Dammann's Corporate MCQs

Question 1

Under Delaware law, which of the following elements does not necessarily have to be included in a corporation’s certificate of incorporation?

(A)The address of the corporation’s registered office in Delaware.

(B)The addresses of the incorporators.

(C)The nature of the business or purposes to be conducted or promoted.

(D)None of the above answers is correct.

Answer 1

(D) is the correct answer.

According to DGCL §102(a)(2), the certificate of incorporation has to name the address of the corporation’s registered office in Delaware. Furthermore, DGCL §102(a)(3) provides that the certificate of incorporation has to contain the nature of the business or purposes to be conducted or promoted. Admittedly, it is sufficient to state that the purpose of the corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware, DGCL §102(a)(3). However, the fact that the purpose can be of a very general nature does not eliminate the necessity to state this purpose in the certificate of incorporation. Moreover, according to DGCL §102(a)(5), the certificate of incorporation must include the name and mailing address of the incorporator or incorporators.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 2

Horizon Corp. is a Delaware corporation. It has two shareholders, namely Ernest and Bert. Each of them holds one share, and each of them is a director of the corporation. The corporation does not have any other directors. In former times, Ernest and Bert were good friends. Now, however, they fight all the time. They cannot agree on anything, and the corporation has not adopted any board resolutions for over a year. Which, if any, of the following statements is correct?

(A)If either Bert or Ernie requests the dissolution of the corporation, the Delaware Chancery Court may dissolve the corporation.

(B)The Delaware Chancery Court cannot dissolve the corporation.

(C)The Delaware Chancery Court can dissolve the corporation, but only if both Ernie and Bert request such a dissolution.

(D)None of the statements above is correct.

Answer 2

(A) is the correct answer.

The dissolution of the corporation in case of deadlock is governed by DGCL §273. Under that provision, the Delaware Chancery Court can dissolve a corporation with two shareholders, each of whom owns 50%, if one of the shareholders petitions for the corporation’s dissolution and if the shareholders are “unable to agree upon the desirability of discontinuing such joint venture and disposing of the assets used in such venture.” These conditions are met in the case at hand.

(B) is incorrect.

See the answer to choice A.

(C) is incorrect.

See the answer to choice A.

(D) is incorrect.

See the answer to choice A.

Question 3

Rebel Corp. is a Delaware corporation. It owns and operates an advertising agency. The corporation has four shareholders named Alexandra, Bella, Carl, and Dave. Rudy is the sole director of Rebel Corp. On January 5, after carefully investigating and analyzing all relevant facts, the board resolves to lease a new office for the corporation. The lease is twice as expensive as that for the old office, but the new office is much more centrally located and looks much more “upscale,” which, in Rudy’s opinion, will make it much easier to attract new customers. The shareholders are furious. All of them are opposed to the board’s decision. However, the next day, Rudy proceeds as planned and leases the new building while canceling the lease for the old office. Which of the following statements is correct?

(A)Rudy has neither violated his duty of loyalty nor his duty of care.

(B)Rudy has violated his duty of care but not his duty of loyalty.

(C)Rudy has violated his duty of loyalty but not his duty of care.

(D)Rudy has violated both his duty of loyalty and his duty of care.

Answer 3

(A) is the correct answer.

Under Delaware law, the duty of loyalty requires the directors to act in the best interest of the corporation. However, this does not mean that the directors have to bow to the wishes of the shareholders. Rather, as the Court of Chancery explained in American Int’l. Rent a Car, Inc. v. Cross, 7583, 1984 WL 8204, at *3 (Del. Ch. May 9, 1984), it is not “a per se breach of fiduciary duty for the Board to act in a manner which it may believe is contrary to the wishes of a majority of the company’s stockholders.” Rather, the directors must act according to what they believe is in the best interest of the corporation, even if the shareholders disagree. Since Rudy believed the move to the new office to be in the corporation’s best interest, he has not breached his duty of loyalty.

Moreover, Rudy has not breached his duty of care either. A violation of the duty of care occurs where a director acts without being reasonably informed. The burden of proof is on the plaintiff. In the case at hand, Rudy made his decision only after carefully investigating and analyzing all relevant facts. (The facts mention that “the board” investigated and analyzed all relevant facts, but the corporation only has a single director, namely Rudy.) Accordingly, Rudy did not violate his duty of care.

(B) is incorrect.

See the answer to choice A.

(C) is incorrect.

See the answer to choice A.

(D) is incorrect.

See the answer to choice A.

Question 4

Which of the following provisions cannot be included in the certificate of incorporation of a Delaware corporation without violating Delaware law?

(A)A provision limiting the duration of the corporation’s existence to a specified date.

(B)A provision imposing personal liability for the debts of the corporation on its stockholders.

(C)A provision eliminating or limiting the liability of a director to the corporation or its stockholders for monetary damages for breach of the duty of loyalty.

(D)A provision requiring for certain corporate actions the vote of a supermajority of 90% of all shares entitled to vote on the matter.

Answer 4

(C) is the correct answer.

DGCL §102(b)(7) allows provisions eliminating the liability of corporate directors for fiduciary duty violations. However, “such provision shall not eliminate or limit the liability of a director … [f]or any breach of the director’s duty of loyalty to the corporation or its stockholders.” Accordingly, any provision seeking to limit or eliminate the liability of a director to the corporation or its stockholders for monetary damages for breach of the duty of loyalty violates Delaware law.

(A) is incorrect.

According to DGCL §102(b)(5), the certificate of incorporation may contain a “provision limiting the duration of the corporation’s existence to a specified date.”

(B) is incorrect.

Under DGCL §102(b)(6), the certificate of incorporation may contain “[a] provision imposing personal liability for the debts of the corporation on its stockholders.”

(D) is incorrect.

Under DGCL §102(b)(4), the certificate of incorporation may contain “[p]rovisions requiring for any corporate action, the vote of a larger portion of the stock or of any class or series thereof, or of any other securities having voting power, or a larger number of the directors than is required by this chapter.” The words “this chapter” refer to the Delaware General Corporation Law.

Question 5

Hypo Corp. is a newly formed Delaware corporation. At its first board meeting on January 1, it issues ten par value shares with a par value of $10 per share at a price of $50 per share. The board does not adopt any resolution regarding the increase in the amount of capital. On June 1, Hypo Corp. issues ten no-par value shares at a price of $20 each. Again, the board adopts no resolution regarding the increase in capital with respect to these shares. On August 8, the corporation’s net assets amount to $10,000,000. The board decides, via resolution, that the capital shall be increased by $50,000. What is the capital of the corporation?

(A)$100.

(B)$300.

(C)$50,000.

(D)$50,300.

Answer 5

(D) is the correct answer.

To answer this question correctly, it is essential to understand the difference between a corporation’s net assets and its capital. A corporation’s net assets equal its total assets minus its total liabilities, DGCL §154. In the case at hand, the facts explicitly state that the corporation’s net assets amount to $10,000,000.

A corporation’s capital is an entirely different concept and one that can best be understood in the context of the rules governing dividends: As a general rule, corporations cannot distribute all of their assets to their shareholders as dividends. Rather, they can only pay dividends “out of [their] surplus,” DGCL §170(a), or, in the absence of a surplus, out of their “net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.”

Let us ignore, for now, the rule that dividends can be declared out of the profits for the current or the preceding fiscal year. Then corporations can only declare dividends out of their surplus. The surplus is defined as the amount by which the corporation’s net assets exceed its capital, DGCL §154. Thus, the term “capital” refers to the amount that the corporation has to hold in reserve before it can pay dividends. In other words, the law wants corporations to amass a “financial safety cushion” before they can distribute money to their stockholders, and the corporation’s “capital” is the number that tells us how big that financial safety cushion must be.

It is crucial to understand this difference between net assets and legal capital. The term “net assets” refers to the assets that the corporation actually has. By contrast, the term “capital” refers to the amount of assets that the corporation must have before it can pay dividends. For example, if the corporation has $1,300,000 in assets and a capital of $1,000,000, then the corporation can pay $300,000 in dividends.

Note that a corporation’s capital tells you very little about the corporation’s actual assets. For example, assume that a corporation’s capital is $10,000. Does that mean that the corporation has net assets in the amount of $10,000? Absolutely not. Rather, a capital of $10,000 only means that unless the corporation has assets in excess of $10,000 (or has made profits in the current or preceding fiscal year), the corporation cannot pay any dividends. But the corporation’s assets may in fact be much lower (or higher) than the corporation’s capital. For example, despite having a capital of $10,000, the corporation may only have assets in the amount of $2000.

Does a corporation violate the law if its assets are less than its capital? Not necessarily. Assume, for example, that a corporation’s capital is $10,000. Furthermore, assume that the corporation has net assets in the amount of $11,000 but that the corporation has not made any profit for five years. If the corporation now pays a dividend in the aggregate amount of $2000 and thereby lowers its net assets to $9000, then the corporation violates Delaware law. That is because the corporation’s surplus (net assets minus capital) was only $1000, and in the absence of profits, the corporation was only allowed to pay dividends out of its surplus. By contrast, if the corporation’s net assets are reduced from $11,000 to $9000 because the corporation’s business loses money or because the corporation’s warehouse is hit by lightning, no violation of Delaware law occurs. In other words, the law does not impose a duty on corporations to have net assets in the amount of the corporation’s capital. Rather, the law simply provides that a corporation cannot pay dividends unless its net assets exceed its capital (or unless the corporation has made profits in the current or the preceding fiscal year).

So how high was the corporation’s capital in the case at hand? A corporation’s capital is not necessarily constant. Instead, it can—and typically will—change over time. Hence, you need to proceed in chronological order: you start with the last known capital and then look for anything that might have increased or decreased the corporation’s capital.

Newly upon formation, the capital of the corporation was zero. This changed when the corporation issued the par value shares. Under DGCL §154, the default rule is that when a corporation issues par value shares, the capital is increased by the aggregate par value of the relevant shares. Because Hypo Corp. made no resolution regarding the effect of the share issuance on the corporation’s capital, we can apply the legal default. This means that the corporation’s capital was increased by ten times ten dollars, i.e., by $100.

On June 1, the corporation issued the no-par value shares. Under §154 of the Delaware General Corporation Law, the default rule is that when a corporation issues no-par value shares, the capital is increased by the total consideration received for those shares. In the case at hand, the board made no resolution regarding the impact of the share issuance on the corporation’s capital, and we can therefore apply the default. This means that the corporation’s capital was increased by an amount equal to the whole consideration, that is, $200 (10 x $20). Thus, following the share issuance on June 1, the corporation’s capital was $100 + $200 = $300.

On August 1, the board adopted a resolution to increase the capital. According to DGCL §154 of the Delaware General Corporation Law, the board can only increase the capital via a board resolution if, after the increase, the net assets are still greater than the capital. In the case at hand, that requirement is met: After the resolution, the capital amounted to $100 + $200 + $50,000 = $50,300. At the same time, the net assets amounted to $10,000,000. Given that the resolution was valid, the capital is now $50,300.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 6

Hypo Corp. is a Delaware corporation. Its capital is $10,000, its total liabilities amount to $5,000, and its total assets amount to $22,000. By how much can the board increase the corporation’s capital without issuing additional shares?

(A)$8,000.

(B)$12,000.

(C)$17,000.

(D)None of the above.

Answer 6

(D) is the correct answer.

Under DGCL §154, the directors may at any time increase the corporation’s capital by a board resolution “directing that a portion of the net assets of the corporation in excess of” the corporation’s capital “be transferred to the capital account.” Therefore, you first need to calculate the net assets. According to DGCL §154 of the Delaware General Corporation Law, “net assets means the amount by which total assets exceed total liabilities.” In other words, net assets equal total assets minus total liabilities (i.e., $22,000 − $5,000 = $17,000). Because the capital can be increased by “a portion of the net assets of the corporation in excess of the corporation’s capital,” DGCL §154, we then have to determine the amount by which the net assets exceed the capital, which amounts to net assets minus capital (i.e. $17,000 − $10,000 = $7,000). Therefore, the board could only increase the capital by a portion of $7,000, which means that choices A, B, and C are incorrect.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 7

Under Delaware law, which, if any, of the following statements is true about the corporation’s registered office.

(A)It has to be located in Delaware.

(B)It has to be located in the same location as the corporation’s primary place of business.

(C)It has to be located at the address of one of the corporation’s incorporators.

(D)None of the above statements is true.

Answer 7

(A) is the correct answer.

According to DGCL §131(a), the corporation’s registered office has to be located in Delaware.

(B) is incorrect.

DGCL §131(a) explicitly provides that the corporation’s registered office does not have to be the same as its place of business. In fact, it is absolutely standard for corporations to have their place of business in some other state such as Texas or Illinois while having merely a registered office in Delaware. Moreover, the registered office requirement is typically satisfied with the help of a service company that serves as a registered agent for thousands of companies. The result is that for thousands of companies, the registered office can be found at the same address, namely at the address of the relevant service provider.

(C) is incorrect.

The Delaware General Corporation Law contains no requirement that the corporation’s registered office must be located at the address of one of the incorporators.

(D) is incorrect.

See the answer to choice A.

Question 8

Which, if any, of the following is not true about the directors of a Delaware corporation.

(A)The number of directors must be fixed in the certificate of incorporation.

(B)A director may resign at any time.

(C)Directors need not be stockholders unless so required by the certificate of incorporation or the bylaws.

(D)All of the above statements are correct.

Answer 8

(A) is the correct answer.

The number of directors does not have to be fixed in the certificate of incorporation. In particular, it can also be fixed in the bylaws, DGCL §141(b).

(B) is incorrect.

A director may resign at any time, DGCL §141(b).

(C) is incorrect.

It is true that “[d]irectors need not be stockholders unless so required by the certificate of incorporation or the bylaws,” DGCL §141(b).

(D) is incorrect.

See the answer to choice A.

Question 9

Hypo Corp. owns $1,100,000 in cash and no other assets. It has liabilities in the amount of $100,000. Hypo Corp. has not made a profit for five years. It has ten shares outstanding. The corporation’s legal capital equals $1,000,000. The board of Hypo Corp. wants Hypo Corp. to pay a dividend in the amount of $10,000 per share. Would this be legal?

(A)Yes, Hypo Corp. can pay the dividend out of its surplus.

(B)Yes, but only because of the nimble dividends rule.

(C)Yes, despite the fact that the corporation does not have a surplus and despite the fact that the nimble dividends rule does not apply.

(D)No, the payment of the dividend would not be legal.

Answer 9

(D) is the correct answer.

Under DGCL §174 of the Delaware General Corporation Law, a corporation may pay dividends either out of its surplus—this is the so-called surplus rule—or, in case there is no surplus, out of “its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year”—this is known as the nimble dividends rule.

According to DGCL §154 of the Delaware General Corporation Law, the surplus equals the “excess, if any, at any given time, of the net assets of the corporation over the amount so determined to be capital shall be surplus.” Furthermore, the net assets refer to “the amount by which total assets exceed total liabilities.” In the case at hand, the net assets equal $1,000,000 and so does the legal capital, so that the corporation does not have any surplus. Accordingly, the desired dividend cannot be paid out of the surplus.

Under the nimble dividends rule, a corporation that has no surplus may pay a dividend out of “its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.” However, in the case at hand, the corporation has not made a profit for the last five years, and therefore cannot invoke the nimble dividends rule either. It follows that it would be illegal for the corporation to pay a dividend at this time.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 10

Gold Corp. is a closely-held Delaware corporation. George is the only director of Gold Corp. He was elected at an annual meeting that took place on January 11. In March, it becomes obvious that George is completely incompetent and is mismanaging the corporation. The shareholders are eager to replace George with another director, but, under the corporation’s bylaws, the next annual meeting will not be held until January 11 of the following year. In addition, George vehemently refuses to call a special meeting. Assume that the corporation’s certificate of incorporation and bylaws do not mention special meetings. Can the shareholders remove George before the next annual meeting?

(A)Yes. Under Delaware law, a special meeting must be called if one-quarter of the outstanding shares entitled to vote support such a request.

(B)Yes. The shareholders can remove George before the next annual meeting by written consent.

(C)Yes. Directors cannot be removed without cause. However, mismanagement constitutes cause for removal.

(D)No, it is not possible for the shareholders to remove George before the next annual meeting.

Answer 10

(B) is the correct answer.

Under DGCL §141(k) of the Delaware General Corporation Law, the general rule is that “[a]ny director may be removed with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors.” Hence, unless the corporation has a classified board, the removal of directors does not require cause.

But can the shareholders make their voices heard? It is not possible for the shareholders to call a special meeting. Under DGCL §211(d), special shareholder meetings may only be called “by the board of directors or by such person or persons as may be authorized by the certificate of incorporation or by the bylaws.” In the case at hand, the corporation’s certificate of incorporation and bylaws do not enable anyone to call special meetings.

However, under DGCL §228(b), shareholders can take action without an annual meeting and even without a vote “if a consent or consents in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted …” In other words, George can be removed by written consent as long as the consent is signed by the holders of a majority of the outstanding shares entitled to vote in an election of directors.

(A) is incorrect.

Under DGCL §211(d), the shareholders do not have the right to insist on a special meeting. See the answer to choice B.

(C) is incorrect.

Under DGCL §141(k), the general rule is that “[a]ny director may be removed with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors.” See the answer to choice B.

(D) is incorrect.

George can be removed by written consent under DGCL §228(b). See the answer to choice B.

Question 11

Which, if any, of the following statements is correct?

(A)A majority of all closely held corporations in the United States are incorporated in Delaware.

(B)Under Delaware law, a short-form merger in which the subsidiary corporation is the surviving corporation is called “consolidation.”

(C)In the case of a short-form merger under Delaware law, approval by the shareholders of the parent corporation is necessary only if the merger resolution amends the certificate of incorporation of the surviving corporation.

(D)None of the statements above is correct.

Answer 11

(D) is the correct answer.

See the answers to choices A, B, and C.

(A) is incorrect.

Whereas a majority of all public corporations in the United States are incorporated in Delaware, most closely held corporations—which constitute the vast majority of all corporations—are incorporated locally, that is, in the state where their primary place of business is located.

(B) is incorrect.

In a merger, two or more corporations are combined in such a way that only one of them still continues to exist after the merger, DGCL §251(a). The law refers to the latter corporation as the “surviving corporation,” DGCL §251(b)(3). When two corporations combine and the result is a wholly new corporation formed as part of the transaction, the law uses the term “consolidation,” DGCL §251(a).

(C) is incorrect.

In a short-form merger, approval by the shareholders of the parent corporation is always necessary when the subsidiary corporation is the surviving corporation, DGCL §253(a).

Question 12

Under the legal default (the rules that apply if neither the certificate of incorporation nor the bylaws provide for something else), which one of the following is not true.

(A)The board of directors may hold its meetings outside of Delaware.

(B)The board of directors has the authority to fix the compensation of directors.

(C)The board is not classified.

(D)One third of the total number of directors constitute a quorum for the transaction of business.

Answer 12

(D) is the correct answer.

According to DGCL §141(b), the legal default is that a “majority of the total number of directors shall constitute a quorum for the transaction of business.”

(A) is incorrect.

According to DGCL §141(g), the legal default is that board meetings may be held outside of Delaware.

(B) is incorrect.

According to DGCL §141(h), the legal default is that “the board of directors shall have the authority to fix the compensation of directors.”

(C) is incorrect.

When the board of directors consists of two or three classes of directors, we say that the board is “classified.” According to DGCL §141(d), the legal default is boards are not classified. Of course, in practice, classified boards are by no means unusual. In particular, among IPO firms (firms that have an initial public offering), the vast majority have classified boards.

Question 13

Larry, Moe, and Bearle want to run a for-profit business together. They want to avoid personal liability. Which of the following entity types does not confer protection against personal liability for all of its owners?

(A)The corporation.

(B)The limited liability company.

(C)The limited partnership.

(D)The statutory close corporation.

Answer 13

(C) is the correct answer.

In a limited partnership, there are two types of partners, namely limited partners and general partners. While the limited partners are not personally liable for debts of the partnership beyond any contribution that they have promised, any general partner faces unlimited personal liability. Moreover, each limited partnership must have at least one general partner. Therefore, the limited partnership does not offer the benefit of limited liability to all of its owners.

If entrepreneurs want to form a limited partnership but do not want to be personally liable, they may choose to form two entities: a corporation (or limited liability company) and a limited partnership in which the corporation (or limited liability company) is the general partner. That way, the entrepreneurs involved can all be limited partners. However, note that this possibility does not change the fact that (C) is the correct answer. That is because the question asks which entity type “does not confer protection against personal liability for all of its owners.” If Larry, Moe, and Bearle form a corporation (or limited liability company) and then also form a limited partnership in which the corporation (or limited liability company) is the general partner, the corporation (or limited liability company) is one of the owners of the limited partnership. Therefore, even in this scenario, the partnership does not “confer protection against personal liability for all of its owners.”

(A) is incorrect.

As a general rule, the shareholders of a corporation are not liable for the corporation’s debts unless the certificate of incorporation provides otherwise.

