Misc. Stuff

Question 1

Agents under the Duty of Loyalty may not:

Answer 1

• Use resources
• reputation
• or property of principal to benefit self.

Question 2

Is Limited Liability automatic?

Answer 2

No. It is a result of performing legal ritual. Shareholder needs to respect the separate nature of the buinsess entity.

Question 3

What do you argue for Enterprise Liability

Answer 3

π argues that the distinct corporations were being run as one company, or as part of one large corporate enterprise.

Prove this by proving that the subsidiaries are all part of one large corporate conglomerate that interacts with each other.

Question 4

What does π prove for PCV

Answer 4

π must prove that ∆ deserves to be liable for the debts and obligations of the corporation.

The pierce the corporate veil, you must prove that the person is operating the corporation not separate from himself and his interests. Must prove that he is not respecting the separate nature of the business and he and his business are one in the same.

Question 5

Requirement of Demand - What is the Demand Futility Rule in CA, NY and DE?

Answer 5

Demand would be futile if a reasonable doubt exists that the board is capable of making an independent decision to assert the cclaim if demand were made.

Only need 1 for a bad board:

1. Majority of board has a material financial or familial interest
2. Majority is incapable of acting independently, for some other reason, such as domination or control
3. Underlying transaction is not the product of a valid exercise of business judgment.

Question 6

Special Litigation Committee: NY and CA

Answer 6

Deference so long as procedurally good.

1. Indepdendence
2. Sufficiency and reasonableness of investigation
3. Good faith

Question 7

Special Litigation Committee: DE

Answer 7

2 prong test:

1. Procedural (independence, suff./reasonable investigation, good faith)
2. Substantive (if CLAIM and BAD BOARD, then COURT deny motion to dismiss and balance ethical, commercial, promotional, etc. factors)

Question 8

Put simply, what is the Business Judgment Rule?

Answer 8

BJR is a rebuttable presumption that in making a business decision, the directors of a corporation acted on an:

1. Informed Basis
   
   • This depends on whether the directors have informed themselves “prior to making a bsuiness decision, of all material information reasonable available to them.”
2. in Good Faith
3. and in the Honest Belief that the action taken was in the best interests of the company.

Question 9

What is informed basis?

Answer 9

Part of BJR.

A director has a duty to act in good faith** and on the basis of the **best information as they manage the corporation.

Board must only gather and consider all material information that is reasonably available. Court will not require board to have every fact.

Question 10

Directors cannot rely on experts all of the time. A director is not entitled to rely on an expert when:

Answer 10

1. Directors did not rely on expert in fact
2. board’s reliance was not in good faith
3. Did not believe expert was competent
4. Expert was not selected with reasonable care
5. Subject matter of case was so obvious that board is negligent
6. The decision of board was unconscionable/fraud

Question 11

Case: Van Gorkem

Answer 11

No BJR if you don’t show actual judgment. Personally liable.

Question 12

What is the Intrinsic Fairness Standard?

Answer 12

A defendant director has the burden of proving the transaction was:

1. Inherently fair and reasonable
2. From the perspective of the corporation
3. Good faith

(duty of loyalty issue)

Question 13

Personal liability attaches to the breach of:

Answer 13

Fiduciary duty of loyalty claim

Question 14

Corporate Opportunity - ALI Approach

Answer 14

• (a) A director or senior executive may not take advantage of a corporate opportunity unless:
  
  • (1) the director or senior executive first offers the corporate opportunity to the corporation and makes disclosure concerning the conflict of interest and the corporate opportunity;
  • (2) the corporate opportunity is rejected by the corporation; and
  • (3) either:
    
    • (A) Rejection is fair to the corporation
    • (B) The opportunity is rejected in advance, following such disclosure by disinterested directors, or in case of a senior executive who is not a director, by a disinterested superior in a manner that satisfies business judgment rule;
    • (C) Rejection is authorized by disinterested shareholders and not equivalent to a waste of corporate assets.

