Business Organizations

J. Gatewood Fall 2013

Corporate Law
1) Governed mostly by Statutory Law.
2) Owners/Investors provide the capital to run the business.
3) Managers run the day-to-day operations of the companies.
4) Employees daily workers
5) The Company (itself)
When you decide which business entity to partake in:
1) What tax treatment do I want? (ie. how the business is to be taxed by the govt)
Double taxation- corporation has to pay taxes on profits (at corporate taxation level)and any $ that is
distributed is taxed again. (This only applies to C-Corps)
Pass through taxation- not taxed at the corp. level; the owners are taxed regardless of whether or not the $
is distributed. (Taxed based on the % of holdings) (owners in corporations are called shareholders)
2) What type of liability am I going to have?
Limited liability- exposure is limited only to the amount of their investment (but cant go after them
personally) (People who have LL: shareholders, limited partners, members or LLC)
Unlimited liability- subject to all damages (this means personal assets) (this applies to all other
organizations not mentioned above)
3) How do I want to manage my business?
Centralized management- C-corps- managed by shareholders and partners
General management- Sole proprietorship, some S-corps; managed by owners
4) The ability to raise capital.
selling shares, investments, etc.
5) Exit strategy or transferability.
In a C-corp it is easy to do: be a shareholder, just buy shares; in a partnership person may be stuck if other
partner doesnt want to buy out limitations on partnership agrmt., may just have to quit and love investment.

1- Introduction
A. Types of Business Entities: Advantages and Disadvantages
1) Sole Proprietorship
a) No separate legal entity. Usually formed with no legal formalities at all aside from possibly a business
license. (mom -n- pop shops)
b) Do not have to file other forms with the states
c) Owners and Business are seen as one entity
d) 3 Main Characteristics
i) Taxes passed through tax, taxed at the owners level
ii) Liability unlimited liability
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iii) Management Direct management- just the owners, more than one manager (look at authority to
bind each other).
iv) Raising Capital- May be difficult because it depends on individual credit
v) Exit Strategy may be difficult because of the nature of the business
2) Partnership v. Corporation
a) Choosing a form of organization usually comes down to choosing between a partnership and a
corporation.
3) Nature of Partnerships: There are two kinds of partnerships: general partnerships and limited
partnerships.
a) General Partnerships: is an association of two or more people who carry on a business as co-owners for
profit. A general partnership can come into existence by operation of law, with no formal papers signed
or filed. Any partnership is a general one unless the special requirements for limited partnerships are
met.
i) You dont need an actual partnership agreement.
ii) Each general partner has unlimited liability.
iii) Each partner has the ability to bind the partnership and each other.
iv) Deemed a separate and legal entity (has its own name) from its partners
v) Unlimited Taxation or Pass through taxation
vi) Partners have equal rights to management (also have the ability to bind partnerships and/or other
partners to an agrmt)
vii) Ability to gain capital is difficult
viii)Exit strategy is difficult because it likely requires other partners to agree
b) Limited Partnerships: can only be created where (1) there is a written agreement among the partners;
and (2) a formal document is filed with state officials. (otherwise will be considered a General
Partnership)
i) Two types of partners: Limited partners have two types of partners (1) one or more general
partners who are each liable for all the debts of the partnership; and (2) one or more limited
partners, who are not liable for all the debts of the partnership beyond the amount they have
contributed.
ii) Only General Partners can bind the partnership or each other. Limited Partners have no right to
manage; only GPs can manage. (Partnership Codebook limited partners can do a little managing- if
a LP manages he can become a GP).
iii) LPs have limited liability
iv) Pass through taxation to GPs and LPs
c) Limited Liability Partnership (LLP): Most states now allow a third type of partnership, the limited
liability partnership. In an LLP, each partner may participate fully in the business affairs without
thereby becoming liable for the entitys debts. These are technically general partnerships. The difference
is vicarious liability.
i) Operate the same as a GP except that MUST file document with Clerk of Superior Ct. and there is no
vicarious liability (in tort- only those who participated or supervised in the tortfeasors activity are
liable.)
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d) Corporations:
i) Must file document (Articles of Incorporation), until then, considered a GP
ii) Deemed separate and distinct entity from shareholders
iii) the default corp. is a C-corp; must elect w/in 90 days after becoming an S-corp
iv) shareholders are passive investors, thus cant participate in management unless elected to the board
v) limited liability
vi) Ownership interests in a corporation are readily transferable (the shareholder just sells stock). A
partnership interest, by contrast, is not readily transferable (all partners must consent to the
admission of a new partner).
e) Limited Liability Companies (LLC): The fastest growing form of organization since the 1990s has been
the limited liability company, or LLC. The LLC is neither a corporation nor a partnership, though it has
aspects of each.
i) Advantages vs. Standard partnership as to liability a member is only liable for the amount of his
or her capital contribution, even if the member actively participates in the business.
ii) Taxed as Partnership LLCs members can elect to be taxed as an S-corp or as a GP. If they elect
partnership treatment, the entity becomes a pass through entity, and thus avoids double taxation of
dividends.
iii) Operating agreement Owners of an LLC (called members) must agree among themselves how
the business will operate. The members do this by an operating agreement to which they all are a
party.
iv) Piercing the veil just as a corporations veil may sometimes be pierced, some decisions hold that
the veil of the LLC may sometimes be pierced, so as to make the members liable for all the LLCs
debts.
v) can be centralized of general management
vi) must file with Secy of State
4) Advantages and Disadvantages of Particular Enterprises
a) Proprietorships
i) Advantages control, simplicity, less expenses, no double-taxation.
ii) Disadvantages unlimited liability, one person manages, transferability.
b) Partnerships
i) Advantages control, simplicity, less expenses, no double-taxation.
ii) Disadvantages unlimited liability and not readily transferable interests.
c) Limited Partnerships
i) Advantages limited liability, separation of ownership and control, less expenses.
ii) Disadvantages unlimited liability for general partners, transferability.
d) Limited Liability Companies
i) Advantages limited liability, separation of ownership and control, less expensive, no double
taxation.
ii) Disadvantages transferability (restricted by operating agreement).
e) Limited Liability Partnerships
i) Advantages limited liability, low expenses, no double taxation.
ii) Disadvantages transferability.
f) Corporations
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i) Advantages limited liability, separation of management and control, transferability, and perpetual
life.
ii) Disadvantages double taxation, management, and higher expenses.