(B) is incorrect.

According to the legal default, the members of a limited liability company are not liable for the limited liability company’s debts.

(D) is incorrect.

As a general rule, the shareholders of a statutory corporation are not liable for the statutory close corporation’s debts unless the certificate of incorporation provides otherwise.

Question 14

Gold Corp. is a public corporation. It is incorporated in Delaware, all of its shareholders live in Illinois, and all of its board meetings take place in Texas, where all of the corporation’s directors live. The corporation’s primary place of business is located in Nevada. Which state law applies to the corporation’s internal affairs?

(A)Delaware law.

(B)Illinois law.

(C)Texas law.

(D)Nevada law.

Answer 14

(A) is the correct answer.

The internal affairs of a corporation are governed by the law of the state where the corporation has been incorporated. Since Gold Corp. was incorporated in Delaware, it is governed by Delaware Law.

Admittedly, New York and California have adopted so-called “pseudo-foreign corporation statutes” that apply parts of New York and California corporate law to corporations that have been formed elsewhere but have strong business contacts to New York and California (cf. Cal. Corp. Code §2115, N.Y. Bus. Corp. L. §§1317–1320). However, these pseudo-foreign corporation statutes do not apply to publicly traded corporations, and Gold Corp. is a publicly traded corporation. Moreover, in the case at hand, Gold Corp. does not have any ties to California or New York.

(B) is incorrect.

See the answer to choice A.

(C) is incorrect.

See the answer to choice A.

(D) is incorrect.

See the answer to choice A.

Question 15

Crouching Tiger Corp. is a Delaware corporation. Since its formation, Crouching Tiger Corp. has only issued ten shares. All of them are currently outstanding, and all of them are no-par value shares. All ten shares were issued on January 1, at a price of $1,000 per share in cash.

By January 15, the corporation’s total assets have dwindled to $20,000, whereas the corporation’s total liabilities amount to $21,000. Understandably, the board is quite concerned. That same day, the board, which had not addressed the issue in any prior resolution, holds a meeting attended by all of the corporation’s directors. At the meeting, the directors unanimously adopt a resolution according to which “half of the consideration received for the shares issued on January 1, shall be capital.” On January 18, the board has another meeting. At this point, the corporation’s total assets amount to $7,000, whereas the corporation’s total liabilities amount to $25,000. At the meeting on January 18, all board members are present, and the board unanimously adopts a resolution according to which “$4,999 of the capital represented by the no-par value shares is hereby transferred to surplus, effective immediately.” What is the corporation’s capital immediately after the board meeting on January 18?

(A)$1.

(B)$5,000.

(C)$5,001.

(D)$10,000.

Answer 15

(D) is the correct answer.

Originally, the corporation’s capital was zero. That changed when the corporation issued the no-par value shares on January 1. With no-par value shares, the default rule enshrined in DGCL §154 is that the capital is increased by an amount corresponding to the total consideration received for the no-par value shares. The board can decide to deviate from that default by board resolution, DGCL §154, but if the shares are issued for cash, that resolution has to be adopted by the time the shares are issued. Here, the total consideration received for the no-par value shares was ten times $1,000, and so amounted to $10,000. To be sure, the board did adopt a resolution according to which only part of the consideration received for the no-par value shares should be capital, but that resolution came too late. Hence, as a result of issuing the no-par value shares, the capital of the corporation was increased from $0 to $10,000.

The board later tried to lower the capital on January 18. In principle, a reduction of capital is possible, DGCL §154. However, under DGCL §244(b), no such reduction is possible if, after the reduction, the corporation’s assets are insufficient to pay its debts. That, of course, is the case here. Even before the intended reduction, the total liabilities were greater than the corporation’s total assets, and that would not have changed as a result of the reduction in capital. Hence, after the board meeting on January 18, the capital is $10,000.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 16

Spring Corp., Summer Corp., and Fall Corp. are Delaware corporations. Each of these corporations has only one class of shares. On January 1, Spring Corp. purchases 51% of the common stock of Summer Corp. On January 2, Summer Corp. purchases 51% of the common stock of Fall Corp. On January 3, Fall Corp. purchases 1% of the common stock of Spring Corp. On May 1, Spring Corp.’s annual shareholder meeting takes place. Which of the following statements is correct?

(A)At Spring Corp.’s annual meeting, the shares held by Fall Corp. cannot be voted or counted for quorum purposes.

(B)At Spring Corp.’s annual meeting, the shares held by Fall Corp. cannot be voted, but they can be counted for quorum purposes.

(C)At Spring Corp.’s annual meeting, the shares held by Fall Corp. can be voted, but they cannot be counted for quorum purposes.

(D)At Spring Corp.’s annual meeting, the shares held by Fall Corp. can be voted, and they can also be counted for quorum purposes.

Answer 16

(A) is the correct answer.

The key provision necessary to answer this question is DGCL §160(c). Its wording is a bit complicated, but the underlying idea is quite simple. The law does not want directors of a given corporation to use shares owned by that corporation to secure their own reelection. For example, imagine that you are the director of Spring Corp. and you are trying to get reelected. Without DGCL §160(c), you could simply let Spring Corp. acquire a majority of its own shares, and at the next annual meeting, you could—acting in Spring Corp.’s name—vote these shares in favor of your own reelection. That is why DGCL §160(c) prohibits the corporation from voting its own shares.

Of course, if you are a Spring Corp. director trying to secure your own reelection, you may take a somewhat more sophisticated approach. For example, you could let Spring Corp. acquire, directly or indirectly, a majority of the shares of Fall Corp. and then use these shares to elect your cronies to the board of Fall Corp. Now that you control the board of Fall Corp., you could ensure that Fall Corp. buys a sizeable number of your own company’s (Spring Corp.’s) shares and votes them in your favor at Spring Corp.’s next annual meeting. To prevent such a scheme, DGCL §160(c) also prohibits those shares from being voted that are indirectly controlled by the corporation where the vote takes place. Keeping these principles in mind, let us turn to the text of DGCL §160(c), which reads as follows:

Shares of its own capital stock belonging to the corporation or to another corporation, if a majority of the shares entitled to vote in the election of directors of such other corporation is held, directly or indirectly, by the corporation, shall neither be entitled to vote nor be counted for quorum purposes.

The term “the corporation” refers to the corporation where the shareholder meeting, i.e., the vote, takes place. In other words, in our case, “the corporation” is Spring Corp. Furthermore, the phrase “own capital stock” refers to shares issued by “the corporation.” In other words, the “shares of its own capital stock” are the shares that you need to elect the directors of “the corporation.” Thus, in our case, you can read DGCL §160(c) as follows:

[Spring Corp. shares] belonging to [Spring Corp.] or to another corporation, if a majority of the shares entitled to vote in the election of directors of such other corporation is held, directly or indirectly, by [Spring Corp.], shall neither be entitled to vote nor be counted for quorum purposes.

The term “other corporation” refers to any corporation that holds shares in the corporation where the shareholder meeting takes place. In other words, if X-corporation holds shares in Y corporation, and Y corporation wants to know whether the shares held by X corporation can be counted at Y corporation’s annual meeting, then Y corporation is “the corporation” (because that is where the annual meeting/the vote takes place) and X-corporation is the “other corporation” (because X-corporation owns the shares that we are trying to throw out). Thus, in our case, you can read DGCL §160(c) as follows:

[Spring Corp. shares] belonging to [Spring Corp.] or to [Fall Corp.], if a majority of the shares entitled to vote in the election of directors of [Fall Corp.] is held, directly or indirectly, by [Spring Corp.], shall neither be entitled to vote nor be counted for quorum purposes.

So, in other words, you cannot count Spring Corp. shares belonging to Fall Corp. if a majority of the shares entitled to vote in the election of directors of Fall Corp. is held directly or indirectly by Spring Corp. Thus, the question is: Does Spring Corp., directly or indirectly hold a majority of the shares entitled to vote in the election of directors of Fall Corp.?

Admittedly, Spring Corp. does not directly hold a majority of the shares entitled to vote in the election of directors Fall Corp. After all, Spring Corp. does not hold any Fall Corp. stock. But Spring Corp. indirectly holds a majority of the shares entitled to vote in the election of directors of Fall Corp. That is because Spring Corp. holds a majority of Summer Corp. stock, and Summer Corp. holds a majority of the common stock of Fall Corp. It follows that under DGCL §160(c), the shares held by Fall Corp. cannot be voted or counted for quorum purposes at the annual meeting of Spring Corp.

(B) is incorrect.

See the answer to choice A.

(C) is incorrect.

See the answer to choice A.

(D) is incorrect.

See the answer to choice A.

Question 17

Monday Corp, Tuesday Corp., and Wednesday Corp. are Delaware corporations. Each of these corporations has only one class of shares. On January 1, Monday Corp. purchases 51% of the common stock of Tuesday Corp. On January 2, Tuesday Corp. purchases 1% of the common stock of Wednesday Corp. On January 3, Wednesday Corp. purchases 51% of the common stock of Monday Corp. On May 1, Monday Corp.’s annual shareholder meeting takes place. Which of the following statements is correct?

(A)At Monday Corp.’s annual meeting, the shares held by Wednesday Corp. cannot be voted or counted for quorum purposes.

(B)At Monday Corp.’s annual meeting, the shares held by Wednesday Corp. cannot be voted, but they can be counted for quorum purposes.

(C)At Monday Corp.’s annual meeting, the shares held by Wednesday Corp. can be voted, but they cannot be counted for quorum purposes.

(D)At Monday Corp.’s annual meeting, the shares held by Wednesday Corp. can be voted, and they can also be counted for quorum purposes.

Answer 17

(D) is the correct answer.

Section 160(c) of the Delaware General Corporation Law reads as follows:

Shares of its own capital stock belonging to the corporation or to another corporation, if a majority of the shares entitled to vote in the election of directors of such other corporation is held, directly or indirectly, by the corporation, shall neither be entitled to vote nor be counted for quorum purposes.

The term “the corporation” refers to the corporation where the shareholder meeting and hence the vote takes place. In other words, in our case, “the corporation” is Monday Corp. Furthermore, the term “own capital stock” refers to shares issued by “the corporation.” In other words, the “shares of its own capital stock” are the shares that you need to elect the directors of “the corporation.” Thus, in our case, you can read DGCL §160(c) as follows:

[Monday Corp. shares] belonging to [Monday Corp.] or to another corporation, if a majority of the shares entitled to vote in the election of directors of such other corporation is held, directly or indirectly, by [Monday Corp.], shall neither be entitled to vote nor be counted for quorum purposes.

The term “other corporation” refers to any corporation that holds shares in the corporation where the annual meeting takes place. In other words, if X corporation holds shares in Y corporation, and Y corporation wants to know if these shares can be counted at Y corporation’s annual meeting, then Y corporation is “the corporation” [because that is where the annual meeting takes place) and X-corporation is the “other corporation” (because X-corporation owns the shares that we are trying to throw out). Thus, in our case, you can read DGCL §160(c) as follows:

[Monday Corp. shares] belonging to [Monday Corp.] or to [Wednesday Corp.], if a majority of the shares entitled to vote in the election of directors of [Wednesday Corp.] is held, directly or indirectly, by [Monday Corp.], shall neither be entitled to vote nor be counted for quorum purposes.

In other words, you cannot count Monday Corp. shares belonging to Wednesday Corp. if a majority of the shares entitled to vote in the election of directors of Wednesday Corp. is held directly or indirectly by Monday Corp. The question is then, does Monday Corp. hold a majority of the shares entitled to vote in the election of directors Wednesday Corp., either directly or indirectly?

Monday Corp. does not “directly” hold a majority of the shares entitled to vote in the election of directors Wednesday Corp. After all, Monday Corp. does not hold any Wednesday Corp. stock. Moreover, Monday Corp. does not indirectly hold a majority of the shares entitled to vote in the election of directors of Wednesday Corp. either. That is because Tuesday Corp. only holds one percent of the shares of Wednesday Corp. That is not enough to give Tuesday Corp. control of Wednesday Corp., and therefore we cannot the shares held by Wednesday Corp. as though they were held by Monday Corp. It follows that DGCL §160(c) of the Delaware General Corporation Law does not apply. Accordingly, the shares held by Wednesday Corp. can be voted and counted for quorum purposes at the annual meeting of Monday Corp. Note that this makes a lot of sense. Given that Tuesday Corp. holds only one percent of the shares of Wednesday Corp., Tuesday Corp. has no control over how Wednesday Corp. will vote its shares, and accordingly, Monday Corp. also lacks control over how Wednesday Corp. will vote its shares. Hence, there is no danger that by allowing Wednesday Corp. to vote its shares at the annual shareholder meeting of Monday Corp., Monday Corp. will somehow control the outcome of that election.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 18

Movie Corporation is a closely held corporation. Its certificate of incorporation provides that the corporation’s directors are to be elected via cumulative voting. The certificate of incorporation also provides that the corporation’s board shall have three directors. The corporation has issued ten shares since it was formed, and all of these ten shares are outstanding. Three of those ten shares are held by Julia, a well-known businesswoman who owns and runs a sole proprietorship with 200 employees. She wants to elect as many of her own employees as possible to the board of Movie Corporation. She assumes, correctly, that none of the other shareholders will vote for her employees. She does not know how many of the other shareholders will vote at the next annual shareholder meeting. Assuming that three directors will be elected at the next annual meeting of Movie Corporation, what is the minimum number of employees that Julia can expect to be able to elect as directors at the next annual shareholder meeting?

(A)One.

(B)Two.

(C)Three.

(D)None of the above.

Answer 18

(A) is the correct answer.

There is an easy and well-known formula to answer this question. The number of shares held by the shareholder must be greater than (C × S) / (D + 1), where C is the number of candidates that the shareholder wants to get elected to the board, S is the total number of shares, and D is the number of directorships to be filled.

In the case at hand, there are three directors to be elected, so D = 3. The total number of outstanding shares is 10, so S = 10. In order to be sure that she can elect one of her candidates, the number of shares held by Julia must be greater than (1 × 10) / (3 + 1) = 10 / 4. Here, Julia holds 3 shares (which amounts to 12 / 4), and so she has enough shares to secure the election of one of her candidates.

By contrast, to elect two of her candidates, the number of shares held by Julia would have to be greater than (2 × 10) / (3 + 1) = 5. But Julia holds only 3 shares and therefore cannot be sure that more than one of her candidates will be elected.

(B) is incorrect.

See the answer to choice A.

(C) is incorrect.

See the answer to choice A.

(D) is incorrect.

See the answer to choice A.

Question 19

Vivian Corp. is a corporation with only one class of stock. On January 1, there are 100 shares of Vivian Corp. stock outstanding. Edward Corp. is a corporation with only one class of shares. On January 1, there are 100 shares of Edward Corp. stock outstanding.

On January 2, Lewis Corp. buys 60 shares of Vivian Corp. stock. Lewis Corp. is a corporation with only one class of stock. There are 100 shares of Lewis Corp. stock outstanding. On January 3, Vivian Corp. buys five shares of Edward Corp. stock. On January 4, Edward Corp. buys 40 shares of Lewis Corp. stock. According to its certificate of incorporation, Lewis Corp.’s board consists of a single director.

On March 6, Lewis Corp.’s annual shareholder meeting takes place. Among the candidates for the board are Morse, an employee of Edward Corp., and Kit. Edward Corp.’s board plans to vote all of its 40 Lewis Corp. shares for Morse, but another shareholder, Phil, who owns 30 Lewis Corp. shares, has already announced that he will vote his 30 Lewis Corp. shares for Kit. At the shareholder meeting, the shares held by Phil and those held by Edward Corp. are represented by proxy. No other shares are represented by proxy or present in person. Which of the following statements is correct?

(A)Morse can expect to be elected to the board of Lewis Corp. at the shareholder meeting on March 6.

(B)Kit can expect to be elected to the board of Lewis Corp. at the shareholder meeting on March 6.

(C)Neither Morse nor Kit can expect to be elected to the board of Lewis Corp. at the shareholder meeting on March 6.

(D)None of the above.

Answer 19

(A) is the correct answer.

Morse can expect to be elected, and here is why. As a general matter, a “majority of the shares entitled to vote, present in person or represented by proxy constitute a quorum at a meeting of stockholders,” DGCL §216(1). Furthermore, a director needs a plurality of the vote to be elected, DGCL §216(3). In the case at hand, the overall number of shares represented at the shareholder meeting of Lewis Corp. is 70 since the only shares present or represented by proxy are the 40 shares held by Edward Corp. and the 30 shares held by Phil.

Obviously, if the 40 shares held by Edward Corp. can be voted and counted for quorum purposes, then the quorum requirement is satisfied since 70 out of 100 shares are represented by proxy. Moreover, in that case, the 40 shares that will be voted in favor of Morse will be sufficient to give Morse a plurality of the vote since the other candidate, Kit, only stands to receive 30 votes.

The question, then, is whether the 40 shares held by Edward Corp. can be voted and counted for quorum purposes. A possible obstacle is DGCL §160(c). Under that provision, the shares held by Edward Corp. cannot be voted or counted for quorum purposes if they “belong” to Lewis Corp. or if they are held by a 50+% subsidiary of Lewis Corp.

In the case at hand, the shares held by Edward Corp. did not formally belong to Lewis Corp. (They were, after all, held by Edward Corp.) Now the expression “belong to” can sometimes be interpreted more generously if the circumstances are sufficiently unusual (see Speiser v. Baker, 525 A2d 1001 (Del. Ch. 1987)). However, in the case at hand, there is no indication that the situation is sufficiently atypical to justify an expansive application of DGCL §160(c).

Thus, the question remains whether the shares held by Edward Corp. are held by a corporation that is a direct or indirect 50% subsidiary of Lewis Corp. That, however, is not the case. To be sure, Lewis Corp. owns more than 60% of Vivian Corp.’s voting stock. Hence, Vivian Corp. is controlled by Lewis Corp. However, Vivian Corp. only owns 5 shares of Edward Corp. It follows that Edward Corp. can vote the shares it holds in Lewis Corp. Therefore, Morse has enough votes to be elected regardless of whether the certificate calls for cumulative voting or regular voting.

(B) is incorrect.

See the answer to choice A.

(C) is incorrect.

See the answer to choice A.

(D) is incorrect.

See the answer to choice A.

Question 20

Thrifty Corp. is a Delaware corporation. Tim is Thrifty Corp.’s sole shareholder, and he is also Thrifty Corp.’s sole director and CEO. Tim always makes sure that all corporate formalities are scrupulously followed. Thrifty Corp.’s total assets amount to $100. Carla is a wealthy individual. On January 1, Thrifty Corp. and Carla enter into an agreement to open a restaurant together; under the agreement, each of them shall get half of the profits. Unfortunately, the restaurant does not attract many patrons.

On January 5, Carla tells Tim: “Why don’t you visit my old friend Rich tomorrow. He is very wealthy. Ask him for a loan to the restaurant in the amount of $100,000. I am sure he will fork over the money.” Tim replies: “OK, I will try.” On January 6, Tim—acting in the name of the “joint venture”—applies for a loan in the amount of $100,000 from Rich, a wealthy individual. Rich is somewhat hesitant, but Tim tells him: “Look, you know full well that Thrifty Corp. is part of the joint venture, and I, as CEO and sole owner of Thrifty Corp., assure you that Thrifty Corp. has more than enough money to pay you back at any time. Thrifty Corp. is swimming in cash.” At the moment of this statement, Tim knows full well that Thrifty Corp.’s total assets only add up to $100. Because of Tim’s false statement, Rich grants the loan to the “joint venture,” and the loan agreement provides that the loan is to be paid back by December 31. When the loan comes due, the restaurant cannot pay it back. Rich wants to know whether he can hold Carla, Thrifty Corp., and/or Tim personally liable.

Which, if any, of the following statements is correct?

(A)Rich can hold Carla liable, Rich can hold Thrifty Corp. liable, and Rich can hold Tim personally liable.

(B)Rich can hold Carla liable. Rich can hold Thrifty Corp. liable. By contrast, Rich will very probably not be able to hold Tim personally liable.

(C)Rich can hold Thrifty Corp. liable, but he can neither hold Carla nor Tim personally liable.

(D)None of the answers above is correct.

Answer 20

(A) is the correct answer.

Let us start with the question of whether Rich can hold Carla and Thrifty Corp. liable. Carla and Thrifty Corp. have created a partnership to run the restaurant since they have formed an association of two or more persons to carry on as co-owners a business for profit, UPA §6, RUPA §202(a).

Is the loan a partnership liability? A contract entered into by one of the partners binds the partnership if the partner acts on behalf of the partnership and with the power to bind the partnership. When Tim obtained the loan, he made it clear that he was representing Thrifty Corp. and that Thrifty Corp. in turn was acting on behalf of the restaurant, that is, the partnership.