​

• (b) A corporate opportunity means:
  
  • (1) any opportunity to engage in a business activity that a director or senior executive learns of (a) during performance of his functions as director or senior executive, or under circumstances where reasonable to believe the offeror expects it to be offered to the corporation, or (b) through use of corporate information or property, if reasonable to believe it would be of interest to the corporation or,
  • (2) any opportunity for business of which a senior executive (but not director) becomes aware and knows is closely related to the business in which the corporation is engaged or expects to engage.
• Under the ALI approach, a director or senior executive cannot take advantage of a corporate opportunity unless the individual first offers the opportunity to the corporation with full disclosure and allows the corporation to reject it first an that rejection must be fair

Question 15

Typical Defenses to Corporate opportunity claims:

Answer 15

• Offeror would refuse to deal with the corporation
• Corporation was financially incapable of pursuing the opportunity
• Presenting the opportunity to the corporation would otherwise be futile.

(these defenses typically fail in ALI Jx’s)

Question 16

Corporate Opportunity: Delaware Approach

Answer 16

• In Delaware, a director or officer does not need to disclose a potential corporate opportunity if:
  
  1. The corporation is financially incapable of pursuing the opportunity
  2. The opportunity is not within the corporation’s line of business
  3. The corporation has not interest or reasonable expectancy, and
  4. The director does not engage in self-dealing and there is no conflict of interest
• When an Officer or Director May Take a Corporate Opportunity:
  
  1. The opportunity is offered to them in their individual capacity
  2. The opportunity is nonessential to the corporation
  3. The corporation has no expectation of the opportunity and
  4. They have not wrongfully utilized corporate resources to take advantage of the opportunity

Question 17

What is a refusal to deal defense?

Answer 17

Case: ERCO

Need to give company chance to refuse the deal

Question 18

Corporate Opportunity Safe Harbor

Answer 18

If you formally submit it to board, it would have been a safe harbor.

Question 19

Can you negotiate away duty not to compete?

Answer 19

Yes, but at arms length and upfront.

Question 20

Who do Dominant Shareholders owe a duty to?

Answer 20

Dominant shareholders have a fiducirary relationship to the cporporation and minority shareholders.

Question 21

When does self-dealing with dominant shareholders happen?

Answer 21

Self-dealing occurs only when a transaction is to the detriment of the minority sharheolders.

Question 22

Rule 10b-5 =

Answer 22

Anti-insider Trading Rule

Question 23

Rule 14e-3 =

Answer 23

Tender Offer Rule

Question 24

Rule 16b =

Answer 24

Short-swing profits rule

Question 25

Commonlaw approach to disclosure/insider information:

Answer 25

No fiduciary duty on the open market. Without fraud or bad faith, no claim.

Question 26

What are the 2 parts of 10b-5?

Answer 26

Insider Information and Fraudulant Statements

Question 27

How would Chiarella have been liable under 14e-3?

Answer 27

If any person has taken a substantial step to commence a tender offer, any person with material nonpublic information that came from someone on the inside (acquring or target company, or any officer/director from offering party) must either disclose or abstain from trading.

Question 28

How is a Tipee liable?

Answer 28

When the Tipper has breached a duty and the tippee should know or reasonably know that there was a breach.

Question 29

10b-5(2): Duties of Trust or Confidence in Misappropriation Insider Trading Cases:

Answer 29

• This section provides a non-exclusive definition of circumstances in which a person has a duty of trust or confidence for the purposes of the “misappropriation” theory of insider trading
• (a) Scope of Rule: This rule shall apply to any violation of Section 10(b) of the Act Rule 10b-5 thereunder that is based on the purchase of sale of securities on the basis of, or the communication of, material nonpublic information misappropriated in breach of a duty of trust or confidence
• (b) Enumerated duties of trust or confidence: A duty of trust or confidence for purposes of the theory exists when the following circumstances, among others: (1) whenever a person agrees to maintain such information in confidence, (2) whenever the person communicating the material nonpublic information and the person to whom it was communicated have a history of sharing confidences, or (3) whenever a person receives or obtains material nonpublic information from his or her souse, parent, child or sibling.
  
  • Examples: Employee requirement where there is a confidentiality agreement
  • Any agreement between two individuals

Question 30

What are the elements of FRAUD?

Answer 30

1. False/ misleading statement
2. Material: A fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision.
3. Scienter: knowing intent to deceive (bad motive)
4. Plaintiff relied on statement
   
   • Alternatively: Fraud on market Theory
5. Caused harm

Question 31

Speculative Information Materiality Test:

Answer 31

with speculative, future-oriented information, to determine materiality, there’s another level of analysis: weigh the magnitude of the information with the likelihood of even happening (i.e. the likelihood of merger)

Question 32

Fraud on the market theory (and how corps rebut it):

Answer 32

• creates a rebuttable presumption of reliance. The theory is based on the efficient capital markets hypothesis, which says that all publicly available information is in the price of the stock at any time of day. The difference between the “artificial” price and the “true” price constitutes the extent of damages.
  