B. Partnerships and Limited Liability

1) Partnerships when two are more people come together for the purpose of carrying on a business for
profit.
a) No documents needed to create the entity. Partnerships are the default form of business. If you do not
choose a different entity, the court is going to say that you are a partnership.
b) Partners Rights
i) Equal right to manage the partnership.
ii) Both have unlimited liability.
iii) The partnership can be terminated at any time.
c) If you name the partnership, then the partnership is the principle and each partner is an agent. If it is not
named, each partner is both principle and agent.
d) Governed by agreement then Uniform Partnership Act 1914 then Reformed Partnership Act 1997.
e) How to determine when a partnership has been formed.
i) Once you share profits, you are partners unless it was for repayment of a loan or similar.
f) Partners are jointly liable for contractual liability and joint-and-severally liable for torts.
2) LLCs, LLPs, and Limited Partnerships
a) Limited Partnerships
i) There is one general partner and one or more limited partners.
ii) Limited partners are looked at as passive investors. They have no management rights, in fact if
they do participate, they can be held liable as a general partner.
iii) Limited partners enjoy limited liability (the amount of their investment).
(1) In order to form a limited partnership, you must file with the Secretary of State. (Certification of
Formation).
(2) Majority limited partners have a fiduciary duty to protect minority limited partners.
b) Limited Liability Partnerships
i) They are exactly like General Partnerships, except that partners are only liable to the extent that they
are personally responsible for the alleged misconduct.
b) Limited Liability Companies (LLC): The LLC is neither a corporation nor a partnership, though it has
aspects of each.
i) Cannot be formed by mistake, you must file a certification of formation with the Secretary of State.
ii) Can be managed by a group of managers, outside manager, member management.
i) Advantages vs. Standard partnership as to liability a member is only liable for the amount of his
or her capital contribution, even if the member actively participates in the business.
ii) Taxed as Partnership LLCs members can elect whether to have the entity treated as a partnership
or as a corporation. If they elect partnership treatment, the entity becomes a pass through entity,
and thus avoids double taxation of dividends.
iii) Operating agreement Owners of an LLC (called members) must agree among themselves how
the business will operate. The members do this by an operating agreement to which they all are a
party.
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iv) Piercing the veil just as a corporations veil may sometimes be pierced, some decisions hold that
the veil of the LLC may sometimes be pierced, so as to make the members liable for all the LLCs
debts.

C. Agency Principle
1) Agency Relationship- a person who can perform on the behalf of another person, making the other peron
liable and escaping liability themselves.
2) 2 types of Agency Relationships:
i) Defined Agency- an agency relationship exists merely by fact that a certain relationship exists (if a
certain relationship exists, there is automatically an agency relationship) Those relationships are:
partnership/partners
partner/partner
LLC/Member
Member/Member
Corp./ Board of Directors and/or Officers
Employer/Employee
ii) Proven Agency- 1 of the above relationships does not exist, yet still trying to prove that a relationship
exists. In order to show that a relationship exists, must show 3 things:
(1) Consent- both Parties must consent to the agency relationship (even if they dont know thats what
they are agreeing to; no formal agreement is necessary); requires express or implied consent to act as
the agent
(2) Control- agent must be responsible to some basic instruction of a principle; must distinguish between
someone who is under the control of the principle or whether he was under his own control while
performing tasks (See Gay Jenson Farms, Co.) To det. this courts look at:
the amt. of control the principal has over the details
whether the person who was doing the work had a separate business
specialized skills
agent uses own tools/ supplies
normally under the direction of another?
**If yes to these then likely an indep. contractor.
(3) On behalf of/Within the Scope of- agent is acting on the behalf of the principal; did the action being
sued for occur within the scope of performing the task on behalf of the principal?
3) Gay Jenson Farms, Co. v. Cargill, Inc.
Had to determine if an agency relationship existed.
Court held that consent was present, Warren acted on behalf of Cargill by acquiring grain for Cargill.
Further, held that there was control bec:
Cargills approval rights
Cargills right to first refusal
daily inspections/sending a regional director, etc.
4) An Agent can bind a principal to vicarious liability for torts if In a DEFINED agency, the tort occurred on behalf of/within the scope of OR
in a PROVEN agency where all 3 points are proven.
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(1) Butler v. McDonalds Corp.

Court held that 1 and 3 were present and that the franchise (little McD) made the corp (Big
MicD) vicariously liable because of the control that Big McD has on the franchise
5) Duties owed in an Agency Relationship
(1) Principal owes to Agent (Gatewood does not care bout this):
a) Principle owes the duty to compensate to the agent, if it is something that is expected.
(1) Is this something that a reasonable person would expect compensation for?
b) Principle has the duty to reimburse the agent for expenses incurred during course of the agency.
(1) But not for loses incurred solely because of the agents negligence.
c) Principle owes the duty of care, good faith, and loyalty.
d) Principle must indemnify the agent for any losses or liabilities for any authorized good faith
performances of the principal
(2) Agent owes to Principal: Primarily duty or care and duty of loyalty
a) Agent owes a duty of loyalty to the Principle.
(1) May depend on the position of the agent. Higher duty of loyalty for president than for an
employee.
(b) Agent owes the duty of care
(c) Agent owes duty of good faith.
6) In order to bind a principal, the agent must be acting on some authority. There are 3 types of authority:
(1) Actual/Express authority expressed authority to do something (or ratification). (ex. go sign this K. )
(2) Implied authority
a) All the authority necessary to accomplish the express authority (ex. go buy me a house); OR
b) authority that exists by virtue of your (the agents) position (ex. president of a company)
(3) Apparent authority authority that a 3rd party believes the agent has based on an act of the principal;
principal has manifested that the agent has authority (ex. Ex-president of a company makes a deal
with a 3rd party that didnt know that the agent was no longer in a relationship with the company and the
3rd party reasonably relied on the belief that the agent had the authority to make the deal.
If the agent lacked the actual or implied authority to make the deal (only had apparent authority), the
agent is liable to the principal.
7) Principal can still make itself liable (even if agent had no type of authority) by:
(1) Implied Ratification (ex. moving into an office space that the agent had leased) OR
(2) Express Ratification (by writing, K, etc.)
8) Exam tip: Analysis for Agency Law
(1) Is there an agency relationship?
Defined
Proven
(2) If Yes, did the agent bind the principal?
Did the agent have authority?
(3) If Yes, Did the injury occur within the scope on/on behalf of the principal?
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A. Partnership Formation
1) General Partnership- may have to prove that the structure is a partnership for the purposes of agency law
because all of the proven agencies require documentation of partnership
2) Formation of a Partnership - 202 of the Uniform Partnership Act
2 or more people coming together to conduct business for a profit is a partnership
If partnership is formed, unless agreed otherwise, each partner is liable for debts, profits are shared
equally, and managements is equal. ( See Martin v. Peyton and Peed v. Peed)
3) 301 of Uniform Partnership Act- states that apparent authority will bind a partner if the act is done in the
ordinary course of business and/or within the scope of business EXCEPT if the 3rd party knew or had
reason to know that the agent had not authority. ** 3rd Party has no duty to verify actual authority
if agent had actual or implied authority, the agent is not liable to the partner(s) or the principal
an act outside of the scope of business binds the partnership ONLY if the act was authorized by the other
partners
4) Summers v. Dooley
Cts. found that Summers had been specifically told not to do the act; he had no authority (apparent can
only be used by 3rd party) and thus could not bind Dooley to the K.
5) National Biscuit Co., Inc. v. Stroud
unlike Summers (which involved 2 partners) the partnership was liable bc. Natl Biscuit Co., Inc. relied
on apparent authority
Ct. held that reliance on authority was reasonable because all partners have/had equal right @
partnership
in this case the agent is also liable to the other partner(s) because he did not have any actual or implied
authority
In order for a partner to bind another partner whether he suit is between the 2 partners, the partner must
have had actual or implied authority, done in the scope.