Did Tim have the power to bind the partnership? As UPA §9, RUPA §306 make clear, a partner has the power to bind the partnership if he acts with authority, though he can sometimes bind the partnership even if he lacks authority. A partner acts with authority if his actions are authorized by the partnership agreement, if the other partners have agreed to his actions, or, failing that, if his actions are undertaken within the ordinary course of business. In the case at hand, Carla had given her consent to obtaining the loan. Therefore, Tim acted with authority and thus had the power to bind the partnership. It follows that the loan agreement has created a partnership liability. Under UPA §15, RUPA §306, the partners are personally liable for the debts of the partnership.

Can Rich also hold Tim personally liable? This would be the case if Tim could be held liable for the liability for Thrifty Corp. since, as noted above, Thrifty Corp. is liable to Rich. Generally, shareholders are not personally liable for the debts of the corporation, DGCL §102(b)(6). However, courts will sometimes pierce the corporate veil. In the case at hand, not only is the corporation undercapitalized, but, more importantly, Tim has resorted to a deliberate misrepresentation regarding the corporation’s assets. Since courts generally pierce the veil in case of fraud, these factors are sufficient to justify veil-piercing. Hence, Tim will be held personally liable.

(B) is incorrect.

See the answer to choice A.

(C) is incorrect.

See the answer to choice A.

(D) is incorrect.

See the answer to choice A.

Question 21

Gold Corp. is a Delaware corporation that was formed seventy-five years ago. According to its certificate of incorporation, it has three directors. Furthermore, the certificate of incorporation grants the board the power to amend, adopt, or repeal bylaws. One day, the board unanimously adopts a bylaw according to which the board shall be classified and shall consist of three classes of directors. At the next shareholder meeting, the shareholders want to replace all three directors. Can they do so?

(A)Yes, because the bylaw classifying the board is void.

(B)Yes, the bylaw classifying the board is not void. However, the shareholder meeting can repeal the bylaw classifying the board with the effect that all directors are up for reelection.

(C)Yes, in case of a classified board, not all directors are up for reelection at each meeting. However, even in case of a classified board, the shareholders can remove directors at any time and without cause.

(D)No, the bylaw classifying the board is valid, and the shareholders cannot repeal a bylaw adopted by the board.

Answer 21

(A) is the correct answer.

The bylaw classifying the board is in fact void. According to DGCL §141(d), the board can be classified but only “by the certificate of incorporation or by an initial bylaw, or by a bylaw adopted by a vote of the stockholders.” In the case at hand, the bylaw was neither adopted by the stockholders nor did it constitute an initial bylaw. Therefore, the bylaw could not classify the board.

(B) is incorrect.

The bylaw is void. See the answer to choice A.

(C) is incorrect.

The bylaw is void. See the answer to choice A.

(D) is incorrect.

The bylaw is void. See the answer to choice A.

Question 22

Gold Corp. is a Delaware corporation. Its certificate of incorporation provides that the board shall have the power to adopt, amend, and repeal bylaws. At Gold Corp.’s annual shareholder meeting, 90% of the shares are present or represented by proxy, and 60% of the shares that are present or represented by proxy are voted in favor of a bylaw provision banning the use of poison pills by the corporation’s board. Which of the following statements is correct?

(A)The bylaw is void, but only because the shareholders no longer had the power to adopt bylaws.

(B)The bylaw is void, but only because it interferes with the board’s power to manage or supervise the management of the corporation.

(C)The bylaw is void, but only because an insufficient number of shares were voted in favor of the bylaw.

(D)The bylaw is valid.

Answer 22

(B) is the correct answer.

Under the legal default, the corporation’s shareholders have the power to adopt, amend, or repeal bylaws, DGCL §109(a). To be sure, the “corporation may, in its certificate of incorporation, confer the power to adopt, amend or repeal bylaws upon the directors,” DGCL §109(a), and Gold Corp. has made use of that option. However, even then, DGCL §109(a) makes it clear that “[t]he fact that such power has been so conferred upon the directors … shall not divest the stockholders … of the power, nor limit their power to adopt, amend or repeal bylaws.” In other words, even where—as in the present case—the certificate of incorporation empowers the board to adopt, amend, or repeal bylaws, the shareholders still retain their power to adopt, amend, or repeal bylaws as well.

Moreover, according to the legal default, “[a] majority of the shares entitled to vote, present in person or represented by proxy, shall constitute a quorum at a meeting of stockholders,” DGCL §216(1). Furthermore, “[i]n all matters other than the election of directors, the affirmative vote of the majority of shares present in person or represented by proxy at the meeting and entitled to vote on the subject matter shall be the act of the stockholders,” DGCL §216(2). In other words, a simple majority of the outstanding shares entitled to vote is needed for the quorum, and a simple majority of the shares present or represented at the shareholder meeting is needed for decision at the shareholder meeting. In the case at hand, both requirements are met.

However, under DGCL §109(2), bylaw provisions must not be “inconsistent with law.” The term “law” includes the provisions of the Delaware General Corporation Law and, in particular, DGCL §141(a) according to which “[t]he business and affairs of every corporation … shall be managed by or under the direction of a board of directors.” Deciding whether or not to adopt a poison pill is part of managing the corporation and is thus a responsibility that DGCL §141(a) reserves for the board. The bylaw at issue interferes with the board’s responsibility and thereby violates DGCL §141(a). Accordingly, the bylaw is void.

(A) is incorrect.

See the answer to choice B.

(C) is incorrect.

See the answer to choice B.

(D) is incorrect.

See the answer to choice B.

Question 23

Peter is the sole director of Gold Corp., a publicly traded Delaware corporation. Gold Corp. acquires 60% of the shares of Silver Corp., another publicly traded Delaware corporation in a cash-for-shares deal. This turns out to be a poor acquisition, as the value of the shares of Silver Corp. declines rapidly within the next few months.

Peter now considers two possible choices. First, Gold Corp. can sell the Silver Corp. shares, thereby realizing a loss which the corporation can deduct from its income and thereby lower its corporate income tax liability. For financial accounting purposes, this solution would make the corporation’s net income for the year substantially lower because the net income would reflect the loss. Alternatively, Peter considers distributing the shares of Silver Corp. as a dividend to Gold Corp.’s own shareholders. This solution has the drawback that neither Gold Corp. nor Gold Corp.’s shareholders realize a loss for tax purposes. On the other hand, the advantage of this solution, as Peter sees it, would be that for financial accounting purposes, the loss resulting loss would be charged against surplus. Fearing that the stock market may react much more negatively to lower net income than to a mere reduction in surplus, Peter opts for the second solution and lets Gold Corp. distribute the shares of Silver Corp. as a dividend. Which of the following statements is correct?

(A)Peter has violated his duty of care, and that is true even if the corporation’s certificate of incorporation contains a so-called exculpation clause that eliminates the liability of directors to the fullest extent permitted by law.

(B)Peter has violated his duty of care, but only if the corporation’s certificate of incorporation does not contain a so-called exculpation clause that eliminates the liability of directors to the fullest extent permitted by law.

(C)Peter has not violated his duty of care, but he has violated his duty of loyalty.

(D)Peter has neither violated his duty of care nor his duty of loyalty.

Answer 23

(D) is the correct answer.

This question is loosely based on Kamin v. American Express Co., 54 A.D.2d 654 (N.Y. 1976). Under Delaware law, corporate directors have fiduciary duties of loyalty and care. However, when they make business judgments, they are protected by the so-called business judgment rule. This means that courts will not second-guess the board’s decision as long as the directors (a) were reasonably informed, (b) acted in good faith, and (c) acted without a conflict of interest. The business judgment rule effectively limits the director’s fiduciary duties. In making business judgments, directors do not violate their duty of care as long as they are reasonably informed. And they do not violate their duty of loyalty, as long as they act in good faith and without a conflict of interest.

In the case at hand, nothing suggests a duty of loyalty violation. There is no indication that Peter faced a conflict of interest. Moreover, a director acts in good faith as long as he does what he honestly thinks is in the best interest of the corporation, and it is for plaintiffs to prove that the director failed to meet this requirement. In the case at hand, Peter sought to protect the corporation’s stock price against an adverse reaction by the stock market, and nothing suggests that he did this for reasons other than to protect the interests of shareholders. Accordingly, we have to assume that he acted in good faith and without a conflict of interest and therefore has not violated his duty of loyalty.

What about the duty of care? As previously mentioned, a director complies with his duty of care as long as he is reasonably informed when he makes his decision. Moreover, to breach the duty of care, a director has to act with gross negligence Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)). In the case at hand, Peter was fully aware of the adverse tax consequences of his decision, and he was therefore reasonably informed when he made his choice. Accordingly, he has not violated his duty of care. Note, in this context, that the business judgment rule can lead to somewhat counterintuitive results with respect to the duty of care. When a director simply overlooks the potential adverse consequences of his decision, he may violate the duty of care if his sloppiness rises to the level of gross negligence. By contrast, if the director knows about the adverse consequences and then absurdly chooses to go through with the relevant decision anyway, his decision is protected by the business judgment rule as long as he also acted in good faith and without a conflict of interest.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 24

Fredo is both the CEO and the chairman of the board of Family, Inc., a Delaware corporation. The other directors are Fredo’s father, Vito, Fredo’s older brother, Santino, and Fredo’s younger brother, Michael.

None of the corporation’s directors holds any shares in the corporation. Also, share ownership is widely dispersed. The corporation produces several successful movies. For the production of one of them, the corporation acquires a beautiful villa in Sicily, Italy. Following the filming of the movie, the relevant property is no longer used. Michael gets into legal trouble in the United States and informs Fredo that he wants to buy the relevant property from the corporation in order to spend some time there. Michael offers to buy the property for $1,000,000.

Fredo thinks the relevant property is worth at most $700,000. The next day, Fredo brings the matter before the board. All directors are present except Michael, who is in Italy at the time. Fredo, who does not have any experience in real estate matters, tells the directors that Michael has offered to buy the property for one million dollars. He also points out that while he has not made any inquiries, he is sure that the property won’t sell for more than seven hundred thousand dollars. Following Fredo’s recommendation, the directors present at the board meeting unanimously resolve to sell the property to Michael. The next day, the corporation enters into a formal sales contract with Michael. Assume that the true market value of the property is $2,000,000.

Which, if any, of the following statements is correct?

(A)Fredo is liable to the corporation, but only because he has breached his duty of care.

(B)Fredo is liable to the corporation, but only because he has acted in bad faith.

(C)Fredo is not protected by the business judgment rule, and this would be true even if his belief that the property was worth $700,000 was based on careful investigation and analysis.

(D)None of the above statements is correct.

Answer 24

(C) is the correct answer.

The business judgment rule applies only to decisions made in the absence of a conflict of interest, in good faith, and in a reasonably informed fashion. In the case at hand, Fredo failed to satisfy the business judgment rule for two reasons. First, he was not reasonably informed. And second, he had a conflict of interest. (Both Fredo and the other directors were related to Michael). Therefore, Fredo is not protected by the business judgment rule, and this would be true even if his belief that the property was worth $700,000 was based on careful and reasonable investigation. Furthermore, note that Fredo did not act in bad faith because he honestly thought the value of the property was $700,000.

(A) is incorrect.

It is true that Fredo has breached the duty of care, but he has also breached the duty of loyalty because he acted in the presence of a conflict of interest. See the answer to choice C.

(B) is incorrect.

Fredo did not act in bad faith because he honestly thought the value of the property was $700,000. See the answer to choice C.

(D) is incorrect.

Choice C is correct. See the answer to choice C.

Question 25

Fredo is both the CEO and the chairman of the board of Family, Inc., a closely held Delaware Corporation with total assets in the amount of $20,000,000. The other directors are Fredo’s father, Vito, Fredo’s older brother, Santino, and Fredo’s younger brother, Michael. The corporation’s directors do not own any shares in the corporation.

On January 1, the corporation sells an old villa to Michael for $1,000,000. The directors had unanimously approved the sale in the honest belief that this was the villa’s true value. However, none of the directors made any effort to verify whether this assumption was correct, and the true market value of the villa was $10,000,000—a fact that any realtor could have told the corporation and that even the most cursory examination of real estate prices in the area would have revealed.

Luca, who has been a shareholder of the corporation for ten years, is outraged. He wants to sue the directors in the Delaware Chancery Court because he (Luca) thinks that they have violated “their duties.” Which, if any, of the following statements is correct?

Which, if any, of the following statements is correct?

(A)The suit has to be brought as a derivative suit. However, demand will be excused on the grounds that it is futile.

(B)The suit has to be brought as a derivative suit, and demand will not be excused.

(C)The suit has to be brought as a direct suit (rather than as a derivative suit), but the demand requirement also applies to direct suits, and in this case, demand will not be excused.

(D)The suit has to be brought as a direct suit, and the demand requirement under Chancery Court Rule 23.1 does not apply to direct suits.

Answer 25

(A) is the correct answer.

The first question that arises is whether the suit has to be brought as a direct suit or as a derivative suit. In the landmark 2004 case Tooley v. Donaldson, 845 A.2d 1031, 1033 (Del. 2004), the Delaware Supreme Court drew the line between direct suits and derivative suits as follows:

“That issue must turn solely on the following questions: (1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?”

In the case at hand, it is the corporation that suffered the harm (a monetary loss resulting from the too-low sales price). Moreover, the corporation would have to receive the benefit of recovery because if the corporation is paid damages, both the corporation’s loss and the shareholders’ loss (which turns on the corporation’s loss) are eliminated. It follows that the suit has to be brought as a derivative suit.

For derivative suits (but not for direct suits), Chancery Court Rule 23.1 imposes a demand requirement, providing that “[t]he complaint shall … allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.” However, no demand needs to be brought if such a demand would be futile. In making that determination, Delaware courts generally apply the so-called Aronson-test. In Brehm v. Eisner, 746 A.2d 244, 256 (Del. 2000), the Delaware Supreme Court summarized this test as follows:

“The test of demand futility is a two-fold test under Aronson and its progeny. The first prong of the futility rubric is ‘whether, under the particularized facts alleged, a reasonable doubt is created that … the directors are disinterested and independent.’ … The second prong is whether the pleading creates a reasonable doubt that ‘the challenged transaction was otherwise the product of a valid exercise of business judgment.’ … These prongs are in the disjunctive. Therefore, if either prong is satisfied, demand is excused.”

Note that the first prong refers to the time that the suit is brought, whereas the second prong refers to the time of the challenged transaction. It is also worth noting that the first prong is satisfied as long as the particularized facts alleged by the plaintiff create reasonable doubt regarding the disinterestedness of a majority of the directors. In other words, the fact that a minority of directors are disinterested at the time the suit is brought does not prevent the plaintiff from invoking the futility doctrine.

In the case at hand, demand was futile under both prongs. The plaintiff can create reasonable doubt regarding the board’s disinterestedness and independence at the time the suit is brought because there is nothing in the case to suggest that any of the directors involved in the transaction have been replaced, and every single one of the directors has a conflict of interest. Moreover, the challenged transaction also failed to satisfy the business judgment rule (both because the board was not reasonably informed and because every single director had a conflict of interest). Therefore, demand was futile.

(B) is incorrect.

Demand will be excused due to futility. See the answer to choice A.

(C) is incorrect.

Luca has to bring a derivative suit rather than a direct suit. See the answer to choice A.

(D) is incorrect.

Luca has to bring a derivative suit rather than a direct suit. See the answer to choice A.

Question 26

Fredo is the sole director of Splurge Corp., a closely held Delaware Corporation with total assets in the amount of $20,000,000. He approves the sale of an old villa belonging to the corporation to Max for a price of $1,000,000. Neither Fredo nor Max owns any of Splurge Corp.’s shares.

Fredo assumed the villa was worth $500,000. However, he never made any effort to verify this assumption. In fact, the true value of the villa was $10,000,000—a fact that any realtor could have told the corporation and that even the most cursory examination of real estate prices in the area would have revealed. The certificate of incorporation of Splurge Corp. contains an exculpation clause which “eliminates the liability of corporate directors for fiduciary duty violations to the fullest extent permitted by law.” Which, if any, of the following statements is correct?

(A)The exculpation provision cannot protect Fredo from liability because he violated his duty of loyalty.

(B)The exculpation provision cannot protect Fredo from liability, but only because the sale of the property to Michael amounted to a distribution in violation of the legal capital rules.

(C)The exculpation provision cannot protect Fredo from liability because the certificate of incorporation may not limit or eliminate the liability of directors for fiduciary duty violations.

(D)In light of the exculpation provision, Fredo cannot be held liable with respect to the sale of the villa.

Answer 26

(D) is the correct answer.

DGCL §102(b)(7) provides that a corporation’s charter can contain a provision eliminating or limiting the liability of a director for fiduciary duty violations, but such a provision cannot eliminate or limit the liability for duty of loyalty violations. In other words, if a corporation’s certificate of incorporation eliminates the directors’ liability for fiduciary duty violations “to the fullest extent permitted by law,” then the director has nothing to fear if he has solely breached his duty of care by failing to be reasonably informed. By contrast, he remains liable if he has breached his duty of loyalty by acting in bad faith or in the presence of a conflict of interest. This said, in the case at hand, there is no indication that Fredo has acted in bad faith or that he faced a conflict of interest. His only fault was a failure to be reasonably informed. Hence, the exculpation clause protects Fredo from any liability regarding the sale of the Villa.

(A) is incorrect.

Fredo did not violate his duty of loyalty. See the answer to choice D.

(B) is incorrect.

The sale did not constitute a distribution. A distribution occurs where assets are transferred from the corporation to a shareholder in his capacity as a shareholder. There is no indication that Max owned any shares in the corporation, and even if he did, there is nothing to suggest that the sale had anything to do with Max being a shareholder.

(C) is incorrect.

DGCL §102(b)(7) allows for provisions that limit or eliminate the liability of directors for duty of care violations, and in the case at hand, Fredo only violated his duty of care, not his duty of loyalty. See the answer to choice D.

Question 27

Pizza Corp. is a Delaware corporation that owns and operates a restaurant offering a wide selection of pizza. It has ten shareholders, each of whom holds exactly one share. Paul, Maria, Christine, and Yael are among Pizza Corp.’s shareholders. Christine is the corporation’s CEO. The corporation has two directors, namely Maria and Yael.

On January 1, when Paul sits in the restaurant enjoying a glass of wine, he is approached by a man he does not know. The man introduces himself as “Lee” and tells Paul: “I hear you are really savvy in the restaurant business. As it happens, my friends and I want to open up another pizza place about 2 miles from here, and we are looking for an investor. Would you care to become one of the shareholders of the corporation we want to form? You would have to invest $20,000.” As they talk about it, Paul realizes that the offer is a great opportunity to make money. To be on the safe side, Paul calls Christine and tells her all about the offer. Furthermore, he asks her if the corporation might be interested in investing. But Christine just says: “Are you kidding? We have got our hands full running our own business,” and hangs up. Thereupon, Paul accepts Lee’s offer. In fact, Pizza Corp. would have had the necessary cash on hand to make use of the investment opportunity that Lee offered to Paul. Which, if any, of the following statements is true?

(A)Paul has violated his duty of loyalty, but not his duty of care.

(B)Paul has violated his duty of care, but not his duty of loyalty.

(C)Paul has not violated any fiduciary duties because he presented the opportunity to Christine and she declined it.

(D)Paul has not violated any fiduciary duties. The same would be true if he had not presented the opportunity to Christine before accepting it.

Answer 27

(D) is the correct answer.

Paul has not violated any fiduciary duties. The reason is quite simple. Paul is a minority shareholder and, as a general rule, minority shareholders do not have fiduciary duties under Delaware law.

In answering this question, many students tend to apply the corporate opportunity doctrine. Under that doctrine, corporate fiduciaries such as officers and directors are, in principle, required to abstain from exploiting business opportunities that belong to the corporation. This doctrine is rooted in the duty of loyalty. Under Delaware case law, a controlling shareholder has fiduciary duties to the corporation. Therefore, a controlling shareholder can potentially violate his duty of loyalty by exploiting opportunities belonging to the corporation. However, Paul is not a controlling shareholder and therefore does not have a duty of loyalty, making the corporate opportunity doctrine inapplicable.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

If the corporate opportunity doctrine were applicable to this case, then the question of whether Paul represented the opportunity to the right person would indeed be relevant. Under Delaware law, a fiduciary is at liberty to exploit a corporate opportunity once he has presented it to the board and the board has rejected it after full disclosure of all pertinent facts. By contrast, presenting a corporate opportunity to the corporation’s CEO is not per se sufficient, even if the CEO rejects the relevant opportunity. Hence, if this case were governed by the corporate opportunity doctrine, presenting it to Christine would not per se suffice to allow Paul to exploit the relevant opportunity. However, as explained in the answer to choice D, the corporate opportunity doctrine does not even apply to this case because Paul does not owe a duty of loyalty to the corporation. Therefore, the causal relationship (“because”) asserted by answer choice C is incorrect.

Question 28

Silver Corp. is a Delaware corporation. Its no-par value shares are currently traded at $1500 per share. Carl is Silver Corp.’s sole director. On January 1, Silver Corp. issues one no-par value share to George in exchange for a used car. Carl, who has carefully investigated the matter, believes in good faith that the car is worth $2000. Rudy is one of the shareholders of Silver Corp. He believes that the car is only worth $1000 at most. Assuming that Rudy is correct, which of the following statements is correct?