  • Corporation can rebut this presumption by:
    
    • Proving that the leak of the merger negated the misstatements and the market reflected the true price
    • Shareholders would have sold stocks anyways and did not rely on the integrity of the market that the market would not have been affected by the misrepresentations anyhow
    • Everyone knows the corporation lies, so no one relied on the lies (all very unlikely and hard to prove)

Question 33

What is the rule for 14e-3?

Answer 33

• If any person has taken a substantial step or steps to commence, or has commenced a tender offer (the offering person) it shall constitute a fraudulent, deceptive or manipulative act for any person who is in possession of material information relating to a tender offer that has been commenced or will be commenced, which he has reason to know is nonpublic and which he has reason to know has been acquired directly or indirectly from
  
  • (i) the offering person,
  • (ii) the issuer of the securities sought, or
  • (iii) any officer, director partner or employee of any other person acting on behalf of the offering person from purchasing or selling securities unless reasonable time prior to such purchase or sale such information and its source are publicly disclosed.
• Rule 14e-3: Narrow because only applies to tender offers but applies to everyone, prohibiting trading on tender offers.

Question 34

What is the Misappropriation Theory?

Answer 34

• based on agency doctrine. Holds that a person who commits fraud in connection with a securities transaction and violated 10b-5 when he misappropriates confidential information for trading purposes, in breach of a duty owed to the source of the information.
• Agent would have to get the principal’s consent to trade on the information/ engage in self-dealing. This prevents the trade from happening at all.

Question 35

What is the Fraud on the Market THeory?

Answer 35

Presumption that Plaintiffs relied on the false misleading statements

Question 36

What is the rule of 16b?

Answer 36

• any beneficial owner (10%), director or officer who profits from any purchase and sale or sale and purchase, transaction within a period of less than 6 months must disgorge such profit to the corporation. Purpose of preventing trading on inside information
• We assume that officers, directors and 10% shareholders are trading on inside information
• Must be beneficial owner both at the time of the purchase and sale

Question 37

Beneficial owner:

Answer 37

is an owner of more than 10% of a corporation’s outstanding shares, and must only disgorge profits if he is a beneficial owner both at the time of purchase and sale.

Question 38

What is the approach for Short-Swing Profits:

Answer 38

• Approach for Short-Swing Profits:
  
  1. Do we have a director or officer
  2. Did these transactions occur within a 6 month time frame
  3. Has there been profit? Buy low, sell high
     ​
• Beneficial Owner:
  
  1. Did they own 10% of the stock at the time of the purchase and sale?
  2. Did these transactions occur within a 6 month time frame
  3. Has there been profit? Buy low, sell high

Question 39

Without proxies, you risk not having a…

Answer 39

Quorum (insufficient shareholders present/represented)

Question 40

Incumbants require a ______ to be reimbursed

Answer 40

bona fide policy dispute

Question 41

Content of Proxy Statements:

Answer 41

1. Board of Directors: must specify nominees for board
2. Director compensation
3. Beneficial ownership of principal shareholders, directors, and management
4. Named executive officer compensation
5. shareholder proposals

Question 42

What does a company want from the SEC re: shareholder proposals

Answer 42

a no action letter

company has to submit 6 copies of their objection to a propsal and reasoning for exclusion.

Question 43

What is the max number of shareholders in a Delaware closed corp?

Answer 43

30

Question 44

What are the 4 Devices of control in closed corps?

Answer 44

1. Cumulative VOting
2. Vote Pooling
3. Voting Trust
4. Class Voting

Question 45

Voting Agreements and Duty of Loyalty

Answer 45

• Elected directors are supposed to choose officers who will act in the best interests of all shareholders, so an agreement to bind each other at the director level traditionally constituted a violation because it “sterilized the board” and takes power out of their hands.
• In close corporations, however, shareholders can bind each other at the director level if such an agreement is unanimous. Furthermore, a shareholder agreement that controls board voting and management decisions should still be enforced so long as the agreement is not fraudulent or harmful to the public, and if there is no objecting minority shareholder.