Corporate Formation
1) Corporation Financing
a) Debt securities the corporation borrows funds from an outside creditor and promises to repay. A debt
security has no ownership interest in the corporation. (Loans, bonds, diventures).
b) Equity securities is an instrument representing an investment in the corporation whereby its holder
becomes a part owner of the business. Equity securities are shares of the corporation, and the investor
becomes a shareholder. (Common and Preferred Stock).
i) Common Stock
(1) Basic fundamental unit in which the corporations shares are divided.
(2) Every corporation must have at least one class of shares that receives all of its income in the
assets of the corporation after all obligations are satisfied.
(3) Generally, common stockholders have all the voting rights.
(4) Does not have to be authorized by the articles of incorporation.
ii) Preferred Stock
(1) Must be authorized by the articles of incorporation.
(2) It must state what preference what preferred stocks have.
c) Order of repayment if the corporation becomes insolvent:
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i) Debt securities preferred stock common stock

d) Authorized Shares the number of shares that a corporation is authorized to issue in AOI.
e) Outstanding Issued Shares ownership of the corporation.
i) If there is 1 share outstanding out of the 1000 authorized, that person has 100% ownership.
ii) Whatever number is outstanding, represents the ownership of a corporation. (4 outstanding = 25%
ownership per share).
f) Dividends
i) Are at the total discretion of the board of directors. They do not have to be paid.
(1) Think of fiduciary duties owed. Why are they not issuing dividends?
ii) Dividends can only be paid out of net profits.
(1) Are all other obligations current? Debt, liabilities, ect.
iii) Dividends cant deplete the corporation (cant pay its debts).
(1) Illegal Dividend you can issue a dividend when there are insufficient profits to issue one.
iv) Corporate Waste
g) Corporate Waste
i) Outside the ordinary course of business.
ii) Severance packages, donating to charities or campaigns, etc. Big director bonuses.
(1) Is this corporate waste? Yes its within their business judgment, but did they violate any of their
fiduciary duties? Care or Loyalty?
2) To form a corporation, the incorporators file a document with the Secretary of State. This document is
usually called the articles of incorporation or the charter.
a) Articles (MBCA 2.02(a))
i) The name of the corporation. Must include company, incorporated, limited, etc.
ii) The number of shares the corporation is authorized to issue.
iii) The street address of the corporations initial registered office and the name of the corporations
initial registered agent who may receive legal process.
iv) The name and address of each incorporator.
b) Incorporators person who signs the articles of incorporation. Articles of Incorporation are a corporate
birth certificate.
i) Under the MBCA 2.01, only on incorporator is necessary, but there may be more than one.
ii) Can be anyone of legal age & does not have to have a relationship to the corporation after it is
formed.
iii) Incorporators can be either natural persons or artificial entities, such as corporations.
iv) No liability as long as they strictly only attend to administrative duties (file articles, hold first
meeting)
v) If they begin doing more than just ministerial duties, they can be considered a promoter.
c) Promoters person who takes initiative in founding and organizing a corporation. A promoter may be
occasionally be held liable for the debts he contracts on behalf of the to-be-formed corporation.
i) They do not have a fiduciary duty as agents yet because the corporation hasnt been formed.
ii) Once the corporation is formed, then they are agents and owe a fiduciary duty to the corp.
iii) Promoters only owe fiduciary duty to other co-promoters (think partnerships).
iv) Promoter Liability
(1) If the contract entered into by the promoter on behalf of the corporation recites that the
corporation has not yet been formed (both parties know that the corporation has not been formed
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yet, full disclosure), the liability of the promoter depends on what the court finds to be the parties
intent. Three scenarios:
(a) Court will view the contract as an offer to the corporation to be performed, which is
revocable by the corporation or the 3rd party.
(i) It becomes a contract if the corporation accepts it.
(ii) The promoter is not on the hook if the corporation doesnt accept the contract, as long as
the promoter cancels the contract.
(b) Look at it as an irrevocable offer. It is an offer to the corporation that only the corporation
can accept or reject it.
(i) So, if the corporation rejects it, the promoter is liable. But, look at the intent. It may be
the case that the promoter could cancel the contract.
(c) Look at it as a contract between the promoter and the 3rd party. There is an understanding
that if the corporation accepts the contract, that the promoter will be released. But if the
corporation does not accept it, the promoter is liable.
(2) If a promoter enters into a contract in the promoters own name without reference to the
corporation, the promoter is always personally liable.
(a) Even if the corporation assigns that contract to the corporation, promoter is still personally
liable along with the corporation unless that are expressly released by novation.
(3) If a promoter enters into a contract in the name of the corporation but the other party doesnt
know that the corporation has not been formed yet, the promoter will be held liable. MBCA
2.04.
(4) Issues:
(a) What personal liability does the promoter have for pre-incorporation activities?
(b) When does the corporation liability attach to these pre-incorporation activities?
(c) What liability does the corporation have for fraudulent conduct of the promoter?
(5) Ways a corporation can relieve a promoters liability:
(a) Acceptance/ratification of liability.
(i) Corporation was in existence at the time of the contract.
(b) Adoption
(i) Corporation wasnt in existence at the time of the contract.
(ii) Can accept expressly or implied from circumstances (benefits).
(c) Corporation starts benefitting from the contract; they are accepting it by implication.
3) Defective Incorporation Liability
a) De Facto Corporation if a person made a good-faith attempt to incorporate.
i) There was a good-faith effort to form the corporation but for some reason there was some sort of
defect in the statutory requirement.
(1) There has to be a statute under which you incorporated.
(2) The defendants have the burden to prove that they made a good-faith effort.
(3) Defendants have to show that they were using the corporate status and acting under the
assumption that they were a corporation.
(4) Most states have abolished the de facto doctrine and expressly impose personal liability on
anyone who purports to do business as a corporation while knowing that incorporation has not
occurred. MBCA 2.04.
b) De Jure Corporation all the rules were followed and the corporation was formed pursuant to statutory
requirement. Filed and accepted. Signed off by secretary of state
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c) Corporation by Estoppel a creditor who deals with the business as a corporation, and who agrees to
look to the corporations assets rather than the shareholders assets will be estopped from denying the
corporations existence.
i) Other parties dealt with you as if you were a corporation. Other company can assert there was no
corporation because the acts they carries out were as if it existed.
4) Piercing the Corporate Veil
a) Mechanism that creditors rely on to hold the shareholders liable for corporations debts when it becomes
insolvent.
b) It is generally accepted that shareholders will be personally liable for their corporations obligations if at
incorporation they fail to provide adequate capitalization.
i) The reason why the corporation is undercapitalized is because shareholders have too much
corporation assets and they are hiding behind the corporation to avoid payments to creditors.
c) Factors that courts will look at to determine if the veil should be pierced:
i) Shareholders failed to maintain adequate records or failed to have corporation formalities (meetings,
resolutions, etc.)
ii) Alter Ego (Ignoring Corporate Formalities) (Gatewood separates Instrumentality and Alto Ego Test)
(1) If a corporation is the alter ego, agent, or instrumentality of a sole proprietor or of another
corporation, its separate identity may be disregarded.
(a) Did the shareholder use corporation accounts as if it was a personal account?
(b) Did the shareholder exert a lot of control over the corporation?
(c) Did the corporation have its own address? Bank Account? Board of Directors?
(d) Comingling of assets or funds?
iii) Whether the corporation was sufficiently capitalized to begin with.
d) Reverse Piercing when shareholders try to pierce their own corporate veil.
e) Equitable Subordination
i) If shareholders of the corporation are also creditors, then their claims are filled AFTER other
creditors who are non-shareholders are paid.
ii) Shareholder/creditors get paid last along with common shareholders.
iii) Courts look to the same elements as piercing the corporate veil to decide on the subordination issue.
5) Ultra Vires
a) Traditionally, acts beyond the corporations articles of incorporation were held to be ultra vires, and
were unenforceable against the corporation or by it.
b) Modern corporate statutes have generally eliminated the ultra vires doctrine. See MBCA 3.04.
c) Your powers must promote your business giving too much charitable donation may be beyond its
power because its irrelevant to promoting your business.
d) Corporation generally have an implied power to make reasonable charitable contributions if it furthers
the corporations business. MBCA 3.02.