(A)Carl has violated his duty of loyalty, and the transaction is voidable.

(B)Carl has violated his duty of loyalty, but the transaction is not voidable.

(C)Carl has not violated his duty of loyalty, but the transaction is voidable.

(D)Carl has not violated his duty of loyalty, and the transaction is not voidable either.

Answer 28

(D) is the correct answer.

The duty of loyalty requires directors to act in what they perceive to be the best interest of the corporation. Moreover, it is for the plaintiff to prove that a director has violated his duty of loyalty. In the case at hand, there is no indication whatsoever that Carl failed to act in what he perceived to be the best interest of the corporation. In particular, the facts specifically state that Carl thought the car was worth $2000. Hence, Carl has not violated his duty of loyalty.

What about the fact that the car was worth less than Carl thought. Note, first, that the consideration for which shares are issued does not have to consist of cash. Rather, under DGCL §152, “[t]he board of directors may authorize capital stock to be issued for consideration consisting of cash, any tangible or intangible property or any benefit to the corporation, or any combination thereof.” Hence, issuing shares in exchange for a used car is entirely permissible. Moreover, “[i]n the absence of actual fraud in the transaction, the judgment of the directors as to the value of such consideration shall be conclusive,” DGCL §152. Under Delaware case law, “[m]ere inadequacy of price, unless so gross as to lead the court to conclude that it was due not to an honest error of judgment but rather to bad faith or to a reckless indifference to the rights of others interested, will not reveal fraud,” (Fidanque v. American Maracaibo Co., 92 A.2d 311, 321 (Del. Ch. 1952)). In the case at issue, Carl has made an honest mistake rather than committed fraud. Accordingly, his judgment as to the value of the car is conclusive.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 29

Gold Corp. is a Delaware corporation. Its par value shares are currently traded at $200 per share, despite the fact that the par value is $600 per share.

Gold Corp. issues one par value share with a par value of $600 to Mark in exchange for an unsecured promissory note with a face value of $600. The board of Gold Corp. reasonably believes that the promissory note is actually worth $550. Does the transaction violate Delaware law? Which of the following statements is correct?

(A)The transaction violates Delaware law, and this would be true even if the share issued to Mark had a par value of $400.

(B)The transaction violates Delaware law. By contrast, the transaction would be entirely legal if the share had a par value of $400.

(C)The transaction does not violate Delaware law, and the same would be true if the share had a par value of $400.

(D)The transaction does not violate Delaware law. By contrast, the transaction would be illegal if the share had a par value of $400.

Answer 29

(B) is the correct answer.

Note, first, that under DGCL §153(a), “[s]hares of stock with par value may be issued for such consideration, having a value not less than the par value thereof, as determined … by the board of directors.” In other words, the par value determines the minimum value of the consideration for which a par value share may be issued. In the case at hand, the value of the consideration, as determined by the board, was lower than the par value, rendering the transaction illegal. Note that no violation against DGCL §153(a) would have occurred if the par value of the share had been $400.

As regards the possibility of issuing shares in exchange for unsecured promissory notes, the law has changed over time. Until 2004, Delaware’s Constitution imposed a requirement that “[n]o corporation shall issue stock, except for money paid, labor done or personal property, or real estate or leases thereof actually acquired by such corporation.” (Del. Const. Art. IX, §3). Not surprisingly, the Delaware Supreme Court held that an unsecured promissory note did not qualify as “actually acquired” consideration with the consequence that stock issued in exchange for an unsecured promissory note was voidable at the election of the corporation (Lofland v. Cahall, 118 A. 1, 4 (Del. 1921)). However, in 2004, the relevant provision was deleted from the Delaware Constitution. Now, DGCL §152 makes it clear that “[t]he board of directors may authorize capital stock to be issued for consideration consisting of cash, any tangible or intangible property or any benefit to the corporation, or any combination thereof.” It follows that issuing stock in exchange for an unsecured promissory note is now entirely legal.

(A) is incorrect.

See the answer to choice B.

(C) is incorrect.

See the answer to choice B.

(D) is incorrect.

See the answer to choice B.

Question 30

Gold Corp. is a Delaware corporation that was formed seventy years ago. Its certificate of incorporation explicitly grants the board the power to adopt, amend, or repeal bylaws. Now, the board believes that it would in the best interest of the shareholders if the corporation had a classified board. Which, if any, of the following statements is not true?

(A)The board can be classified by amending the certificate of incorporation.

(B)Gold Corp.’s board can adopt a bylaw classifying the board.

(C)Gold Corp.’s shareholders can adopt a bylaw classifying the board.

(D)All of the statements above are true.

Answer 30

(B) is the correct answer.

The bylaw classifying the board is void. According to DGCL §141(d), the board can be classified but only “by the certificate of incorporation or by an initial bylaw, or by a bylaw adopted by a vote of the stockholders.” In the case at hand, the corporation was formed back in 1925, so classifying the board via an initial bylaw is no longer an option. Accordingly, the only options now available are classification via the certificate of incorporation and classification via shareholder-adopted bylaw.

(A) is incorrect.

It is true that the board can be classified by amending the certificate of incorporation. According to DGCL §141(d), the board can be classified “by the certificate of incorporation or by an initial bylaw, or by a bylaw adopted by a vote of the stockholders.”

(C) is incorrect.

It is true that the board can be classified via a shareholder-adopted bylaw, DGCL §141(d). Moreover, the fact that the corporation’s certificate of incorporation explicitly authorized the board to amend, repeal, or adopt bylaws does not prevent the shareholders from adopting a bylaw classifying the board. Under the legal default, the corporation’s shareholders have the power to adopt, amend, or repeal bylaws, DGCL §109(a). Furthermore, even where—as in the present case—the certificate of incorporation empowers the board to adopt, amend, or repeal bylaws, the shareholders still retain their power to adopt, amend, or repeal bylaws as well, DGCL §109(a).

(D) is incorrect.

(D) is incorrect because (B) is the correct answer.

Question 31

Gold Corp. is a Delaware corporation. It owns and operates a car factory. That car factory accounts for 95% of the corporation’s assets and 100% of the corporation’s profits. The remaining assets take the form of a restaurant, which is not, however, profitable. One day, the board of Gold Corp. announces that it will lease the car factory to Silver Corp. because Gold Corp.’s own cars have become unfashionable, whereas Silver Corp. plans to use the factory to produce very profitable electric cars and is willing to compensate Gold Corp. handsomely for the use of Gold Corp.’s factory. Which of the following statements is correct?

(A)The board’s decision has to be approved by Gold Corp.’s shareholders, and the same would be true if the factory accounted for only 50% of Gold Corp.’s assets and if Gold Corp.’s remaining assets were profitable.

(B)The board’s decision has to be approved by Gold Corp.’s shareholders. However, no such shareholder approval would be needed if the factory accounted for only 50% of Gold Corp.’s assets and if Gold Corp.’s remaining assets were profitable.

(C)The board’s decision does not have to be approved by Gold Corp.’s shareholders, and the same would be true if Gold Corp. had sold—rather than leased—the factory to Silver Corp.

(D)The board’s decision does not have to be approved by Gold Corp.’s shareholders. However, shareholder approval would be needed if Gold Corp. had sold—rather than leased—the factory to Silver Corp.

Answer 31

(B) is the correct answer.

Under DGCL §271, the board’s decision to “sell, lease or exchange all or substantially all” of its property or assets has to be approved by a majority of the outstanding stock of the corporation entitled to vote thereon. The only question, therefore, is whether the factory constitutes “all or substantially all” of the corporation’s assets.

In the past, Delaware courts defined the term “all or substantially all” extremely broadly. In one case, Katz v. Bregman, 431 A.2d 1274 (Del. Ch. 1981), the Court went so far as to apply DGCL §271 despite the fact that the assets that were sold represented only about 51% of the corporation’s assets and accounted for only about 52% of its pre-tax net operating income. However, in the 2004 case Hollinger v. Hollinger International, 858 A.2d 342, 385 (Del. Ch. 2004), the Delaware Chancery Court returned to a much more restrictive interpretation of DGCL §271. The Court made it clear that “substantially all” means “substantially all” and that DGCL §271 therefore cannot be applied where the assets that remain are both substantial and viable. Against this background, DGCL §271 presumably applies where the factory constitutes 95% of the corporation’s business, especially given that the remaining assets are not profitable. By contrast, if the factory had constituted only 50% of the corporation’s assets and if the remaining parts had been profitable, then DGCL §271 would not have applied.

(A) is incorrect.

See the answer to choice B.

(C) is incorrect.

See the answer to choice B.

(D) is incorrect.

See the answer to choice B.

Question 32

Miriam Corp. is a publicly traded Delaware corporation. According to its certificate of incorporation, its board has five directors. As of January 1, these five directors are Tim, Tom, Mary, Larry, and Clarinda. Tom, Mary, and Larry are Tim’s children. Tim does not have any ties to Clarinda.

On February 1, Tim buys a parcel of real estate from Miriam Corp. for $1,000,000. At the time of the transaction, the market value of the property is $1,200,000.

Before the relevant documents are signed, the transaction is approved by the board of Miriam Corp. At the relevant board meeting, which takes place on February 1, all directors are present, and four of them approve the transaction, with only Clarinda voting against it.

On March 1, the annual shareholder meeting of Miriam Corp. takes place. Tim and Tom are reelected to the board. By contrast, Mary, Larry, and Clarinda are not reelected. In their stead, Matt, Joanne, and Justin are elected to the board. None of the three new directors has any ties to Tim, Tom, Marry, Larry, or Clarinda.

Jill is a longtime shareholder of Miriam Corp. On April 1, Jill brings a derivative suit with the aim of making Tim pay damages to the corporation.

Jill did not make any demand on the board of Miriam Corp. before filing her derivative suit. Jill owns 67% of the outstanding shares of Miriam Corp. Which, if any, of the following statements is correct?

(A)Demand is excused. However, the derivative suit will be dismissed because Jill cannot fairly and adequately represent the interest of the other shareholders.

(B)The derivative suit will be dismissed because demand is not excused. By contrast, there is no reason to believe that Jill cannot fairly and adequately represent the interest of the other shareholders.

(C)The derivative suit will be dismissed both because demand was not excused and because Jill cannot fairly and adequately represent the interest of the other shareholders.

(D)Jill’s derivative suit will not be dismissed.

Answer 32

(B) is the correct answer.

For derivative suits (but not for direct suits), Chancery Court Rule 23.1 imposes a demand requirement, providing that “[t]he complaint shall … allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors….” However, no demand needs to be brought if such a demand would be futile. In making that determination, Delaware courts generally apply the so-called Aronson test. This test has two prongs, and demand is considered futile if at least one of these prongs is satisfied.

Under the first prong, demand is futile if the plaintiff has alleged particularized facts that create reasonable doubt whether, at the time the suit is brought, the directors are disinterested and independent. The underlying idea is that it makes no sense to ask the board to sue on behalf of the corporation if the board cannot be expected to make that decision in a disinterested manner. Importantly, for this prong to be satisfied, the plaintiff only needs to create reasonable doubt regarding the disinterestedness and independence of a majority of the directors. Hence, the fact that a minority of the directors are disinterested and independent does not make the derivative suit inadmissible.

Under the second prong, the plaintiff’s pleading has to create a reasonable doubt that the challenged transaction satisfied the business judgment rule. The underlying idea is that if the challenged transaction failed to satisfy the business judgment rule, then the directors may face personal liability and therefore cannot be expected to act impartially in deciding whether or not to bring suit on behalf of the corporation.

If one were to apply the Aronson test to the situation at hand, the derivative suit would be admissible. That is because the challenged transaction clearly failed the business judgment rule. The sale of the property to Tim was a self-dealing transaction in which four of the five directors faced a clear conflict of interest.

However, there are some situations in which the Aronson test does not apply. These situations have in common that despite the fact that the challenge transaction flunked the business judgment rule, the corporation’s board can be expected to make a disinterested decision about whether or not to sue at the time that the derivative suit is filed. In Rales v. Blasband (634 A.2d 927, 933–34 (Del. 1993)), the Delaware Supreme Court summarized the relevant legal principles as follows:

“Consistent with the context and rationale of the Aronson decision, a court should not apply the Aronson test for demand futility where the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit. This situation would arise in three principal scenarios: (1) where a business decision was made by the board of a company, but a majority of the directors making the decision have been replaced; (2) where the subject of the derivative suit is not a business decision of the board; and (3) where … the decision being challenged was made by the board of a different corporation.”

If any of the three situations described above is given, demand is futile only if the plaintiff alleges particularized facts creating doubt regarding the disinterestedness of a majority of the directors at the time the suit is filed. In other words, in those cases, demand futility requires that the first prong of the Aronson test is satisfied. In the case at hand, this requirement is not met. A majority of the directors had in fact been replaced after the challenged transaction, and, at the time the derivative suit is filed, more than half of the directors had no conflict of interest and were not involved in the challenged transaction. Therefore, demand is not excused, and the derivative suit is inadmissible.

By contrast, there is no reason to think that Jill cannot fairly and adequately represent the interests of the other shareholders. Essentially, this requirement is met as long as there is no obvious conflict of interest between the plaintiff and the other stockholders, and, in the case at hand, nothing suggests a conflict of interest.

(A) is incorrect.

See the answer to choice B.

(C) is incorrect.

See the answer to choice B.

(D) is incorrect.

See the answer to choice B.

Question 33

Miriam Corp. is a publicly traded Delaware corporation. According to its certificate of incorporation, its board has five directors. As of January 1, these five directors are Tim, Tom, Mary, Larry, and Clarinda. Tom, Mary, and Larry are Tim’s children. Tim does not have any ties to Clarinda.

On February 1, Tim buys a parcel of real estate from Miriam Corp. for $1,000,000. At the time of the transaction, the market value of the property is $1,200,000.

Before the relevant documents are signed, the transaction is approved by the board of Miriam Corp. At the relevant board meeting, which takes place on February 1, all directors are present, and four of them approve the transaction, with only Clarinda voting against it.

Jill is a longtime shareholder of Miriam Corp. For more than twenty years, she has been the owner of 67% of the outstanding shares of Miriam Corp. On March 1, Jill presents the board of Miriam Corp. with a written demand to sue Tim for damages. However, the board, on March 15, decides via a unanimous resolution not to bring suit against Tim. On April 1, Jill brings a derivative suit with the aim of making Tim pay damages to the corporation. Which, if any, of the following statements is true?

(A)Jill’s derivative suit will be dismissed unless she can show that the board of Miriam Corp. acted in bad faith or without being reasonably informed when it decided not to bring suit against Tim.

(B)Jill’s derivative suit will be dismissed, but only if the board of Miriam Corp. can show that it acted in good faith and in a reasonably informed fashion when it decided not to bring suit against Tim.

(C)Jill’s derivative suit will not be dismissed because the directors of Miriam Corp. were not disinterested when they decided not to bring suit against Tim.

(D)Jill’s derivative suit will not be dismissed because she has made a prior demand on the corporation. This outcome would be the same even if the directors of Miriam Corp. did not have a conflict of interest.

Answer 33

(A) is the correct answer.

For derivative suits (but not for direct suits), Chancery Court Rule 23.1 imposes a demand requirement. However, that does not imply that making such a demand before bringing suit is a good idea. If the plaintiff makes a demand on the corporation, and the board of the corporation decides not to bring suit, then that decision is, in principle, protected by the business judgment rule (Zapata v. Maldonado, 430 A.2d 779, 784 n.10 (Del. 1981)). Even worse, by making the demand, the shareholder has, in effect, conceded that the board is disinterested and independent. Consider the following excerpt from Spiegel v. Buntrock (571 A.2d 767, 777 (Del. 1990)):

“Whenever any action or inaction by a board of directors is subject to review according to the traditional business judgment rule, the issues before the Court are independence, the reasonableness of its investigation and good faith. By electing to make a demand, a shareholder plaintiff tacitly concedes the independence of a majority of the board to respond. Therefore, when a board refuses a demand, the only issues to be examined are the good faith and reasonableness of its investigation.”

As a result, once a demand has been made, the shareholder cannot sue on behalf of the corporation unless he can show that the board, in refusing to sue, acted in bad faith or without being reasonably informed. Note that the burden of proof is on the plaintiff.

Note that the Spiegel approach has the perverse consequence of giving plaintiffs a strong incentive not to make a demand on the corporation before bringing suit because it is much easier to argue that demand was futile than to show that the board acted in bad faith or without being properly informed in rejecting a demand to bring suit.

(B) is incorrect.

See the answer to choice A.

(C) is incorrect.

See the answer to choice A.

(D) is incorrect.

See the answer to choice A

Question 34

Miriam Corp. is a publicly traded Delaware corporation. According to its certificate of incorporation, its board has five directors. As of January 1, these five directors are Tim, Tom, Mary, Larry, and Clarinda. Tom, Mary, and Larry are Tim’s children. Tim does not have any ties to Clarinda.

On February 1, Tim buys a parcel of real estate from Miriam Corp. for $1,000,000. At the time of the transaction, the market value of the property is $1,200,000.

Before the relevant documents are signed, the transaction is approved by the board of Miriam Corp. At the relevant board meeting, which takes place on February 1, all directors are present, and four of them approve the transaction, with only Clarinda voting against it.

Jill is a longtime shareholder of Miriam Corp. For more than twenty years, she has been the owner of 67% of the outstanding shares of Miriam Corp. On March 1, Jill files a derivate suit in the Delaware Chancery Court. The corporation asks the court to dismiss the suit because Jill never made a demand upon the corporation, but the court deems the suit to be admissible.

On May 1, the annual shareholder meeting of Miriam Corp. takes place. The shareholders, outraged at the behavior of the board, elect five new directors: Jack, Joe, Jim, James, and Mike. On June 1, the new board creates a “litigation committee” consisting of Jack, Joe, and Jim. On July 1, the litigation committee is entrusted with the task of evaluating whether the dismissal of the derivative suit is in the best interest of the corporation. The litigation committee unanimously adopts a resolution according to which the derivative suit is not in the best interest of the corporation and should be dismissed.

Miriam Corp. submits this resolution to the Chancery Court and asks the court to dismiss Jill’s suit.

Which, if any, of the following statements is correct?

(A)If the Chancery Court, exercising its own business judgment, deems the dismissal of the suit to be in the best interest of Miriam Corp., it will dismiss the suit unless Jill can show that the litigation committee acted in the presence of a conflict of interest, in bad faith, or without being reasonably informed.

(B)If the court, exercising its own business judgment, deems the dismissal of the suit to be in the best interest of Miriam Corp., it will dismiss the suit, but only if the corporation can show that the litigation committee was reasonably informed and disinterested and acted in good faith.

(C)The court will automatically dismiss the suit unless Jill can show that the litigation committee acted in the presence of a conflict of interest, in bad faith, or without being reasonably informed.

(D)The court will automatically dismiss the suit, but only if the corporation can show that the litigation committee was reasonably informed and disinterested and acted in good faith.

Answer 34

(B) is the correct answer.

For derivative suits (but not for direct suits), Chancery Court Rule 23.1 imposes a demand requirement. No demand needs to be brought if such a demand would be futile. However, even if demand is found to be futile, that is not the end of the story. Rather, the corporation may still be able to get the suit dismissed with the help of a special litigation committee. The leading case is Zapata v. Maldonado, 430 A.2d 779 (Del. 1981). There the Delaware Supreme Court held that if a court is faced with a request by a special litigation committee to dismiss a derivative suit, the court has to apply a two-step test (id. at 788). First, the litigation committee’s decision has to satisfy all three requirements of the business judgment rule: good faith, reasonable information, and disinterestedness. Crucially, it is the corporation—rather than the plaintiff—that has to prove that these requirements are met. Second, even if the business judgment rule requirements are satisfied, the court will not necessarily dismiss the derivative suit. Rather, the court will then apply its own business judgment to decide whether the continuation of the litigation serves the best interest of the corporation. Answer choice B summarizes these principles and is therefore correct.

(A) is incorrect.

As a general rule, the burden of proof regarding the elements of the business judgment rule is on the plaintiff. However, that allocation of the burden of proof no longer applies when a litigation committee asks the court to dismiss an admissible derivative suit. In that situation, it is the corporation that has to prove that the committee’s decision satisfies the elements of the business judgment rule. See the answer to choice B.

(C) is incorrect.

This answer choice is incorrect for two reasons. First, when a special litigation committee asks the court to dismiss an admissible derivative suit, the burden of proof regarding the elements of the business judgment rule is on the corporation. See the answer to choice A. And second, even if the court comes to the conclusion that the elements of the business judgment rule are satisfied, it will not dismiss the derivative suit automatically. Rather, the court will use its own business judgment to determine whether the continuation of the derivative suit lies in the interest of the corporation. See the answer to choice B.

(D) is incorrect.

Rather than dismissing the suit automatically, the court will use its own business judgment to determine whether the continuation of the suit lies in the corporation’s best interest. See the answer to choice B.