Question 46

Delaware §351 Management by Stockholders

Answer 46

• The certificate of incorporation of a close corporation may provide that the business of the corporation shall be managed by the stockholders rather than by a board
  
  • (1) No meeting of stockholders need be called to elect directors
  • (2) the stockholders shall be deemed to be directors for purposes of applying provisions of this chapter; and
  • (3) The stockholders of the corporation shall be subject to all liabilities of directors
• Problem: Could subject yourself to liability for piercing the corporate veil. Solution: many states have a statute that allows close corporations not to follow corporate formalities, so you will not be liable for PCV

Question 47

Defining Characteristics of Close Corporation:

Answer 47

Shareholders are also managers in the business (i.e. no separation of ownership and control/ integration of ownership and control)
Tends to have a smaller number of shareholders
No ready market for the shares (corporate stock)

Question 48

Transfer Restrictions:

Answer 48

shareholders in close corporations can impose restrictions on the transfer of shares. Such restrictions may be included in the articles of incorporation or in the bylaws or the shareholders may enter an agreement at the shareholder level. Transfer restrictions act as a way of maintaining or preserving a certain allocation of control.

Question 49

Model Act §6.27: Restriction on Transfer of Shares and Other Securities

Answer 49

• (a) The articles of incorporation, bylaws, an agreement among shareholders, or an agreement between shareholders and the corporation may impose restrictions on the transfer of shares of the corporation.
• (b) A restriction on the transfer of shares is valid and enforceable if the restriction is authorized by this section and its existence is noted conspicuously on the front or back of the certificate. Unless so noted, a restriction is not enforceable against a person without knowledge of the restriction.
• (d) A restriction on the transfer or registration of transfer of shares may:
  
  • (1) Purchase Option: Obligate the shareholder first to offer the corporation or other persons an opportunity to acquire the restricted shares (right of first refusal);
  • (2) obligate the corporation or other persons to acquire the restricted shares
    
    • Mandate corporation to buy out one of the shareholders shares (retirement, death, disability, the shareholder wants to get out)
    • What if the corporation doesn’t have the money to buy the shares?
      
      • Prepare a reserve fund (every month or quarter put money in the fund)—reserved for the mandatory buy-out when that day comes
      • Take out life insurance under the key individuals—that the corporation would pay for and the pay-out goes to the corporation (NEGOTIATE UP-FRONT)
  • (3) require the corporation, the holders of any class or its shares or another person to approve the transfer of the restricted shares, if the requirement is not manifestly unreasonable;
  • (4) prohibit the transfer of the restricted shares to designated persons or if the prohibition is not manifestly unreasonable.

Question 50

Fiduciary Duties of Shareholders in Close Corporations:

Answer 50

shareholders in close corporations owe one another more significant fiduciary duties because the close corporation shareholders are more like partners and owe each other honesty, integrity and loyalty.

Question 51

Freeze-Out in Close Corporation Test:

Answer 51

• Majority’s burden to demonstrate that business decisions were made for a legitimate business purpose. The court affords the majority deference to determine a legitimate business purpose for what it did
• Court also place a burden on minority shareholders to demonstrate there was a less harmful alternative

Question 52

Examples of Freeze-Outs:

Answer 52

1. Removing shareholder from board
2. Removing shareholder from officer position
3. Lowballing on share purchase price
4. Suspending dividends
5. Eliminating Salary

Question 53

Common Law vs. Delaware in Close Corporation:

Answer 53

• Delaware does not go out of its way to protect minority shareholders—they can protect themselves by contracting out: shareholder agreement, articles, adopt cumulative voting or buy-out provision
• Common Law: Minority shareholders are vulnerable and the court helps them

Question 54

Minority Shareholder in Close Corporation Protections:

Answer 54

1. Private ordering
2. Fiduciary duty law
3. Statutory Protection
4. Reasonable expectation Doctrine

Question 55

Minority Shareholder in Close Corporation Protections:

Private ordering:

Answer 55

Contract in articles of incorporation, shareholder agreements—upon death, retirement, don’t get along anymore, here is the formula. We will buy you out at a particular price
o Parties can adopt supermajority voting provision
o Transfer restrictions: mandatory buy-out
o Buy-out provisions

Question 56

Minority Shareholder in Close Corporation Protections: Fiduciary Duty Law

Answer 56

• if the parties fail to negotiate a buy-out agreement, the minority shareholder can go to the court and say that
  
  • Shareholders of close corporation owe each other fiduciary duty
  • Analysis:
    