Corporate Management
1) Directors
a) Board of Directors are agents of the corporation as a whole.
b) The board of directors of the corporation has general responsibility for the management of the business
and the affairs of the corporation. MBCA 8.01.
c) Directors have the power to manage the corporation as a group. One director cant bind the corporation.
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d) Once they are elected, they owe a fiduciary duty to the corporation and its shareholders.
e) Generally, board action is taken at a Board of Directors meeting under the MBCA.
f) When a meeting is called, a majority vote of the directors can bind the corporation as long as a quorum
is present.
i) Quorum minimum number of directors that must be present at the meeting before any action can
be taken.
(1) Usually, the quorum is a majority of the total directors in office.
(2) The quorum must be present at the time the vote is taken in order for the vote to constitute the
act of the board. A director may leave and thereby remove the quorum.
g) Action can be taken and voted on without a meeting as long as there is written consent by all quorum.
h) The full board may appoint various committees.
i) They must have an audit committee made up of independent directors (public companies)
according to Sarbanes-Oxley.
2) Officers
a) The MBCA does not require a corporation to have an specific officers, but rather provides that a
corporation shall have the officers described in its bylaws or appointed by the board pursuant to the
bylaws. MBCA 8.40.
b) Officers are agents of the corporation and so the general principles of agency apply to them.
c) Ways that an agent can bind a corporation:
i) Express actual authority this authority can be given in the corporations bylaws, or by a resolution
adopted by the board.
ii) Implied authority is the authority that is inherent in the office. Must be expressed authority first.
Usually, it is authority that is inherent in the particular post occupied by the officer. All those acts
necessary to accomplish my expressed authority.
(1) There is an assumption that certain positions can do certain things.
iii) Apparent authority if the corporation gives observers the appearance that the agent is authorized
to act as he is acting.
(1) Example: only law firm partners can sign service of process receptionist accepts service of
process by mistake corporation doesnt act to correct the wrong receptionist has apparent
authority to receive process of service.

Fiduciary Duties ALWAYS ANALYZE FIRST

1) Duty of Care
a) A director or officer must behave with that level of care, which a reasonable person in similar
circumstances would use. (Negligence Standard)
b) Directors
i) Need to be performing general monitoring (attending meetings, financial affairs, etc.)
ii) Whether they violated their duty of care is measure by the Business Judgment Rule.
iii) If a director made a decision on well-informed information, in good faith as a reasonable person
would do, his decision will not be second guessed and BJR applies.
c) Business Judgment Rule (MBCA 8.3)
i) Judicial Review standard a standard which the court will review the actions of the Board.
ii) The person challenging the directors actions has the burden of proving that the statutory standard
was not met.
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iii) Have to show no conflict of interest, reasonably well-informed, and rational belief decision was in
the business interest
iv) In discharging their duties, directors are entitled to rely on information, opinions, reports, or
statements, if prepared or presented by:
(1) Corporate officers or employees whom the director reasonably believes to be reliable;
(2) Legal counsel, accountants, or other persons of professional competence;
(3) A committee of the board of which the director is not a member.
v) Only protects mistakes in decision making.
vi) Only a defense for violation of Duty of Care, not Loyalty or Faith.
vii) Does not apply to negligence in the process used, decision that had no business purpose, selfdealing, corporate waste, or nonfeasance.
(1) Malfeasance accused of doing something that violates the duty of care.
(2) Nonfeasance director failed to do something when they should have acted.
2) Duty of Good Faith
a) Interwoven into duty of care and duty of loyalty.
b) Am I acting in the best interest of the corporation?
c) Reasonable person standard. (Particular to your skill set).
3) Duty of Loyalty
a) Requires that the director act in the best interest of the corporation.
b) The problems in this area are whether the director has a conflict of interest or if there is any self-dealing.
i) Possible insider trading problems.
c) If a director has a conflicting interest in a transaction in which their corporation is a party, a conflict of
interest arises.
d) Interlocking Directors on the board of two corporations.
e) The director has a conflicting interest if they are (or if one of their relatives are):
i) A party to the transaction;
ii) Has a beneficial financial interest; and
iii) Is a director, general partner, agent, or employee of another entity.
f) When looking at a conflicting interest transaction, the courts look at The Intrinsic Fairness Test.
MBCA 8.61-8.63 as it is applied to INTERESTED DIRECTORS (Business Judgment Rule applies to
the disinterested directors)
i) Two factors:
(1) The process of the decision
(2) Whether it was fair to the corporation
ii) The transaction was approved by a majority of the directors without a conflicting interest after
disclosure; or majority of shareholder votes without a conflicting interest.
iii) The transaction was fair to the corporation.
(1) What was the value of what was received?
(2) What was the need for the property?
(3) Burden on the Defendant.
g) Common Law Approach need both full disclosure and fair approval process.
h) Statutory Approach if you comply with the statute (disinterested directors approval process), then the
burden is shifted to the Plaintiff to show how this transaction was not fair to the corporation.
i) Gatewoods Approach burden is on the Director (defendant) to prove both fair process and fair
substance.
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4) Corporate Opportunity Doctrine

a) The directors fiduciary duties prohibit them from diverting a business opportunity from their
corporation to themselves without first giving their corporation an opportunity to act.
b) Directors are prohibited from taking advantage of business opportunities only if their corporation would
have an interest or expectancy in the business opportunity.
c) Duty of fiduciary to act with undivided loyalty to the corporation.
d) Demand utmost good faith in his relationships with the corporation that he represents.
e) Courts analysis:
i) Is it, in fact, a corporate opportunity? three tests
(1) Interest/expectancy test focuses on the circumstances.
(a) Whether the corporate was needed or unique.
(b) Whether the corporation was expecting that opportunity.
(2) Line of Business Test
(a) Whether the opportunity was similar or in line with what the corporation was already doing.
(b) Pepsi case (Guth v. Loft)
(3) Fairness Test totality of the circumstances
(a) Whether or not its fair to the corporation if a director takes the opportunity.
ii) Secondly, does the corporation want it or have the means to take the opportunity?
(1) Both of the above must be yes in order for a director to have violated his duty of loyalty.