Question 35

Heist Corp. is a privately held corporation with annual revenues of about $50,000,000. For more than twenty years, the board of Heist Corp. has had the same three members, namely Steven, Alice, and Wally.

One of the corporation’s accountants is Catherine. Unfortunately, Catherine, who is paid a salary of $70,000 a year, has long had a gambling problem and has, for some time, been stealing large amounts of money—about $2,000,000 a year—from the corporation to finance her ever-increasing gambling losses.

Steven, Alice, and Wally have always been unaware of the fact that Catherine is stealing money from the corporation. However, at some point, Steven comes across a newspaper article on Las Vegas featuring a picture of Catherine and describing her as “a daring roulette player, often betting hundreds of thousands of dollars in a single night.” Steven immediately recognizes Catherine in the picture. He is mildly curious as to how Catherine is financing her hobby because he knows that Catherine is from a family of modest means and has had to hold various jobs to finance her college education. However, Steven does not follow up because he thinks that perhaps Catherine has “won the lottery or something,” even though, shortly before, another accountant, Bill, has alerted Steven to the fact that some of the numbers for which Catherine was responsible in the accounting department “seem to be wrong in a really big way.”

In the following years, Catherine manages to steal another $4,000,000 from the corporation. Finally, her actions are discovered. Unfortunately for the corporation, Catherine has already gambled away all of the stolen money, and so none of the money can be recovered. The corporation’s certificate of incorporation does not include a liability waiver for fiduciary duty violations.

Does Steven risk being held personally liable?

(A)Yes, unless the corporation had in place an internal monitoring system designed to detect wrongdoing on the part of the employees.

(B)Yes, because he acted in bad faith.

(C)No, because directors are entitled to rely on the reports prepared by the corporation’s employees.

(D)None of the three statements above (A, B, C) is correct.

Answer 35

(D) is the correct answer.

Steven can be held liable if he has violated his fiduciary duties. Directors can violate their fiduciary duties by failing to monitor the corporation’s business in an appropriate manner. However, it is very important in this context to distinguish between the duty of care and the duty of loyalty.

In order for the duty of loyalty to be breached, the director’s failure to monitor must rise to the level of bad faith. For example, a director who simply decides not to exercise his duties anymore, thereby “abandoning” his office, violates his duty of loyalty. Similarly, a director who is aware of an employee’s wrongdoing but fails to step in because he has become indifferent to the corporation’s fate, acts in bad faith. By contrast, mere negligence or stupidity does not constitute bad faith. Accordingly, Steven has not breached his duty of loyalty.

Even if a failure to monitor does not breach a director’s duty of loyalty, it may still constitute a breach of the duty of care. The duty of care can be violated for one of two reasons. First, a director violates his duty of care if he ignores obvious danger signs (“red flags”) that should have alerted him to possible wrongdoing. It must be kept in mind that a violation of the duty of care requires gross negligence. Second, corporations are expected to have in place a “system of watchfulness” that will allow their directors to become informed about employee wrongdoing. Having no such system in place constitutes a violation of the duty of care.

Even if a director has violated his duty of care, he may not be liable to the corporation. A corporation’s certificate of incorporation may contain a clause limiting or eliminating a director’s liability for violations of the duty of care. If the certificate of incorporation contains a liability waiver for duty of care violations, then a director’s failure to monitor only exposes him to personal liability if it rises to the level of a duty of loyalty violation.

Answer choices A, B, and C do not apply these principles correctly. See answers to choices A, B, and C.

(A) is incorrect.

Steven violated his duty of care regardless of whether the corporation had in place a system of watchfulness. The duty of care does not only require corporate directors to make sure that the corporation has in place some system of watchfulness to ferret out employee wrongdoing. Rather, directors also violate their duty of care by ignoring obvious danger signs. This is what Steven did when he brushed aside both the information about Catherine’s gambling and Bill’s report about possible accounting inaccuracies. Hence, Steven can be held personally liable. See the answer to choice D.

(B) is incorrect.

Steven did not act in bad faith because he did not know that Catherine was stealing from the corporation. Mere stupidity does not amount to bad faith. See the answer to choice D.

(C) is incorrect.

Under DGCL §141(e), directors can rely in good faith on reports that the corporation’s employees present to the corporation. However, this principle does not allow directors to ignore obvious red flags pointing to employee wrongdoing.

Question 36

Big Corp. and Small Corp. are Delaware corporations. Each of them has only one class of shares. Big Corp. holds 92% of the shares issued by Small Corp. The boards of Big Corp. and Small Corp. want the two corporations to merge, with Small Corp. being the surviving corporation. Which of the following statements is correct?

(A)The merger does not have to be approved by Big Corp.’s shareholders, and that is true regardless of whether the merger is undertaken as a long-form merger or a short-form merger.

(B)If the merger is undertaken as a short-form merger, then it does not have to be approved by Big Corp.’s shareholders. By contrast, if the merger is undertaken as a long-form merger, then it does have to be approved by Big Corp.’s shareholders.

(C)If the merger is undertaken as a long-form merger, then it does not have to be approved by Big Corp.’s shareholders. By contrast, if the merger is undertaken as a short-form merger, then it does have to be approved by Big Corp.’s shareholders.

(D)The merger has to be approved by Big Corp.’s shareholders regardless of whether it is a long-form merger or a short-form merger.

Answer 36

(D) is the correct answer.

Long-form mergers are governed by DGCL §251. As a general rule, a long-form merger has to be approved by the shareholders of both companies, DGCL §251(c). Admittedly, there exists an exception to this rule. Under DGCL §251(f), if the merger is a relatively unimportant transaction for one of the companies involved, the shareholders of that company do not have to approve the merger. However, that exception requires inter alia, that the relevant corporation is the corporation that survives the merger. In the case at hand, Big Corp. did not survive the merger, and, accordingly, the approval of Big Corp.’s shareholders cannot be rendered unnecessary by DGCL §251(f).

But what if the transaction was structured as a so-called short-form merger? Short-form mergers are governed by DGCL §253. A short-form merger is only possible in those cases where one of the corporations holds 90% or more of the outstanding shares of the other corporation, DGCL §253(a). As a general rule, a short-form merger does not have to be approved by the shareholders of either of the corporations involved, DGCL §253(a). However, there exists an important exception to this rule. If the parent corporation does not survive the merger, then the merger requires the approval of the parent corporation’s shareholders, DGCL §253(a). In the case at hand, this exception is applicable because Big Corp. is the parent corporation, and Big. Corp. does not survive the merger. Hence, the merger has to be approved by Big Corp.’s shareholders.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 37

Gold Corp. and Silver Corp. are both Delaware corporations. Silver Corp. has only one class of stock. Gold Corp. owns 92% of the shares of Silver Corp. The board of Gold Corp. wants to merge Gold Corp. with Silver Corp., and Gold Corp. is to be the surviving corporation. Will it be possible to merge both corporations without allowing the minority shareholders of Silver Corp. to vote on the merger?

(A)No, because a merger must always be approved by a majority of the shareholders in both corporations.

(B)No, because a merger must always be approved by the shareholders of the non-surviving corporation.

(C)Yes, and the same would be true if Silver Corp. were the surviving corporation.

(D)Yes, but if Silver Corp. were the surviving corporation, then the approval of the minority shareholders of Silver Corp. would be needed for the merger.

Answer 37

(C) is the correct answer.

Because Gold Corp. already owns 90% of Silver Corp.’s shares, the merger can be undertaken as a so-called short-form merger under DGCL §253. A short-form merger under DGCL §253 does not require the approval of the shareholders of the subsidiary corporation. Hence, in a short-form merger, the minority shareholders of the subsidiary do not get to vote on the merger, and that is true regardless of whether the subsidiary corporation (Silver Corp.) or the parent corporation (Gold Corp.) is the surviving corporation.

(A) is incorrect.

See the answer to choice C.

(B) is incorrect.

See the answer to choice C.

(D) is incorrect.

See the answer to choice C.

Question 38

Gold Corp. and Silver Corp. are publicly traded Delaware corporations. Each of these corporations has only one class of shares, and these shares are listed on the New York Stock Exchange. Eventually, both corporations merge in a so-called long-form merger under DGCL §251, with Gold Corp. being the surviving corporation.

George is a shareholder of Gold Corp. He voted against the merger, and he had sent a letter to the board of Gold. Corp. before the merger vote, demanding appraisal. Under the merger agreement, George will receive $1000 in cash for every Gold share he held. By contrast, each Silver Corp. shareholder will receive two shares in the surviving corporation for each Silver Corp. share. twelve days after the meeting, George sent a written letter to the corporation demanding appraisal. The corporation declined.

George, who has held his Gold Corp. shares for more than ten years, now wants to know if he is entitled to appraisal. Which of the following statements is correct?

(A)George is not entitled to appraisal. Appraisal is not available when the shares of the corporations involved in the merger are listed on a national securities exchange.

(B)George is not entitled to appraisal. Appraisal is not available when a shareholder receives cash for his shares.

(C)George is entitled to appraisal, and this would be true even if he had not notified the board of Gold Corp. of his desire to seek appraisal before the merger vote.

(D)George is entitled to appraisal, but this would not be true if he had failed to notify the board of Gold Corp. of his desire to seek appraisal.

Answer 38

(D) is the correct answer.

In order for George to be entitled to appraisal, two conditions must be met. First, appraisal rights have to be available, cf. DGCL §262(b). And second, he must have complied with the relevant procedural and other requirements in DGCL §262(a) and (d).

According to DGCL §262(b), appraisal rights are generally available in case of a long-form merger under DGCL §251. However, there are exceptions to this rule. Inter alia, under DGCL §262(1)(a), no appraisal rights are available if the shares for which appraisal is sought were listed on a national securities exchange. But there is a counter-exception to the exception. According to DGCL §262(1)(a), appraisal rights are available after all, if under the merger agreement, the shareholder receives anything for his shares other than certain types of consideration. Crucially, cash is one of the “approved” types of consideration but only if it is received “in lieu of fractional shares.”

For example, if the merger agreement had provided that every Gold Corp. shareholder receives one share in the surviving corporation for every two shares in the old corporation and—if the shareholder holds an uneven number of shares—$1,000 for the remaining “odd” share, then appraisal would not be available. But in the case at hand, the merger agreement provides that the Gold Corp. shareholders get cash for all of their Gold Corp. shares rather than merely for fractional shares. Accordingly, appraisal rights are available.

The question remains, though, whether George has also met the procedural requirements imposed by DGCL §262(a) and (d). As demanded by DGCL §262(a), George has neither voted for the merger nor consented to the merger in writing. Moreover, he has held his shares throughout the merger. And as required by DGCL §262(d)(1), George sent the corporation a written demand for appraisal before the vote on the merger. Moreover, he made a written demand for appraisal after the meeting. Note that such a request must be made within 20 days after the corporation has notified the shareholders that appraisal rights are available, see DGCL §262(d). George made his written demand in a timely fashion. Therefore, George is entitled to appraisal.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

Under DGCL §262(a), a shareholder is entitled to appraisal only if he has complied with the requirements of DGCL §262(d). If George had not notified Gold Corp. before the merger vote of his demand for appraisal, then he would not have complied with DGCL §262(d)(1), and therefore, he would not be entitled to appraisal. See the answer to choice D.

Question 39

Delicious Corp. owns and operates a bakery. The corporation has three shareholders, namely Tina, Alexandra, and John, each of whom owns exactly one share. Since the corporation was formed ten years ago, each of the three shareholders has continuously occupied a place on the board, and each of them has continuously worked at the bakery as an employee in exchange for a steady salary. The corporation has never paid any dividends.

Unfortunately, Alexandra and John have a fallout over personal matters, and after that, the two do not get along anymore. Subsequently, Alexandra persuades Tina that it is in the best interest of the corporation if John is not reelected to the board and if his employment with the corporation is also terminated. Accordingly, at the next annual shareholder meeting, Tina and Alexandra use their votes to elect Alexandra, Tina, and their friend George to the board. The next day, the corporation fires John from his job at the bakery. Which of the following statements is correct?

(A)Under Delaware’s oppression statute, a court can dissolve a closely held corporation if those in control oppress the minority shareholders.

(B)Unlike various other states, Delaware has not adopted an oppression statute. However, under Delaware law, closely held corporations are governed by so-called “partnership-style” fiduciary duties. As a result, the corporation has to treat all shareholders equally unless it can show a legitimate reason for disparate treatment. Given that John’s personal fallout with Alexandra is no legitimate reason for disparate treatment, John’s termination and the failure to reelect him as a director were illegal.

(C)Delaware has adopted both an oppression statute and partnership-style fiduciary duties for closely held corporations.

(D)Delaware has adopted neither an oppression statute nor partnership-style fiduciary duties for closely held corporations.

Answer 39

(D) is the correct answer.

Shareholders in closely held corporations are notoriously vulnerable to exploitation by controlling shareholders or controlling groups of shareholders. Often the corporation fails to pay dividends such that the shareholders can only obtain money from the corporation by working for the corporation. Yet sometimes, the controlling shareholder or shareholders use their clout to make sure that they are the only ones obtaining such employment. To help minority shareholders in such a situation, states have taken different approaches.

Some states have adopted so-called oppression statutes. These statutes allow courts to dissolve the corporation at the request of a minority shareholder if the minority shareholder or shareholders are being oppressed by those in control. Other states impose strong partnership-style fiduciary duties on shareholders in a closely held corporation. The underlying idea is that in terms of their governance, closely held corporations are really more akin to partnerships than to public corporations. In states with partnership-style fiduciary duties, the corporation may have to treat its shareholders equally unless it can show a legitimate reason for disparate treatment (Wilkes v. Springside Nursing Home, Inc., 353 N.E.2d 657 (Mass. 1976)). Some states have even adopted both approaches, combining partnership-style fiduciary duties with oppression statutes. On the other hand, there are also states that have not adopted any special protections for shareholders in closely held corporations, and Delaware is one of these states. In other words, Delaware has neither adopted partnership-style fiduciary duties nor has Delaware enacted a so-called oppression statute.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 40

George owns 90% of the shares of Truffles Corp., a Delaware corporation. On January 1, the shares of Truffles Corp. are listed at $100 per share. That same day, George sells his entire stake for $200 per share to Alexandra in a private transaction. Alexandra hopes to install new management and reduce the workforce of the company by 50%. Nyusha is a minority shareholder in Truffles Corp. She wants to know if she can somehow, directly or indirectly, participate in the premium that George received for his shares. Which of the following statements is correct?

(A)Under the so-called corporate opportunity doctrine, George has to pass the control premium ($100 per share) on to the corporation. Therefore, Nyusha profits indirectly.

(B)Under the Williams Act, Alexandra has a duty to acquire shares pro rata from all shareholders willing to sell and at the same price. Therefore, Nyusha can sell her shares to Alexandra at the same price that George did.

(C)Under the so-called looting doctrine, Nyusha can demand damages from George.

(D)George does not have to share the consideration that he received with anyone, and he does not owe damages either. Moreover, Alexandra has no duty to purchase shares from Nyusha.

Answer 40

(D) is the correct answer.

Control of a corporation is valuable. For that reason, a controlling stake in a corporation is typically sold at a higher price per share than the price paid for individual shares. In other words, the seller of a controlling stake typically receives a so-called control premium when he sells his controlling stake. The question, then, is whether he can keep this premium for himself or whether he has to share it with the corporation and/or the other shareholders.

Under Delaware law, the general principle is that the seller of a controlling stake can keep the entire control premium for himself. Thus Delaware law has never embraced the position taken by the famous case Perlman v. Feldman, 219 F.2d 173 (2d Cir. 1955), which, based on a very idiosyncratic set of facts, came to the conclusion that the sale of a controlling stake at a premium amounted to the appropriation of a corporate opportunity with the result that the seller had to share the premium.

The Williams Act takes a different approach but only with respect to tender offers. In case of a tender offer, the acquirer has to buy shares pro rata from all shareholders willing to sell, and he has to buy those shares at the same price. However, the Williams Act requires a tender offer, and, in the case at hand, Alexandra bought the shares from George in a so-called private transaction. Therefore, the Williams Act does not apply.

Moreover, this case does not justify the application of the so-called looting doctrine. The looting doctrine, as applied by Delaware courts, concerns the requirements of the duty of care in the context of a sale of control: “[W]hen the circumstances would alert a reasonably prudent person to a risk that his buyer is dishonest or in some material respect not truthful, a duty devolves upon the seller to make such inquiry as a reasonably prudent person would make, and generally to exercise care so that others who will be affected by his actions should not be injured by wrongful conduct,” Harris v. Carter, 582 A.2d 222, 234–35 (Del. Ch. 1990). If the seller fails to fulfill that duty, he may be liable for damages. However, in the case at hand, nothing suggests that Alexandra was dishonest or had any plans to plunder the corporation. Appointing new managers and slashing the workforce are perfectly legitimate (and fairly common) steps for a buyer to take, however unpleasant they may be for the company’s employees.

(A) is incorrect.

The sale of a controlling stake at a premium does not amount to the appropriation of a corporate opportunity. See the answer to choice D.

(B) is incorrect.

The Williams Act does not apply to this case for lack of a tender offer. See the answer to choice D.

(C) is incorrect.

Alexandra’s plans for the corporation have nothing to do with looting. Hence, even assuming that George was aware of Alexandra’s plans, one cannot apply the looting doctrine. See the answer to choice D.

Question 41

Which, if any, of the following statements is correct?

(A)In case of a long-form merger under Delaware law, the minority shareholders must be given the option of receiving shares in the surviving corporation unless they receive, as consideration for their shares, shares in another publicly traded corporation or cash in lieu of fractional shares.

(B)“Scorched earth,” “Pac-Man,” “greenmail,” and “black tower” are all names that are frequently used to refer to certain antitakeover defenses.

(C)A board can be classified into up to five classes of directors.

(D)None of the statements above is correct.

Answer 41

(D) is the correct answer.

See the answers to choices A, B, and C.

(A) is incorrect.

The Delaware General Corporation Law does not prescribe the type of consideration that the shareholders must be given in a long-form merger. Certain types of consideration will cause the shareholders to have appraisal rights where they otherwise would not, DGCL §262(b)(2), but that was not the question.

(B) is incorrect.

Three of the terms, namely “scorched earth,” “greenmail,” and “Pac-Man,” are, in fact, used to refer to antitakeover defenses. In a Pac-Man defense, the target tries to gain control of the acquirer before the acquirer can gain control of the target. In the scorched earth defense, the target company seeks to deter the hostile acquirer by making itself unattractive, for example, by taking on much more debt. Greenmail means that the target pays the hostile acquirer to go away. By contrast, there is no antitakeover defense by the name of “black tower.”

(C) is incorrect.

DGCL §141(d) allows classified boards, but the maximum number of classes under this provision is three, DGCL §141(d).

Question 42

Which, if any, of the following four statements (A, B, C, D) is correct?

(A)A corporate board cannot have more than 14 directors.

(B)A corporation cannot ban the use of poison pills in its certificate of incorporation.

(C)Under Delaware law, directors can never take into account the interests of stakeholders such as workers in making their decision.

(D)None of the three statements above (A, B, C) is correct.

Answer 42

(D) is the correct answer.

See the answers to choices A, B, and C.

(A) is incorrect.

The Delaware General Corporation Law does not impose an upper limit on the number of directors. Rather DGCL §141(b) simply provides that the board of directors “shall consist of 1 or more members.”

(B) is incorrect.

Under DGCL §102(b)(1), the certificate of incorporation may contain “[a]ny provision for the management of the business and for the conduct of the affairs of the corporation, and any provision … limiting and regulating the powers of the corporation, the directors, and the stockholders….” Accordingly, Delaware corporations are free to include in their charter a provision banning poison pills.

(C) is incorrect.

Many states have enacted so-called “constituency statutes” that explicitly authorize the board to take into account the interests of constituencies other than shareholders, either generally or at least in the context of hostile takeovers. Delaware has not enacted such a statute. However, the Delaware Supreme Court has made it clear than when the corporation decides whether or not to take defensive measures against a takeover, it is legitimate for directors to take the interests of non-shareholder constituencies into account, at least as long as the break-up, change in control, or sale of the corporation has not become inevitable. Cf. Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 995 (Del. 1985):

“If a defensive measure is to come within the ambit of the business judgment rule, it must be reasonable in relation to the threat posed. This entails an analysis by the directors of the nature of the takeover bid and its effect on the corporate enterprise. Examples of such concerns may include: inadequacy of the price offered, nature and timing of the offer, questions of illegality, the impact on “constituencies” other than shareholders (i.e., creditors, customers, employees, and perhaps even the community generally), the risk of non-consummation, and the quality of securities being offered in the exchange.”

Question 43

Bride Corp., Groom Corp., and Hostile Corp. are publicly traded Delaware corporations. Bride Corp. owns and operates an online travel agency. Groom Corp. owns and operates a hotel chain. Both corporations plan to merge because they hope to create substantial synergies by combining their two businesses. They sign a merger agreement, which contains a so-called “fiduciary out.” Before the merger agreement was announced, the shares of Bride Corp. traded at $50 per share. Under the merger agreement, each Bride Corp. shareholder will receive one share in the surviving corporation for each old Bride Corp. share, and the shares in the surviving corporation are thought to be worth about $60 per share. Before the merger, Bride Corp. does not have a controlling shareholder. However, after the merger, the surviving corporation will be controlled by Linus, who is currently the controlling shareholder of Groom Corp.