    • Majority shareholders: can prove that they have a legitimate business purpose
    • Minority shareholder: less harmful alternative

Question 57

Minority Shareholder in Close Corporation Protections: Statutory Protection

Answer 57

Involuntary dissolution statute: statute gives me rights to have liquidation, to protect my interests, alternatively court if you want to order a buy-out that’s okay too

Question 58

Minority Shareholder in Close Corporation Protections: Reasonable Expectation Doctrine

Answer 58

I had a reasonable expectation that I would be treated fairly, or that I would be getting dividends (return on labor or investment)—court may give them relief

Question 59

In lieu of involuntary dissolution, the court may order

Answer 59

an equitable remedy (i.e. it may order the corporation or majority shareholders to buy out the minority shareholder.)

Question 60

Transfer of Control Rules

Answer 60

• There is no legal impediment to transfer control for a premium and agreement to transfer the board with it, so long as you are transferring more than 51%, you can also safely transfer control of the board
• Transferring effective control: there is room to attack. The question is whether the less than 50% is effective control. In public corporation, anything over 20% is generally effective control.
  
  • Burden: on the person challenging the transfer of the board
  • It is illegal to sell management positions by themselves

Question 61

What is a Freeze-out Merger?

Answer 61

a dominant shareholder forces minority shareholders out of their holdings by cashing them out against their will. Courts review such transactions under inherent fairness standard (not the business judgment rule). The inherent fairness standard has two aspects: fair dealing and fair price.

Question 62

Fair Dealings (Weinberger)

Answer 62

• First minority shareholder must allege specific acts of fraud or misrepresentation to convince the court to apply the inherent fairness standard.
• Then the dominant shareholder bears the burden of proving the inherent fairness of their action (fair dealing and fair price)
  
  • Generally relies on shareholders vote to show fairness
• If a majority of shareholders have agreed then it shifts back to minority shareholder to prove that all relevant material information was not disclosed during the vote
• Majority has the burden to prove that all relevant material information was disclosed and inherent fairness of the transaction

Question 63

New York Business Corporation Law § 717(b): Constituencies Statute

Answer 63

• In taking action, including, without limitation, action which may involve or relate to a change or potential change in the control of the corporation, a director shall be entitled to consider without limitation, (1) both the long-term and the short-term interests of the corporation and its shareholders and (2) the effects that the corporation’s actions may have in the short-term or in the long-term upon any of the following:
  
  1. the prospects for potential growth, development, productivity, and profitability of the corporation
  2. the corporation’s current employees
  3. Corporations’ retired employees
  4. Corporation’s customers and creditors
  5. The ability of the corporation to provide, as a going concern, goods, services, employment opportunities and employment benefits and otherwise to contribute to the communities in which it does business
• Nothing in this paragraph shall create any duties owed by any director to any person or entity to consider or afford any particular weight to any of the foregoing
• State legislature authorizing the directors to consider these alternative constituencies
• Delaware and California have never enacted a corporate constituency statute

Question 64

What is the enhanced business judgment rule?

Answer 64

Enhanced business judgment rule standard. It found that directors often defend against a takeover attempt to protect their board positions and jobs, which implicates the duty of loyalty (and self-dealing). Business judgment does not immediately apply

• (1) First, board must show that there are reasonable grounds to believe there is a danger to corporate policy and effectiveness
  
  • To meet this burden, the corporation must show they acted in good faith and after a reasonable investigation
• (2) Second, any defensive device must be reasonable in relation to the threat posed
  
  • In implementing a proportional device, board may consider:
    
    • Inadequacy of the price offered
    • Nature and timing of the offer
    • Questions of illegality and the impact of stockholders and other constituencies (i.e. creditors, customers, employees and the community)
    • Risk of non-consummation
    • Quality of securities being offered in exchange
• If the board satisfies both prongs, it is entitled to the business judgment rule
  
  • Then shareholders can show fraud or bad faith. If they can show fraud or bad faith, then they can hold the directors personally liable. But the business judgment rule is hard to overcome

Question 65

What is a Junk Bond?

Answer 65

is a form of debt security where the value of the piece of paper is significantly less.

Question 66

What is the Unocal Test?

Answer 66

1. First the board must show that there are reasonable grounds to believe there is a danger to corporate policy and effectiveness by showing good faith and reasonable investigation.
2. Second, a defensive device implemented must be reasonable in relation to the threat posed, proportional