Shareholders
1)
2)
3)
4)
5)
6)

Shareholders are passive in nature and have no authority to run or manage the corporation.
They are owners of the corporation, and therefore than can force certain actions.
Preferred stock get something first
Common stock gets at the same time as everyone else
Payment to creditors, then preferred then common stock
Shareholder powers (MBCA 2.07)
a) To amend/repeal the by-laws.
b) Call a special meeting.
c) Request special meetings (10% of shareholders request it).
d) Vote on actions by unanimous consent in lieu of meeting.
e) Inspect corporate books and records.
f) Voting.
g) Vote by proxy.
h) Elect directors.
i) Create voting trusts/shareholders agreements.
j) Initiate derivative suits.
k) Remove directors or fill board vacancies. (Cannot remove officers)
l) Amend articles of incorporation.
m) Approve mergers, sale of substantial assests, appraisal rights, dissolution of corporation.
n) They can sure directly for violation of any of the above rights.
7) Shareholder Voting
a) Shareholders vote by plurality vote.
13

b) A quorum must attend a meeting before a vote may validly be taken. A majority of the votes entitled to
be cast (majority of all shares outstanding (not shareholders) & entitled to vote) on the matter will
constitute a quorum unless the articles differ.
i) When a shareholders quorum is met, its deemed to be met for the entire meeting even if some leave
during the meeting unlike the directors quorum rules.
c) Straight voting scheme
i) 1 vote per share, minority is at a disadvantage.
ii) 100 shares 100 votes per matter.
d) Cumulative voting scheme
i) Shareholders can cumulate all their votes & vote however they want.
ii) 100 shares 100 votes per matter, or split it up.
iii) Requirements for Cumulative voting:
(1) Articles must provide for this voting, it is not automatic.
(2) Must give notice of intent to vote cumulatively prior to the meeting.
iv)
e) Annual Shareholder Meetings
i) General meetings once a year for the purpose of electing directors or other general matters.
ii) No prior notice is required for what is to be voted on.
f) Special meetings 10/50 rule
i) Notice given to shareholders when some big decision needs to be voted on.
ii) Only the thing that is stated on the notice can be voted on at the meeting.
iii) Anything that is not an annual meeting is a special meeting.
8) MBCA 7.28 unless otherwise stated, directors are elected by a plurality of the votes cast be the
shareholders.
9) Record Owners purchased shares and registered with the corporation.
a) Corporation is only required to deal with record owners.
b) Shares entitled to vote are shares that are registered with the corporation on a record date.
i) If there is no record date, then the date the notice is sent out is the record date.
10) Beneficial Owners purchased shares from record owners but have not registered with the corp.
11) Shareholders inspection rights
a) Shareholders have the right to inspect books/records and obtain a shareholders list.
b) Shareholder has to show that there was a proper purpose for inspecting the records.
12) Proxy Contests
a) Proxy is someone who is authorized by the record shareholder to vote that record holders shares at
any meeting. According to the MBCA proxy is the actual person voting.
i) Creates an agency relationship, therefore all agency rules apply to proxies.
ii) The agent owes a fiduciary duty to the principal (record holder) to vote how the record shareholder
wants to vote.
iii) Under the MBCA, a proxy is only valid for 11 months.
iv) Proxies that are couple with an interest are irrevocable.
v) Proxies that are not coupled with an interest are revocable. (Paying fee for proxy service).
vi) Anyone can solicit proxy appointments from shareholders including management, other
shareholders, or outside 3rd parties.
(1) Usually its management soliciting proxies.
13) Shareholder Agreements/ Trust Agreements
14

a) To ensure that a group of shares will be voted in a particular way in the future, one or more shareholders
may create a voting trust by:
i) Entering into a signed agreement setting for the trusts terms;
ii) Transferring legal ownership of their shares to the trustee.
b) What constitutes a voting trust?
i) There must be a complete separation of voting rights from other rights of ownership of shares.
ii) Trustee has the ability to vote the way they choose. (Can be a 3rd party).
iii) Must be in writing and recorded at the corporation.
iv) Limited in duration. The MBCA limits it to 10 years.
c) Voting Agreements rather than creating a trust, shareholders may enter into a written and signed
agreement that provides for the manner in which they will vote their shares. It is usually not specifically
enforceable. MBCA 7.31.
i) Normally happens in closely held corporations.
ii) There must be some mechanism that employs when shareholders fail to agree on a matter.
d) Proper Purpose Doctrine
i) Shareholder agreements or trust cannot be founded on fraud or illegality.
ii) To exclude minority shareholders improper.
iii) To maintain control proper.
14) Closely Held Corporations
a) A close corporation is one with the following traits:
i) A small number of stockholders;
ii) A lack of any ready market for the corporations stock; and
iii) Substantial participation by the majority stockholders in the management, direction, and operation of
the corporation.
iv) The biggest trait is transferability. If you cant sell shares its closely held.
b) Owners want to keep shares close very few shareholders usually limited to family/friends.
c) S-Corps are usually considered closely held corporations.
d) Generally, shareholders are also officers and directors.
e) More close to a partnership than to a corporation may owe a duty to everyone in the corporation.
f) What defines a closely held corporation?
i) Whether there is an active market for the shares; and
ii) Whether there is an exit strategy.
(1) If you cant sell shares without other shareholder approval.
(2) Buy/sell agreement dissatisfied shareholders can go to other shareholders to purchase their
shares or purchase the other shareholders shares
(3) Right of first refusal bona fide offer, make same offer to other shareholders
(4) Right of first offer - make offer to shareholders, then to others
g) Fiduciary duties owed by controlling shareholders
i) Cant vote for some transaction in which the majority holders benefit and the minority shareholders
dont. You owe them a duty to look out for them.
ii) MBCA at least a 10% shareholder.
iii) De Jure Control you own at least 51%.
iv) De Facto Control you own less than 51% but your percentage allows you to have control.
v) Same fiduciary duty like partners in a partnership.
vi) Good faith and loyalty.
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vii) Equal Opportunity and Access fair dealing (Intrinsic Fairness Test)
(1) Controlling shareholder owes a fiduciary duty to minority shareholders as in partnerships.
(2) Was there self-dealing?
(a) Yes controlling shareholder must prove that it was done in detriment to minority.
(b) No business judgment rule applies.

