal bylaws shall be in the stockholders entitled to vote (plus, directors may also have this power if so provided in the articles of incorporation)

Question 21

Shareholder Voting on Fundamental Transactions

Answer 21

YES (e.g., Merger)

Question 22

Shareholder Voting on Precatory Measures + Corporation’s Response

Answer 22

Qualifying shareholders can put a proposal before their fellow shareholders (company pays expenses)

This SH must have owned at least 1% or $2,000 (whichever is less) of the issuer’s securities for at least one year prior to the date the proposal is submitted

Corp Response:
(1) The Corp is required to include the proposal UNLESS it can prove to the SEC that it may be excluded under Rule 14a-8 (e.g., law would be violated, involves special interest, not relevant to firm’s operations)

(2) Corp can include the proposal with opposing statement

(3) Corp can negotiate with proponent

Question 23

Shareholder Duties: Selling (Two Main Laws)

Answer 23

Securities Fraud Lawsuits (both gov and private Ps)

Insider Trading Prohibition (enforced by SEC and DoJ)

Question 24

Requirements for Private Securities Fraud Suit

Answer 24

(1) Material misrepresentation or omission
● Substantial likelihood that a reasonable shareholder would consider the fact important”

(2) Scienter
● Requires pleading with “particularity facts giving rise to a strong inference that the defendant acted with the intent to deceive, manipulate, or defraud

(3) Reliance
■ “Fraud on the market” theory: Rebuttable presumption that investor relied on integrity of public trading market price when making investment decision, so investor need not have seen misrepresentation (i.e., If you lied and the stock went up because of the lie, then we’re going to assume they relied on this)

(4) Causation
● Fraud caused the plaintiff’s loss (Change in stock prices when truth revealed)

Question 25

Classic Insider Trading

Answer 25

A fiduciary trades in shares of their own firm, based on information gained as a fiduciary

Question 26

Tipper and Tippee liability

Answer 26

From Dirks, Rule10b-5

If someone who obtains insider knowledge then “tips” someone else, the tipee is not liable.

Question 27

Constructive Insider

Answer 27

People who can violate insider trading prohibitions

Someone is a Constructive Insider if they:
(1) Obtain material nonpublic information from the issuer,
(2) With an expectation on the part of the corporation that the outsider will keep the disclosed information confidential, and
(3) The relationship at least implies such a duty

Question 28

Misappropriation Theory

Answer 28

From Rule 10b-5; O’Hagan [expanded the definition of what constitutes insider trading based on misappropriation theory]

A person has a duty of trust or confidence for the purpose of misapp. theory (Non-exhaustive list):
(1) whenever a person agrees to maintain information in confidence;
(2) whenever the people communicating have a history such that the recipient of information knows or should reasonably know that the information is confidential; or
(3) whenever the information is obtained from a spouse, parent, child, or sibling, UNLESS recipient shows that history of no expectation of confidentiality

Question 29

Defense to Insider Trading Claim: Pre-Planned Transactions

Answer 29

Any person executing pre-planned transaction that was established in good faith at a time when that person was unaware of material nonpublic information has an affirmative defense against accusations of insider trading

Question 30

Prohibiting Insider Trading During a Tender Offer

Answer 30

Once substantial steps are made towards a tender offer, anyone who possesses MNPI about the offer is prohibited from trading in the target’s securities (except the bidder).

Prohibits anyone connected with the tender offer from tipping MNPO

NOT premised on a breach of fiduciary duty
■ O’Hagan upholds it anyway

Question 31

Statutory Insider Trading Rules

Answer 31

(a) Reporting obligations
■ If a “statutory insider” (own over 10%, are a director or officer) then must report ownership stake to SEC

(b) Bright-line short-swing trading rule.
■ Statutory insider profits from a purchase and sale within six months are recoverable by the firm

Question 32

Statutory Insider Trading Approach

Answer 32

(1) Is the company public?

(2) Is the defendant a director, officer, or beneficial owner of the company?
■ Directors and officers: you can match any transactions within 6 months while in position
■ Beneficial owner: only if she owned more than 10% at the time of the purchase and of the sale, and within 6 months

(3) Can you match any purchase and sale within a 6 month period that yields profits?

Question 33

Universal Proxy Access Rules

Answer 33

Historically, shareholders voting by proxy in contested director elections were unable to vote for a combination of director nominees from competing slates.

A universal proxy card lists the names of all duly-nominated director candidates, regardless of whether the candidates were nominated by management or shareholders.

Under new Rule 14a-19, Commission requires use of universal proxy cards by management and shareholders soliciting proxy votes in director election contests.

New rule applicable to all shareholder meetings involving director elections held after August 31, 2022