The day after the merger agreement is signed, Hostile Corp. announces that it will launch a hostile tender offer for 90% of Bride Corp.’s shares at a price of $100 per share. Concerned that this bid will derail the merger, the board of Bride Corp. adopts a poison pill that is triggered if any hostile bidder acquires 20% or more of Bride Corp.’s shares. Assuming that litigation ensues of the following statements concerning the adoption of the poison pill is correct?

(A)The decision to adopt the poison pill is protected by the so-called business judgment rule. Unocal and Revlon do not apply.

(B)The court will apply the so-called Unocal standard to the decision to adopt the poison pill. By contrast, Revlon does not apply.

(C)The court will apply the so-called Weinberger standard. Unocal and Revlon do not apply.

(D)The court will look to Revlon in scrutinizing the decision to adopt the poison pill.

Answer 43

(D) is the correct answer.

As a general rule, the board’s decisions are protected by the business judgment rule. However, antitakeover measures are inherently problematic because in preserving the target company’s independence, corporate directors can also protect their own jobs. Therefore, Delaware courts have long made it clear that antitakeover measures are subject to a somewhat stricter standard of review.

At the very least, courts will apply the so-called Unocal standard. Under this standard, a court will not apply the business judgment rule straight away but instead begin its analysis with a preliminary inquiry. More specifically, the court will ask whether the board of the target company had reasonable grounds for believing in a threat to corporate policy or effectiveness and whether the defensive measure was reasonable in relation to the threat posed. Only if the answer to both questions is yes, will the court then proceed to review the measure under the generous business judgment rule. By contrast, if the answer to one of the questions is no, then the directors have violated their fiduciary duties by adopting the relevant defensive measures.

In some cases, however, the Court will apply an even stricter standard than the Unocal standard, namely the so-called “Revlon standard.” Once the Revlon standard applies, “the object no longer is to protect or maintain the corporate enterprise but to sell it to the highest bidder.” (Revlon, Inc. v. Macandrews & Forbes Holdings, Inc., 506 A.2d 173, 184 (Del. 1986)). Note that it is common to speak of the “Revlon standard” or “Revlon duties” even though it might be more accurate to speak of the Revlon objective. Cf. Malpiede v. Townson, 780 A.2d 1075, 1083 (Del. 2001)(“In our view, Revlon neither creates a new type of fiduciary duty in the sale-of-control context nor alters the nature of the fiduciary duties that generally apply. Rather, Revlon emphasizes that the board must perform its fiduciary duties in the service of a specific objective: maximizing the sale price of the enterprise.”)(footnote omitted). In case you are answering an essay question and you are unsure about the terminology your instructor prefers, it might be safest to just use the word “Revlon” without adding any other nouns such as “duty” or “standard.”

So, when exactly is Revlon triggered? Revlon applies, “when a corporation undertakes a transaction which will cause: (a) a change in corporate control, or (b) a break-up of the corporate entity” (Paramount Communications v. QVC Network, 637 A.2d 34, 48 (Del. 1994)).

A change in control, in this sense, occurs where the target corporation originally lacked a controlling shareholder but will have a controlling shareholder after the consummation of the transaction (Paramount Communications v. QVC Network, 637 A.2d 34, 43 (Del. 1994)). The intuition underlying this last scenario is that as long as the target corporation still has a dispersed ownership structure, its shareholders can hope that future acquirers will pay a premium for their shares to gain control. However, once the target has a controlling shareholder, that controlling shareholder will be the only one to obtain a control premium in future control sales. Thus, if a transaction causes the target corporation to end up with a controlling shareholder, this transaction is the target shareholders’ last chance to be paid a control premium.

An interesting question is whether Revlon also applies if the surviving corporation has dispersed ownership, but the target shareholders are “cashed out” as part of the merger. The argument for applying Revlon in this case is that once the target shareholders have been cashed out, they no longer have the chance to be paid a control premium in the future. The Delaware Supreme Court has not weighed in on this question. In Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 242–43 (Del. 2009), the Delaware Supreme Court applied Revlon to a cash-out merger. However, Lyondell involved a merger with a privately held corporation with a controlling shareholder, and so it did not involve a case where the surviving corporation had a dispersed ownership structure. The Delaware Chancery Court, on the other hand, has repeatedly held that a merger triggers Revlon if the target shareholders are cashed out even if the surviving corporation has dispersed ownership (e.g., In re NYMEX Shareholder Litig., CIV.A. 3621-VCN, 2009 WL 3206051, at *5 (Del. Ch. Sept., 30, 2009); In re Lukens Inc. Shareholders Litig., 757 A.2d 720, 732 (Del. Ch. 1999), aff’d sub nom. Walker v. Lukens, Inc., 757 A.2d 1278 (Del. 2000)).

Assuming—in line with the Delaware Chancery Court’s case law—that cash-out mergers automatically trigger Revlon, the next question is whether the fact that part of the consideration that target shareholders receive is cash. In In re Santa Fe P. Corp. Shareholder Litig., 669 A.2d 59, 64 (Del. 1995), the Delaware Supreme Court declined to apply Revlon to a merger in which the target shareholder received consideration consisting of 33% cash and 67% stock. By contrast, faced with a merger that involved consideration consisting of roughly equal parts stock and cash, the Delaware Chancery Court held that Revlon would likely apply. In re Smurfit-Stone Container Corp. Shareholder Litig., CIV.A. 6164-VCP, 2011 WL 2028076, at *11 (Del. Ch. May 20, 2011), as revised (May 24, 2011).

In the case at hand, the shareholders of Bride Corp. will receive shares in the surviving corporation. Therefore, the question of whether cash-out mergers automatically trigger Revlon does not become relevant. However, the facts explicitly state that Bride Corp. did not have a controlling shareholder prior to the merger, whereas the surviving corporation will have a controlling shareholder (Linus). Hence, the merger involves a change in control and triggers Revlon.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 44

Target Corp. is a publicly traded corporation that does not have a controlling shareholder. On January 1, Hostile Corp. announces that it will launch a tender offer in order to acquire a controlling stake in Target Corp. The board of Target Corp. meets on January 2. After careful consideration of the facts, the directors of Target Corp. come to the conclusion that “our days as an independent corporation are numbered” and that “whoever acquires Target Corp. will sell off its various divisions piece by piece.”

However, because the board is unhappy with the terms of Hostile Corp.’s planned tender offer, the board of Target Corp. starts looking around for another potential acquirer and finally decides to pursue a merger with Friendly Corp., another publicly traded corporation. Friendly Corp. is currently controlled by Solon, a wealthy investor who owns 96% of the stock of Friendly Corp. If the merger with Friendly Corp. takes place as planned, Solon will own 57% of the shares of the surviving corporation. Target Corp.’s board adopts a poison pill to ensure Hostile Corp. cannot derail the merger with Friendly Corp. Assuming that litigation ensues of the following statements concerning the adoption of the poison pill is correct?

(A)The decision to adopt the poison pill is protected by the so-called business judgment rule.

(B)The court will apply the so-called Unocal standard to the decision to adopt the poison pill. Revlon does not apply.

(C)The court will look to Revlon in scrutinizing the decision to adopt the poison pill.

(D)The court will apply the so-called Weinberger standard. Unocal and Revlon do not apply.

Answer 44

(C) is the correct answer.

In this scenario, Revlon applies. As the Delaware Supreme Court held in Paramount Communications v. QVC Network, Revlon applies where “a corporation undertakes a transaction which will cause: (a) a change in corporate control; or (a) a break-up of the corporate entity.” For Revlon to apply, it is sufficient that one of the two Revlon triggers (change in control or breakup) applies. In the case at hand, both factors are present. Target Corp.’s board has concluded that any acquirer will sell various divisions piece by piece,” meaning that a break-up is inevitable. Furthermore, the merger also involves a sale in control.

Delaware courts have recognized two main categories of cases in which a merger leads to a change in control. The first category involves cases, where, before the transaction, control of the corporation “is not vested in a single person, entity, or group but vested in the fluid aggregation of unaffiliated stockholders,” whereas, after the transaction, the corporation will have a controlling stockholder. This is the case here since Solon will have a controlling stake in the surviving corporation.

The second category includes cases where the corporation had dispersed ownership before the merger and its shareholders are cashed out as part of the merger. Admittedly, the Delaware Supreme Court has not yet held that cash-out mergers automatically trigger Revlon despite the fact that the surviving corporation has dispersed ownership. However, the Delaware Chancery Court has repeatedly held that such cash-out mergers cause Revlon to be applicable (e.g. In re NYMEX Shareholder Litig., CIV.A. 3621-VCN, 2009 WL 3206051, at *5 (Del. Ch. Sept., 30, 2009); In re Lukens Inc. Shareholders Litig., 757 A.2d 720, 732 (Del. Ch. 1999), aff’d sub nom. Walker v. Lukens, Inc., 757 A.2d 1278 (Del. 2000)). An interesting problem is raised by cases where part of the consideration that the shareholders receive is cash and part is shares in the surviving corporation. In In re Santa Fe P. Corp. Shareholder Litig., 669 A.2d 59, 64 (Del. 1995), the Delaware Supreme Court declined to apply Revlon to a merger in which the target shareholder received consideration consisting of 33% cash and 67% stock. By contrast, faced with a merger that involved consideration consisting of roughly equal parts stock and cash, the Delaware Chancery Court held that Revlon would likely apply. In re Smurfit-Stone Container Corp. Shareholder Litig., CIV.A. 6164-VCP, 2011 WL 2028076, at *11 (Del. Ch. May 20, 2011), as revised (May 24, 2011).

In the case at hand, the shareholders of Target Corp. received cash in the surviving corporation, so the case law on cash-out mergers does not become relevant. However, as explained above, the case nonetheless involved both a breakup of the company and a change in control. Therefore, Revlon applies.

(A) is incorrect.

See the answer to choice C.

(B) is incorrect.

See the answer to choice C.

(D) is incorrect.

See the answer to choice C.

Question 45

Focused Corp. is a privately held corporation with nine shareholders. Each of the nine shareholders owns one share. Focused Corp’s only asset is a paper factory. On January 1, the board of Focused Corp. unanimously and after careful deliberation decides to lease the paper factory to Leasing Corp. for $10,000,000 in cash per year, while also deciding to let the shareholders vote on the matter before finalizing the contract. Under the lease agreement, each party can send the other a written letter of termination, which must be mailed no later than the end of June in any given year. If such a letter is sent, the lease ends at the end of the year in which the letter was mailed. At the annual meeting of Focused Corp, which takes place on May 1, five shares of Focused Corp. are present or represented by proxy. Out of those five shares, three are voted in favor of the lease, the other two shares are voted against. Which of the following answers is correct?

(A)The lease required shareholder approval. However, it was approved by a sufficient number of shares. That is because the lease was approved by a majority of the shares present or represented by proxy, and the quorum requirement was met as well.

(B)The lease required shareholder approval, and it was not approved by a sufficient number of shares.

(C)The lease did not require shareholder approval but only because Focused Corp. is a privately held corporation.

(D)The lease did not require shareholder approval, and the same would be true if Focus Corp. was a publicly traded corporation.

Answer 45

(B) is the correct answer.

Under DGCL §271, “[e]very corporation may at any meeting of its board of directors or governing body sell, lease or exchange all or substantially all of its property and assets …, when and as authorized by a resolution adopted by the holders of a majority of the outstanding stock of the corporation entitled to vote thereon.” Over time, the Delaware Supreme Court’s understanding of what “substantially all” means has changed. Older cases tend to be quite generous in applying this criterion. One decision, Katz v. Bregman, 431 A.2d 1274, 1275 (Del.Ch.1981), even went so far as to require shareholder approval in a case that involved the sale of assets worth less than 60% of the corporation’s total value. However, as Delaware’s case law on fiduciary duties became more developed and allowed Delaware courts to protect shareholders even without recourse to formal approval requirements such as the one contained in §271, Delaware changed its approach. In the landmark decision Hollinger Inc. v. Hollinger Intern., Inc., 858 A.2d 342, 385 (Del. Ch. 2004), the Delaware Chancery Court held that “if the portion of the business not sold constitutes a substantial, viable, ongoing component of the corporation, the sale is not subject to Section 271” (footnote omitted). In the case at hand, the factory is Focused Corp’s only asset, and so even under the modern approach, DGCL §271 applies to the transaction. Furthermore, note that DGCL §271 explicitly mentions the decision to lease assets. In sum, the transaction had to be approved by the shareholders.

Because DGCL §271 requires a “resolution adopted by the holders of a majority of the outstanding stock of the corporation entitled to vote thereon,” at least five of Focused Corp’s nine shareholders had to approve the lease. Since only three shareholders voted in favor, the lease was not approved by the necessary number of shares.

(A) is incorrect.

See the answer to choice B.

(C) is incorrect.

See the answer to choice B.

(D) is incorrect.

See the answer to choice B.

Question 46

Gold Corp. is a public corporation. It is incorporated in Delaware. On January 1, Gold Corp.’s board learns that some of the corporation’s shareholders may be planning to bring lawsuits for alleged fiduciary duty violations against the corporation in state court in various states. The director who stands accused of having violated his fiduciary duties left the corporation several years ago and has no ties to any of the current directors, all of whom joined the board in the previous year. After carefully investigating and discussing the pertinent facts, the directors of Gold Corp. come to the conclusion that multiple parallel lawsuits in different states would not be in the shareholders’ best interest. Therefore, at a board meeting on February 1, Gold Corp’s board unanimously adopts a bylaw according to which Delaware courts constitute the exclusive forum for any lawsuit against Gold Corp. that is based on the violation of fiduciary duties under Delaware corporate law by current or former directors or officers. The bylaw also clarifies that it is subject to federal law and, in particular, does not seek to limit or otherwise regulate the jurisdiction of federal courts.

On March 1, the board of Gold Corp. meets again. After carefully investigating and discussing all the pertinent facts, the board of Gold Corp. unanimously adopts a bylaw under which any shareholder who sues Gold Corp. based on Delaware corporate law must reimburse Gold Corp.’s litigation expenses “unless the shareholder obtains a judgment on the merits that substantially achieves the full remedy sought.”

Which of the following statements is correct?

(A)Both bylaws violate Delaware law.

(B)The exclusive-forum bylaw adopted on February 1 violates Delaware law, whereas the fee-shifting bylaw adopted on March 1 does not violate Delaware law.

(C)The exclusive-forum bylaw adopted on February 1 does not violate Delaware law, whereas the fee-shifting bylaw adopted on March 1 violates Delaware law.

(D)Neither bylaw violates Delaware law.

Answer 46

(C) is the correct answer.

According to DGCL §115, a corporation’s certificate of incorporation or bylaws “may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State.” This provision makes it legal for corporations to include so-called exclusive-forum provisions in their charters or bylaws. DGCL §115 defines internal corporate claims as “claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.”

Of course, in light of the supremacy clause of the U.S. Constitution, Delaware law cannot ignore the limits that the U.S. Constitution’s due process clause imposes on its jurisdictions. Nor can Delaware law determine the jurisdiction of federal courts. Therefore, DGCL §115 explicitly mentions that the exclusive forum requirement has to be in compliance with “applicable jurisdictional requirements.” However, in the case at hand, the exclusive-forum bylaw adopted on February 1 does not purport to govern the jurisdiction of federal courts. Moreover, it only concerns cases over which Delaware courts have jurisdiction because states always enjoy jurisdiction over the internal affairs of domestic corporations.

Gold Corp’s bylaw is designed to avoid any conflict with federal law and thus passes muster under §115 as well as under federal law. It is also worth noting that the mere fact that the exclusive-forum bylaw may apply to potential future lawsuits against the directors that adopted it is insufficient to create a conflict of interest. In sum, the exclusive-forum clause adopted on February 1 is entirely legal.

By contrast, the fee-shifting clause adopted on March 1 violates DGCL §109(b). Under that provision, “[t]he bylaws may not contain any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an internal corporate claim, as defined in § 115 of this title.” When the Delaware legislature enacted this provision in 2015, it thereby overruled the Delaware Chancery Court’s decision ATP Tour v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), which had held fee-shifting provisions to be legal under Delaware law.

Incidentally, a fee-shifting provision in the certificate of incorporation would also violate Delaware law. Under DGCL §102(f), “[t]he certificate of incorporation may not contain any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an internal corporate claim, as defined in § 115 of this title.”

(A) is incorrect.

See the answer to choice C.

(B) is incorrect.

See the answer to choice C.

(D) is incorrect.

See the answer to choice C.

Question 47

Target Corp. and Bidder Corp. are publicly traded corporations. The certificate of incorporation of Target Corp. contains a provision that prohibits Target Corp.’s board from taking defensive measures against takeovers. On January 1, the CEO of Bidder Corp. announces that Bidder Corp. will soon launch a tender offer to acquire 90% of Target Corp.’s shares. He notes that the tender offer price will be around $100 per share. Although Target Corp.’s shares have lately been trading at $40, the directors of Target Corp. believe that the tender offer price suggested by Bidder Corp.’s CEO is much too low. Therefore, after careful investigation and analysis of all pertinent facts, the board of Target Corp. unanimously adopts a so-called flip-in poison pill. Which of the following statements is correct?

(A)The adoption of the poison pill is void, but only because it violates Target Corp.’s charter.

(B)The adoption of the poison pill is void, and this would be true even if Target Corp.’s charter did not contain a ban on antitakeover measures.

(C)The adoption of the poison pill is legal, but only because the charter provision banning antitakeover measures is void.

(D)The adoption of the poison pill is legal despite the fact that the charter provision banning antitakeover measures is legal.

Answer 47

(A) is the correct answer.

Note, first, that it is legal for a corporate charter to include a ban on antitakeover provisions. Under DGCL §102(b)(1), the certificate of incorporation may contain “[a]ny provision for the management of the business and for the conduct of the affairs of the corporation, and any provision … limiting and regulating the powers of the corporation, the directors, and the stockholders….” Accordingly, Delaware corporations are free to include in their charter a provision banning antitakeover measures. Since board resolutions have to comply with valid provisions in the certificate of incorporation, the ban on antitakeover measures renders the adoption of the poison pill void.

By contrast, if it were not for the relevant charter provision, the adoption of the poison pill would be perfectly legal. In particular, the adoption of the poison pill does not violate the board’s fiduciary duties. The leading case is Unocal Corp. v. Mesa Petroleum Co (493 A.2d 946 (Del. 1985)). There, the Delaware Supreme Court made it clear that, in principle, the business judgment rule applies to defensive actions taken by the target board. However, it also pointed out that because of the conflict of interest that directors inevitably face when trying to preserve the independence of the target corporation, the board’s actions had to pass two additional hurdles in order “to come within the ambit of the business judgment rule”: The directors “must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed” and, in addition, the defensive measure “must be reasonable in relation to the threat posed.” (Unocal Corp. v. Mesa Petroleum Co, 493 A.2d 946, 955 (Del. 1985)). Both requirements are applied very generously, though. For example, in order to show reasonable grounds for believing in a threat to corporate policy and effectiveness, it is sufficient for the target corporation’s board to argue that it thought the company was undervalued by the market and that the bid was too low. Furthermore, Delaware courts have made it clear that the adoption of a poison pill generally constitutes a reasonable response to the threat posed by a tender offer. Hence, if it were not for the ban on antitakeover provisions in the charter, the board could have adopted the poison pill without violating its fiduciary duties.

(B) is incorrect.

See the answer to choice A.

(C) is incorrect.

See the answer to choice A.

(D) is incorrect.

See the answer to choice A.

Question 48

Operator Corp. is a Delaware corporation. Mark is Operator Corp.’s sole shareholder, and he is also Operator Corp.’s sole director and CEO. Mark always makes sure that all corporate formalities are scrupulously followed. Operator Corp.’s total assets amount to $10, a fact that Mark is well aware of. Alicia is a wealthy individual.

On January 1, Alicia and Mark—the latter acting in his capacity as Operator Corp.’s CEO—both sign a written agreement entitled “Joint Venture Agreement.” That agreement provides:
“Operator Corp. and Alicia hereby start a joint venture. The purpose of the joint venture is to own and operate a restaurant. Alicia and Operator Corp. will each receive 50% of the profits that the joint venture makes.”

Assume that the applicable state law has no special legal rules for “joint ventures.”

On January 2, Alicia orders two restaurant tables at a total price of $400 from Gregory, a supplier. She makes it clear that she is acting for “the joint venture between Alicia and Operator Corp.,” and promises that Gregory will be paid by January 7. The next day, Gregory delivers the tables. When he demands payment two weeks later, the “joint venture” has no assets left. George wants to know who is liable to him for the $400.

(A)George can hold Alicia liable, George can hold Operator Corp. liable, George can hold the “joint venture” liable, and he (George) can very probably hold Mark liable.