Federal Securities Law

1) Rule 10b-5
a) Deals with Securities Fraud and Insider Trading.
b) Under rule 10b-5 it is unlawful for any person directly or indirectly, by the use of any means or
instrumentality of interstate commerce or the mails, or of an facility of national securities exchange, to:
i) Employ and device, scheme, or artifice to defraud;
ii) Make any untrue statement of a material fact or omit to state a material fact necessary in order to
make the statements made, in light of the circumstances under which they were made, not
misleading; or
iii) Engage in any act, practice, or course of business that operates or would operate as a fraud or a
deceit upon any person, in connection with the purchase or sale of any security.
c) Elements:
i) Must be material
(1) If there exists substantial likelihood that a reasonable shareholder would consider it important in
deciding to purchase/sell a security.
ii) Have to have standing
(1) In connection with purchase/sale
(2) You must be the person who actually purchased/sold.
(3) You must purchase/sell based on misstated fact or omission.
(4) You must have the right to purchase/sell your shares.
iii) Scienter
(1) The conduct complained of must have been undertaken with an intent to deceive, manipulate, or
defraud. Mere negligence is not enough.
iv) Deception
(1) Misstatement or omission must have the purpose to deceive or manipulate.
v) Loss Causation
(1) Plaintiff must establish some sort of link between the Defendants misstatement/omission and
Plaintiffs loss.
(2) But for Test. But for Ds actions, P would not have suffered a loss and that the misstatement/
omission was a substantial factor in producing Ps loss.
vi) Reliance Causation
(1) Reliance on misstatement
(a) P must prove that he heard/saw the misstatement and that it played a significant role in his
decision regarding the transaction.
(b) Not necessary that P actually relied could have relied on someone who relied.
(c) Reliance must be reasonable.
(2) Reliance on omission
16

(a) Courts generally assume reliance if a reasonable investor would have considered the info
important if the fact have been disclosed.
(3) Reliance on projection
(a) Must be cautionary language and projection must have been made in good faith.
(b) Safe Harbor Rule protects a corporation from liability and the burden is on the Defendant
to prove that the projection was prepared with a reasonable basis and was disclosed in good
faith.
(4) Fraud on the Market Theory
(a) If fraud affects the market price reliance is presumed.
(b) An investor who buys or sells stock at the price set by the market does so in reliance on the
integrity of that stock, which in turn is based on publically available information.
d) Information becomes Public when its disclosed in a manner that ensures availability to the
investing public, it is widely disseminated, and there is a reasonable time to act upon the information.

2)
3) Insider Trading
a) Usually brought by the SEC, but could also be the corporation.
17

b) Concerned with whether there is a duty to disclose or not.

c) Common Law
i) Applied to classic insiders, directors/officers, since they are fiduciaries of the corporation.
ii) Duty does not extend to private dealings with stockholders.
iii) Directors/Officers may take advantage of inside information when trading on the open market.
(1) Exceptions: actual fraud or misrepresentation, face-to-face transactions with material non-public
information.
d) Rule 10b-5 provides exceptions to the common law rule.
i) Applies to any person when you deal with insider trading & there is some fiduciary duty owed if
there is no fiduciary duty owed (overheard conversation) there is no liability
ii) Info must be non-public at the time.
iii) Once info is public, you are free to trade.
iv) Public information reference above.
v) Failure to disclose must violate one of the fiduciary duties.
e) Classic insider pure insider director or officer
f) Constructive Insider
i) One, who because of their relationship with the corporation, is afforded access to non-public
information.
(1) Examples: attorneys, accountants, investment banker, financial consultant, etc.
ii) Employees of constructive insiders as people who owe a duty to the source.
g) Misappropriator
i) Person commits fraud when he misappropriates confidential information and violates his duty to the
source by some sort of agency relationship.
(1) Example, employee of constructive insider.
h) Tippee
i) Arises when an insider passes information to another person who trades on the basis of that inside
information.
ii) For a Tippee to be liable, its necessary to determine whether the insider breached a fiduciary duty.
iii) Whether the insider received a benefit as a result of the disclosure of the tip.
(1) Benefit does not have to be money, could be a closer friendship.
iv) Tipper is liable whether or not the Tippee actually trades on that information.
v) Tippee is liable only if he trades on the basis of that information.
i) 16b Strict Liability Statute short swing profit if they have done it, they are liable
i) Officers/directors/10% shareholders.
ii) Shares are publically traded OR 500 shareholders/$5 million in assets
iii) Sold/purchased shares within 6 months of each other.
iv) Profits go back to the corporation
j) INSIDER TRADING ANALYSIS (see attached chart as well)
i) Is the person an insider or an outsider?
Corporation/SEC Action
I.
Insider
a. Director/Officer/10% Shareholders (16b) (Strict Scrutiny)
i. Purchase/Sale within 6 months of each other (short sales).
ii. Actual use of insider information is irrelevant.
b. Special Relationship (10b-5) because of the relationship, they are allowed access to info.
18

i. Material, Non-public information.

ii. Standing
iii. Scienter (trade on the basis of).
iv. Loss causation (profit gained/loss saved).
c. Public Information disclosed in a manner that ensures availability to the investing public,
widely disseminated & reasonable time to act on it.
II. Outsider
a. Missappropriator (10b-5)
i. Violates a duty owed to the source of the inside information.
1. Need to show that the source owed the original duty to the Corp.
b. Tippee (10b-5) Analysze receipt of information, disclosure of information, use of information
i. Insider or Misappropriator (Tippers) passes information to another person knowing (or
should know) that that other person will trade. That other person is the tippee.
ii. Tippers are liable no matter whether the Tippee trades or not.
1. But the Tippor must gain a direct or indirect personal benefit.
iii. If a Tippee passes the information onto someone else, they become the Tipper and the
new person becomes the Tippee.
iv. Tippees if they trade on the basis of the information, then 10b-5.
v. Did the original tip come from an insider?
1. Did the insider benefit from the disclosure of the information?
2. If the insider benefitted, regardless whether the Tippee traded 10b-5 violation.
3. Tippee is liable only if he trades and satisfies 10b-5 analysis.
a. Defenses:
i. I planned on doing it all along, I did not act on the tip!
ii. So many people knew about this already it was public info!
iii. Traded after it was publically announced!
16b vs. 10b-5 vs. 14(a)
16b (only applies to officers, directors, 10% stockholders) only applies to securities registered and
traded on a national market (stock market)
10b-5 applies to all securities. No time limit.
14(a)(9) involves proxy claims, as to false or material statements in proxy statement same analysis as
10(b)(5)
SEC Rule 14a-9(a) - this rule applies to omission or misleading statements "in connection with any
tender offer or request or invitation for tendres, or any solicitation of security holders in opposition to or
in favor of any such offer, request, or invitation."
ii) Calculating Profits = Highest Sale Price and Lowest Purchase Price

Mergers and Acquisitions

1) Horizontal Merger a merger between two corporations that are in the same line of business.
a) Example: Ford and Mercedes
2) Vertical Merger a merger between two corporations that are connected in some way.
a) Example: A manufacturer and supplier of a good.
3) Conglomerate Combination a merger between two corporations that are in different types of business.
19

4) Acquisitions when there is a purchasing of all the assets of a company.

5) Tender Offer when a corporation makes an offer to shareholders of a different corporation to purchase
their shares in order to gain control of that corporation.
6) Types of Mergers:
a) Statutory/Straight Merger follows the procedure set out in the statute.
i) A (survivor) B (merges into A and disappears)
ii) This is the most basic type of merger in which one company survives while the other company
ceases to have any type of legal identity.
iii) The board of directors of both corporations have to approve the plan to merge.
iv) Bs liabilities become As liabilities (loans, debts, etc.)
v) Shareholders whose shares will be affected must also approve the merger.
vi) Shareholders of B can get:
(1) Stocks of company A;
(2) Cash (freeze-out merger);
(3) A combination of cash and stocks.
b) Consolidation Merger when two companies form a new company
i) A & B (both disappear) form a new corporation C.
ii) C assumes all liabilities of both A and B.
iii) Shareholders whose shares will be affected must approve the plan of merger.
iv) Generally, you do a consolidation when both corporations have significant identities.
(1) Example: IBM and Microsoft = IBM Microsoft
v) A and B shareholders receive stocks of C, or cash, or both.
c) Straight Triangular Merger
i) The acquirer creates a subsidiary for the purpose of the transaction. Usually this subsidiary has no
assets except shares of stock in the parent. The target is then merged into the acquirers subsidiary.
ii) A (parent corporation) creates As (subsidiary), then As B (disappears)
iii) As shareholders dont get to vote on the merger because the merger is between As and B.
iv) Bs liabilities go to As, and not to A. Hence, As assets are protected from Bs liabilities.
v) Again, B shareholders can get shares (of A or As), cash, or both.
d) Reverse Triangular Merger
i) This is the same as the straight triangular merger except that the acquirers subsidiary merges into
the target corporation.
ii) A (parent corp) creates As (subsidiary), then As (disappears) B (survives)
iii) So now, B is essentially a subsidiary of A.
iv) A does not have to assume the liabilities of B, nor does A have to get their shareholders approval.
v) If B had a lot of assets (publishing rights, patents, etc.), B can survive in order to retain those rights.
e) Short Form Merger
i) A parent company owning at least 90% of the outstanding shares of each class of a subsidiary
corporation may merge the subsidiary into itself without the approval of the shareholders.
f) Freezeout Mergers
i) Short form mergers are a type of freezeout merger.
ii) The leading freezeout technique is the cash-out merger.
iii) The insider causes the corporation to merge into a well-funded shell, and the minority holders are
paid cash in exchange for their shares, an amount determined by the insider.
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iv) Example: Bob is a 70% shareholder of A, Inc. He wants to get rid of the minority shareholders. So,
he creates B, Inc., for which he is the sole shareholder and funds it with $1 million. Bob then gets A
and B to agree to a merger plan in which each of As shares will be exchanged in the merger for $1.
The minority stockholders are then eliminated/or cashed out by B, Inc. paying them $300,000. Now
Bob has total control plus $700,000 still to fund B, Inc.
v) See MBCA 11.01.
g) Acquisitions/Purchase of Assets
i) A (survivor) Consideration B (transfers assets to A, either disappears or survives)
ii) Board must approve any asset sale.
iii) Since the shares of A are not affected, only B shareholders have a right to vote.
(1) Usually shareholder approval is required only if all or substantially all of B assets are being
sold. Under the MBCA, approval is required if B would be left without a significant continuing
business activity.
(2) Quantitative 90% of assets amount to least of its assets.
(3) Qualitative 10% of assets amount to most of its assets.
iv) Analysis
(1) Ordinary Course of Business Test
(a) Does not require shareholder approval if its ordinary course of business.
(b) Quantitative Test how much of its assets make up the corporation.
(c) Qualitative Test can the corporation still survive without its assets.
(2) Sale of all or substantially all requires shareholder approval.
(a) If selling less than 25%, it will not qualify as all or substantially all under Fed Stat.
h) Appraisal Rights
i) Give dissatisfied shareholder in certain circumstances a way to be cashed out of his investment at
a price determined by a court to be fair.
(1) Provides a safety valve to remedy dissenters unhappiness without interrupting the acquisition.
(2) Monitor self-dealing by the board of directors.
(3) Address conflict of interest problem on the part of the majority shareholder.
(4) Protects minority shareholders & affords them a way out.
ii) MBCA 13.21
(1) If a shareholder vote is required for a fundamental change, shareholder must:
(a) Give written notice of their intent to dissent prior to the vote;
(b) Refrain from voting in favor of the plan;
(c) Dissenting shareholder must follow procedure;
(d) Make a written demand for payment of the fair value of their shares.
iii) A shareholder of either company involved in a merger has appraisal rights if he had the right to vote
on the merger.
iv) Shareholders of a corporation that is selling substantially all of its assets also get appraisal rights.
v) Delaware gives appraisal rights to mergers, but not asset sales.
vi) Georgia follows MBCA 13.02
(1) If your shares are unaffected after merger, you have no appraisal rights.
vii) Challenging the fairness of a merger analysis:
(1) Do you have appraisal rights?
(2) Was the transaction fair?
(a) Did the Board violate the duty of care?
21

(i) Business Judgment Rule applies to duty of care.

(b) Did the Board violate the duty of loyalty?
(i) Approval process and the substance of the merger fair?
1. Fairness of the Process
a. There must be full disclosure of all conflicts of interest
b. Disinterested directors or shareholders must approve.
2. Fairness of the Substance
a. Was the price fair?
b. Value of what was received versus the price on the open market.
(ii) Conflict of Interest, Self-Dealing?
Back in the day, I was an old school playa. I used to go to bars and try to pick up women. That makes me the
bidder, I see my target across the room, a woman. I walk up to her with my denzel walk and give her my best
playa line. Grant a dying mans last wish, marry me. The marriage is the merger. If she says yes, its a nonhostile takeover. When she says hell no I go to her friends, the shareholders, and ask them for their support.
Ill give you all this stuff if you support me is a tender offer. She says okay, Ill marry you, but, first, theres
some stuff you gotta know. Im pregnant (poison pill) and I need to have more kids and have a huge house
(lock-up). Im also engaged to another person (white-knight).

Tender Offers and Hostile Takeovers

1) Tender offers: A tender offer is an offer to stockholders of a publically held corporation to exchange their
shares for cash or securities at a price higher than the previous market price.
a) Tender offers are primarily governed and regulated by the Williams Act, part of the federal Securities
and Exchange Act of 1934.
i) 13(d)
(1) Requires any person who acquires more than 5% of any stocks in total, including shares that they
already own, to file a Schedule 13 statement with the SEC within 10 days.
(2) Includes: the identity of the purchaser, where the money came from, purpose of the purchase,
plans for the target corporation, and any other arrangements with another person regarding the
target corporations shares.
ii) 14(d)
(1) Requires any person who makes a tender offer for more than 5% of stock file a statement like the
13(d) and must make extensive disclosures.
(2) Bidder must disclose their information and the terms of the offer.
(3) Any shareholder who tenders to a bidder has the right to withdraw his stock from the tender offer
at any time while the offer remains open.
(4) If a bidder offers to buy only a portion of the outstanding shares of the target, and the holders
tender more than the number that the bidder has offered to buy, the bidder must buy in the same
proportion from each shareholder. This is called pro rata.
(5) Bidder must file its offering document with the SEC and hand deliver a copy to the target and
competing bidders.
(6) Target must send disclosures about recommendations, file a Schedule with the SEC and send the
schedule to the bidder.
iii) 14(e)
22