(B)George can hold Alicia liable. He (George) can hold Operator Corp. liable. George can hold the “joint venture” liable. By contrast, George will very probably not be able to hold Mark personally liable.

(C)George can hold Operator Corp. liable, and he (George) can hold the “joint venture” liable. By contrast, neither Alicia nor Mark can be held personally liable by George.

(D)George can very probably hold Mark liable. George can hold Operator Corp. liable. George can hold the “joint venture” liable. By contrast, George cannot hold Alicia personally liable.

Answer 48

(B) is the correct answer.

Let us start with the question of whether George can hold the “joint venture” liable. The joint venture really turns out to be a partnership since it is an association of two or more persons to carry on as co-owners a business for profit, UPA §6, RUPA §202(a). The fact that Operator Corp. and Alicia called the partnership a “joint venture” does not matter. If the conditions of UPA §6, RUPA §202(a) are met, a partnership is formed even if the partners have no intention of farming a partnership, cf. RUPA §202(a).

The question, then, is whether the partnership is liable to George. The debt vis-a-vis George is a contractual obligation. A contractual obligation of the partnership arises under UPA §9, RUPA §301 if a partner acts on behalf of the partnership in concluding a contract and has the power to bind the partnership. The contract was concluded by Operator Corp. acting through its CEO Mark. When concluding the contract, Operator Corp. was explicitly acting on behalf of the joint venture and because the joint venture is a partnership, it was acting on behalf of the partnership. Operator Corp. also had the power to bind the partnership because Operator Corp. acted with authority. Each partner has the authority to incur transactions in the ordinary course of business, and buying tables is a standard transaction for a restaurant. It follows that the “joint venture,” which really is a partnership, is liable to George with respect to the $100.

Alicia and Operator Corp. are also liable to George since under UPA §15, RUPA §306, partners are personally liable for the debts of the partnership.

The question remains whether Mark is personally liable. This depends on whether he can be held liable for Operator Corp.’s debt, and that in turn depends on whether we can pierce the veil. However, there is no sufficient reason for veil piercing. One could argue that the corporation was undercapitalized (its assets were only $10), but undercapitalization alone is generally not thought to be a sufficient reason for piercing the corporate veil (even in tort cases). Undercapitalization plus a failure to follow corporate formalities might be enough to pierce, but as the question explicitly states “Mark always makes sure that all corporate formalities are scrupulously followed.” Hence, it is highly unlikely that the veil will be pierced. It follows that George can hold the joint venture, Alicia, and Operator Corp. liable but very probably not Mark.

(A) is incorrect.

See the answer to choice B.

(C) is incorrect.

See the answer to choice B.

(D) is incorrect.

See the answer to choice B.

Question 49

Peter is the sole director of Gold Corp., a publicly traded Delaware corporation. He also owns 1% of the shares of Gold Corp. Peter, acting in his capacity as Gold Corp.’s sole director, hires his sister Pamela to do consulting work for the corporation. Pamela is paid $200,000 for her services. In fact, however, her work is largely useless, and Peter knew this in advance; he hired her solely because she is his favorite sister.

When the shareholders find out about the contract between Pamela and the corporation, they are furious. John has been a shareholder of the corporation for ten years. He brings a derivative suit against Peter, asserting a breach of the duty of loyalty, and the Delaware Chancery Court ends up deciding that Peter has to pay damages to the corporation in the amount of $200,000. Moreover, at the next annual meeting, Peter is not reelected; instead, the shareholders elect Tom as Gold Corp.’s next director. Tom believes it is bad for the corporation’s reputation if Peter is “left out in the cold.” Also, Tom points out that the corporation’s articles of incorporation contain a provision according to which “all directors shall be fully indemnified against expenses and judgments, regardless of whether they acted in good faith.”

Therefore, Tom decides that the corporation will indemnify Peter both with respect to the judgment ($200,000) and regarding the legal expenses that Peter has incurred ($40,000). Which of the following statements is correct?

(A)Tom’s decision is legal, but only if the corporation’s articles of incorporation contain a so-called exculpation clause.

(B)Tom’s decision is legal, and this is true regardless of whether the corporation’s articles of incorporation contain an exculpation clause.

(C)Tom’s decision is illegal because it amounts to an illegal dividend.

(D)Tom’s decision is illegal, and that is true despite the fact that the payment that Tom wants the corporation to make does not constitute a dividend.

Answer 49

(D) is the correct answer.

Note, first, that the decision to reimburse Peter does not constitute a dividend. A dividend is a distribution made to a shareholder in his capacity as a shareholder. In the case at hand, however, the payment had nothing to do with the fact that Peter was also a shareholder of the corporation. Rather, it solely concerned him in his role as a former corporate director.

However, the decision to indemnify Peter is illegal because the corporation lacked the power to indemnify Peter to the relevant extent. To be sure, it is up to the board to manage—or supervise the management of—the corporation’s business, DGCL §141(a). However, the ability of the corporation to reimburse its directors with respect to lawsuits is governed by DGCL §145. In applying this provision, one has to distinguish very carefully between its various paragraphs.

The most far-reaching rule in DGCL §145 is contained in paragraph (c), which under certain circumstances gives the director a right to be indemnified. If the requirements of DGCL §145(c) are met, then that is all it takes—one does not also have to address the question of whether the corporation has the power to reimburse the director. Waltuch v. Conticommodity Services, Inc., 88 F.3d 87 (2d. Cir. 1996). However, in the case at hand, the requirements of DGCL §145(c) are not met because Peter did not win on the merits or otherwise.

If the preconditions of DGCL §145(c) are not met, then the director has no statutory right to be indemnified. This does not necessarily imply that the director won’t be indemnified. However, in the absence of a statutory right to indemnification under DGCL §145(c), the corporation can indemnify the director only if it has the power to do so under DGCL §145(a) or (b). If the requirements set forth in DGCL §145(a) or (b) are not met, then the corporation lacks the power to indemnify. And accordingly, any provision in the articles of incorporation or in a contract between the director and the corporation calling for such indemnification would be void. It is also worth noting that subsections (a) and (b) of DGCL §145 only grant the board the power to indemnify but, as a legal default, do not impose a duty to indemnify. Accordingly, even if the conditions of subsections (a) and (b) are met unless the corporation has incurred a contractual or other obligation towards the director to exercise its power of indemnification in his favor, the board has to make a choice whether to indemnify or not. In exercising that choice, the board has to observe its fiduciary duties of loyalty and care.

In applying these principles to the case at hand, the first question is whether the corporation even had the power to indemnify Peter under DGCL §145(a) or (b). DGCL §145(a) pertains to third-party litigation, whereas DGCL §145(b) concerns those cases in which the director is sued by a shareholder bringing a derivative suit or by the corporation. Because the case at hand concerns a derivative suit, the corporation’s power to indemnify Peter is governed by DGCL §145(b). Under that provision, indemnification is possible only if the director acted in good faith. Here, Peter acted in bad faith because he consciously put his sister’s interests ahead of those of the corporation. Note, in this context, that under Delaware law, the good-faith requirement of the duty of loyalty is entirely subjective. If Peter had believed that hiring Pamela was in the best interest of the corporation, then he would not have violated the good faith requirement of the duty of loyalty, no matter how idiotic his belief.

Because Peter acted in bad faith, the corporation did not have the power to reimburse him under DGCL §145(b). In any case, under Section 145(b) of the Delaware General Corporation Law, the corporation can only indemnify the director against expenses (including attorney’s fees) but not against judgments or amounts paid in settlement. Moreover, if the director has been held liable in court, then he cannot even be indemnified against his expenses “unless and only to the extent” that the court in which the suit was brought determines on application that the director is fairly and reasonably entitled to indemnity. Therefore, even if Peter had not acted in bad faith but had been found liable on other grounds, Tom’s decision would have been illegal.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 50

Angel Corp. is a publicly traded corporation. Angel Corp. has only one class of stock. Its board is not classified. Cordelia owns 91% of the shares of Angel Corp. One day, Michelle calls Cordelia and tells her that she wants to buy Cordelia’s stake in Angel Corp. at a “fat premium” over the listing price. In fact, the premium alone is to amount to $100,000,000. Michelle truthfully tells Cordelia that once she (Michelle) has bought the shares held by Cordelia, she (Michelle) wants to merge Angel Corp. unto Demon Corp., a corporation that is wholly owned by Michelle. Michelle plans to undertake the merger in such a way as to cash out the minority shareholders of Angel Corp. Cordelia wants to accept Michelle’s offer. Which, if any, of the following four statements is true?

(A)Cordelia will be able to keep the entire premium to herself. However, if Michelle wants to merge Angel Corp. unto Demon Corp. within three years after acquiring Cordelia’s stake, she will need the approval of the board of Angel Corp. that is in place at the time of the transaction with Cordelia. In exchange for giving its approval, the board has to try to get something in return from Michelle, and that something will benefit all the shareholders of Angel Corp., including the minority shareholders.

(B)Cordelia will be able to keep the entire premium to herself. Moreover, Michelle will not need the approval of the board of Angel Corp. that is in place at the time of the transaction with Cordelia in order to carry out the merger. That would be true even if the stake acquired from Cordelia only comprised 89% of Angel Corp.’s shares.

(C)Cordelia will not be able to keep the entire premium to herself because the planned merger with Angel Corp. falls under the so-called looting doctrine.

(D)Cordelia will be able to keep the entire premium to herself. However, this would not be true if the stake comprised less than 90% of Angel Corp.’s stock because, in that case, Michelle would have to launch a tender offer before being able to carry out the planned merger.

Answer 50

(B) is the correct answer.

Under Delaware law, the controller who sells his controlling stake in a private sale of control (a sale of control not involving a tender offer) has no general duty to share the control premium with the minority shareholders. It is also true that this principle is limited by the principle set forth in In re Digex decision (789 A.2d 1176 (Del. Ch. 2000)): Under DGCL §203(a), the acquirer will sometimes need the consent of the target corporation’s board if the acquirer wants to undertake a merger within three years of acquiring his stake in the target corporation (more specifically, within three years of becoming an “interested shareholder”). Under In re Digex, the board of the target should not give that waiver away for free but should rather try to get something in return.

However, in this case, Michelle does not need such a waiver since she acquires a stake of 91% and since, under DGCL §203(a)(2), no waiver is required if upon “consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced.” Given that Michelle does not need a waiver from the incumbent board, there is no reason for her to share the control premium with the minority shareholders or the corporation.

(A) is incorrect.

Under DGCL §203, the acquirer sometimes needs the approval of the incumbent board if the acquirer wants to merge with the controlled corporation within three years. However, under DGCL §203(a)(2) no such approval is required if the acquirer has managed to acquire 85% or more of the controlled corporation. Given that Michelle has bought a 90% stake, she will not need the incumbent board’s approval.

(C) is incorrect.

Under the so-called looting doctrine, a controlling shareholder violates his duty of care if, despite obvious warning signs, he sells his controlling stake to a buyer who then proceeds to loot the corporation to the detriment of the other shareholders. Delaware courts have adopted a relatively narrow understanding of the looting doctrine, insisting that the seller may only incur liability in the case of gross negligence. However, none of this matters in the case at hand since there are absolutely no signs that Michelle plans to plunder the corporation.

(D) is incorrect.

Even if Michelle held only 89% of the controlled corporation, she could undertake a merger—namely a so-called long-form merger under DGCL §251—without first launching a tender offer. Moreover, even if she wanted to undertake a short-form merger under DGCL §253, which requires the parent corporation to hold 90% or more of the shares of the subsidiary, a prior tender offer is not absolutely necessary. For example, if Michelle held 89% of the outstanding shares of Angel Corp., she could try to purchase another 1 percent of the outstanding shares on the open market (through her broker) without launching a tender offer.

Question 51

Which, if any, of the following statements is true?

(A)In a long-form merger, the merger agreement may amend the certificate of incorporation of the surviving corporation, but only to the extent that the merger complies with the general rules on charter amendments.

(B)In a short-form merger, the certificate of incorporation of the surviving corporation can sometimes be amended without complying with the general rules on charter amendments, but in that case, the merger must always be approved by the shareholders of the surviving corporation.

(C)The par value of shares cannot be changed without the unanimous consent of the par value shareholders.

(D)None of the three statements above is true.

Answer 51

(D) is the correct answer.

See the answers to choices A, B, and C.

(A) is incorrect.

It is not true that, in a long-form merger, the merger agreement may amend the certificate of incorporation of the surviving corporation only to the extent that the merger complies with the general rules on charter amendments. Instead, DGCL §251(e) generally allows for the merger agreement to amend the certificate, and Delaware case law clearly states that an amendment under DGCL §251(e) does not have to comply with the general rules on charter amendments (see Warner Communications Inc. v. Chris-Craft Industries Inc., 583 A.2d 962, 969–70 (Del. Ch. 1989)).

(B) is incorrect.

Under DGCL §253(c), the certificate of incorporation of the surviving corporation in a short-form merger can be changed without recourse to the general rules on charter amendments. The relevant changes simply have to be put forth in the merger resolution adopted by the parent corporation.

Obviously, the parent corporation’s power to change the certificate of incorporation of the surviving corporation is potentially quite dangerous for the shareholders of the parent corporation. This is because as a general rule, the shareholders of the parent corporation are not entitled to vote on the short-form merger unless the subsidiary corporation is the surviving corporation, DGCL §253(a). The underlying idea is that if the parent corporation survives the merger, the merger is not sufficiently important for the shareholders of the parent corporation to require their approval.

However, once the parent corporation is given the power to change the certificate of incorporation, this picture changes drastically. After all, what prevents a corporation’s management from abusing the rules on short-form mergers for the purpose of changing their corporation’s certificate of incorporation without the consent of the shareholders? For example, assume that a corporation’s management wants the corporation’s charter to include a so-called staggered board provision that divides the board into three classes, DGCL §141(d), and has the effect that directors can only be removed for cause, DGCL §141(k)(1). To change the corporate charter without the shareholders’ consent, the corporation’s board could (1) incorporate a wholly owned subsidiary, (2) merge that subsidiary unto the parent corporation in a short-form merger with the parent corporation as a surviving corporation, and (3) change the certificate of the parent corporation as part of the short-form merger by including the relevant changes in the resolution of merger. To prevent this type of maneuvering, DGCL §251(e) makes it clear that changes to the certificate of incorporation can only be made via the resolution of merger if the subsidiary corporation is the surviving corporation. That takes the sting out of the problem since a short-form merger in which the subsidiary corporation is the surviving corporation requires the approval of the parent corporation’s shareholders, DGCL §253(a). In general, therefore, the Delaware General Corporation Law ensures that a short-form merger cannot be used to bring about changes to the parent corporation’s certificate of incorporation without the approval of the parent corporation’s shareholders.

There is, however, one exception to this rule. Under DGCL §253(b), the resolution of merger can change the name of the surviving corporation, regardless of whether the surviving corporation is the parent corporation or the subsidiary. Moreover, because a corporation’s name is set forth in the certificate of incorporation, DGCL §102(a)(1), changing the corporation’s name means changing the charter. And in those cases where the parent corporation is the surviving corporation, this change does not require a vote by the parent corporation’s shareholders. In other words, because of DGCL §253(b), there exists a scenario in which the certificate of incorporation can be amended as part of a short-form merger without a shareholder vote.

(C) is incorrect.

It is not true that changing the par value of shares always requires the unanimous consent of the par value shareholders. The general rules on changes to the certificate of incorporation, also called the charter, can be found in DGCL §§241, 242. Assuming that the corporation has already received payment for any of its capital stock, it is DGCL §242 that applies. The extent to which amendments to the certificate of incorporation require shareholder approval is set forth in DGCL §242(b). That provision imposes two types of approval requirements. First, all charter amendments must be approved by a majority of the outstanding shares entitled to vote thereon, DGCL §242(b)(1). Second, if the charter provides for different classes of shares, then there are some cases in which a charter amendment also requires the approval of a particular class of shareholders. For example, if the charter amendment seeks to change the special rights of a particular class of shares, then the relevant amendment can only take effect if a majority of shares within that particular class are voted in favor of the amendment, DGCL §242(b)(2). Crucially, with respect to the case at hand, changing the par value of par value shares is one case where the approval of the relevant class of shareholders is needed: under DGCL §242(b)(2), the “holders of the outstanding shares of a class shall be entitled to vote as a class upon a proposed amendment … if the amendment would … increase or decrease the par value of the shares of such class…” However, this approval does not have to be unanimous. Rather, even if a charter amendment requires the approval of a particular class of shareholders (in addition to the approval by a majority of all outstanding shares), it is sufficient that a majority of the shares of that class are voted in favor of the amendment, DGCL §242(b)(1). Accordingly, the statement that an amendment, which alters the par value of the par value shares requires the unanimous consent of the par value shareholders is wrong.

Question 52

Inertia Corp. is a publicly traded corporation. Its shares are listed on the New York Stock Exchange. Inertia Corp. has three divisions, all of which are organized as wholly owned subsidiary corporations of Inertia Corp. These subsidiary corporations concentrate on three completely different fields, namely waste disposal, space-exploration related technology (“rocket science”), and diapers.

Ann is a shareholder of Inertia Corp. Since January 3, 2019, she has held 100 Inertia Corp. shares. After she bought the shares in 2019 for a total price of $20,000, their value reached its lowest point on March 20, 2020, when their total value was $5,000. Since then, the shares’ total value was always between $5,000 and $6,000. Ann is outraged at this development of the value of her shares.

Finally, Ann decides to get active. That same year, she asks the corporation to include into its proxy materials a shareholder proposal. The proposal asks for a shareholder resolution recommending that the board “break up” the corporation by selling its many different divisions. However, the board wants to exclude the proposal from the corporation’s proxy materials. Which of the following statements, if any, is true?

(A)In its current form, the proposal can be excluded on the ground that it violates state law and on the ground that it interferes with management functions.

49
(B)In its current form, the proposal can be excluded on the ground that it violates state law. It cannot, however, be excluded on the ground that it interferes with management functions.

(C)In its current form, the proposal cannot be excluded on the ground that it violates state law. Nor can it be excluded on the ground that it interferes with management functions.

(D)None of the three statements above (A, B, C) is true.Inertia Corp. is a publicly traded corporation. Its shares are listed on the New York Stock Exchange. Inertia Corp. has three divisions, all of which are organized as wholly owned subsidiary corporations of Inertia Corp. These subsidiary corporations concentrate on three completely different fields, namely waste disposal, space-exploration related technology (“rocket science”), and diapers.

Ann is a shareholder of Inertia Corp. Since January 3, 2019, she has held 100 Inertia Corp. shares. After she bought the shares in 2019 for a total price of $20,000, their value reached its lowest point on March 20, 2020, when their total value was $5,000. Since then, the shares’ total value was always between $5,000 and $6,000. Ann is outraged at this development of the value of her shares.

Finally, Ann decides to get active. That same year, she asks the corporation to include into its proxy materials a shareholder proposal. The proposal asks for a shareholder resolution recommending that the board “break up” the corporation by selling its many different divisions. However, the board wants to exclude the proposal from the corporation’s proxy materials. Which of the following statements, if any, is true?

(A)In its current form, the proposal can be excluded on the ground that it violates state law and on the ground that it interferes with management functions.

(B)In its current form, the proposal can be excluded on the ground that it violates state law. It cannot, however, be excluded on the ground that it interferes with management functions.

(C)In its current form, the proposal cannot be excluded on the ground that it violates state law. Nor can it be excluded on the ground that it interferes with management functions.

(D)None of the three statements above (A, B, C) is true.

Answer 52

(C) is the correct answer.

The so-called shareholder proposal rule allows a shareholder, under certain conditions, to have her own proposal included in the corporation’s proxy materials, provided the shareholder meets certain holding requirements and demonstrates eligibility (17 C.F.R. §240.14a–8 = Rule 14a–8).

The Proxy Rules only apply to securities registered under §12 of the Securities Exchange Act. That includes those securities (including shares) that are listed on a national securities exchange (Securities Exchange Act §12(a)). In the case at hand, the corporation’s shares were traded on the New York Stock Exchange, so the proxy rules are applicable.

In order to be eligible to submit a proposal, the shareholder must have continuously held “at least $2,000 in market value, or 1%, of the company’s securities entitled to be voted on the proposal … for at least one year …,” Rule 14a–8(b)(1). Since Ann has owned at least $5,000 worth of shares, she easily meets this requirement. There are various other procedural requirements to be met, but the facts of the question are unclear in this respect.

Even if a shareholder proposal complies with all procedural requirements, Rule 14a–8(b)(i) lists various substantive grounds on which the corporation can exclude shareholder proposals. In particular, the corporation can exclude shareholder proposals that are improper under state law or shareholder proposals that deal with a matter relating to the company’s ordinary business operations.