(1) Makes it unlawful to make an untrue statement of a material fact, to omit to state any material
fact, or to engage in any fraudulent, deceptive, or manipulative act in connection with the tender
offer.
(2) Applies for all tender offers, no matter how much the percentage.
(3) Applies to registered and unregistered tender offers.
(4) Tender offers must be open for at least 20 business days.
(5) If the tender offer is not subject to 14(d), the bidder is not required to send its offer to the target.
(6) Target must disclose their position to shareholders regarding the tender offer.
2) Hostile Takeovers
a) Management does not approve of the takeover and recommends to its shareholders not to agree to the
takeover.
b) Proxy fights a bidder solicits target shareholders to vote for their pick of directors.
c) Tender Offer
i) Bidder offers to purchase shares from the shareholders in order to gain 100% control, or at least
51%.
ii) Bidder usually will offer a premium price for the shares, well over the market price.
iii) If Bidder can gain at least 51% control, then he can later use a freezeout merger to get rid of the rest
of the shareholders.
iv) Target employs Defensive Maneuvers:
(1) Super Majority Provision: amend the articles of incorporation to require more than a simply
majority of shareholders to approve any merger or asset sale.
(2) Staggered Board: only a minority of the board stands for election each year, so that a hostile
bidder cannot gain control immediately even if he owns a majority of the shares.
(3) New class of Stock: create a second class of common stock and require that any merger or asset
sale be approved by each class; then, the new class can be placed with persons friendly to the
management.
(4) Poison Pill: bad things happen to the bidder if it obtains control of the target, thereby making the
target less attractive.
(a) Example: shareholders can obtain securities at a substantial discount if there is a tender offer
by the bidder announced.
(5) Call Plans: a call plan gives stockholders the right to buy cheap stock in certain circumstances.
(a) Flip in plan shareholders can get securities in the target corp at a discount before the
merger, which will allow shareholders to redeem those shares at the premium price offered
by the bidder.
(b) Flip over plan shareholders can get securities in the bidder at a discount after the merger.
(6) Put Plans: another poison pill is if the bidder buys some, but not all of the targets shares, the
put gives each target shareholder the right to sell back his remaining shares at a pre-determined
fair price.
(7) White Knight: The target may find itself a white knight who will acquire the target instead of
letting the hostile bidder do so.
(a) Often the white knight is given lockup, which is some special inducement to enter the
bidding process, such as a crown jewel option (option to buy the targets best businesses at
a below-market price).
d) For shareholders who want to tender their shares, they can allege violation of duty of care or loyalty by
the Board for not acting in the best interest of the shareholders.
23

i) Duty of Care business judgment rule

ii) Duty of Loyalty conflict of interest or self-dealing
(1) Fair transaction and substance?
(2) Conflict of interest may arise because the Directors are more worried about their job than about
what is best for the shareholders. Plaintiffs argument.
(3) The Directors would counter saying that they were acting the best interest of the shareholders
and the company, business judgment rule.

Derivative Suits
1) In a derivative suit, an individual shareholder (typically an outsider) brings suit in the name of the
corporation against the individual (usually an insider such as an officer or director) wrongdoer.
2) A direct lawsuit is not derivative.
a) A direct lawsuit is when 1 or more shareholders sue the corporation alleging that the corporation denied
that shareholder some contractual right owed.
3) Most derivative suits brought against insiders are for breach of the fiduciary duties of care or loyalty.
4) Requirements for a derivative suit:
a) Contemporaneous and Continuous Ownership
i) P must have owned his shares at the time of the wrongdoing.
ii) P must remain a shareholder until the suit is resolved or finalized.
iii) A merger or a selling of the shares terminates the lawsuit because of standing.
iv) If a freezeout merger happens just to eliminate the derivative suit, the shareholder can file a direct
lawsuit.
v) Exceptions to this rule:
(1) Continuing Wrong (started before you were a shareholder)
(a) If the wrongdoing is continuous such that it continues into your period of ownership, you can
still bring a derivative suit as long as they are still doing the wrong while you own your
shares.
(2) Double Derivative Actions
(a) If you own shares of a parent corporation and the wrong is done in a subsidiary, you can still
maintain a derivative action on behalf of the subsidiary.
(3) Operation of Law Transfers
(a) You receive shares from someone else (inheritance, divorce, etc.) by operation of law.
(b) Person who owned it at some point had a right for a derivative suit at the time it gets
transferred to you.
(4) Undisclosed Wrongs
(a) If the wrong has been concealed at the time you had your shares, then you would have a
claim once the wrong has been discovered.
b) Facts alleged must be verified in a verified complaint
i) Shareholder must verify or attest in good faith that they have a valid and true complaint.
ii) Must be personal knowledge.
c) Shareholder must post some sort of bond
i) If you lose or withdraw your claim, then you will pay the corporations litigation costs.
d) Demand Rule prior demand (most important requirement)
24

i) Shareholder must make a written demand on the board of directors before commencing the
derivative suit. The demand asks the board to bring suit or take other corrective action.
(1) Only if the board refuses can P then commence the suit.
ii) Demand requirement may be excused if it is futile (conflict of interest, not independent, structural
bias).
5) Indemnification
a) Corporation is required to indemnify Directors and Officers when the director/officer is completely
successful in defending himself against the charges or if the corporation agreed to indemnify in a
contract.
b) Most companies have D&O insurance for indemnifying them for cost of litigation expenses if they win
the lawsuit.
c) The corporation may or may not indemnify the officer or director if they lost the lawsuit this is
usually found within the bylaws or state statues.
i) What was the wrong?
ii) How culpable were they?
iii) Good faith harms.
d) MBCA 8.51

Code Sections
MBCA
2.01 - Incorporators
2.03 - Incorporation
2.04 Liability for Preincorporation Transactions
2.05 Organization of Corporation
2.06 - Bylaws
3.04 Ultra Vires
6.01 Authorized Shares
6.03 Issued and Outstanding Shares
6.20 Subscriptions for Shares Before Incorporation
6.21 Issuance of Shares
6.22 Liability of Shareholders
6.30 Shareholders Preemptive Rights
6.31 Corporations Acquisition of its Own Shares
6.40 Distributions to Shareholders
8.01 Requirement for and Duties of Board of Directors
8.04 Election of Directors by Certain Classes of Shareholders
8.08 Removal of Directors by Shareholders
8.10 Vacancy on Board
8.11 Compensation of Directors
8.20 Meeting
8.21 Action Without Meeting
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8.22 Notice of Meeting

8.24 Quorum and Voting
8.25 Committees
8.40 Officers
8.41 Duties of Officers
8.43 Resignation and Removal of Officers
8.44 Contract Rights of Officers
8.30 Standards of Conduct for Directors
8.31 Standards of Liability for Directors
Subchapter F Directors Conflicting Interest Transactions
8.60 Subchapter Definitions
8.61 Judicial Action
8.62 Directors Action
8.63 Shareholders Action
11.01 Definitions
11.02 Merger
11.04 Action on Plan of Merger
11.05 Merger Between Parent and Subsidiary
11.07 Effect of Merger
12.01 Disposition of Assets not requiring Shareholder Approval
12.02 Shareholder Approval of Certain Dispositions
13.20 Notice of Appraisal Rights
13.21 Notice of Intent to Demand Payment
13.22 Appraisal Notice and Form
13.23 Perfection of Rights; Right to Withdraw
13.24 Payment
13.25 After-Acquired Shares
13.26 Procedure if Shareholder Dissatisfied with Payment or Offer

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