In determining whether a shareholder proposal is improper under state law, one provision to be taken into account is DGCL §141(a), which reserves the management of the corporation to the board of directors (as opposed to the shareholders). Shareholder proposals that call for the shareholders to give binding instructions to the board of directors violate DGCL §141(a) and are therefore improper under state law. However, in the case at hand, Ann did not seek a binding shareholder proposal. Rather, she sought a solution “recommending” a particular course of action, a so-called “precatory resolution.” Since shareholders are free to make suggestions to the board without running afoul of DGCL §141(a), this proposal is not improper under state law.

This leaves the question of whether Ann’s shareholder proposal can be excluded on the ground that it deals with a matter relating to the company’s ordinary business operations. That would be the case if it pertained to the day-to-day running of the corporation’s business. However, that is not the case. Rather, the proposal aimed at a fundamental restructuring of the corporation’s business.

Note, by the way, that the two grounds for exclusion have similar but distinct scopes of application. Because of DGCL §141(a), any binding resolution that tells the board how to run the corporation’s business is improper under state law; and that is true regardless of whether it pertains to day-to-day matters or to matters of fundamental importance. However, you can avoid falling afoul of DGCL §141(a) by phrasing your proposal as a mere recommendation to the board. By contrast, shareholder proposals that deal with matters relating to the company’s ordinary business operations can be excluded regardless of whether or not the shareholder aims at a binding instruction or at a mere recommendation. But this exclusionary ground can be avoided by focusing on matters that that are important enough to go beyond the company’s ordinary business operations.

(A) is incorrect.

See the answer to choice C.

(B) is incorrect.

See the answer to choice C.

(D) is incorrect.

See the answer to choice C.

Question 53

Gold Corp. is a publicly traded corporation. Its shares are listed on the New York Stock Exchange. Gold Corp.’s certificate of incorporation provides that Gold Corp.’s board shall have three directors and that it shall be classified into three classes.

Betty has owned 2% of the stock of Gold Corp. since January 2000. In March 2020, the total value of her stock briefly fell to $1,500 (one thousand five hundred dollars), but it has since rebounded to $5,000,000. Betty has been unhappy about Gold Corp’s classified board for some time.

In 2016, Betty first decided to get active. That same year, she asked the corporation to include into its proxy materials a shareholder proposal. The proposal asked for a shareholder resolution recommending “that the board adopt a resolution to amend the corporations’ certificate so as to eliminate the provision providing for a classified board” and “that the board then submit the amendment to the shareholders for approval.” That year, Betty’s proposal was included in the corporation’s proxy materials. However, at the annual shareholder meeting, the proposal received only 1% of the vote.

In Aril 2019, Betty resubmitted her proposal, and it was again included in the corporation’s proxy materials. This time, her proposal gathered 5% of the vote.

In April 2020, Betty submits the same proposal once more. However, this time, the board wants to exclude the proposal from the corporation’s proxy materials.

Which of the following statements, if any, is true?

(A)The proposal can be excluded on the ground that it violates state law.

(B)The proposal can be excluded under the law governing resubmissions.

(C)The proposal can be excluded on the ground that it deals with a personal grievance.

(D)None of the three statements above (A, B, C) is true.

Answer 53

(B) is the correct answer.

The so-called shareholder proposal rule allows a shareholder, under certain conditions, to have her own proposal included in the corporation’s proxy materials, provided the shareholder meets certain holding requirements and demonstrates eligibility (17 C.F.R. §240.14a–8 = Rule 14a–8).

The Proxy Rules only apply to securities registered under §12 of the Securities Exchange Act. That includes those securities (including shares) that are listed on a national securities exchange, see Securities Exchange Act §12(a). In the case at hand, the corporation’s shares were traded on the New York Stock Exchange, so the proxy rules are applicable.

In order to be eligible to submit a proposal, the shareholder must have continuously held “at least $2,000 in market value, or 1%, of the company’s securities entitled to be voted on the proposal … for at least one year …,” Rule 14a–8(b)(1). The total value of Betty’s shares briefly dipped below $2,000 a month before she submitted her proposal. However, because Betty has continuously held two percent of the corporation’s stock since the year 2000, she easily satisfies the ownership requirement of Rule 14a–8(b)(1). There are various other procedural requirements to be met, but the facts are unclear in this respect.

Even if a shareholder proposal complies with all procedural requirements, Rule 14a–8(b)(i) lists various substantive grounds on which the corporation can exclude shareholder proposals.

Rule 14a–8(b)(i)(2) allows the corporation to exclude proposals that “would, if implemented, cause the company to violate any state, federal, or foreign law.” In determining whether a shareholder proposal is improper under state law, one provision to be taken into account is DGCL §141(a), which reserves the management of the corporation to the board of directors. Shareholder proposals that call for the shareholders to give binding instructions to the board of directors violate DGCL §141(a) and are therefore improper under state law. However, in the case at hand, Betty did not seek a binding shareholder proposal. Rather, she sought a shareholder resolution “recommending” a particular course of action, a so-called “precatory resolution.” Since shareholders are free to make suggestions to the board without running afoul of DGCL §141(a), this proposal is not improper under state law. Moreover, there is no indication that Betty’s proposal violates any other state, federal, of foreign law. Hence, the corporation cannot exclude Betty’s proposal under Rule 14a–8(b)(i)(2).

Rule 14a–8(b)(i)(4) permits the corporation to exclude a proposal if the proposal “relates to the redress of a personal claim or grievance against the company or if it is designed to result in a benefit [to the proposing shareholder], which is not shared by the other shareholders at large.” While Betty has long been unhappy with Gold Corp.’s classified board, this does not make her concern a personal grievance. Rather, the existence of a classified board is a corporate governance matter that impacts all shareholders. Therefore, the corporation cannot exclude Betty’s proposal under Rule 14a–8(b)(i)(4).

Rule 14a–8(b)(i)(12) governs so-called resubmissions, that is, shareholder proposals that have been submitted at least twice. The rule creates a relatively complex system of rules. However, the underlying intuition is simple. On the one hand, the law does not want the other shareholders to be bothered again and again with some crank proposal. (Readers who doubt the wisdom of this principle are advised to consider the story of Cato the Elder and the Third Punic War.) On the other hand, it can be entirely legitimate to have the shareholder meeting reconsider a proposal that it considered before. After all, circumstances can change, and shareholders can change their minds.

To strike a balance between these two principles, the law essentially focuses on three factors. First, if quite a bit of time has passed since the shareholders have last been confronted with the relevant question, it should be harder for the company to exclude the proposal. After all, the more time has passed, the likelier it is that circumstances have changed or shareholders have changed their minds. Second, the more frequently the proposal was included in the last five years, the easier it should be for the corporation to exclude it now. The intuition behind this principle is that a proposal, which has already been rejected several times in the last five years, is more likely to be rejected again than a proposal that has only been submitted once before. Third, the more votes the proposal gathered from the more shareholders in the past, the harder it should be for the corporation to exclude it now. This principle is also intuitive: the more support the proposal gathered the last time it was included, the lower the risk that it’s a crank proposal and the higher the likelihood that it will convince a majority of the shareholders this time around.

Rather than asking corporations and courts to balance these various factors, Rule 14a–8(b)(i)(12) creates a formal set of tests. The first question you need to figure out is how often the proposal was submitted to the shareholders within the preceding five calendar years.

Rule 14a–8(b)(i)(12)(i)) applies if the proposal was submitted only once within the preceding five calendar years. A proposal submitted only once previously within the five preceding calendar years cannot be excluded if it received at least 3% of the vote the last time it was submitted. Moreover, a proposal submitted only once previously within the five preceding calendar years cannot be excluded if the shareholder meeting for which it is submitted is held more than three calendar years after the time when the proposal was last included. By contrast, if the proposal received less than 3%, then the corporation can exclude it for “for any meeting held within 3 calendar years of the last time it was included” (Rule 14a–8(b)(i)(12)(i)). In the case at hand, Betty submitted the proposal twice within the preceding five calendar years (2016 & 2019), and so Rule 14a–8(b)(i)(12)(i)) does not apply.

Rule 14a–8(b)(i)(12)(ii)) applies if the proposal was already submitted twice within the preceding five calendar years. A proposal submitted twice within the preceding five calendar years cannot be excluded if, the last time it was submitted, the proposal garnered at least 6% of the vote or if more than three calendar years have passed since it was last included. By contrast, the proposal can be excluded “for any meeting held within 3 calendar years of the last time it was included” if, the last time it was submitted, the proposal received less than 6% of the vote. In the case at hand, Betty had submitted her proposal twice before (2016 & 2019). The last time it was submitted, the proposal received 5% of the vote, which is less than the required 6%. Therefore, the corporation is allowed to exclude her proposal “for any meeting held within 3 calendar years of the last time it was included.” Since the 2020 meeting takes place within three calendar years of the last time the submission was included, the corporation can exclude Betty’s proposal.

Question 54

Gold Corp. and Silver Corp. are publicly traded corporation. Both corporations’ shares are listed on the New York Stock Exchange. Gold Corp. owns 60% of the shares of Silver Corp. On January 3, the CEO of Gold Corp. announces that Gold Corp. is interested in pursuing a merger between Gold Corp. and Silver Corp., the idea being that Gold Corp. will be the surviving corporation and the minority shareholders of Silver Corp. will receive cash for their shares. The CEO of Gold Corp. also announces that Gold Corp. will only go through with the merger if it is approved by Silver Corp.’s minority shareholders.

Soon thereafter, the board of Silver Corp. creates a “special committee” consisting of Silver Corp.’s three independent directors. Silver Corp. has nine directors in total, but whereas three are independent, the others are employees of both Gold Corp. and Silver Corp. According to the board resolution creating the committee, the committee is responsible for negotiating a possible merger between Gold Corp. and Silver Corp. Furthermore, the committee shall have the power “to just say no” if it does not approve of the merger, and shall be entitled to hire its own legal and financial advisors.

Gold Corp. originally offers $50 per share, a price that is ten percent above the stock price at the time just before Gold Corp. announced its intention to explore a merger. The committee, however, believes that this offer does not reflect the true value of Silver Corp’s shares and demands at least $70 per share. Fierce negotiations follow, and Gold Corp.’s CEO, frustrated with the perceived inflexibility of Silver Corp’s special committee, repeatedly points out that, if the negotiations fail, Gold Corp. will simply launch a tender offer for Silver Corp’s remaining shares and thereby take the matter directly to Silver Corp’s minority shareholders. Silver Corp.’s committee eventually relents and indicates that it is willing to accept a cash-out price of $60 per share. Thereafter, a merger agreement providing for a cash-out price of $ 60 per share is formally approved by the boards of both corporations as well by Silver Corp.’s special committee. Subsequently, the merger agreement is also approved by a majority of the shareholders of each corporation, including a majority of the minority shareholders of Silver Corp.

George is a shareholder of Silver Corp. He believes that the cash-out price is too low and wants to bring a lawsuit against Gold Corp. based on a violation of fiduciary duties. Which standard of scrutiny would the Delaware Chancery Court apply, and which party bears the burden of proof regarding the existence of a breach of fiduciary duty?

(A)The Delaware Chancery Court will apply the business judgment rule but only because both Silver Corp’s minority shareholders and Silver Corp’s special committee have approved the merger.

(B)The Delaware Chancery Court will apply the business judgment rule. This would be true even if Silver Corp’s minority shareholders had not approved the merger.

(C)The Delaware Chancery Court will apply the entire fairness standard but only because of Gold Corp’s threat to resort to a tender offer.

(D)The Delaware Chancery Court will apply the entire fairness standard, and this would be true even if Gold Corp. had not threatened to resort to a tender offer.

Answer 54

(D) is the correct answer.

The merger between Gold Corp. and Silver Corp. is a so-called long-form merger (DGCL §251) between a controlling shareholder and a controlled corporation.

Recall that there are two types of control: formal control and de-facto control. A shareholder has formal control if the shareholder holds a majority of the votes. In that case, it is also common to speak of a “majority shareholder.” A shareholder has de facto control if the shareholder exercises actual control over the controlled corporation. To determine if a shareholder exercises actual control, courts will look at all the facts of the case. For example, did the controller successfully tell the controlled corporation’s board how to proceed?

Formal and de-facto control are not mutually exclusive. On the contrary, majority shareholders will generally also have de-facto control. However, if a shareholder owns a majority of the votes, you can conclude that the shareholder is a controlling shareholder without analyzing whether the shareholder also enjoyed de-facto control. In the case at hand, Gold Corp. owned 60% of the shares of Silver Corp., and since nothing in the facts suggests otherwise, we can assume that each share entitles the holder to one vote, which is the legal default rule set forth in DGCL §212(a). Hence, Gold Corp. qualifies as a controlling shareholder.

Furthermore, we know that the merger is a so-called long-form merger under DGCL §251 because a 60% ownership stake is not enough for a short-form merger under DGCL §253. A controlling shareholder can only undertake a short-form merger under DGCL §253 if the controlling shareholder owns “at least 90% of the outstanding shares of each class of stock entitled to vote on a merger.” Furthermore, the facts state that the shareholders of both corporations have approved the merger. In a short-form merger, the subsidiary corporation’s shareholders do not get to vote on the merger (DGCL §253), and even the approval of the parent corporation’s shareholders is only needed if the parent corporation is not the surviving corporation. In addition, the facts mention a merger agreement, and whereas such an agreement is necessary for a long-form merger under DGCL §251(a), a short-form merger under DGCL §253 only requires a so-called resolution of merger, cf. DGCL §253(a). In sum, the size of Gold’s ownership stake (60%), the fact that the shareholders of both corporations were asked to approve the merger, and the existence of a merger agreement all imply that the merger was a long-form merger.

By default, a long-form merger between a controlling corporation and the controlled corporation is subject to the so-called entire fairness standard. However, the question is whether the fact that the merger was approved by Silver Committee’s special committee and by a majority of Silver Corp.’s minority shareholders justifies a different approach. For a long time, Delaware courts took the position that a long-form merger between a controlling corporation and the controlled corporation would always be subject to the entire fairness standard. Kahn v. Lynch Commun. Sys., Inc., 638 A.2d 1110, 1117 (Del. 1994). If the merger was approved, after full disclosure, by either an independent committee or by a majority of the minority shareholders, the burden of proof would shift to the shareholder plaintiff. Id. However, even then, the applicable standard of scrutiny would still be the entire fairness standard. Id.

However, in 2014, following the Chancery Court’s lead, the Delaware Supreme Court embraced a more generous approach. In its landmark decision Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014), the Delaware Supreme Court held that a merger between a controlling corporation and the controlled corporation is subject to business judgment rule protection if “(i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.” Id. at 645. These conditions are now commonly referred to as the MFW conditions. The Delaware Supreme Court clarified that the expression “ab initio” means “before substantive economic negotiation[s].” Olenik v. Lodzinski, 208 A.3d 704, 718 (Del. 2019).

In the case at hand, there are two reasons why the MFW conditions are not satisfied. First, there is no indication that Gold Corp. announced in advance that the merger would be contingent on approval by both the special committee and the controlling shareholder. The mere fact that both the special committee and the minority shareholders ended up approving the merger does not change this fact. Part of the reason why it makes sense to demand an ex-ante announcement on the part of the controlling shareholder to observe the MFW conditions is that the special committee may have a stronger negotiating position if the controller has committed to abstain from the merger in the absence of the merger’s approval by both the special committee and the minority shareholders.

The second reason why the MFW conditions are not satisfied lies in Gold Corp’s repeated threats to resort to a tender offer if the negotiations failed. Delaware Courts have repeatedly held that the controlling shareholder’s threat to abandon the negotiations in favor of another transactional approach undermines the committee’s ability to negotiate effectively. See Kahn v. Lynch Commun. Sys., Inc., 638 A.2d 1110, 1121 (Del. 1994); In re Dell Techs. Inc. Class v. Stockholders Litig., CV 2018-0816-JTL, 2020 WL 3096748 (Del. Ch. June 11, 2020)(threat to invoke conversion right). It follows that the transaction between Gold Corp. and Silver Corp. remains subject to the entire fairness standard. And because Gold Corp. failed to condition the merger on the approval of both an independent committee and Silver Corp.’s minority shareholders, the entire fairness standard would apply even if Gold Corp. had not threatened to resort to a tender offer.

(A) is incorrect.

See the answer to choice D.

(B) is incorrect.

See the answer to choice D.

(C) is incorrect.

See the answer to choice D.

Question 55

Silver Corp. is a publicly traded corporation whose shares are listed on the New York Stock Exchange. Gold Corp. is a privately held corporation. Luke owns 80% of Gold Corp.’s shares. Gold Corp. owns ten percent of Silver Corp’s shares and is Siler Corp’s largest shareholder.

On January 1, Silver Corp’s shares trade at $60 per share. That same day, Gold Corp’s CEO informs the board of Silver Corp. that Gold Corp. would be willing to enter into a merger with Silver Corp, in which Gold Corp. would be the surviving corporation and in which Silver Corp’s shareholders would receive $100 per share in cash. After carefully researching and discussing all pertinent facts and consulting with both lawyers and financial advisers, Silver Corp’s board declines Gold Corp’s offer because Silver Corp’s directors all believe that the true value of Silver Corp exceeds $100 per share.

In April, a major investment of Silver Corp. turns sour, and Silver Corp’s board, after careful discussion of all pertinent facts, decides that selling the corporation becomes inevitable. Silver Corp’s board thereupon contacts various buyers that it believes to be potential acquirers, but only Gold Corp. is interested in purchasing Silver Corp. Given Silver Corp’s deteriorated prospects, Gold Corp. only offers to pay $85 per share. Despite the lack of plausible alternatives, Silver Corp’s board bargains hard with Gold Corp., causing Gold Corp. to increase its bid several times, until Gold Corp. tells Silver Corp. that Gold Corp’s final bid is $110 and that under no circumstances will it pay more money. Still unable to come up with an alternative buyer and having carefully discussed all pertinent facts, Silver Corp’s board agrees to the price and enter into a merger agreement with Gold Corp. The merger agreement, which calls for a long-form merger, is subsequently approved by a majority of the shareholders of both corporations after full disclosure of all material facts.

One of Silver Corp’s old shareholders wants to bring a lawsuit based on fiduciary duty claims against the directors of Silver Corp. Which standard of scrutiny will apply to the transaction?

(A)The Delaware Chancery Court will apply the business judgment rule because the transaction is not subject to Revlon.

(B)The Delaware Chancery Court will apply the entire fairness standard because the transaction is subject to Revlon.

(C)The Delaware Chancery Court will apply the business judgment rule regardless of whether the transaction is subject to Revlon.

(D)The Delaware Chancery Court will apply the entire fairness standard regardless of whether the transaction is subject to Revlon.

Answer 55

(C) is the correct answer.

In its landmark decision Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015), the Delaware Supreme Could held that the business judgment rule must be applied to a merger, which is not subject to the entire fairness standard and which is approved by the minority shareholders after full disclosure, regardless of whether that merger triggers Revlon.

This decision is persuasive for two main reasons. First, even if Revlon applies to a transaction, it essentially changes the board’s objective, which now lies in obtaining the highest price for the target shareholders. Cf. Malpiede v. Townson, 780 A.2d 1075, 1083 (Del. 2001)(“In our view, Revlon neither creates a new type of fiduciary duty in the sale-of-control context nor alters the nature of the fiduciary duties that generally apply. Rather, Revlon emphasizes that the board must perform its fiduciary duties in the service of a specific objective: maximizing the sale price of the enterprise.”)(footnote omitted). In other words, Revlon does not answer the question what the appropriate standard of review is. Second, and more importantly, if a merger, which is not subject to entire fairness, is presented to the minority shareholders for approval, the minority shareholders can protect themselves if they believe the price to be unfair. See Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304, 313 (Del. 2015).

This leads to the question of whether, in the case at hand, the merger was subject to entire fairness review. Under Delaware law, mergers between a controller and the controlled corporation are generally subject to entire fairness review, though the business judgment rule applies instead if “(i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.” Kahn v. M&F Worldwide Corp., 88 A.3d 635, 645 (Del. 2014).

However, in the case at hand, nothing indicates that Gold Corp. was Silver Corp.’s controlling shareholder. Recall that there are two types of control: formal control and de-facto control. A shareholder has formal control if the shareholder holds a majority of the votes. In that case, it is also common to speak of a “majority shareholder.” A shareholder has de facto control if the shareholder exercises actual control over the controlled corporation. To determine if a shareholder exercises actual control, courts will look at all the facts of the case. For example, did the controller successfully tell the controlled corporation’s board how to proceed? In the case at hand, Gold Corp. owned only 10% of the shares of Silver Corp. and therefore did not have formal control. Moreover, the hypothetical does not contain any facts suggesting that Gold Corp. enjoyed de facto control. Admittedly, the facts mention that Gold Corp. was Silver Corp.’s largest shareholder. However, that alone is insufficient to create de-facto control. Otherwise, practically every corporation would have a controlling shareholder.

In sum, the merger was not subject to the entire fairness standard, and it was approved by the minority shareholders after full disclosure. Under Corwin, this means that the business judgment rule applies, regardless of whether the merger triggers Revlon.

(A) is incorrect.

See the answer to choice C.

(B) is incorrect.

See the answer to choice C.

(D) is incorrect.

See the answer to choice C.